Posts Tagged ‘Shareholders’

S&P Downgrade Costs Investors $1 Trillion

Wednesday, September 14th, 2011

Shareholders in American companies can blame Standard & Poor’s  for taking $1 trillion of their money after the rating firm downgraded Treasury securities for the first time in American history to AA+ from AAA.  Now, some of the most experienced investors say the stock market losses make no sense.  While the benchmark index for U.S. equities fell as much as 6.7 percent — or $1.03 trillion — since the downgrade, 10-year Treasuries rallied the most in more than two years and the government financed its quarterly debt obligations at the lowest interest rates ever.  Treasuries have returned two percent since the downgrade. 

“One of the most perverse things I’ve seen in 25 years of doing this is that S&P downgrades the United States government, and investors’ reaction is to run towards the securities that they downgrade, selling businesses without asking at what price,” said Kevin Rendino, a money manager at BlackRock Inc., which oversees $3.65 trillion.  “Equity prices have swung too far.” 

The downgrade, which diverged from Moody’s Investors Service and Fitch Ratings, turned investors’ focus from the 10th consecutive quarter in which S&P 500 companies topped analyst earnings forecasts.  Per-share profits had climbed 18 percent among companies in the index, with 76 percent topping the average analyst projection, according to data compiled by Bloomberg.  Sales grew by 13 percent. 

“It did a lot of damage to confidence, which had been shaky anyway,” Liz Ann Sonders, New York-based chief investment strategist at Charles Schwab, said.  “We had started to get a sense of a little bit of a lift for the economy in the second half of the year, and you just kind of wiped it out because of the lack of confidence in our political leaders. S&P reflected that with the downgrade, but what it ended up causing was a real confidence crisis, more than an economic crisis.” 

Additionally, the Chicago Board Options Exchange volatility index jumped 50 per cent to 48, the highest level in 29 months and the biggest jump in more than four years, the first trading day after the downgrade was announced. 

“We’re starting to see real disorderly selling, far more than what we’ve been seeing,” said Matthew Peron, head of active equities at the Chicago-based Northern Trust, which manages approximately $650 billion in assets.  At Jersey City-based Knight Capital, senior equity trader Joseph Mazzella said that “It’s scary.  It really is.  I hate it when the market closes below its low, as it sets the stocks up for a follow-through tomorrow.” 

President Barack Obama said that he blames political gridlock in Washington, D.C., for the downgrade.  He announced plans to offer recommendations on ways to cut the federal deficit.  Agreeing with the president is William Suplee, a financial manager with Structured Asset Management in Paoli, PA.  “Almost universally my clients are blaming this on ‘The Government’, this lack of confidence – and that is what it is.  This sell-off is uniformly blamed by my clients on the government’s inability to act rationally. 

According to Genna R. Miller, Ph.D., Visiting Instructor, Economics Department, Duke University, “In terms of the CPA profession, there may have been some fear that the negative outlook on U.S. sovereign debt, as well as possible increases in interest rates, may have caused a further downturn in the economy.  Such a downturn in the economy may have been expected to reduce the demand for accounting services, as clients’ incomes declined.  However, as there have only, at this point in time, been minimal impacts on the economy and the accounting profession, this does not appear to be the case.  It may be the case that the income elasticity of demand for accounting services may actually be quite inelastic.  The income elasticity of demand tells us the percentage change in quantity demanded for accounting services divided by the percentage change in clients’ incomes.  Thus, if there is a relatively inelastic income elasticity of demand, then clients who have had accounting services in the past may continue to do so, despite any declines in their own income.  On the flip side, some financial planners may have experienced an increase in business as some clients may have needed to re-assess portfolio values from a tax perspective or may have needed to comply with disclosure policies with respect to increased risk.”

Mark Vitner, Managing Director & Senior Economist, Wells Fargo Securities, LLC, offers this perspective.  “I think most firms understand that the downgrade does not affect many private businesses.  The downgrade and the problems with the federal budget deficit that precipitated it are primarily a problem for state and local governments and government contractors.  Businesses and governments that receive a large part of their funding from the federal government will be most impacted by the downgrade and renewed emphasis on deficit reduction.”

Rick Mattoon of the Fed believes the downgrade will affect mostly the secondary markets like municipals funds.  Listen to his podcast here.

Bernanke Talks Tough on Bank Regulation

Wednesday, May 18th, 2011

The Federal Reserve is identifying risks in the financial system that could someday erupt into a new financial crisis, but regulators must be careful not to unintentionally hamper lending as they set up new oversight, according to Chairman Ben Bernanke.   “We want the system to be as strong and resilient as possible,” and more intense oversight and changes such as requiring banks to hold more capital will help, said Bernanke at the Federal Reserve Bank of Chicago’s Bank Structure & Competition conference.  “If we can’t arrest risks, we want to make sure the financial system is defending itself,” he said.  The Dodd Frank Act establishes governmental structures to analyze risk aimed at preventing another financial failure as harsh as the one that almost brought down the world’s economy in the fall of 2008.

Through the Financial Stability Oversight Council and within the Fed, regulators are still analyzing what can cause “systemic risk,” – identified as risk that can cause widespread financial failure, Bernanke said.  Similar actions are underway in other nations; Bernanke said that regulators worldwide are communicating with each other while implementing their own systems.  If the new structures had been in place previously, Bernanke said, the 2008 financial crisis likely would not have happened. The old system of regulation spread authority across too many entities, was poorly coordinated, and problems “fell through the cracks.”  As the Federal Reserve develops a structure for analyzing risk, Bernanke said the focus must go beyond “fighting the last war.”  Future financial threats may differ from those of the past, which is why the banking industry currently is facing new oversight.  When some banks announced plans to pay shareholders dividends, regulators applied “stress tests” to their finances to determine if the institutions would be sound even if the economy weakened.  According to Bernanke, the government’s new stress testing system has provided accurate assessments of bank finances.

Even so, the regulations – the first new ones in 70 years — will be written to encourage bank compliance.  “No one’s interests are served by the imposition of ineffective or burdensome rules that lead to excessive increases in costs or unnecessary restrictions in the supply of credit,” Bernanke said.  “Regulators must aim to avoid stifling reasonable risk-taking and innovation in financial markets, as these factors play an important role in fostering broader productivity gains, economic growth, and job creation.”

Bernanke and Fed officials are trying to balance the need to diminish the risk of another financial crisis with the aim of stimulating the economy after the worst recession since the Great Depression. The Dodd-Frank Act gives the Fed the job of overseeing the biggest financial companies.  “While a great deal has been accomplished since the act was passed less than a year ago, much work remains to better understand sources of systemic risk, to develop improved monitoring tools, and to evaluate and implement policy instruments to reduce macro-prudential risks,” Bernanke said.

Lawmakers who solidly opposed the financial overhaul legislation, say Dodd-Frank goes too far and might make it more difficult for American banks to compete globally.  Some are working to cut funding for agencies established by the law and limit the scope of new rules.  According to the General Accounting Office, the law will cost nearly $1 billion to implement in 2011.

Additionally, Bernanke cited the sovereign-debt concerns in Europe as an example where the analysis led to the May 2010 decision by the Federal Open Market Committee to authorize “dollar liquidity swap lines with other central banks in a pre-emptive move to avert a further deterioration in liquidity conditions.”

To listen to our podcast on financial reform with Anthony Downs of The Brookings Institution, click here.

The Fed Is Sending Big Banks Back to the Virtual Treadmill

Thursday, December 2nd, 2010

The Fed Is Sending Big Banks Back to the Virtual Treadmill

The Federal Reserve is going to subject the nation’s 19 largest banks to a new round of stress tests to determine if they are healthy enough to pay dividends to their shareholders again.   The Fed plans to use a conservative approach, applied with an even hand, on the nation’s largest and most complex banks.  The tests also will determine if the Fed needs to repurchase shares or take other actions to protect the banks’ cushions against possible future losses.

The planned tests are a lower profile version of the 2009 round, when regulators determined exactly how much capital big banks needed to survive worst-case economic conditions.  According to Fed officials, those stress tests were an excellent lesson about how to regulate banks in a way the mirrors events taking place in the broader economy.  The Fed plans to apply those lessons to the new stress tests.

“We anticipate that some firms with high capital levels that have been retaining solid earnings for several quarters will be interested in increasing or resuming dividends,” said Fed Governor Daniel Tarullo.  “We will expect firms to submit convincing capital plans that demonstrate their ability to absorb losses over the next two years under an adverse economic scenario that we will specify, and still remain amply capitalized.”

Although the big banks appear to be significantly healthier than they were two years ago, several risks remain.  Other than the possibility of another economic downturn, banks face potential court challenges from investors who own mortgage-backed securities.  Some believe the banks should bear responsibility for loans that went south because they used improper procedures on these “put backs”.