The Volcker Effect

2010-01-26

The market was humming along quite nicely, digesting a slightly negative Case-Shiller home price index and a slightly positive consumer confidence index reading, until in the afternoon Paul Volcker (chairman of the newly formed Economic Recovery Advisory Board) starter speaking to some institutional investors as arranged by one of the brokerage firms.  His commentary was very negative for banks, highlighting that the separation of proprietary exposures from FDIC-insured institutions is going to have a much more widespread impact than originally anticipated.  Financials led the sell-off and dragged down the entire market.  Citigroup suddenly gapped down around that time and Goldman ended up below $151 with strong support expected at the $150 level.  The financial sector reversed from positive to -1.4% for the day, while the market ended up only slightly in the red.  The Dow was down 3 points or 3 bps, the S&P was down 5 points or 42 bps, and the Nasdaq was off by 7 points or 30 bps.

Our take: following the blow to Obama on the healthcare plan, he had to win back voters' support, so he turned to the most popular subject of the day -- "bank bashing" -- by pushing forward Volcker's proposals.  Bringing forth Volcker helps in two ways: he wins Obama public support, but also can diffuse the situation that cropped up around Bernanke's re-election at the end of January.  Bernanke is seen as a supporter of banks, so populist sentiment was against him.  Obama now has something to talk about at his State Union address tomorrow, but can also "give" Volcker to the populists in exchange for keeping Bernanke in power.  The problem will be reigning in Volcker, because this is his chance to push for his long-held beliefs that large banks should be broken up (regardless of whether he believes that prop trading was the root cause of the financial crisis, which he most likely doesn't agree with).  However, this could destabilize the weakened financial system once again and hold the economy behind for much longer than it has to.  Our question is: why aren't we focused more on creating jobs and then dealing with secondary issues like that?  Out read-through: at least the government realizes that re-confirming Bernanke is of critical importance for the market and the economy, and probably the Volcker Plan will be significantly diluted -- if it goes anywhere -- once it loses steam after Bernanke's re-confirmation.

On the economic news of the day, the Case-Shiller 20-city composite was down 5.3% year-over-year vs. 5.0% consensus.   The index was down 0.2% month-to-month in November 2009.  Overall, the housing market is improving, but it was somewhat concerning that some of the weak markets made new troughs.  Consumer confidence surprised on the positive with a 55.9 reading vs. 52.9 in December and 53.5 consensus for January.  The FHFA house price index showed another increase in single-family home prices based on data from Fannie and Freddie derived from transactions involving conforming conventional mortgages purchased or securitized by the two GSEs.  The price index was up 0.7% from Oct to Nov, following a 0.6% gain from Sept to Oct, potentially reflecting government incentive programs for first-time homebuyers.

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