Saturday, March 14, 2009

Your Next Trades for Mark-To-Market, The Modernized Uptick Rule, The PPIF and TALF

Everyone following the financial markets recently saw major pops across the spectrum. Rumors about FAS 157/mark-to-market/fair value accounting modifications, the reinstatement of the uptick rule, the coming public/private partnership relating to the buying up of distressed assets, along with some of our largest banks announcing they had operating profits over the first two quarters of 2009 made the stock market run like the wind.

Now, rumor is turning into reality. More light has been shed relating to FASB 157 and the uptick rule- scaring the pants off the shorts. Indeed, shorts have been covering their positions near and far. Yet, with each continuing ramp up of the market, they continue to arrogantly believe that the bear market rally is nothing but a dead cat bounce- and are trying desperately to catch a top to short, only to realize they miscalculated- and have to cave in and cover-buy, each with successive short-squeeze fuel. Hence the market has been heading higher and higher. The short-seller vernacular has, indeed, changed from a "single-day" short squeeze to a "one week" bear-market rally- and as things continue to ramp up, this, too, will change to a "few week" bear-market rally. And then some.

You see- the estimated $7-10 trillion of Big Dog longs out there in the world will finally decide to come back in the market for the long haul. This has happened many times before. What starts out as a dead cat bounce catches fire like a twig in the forest, and turns into a raging bull-market. I've said it before- and I'll say it again. The long becomes the new short- and the day-trading clueless herd of shorts get overwhelmed and booted out of the game. Many short-selling funds have closed their positions and are now going long.

Here's more fuel for the fire coming this week:

One day after being confronted by an angry, impatient unified and bipartisan House Financial Services Committee- FASB, the SEC and the OCC agreed to finally move on mark-to-market and fair value modifications after 6 months of endless studies, evaluations and delays- else Congress would do it for them. To this end, FASB announced Friday that they were meeting Monday, March 16, 2009 (8am) to discuss issuing guidance clarifying M2M as applied to assets in illiquid markets A major step in the right direction- and just one of the important modifications coming. The HFSC wants all FAS 157 modification plans in place by early April- and in time for the upcoming April 2, 2009 G20 meeting. FASB will be voting on the matters discussed at the Monday meeting by then- which, in summary, would put discretion in the hands of the company to determine if a market for an asset is liquid and whether a transaction is distressed. FASB has put its M2M proposals up for public comment with the aim being to enable companies to use the mods for their 1st quarter 2009 earning reports.

Also on Monday, TALF will be kicking in upwards of $10 billion towards unfreezing the secondary credit market. And, the Obama administration will be seeing to shelling out stimulus bill cash toward reducing small-business lending fees. The government would also increase guarantees on some SBA loans to 90%. Officially the TALF will be launched to the world on Thursday (March 19, 2009), designed to unfreeze the consumer lending market.

On Thursday March 19, 2009 (10:30a), the powerful Senate Committee on Banking, Housing and Urban Affairs, led by Chairman, Senator Christopher Dodd (D-Conn), will also hold a hearing- Modernizing Bank Supervision and Regulation- which is another positive for the financials.

And, this week, big rumor has it that the Treasury may finally begin to roll out initial details of the much-anticipated PPIF (the Public Private Investment Fund). The markets are highly tuned for specifics relating to this plan that is designed to enable private investors to buy up distressed assets with the government acting as a backstop- providing low-cost funding and insurance- with potential returns for both the private side and the taxpayer. A huge bullish catalyst for the markets as the plan steps up in March.

Also, SEC Chairwoman, Mary Schapiro, said last week that the SEC is aiming to reinstate the uptick rule- with a proposal due in April. The SEC is meeting on April 8, 2009 to discuss various "price-test" options and alternatives related to short-selling (stay tuned for developments relating to these "alternatives"). Market pundits who think this is going to be the same old uptick rule, one which might be ineffective in today's fast-trading high volume markets, will be in for quite a shock when the modernized uptick rule with a new price test is finally rolled out. Much to Schapiro's credit- the new version (or alternative) will be quite effective, indeed. Equally important in any ultimate decision made by the SEC will be to what extent it is applied to market-makers in both the equity and options markets.

There have been those who have said that if the SEC were truly interested in reinstating the uptick rule, they would do it immediately- however, it will take a bit of time, technologically-speaking, to implement any modernized or alternative version (plus, the SEC has to go through the short "public commentary period"- which could put a final rule in place by the end of the 2nd quarter 2009).

Democratic Senator Ted Kaufman (D-Delaware) and Senator Johnny Isakson (R-Georgia) have also just introduced a bill that would order the SEC to reinstate the uptick rule within 60 days- with provisions that would prevent short-sellers in financial stocks from placing a short-sale order lower than 5c above the last transaction price- and would give priority to any longs selling shares. Rep Harold Ackerman (D-NY) has already introduced a bill in the House to restore the uptick rule.

To summarize "what's been what" with M2M modifications thus far:

Back in early February 2009, Chairman of the House Financial Services Committee, Rep Barney Frank (D-Mass), 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." He has also, more recently, stated that there will be "substantial changes" made to mark-to-market.

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. Particularly important are issues regarding institutions that have capital requirements (ratios) tied to marks on certain assets.

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.

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."

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. Back in the early 80's, Mr. Volcker was responsible for bringing the United States out of a terrible financial crisis.

Volcker is also Chairman of the highly influential Group of 30. Another member is the G-30 is none other than current Treasury Secretary- Tim Geithner. In fact, if President Obama were thinking of replacing current Fed Chairman Ben Bernanke with anyone who has history in his favor- that would be Volcker. Without a doubt, Geithner and Volcker would be a formative combination in resolving the current market crisis.

The G-30 is pro-revisiting M2M and making changes- which will be major market movers..

Section 12 of the G-30's recommendations:

Fair Value Accounting
Recommendation 12:

a. Fair value accounting principles and standards should be reevaluated with a view to developing more realistic guidelines for dealing with less liquid instruments and distressed markets.
b. The tension between the business purpose served by regulated financial institutions that intermediate credit and liquidity risk and the interests of investors and creditors should be resolved by development of principles-based standards that better reflect the business model of these institutions, apply appropriate rigor to valuation and evaluation of intent, and require improved disclosure and transparency. These standards should also be reviewed by, and coordinated with, prudential regulators to ensure application in a fashion consistent with safe and sound operation of such institutions.
c. Accounting principles should also be made more flexible in regard to the prudential need for regulated institutions to maintain adequate credit loss reserves sufficient to cover expected losses across their portfolios over the life of assets in those portfolios. There should be full transparency of the manner in which reserves are determined and allocated.

Here is an excerpt from the:

FEBRUARY 26, 2009

"3. As the financial crisis evolved, weaknesses in
accounting, credit rating agencies and other market
practices were exposed.

Fair value accounting rules were inconsistently
applied and have contributed to downward spiraling
valuations in illiquid markets. Credit rating agencies
failed to analyze collective debt obligations with
sufficient vigor. Clearance, settlement and collateral
arrangements for obscure derivative contracts created
uncertainty and need clarification..."

Warren Buffett has told CNBC that "mark-to-market accounting should be retained, but regulators shouldn't use it so much to require institutions to increase their reserves." This is in keeping with one of the primary modifications that can (and should) be made relating to M2M- and would result in relieving substantial pressure on the banking system- a major positive for financial stocks.

Buffett also thinks that debt currently valued at mark-to-market is a "good buy"- which bodes well for the forthcoming public/private partnership (PPIF) being put in place, assuming Buffett's sentiment echoes that of other private investors looking to buy up the "bad" assets (although pricing these assets is as much a function of whatever investors will actually want to pay for them as much as what they're marked to on an accounting basis. Currently, buyers turn (or would turn) a profit by taking advantage of the spread caused by M2M accounting rules and realities).

All indications presently show that there are many private investors who are willing to buy up debt (and are doing so), especially assets that are of a "less-toxic" nature, and, obviously, at as low a price as possible- whereas the holders of these assets would want to sell them as high as possible. Many potential large investors are jockeying for the most favorable terms and regs that would best support their agendas.

The most recent mark-to-market stock market catalyst was the March 12, 2009 House Financial Services Committee hearing spotlighting M2M and fair value accounting under FASB 157. In this hearing you heard testimony relating to the above modifications.

Back to normal mortals.

On certain finance television channels, there are a couple of TV anchors (with 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 major "tweaks" made- which will be game changers in. Especially in regard to banks' capital requirements and relating to distressed assets traded in liquid/illiquid markets- all of which will allow to investors to have more far more accurate information in evaluating companies and relieve substantial pressure on banks. Fed Chairman Ben Bernanke has recommended re-visiting these areas.

Investors should focus their attention on what Frank, Bernanke, Geithner, Volcker and Buffett have all said in regard to the value of making effective M2M modifications- rather than on what these certain clueless TV anchors say. Furthermore- one of these anchors keeps harping that the government doesn't have a "plan" as to what to do with toxic/distressed assets- which is also untrue- as the government has said they have the public/private partnership under way with the idea of providing low-cost loans to stimulate the buying up of these assets on the private side. Unfortunately, TV anchors and regulars have more "TV time" in which to spout a lot of misinformed nonsense. Most investors, however, have figured out who to trust and who not to trust.

So, how should longs and shorts continue to play the constant stream of mark-to-market, uptick rule, PPIF and TALF announcements, updates and meetings seemingly coming every day- that will continue to affect the markets over the next 4-6 weeks? As I've said before- 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.

Longs definitely don't want to get caught chasing financials or other stock sectors as the markets head up- as I've said many times before- 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 continue to run, leading the charge. Insurance stocks like Genworth Financial (GNW) especially, and Prudential Financial (PRU) are so oversold it's mind-boggling. Genworth is particularly interesting because it doesn't insure CDO's- and, therefore stands to benefit most with a broad market ramp up where wealth insurance is finally going in the right (bullish) direction.

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

Remember- bear market rallies can suddenly turn into bull market rallies in the blink of an eye. As short-covering continues, this will have the inadvertent effect of pulling more and more of that Big Money in- before things run off without them. Indeed, last week's rally included large institutional investors (pension, mutual and insurance funds) finally beginning to come back into the stock market, according to Stuart Frankel & Co. president and NYSE floor-maven, Jeffrey Frankel.

Can you say- "No bull left behind?"

GT McDuffy

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

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