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Monday 22 September 2008
Market Rally Built on a Government Rescue: Can it Last?
Yet with the terms of possible further assistance not spelled out, there is no guarantee that the upturn in the stock market will continue. More in comments... View PDF
Market Rally Built on a Government Rescue: Can it Last?
By Paul J. Lim 21 September 2008
It may take economists years to measure how much this financial crisis has curtailed lending and slowed economic growth.
But if you’re an investor, you probably have a more immediate question in mind: namely, has the sell-off in financial stocks ended?
With shares of banks, brokerages and insurers soaring in response to government rescue plans, it may look like it. But many fundamental problems remain. While the U.S. Treasury secretary, Henry Paulson Jr., has proposed that the government buy $700 billions of dollars’ worth of distressed mortgage securities, many details need to be worked out, notably the price that would be paid for them. As a result, few market watchers are confident that financial stocks have already reached a bottom.
“Maybe we are getting closer to a low point,” said Standard & Poor’s chief investment strategist, Sam Stovall.
It doesn’t take a genius to see that financial stocks have taken an awful beating. In the recent downturn, measured against the last six major market declines, going back to the late ‘60s, financial shares in the Standard & Poor’s 500-stock index registered their worst losses in recent memory. The question is whether the carnage is, for the most part, over.
Since the market peaked last October, financial stocks - now the second-largest segment of the S&P 500, representing 15 percent of the index - had fallen 49 percent at their close on Wednesday. That’s worse than the 36 percent decline for the sector in 1990, in the heart of the savings and loan crisis.
That earlier crisis was worse by some other measures, however. Between 1989 and 1991, for example, 1,187 banks and S&L’s went under, representing more than $454 billion in assets, according to the Federal Deposit Insurance Corp.
So far this year, there have been 11 failures of these institutions, representing total assets of around $40 billion. Of course, Washington Mutual is exploring a sale and there are, no doubt, more failures coming. That isn’t an encouraging picture.
T. Timothy Ryan Jr., president and chief executive of the Securities Industry and Financial Markets Association, served as director of the Office of Thrift Supervision during the savings and loan cleanup in the early 1990s. He said that despite the bleak headlines, savings institutions “are in much better financial shape” today than they were between 1989 and 1993.
But, of course, at this point, savings institutions may be the least of the financial sector’s problems. This time around, we’re not dealing just with insured deposits at banks and thrifts, but with a range of financial institutions and credit instruments whose implosion could have serious and unforeseen consequences.
The American International Group, which the U.S. government agreed to bail out for $85 billion, is one of the world’s biggest insurers. A failure of its global web of credit derivatives might have severely damaged many other institutions, which is apparently why the Federal Reserve Board took emergency action to help prop up an insurance company. Merrill Lynch, which agreed last week to be sold to Bank of America, and Lehman Brothers, which filed for bankruptcy on Monday, are among the biggest U.S. investment banks and brokerages. And it doesn’t stop there.
Morgan Stanley is considering a merger with Wachovia or other institutions. For all of these firms there is continuing uncertainty about the value of the mortgage-related instruments in their portfolios, and about the extent of government help that may be forthcoming.
If its deal goes through, Merrill will continue to operate as part of Bank of America. And when you take a long view of market history, it’s not unheard of for brokerage firms like Lehman to file for bankruptcy, said James Paulsen, chief investment strategist for Wells Capital Management in Minneapolis.
He pointed out that Drexel Burnham Lambert, for example, which popularized junk bonds in the 1980s, filed for bankruptcy in 1990. “But you’d swear from listening to the coverage that this was the first time people had ever seen a broker fail,” Paulsen said.
Stovall added that many past brokerage failures came at or near market bottoms. Drexel filed for bankruptcy on Feb. 13, 1990, and eight months later, the market rebounded from a major downturn.
This time around, the circumstances are unusual, to say the least. The catalyst for the rebound for financial stocks has already occurred. It is clearly the promise of a massive government rescue.
Yet with the terms of possible further assistance not spelled out, there is no guarantee that the upturn in the stock market will continue.
What is more, especially in an election year, there is a real possibility of a reaction against the “moral hazard” that may be implicit in government assistance for institutions that invested recklessly. Little is certain except that more pain is coming for at least some of the financial companies.
1 comment:
Market Rally Built on a Government Rescue: Can it Last?
By Paul J. Lim
21 September 2008
It may take economists years to measure how much this financial crisis has curtailed lending and slowed economic growth.
But if you’re an investor, you probably have a more immediate question in mind: namely, has the sell-off in financial stocks ended?
With shares of banks, brokerages and insurers soaring in response to government rescue plans, it may look like it. But many fundamental problems remain. While the U.S. Treasury secretary, Henry Paulson Jr., has proposed that the government buy $700 billions of dollars’ worth of distressed mortgage securities, many details need to be worked out, notably the price that would be paid for them. As a result, few market watchers are confident that financial stocks have already reached a bottom.
“Maybe we are getting closer to a low point,” said Standard & Poor’s chief investment strategist, Sam Stovall.
It doesn’t take a genius to see that financial stocks have taken an awful beating. In the recent downturn, measured against the last six major market declines, going back to the late ‘60s, financial shares in the Standard & Poor’s 500-stock index registered their worst losses in recent memory. The question is whether the carnage is, for the most part, over.
Since the market peaked last October, financial stocks - now the second-largest segment of the S&P 500, representing 15 percent of the index - had fallen 49 percent at their close on Wednesday. That’s worse than the 36 percent decline for the sector in 1990, in the heart of the savings and loan crisis.
That earlier crisis was worse by some other measures, however. Between 1989 and 1991, for example, 1,187 banks and S&L’s went under, representing more than $454 billion in assets, according to the Federal Deposit Insurance Corp.
So far this year, there have been 11 failures of these institutions, representing total assets of around $40 billion. Of course, Washington Mutual is exploring a sale and there are, no doubt, more failures coming. That isn’t an encouraging picture.
T. Timothy Ryan Jr., president and chief executive of the Securities Industry and Financial Markets Association, served as director of the Office of Thrift Supervision during the savings and loan cleanup in the early 1990s. He said that despite the bleak headlines, savings institutions “are in much better financial shape” today than they were between 1989 and 1993.
But, of course, at this point, savings institutions may be the least of the financial sector’s problems. This time around, we’re not dealing just with insured deposits at banks and thrifts, but with a range of financial institutions and credit instruments whose implosion could have serious and unforeseen consequences.
The American International Group, which the U.S. government agreed to bail out for $85 billion, is one of the world’s biggest insurers. A failure of its global web of credit derivatives might have severely damaged many other institutions, which is apparently why the Federal Reserve Board took emergency action to help prop up an insurance company. Merrill Lynch, which agreed last week to be sold to Bank of America, and Lehman Brothers, which filed for bankruptcy on Monday, are among the biggest U.S. investment banks and brokerages. And it doesn’t stop there.
Morgan Stanley is considering a merger with Wachovia or other institutions. For all of these firms there is continuing uncertainty about the value of the mortgage-related instruments in their portfolios, and about the extent of government help that may be forthcoming.
If its deal goes through, Merrill will continue to operate as part of Bank of America. And when you take a long view of market history, it’s not unheard of for brokerage firms like Lehman to file for bankruptcy, said James Paulsen, chief investment strategist for Wells Capital Management in Minneapolis.
He pointed out that Drexel Burnham Lambert, for example, which popularized junk bonds in the 1980s, filed for bankruptcy in 1990. “But you’d swear from listening to the coverage that this was the first time people had ever seen a broker fail,” Paulsen said.
Stovall added that many past brokerage failures came at or near market bottoms. Drexel filed for bankruptcy on Feb. 13, 1990, and eight months later, the market rebounded from a major downturn.
This time around, the circumstances are unusual, to say the least. The catalyst for the rebound for financial stocks has already occurred. It is clearly the promise of a massive government rescue.
Yet with the terms of possible further assistance not spelled out, there is no guarantee that the upturn in the stock market will continue.
What is more, especially in an election year, there is a real possibility of a reaction against the “moral hazard” that may be implicit in government assistance for institutions that invested recklessly. Little is certain except that more pain is coming for at least some of the financial companies.
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