Monthly Archives: April 2010

Bank Equity Investors Must Pay Close Attention to Financial Reform

Posted on April 27, 2010 by | Leave a comment

Sen. Blanche Lincoln, D-Ark., got a measure into the financial regulatory reform bill written by Sen. Chris Dodd, D-Conn., that would force banks to divest their derivatives-trading operations. While the measure could still die, it shows that lawmakers are willing to consider ideas that could seriously affect derivatives portfolios of major banks, according to The Wall Street Journal. The proposal likely would have a number of consequences for banks, bank-stock investors and taxpayers.

Sen. Richard Shelby, R-Ala., suggested he would look closely at a proposal for regulating derivatives hammered out Sunday by Sen. Dodd and Sen. Lincoln. The idea of forcing banks to spin off derivatives trading is strongly opposed by many major banks, which earn billions of dollars yearly on such trading.  For bank stock investors, this would be the most damaging aspect of the legislation.

Sen. Judd Gregg, R.-N.H., denounced the proposal as “punitive language put in out of spite,” and dismissed the idea as “pandering populism, which just simply dislikes anything that has to do with Wall Street.”

Gary Gensler, chairman of the Commodity Futures Trading Commission, called the Senate’s bill to overhaul financial regulation a “strong product” but did not lend his support to the proposal that would force banks to divest their derivatives-trading operations. Gensler declined to directly comment on the controversial proposal. “I know I’m not answering your question,” he said. “There’s a perverse outcome of this crisis, that somehow the markets perceive that in the next crisis, these large financial institutions, the taxpayers will stand behind them. And we have to sever that belief.”

Yesterday, Senate Republicans voted to block the financial regulatory reform legislation proposed by Democrats from reaching the floor for debate. Republicans said the bill needs substantive changes and that Democrats are rushing it. However, both sides said they expect some form of the legislation to be approved eventually.

Sens. Shelby and Dodd met before the vote, and vowed to continue efforts this week to piece together a compromise agreement. “Our goal is a good bill, a bill that works for the economy, that works for the American people,” Sen. Shelby said. Sens. Shelby and Dodd still disagree on several points, congressional aides said. Sen. Shelby wants other banking regulators to play a role in the new consumer watchdog, a move opposed by Democrats who say that would dilute the proposed agency’s authority.

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Posted in Banking, Economy, Regulatory Reform

Municipal Bond Mutual Funds Feeling Left Out

Posted on April 26, 2010 by | Leave a comment

While more money is flowing into mutual funds, funds focused on municipal bonds are continuing to see a decline in investments, according to an article in The Bond Buyer. Lipper FMI data show $118.4 million went into municipal bond funds last week, down from an average of $297.6 million a week for the past four weeks. However, the average was the lowest level since January 2009.

Since the Federal Reserve Board is holding the federal funds rate near zero, holding cash is severely unattractive.  For a while, investors put their cash in municipal bond funds in order to get some extra yield, tax-free, without taking on too much risk.  Now, however, that the economic news is improving, investors feel like taking on more risk for more yield.

According to iMoneyNet, the yield on a tax-free money fund is a paltry 0.04 percent. Investors can earn substantially more than that by extending to municipals with slightly longer maturities. The $3 billion Wells Fargo Advantage Short-Term Municipal Bond Fund, for instance, holds bonds with an average maturity of 2.6 years and yields 1.83 percent — 179 basis points more than the average tax-free money fund.

Tax-free money funds have now bled $131.73 billion — 27 percent of their assets — since the Fed cut its target for short-term interest rates to essentially zero in December 2008.

EPFR Global, a fund-tracking firm, said emerging market bond funds last week notched their second-best week ever with $1.28 billion in flows. The best week ever was the one before.  Funds investing in stocks from such places as Russia, China, and Africa continue to garner new money, EPFR said, while technology, real estate, and commodity funds all continue to take in cash.

To further illustrate risk appetites: last week Russia tapped the bond market for the first time since the country defaulted on its debt in 1998. It paid 125 basis points over the Treasury yield for five-year ­maturities.

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Posted in Fixed-Income, Investing, Municipal Bonds, Personal Finance

Criticism of Obama’s Financial Reform Plan Focuses on Negative Economic Effects

Posted on April 23, 2010 by | Leave a comment

President Obama, speaking to the financial industry in New York yesterday, demanded that his financial reform plan be enacted by Congress as soon as possible to prevent another economic crisis.  “Unless these reforms are enacted, our house will continue to sit on shifting sands, leaving our families, businesses and the global economy vulnerable to future crises,” Obama said. Reactions from Wall Street were mixed. “While we disagree on some of the details — specifically on the Volcker rule and aspects of the derivatives portion of the legislation — it should not distract us from our overall shared goal of passing responsible reform,” SIFMA President and CEO Timothy Ryan said in a statement.

One argument for not rushing into a major overhaul of the financial regulatory system has been left out of the discussion up until now.  Severely increased regulation for the sake of “doing something” would both hamper economic growth and possibly cause another financial crisis.

Congress needs to find a way to simplify legislation on financial-regulatory reform, Harvard University professor Niall Ferguson and IMG World Chairman and CEO Ted Forstmann write in a Wall Street Journal commentary. The two acknowledge a need to limit leverage and better regulate derivatives, but they argue that the 1,300-page bill being discussed would significantly limit the efficiency of capital markets. “Let us not believe we can abolish both bailouts and depressions, other than by creating another layer of government regulation,” they write.

In addition, legislation to overhaul financial regulation being considered by the Senate could very well cause, not prevent, the next financial crisis, writes Peter Schiff, president of Euro Pacific Capital. Schiff’s InvestmentNews commentary is a response to President Barack Obama’s speech to Wall Street, during which Obama said a “failure of responsibility” has permeated Washington and New York. “Obama claims he wants ‘common sense rules’ to be put in place,” Schiff writes. “Yet, his reform proposal defies common sense.”


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Posted in Banking, Economy, Regulatory Reform

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Producer Price Index for March 2010 Rises 0.7 Percent

Posted on April 22, 2010 by | Leave a comment

The Producer Price Index increased by 0.7 in March 2010. However, excluding volatile food and energy numbers, the index rose a more modest 0.1 percent. Inflation remains tame, likely prompting the Fed to hold the federal funds rate low.

The headline number  was driven higher by atypical winter freezes that pumped up food prices and a partial rise in gasoline prices.  Food prices spiked 2.4 percent, after a 0.4 percent rise in February. The March surge reflected the loss of some vegetables to atypically cold winter weather in key growing regions in the U.S. For the latest month the fresh and dried vegetables category surged a monthly 49.3 percent.

The energy component rebounded 0.7 percent after dropping 2.9 percent the month before. Gasoline rose 2.1 percent after a 7.4 percent drop in February.

At the core level, inflation is almost nonexistent outside of commodities related gains. According to the BLS, 85 percent of the core rise came from higher jewelry prices due to higher gold and other metals costs.

For the overall PPI, the year-on-year rate jumped to 6.1 percent from 4.6 percent in February (seasonally adjusted). The core rate year-ago pace edged down to a very modest 0.8 percent from 0.9 percent the month before. On a not seasonally adjusted basis for March, the year-ago increase for the headline PPI was up 6.0 percent while the core was up 0.9 percent.

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For additional information, please click on the “Inflation Measures” page on the menu bar at the top the blog.  Then, scroll down to Producer Price Index.

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Posted in Economy, Indicators, Producer Price Index

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Bank of America is Deeply Undervalued: The Economist

Posted on April 22, 2010 by | Leave a comment

An article in The Economist examines the balance sheet of Bank of America (symbol: BAC) and its shotgun marriage with Merrill Lynch September 2008 and finds that the stock market has likely punished BAC’s stock price too much.

To be sure, when Bank of America first scooped up Merrill as the investment bank was failing due to severe mortgage losses, shareholders were enraged at the price ($50 billion in BAC stock) Bank of America paid.  It then took $45 billion of federal funds (through the Troubled Asset Relief Program) to stabilize the financial institution, causing public outrage.  However, Bank of America has repaid the $45 billion of taxpayer funds, and the combination with Merrill may soon pay off.

Merrill’s Advantages Outweigh the Negative

The article points out that, in the Merrill deal, “BofA got a pile of noxious mortgage securities, but also top-notch securities-trading and underwriting businesses, and Merrill’s “thundering herd” of brokers and wealth managers, the jewel in its crown.”  The financial firm is now a powerhouse in both brokerage and capital markets.  “According to Dealogic [Bank of America] was number two in global investment-banking fees last year, behind JPMorgan Chase, which posted another strong set of trading and investment-banking profits on April 14th. Alone, BofA was a lightweight.”  In addition, Merrill offers access to international markets that Bank of America never had.  “[Merrill's] brand is strong abroad: it has three times more relationships than BofA does in Europe, Asia, Africa and the Middle East (though it has made less headway in China than some of its Wall Street rivals).”

Undervalued

Bank of America’s stock has struggled to climb toward the $20 level, currently resting below $19 per share.  A couple of reasons are that markets are skeptical as to whether large financial conglomerates can still compete in the post-financial crisis world and whether looming financial reform will clip the financial institution’s wings.  That said, “Dick Bove, a veteran bank analyst with Rochdale Securities, thinks the group could fetch $53 per share in a break-up. That is almost three times its current worth.”

[Disclosure:  Trafalgar Investment Advisers LLC maintains a long position in BAC in its model portfolio and in certain clients' portfolios]

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Posted in Banking, Investing, Personal Finance

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