Thursday, November 1, 2007

Banks Under Severe Pressure as Markets Crack

One day after a 25 basis point reduction in the federal funds rate, Wall Street implodes.

This is not supposed to happen in healthy markets, and it's becoming more and more apparent that the US Equity markets are anything but healthy. Conventional wisdom would assert that investors took the Fed's policy statement - accompanying the rate reduction - to mean that there would be no more rate cuts to follow this year, and also doesn't expect the economy to continue growing at a level pace, despite yesterday's report of 3.9% growth in 3rd quarter GDP.

Dow 13,567.87 -362.14; NASDAQ 2,794.83 -64.29; S&P 500 1,508.44 -40.94; NYSE Composite 10,022.08 -289.53

Considering the massive trading volume, it was more like a rush for the exits rather than an orderly retreat. Stocks were hammered as two major Dow components, CitiGroup (C) and ExxonMobil (XOM) were the bearers of bad news.

CitiGroup was downgraded by CIBC from Sector Outperform to Sector Perform, which was actually somewhat kind, considering that the basis for the shift. In a related note, the analyst reported that CitiGroup would have to raise nearly $30 billion in capital to reach par with its peers in terms of their capital-to-equity ratio.

ExxonMobil, meanwhile, missed estimates for 3rd quarter earnings by 4 cents, at $1.70 per share. One can hardly shed a tear for the company that boasted record profits as oil prices rose dramatically over the past 5 years.

Declining issues trounced advancers by a better than 5-1 ratio, while new lows ruled the day over new highs, 444-194. It was a dramatic reversal of market conditions, which just a day ago, looked bullish.

The question on everyone's lips apparently is, "what's the problem?" Fed chairman Bernanke and Treasury head Paulson have jawboned the market for months concerning the housing situation. What they have not been completely open about is the condition on banks and credit markets, which are in serious straits.

The credit conundrum stems from the toxic paper issued by mortgage lenders, packaged as investments and sold at various face values as SIVs (Structured Investment Vehicles). Many of these packaged offerings were loaded with sub-prime and otherwise non-performing loans and today some are worthless or valued at only pennies on the dollar.

The major banks, such as Citibank, Wells Fargo, Bank of America and countless other smaller lenders were both buyers and sellers of these "investments" through their brokerage and hedge fund subsidiaries and these losses simply cannot be written off quickly enough. What's worse is that there are more of these sloshing around everywhere, and as more homeowners default, more of the investments holding the notes blow up. The bulk of these have not yet hit the market and the banks are suffering the impact.

Today's market action is not one which occurred in a vacuum. The condition of credit markets is deteriorating by the day and astute individuals are getting out of banking stocks and most other equities before the stampede engulfs them all.

Making matters worse is the high price of oil, which actually slipped a bit today, down $1.04 to $93.49, though the move higher was largely the result of the Fed's rate reductions in September and October.

Gold and silver followed suit, losing marginally on the day.

Economic conditions in the United States are terrible, to put it lightly. Between the Fed's constant interest rate tinkering and the government's refusal to curb deficit spending, the value of the dollar has shrunk considerably over the past 6 years. we are paying the price for rampant credit expansion under Greenspan, off-budget expenditures for the conflicts and occupations in Iraq and Afghanistan, lack of regulatory control in mortgage and credit markets and a wickedly overpriced stock market.

A return to a strong dollar standard would be the best and most rational approach, but the Fed and Washington politicians aren't interested in the painful truths of serious fiscal and monetary restraint. The Fed's combined 75 basis point reduction in rates has only exacerbated the problem and Wall Street's crying for more isn't helping.

There's going to be a lot of pain to be doled out and the longer officials saddled with the charge of managing the economy wait to act, the worse the downfall will be.

Tomorrow, non-farm payrolls for October will be reported before the open, though it may simply be a sideshow to the ravages inflicted on the markets by investors with better things to do with their money than to see it slowly, inexorably evaporate.

We may see a dead cat bounce or another day like today, where everyone and anyone is selling just about anything and everything.

If the Democrats had moved for impeachment last winter, and the Republicans in congress actually had a conscience, we may have avoided some of this. But now, with the most incompetent president in the history of the nation still sitting for another 15 months, we may be seeing the beginning of the 21st century's reprise of the Great Depression. God save us all.

NYSE Volume 4,328,372,500
NASDAQ Volume 2,626,966,750

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