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Feds Balance Opposing Sides and Large Bank Stocks Fall

Believing that we have reached the bottom because of a long rally is wishful thinking as much pessimism and uncertainty still underlies the economy. Uncertainties surrounding the financial sector are further triggered after listening to the mixed messages sent by policy makers this week. An administration who has been sending messages of backing the large firms such as American International Group (AIG), Bank of America (BAC), and Citigroup (C) countered this argument by attempting to set a more balanced tone this week and not favor the big firms unfairly over the community banks and angry tax payers.

As the two-week stock rally faded this week, it became evident that the rises on major indices since March 10 were nothing more than a bear market rally and probably the result of short covering, specifically for the financial sector. Stocks rallied intensely on Wednesday after the Federal Reserve shocked the markets, saying it would buy $300 billion in longer-term treasury securities over the next six months. Additionally, it decided to keep key interest rates at historically low levels in order to boost the credit market. These announcements set a tone emphasizing that government efforts will return the economy to sustainable growth and caused much optimism and surge in the market.

However after absorbing the news, Wednesday’s victory was short lived as the market mood failed to continue the uptrend rally. On Thursday, the rally stalled as investors worried that the Federal Reserve’s plan to buy government bonds and debt securities will cause inflation. Major indices further weakened on Friday after Sheila Bair, Chairman of the FDIC, said that emergency fees are necessary to keep the FDIC funded. She said that the fund used to insure customer’s deposits may be insolvent by the end of the year. This news comes in when financial institutions are already struggling and to add on may have to face higher fees to keep FDIC funded. Week ended as The Dow Jones Industrial fell 1.7 percent to 7,278, the Nasdaq dropped 1.8 percent to 1,457, and the S&P 500 declined 2 percent to 769.

The financials led the markets lower on Friday as Washington sent mixed messages at a time when investors analyze every detail uttered by the policy makers hoping they may spill some insight from the on-going stress-tests. These stress tests are evaluating approximately twenty banks on two scenarios: one based on current economic conditions and the other on a more severe economic recession. In the stress tests, regulators are reviewing the nation’s biggest banks to see if they have enough capital to absorb losses incase of an extreme economic downturn. While the tests are on-going, anything even remotely sensitive that policy makers say gets analyzed as being indicative of a potentially worrisome situation that they are seeing in the tests, but not explicitly revealing.

Beginning with President Obama who announced plans of his administration to propose new financial industry oversight that includes a resolution authority, similar to the FDIC, which can seize control of banks, take over their bad assets and sell the good ones.

Additionally, FDIC Chairman Sheila Bair said the government’s strategy in the financial crisis of bailing out large institutions tagged as “too big to fail” must be replaced by a new system of supervision that prevents institutions from taking on excessive risk and becoming so large that their failure can threaten the financial system.

Similarly, Democrat Senator Christopher Dodd, suggested that it makes sense to give the FDIC the authority to take over and resolve big institutions whose collapse would threaten the financial system.

Finally, Ben Bernanke also emphasized the same tone on Friday when he said that improved resolution procedures for large nonbank firms would help reduce the too-big-to-fail problem by giving the government the option of safely winding down a systemically important firm rather than keeping it operating.

Much of this mild tone against the big firms were probably set to balance support for all sides as the Feds may be facing pressure from the community banks who feel the big banks are being favored and the angry tax payers who have long been against the big banks receiving TARP money. However, regulators’ attempts to balance their support for all parties sent mixed signals to the investors and triggered further uncertainty on large bank stocks such as BAC which closed below 10.7 percent and JPM which closed below 7.21 percent on Friday. Both Bernanke and Geithner have emphasized against nationalization and nothing indicates that standpoint has changed, but the recent tone raises questions that may cause large bank stocks to be volatile next week. As of now, Obama’s administration is still against nationalization of big banks, but seek a new system for the safe resolution of nonbank firms.

Much of these “too big to fail” uproar from Washington was also influenced by intense outrage over millions in bonuses paid to AIG employees. AIG has received $182 billion in federal bailout money. On Thursday, Democrats rushed a bill to levy a 90 percent tax on bonuses paid to employees with family incomes above $250,0000 at all companies that have received at least $5 billion in government bail out. Bank CEOs took opposing stand against this bill and expressed their concerns against it. Internal concerns about this bill may signal further volatility in large bank stocks next week, specifically JPM, C, and BAC as questions mount about retaining talent and unfairly punishing the non-deserving employees. Drops this week after a bear market rally was expected and should not be a sign of failing stocks. Early next week should be a close watch for large bank stocks as Geithner reveals his much awaited plan to rid the financial system of toxic assets. Also, keeping in mind that a full stress test is not available yet, results of which if made public would offer more insight. Bank of America’s Ken Lewis stated, “Given all that I know, I am confident that we will pass the stress test.” And added that, “The bank could turn over the TARP money now if it weren’t maintaining higher-than-normal capital cushions because of the fragile state of the financial system.” First quarter results are also awaited to provide insights to the direction for these stocks. Citi and Bank of America CEOs have hinted a profit for the first quarter, but their statements prove nothing until the final results are posted mid to later part of April. If the positivity hinted by the CEO’s hold truth and the profits are significant enough to indicate strong and sustainable earning power of these firms, then the financial sector may once again see a rally in April.