Puts and Calls: Deconstructing last week’s market swings

Tom Karol Occasional Political Commentator
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U.S. markets up: The markets closed up on Monday, based largely on positive developments in Europe. The Dow was up almost 4 percent and the S&P 500 up 4.5  percent and the Nasdaq closed up almost 5 percent.

Asian and European markets rallied early Monday after the European Union authorized a $955 billion bailout, made up of loans from 16 Euro-zone governments, and contributions from an EU emergency fund and the IMF. The Bloomberg Europe Banks and Financial Services Index, led by gains by Spanish, Portuguese, Greek and French banks, rose 15 percent on Monday, the largest gains in more than 18 months.

On Sunday, voicing U.S. concerns of contagion and support for decisive action, President Obama spoke to the German chancellor and the French president on the need to restore global investor confidence. As further evidence of global cooperation, the Bank of Japan held an emergency board meeting Monday and agreed to invest an additional $21.6 billion into financial markets for the second consecutive trading day to help ease credit.

After last week’s market fall, questions remain:

  • The Wall Street Journal reported that U.S. exchanges took early Monday precautions after last week’s turmoil, invoking rarely used rules allowing designated market-makers to not show prices and doubling the threshold levels for labeling erroneous trades.
  • The SEC met Monday with the heads of the major U.S. stock exchanges in Washington, including the chief executives of the New York Stock Exchange and Nasdaq, according to reports. The heads of electronic exchanges Direct Edge and the BATS Exchange also attended.
  • In a joint statement on Friday, the SEC and CFTC said the extreme volatility of the markets is “inconsistent with the effective functioning of our capital markets, and we will make whatever structural or other changes are needed.”
  • Appearing on CBS’s “Face the Nation” Sunday, Senate Banking Committee Chairman Chris Dodd, Connecticut Democrat, said, the SEC must “step up very quickly and let us know what happened here and what steps need to be taken.”
  • The House Financial Services Capital Markets Subcommittee will hold a hearing Tuesday titled: “The stock market plunge: what happened and what is next?” on the causes of the market’s drop, with testimony from SEC Chairwoman Mary Schapiro, CFTC Chairman Gary Gensler, NYSE Euronext Chief Operating Officer Lawrence Leibowitz and Nasdaq Executive Vice President Eric Noll.

Not an accident? On Friday, Bloomberg reported that the SEC was looking to determine if market participants accidentally or maliciously entered orders that derailed normal trading. On Sunday, the White House’s homeland security and counterterrorism adviser, John Brennan, said in a television interview there was “no indication … not at all” that a cyber attack could be behind the chaos that shook Wall Street on Thursday. But on Monday, the Hill reported that Obama had not ruled out sabotage. White House press secretary Robert Gibbs said, “I wouldn’t rule anything in or rule anything out.” It is unclear whether law enforcement or Homeland Security have been participating in the SEC and CFTC meetings.

Financial reform: According to the Washington Post, Senate Majority Leader Harry Reid of Nevada hopes to wrap up the financial overhaul bill by the end of the week, but with no votes scheduled for Monday or Friday, that leaves lawmakers just three days to hammer out the differences. Some problems, such as the argument over resolution authority — the “too big to fail” debate — has ended, according to Dodd, and opposition to the proposed consumer protection agency has been addressed. Compromises are springing up everywhere. Fed independence has been resolved, new audit rules have been created and both Democratic and Republican choruses are singing from the same hymnals on deposit-insurance fees. The major obstacles remaining, and they are major, are the “Volker rule,” which would preclude deposit taking banks from offering investment banking services, and the extremely complex issue of derivatives regulations.

Amendments continue to be offered. In a statement to the Wall Street Journal, Sen. Carl Levin, Michigan Democrat, said he is drafting legislation to prevent conflicts of interest by “prohibiting companies from taking the opposite side of the deal for their own account,” at least when they are marketing investments they have created themselves.

Financial reform, immigration and climate change weren’t enough for the Senate? Several times in recent days, Reid has ticked off other priorities on the Senate’s big list. Appropriation bills. Food-safety legislation. Tax provisions. Presidential nominations. A jobs package. Obama nominated Solicitor General Elena Kagan to the Supreme Court Monday, directing the Senate to act as quickly as possible so she can get busy.”