MarketView for July 15

 

 

Summary  

 

Despite being a momentous day with regard to legislation finally passed by the Senate and now on the way to the President’s desk that is the most encompassing financial regulation bill passed since the Great Depression, share prices were for the most part unchanged.

 

After being down in the morning, the major equity indexes recouped those losses as word reached the Street that Goldman Sachs had reached an agreement settle its problems with the SEC by paying the largest fine in history, although it amounts to only about two weeks of earnings for the firm, and BP had finally had some success in the Gulf of Mexico.

 

BP's shares rose 7.6 percent after the company said no oil is leaking from its blown-out well in the Gulf of Mexico for the first time since the accident began in April. Shares of Goldman rose 4.4 percent to $145.22. The potential resolution of two major overhangs -- BP's oil spill and fraud charges against Goldman Sachs by the SEC -- was enough to turn market sentiment around in the last half hour.

 

Goldman said it would pay $550 million to settle SEC charges that it misled investors in a subprime mortgage product. Goldman's shares continued to climb after the bell, rising 2.9 percent to $149.40.

 

Despite the turnaround, the Dow and Nasdaq both ended a hair lower, snapping a seven-day winning streak. BP ended up at $38.92 after it said initial results showed a newly placed cap had completely contained the flow of oil from the ruptured well.

 

The three major equity indexes spent most of the day in negative territory, weighed down by a subdued outlook on the economy from JPMorgan Chase and disappointing factory data. An unexpected decline in regional factory activity and a third straight month of decline in producer prices raised concerns about deflation, cooling enthusiasm for the strong start to the earnings season that had lifted stocks off recent lows.

 

JPMorgan reported quarterly earnings that exceeded expectations, but offered a cautious outlook on the economy. Much of the company's gains came from areas that will not continue to produce similar income going forward.

 

The stock recovered to add 0.3 percent to $40.46, but its sober economic view hit the shares of competitors, down 1.2 percent at $4.16, and Bank of America down 1.8 percent at $15.39. Both report earnings on Friday.

 

Google was a disappointment to the Street after the bell, reporting an earnings number that missed expectations, thereby sending its shares down 4.7 percent to $470.79 in afterhours trading.

 

Advanced Micro Devices reported results after the bell that exceeded expectations as corporate spending on tech hardware strengthened. Its shares climbed 4.6 percent to $7.75 in extended-hours trading.

 

In a busy day for economic news, the Philadelphia Federal Reserve Bank said factory activity in the mid-Atlantic region fell unexpectedly, while the New York Federal Reserve Bank said New York manufacturing hit the lowest since December 2009.

 

The U.S. Labor Department said the Producer Price Index declined for a third straight month. In June, the PPI fell 0.5 percent.

 

Goldman Sachs to Settle for $550 Million

 

Goldman Sachs agreed to pay $550 million to settle civil fraud charges over how it marketed a subprime mortgage product, ending months of negotiations that rattled the bank's clients and investors. According to the SEC, the penalty was the largest ever for a financial institution, and leaves the door open for future civil suits. Another way to look at it is that the fine is a slap on the wrist for a bank that earned more than $13 billion last year. It is about two weeks of income.

 

Goldman's shares rose more than 9 percent in late and after market trade to $152.20 on reports that the bank was close to settling and the actual announcement. The investment bank's market value had plunged by more than $25 billion since the SEC pressed charges on April 16.

 

The lawsuit shook Goldman's business to a much greater degree than executives at the firm had expected. Goldman executives have found themselves working harder than usual, meeting with clients and working to assure them that it is business as usual. Major clients have generally stuck with Goldman, although some customers with large public profiles have been more cautious in working with the firm of late.

 

Investors and former employees have been speculating that Goldman Chief Executive Lloyd Blankfein may have taken a big enough hit to his credibility that his days at the helm of the firm are numbered.

 

The settlement leaves the door open for additional enforcement actions by the SEC and further investigation by federal prosecutors. The Department of Justice could still pursue criminal charges, although lawyers said that was unlikely. The SEC said it planned to continue its lawsuit against Fabrice Tourre, the vice president at Goldman accused of putting the deal in question together.

 

And after settling with the SEC, Goldman must now fend off lawsuits from shareholders and other interested parties. Earlier this month, the investment bank asked a judge to combine 18 shareholder lawsuits in the wake of the SEC's charges.

 

Goldman acknowledged as part of the settlement that its marketing materials were incomplete, which lawyers said was unusual. But it did not admit or deny the allegations. The settlement only resolves the issue of this transaction in particular.

 

The Wall Street Journal reported late on Wednesday that Goldman had pressed regulators to agree to a global settlement, which would effectively have ended any SEC investigations into other collateralized debt obligations underwritten or marketed by the Wall Street firm.

 

Of the $550 million settlement, $250 million will be returned to harmed investors, and $300 million will go to the U.S. Treasury. Of the $250 million, $150 million will go to Germany's IKB, and $100 million will go to the Royal Bank of Scotland.

 

The settlement is subject to approval by a federal judge, which independent legal experts said was likely. The fact that the commission was split was evidence to many on Wall Street and even at the SEC itself that the government had a weak case.

 

The SEC announced the settlement during a news conference in Washington. It was announced the same day Wall Street reform cleared Congress and headed to President Barack Obama for his signature.

 

Initially, Goldman was defiant and refused to negotiate a settlement with the regulator. However, a month after the fraud charges were filed, top Goldman officials, including the bank's chief financial officer David Viniar, started talking to the SEC. The lawsuit hinged on the narrow issue of whether Goldman failed to disclose relevant information to a client and many of Goldman’s competitors viewed the case as weak.

 

Decline in Jobless Claims

 

New claims for unemployment benefits declined last week falling to what is almost a two-year low. That was the good news. On the other side of the slate, industrial output was weak and another drop in wholesale prices in June continued to point to a slow economic recovery.

 

The Labor Department reported that initial claims for state unemployment benefits fell by 29,000 claims to 429,000 claims last week, the lowest level in 23 months, as seasonal layoffs at factories eased. The Department also reported that its producer price index fell 0.5 percent in June as gasoline prices fell and food costs recorded their largest decline since April 2002. The so-called core rate, which removes the volatile food and energy sectors, chalked up a small 0.1 percent gain after increasing 0.2 percent in May.

 

The relatively good news on employment was overshadowed by a Federal Reserve report showing industrial production rose 0.1 percent last month, braking sharply from May's 1.3 percent advance. Manufacturing output declined 0.4 percent, snapping a three-month streak of gains.

 

That weakness probably persisted this month, with measures of factory activity in New York State and the mid-Atlantic region slowing sharply from June. Growth in New York State was the slowest in seven months, while expansion in the mid-Atlantic region retreated to levels last seen in August.

 

The manufacturing reports reinforced views that the recovery from the worst recession since the 1930s lost momentum in the past few months -- much sooner than most economists had expected.

 

A decision by manufacturers such as General Motors, who normally shut down their plants this time of year for retooling, to continue production helped to reduce the number of people filing for unemployment benefits last week.

 

A Labor Department official said the drop in claims was not restricted to the auto industry, but manufacturing as a whole, a factor some analysts believed could result in industrial output picking up this month after June's small gain.

 

Last week, the four-week moving average of new jobless claims, considered a better measure of underlying labor market trends, fell 11,750 to 455,250.

 

With inflation subdued due to weak energy prices, high unemployment and ample spare industrial capacity, analysts believe the Fed will keep overnight interest rates near zero until the second half of next year.

 

Industrial capacity in use held steady at 74.1 percent, up sharply from a year earlier, but still 6.5 percentage points below its average from 1972 to 2009, the Fed said. The combination of sluggish manufacturing and producers' inability to raise prices has some worried that deflation is stalking the economy.

 

Congress Passes Financial Reform

 

The Senate on Thursday approved the broadest overhaul of financial rules since the Great Depression and sent it to President Barack Obama to sign into law. The House had already passed the legislation.

 

By a vote of 60 to 39, the Senate passed a sweeping measure that tightens regulations across the financial industry in an effort to avoid a repeat of the 2007-2009 financial disaster. It was not easy. Wall Street had fought bitterly to derail the legislation, which leaves few corners of the financial industry untouched. It establishes new consumer protections, gives regulators greater power to dismantle troubled firms, and limits a range of risky trading activities in a way that would curb bank profits.

 

"Unless your business model depends on cutting corners or bilking your customers, you have nothing to fear from this reform," Obama said. He is expected to sign the bill into law next week.

 

The Senate vote caps more than a year of legislative effort after Obama proposed reforms in June 2009. The House of Representatives approved the legislation last month. Financial markets showed little reaction on Thursday as the Street had already factored in the bill's impact.

 

Although Obama originally had hoped for bipartisan support for reform, only three Republican senators voted in favor of the bill, joining 55 Democrats and two Independents. One Democrat opposed it. With Republicans poised for big gains in the November congressional elections, Democrats are eager to show voters that they have tamed an industry that dragged the economy into its deepest recession in 70 years.

 

"I regret I can't give you your job back, restore that foreclosed home, put retirement monies back in your account," said Democratic Senator Christopher Dodd, one of the bill's chief authors. "What I can do is to see to it that we never, ever again go through what this nation has been through."

 

JPMorgan Chase said the bill would not compromise its business model but might hurt profitability. "We'll have some effect on revenues and margins and volumes," its chief executive, Jamie Dimon, said.

 

As the largest U.S. derivatives dealer, JPMorgan could have the most to lose from the bill, which aims to curb lucrative trading in risky over-the-counter derivatives and force banks to end trading for their own profits.

 

Along with the health-care overhaul, Democrats can now point out that they have passed two far-reaching reform efforts that will likely shape American society for generations.

 

The public's understanding of the regulatory revamp is very low, according to an Ipsos online poll released on Thursday. Of those polled, 38 percent had never heard of the reform, while 33 percent had heard of it but knew nothing about the bill. Other polls show the public divided about its merits.

 

And even as Democrats hope the regulatory crackdown will help them win support in the November elections, many voters remain angry at lawmakers for spending hundreds of billions in taxpayer dollars to prop up Wall Street while Main Street struggled amid a deep recession.

 

The legislation has also won Democrats few friends on Wall Street as wealthy donors have started to steer more campaign contributions to Republicans.

 

Under the 2,300-page bill, mortgage brokers, student lenders and other financial firms will have to answer to a new consumer-protection authority, though auto dealers will escape scrutiny. Regulators, who scrambled to contain the damage from failing firms like Lehman Brothers in the last crisis, will have new authority to dismantle troubled firms if they threaten the broader economy. A council of regulators will monitor big-picture risks to the financial system and many large banks will have to set aside more capital to help them ride out tough times.

 

Large private-equity and hedge funds will face more scrutiny from federal regulators, and credit-rating agencies could potentially see their entire business model upended. Much of the $615 trillion over-the-counter derivatives market will be routed through more accountable and transparent channels, and banks will have to spin off the riskiest of their swaps clearing desk operations.

 

Wall Street deployed an army of lobbyists to fight the bill, but they were undermined by the industry's tone-deaf decision to award fat bonuses to executives only months after the government put up $700 billion in bailout funds. Most Republicans argued the bill is an intrusive overreach that fails to address problems in the housing market that spurred the crisis.

 

Even after the legislation is signed into law, financial firms will face years of uncertainty as regulators put the measures into effect.

 

The Obama administration plans to move as quickly as possible to provide clarity and certainty about the new rules, Treasury Secretary Timothy Geithner said. "This is the beginning, not the end, of the process of financial reform," he said.