Don't Fight This Fed

As we ponder what to do in the short term with this spike in the market, I would like to note that it would be difficult to have imagined a speech and Q&A that could have had more bullish medium term implications than the one Big Ben delivered at the Council of Foreign Relations today. In truth, Big Ben reiterated several themes he has mentioned in other forums. But today’s speech reflects greater clarity and a holistic integration of the various issues. I recommend reading the entire text carefully and going over to youtube.com and looking at the Q&A. Here are some quick observations:

1. Mark-to-market and other regulations that exacerbate pro-cyclicality must be revised. This not only includes M2M but other government regulations and accounting rules regarding capital and loss recognition such as those detailed so well in “Unruly Accounting”. He was even clearer on this point in the Q&A than he was in the text. Big Ben is signaling clearly that these rule changes ARE GOING TO HAPPEN. It is not a matter of if, but when. Big Ben has to be careful not to step on toes because this is not within his authority or jurisdiction. But given those constraints, the handwriting that Big Ben has scribbled on the wall could hardly be clearer.

2. When? In the Q&A Big Ben said that normally such decisions require time and deliberation. But then he said, “Given what is going on in the world, we should look to identify the weak points to mark-to-market and work to make some improvements on a more expeditious basis.” In other words, policy makers realize that they need to move quickly on this. So expect movement on this front.

3. The Fed and the administration will not allow the big banks to fail. He actually placed that in a bold faced heading in the prepared remarks. Any more clarity needed?

4. The government does not want to dilute current common shareholders and will do all it can to accommodate them. The government plan is to use the stress test to determine how much capital the banks need in an “adverse scenario” that is worse than consensus forecasts. The government will then give the banks all the capital they need to cover projected losses in the form of preferred shares. The government will give banks plenty of time to repay the government so that common shareholders will not have to suffer dilution. ONLY if losses are larger than expected and banks are not able to raise capital on terms that are more favorable, will the preferred shares be converted to common. This is a HUGE buy signal for banks such as Bank of America (BAC).

Ben Bernanke is the only government official that is providing leadership in this crisis. From his post at the Fed, there is only so much that he is authorized to do – and he has been stretching the limits of Fed authority at that. But bold leadership is what is required right now and Big Ben seems to realize that the Obama team has got leadership “issues” and that somebody has to step up.

My recommendation: Don’t fight this Fed. Bernanke is putting himself on the line and is delineating a coherent agenda for dealing with this crisis. Big Ben clearly understands that fiscal stimulus and budget plans are virtually irrelevant. EVERYTHING depends on stabilizing financial institutions. Big Ben is telling us that the regulatory rule changes and the capital that banks need are coming and that it will be provided in a market-friendly way.

If you want a better signal than that, I think you will be buying 15% higher from here.

Long BAC Leaps