Early Morning Look

From a major NY Trading Desk 10/27:

Central banker judgment is the ultimate regulatory loophole

Only time will tell how effective the new rules and regulations currently being implemented by policymakers in the Western world will be. I’ll throw my two cents in and say that simply letting bad businesses fail would greatly curtail the quantity of new legislation needed to create a more just, less fragile financial system. I’m arguing, implicitly, for a less activist Federal Reserve (if we insist on keeping this central banking model, although we’ll see how H.R. 1207 progresses) and a more principles-based monetary policy. Ad-hoc judgment from central bankers too often errs on the side of laxity and accommodation, their protestations to the contrary notwithstanding (and yes, even Paul Volcker was accommodative – look into his handling of the LDC debt crisis). This isn’t a criticism of any one individual, it’s an observation on human behavior.

Regulators, legislators take the spotlight
Stepping down from the soapbox, yesterday’s session was dominated by the noise out of Brussels and Washington D.C. First, as we in the U.S. were arriving to work, the European Commission ruled that Dutch financial services giant ING must sell its insurance business and its U.S. banking arm “as compensation for the state aid it has received during the financial crisis,” according to the Financial Times. The ruling will cut ING’s balance sheet nearly in half. The stock fell -18% in Amsterdam and is lower again this morning (though it appears to be rallying as I write).

Meanwhile, our own regulators, if leaks from unidentified “House aides” are to be believed, are taking a different tack. Rather than force “systemically important,” or “too big to fail (TBTF),” financial conglomerates to break themselves up immediately as the Europeans appear to be doing, our regulators would rather allow them to continue doing business until they are teetering on the edge of collapse – at which point new legislation would allow the government to seize the institution (whether it’s a bank or not), “fire directors, wipe out shareholders and force creditors to take big discounts on their debt.” That’s according to the Financial Times. The FT and the Associated Press cite “one person involved” with the new legislation (currently being crafted by House Financial Services Committee Chair Barney Frank) and “a House aide familiar with the plan,” respectively, in reporting that the banks will not have to contribute regularly to any kind of fund that would be drawn on in the event of a seizure/restructuring. Rather, the seized institution would “contribute an amount after the event.” (FT) That sounds to me like profit clawbacks. Okay, I have to step back up onto my soapbox here: doesn’t the European plan make much, much more sense? Don’t we have bankruptcy courts? I get it – they’re systemically dangerous, so you can’t risk a sloppy bankruptcy…so…break them up, maybe? (source: Bloomberg; Financial Times; Associated Press)

Financials have a tough go of it

Stepping back down from the soapbox, the specter of heavy government involvement – in whatever form it materializes – with the biggest banks sent their shares reeling (C -4.3%; BAC -5.1%; JPM -3.1%; WFC -3%). The major financial institutions with the smallest commercial banking presence – Goldman Sachs and Morgan Stanley – fell just -0.6% each. Citigroup added Bank of America to its list of top stock picks midday, an announcement that evoked equal parts skepticism and amusement amongst the folks I talk to. The announcement had a minimal – if any – impact on B of A’s shares. The regional banks were submarined by a downgrade of SunTrust Banks and negative comments on the regional banking sector (“Recognition is developing that many regional banks, SunTrust included, may not show a profit until 2011”) from Rochdale Securities’ Dick Bove. The insurers also fell sharply (most down between -3% and -6%) in sympathy with ING. (source: Bloomberg)

And, finally, the home buyer tax credit

Adding to the woes of a market already skittish over the prospect of a re-regulated financial system, a note from research firm ISI Group that cast doubt on the notion that the $8,000 tax credit for first time home buyers would be extended (in some form) pulled the market off of its morning highs (+1.1% for the S&P 500) and by noon the market was lower by over -1%. Reassuring comments on the matter from Florida Senator Bill Nelson (he told reporters that the program would likely be extended later this week) failed to reverse the decline. Further gains from Amazon.com (+5.2%) and Microsoft (+2.4%) after their stellar earnings reports last week cushioned the blow for the Nasdaq, but all in all it was a very disappointing – and bizarre – session. (source: Bloomberg)

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