Until confidence returns on the solvency of banks, the market is unlikely to break out of the range between 750 and 900 on the Standard & Poor's 500 and between 7500 and 9000 on the Dow Jones Industrial Average, traders say.
Many large banking stocks are trading at distressed levels, and Bank of America closed Wednesday at its lowest level since 1990. A pattern has emerged where banking stocks lead the broad market on a rally at the first signs of new government intervention, only to return to their downward ways during the ensuing weeks as the harsh reality sinks in: There is no quick fix to fears of insolvency in the banking system.
Recent stock-market action reminds some market participants of the short-lived rallies when a plan to rescue mortgage lenders Fannie Mae and Freddie Mac was unveiled, or when the Troubled Asset Relief Program, or TARP, financial rescue package was floated.
So far, some traders say, there is little reason to believe the unfolding of this new plan will be any different to the other instances of "buy the rumor, sell the news."
In this case, there is no guarantee that any government plan will stabilize the financial sector, and there remains the possibility that the government could have to take big ownership stakes that would dilute current shareholders. "Every time we have some kind of financial stimulation from the government, we definitely pop initially, but the overall trend tends to be lower" for the financials and the market, said Ryan Detrick, senior technical strategist at Schaeffer's Investment Research.
There's a lot of important information in the preceding paragraph. In addition, I'm going to spend the day on this because I think it's a really important question.
Let me begin with a few observations:
-- The modern economy requires a well-functioning financial system. Without it, we're essentially dead in the water. So long as the financial sector is in the middle of this extended crisis the economy cannot grow at full potential.
The basic issue has been and still is how to deal with toxic assets. Everybody owns either the loans directly or a large enough block of securitized loans that their respective balance sheet is effected. No plan adequately deals with what to do with these assets. The bad bank idea implies that at some time the institutions will have to sell the assets to another party. Let's assume these assets are not correctly valued. That means the sale will force institutions to take a big loss, probably hurting its balance sheet further.
The idea of nationalizing the banks runs into different problems. From the question of who to nationalize, to how to actually perform the transition from private to public ownership to preventing the politicalization of the banking sector once the public owns the shares this idea is also fraught with problems. I detailed the problems in more detail in this article.
What people seem to be clamoring for is a one shot solution where Congress passes bill X with provisions Y and afterward everything moves forward. Personally, I don't see how that can happen. The problems are too big and wide and far too complicated. I think the answer will come piecemeal at best. And as a result, the US economy will grow at below potential for at least this year and probably into the next.
