Are junk stocks jumping with bail out funds ?

Our View:

A recent Wall Street Journal analysis shows that junk stocks have been the most vibrant in the recent market rally with trash financial stocks with the riskiest outlook performing the best. If that is so this sudden buoyancy in the Stock markets is possibly the result of yet another massive regulatory failure .

In the last few months when the Fed & Treasury doled out bailout money with taxpayer funds and later printed $ 1 Trillion paper money to do the TARP funding, it not only increased money supply but increased liquidity in the hands of the same Banks that had caused the September crisis, without adequate stipulations on its mode of spending. The Obama administration had publicly announced that the bailout money was to ensure that Banks kept lending money to keep the wheels of economy lubricated, which meant that lending operations not stock market trading should have been a priority of the Wall Street big boys who were being funded. But interestingly neither the Treasury nor the Fed had added that as a binding stipulation.

Bloomberg analyst Jonathan Weil had warned only a few weeks ago that the Treasury Department’s Public – Private investment program will ensure enhanced liquidity and encourage the struggling financial institutions to swap their assets, including the most- toxic mortgage related derivatives with one another at inflated prices. . The purchases will be financed by big government loans, or TARP funds so that taxpayers are at risk for the bulk of any losses.

The first warnings of short term profiteering by the “bailed out big boys” came from the Q1 Report of Goldman Sachs which used the enhanced liquidity for fixed income trading profits. Despite Goldman Sachs impressive Q1 Profits. Standard & Poor’s kept its “negative” outlook on the firm, citing the fact that profit was concentrated in fixed-income trading.

There is a feeling among some analysts that the big boys of the Wall Street are using dealers, brokers and smaller intermediaries in a you pat my back, I pat yours, move to create a artificial demand and clear the junk from there portfolio, including selling off stocks owned by individuals using the momentum generated by the liquidity from the taxpayer’s bailout money . If true, it remains to be seen if such manipulations are sustainable in the long run.

One thing however remains clear. This enhanced liquidity ensured by the Federal Reserve & the Treasury will do nothing to improve the lending process and pure banking operations that the Obama Government actually wanted, as these Banks have been given a free hand to choose their way on how to stay liquid & generate profits

The results of the self conducted stress tests by the 19 “too big to fail Banks” will be announced by the Government in the first week of May. It is understood that even after liberal re-interpretation of accounting norms to suit their shaky balance sheets, a few banks may not meet the diluted criteria of safe banks. Already Charles Bowsher the Chairman of the Federal Home Loan Bank system’s Office of Finance resigned late last month citing inability to sign the audit report of the Home Loan Banks as he did not agree with the standards and processes for valuing the mortgage-backed securities.

The 77 year old, Bowsher an extremely respected figure in the Banking Circles headed the the Office of Finance, since 2007, that issues and services all the debt for the 12 regional Federal Home Loan Banks, that currently amounts to $ 1.26 Tr. It is the largest U.S. borrower after the federal government, at the head of the pipeline that ensures low cost loans to be distributed to the people through over 8000 member Banks and financial Institutions. The bone of contention was none other than the valuation of the toxic mortgages held by the FHL regional Banks, which in some cases were shown in their books to be much higher than even the securities actually held by the Banks. In short the mortgage values were being grossly manipulated and Bowsher an ex- Comptroller General declined to sign on the audit committee report that would certify such a financial statement.

In absence of a proper framework and a reasonable regulatory mechanism and external audit provisions it is likely that the bail out funds and the TARP money will once again be used for speculation and new junk stocks will be the flavour of the season till they too crash in the markets and turn toxic. If that happens it will start of another downward spiral perhaps deeper than the one that preceeded it.

In this blog from “ecology to economy” we deal with discussing sustainable practices which includes sustainable profits and stock prices.
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