Banking Industry Backlash
January 25, 2010
Good afternoon. Last week was the worst week in the market since last March, with the SPY down over 4% to close at 109.21. That closing number is also lower than the 111.44 closing number from last year, wiping out all of the early January gains. The VIX was up a dramatic 52% for the week to close at 27.30, and erased a lot of the upward sloping volatility skew we talked about last week.Unfortunately, retail margin requirements do not generally allow being short time (or calendar) spreads (meaning being long the near term option and short the further out option) or we could possibly have profited handsomely by last weeks move. In any case the market sell-off was driven (by general consensus) by the President’s declaration of new rules for commercial banks including new taxes, something of the level of $90 B for the twenty largest banks over ten years. There also would be some curbs on so-called “proprietary trading” that remains ill defined, but something short of a reinstitution of the recently repealed Glass-Steagall Act.
In addition, it appears the re-confirmation of Federal Reserve Chairman Ben Bernanke might be in some trouble.
Obviously there is a serious backlash of sorts going on in Washington against the banking industry as the powers to be recognize the extent of the franchise the largest banks currently have, the lack of adult management in place that contributed to the current crisis, and the general inability of the Boards to hold back bonuses for even a year (in effect putting it in the face of those who bailed them out). My read of the attitude of our new President (again, only one man’s opinion) is that the more he learns about the financial industry, and I think he was originally fairly weak in that area, the more horrified he becomes. There has been way too much concentration allowed in the last couple of decades, no thought whatsoever of the ramifications of failure given the concentration levels, and practices that have become common that are so anti-common sense as to be almost laughable. Just as a quick example of anti-common sense, how many realize that if I were to put in an order for my clients to execute a trade, and want to do the same thing for my personal account, I cannot enter my order at the same time. However, if I was to trade against my clients order that would be acceptable under the rules. So it is perfectly okay for a firm like Goldman to put out a buy on a stock, then sell it to you from their firm account, in essence taking the opposite position. Remember in the movie Stripes when the late John Candy looks at the other fellow’s poker hand, sees the flush, and says, “ If it were me, I would bet everything. But that’s me. I am an aggressive gambler. Mr. Vegas” The fellow raises, and John picks up his own hand, which he knew all along was a full house, and says, “I win.” That scene is similar to a firm trading against you on their recommendation, but perfectly legal according to the warped rules of our SEC.
The most important part of the President’s dilemma, and the most interesting from an economic perspective, is what to do with an industry that has become, at the upper levels, way too big and non-competitive. We have a lot of laws in this country, and a lot of opportunity for people in government to essentially choose which ones they care to enforce. We see that at every level, from the local enforcement people in Illinois choosing to go lightly on political corruption and fraud (go figure) to the people in Washington virtually ignoring anti-trust laws for a couple of decades. If fact, they have been ignored to such and extent that most people probably don’t even think they exist any more. When a competitor takes over another at a premium, all you see is a steady stream of shareholders celebrating their new found wealth and talking heads crowing about the big new “deal” meaning that all is right in the investment world. Very little time is given to the competitive ramifications, which are virtually always negative. You do not have people jumping up with the opening line of the Act “Every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce among the several states, or with foreign nations, is declared to be illegal.” Sec. 2 goes on to state very clearly that anyone trying to monopolize is guilty of a felony. Having said that, virtually every President since the revered (history can be so rose tinted) Ronald Regan has virtually ignored anti-trust laws, every merger was a good merger, especially banks.
So there appears, now with the new proposals by President Obama, four ways to deal with monopoly power. The first, and easily the best, would be to prevent combinations or mergers that create the monopoly power in the first place. Is there any real economic reason for Chemical Bank to have taken over Manufacturers Hanover, then Chase Manhattan? That reason would get more elusive if we tried to figure out why Chase was allowed to merge with JP Morgan, or that combined firm with Banc One? So the best way to enforce the laws against monopoly is to do just that, do not let the combinations occur in the first place. Should we throw in jail all the politicians that ignored the law, or maybe execute them? How many jobs were lost in this process, and whom did it benefit? Did the amount of assets on the balance sheets of Citi or Bank of America really have to be $2 T to be efficient, given that the total tax take of the U.S. government is “only” $2.4 T?
The second way to deal with monopoly issues is to break them up. Examples would be the old Standard Oil Company and AT&T. You can understand Standard Oil since it was formed before the Sherman Act passed, but why would you ever have to go through that expensive and lengthy process if you could just stop the combination from happening in the first place. Not to mention that it really looks bad for government to approve a merger, then later go to court to break it up. This is not a very efficient way to enforce the Act.
The third way is accept the cartel or monopoly as necessary for some reason, and regulate how much the companies can charge. Examples are utilities, railroads and airlines for a while, really anything that is deemed inefficient for “real” competition (for example it might not make sense to have 5 gas lines from competing companies running under the street). The traditional way to deal with this is to have some sort of process to regulate how much the gas company can charge, or the railroad before rates were de-regulated.
President Obama has brought up a fourth, and I think very dangerous, method. I really doubt if he has connected the dots on what he is saying, but his proposed tax on what is essentially the Banking cartel is a whole new entrant into the tools of dealing with anti-trust issues. He is essentially saying that we will accept he cartel and the incredibly excessive monopoly power (they give you nothing on your money and charge you 25% on your credit card) and just apply what amounts to a cartel tax to the whole mess. I will say this; with all due respect for those I have talked to that are losing sleep over the plight of the poor banks, the banks may love this deal. To be able to monopolize and plunder at will, with the only stipulation being you have to pay a special cartel tax to make up for the monumental governmental screw up allowing it to happen in the first place, that is spectacular. Again, my friends so worried about the poor Banks, we are talking about the top twenty Banks paying $90 B over ten years, or an average of $9 B a year. If the economy picks up at all, given the franchises the Banks have been essentially granted due to governmental ineptitude, that $90 B will be pittance of what they will make. The question and problem is that is not the government’s job. Nowhere in the Act that I read gives the President the right to ignore the damage monopoly power can do to the general population and merely tap into it because the government is broke. This is insanity! Break them up, and have all mergers off limits for the next 25 years. Don’t look at it as a further opportunity to sneakily tax the population through some indirect method. Let’s see, allow the Banks to monopolize and steal, but get our piece, is this administration from Illinois?
How do we trade it? Well, we certainly want to stay protected, as the steady stream of less than well thought out ideas keep lobbing out of Washington. I still think, despite everyone’s worries to the contrary, that the Banks will end up just fine. My guess, and I shudder as I say it, is that they will be quasi granted their new cartel status and the tax will be passed at a level barely above being an irritant. I think that really is abhorrent, as the amount of money being gouged out of middle and lower class America in the credit card area should have people executed. I think we may correct further, but if the financial ETF, the XLF, gets sold off to an absurd level, say under $13.50, we need to get long seriously. Unfortunately, these people will not lose to any meaningful extent. As for the rest of the market, I would stay cautious, my chances of a serious double dip keep increasing by the month. We will see a little bounce in the economy with the stimulus money going through, but I think, unfortunately, that it will not be self-sustaining. I will be happy to be wrong on this.
Tune in to hear the NEW “Stocks and Jocks” show on February 1, 2010 as we will begin airing on 1240AM Chicago radio from 5:30am – 7:00am CST and as usual, the show will be streaming live online as well as available for download later. www.StocksAndJocks.net