Thoughts from Joe - August 24, 2012

Top Eight

1. The SEC backed off potential money market reforms that could have transformed the industry.  But the fight isn't over yet.  At least two regulatory bodies, the Fed and the Financial Stability Oversight Council, may force dramatic changes to the $2.7 trillion industry, though the procedure for such changes is unclear.  A significant problem faced by our economy is regulatory uncertainty. The SEC is charged with regulating money funds, but since the Commission doesn't feel new regulations are necessary, other agencies are tripping over themselves in what looks like a regulatory power grab.  In the meantime, private industry burns much effort and energy simply trying to see what rules may be in place in the future, instead of improving product efficiencies, delivery, and service to their clients.  Such destructive distraction is happening in most every part of the financial services sector as well as such wide-reaching areas as health care, taxes, and municipal strength.  The private sector needs to know the rules and the rules need to be stable in order for growth to follow.
2. Agency limits recovery levels in short sales for second-lien holders. Properties with Fannie and Freddie guaranteed first mortgages will now be limited to just $6,000 recovery for second-lien holders when a short sale occurs, as opposed to the typical haggling that delays such transactions.  I'm curious:  If the lenders knew this limit would be in place when they originally made the second mortgage loans, would they have demanded a higher interest rate and better terms? Perhaps not made the loan at all in the first place?  It is just this sort of regulatory uncertainty that is keeping the private sector away from the mortgage market. (see item #6)
3. Problems found in 100 percent of brokerage firms audited exhibited problems. The motivation behind all firms includes making money.  The typical Wall Street brokerage firm is under attack due to the industry's efforts to imply fiduciary duty - which does not exist - while providing biased advice or faulty operational controls.  Recent experiences with Madoff, MF Global, and Peregrine Financial will only drive regulators and watchdogs to take a closer look.  In my opinion, the old model of "who's-your-buddy" is on its way out, in favor of the Registered Investment Advisor model.
4. Investment banks institute "unofficial" 25 day quiet period post IPO for JOBS issuances.  Though the new law allows banks to issue research on the day of an IPO, it seems there is an understanding on Wall Street to wait 25 days from issuance.  The uncertainty around the regulation stems from the SEC's delayed comments on the new law.  By delaying sell-side research - which gives further insight into a new company's operations - demand for new issuances may be dampened, working against the original goals of the JOBS act.
5. Minutes from the Fed's most recent policy meeting stir thoughts of QE3.  The eye-catching quote was "many members judged that additional monetary accommodation would likely be warranted fairly soon unless incoming information pointed to a substantial and sustainable strengthening in the pace of the economic recovery."  So, does growth in the housing sector, increased consumer confidence, higher payroll growth, and greater retail sales constitute a "substantial and sustainable strengthening"?  Likely not.  I continue to look for additional QE this year - but I also don't believe it will do much except temporarily prop up the stock market.
6. The housing market continues to show signs of stabilization but Fannie Mae adds some headwinds.  The Zillow Home Value Index rose 0.5 percent in July and is up 1.2 percent over the last twelve months while existing home sales bounced off an eight month low.  Unfortunately, an overwhelming majority of home loans come from Fannie and Freddie, and the former just tightened lending standards which will provide some headwinds.  Even though we've had a few months of positive data on the housing front, I am skeptical we can see a full recovery without housing finance returning to the private sector.
7. Germany and France turn up the heat (slightly) on Greece.  Showing a united front, the two major European powers stated intentions to see progress in Greece before increasing support.  Additionally, the ECB said it would wait for Germany's constitutional court to rule on the legality of the zone's bailout programs before announcing a bond-buying program. In other words, more of the same this week as the eurozone heads toward breakup.
8. Buffet reduces muni exposure.  The Oracle of Omaha has not always had the best timing (see2008's Goldman Sachs investment), however this recent contrarian move looks like a good one considering: Huge recent supply, several unprecedented bankruptcies, shift in California law that works against bondholders, and the continued cash crunch in municipalities.

Key Indices

Source: Bloomberg

Looking Ahead

• We will get a moderate amount of economic data next week with most speculation likely focused on the September 12 - 13 FOMC meeting and possible QE.  Should the Fed want to go through with QE3, it could be announced next Friday during Bernanke's speech in Jackson Hole.
• Next week's Republican Convention will dominate headlines, though neither convention is likely to move markets.
• Earnings releases include:
  • Wednesday: Pandora, TiVO
  • Thursday: Splunk
• There are no innovation-oriented IPOs expected next week.