Puts and Calls: Markets fall as Congress debates financial regulatory reform

Tom Karol Occasional Political Commentator
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The first amendment: An amendment offered by Senate Banking Committee Chairman Chris Dodd, Connecticut Democrat, and Ranking Member Richard Shelby, Alabama Republican, to the Restoring American Financial Stability Act (S. 3217) was adopted Wednesday by a vote of 93 to 5. According to Congressional Quarterly, the amendment drops the proposed $50 billion resolution fund that would have covered the costs of a major financial collapse, and empowers the Federal Deposit Insurance Corporation (FDIC) to liquidate large firms with a credit line from Treasury. The amendment requires congressional approval before the government could guarantee the debt of a financial firm.

Financial reform warnings: With more than 36 major amendments circulating, the work on financial reform in the Senate will be neither quick nor easy. Senate Majority Leader Harry Reid, Nevada Democrat, is warning senators against planning vacations for the first week in August, when Congress typically breaks. This is a significant threat as August is prime campaigning season and Reid is trailing in the polls. Even if financial reform can be resolved in relatively short order, Congress still plans to address emergency spending measures — complicated further by the announced retirement of House Appropriations Chairman David Obey, Wisconsin Democrat — a contentious energy and climate bill, and an even more contentious immigration reform effort.

Financial markets take a hit: As Congress worked to address financial reform, the markets suffered their worst drop in three months as worries spread about Europe’s financial stability and Euro zone policymakers and the head of the International Monetary Fund warned of looming financial contagion. The Dow Jones Industrial Average fell 225.06 points, or 2 percent, to 10926.77, its worst daily decline in both point and percentage terms since February. The Nasdaq composite dropped 3 percent and the CBOE Market Volatility “fear index” jumped almost 19 percent. On a positive note, Tuesday saw the Dow’s fourth straight triple-digit point move, indicating higher trading volume.

  • One of Tuesday’s biggest losers — and a major factor in the Nasdaq composite’s slip — was Apple (AAPL), which dropped almost 3 percent on reports that the Department of Justice and the Federal Trade Commission are deciding which agency will open an antitrust inquiry into Apple’s software development policy. Apple is refusing to support Adobe (ADBE) on Apple applications and is requiring software developers who create apps for the iPhone and iPad to use Apple’s programming tools exclusively.
  • Shares of the U.K. insurer Prudential (PRU.LN) dropped more than 1 percent when the company announced a delay in its deal to buy an Asian unit from AIG (AIG). Prudential had to postpone the sale of $20 billion of shares to investors to fund the deal and work with regulators to refine the capital position of the enlarged group under the U.K. insurance groups directive. The deal could benefit the U.S. government, as Treasury and the Fed have lent or invested almost $140 billion to bail out AIG.

New bank tax proposed: Tuesday on Capitol Hill, Treasury Secretary Tim Geithner pitched a new bank fee that would apply to financial institutions with more than $50 billion in assets that are eligible for an array of emerging assistance programs, including the TARP and lending programs set up by the FDIC and the Fed. American subsidiaries of foreign-owned banks would also be covered. Geithner said that more than 99 percent of American banks, which he said provide most small loans to businesses and farms, would not be subject to the tax.

More on the bailout: Fannie Mae and Freddie Mac claim their repayment obligations are keeping them from becoming viable. In its Form 10-K filled with the SEC, Fannie reported that the $7.6 billion that it will pay in dividends “exceeds our reported annual net income for all but one of the last eight years, in most cases by a significant margin.” Fannie and Freddie were essentially nationalized in 2008 and together have received about $130 billion in bailout funds. In exchange for that funding, the administration received senior preferred stock from the two companies that pays an annual 10 percent dividend in cash, or 12 percent in stock. As part of the deal, Treasury is also required to provide additional capital as needed to correct any net worth deficiencies through 2012. Sens. John McCain, Arizona Republican; Judd Gregg, New Hampshire Republican, and Shelby now plan to offer an amendment that would force the government to end its conservatorship of Fannie and Freddie in two to three years and terminate government subsidies to Fannie and Freddie thereafter.

Priorities: The Securities and Exchange Commission’s (SEC) stated mission is “to protect investors, maintain fair, orderly and efficient markets and facilitate capital formation.” Last month, the SEC acknowledged that, because of limited resources, it would only be able to examine 9 percent of registered investment advisers and 17 percent of investment company complexes in 2011. The SEC has allocated resources, however, to a broad investigation into certain companies doing business in Cuba, Iran, the Sudan and Syria — countries designated by the Department of State as having “repeatedly provided support for acts of international terrorism.” The SEC investigation is said to include inquires of several companies in the pharmaceutical and energy industries.