Bankers Take the Spotlight
Liz Rappaport
08/11/07 - 09:28 AM EDT
The uncertainty that caused last week's dramatic stock market swings and central bank interventions will stoke investors' fears for a while, but traders likely will know more next week about the illiquid credit valuations behind the turmoil.
As the dust settles after a week in which the
Dow Jones Industrial Average had both its single biggest advance this year and its second-biggest decline, investment banks will likely be working overtime.
The largest Wall Street brokerage firms have been trying to mark to market or determine the market value of illiquid esoteric securities that have gone sour in the ripple effects of the subprime mortgage meltdown.
The uncertainty caused the Dow to fall 387 points on Thursday, and another 31 points by day's end on Friday. But despite central bank liquidity injections and laments on Wall Street that the markets need emergency federal funds rate cuts, the large-cap index remained higher for the week by 0.4%.
In the coming week, many fund managers may see their day of reckoning: July's month-end portfolio evaluations by prime brokerage firms that lend to these funds will include some of these best attempts at valuations. Many investors have pointed to Aug. 15 as a day to watch, as margin calls and collateral requirements issued then could generate some forced selling of more liquid assets.
With the
Securities and Exchange Commission now combing through Wall Street brokerage firms' books to ensure they are being consistent in their accounting methodology, the pressure will likely be on for these firms to be conservative in their valuations.
This could well mean more hedge fund blowups and cascading, fear-driven selloffs. It may also mean more declines for the financial sector, particularly brokerage houses like
Bear Stearns(BSC),
Lehman Brothers(LEH),
JPMorgan(JPM),
Morgan Stanley(MS) and
Goldman Sachs(GS), among others.
Without accurate valuations, banks are unclear on how much margin collateral to demand, or how much exposure they have in their own warehouses and proprietary trading desks. The uncertainty reached an apex last week, when French bank
BNP Paribas seized up withdrawals from two of its funds after acknowledging it is unsure of how at risk the bank is from these types of investments.
"It is unknowable how far this goes, but as surely as night follows day, it is spreading," says Jeffrey Saut, chief equities strategist at Raymond James.
The ensuing panic after BNP's news Thursday caused banks to scramble for cash to cover potential losses and to increase their lending rates to each other. That caused the European Central Bank, the
Federal Reserve and the Bank of Japan, among others, to inject unusually large amounts of liquidity into the system.
The Fed had injected $35 billion earlier in the day, after $24 billion on Thursday morning. At around 1:50 p.m. EDT Friday, the Fed set up a third operation to offer an extra $3 billion into the system, seemingly to ensure enough liquidity for the weekend. The special actions were the greatest the markets have seen since after the Sept. 11, 2001, terrorist attacks. The Fed added a daily average of $75.3 billion in the week after the attacks, according to
Bloomberg.
The Fed seems to be doing its best to support the financial system without convening an emergency meeting of the Federal Open Market Committee to make rate cuts. But if market turmoil persists, expectations for such intervention will surely surge again. And the Fed will once again be threading the narrow needle of reassuring panicky markets without exacerbating the crisis.
"Like everyone else, [central banks] face uncertainty about the future (most of which is shared uncertainty), but, unlike almost anyone else, they must maintain an aura of wisdom, of being in control, almost as if they did know (a lot) more about the future than the rest of us," writes Ethan Harris, chief economist at Lehman Brothers. "They do not."
Likewise, investors may find out if the government-sponsored agencies
Fannie Mae(FNM) and
Freddie Mac(FRE) will be allowed to buy up more mortgage-backed securities.
"I'd be surprised to see an emergency meeting, unless there was a market crash," says Saut. Saut says that recent market action like Thursday's 387-point drop in the Dow was not a crash, but part of a "selling stampede" that began July 19 after the Dow hit 14,000. He says stampedes generally take 17 to 24 trading sessions to the downside to wear out, and they can easily be interrupted by one- to three-day "throwback rally" attempts.
Friday was day 16.
Occasionally these stampedes last 25 to 27 days, Saut says, but "they are rare." The longest march he can remember in any direction was a 38-session upturn into the 1987 stock market crash on Oct. 19.
In the middle of the day Friday, the fed funds futures market had priced in 100% odds of a rate cut by September, and 100% odds of another cut by the end of the year, according to Miller Tabak.
And whether the Fed cuts rates or not, headlines like those from troubled mortgage lender
Countrywide Financial(CFC) Friday morning that the "unprecedented" disruptions in the credit markets may continue are surely not over.
Traders will have to digest much more economic data next week than they had this week as well, but any spillover from the current financial system trouble is unlikely to show up in July data.
Retail sales, to be reported Monday, are expected to show a modest rise for July. Producer prices and consumer prices measured by the PPI and CPI are likewise expected to show only a small uptick. The PPI is due Tuesday, while the CPI is out Wednesday.
Investors will get the report Thursday on housing starts and building permits for July.
Among companies, major retailers -- including giants
Wal-Mart (WMT),
Macy's(M) and
Home Depot(HD) -- will begin reporting their second-quarter results, providing added insight on how any credit and housing woes may be spreading to the consumer.
Long story short, keep holding on to your hats.
