Market Update
Dwight Johnston
Vice President, Economic & Market Research
Breaking The Endless Cycle
From the stock market’s perspective, January did not provide a very good kickoff to 2009. Equity traders came into the New Year with expectations that the market would trade higher in anticipation of the new fiscal stimulus program. But the relentless drumbeat of negative news about the banking industry undermined all attempts to generate optimism from presumed benefits coming from a stimulus plan. The fiscal stimulus program is still being debated in Congress, but some version of the plan is likely to be signed in February. But the attention now has shifted away from the stimulus bill to yet another major bailout effort for the banking industry.
Some form of a good bank/bad bank strategy will be the centerpiece of this latest “solution” for the banking industry that should be rolled out before the halfway point of February. The idea is to get the “bad” assets off the balance sheets of banks. In theory this will keep the banks privately managed, attract new capital, and protect some value for current equity and debt holders of the banks. The problems with any plan that stops short of nationalization of the top tier banks include valuing the “bad” assets and determining which assets are “bad” and which are merely injured. The banking industry is likely halfway or less than halfway through accounting for losses on securities and loans.
Additionally, with the deteriorating characteristics of other forms of consumer and commercial lending, banks simply don’t know what assets will turn bad in the future. Banks are currently carrying many assets as performing now that won’t be in the future. If the government sets up a structure that only addresses current “bad” assets, the effort will fail. Private capital will not flow into banks, and banks will still hoard any money to shore up eroding capital. Nationalization of the top tier banks would be a last resort solution, but it is appearing more likely than ever that that will be the ultimate answer. For almost two years recurring financial problems have undercut any and all efforts to stem the market and economic decline. It’s time to end the façade that the final solution to the banking crisis is yet another hybrid program.
In the meantime, based on the economic data reported in January, the economy was in a downward spiral in the waning months of 2008. More job losses and even less consumer spending are almost inevitable in the first few months of 2009 as the negative trickle down effect works through the economy. There are hopeful signs that some critical economic sectors could bottom this year, and I discussed those at length in my January 13 Longer-term Commentary; the risk is that the headline economic news we’ll see ahead will create a negative feedback loop in which bad news drives even further retrenchment by consumers and businessmen alike. We’ll need some positive surprises along the way to break that cycle. After all the negative surprises in 2008, isn’t it about time that some positive surprises come our way?
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