Good Evening: A day after stocks endured their worst pounding ever on the inauguration day of a U.S. president, investors decided to take back most of yesterday’s losses. It seems that decent earnings news out of IBM, some purchases of BAC stock by senior management, and some further hints about Mr. Obama’s economic plans combined to push prices higher. In movie parlance, “take 2″ of the inauguration rally turned out to be a keeper.

Equity index futures were higher prior to this morning’s open in the wake of a surprisingly good earnings report from IBM. I don’t know enough about Big Blue’s business to comment on the quality of their “beat”, but market participants certainly liked the news out of Armonk. Also on the positive side were reports from Northern Trust and BONY/Mellon, showing that yesterday’s poor showing by State Street was an anomaly among the asset-gathering banks. Equities jumped 2% in the early going today, but an awful housing market index reading thirty minutes into the day put an immediate halt to the rally (see Merrill’s take below). The major averages headed back down and tested the unchanged mark before stabilizing.

But hopes for some positive news out of Apple this evening (and they delivered) and some assurances from team Obama that the economy was indeed priority #1 helped spark a rise in stock prices that didn’t stop until the closing bell rang. It was disclosed during the trading session that Bank of America CEO, Ken Lewis, and 5 directors bought BAC stock. The whole financial sector levitated on the news. By day’s end, the Dow’s 3.5% gain paled in comparison to the 5.3% advance in the Russell 2000. Treasurys, however, choked at the prospect of absorbing more than half a trillion of new debt issuance during the next three weeks (see below). The yield curve steepened in response, with 10′s and 30′s seeing their yields rise 15 bps and 18 bps respectively. Also reversing today was the U.S. dollar, which gave back 1.3% against its major competitors. Commodity prices responded by posting a nice gain of their own. Led by a 6% rise in crude oil, the CRB index gained almost 2% today.

Below you will find the latest “Investment Outlook” from PIMCO’s Bill Gross. Entitled, “Andrew Mellon vs. Bailout Nation”, Mr. Gross tackles the subject of our government’s response thus far to the credit crisis still roiling our markets. Not only does Mr. Gross not apologize for backing the “bailout nation” approach, he points out that we would likely be much worse off if we had taken Andrew Mellon’s advice (he was Treasury Secretary under Herbert Hoover) and let Mr. Market sort it all out. I agree with him in that I think our entire financial system would have utterly collapsed, followed by a collapse in the economy that would have made the recession now under way look robust by comparison. I also agree that we cannot “prove a negative nor recreate history to show what might have been”. We’ve chosen our interventionist path, says Mr. Gross, so let’s get on with deciding the best way forward.

President Obama may have his own ideas, but given all the positive feedback I’ve received about my “matching gift” idea for the TARP, I want to revisit the concept to answer concerns posed by readers. More than one worried about the pricing of the toxic assets that would wind up in the TARP, and they especially worried about the government’s role in picking the proper price. Fear not, I say, since the government doesn’t have to make these pricing decisions. The banks themselves pick the price that their bonus pools are willing to pay and the government simply matches by paying the same price (either 1 to 1, 2 to 1, or some other, debatably optimal ratio). If the banks pick too low a price, then both the bonus pool and the TARP will do well. If the banks pick too high a price, then they are only sticking it to themselves, as well as to taxpayers. The banks will thus have an incentive to mark the assets properly for sale to both their employees and the TARP.

Other readers were quite enthusiastic about this “matching gift” idea, so much so that a few want to forward it to Washington. I can only say that I don’t see why it couldn’t work. Warren Buffett came up with a similar idea (find a market price and then match with government funds), so I’m just building on his idea using Credit Suisse’s equally excellent plan. The concept is to put the employees and senior management at the banks on the hook while giving them an incentive to properly mark all this drek. Done well, with market-based incentives and help from the taxpayers who will have to pay up, anyway, we could all win. I know of at least two readers who are trying to find a way to get my idea in front of the Treasury Department, and I’m sure there are other good ideas out there. Let’s share them, improve upon them, and forward them on for consideration. It would be a shame if good ideas simply received a quiet nod before the delete key rendered them to electronic heaven.

– Jack McHugh

U.S. Stocks Jump on Obama Plan, Insider Buys at Bank of America

Treasuries Drop Amid Concern Rescue Effort to Swell Debt Sales

Andrew Mellon vs. Bailout Nation — Investment Outlook, by Bill Gross, PIMCO

No floor for housing pdf

Category: BP Cafe, Markets

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

7 Responses to “Inauguration Rally — “Take Two””

  1. quiddity says:

    I don’t see the “bonus pool” approach as all that reassuring. Presumably the value of the toxic assets is unknown, so all the pool does is make executives share in the upside (or downside) along with the government of what’s basically a gamble. While that may make for a better sense of equality – and hugely better than the current set up – it doesn’t mean that we’ll get pricing that reflects the real value of the paper. (And I know “real value” is a loaded term.)

    Also, bonuses are, well, bonuses. I think there is a good chance that a top executive would be willing to forgo that extra money, as it were, if it meant getting the government to overpay. The government overpaying means that the bank and its shareholders have not absorbed the full loss of the paper. The bank survives more or less intact, and the executives are still there doing quite nicely.

    Maybe it would work, and I applaud fresh thinking like that proposed by Mr. McHugh, but I remain skeptical.

  2. BlankReg says:


    - The value of the toxic assets are only as unknown as the values of any other assets. There is no such thing as a known value separate from bids and offers — that’s why markets exist. “Presumably” — you nailed it. These assets DO have bids. When a bank or govt official says that the value is unknown, they really mean “the bids are so low we want to pretend that they don’t exist”. That way we don’t have to mark them down, and can justify generous overpayment by the TARP/Fed. The problem that this plan addresses is exactly that: “if you think that the real value is higher than the existing bids, then bid the fair value yourself, and the public will mimic your bid, times 2.”

    - Bonuses at banks are actually a quite significant part of compensation (Jack mentioned this).

    - The notion that an exec would willingly hurt his own finances for the financial benefit of the shareholders is, I think, unlikely, given recent history.

  3. Moss says:

    We need to get these ideas to CNBC and Bloomberg for discussion.

  4. Thisson says:

    Under this proposal, aren’t the executives incentivized to price the bad assets at almost zero?

    This way they get all the upside, and the bank’s shareholders get all the downside (par for the course, right?)

  5. batmando says:

    @ Thisson
    “Under this proposal, aren’t the executives incentivized to price the bad assets at almost zero?
    This way they get all the upside, and the bank’s shareholders get all the downside (par for the course, right?)”

    This at least gets all the crap out in the open. If priced at zero, anything left on the bank’s books (i.e., not bonused out) would have the same chance at recovery that the exec’s see as an incentive to take it as bonuses. ne pas?

  6. Jack McHugh says:

    The numbers are indeed daunting, and Nouriel was on it from the outset. The one issue I have with “grabbing” the assets ASAP is that the remaining assets won’t support the deposit base and we could see a nasty run on banks of all sizes. My plan is by no means comprehensive (as I said two nights ago, “a partial solution”), but the one aspect that will reasonate with average taxpayers is that the bankers are on the hook, too. In doing so, it might help avoid runs as other, more comprehensive solutions are put in place.

  7. John Reeder says:

    Thisson and BlankReg – Right on. Jack-I think this is a homerun of an idea. Bank execs will be incentivized to mark the assets as low as they can and still hold on to their jobs. Keep in mind if the assets go too low, the execs will be out on their asses.

    I love this idea and will be sending it to my congressional representatives. Maybe every day.

    As Jack points out, at least a part of the upside of this idea is that it counteracts the feeling of helplessness that arises out of watching the government get gamed by the same guys that gamed the system in the first place. I don’t even hold anything against the bank execs that put us in this position. They acted out of self interest and were simply working in a system that did not have enough safeguards in place to ensure that they didn’t game the system. Then the government comes along to try to “fix” things and screws it up even more!