MarketView for December 19

 

 

Summary 

  

Banks dragged the stock market lower on Monday; with losses accelerating after Bank of America's stock price fell below $5 for the first time in nearly three years. When BofA’s share price dropped below $5, it ignited a late-day sell-off in the markets. More than 29 million shares of the stock traded, accounting for about 5.4 percent of the day's total trading. The bank's woes underscore the headwinds buffeting the financial sector on both sides of the Atlantic.

 

After falling nearly 3 percent last week, Monday's losses brought the S&P 500 close to the 1,200 level, cited by traders as an important support level. Losses could accelerate if that level is breached.

 

To make matters worse, warnings of deteriorating conditions in the euro zone and concerns about tougher capital rules could cut into profits of the nation’s largest banks, also put pressure on financial shares throughout the day.

 

Adding to the concern were some comments from Mario Draghi, president of the European Central Bank, who said the economic outlook contained substantial downside risks, adding that 2012 would be a difficult year for banks. BofA closed down 4 percent at $4.99 while JPMorgan Chase fell 3.7 percent to $30.70 and Citigroup was down 4.6 percent to close at $24.82.

 

As a result, there were signs during the day that a rotation was underway as money moved into some of the defensive sectors, with healthcare and consumer staples showing the greatest stability.

 

Traders also cited a Wall Street Journal report that the Federal Reserve was keen for U.S. banks to hold more capital than required by U.S. law as weighing on bank shares.

 

Investors also kept a watchful eye on developments in North Korea after the death of its leader, Kim Jong-il, and as state-controlled media hailed his untested son as the "Great Successor."

 

Adding to day’s worries, Fitch warned on Friday it may downgrade the ratings of France and six other euro zone countries, saying a comprehensive solution to the region's debt crisis was "technically and politically beyond reach".

 

In company news, Winn-Dixie Stores rose 71 percent to $9.29 after agreeing to go private in a $560 million all-cash deal with Bi-Lo LLC.

 

Fed Plan on Oversight Coming

 

The Federal Reserve will soon release a highly anticipated proposal for how it will oversee the largest banks. The proposal, which includes a group of rules such as new capital and liquidity requirements, was mandated by the 2010 Dodd-Frank financial oversight law, enacted in response to the financial crisis.

 

The rules are intended to make large banks more stable by ensuring they have enough capital and liquidity to absorb market shocks. They will also require banks to act to strengthen themselves if it appears they are heading into trouble, such as being overexposed to risky assets.

 

Release of the proposal could come as early as Tuesday, but it is possible it could be delayed until January if the proposal does not receive final approval this week from all members of the Fed's board.

 

Once the proposal is released, the banking industry and public will be allowed to give the Fed feedback before a final set of rules is implemented.

 

Under Dodd-Frank, the Fed is charged with providing more oversight of the largest U.S. financial firms. This includes all banks with more than $50 billion in assets, such as Goldman Sachs, JPMorgan Chase and Citigroup and any financial firm the government identifies as being important to the functioning of financial markets and the economy. The government has yet to decide which non-banks, such as insurance companies and hedge funds, meet this standard.

 

The capital requirements the Fed will lay out are expected to closely mirror the standards agreed to earlier this year by regulators from around the world as part of the Basel III agreement. Implementation of the agreement is due to start in 2013.

 

The Basel agreement will require banks to maintain top-quality capital equal to 7 percent of their risk-bearing assets. In addition, global "systemic" banks may have to hold up to an additional 2.5 percent. A 1 percent surcharge would be imposed on banks that became significantly larger.

 

Fed Governor Daniel Tarullo said in November that the Basel agreement, blessed by the Federal Reserve, was consistent with the capital rules expected to be issued under Dodd-Frank. Banks have complained the Basel rules, which increase the amount they are funded by equity as opposed to debt, will cause them to lend less, thereby hurting economies.

 

Regulators and academics who support the rules contend that a more stable financial industry will better serve economies. Basel negotiators are still hammering out the final details on liquidity requirements.

 

At a panel discussion Monday in Charlotte, North Carolina, Bank of America CEO Brian Moynihan said in crafting new capital requirements, regulators will have to balance the need to prevent a future financial crisis with the need for banks to make loans that improve economic growth.

 

Higher capital requirements "have an impact (on lending), but it's meant to have an impact," Moynihan said. "The question is: 'Do we get the balance right?'" After the discussion, Richmond Federal Reserve President Jeffrey Lacker said dampening lending is not necessarily a bad thing.

 

In the run-up to the financial crisis, "we had too much lending going on," Lacker told reporters. "Households were in too much debt and that's why we had the problem we had in the housing market."

 

Banks are anxiously awaiting the Fed's proposal to see what the central bank would have them do if their financial positions deteriorated. Dodd-Frank requires the Fed to lay out mandatory "early remediation."

 

The dilemma is to create requirements that would allow a bank to recover instead of putting it into a death spiral by raising concerns in markets that the institution was in peril.

 

Mark Van Der Weide, a senior staff member at the Fed's Division of Banking Supervision and Regulation, said at a conference in September that one of the biggest challenges was deciding the parameters that would force a bank or financial institution to shore up its capital position.

 

Congress Fails Again

 

With a tax cut for 160 million workers set to expire in less than two weeks, Republicans and Democrats in Congress on Monday were mired in a last-ditch battle over extending it. In a surprise turnabout, Republicans in the House of Representatives are now pushing for a one-year extension of the payroll tax cut and have rejected a short-term compromise struck by Republicans and Democrats in the Senate at the weekend.

 

House Republicans had initially expressed concerns over the economic benefits of renewing the tax break, which expires on December 31, and soon-to-expire jobless benefits.

 

The House is expected late on Monday to defeat the bill passed overwhelmingly by the Senate on Saturday and then seek negotiations on a new compromise measure. However, the path to compromise was far from clear as Democrats took a hardline stance and accused House Republicans of reneging on the deal between their brethren and Democrats in the Senate.

 

Democratic Senate leader Harry Reid said he was unwilling to reopen negotiations. Almost all senators have already left Washington for the holidays and the Democratic-controlled chamber has no legislative business scheduled until January 23.

 

The stand-off between Republicans and Democrats raised the specter of a $1,000 tax hike on the average American worker and millions of unemployed losing their benefits. The rebellion by House Republicans against the Senate deal, which had the blessing of Senate Republican leader Mitch McConnell, raised fresh questions about Speaker John Boehner's control over his restive caucus, which has repeatedly balked this year at compromising with Democrats.

 

At issue is a phone call between Boehner and rank-and-file members on Saturday. Apparently Boehner initially backed the Senate deal but back-pedaled after being caught off guard by the angry response of members. Naturally, Boehner has since denied flip-flopping on the issue.

 

Boehner has struggled to control his caucus, which includes scores of Tea Party-affiliated members elected to Congress in the November 2010 elections, propelled by voters furious about a bad economy and government spending.

 

At least two Republican senators blasted House Republicans for refusing to approve the Senate deal.

 

"The House Republicans' plan to scuttle the deal to help middle-class families is irresponsible and wrong," said Republican Senator Scott Brown.

 

Senator Richard Lugar said House members must do what is "best for the country" and pass the Senate measure.

 

Without a deal, workers' payroll taxes will rise on January 1 to 6.2 percent, from the current 4.2 percent. Some unemployment benefits, now at 99 weeks amid the weak economy, also would begin phasing out early next year, ending benefits for millions of people who have been jobless for an extended period.

 

The end-of-year fight caps a tumultuous year and will deepen the sense of dysfunction in Washington. This latest battle caught even cynical Capitol Hill watchers by surprise.

 

Credit rating agencies are already skeptical Washington's politicians have the political will to steer the country through global economic instability. Americans heading to the polls in 2012 have also lost confidence in Congress, opinion polls show.

 

For much of 2011, Republicans and Democrats sparred over spending, debt levels and taxes, bringing the government to the brink of shutdown and costing the United States its prized AAA credit rating from Standard & Poor's rating agency.

 

If the House formally requests negotiations with the Senate, as expected, Reid will have to decide whether to reverse course and bring senators back to do more legislating.

 

Before voting to request new talks with the Senate, the House is expected to defeat the Senate-passed bill. If Reid then refuses to engage in new negotiations, it's unclear if lawmakers would find yet another way to avoid having the payroll tax revert to its pre-2011 6.2 percent, at least until early next year when Congress starts its 2012 session.