Friday, February 13, 2009

How To Play The Mark-To-Market Suspension

As everyone following the financial markets knows- every time a "rumor" or "sound-byte" surfaces that the FASB 157 mark-to-market provision might be suspended (or modified), the stock market runs like the wind. Recently, for example, rumors led to a giant comeback rally in the financials and other sectors. And, on February 10, more mark-to-market rumors flew in after-hours in regard to a modification possibility to be included in the Obama Financial Stability Plan- and again, the market was stoked. The market rallied into, and through the next trading day as the "TARP Accountability" hearing limped onward.

TALF- good. TARP- not so good.

Democratic Representative and Chairman of the House Financial Services Committee, Barney Frank, recently said, "One of the things I think we should be exploring is the extent to which you can retain mark-to-market but make the consequences discretionary with the regulators rather than automatic."

There are several elements of the current "M2M" model which need to be resolved, rather than using the "one size fits all" rules under FASB 157: marking certain assets at maturity, marking assets trading in illiquid/liquid markets, marking assets in regard to a company's model and marking assets not easily "discovered," etc - to which, if modified/resolved, would help companies become truly transparent and potentially show many companies to be stronger, less underwater and in certain cases, no longer insolvent.

In the words of Congressman Paul E. Kanjorski (D-PA), Chairman of the House Financial Services Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises, he wants "to find a way – within the existing independent standard-setting structure – to still provide investors with the information needed to make effective decisions without continuing to impose undue burdens on financial institutions."

Furthermore, while the government is trying to figure it all out, including the public/private partnership, some have also recommended suspending M2M altogether.

There is nothing wrong with M2M bringing transparency to investors as to a company's financial position- but, true transparency has proved to be quite complicated (and unfair in many cases) in the real world.

The powerful Paul Volcker, former Fed Chairman, and now one of Obama's key advisors, is a big advocate for modifications of the current M2M.

On certain finance television channels, there are TV anchors (who have very limited or no economic cred) who have said that suspending or modifying M2M won't "do anything"- which, of course, is utterly ridiculous, so take them with a grain of salt. In fact, at very least, there will definitely be some "tweaks" made- which will be game changers in themselves.

The next potential mark-to-market rumor catalyst will come shortly when the House Financial Services Committee holds a hearing spotlighting the matter on March 12, 2009.

Also on the table with the SEC is the potential reinstatement of the uptick rule (or a modified version of it)- another major market-moving event.

Section 132 of the Emergency Economic Stabilization Act of 2008 "Restates the Securities and Exchange Commission’s authority to suspend the application of Statement Number 157 of the Financial Accounting Standards Board if the SEC determines that it is in the public interest and protects investors."

Meantime, short-sellers have been pummeling financial stocks with utter impunity. Yet, in the front of every short-seller's mind (at least the smart ones), is the dread of a sudden announcement that mark-to-market has been suspended or modified- and causing a fast and furious short-covering stampede, in tandem with longs crashing into the financials with utter abandon.

This has to be causing shorts severe anxiety- eyes and ears glued to the news, fingers glued to the mouse, trade tickets already filled out- ready to cover-buy on a dime.

But what if an announcement comes overnight- or over a weekend, after the extended-trading session is over, or before the pre-market session begins? Could you imagine the sheer short-seller panic as they get caught with financials opening pre-market at something like a minimum of 20% higher- and then ratcheting up another 20% in the first minutes of trading?

So, how should longs and shorts play the strong possibility of a mark-to-market announcement coming any day now? Well, for one thing- it's probably not a good idea to be short overnight or over the weekend. And, longs would want to get in before after-hours closes, leading into the next trading day.

Of course, there are many shorts who are arrogant enough to believe that getting caught in a massive short-squeeze can never happen to them. Not with the media pundits trash-talking financials across the board. But- it is obvious that, if a mark-to-market rumor can cause a swift and large pop in the market- imagine what the real announcement will cause!

And, of course, as other details of the trillion dollar TALF come to the fore over the next few weeks- the markets will ultimately lock into incredibly bullish momentum...and not look back.

Longs don't want to get caught chasing financials once the announcement comes- not with all of that Big Money sitting impatiently in Treasuries and Money-Market funds collecting pennies- all suddenly piling into the equity markets for the long bull run. Bank stocks (C, MS, JPM, BAC, GS) and ETFs (XLF, UYG) are but a few of the beaten-down stocks that will be first out of the gate, leading the charge. Nothing worse than that sinking feeling longs get when they are kicking themselves for not getting in BEFORE the news hits the street.

So these are my St. Paddy's Day words of wisdom for all you traders:

If you are long on financials- hold your positions (and ride out any dips). Shorts- don't get caught short-squeezed overnight.

Be long. Be strong. And, be a champion...

Meantime- keep track of how proposed bill H.R. 607 ("To direct the Securities and Exchange Commission to issue guidance on the interpretation of fair value accounting") progresses (RSS Feed).

Also- click here on March 12, 2009 to hear the HFSC mark-to-market hearing live.

GT McDuffy

(Disclosure: author holds no positions in any of the stocks mentioned in the article above)

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