Tuesday, April 21, 2009

How A Phony Story Moved The Market Yesterday - A Sign Of Nervousness....Or Stupidity?

Yesterday, the market "decided" to panic in financials. Or, maybe, someone NEEDED some panic in financials.....

Let us consider the factors: market conditions, vested interests, a questionable leak and an influential mainstream media source.

Market Conditions

Financial stocks and the overall market have enjoyed a big run. Nearly everyone, even those who are bullish on the group, expected that there would be a pullback. In these circumstances, this acts as tinder. All we needed was a match.

The Vested Interests

Jim Cramer noted on CNBC that he was bombarded with emails while he was on vacation. People wrote him within seconds of earnings announcements, seeking his endorsement that earnings were all wrong. Many traders needed this pullback, either because they were short, or to find an entry point.

The 'Leak'

The day started with a "leak" late Sunday evening from a blog called the Turner Radio Network. This got a lot of play in Monday's premarket trading. Mainstream media and bloggers picked up the story that most banks were failing the "stress test" and that the banking system was on the verge of collapse. Many people apparently believed, at least initially, that Turner meant Ted, not Hal.

Although reasonably intelligent people quickly realized the dubious nature of this source, the story continued to get plenty of play on blogs.

Denials from Treasury about this story had zero impact. It would be nice to think that bogus information has no effect, but it got the ball rolling. It helped to create a receptive climate for other stories, including the very critical analysis of the earnings report from BAC.

The Times Chimes In

This story was immediately embraced by commentators as official Obama policy. Why?

The New York Times ran an article about the TARP program and a purported conversion of the government's preferred bank shares into common stock. The story was poorly sourced. It should have been noted that the proposed change would affect the tangible common equity ratio, or TCE, but not overall bank capabilities. The TCE is a favored measure of bearish bank analysts but not a measure of regulatory capital.

A look at the story supports this analysis. Here is the key quote from the Times article:

The White House chief of staff, Rahm Emanuel, alluded to the strategy on Sunday in an interview on the ABC program This Week. Mr. Emanuel asserted that the government had enough money to shore up the 19 banks without asking for more.

"We believe we have those resources available in the government as the final backstop to make sure that the 19 are financially viable and effective," Mr. Emanuel said. "If they need capital, we have that capacity."

Let us now compare this with the actual text from the program. Emanuel carefully avoided any implication of a specific policy or use of the nationalization language. He noted, several times, that this was a sensitive issue and that he did not have specific results. He merely stated that the administration believed current resources were adequate. Here is a key quote, as recounted on the ABC News Web site, but anyone who is interested in the truth should go back to the full interview:

"And you will avoid any kind of temporary nationalization?" I asked.

"I think we will be able to avoid that," he said. "And again, obviously -- I want to be careful, George, because this is very important, and rightfully so. I believe we have the resources. I believe -- not only -- I believe we will not have to deal with nationalization, and that's not the goal, nor do we think that's the right policy objectives here."

This article says nothing about conversion to common stock. It is also not the way policy makers float a trial balloon. When policy makers want to do that, they pick a good outlet and do an unsourced story, citing unnamed "high officials" or the like. It is very specific about the policy in mind, or else it would do no good.

My own reading is that Emanuel and the administration, rightly or wrongly, believe that the public-private investment program, or PPIP, will address what it refers to as "legacy assets." The administration expects the remaining funds to have enough leverage to guarantee loans to private investors. We will not know the answer to this until May 15 when this is announced. For those of you keeping score at home, this is eight full months after former Treasury Secretary Henry Paulson went to Congress with the plan for dealing with these assets.

The failure to understand the importance of this issue and deal with it quickly is the biggest single policy failure of both the Bush and the Obama administrations, exacerbated by the intervening transition of power.

The assembled punditry are all too willing to ascribe a policy decision to Obama, based simply upon this vague article.

The Limits to Being Right

Let us suppose that you had the skill to read the Turner story and to immediately recognize the flaw. Let us further suppose that you checked out the ABC News and New York Times sources.

It would not have helped your trading. The trade is more about understanding what other market participants will do. As John Maynard Keynes noted, you need to watch the faces of the judges, not the contestants. Many market participants are so skeptical about Obama and about government in general that they are always willing to believe the worst.

In the longer run, it is a mistake to confuse your political opinions with your investment decisions. Financial stocks will find their level. Those who are looking for an entry have their chance.

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