Puts and Calls: Europe stumbles as euro surrenders Monday’s gains

Tom Karol Occasional Political Commentator
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Euro rescue stumbles: The euro has given back all of Monday’s gains and the benchmark gauge for European shares is down after registering its largest gain in 17 months. Some analysts question the decision to solve a debt crisis by issuing more debt; others are concerned the existence of the rescue fund creates a moral hazard, weakening the incentive for countries to maintain fiscal discipline. Stocks fell Tuesday in Europe and Asia, and U.S. markets closed down slightly. To make matters worse, an internal IMF assessment paints a gloomy picture of Greece’s ability to recover economically, with years of high unemployment, slow growth and political bickering threatening to undermine a recently approved international rescue program.

SEC chairman: “The SEC is not fast enough to keep up with the market:” Regulators testified before Congress on Tuesday about the mysterious 1,000-point drop in the markets last week, but we unable to identify the causes. Neither the SEC nor the exchanges have uncovered evidence of an erroneous “fat finger” trade: “We cannot yet definitely rule that possibility out.” They have  not identified any information consistent with computer hacker or terrorist activity. This lack of information may mean that these events did not cause the glitch, but it may not. “One of the challenges we face in recreating the events of last Thursday is the reality that the technologies used for market oversight and surveillance have not kept pace with the technology and trading patterns of the rapidly evolving and expanding securities markets” according to testimony by SEC Chairman Schapiro. If the regulators can’t keep up with the legitimate evolving operations of the markets, how can they possibly be expected to prove or disprove malicious or accidental variations?

Some participants sure seem to understand the markets: According to filings with the SEC, investment trading operations at Goldman Sachs made profits of at least $25 million every trading day in the first quarter of 2010. On 35 of the 63 working days in that same quarter, they made more than $100 million per day. JPMorgan’s trading unit reported making an average of $118M daily during the same period. Seeking Alpha reports that, all told, the 14 largest investment banks posted a combined $79 billion in first quarter revenues, marking the best numbers in three years and falling just 1% short of the record.

Financial reform continues: The big banks’ profit gains could backfire, however, lending ammunition to lawmakers trying to rein in banks’ proprietary trading, apply a global bank tax and require higher liquidity levels. As part of financial reform, the Senate on Tuesday passed legislation requiring new audits of the Fed by a resounding 96-to-0 vote. The bill was a watered down version of the original proposal that was strongly opposed by the White House and Fed, who argued that the bill would compromise the independence of U.S. monetary policy. The bill that passed would require an audit of the Fed’s emergency lending during the financial crisis and a new audit of the central bank’s governance. It expressly leaves out an audit of the Fed’s monetary policymaking. Next up this week is consumer protection, with several Senators offering exemptions for smaller businesses.

Some parts of government are doing OK in the markets, too: A report by the Special Inspector General for the Troubled Asset Relief Program (TARP) said Treasury is getting good prices in selling off the warrants it received from troubled banks, but the process does not show how they got the prices they did, and whether or not better prices could have been obtained. Though the prices negotiated by the Treasury for bank warrants have been at prices largely at or above estimated values, the Treasury failed to document the decisions of the internal panel in charge of handling the warrants and didn’t document the substance of its negotiations with banks. “When a brief telephone call can mean the difference of tens of millions of dollars, it is a basic and essential element of transparency and accountability that the substance of that call can be documented contemporaneously.”

Less positive TARP news: A major recipient from the TARP program AIG and the U.K. firm Prudential are in talks to revise the composition of their $35.5B deal for AIG’s Asian unit. AIG Chief Executive Benmosche is said to have told employees he is confident a $35.5 billion deal to sell its Asian life insurance unit would move forward. Still impeding the deal is U.K. regulators concerns about the unit’s capital position after the deal. Restructuring the deal that fell apart last month may require that the cash amount paid to the U.S. government, which owns 80 percent of AIG, be cut by some $2 billion from the $25 billion originally proposed. A failure to close the deal would set back the insurer’s repayment plans and could turn into a political and public relations disaster for both AIG and the U.S. government.