RISK PREMIUM: “MONDAY, MONDAY, MAY THE MARKET BE SO GOOD TO ME” (my hopeful improvement on lyrics by The Mamas & The Papas)

For The Week Ended: September 26^th, 2008

STOCKS APPEAR TO BE CONSOLIDATING

Monday is now the new Friday (which can’t help but bring to mind lyrics from the hit song by The Mama & The Papas, “Monday, Monday, can’t trust that day”).  It seems likely that stocks will do little more than move in an ever-increasing narrower band while waiting for Congress to pass the administration’s $700-billion economic rescue package.  The market will be under downward pressure as investor confidence continues to erode while awaiting passage of the legislation.  On the other hand, swift action, based on substantial and substantive initiatives, could help galvanize the “consolidation” which has been underway for at least the past two weeks.  Unfortunately, based on our reading of the House’s draft proposal negotiations, too many members of that body are using the hearings to engage in election-year grandstanding (The economy sputters while elected officials play partisan politics).  Meanwhile, the bad news in the troubled financial sector continued unabated as it was announced that Washington Mutual had collapsed in the largest bank failure to date.

WHAT’S AN INVESTOR TO DO AS LOSERS STILL OUT-NUMBER WINNERS

It appears as though this is a period to seek out safety and buy only those stocks which are of the utmost quality.  It is very dangerous to play the legislative game; there have already been significant changes since Thursday (September 25) to the plan crafted by the House.  The Dow Jones Industrials opened the week at 11,394.42 and closed it at 11,143.13, down 251.29 points or roughly 2%.  Volatility seemed relatively light compared to recent trading weeks, with the Dow trading in a 754 high/low range over the five days.  Buyers were largely absent, with only 634 New York Stock Exchange stocks closing higher on the week.  They were eclipsed by 2,683 stocks ending the week lower while 26 remained unchanged.  Based on our Risk Premium model, the Dow Industrials were nominally bullish (7.51% versus 7.78%, week over week).  Conversely, the Dow Transportation and Utility Indices remained bearish.  In short, it was a week best characterized as a “traders market,” with the market not giving a convincing performance in either direction as investors anxiously awaited passage of a rescue package.

TARP IS SO YESTERDAY SO NOW IT’S CONGRESS’ THREE “Rs”: “REINVEST, REIMBURSE, REFORM”

The rescue package was initially called the “Economic Recovery and Corporate Accountability Act of 2008.”  (Informally it was referred to as TARP, a nice “cover” for “Troubled Asset Relief Program.”)  But the formal moniker failed to pass muster with Congress.  Instead, by Sunday, the plan’s new working name was “Reinvest, Reimburse, Reform” (The title seems to be getting more politically correct as does the substance of the latest draft).

After “heavy-bipartisan-lifting,” a “sort of” consensus seems to have developed around the original Bush-Paulson plan to stabilize American financial markets.  Foremost among these “improvements” is the requirement of Congressional review for any future commitment of taxpayers' funds.  If the government loses money, the financial beneficiaries will have to pay back the taxpayers.

The three main provisions of the financial rescue legislation are:

ü  Reinvest in the troubled financial markets to stabilize our economy and insulate Main Street from Wall Street

ü  Reimburse the taxpayer through ownership of shares and appreciation in the value of purchased assets

ü  Reform  Wall Street practices with strong Congressional oversight and no golden parachutes

CRITICAL “IMPROVEMENTS” (the Democrat’s words, not ours) TO THE RESCUE PLAN

Democrats have remained adamant about protecting American taxpayers and Main Street and want to see these concerns provided for in the Bush-Paulson plan.  Accordingly, they are insisting that the following must be part of any economic recovery legislation:

ü  Protection for taxpayers by ensuring they share in any profits generated by the plan

ü  Gives taxpayers an ownership stake and profit-making opportunities with participating companies

ü  Puts taxpayers first in line to recover assets if a participating company fails

ü  Guarantees taxpayers are repaid in full if other protections have not actually produced a profit

ü  Allows the government to purchase troubled assets from pension plans, local governments and small banks that serve low- and middle-income families

EXECUTIVE COMPENSATION

The rescue plan would ban excessive compensation for chief executive officers (CEOs) and other top executives of participating companies by placing certain restrictions on their remuneration.  Among the provisions:

ü  No multi-million dollar golden parachutes

ü  Limits CEO compensation that encourages irresponsible risk-taking

ü  Repayment of bonuses based on promised gains that later turn out to be false or inaccurate

ü  Strong independent oversight and transparency

INCREASED OVERSIGHT

Under the plan there would be four separate independent oversight entities or processes to protect taxpayers’ interests:

ü  A GAO presence at the Treasury to oversee the program and conduct audits to ensure strong internal controls, and to prevent waste, fraud and abuse

ü  An independent Inspector General to monitor the Treasury Secretary's decisions

ü  Meaningful judicial review of the Treasury Secretary's actions

ü  Transparency by requiring posting of transactions online to help private sector oversight

HOME FORECLOSURES

In order to help prevent home foreclosures (projected at two million in the next year) from crippling the economy the government would be able to use its powers as the owner of mortgages and mortgage-backed securities to facilitate loan modifications by:

ü  Reducing principal and or interest rates and extending the payback time

ü  Extending provisions (passed earlier by this Congress) to void tax liability on foreclosed mortgages

ü  Assisting small businesses needing credit by aiding small community banks hurt by the mortgage crisis and allowing these banks to deduct losses from investments in Fannie Mae and Freddie Mac stocks

RISK PREMIUM STATISTICS

§         The Industrial Risk Premium ended at 7.51% versus 7.78%

§         The Transportation Risk Premium increased to 7.91% from 7.67%

§         The Utility Risk Premium increased to 7.76% from 7.65% n

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