UNDER THE GUN / BARRON´S ( RECOMMENDED READING )

MONDAY, JUNE 22, 2009

UP AND DOWN WALL STREET

Under the Gun

By ALAN ABELSON

The Fed has been thrust into the middle of the fracas over financial reform. What it means for investors.

WHAT'S THE WORLD COMING TO WHEN YOU CAN'T RIG an election these days without the populace making a big fuss about it? Doesn't anyone have a decent respect for tradition anymore? You run a nice tight theocratic dictatorship in which people breathe only by permission and all of a sudden they're all atwitter just because you stole an election.

Really, one can't blame the bozos in charge of Iran for being sore. You'd be furious, too, if after kicking butts and chopping off heads for 30 years with barely a murmur of complaint, hundreds of thousands of men and -- even worse -- women are pouring out into the streets raising an awful ruckus.

Don't the rabble-rousers realize they're distracting their blessed leaders from the sacred task of building a nuclear bomb, the better to threaten the neighbors with, or maybe drop? A mushroom cloud is a beautiful sight to behold. And, anyway, what's the big beef? -- they let the preordained losers have 34% of the vote.

The stock market, which usually gets riled up if a camel stubs its toe, responded to the Persian turmoil with uncharacteristic aplomb. For that matter, the oil market was similarly unperturbed. Perhaps investors, unlike any number of self-anointed pundits, had correctly divined that the mob running Iran hadn't the slightest intention of surrendering their fiefdom, come hell or high water.

Besides, the Street's attention was fixed on something closer to home and to its heart: the Obama proposal for a sweeping regulatory overhaul of the financial industry. The actual unveiling of the plan was seemingly greeted with a kind of grudging approval manifested in a modest gain in share prices. It's always possible, though, that investors' fears may have been tempered by the comforting knowledge that once Congress waded in, whatever misbegotten legislation emerged would bear as much resemblance to the president's blueprint as a duck to a donkey and, in any case, those Washington vigilantes (a.k.a. lobbyists) would keep them safe.

It could be, too, that they're grown so accustomed to equating not-as-bad with good that anything shy of a ban on capital gains would have occasioned a sigh of relief. On the face of it, moreover, some of the proposals appear simply too outlandish and strikingly contrary to long-standing practice to merit serious concern. Like the idea that brokers must put the interest of their customers ahead of their own.

One unintended consequence of the president's proposal, as alluded to by our friends at ISI Group, has been to thrust the Fed smack in the middle of the budding fracas over what should be regulated and who should do the regulating. If the administration has its way, the Fed's powers would be significantly enhanced.

Whatever the ultimate fate of the legislation -- and it's dead certain that some kind of regulatory reform will become law to appease the populist rage inflamed by bailouts, foreclosures and job losses -- the argument over the Fed's role is destined to leave an imprint on the investment landscape.

As ISI tellingly observes, in the months ahead, the Fed may have to consider nudging rates higher. It's one thing for it to face political pressure not to tighten; that comes with the territory. But it's a much different thing when the Fed finds itself the focus of the debate over regulatory reform. And there's this, too: Chairman Bernanke's contract runs out at the end of January, and we suspect he'd dearly love to hold on to the job.

All of which suggests that he won't be tossing money around with quite the abandon he has been, nor will he be in any great hurry, if he can at all avoid it, to lift interest rates. You can't help but feel a twinge of sympathy for Ben, since the bulk of the blame for the implosion of both the financial system and the economy belongs to his inept predecessor, good old Alan Greenspan.

On that score, no better measure of how the political winds are blowing than the quip repeated by Connecticut's Christopher Dodd, the Democratic point man on the push for financial reform in the Senate, that expanding the Fed's regulatory reach was akin to rewarding a son with a bigger, faster car after he's just totaled the family station wagon.

EVEN BEFORE MR. OBAMA WENT public with his intended redo of the financial sector, and before Iran erupted, and before the revelation that the inmates in charge of the asylum known as North Korea, just for the sheer glee of it, might be pitching a missile in the direction of Hawaii, the stock market began acting a bit more demurely than in this year's rowdy rally that kited the averages as much as 40% higher, and, what's more, performed that amazing feat in a mere four months.

It's not surprising, of course, that after such a rousing dash upward, a touch of buyers' fatigue set in. And there were signs, inconceivable as it may seem to investors in the flush of such a spectacular showing, that the market having gone so far in such a brief stretch had priced everything into share prices but reality.

There were hints, as well, that bullish sentiment, which for a spell remained fairly constrained, had escalated to something approaching euphoria. Investors Intelligence readings of advisory sentiment showed most of these supposed savants, who often function best as contrary indicators, have come a bit late to the party; in recent weeks, the percentage of bulls among them have registered in the mid-40s, compared with the low 20s for the bears.

Moreover, trading took on a distinctly more speculative tone, with small stocks chalking up big gains despite their conspicuous lack of very much in the way of sales and nothing in the way of profits or prospects. And perhaps the most persuasive evidence of the gamier spirit abroad in Wall Street is that, despite the mounting demolition of the commercial-property market, Morgan Stanley plans to sell re-securitized commercial mortgages.

Which, as one portfolio pro acidly observed to Dow Jones Capital Markets, amounts to peddling tarnished assets nicely repackaged with higher ratings. That kind of thing has been going on in residential asset-backed securities in recent months, presumably fueled by the notion that the housing decline has bottomed. But that it now has spread to commercial mortgages when things are getting notably worse is clear indication that the mind-set and, indeed, some of the very stuff that got us into such a jam is back. Alas.
IN OUR UNENDING SEARCH for good news to lighten the mood of our readers and escape the blemish of being labeled a perpetual Gloomy Gus, we've unearthed confirmation that there's always a bright spot, no matter how hard the times. For that heartening epiphany we're grateful to a most unlikely source -- the Memorial Park Cemetery in Indianapolis.

We know you're dying to learn what the good news from Memorial Park is, so we won't keep you in suspense. It's a buy-one, get-one-free sale of grave sites. How about that! In case you were wondering about it, the fellow running the cemetery says this is just one of those promotions it puts on around Memorial Day. Business, he insists, is fine. Whew, what a relief!

THOSE EXCITED SIGHTINGS of green shoots of economic recovery that have fed the voracious investment appetite since the market bottomed back in early March reminds us of nothing so much as the UFO mania that blossomed some years back. And like the UFOs, the green shoots seem to be largely in the eye of the beholder.

We perhaps should mention that at least one market commentator has gone beyond the green-shoot stage and declared that the recession ended in April. We confess we hadn't noticed that resolution so devoutly to be desired, but, then, maybe we need a new prescription for our specs.

In like vein, all the fuss about the dip in continuing claims for unemployment insurance ignored not only the resumed rise in new claims, but also, as Bill King of the King Report has noted, the fact that something in the neighborhood of 50% of the folks on the jobless rolls have exhausted their benefits, which typically are good for 26 weeks. So the decline that prompted so much celebration might just as easily be viewed as eloquent testimony of just how tough it is to find a job.

Prominent among the illusory signs of a turn in the economy is last week's report of an uptick in housing permits and starts. Here, too, the glad cry went out that the "housing slump is over."

Mark Hanson, the savvy proprietor of Hanson Advisors, who knows just about everything there is to know about real estate and mortgages, has his own informed and decidedly less optimistic take on the tad better numbers of residential construction.

Mark points out that permits and starts remain only slightly above the January and February lows. And the modest gains they posted "can be viewed as a bad thing" for the housing market because it adds supply at "the very time foreclosure-related supply is rising sharply." By the official count, there's a formidable 10.2 months' inventory of unsold homes hanging over the market, and Mark reckons the actual supply is between 14 and 16 months.

And, he warns, "We still have the mid-to-high-end implosion ahead of us." An implosion that he envisions will drag down that segment of the market some 50% to 70% from its elevated peaks in 2007.

Watch out, below.

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