At the end of a two-day summit, leaders from the Group of 20 nations said they plan to cooperate on an overhaul of financial regulations to prevent arbitrage in the global system. By the end of next year, banks will be required to hold more capital, and compensation policies will need to be linked to longer-term performance. Also, systems will be created for winding down cross-border financial institutions. Since these developments will have a direct impact on the profitability of financial firms, investors need to follow the progress and timing of financial industry reform measures.
Securities Industry and Financial Markets Association President and CEO Timothy Ryan called the proposals “unprecedented.” “While individually each initiative may have merit – and the industry supports many reforms – taken together, these reforms could negatively impact investors, capital flows, and economic growth and job creation during a period of global economic vulnerability,” Ryan said. The G-20 also released a statement about its plans for maintaining stability in financial markets and encouraging economic growth, among other goals.
“Our reform is multifaceted but at its core must be stronger capital standards, complemented by clear incentives to mitigate excessive risk-taking practices,” the G-20 said. “Capital allows banks to withstand those losses that inevitably will come.”
The member countries committed to conduct “robust, transparent stress tests as needed” and called on banks to retain a greater portion of current profits to bolster capital. The statement didn’t go as far as the Financial Stability Board (an international organization established to address vulnerabilities and to develop and implement strong regulatory, supervisory and other policies in the interest of financial stability that is comprised of senior representatives of national financial authorities (central banks, regulatory and supervisory authorities and ministries of finance), international financial institutions, standard setting bodies, and committees of central bank experts) recommendation that banks restrict dividends, stock buybacks or compensation.
The G-20 said it would support introducing an international leverage ratio, adjusted for differences in accounting regimes that could supplement existing Basel II risk-based standards. The leaders called on financial companies deemed “systemically important,” meaning that their failure would pose a risk to the entire financial system, to develop contingency and resolution plans that work internationally.
To reduce the risk of derivatives traded over the counter, the G-20 proposed moving all standardized contracts onto exchanges or electronic platforms, where appropriate, by the end of 2012. Trades should be cleared through central counterparties and reported to trade repositories, the G-20 said. Some contracts would be subject to stricter capital requirements.
The G-20 was unusually detailed, underscoring both the cohesiveness of the member countries on this issue and their determination to instill real financial regulatory reform across the globe. The goal of such reform is to slow lending and, thus, slow growth to avoid damaging asset bubbles. Investors need to pay close attention as financial regulatory reform measures, such as those proposed by the G-20, make their way toward becoming reality. Stock markets have enjoyed a remarkable rally on the back of government spending, very easy monetary policy, and no meaningful financial reform. Those trends may be reversed in short order, and a subsequent reversal in stock markets as a result, would not be out of the question.
Gregg D. Killoren
victoria1014
A Look Behind the Improvement in Housing Prices
According to the latest S&P/Case-Shiller 20-City Home Price Index prices fell 13.3 percent year-over-year in July 2009, less than the expected decline of 14.2 percent. It is the smallest decline since February 2008 and it takes the index to the highest reading since January 2009 as it rose 1.61 percent month-over-month. At 144.23, the index is down 30 percent from the all time high in July 2006.
The following cities top the list of regional peak decliners: Las Vegas at -54.82 percent, Phoenix at -53.10 percent, Miami at -47.57 percent, Detroit at -44.71 percent and San Francisco at -40.99 percent.
Although the stabilization in home prices is certainly welcome, the reasons behind the apparent stabilization include the $8,000 first-time homebuyer tax credit which expires on December 1, 2009, and the fact that on a seasonal basis, June and July tend to be the strongest months for home sales.
In almost every case of positive economic data that has driven the incredible stock market rally, we find the same underlying factor: government spending. Now, what seems like a lifetime ago, but was really only about 10 or 11 months prior, this author wrote an argument in favor of government spending in the midst of the credit crisis to replace lost private sector, especially consumer, spending. The idea behind the concept of loose monetary policy and quantitative easing is to prevent a panic like those of 1907 (which is why we have the Federal Reserve today) and the Great Depression (the genesis of almost all banking and securities laws).
Averting a global panic has been accomplished, and the recovery in the stock market is not unexpected for that reason. However, the recent return to extreme risk-taking in the markets is completely unwarranted and likely driven by the belief that the government will bailout the stock market by spending to boost every economic sector. In order for the market valuation to hold up over time, private sector spending would have to return to its pre-credit crisis levels, which means more borrowing and no saving. That is not going to happen, as the savings rate has recently popped above 4 percent and should continue to climb up towards 8 percent, which, in the long run, is healthy for the economy.
The government cannot spend indefinitely to keep the stock market happy. Moreover, in a report released in June, the Bank for International Settlements (BIS) noted there is a “significant risk” that monetary and fiscal stimulus will lead only to “a temporary pickup in growth, followed by a protracted stagnation.” The BIS further stated, “The big and justifiable worry is that, before it can be reversed, the dramatic easing in monetary policy will translate into growth in the broader monetary and credit aggregates.” That will “lead to inflation that feeds inflation expectations or it may fuel yet another asset-price bubble, sowing the seeds of the next financial boom-bust cycle,” this BIS said. In addition to the risk of stoking inflation, the unprecedented policies “may be insufficient to put the economy on the path to recovery,” the BIS warned.
One key to consumer spending is housing. People tend to feel wealthy when their houses gain in price, and to the contrary, people feel poorer when their houses decline in value—a phenomenon known as the “wealth effect.” So, to repeat, unless the federal government is going to permanently subsidize housing (there are bills in Congress to extend the homebuyer tax credit, but they are meeting with resistance over concern about the fiscal deficit) it is questionable as to whether the housing recovery is real. Peter Boockvar writes “With an expected pick up in foreclosures, continued compression in higher end home prices and the uncertain fate of the tax credit, we’ll see if the improvements in pricing can continue in the face of this. The worst of the financial crisis will end when home prices stop going down, and I don’t believe we’ve seen the worst of the price declines in this cycle notwithstanding the recent government induced bounce.”
In a recent speech, Federal Reserve Bank of Dallas President Richard Fisher artfully sums up the current dynamic:
In sum, do not bet the farm on equities—the two are inextricably linked.
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Posted in Economy, Housing, Investing, Market Commentary
Tagged Economy, Housing Prices, Investing, Market Commentary