By William Patalon III
Money Morning/The Money Map Report
U.S. stocks yesterday (Monday) staged their biggest rally since the Great Depression – with the Dow Jones Industrial Average soaring an all-time record 936 points – on a Federal Reserve-led push to flood the ailing global financial system with dollars and on a U.S. government plan to buy stakes in banks.
The rally was sparked by commitments from the major financial nations to cooperate in getting the credit markets functioning again, and by news that U.S. officials were putting the finishing touches on Washington’s version of a rescue plan under which the U.S. Treasury Department will invest an estimated $125 billion in nine major U.S. banks, and another $125 billion in smaller financial institutions, Bloomberg News reported early this morning (Tuesday).
The White House announced that U.S. President George W. Bush would meet at 7:30 a.m. EDT today with members of his financial markets working group. He’ll make a statement about the plan at 8:05 a.m. U.S. Treasury Secretary Henry M. “Hank” Paulson Jr., U.S. Federal Reserve Chief Ben S. Bernanke and Federal Deposit Insurance Corp. Chair Sheila C. Bair will discuss the plan during an 8:30 a.m. news conference, MarketWatch.com and Bloomberg both reported.
“These are tough times for our economies, yet we can be confident that we can work our way through these challenges and America will continue to work closely with the other nations to coordinate our response to this global financial crisis,” President Bush told reporters yesterday following a meeting with Italy Prime Minister Silvio Berlusconi at the White House.
After an eight-day losing streak – the worst for the Standard & Poor’s 500 Index since 1996 – those dramatic worldwide developments were enough to spawn a rally of historic proportions in U.S. shares. The S&P 500 rebounded from its worst week in 75 years with an 11.6% advance, jumping 104.13 points to close at 1,003.35. The Dow zoomed 936.42 points, or 11%, to close at 9,387.61 – eviscerating the previous record of 499 points, set in March 2000, and posting its best percentage gain since 1933.
The Nasdaq Composite Index climbed 194.74, or 12%, to 1,844.25. Sixteen stocks gained for each that fell on the New York Stock Exchange.
Last week's 18% declines pushed both the S&P 500 and Dow down more than 40% from their peaks last October.
The S&P 500 ended the trading day Friday at 17 times reported earnings of its companies, the cheapest valuation in more than a year. Yesterday’s really boosted the Price/Earnings ratio to 19.2. The S&P 500 is still down 32% this year, positioning it for its worst yearly loss since 1937.
“The worst of the immediate danger is past,” Bruce McCain, chief investment strategist at Key Private Bank ( ) in Cleveland, which manages $30 billion, told Bloomberg, the well-known financial news service.“It's always easier when you've got markets going up and you're not having to talk clients back in off the ledge.”
Kevin Divney, chief investment officer at Putnam Investments in Boston, told Bloomberg Television that “the real catalyst is the levels of valuation.”
But not everyone was quite so sanguine. Money Morning Investment Director Keith Fitz-Gerald cautioned that one strong day in the markets – even a record one – doesn’t necessarily mean there’s a full-fledged rebound in store.
“The real economic growth rates in the financial sector are unclear,” Fitz-Gerald said in an interview. “To say that it’s an accounting nightmare is an insult to the Hollywood honchos who actually make their living transforming nightmares into movies. Fiction writers could not concocted a better horror story than the one that’s rocked world financial markets since last November. Despite all the mergers and acquisitions, and the emergency bailouts, that we’ve seen to date, Wall Street hasn’t even begun to address the underlying business prospects – on anything more than a superficial level – of the lion’s share of the companies that are being bailed out.” [For Fitz-Gerald’s full take on yesterday’s market action – including some insights on how he believes investors should navigate the uncertainty – check out his special market commentary that appears elsewhere in today’s issue.]
All 10 industries in the S&P 500 added more than 7%. Monday’s worldwide rally – which ranged from Tokyo to New York – sent the MSCI World Index up 9.5 %, the biggest gain since the gauge was created in 1970, MarketWatch reported.
The bond market was closed for the Columbus Day holiday. The dollar fell the most in three weeks against the euro.
Details of a Bailout/“Rescue” Plan
On Sunday, the major European Union nations hinting it's on board with its own rescue plan, MarketWatch reported. [For details of the sweeping European rescue plan, check out this related report elsewhere in today’s issue of Money Morning.]to safeguard their banks and financial system, according to The Associated Press. Global efforts to rescue the international banking system gathered force yesterday, with Europe leading the way to provide money to shore up its financial sector and calm traders, and the U.S.
U.S. bankers were summoned to the Treasury Department yesterday, as the U.S. government prepared additional measures to stabilize markets, reported the U.S. shortwave broadcasting service, The Voice of America.
Over the weekend, Treasury Secretary Paulson had called the heads of the five biggest U.S. banks to come to Washington for face-to-face talks about the rescue plan, according to people briefed on the matter. Goldman Sachs Group Inc. (GS) Chief Executive Officer Lloyd C. Blankfein, Morgan Stanley (MS) CEO John J. Mack, Citigroup Inc. (C) CEO Vikram Pandit, JPMorgan Chase & Co. (JPM) CEO Jamie Dimon and Bank of America Corp. (BAC) CEO Kenneth D. Lewis were all asked to attend, according to The AP.
The CEOs had been in Washington this past weekend to meet with international finance officials at the annual meetings of the International Monetary Fund (IMF) and World Bank. This group of U.S. banking sector leaders met with Paulson and Fed Chairman Bernanke for about three hours yesterday, several news sources have said.
When asked for precise details about the plan that’s to be unveiled early today, U.S. Treasury officials remained mum. Indeed, sources would only say that it would include a “series of comprehensive actions to strengthen public confidence in our financial institutions and restore functioning of our credit markets.”
However, after the CEO meetings, some details began to leak out. Industry insiders speculated late yesterday that the Federal Reserve and Treasury Department had outlined a plan to inject as much as $250 billion of the $700 billion rescue plan into top U.S. banks.
In addition, to jumpstart “Interbank” lending, the FDIC would actually insure new senior preferred debt for three years.
The Treasury Department would take the equity stakes in banks using authority it was granted under the $700 billion bank rescue plan enacted two weeks ago.
“We're talking about making investments in these banks in a way that doesn't necessarily punish existing shareholders,” Charles Bobrinskoy, vice chairman of Ariel Investments LLC, which manages $13 billion, said on Bloomberg TV. "Most of the bank actions to date in the U.S. have been good for bondholders but terrible for common stockholders."
Government actions this year to prevent bankruptcies at investment bank Bear Stearns Cos., mortgage lenders Fannie Mae (FNM) and Freddie Mac (FRE) and insurer American International Group Inc. (AIG) resulted in near-total losses for the firms' shareholders.
The collapse of New York-based Lehman Brothers Holdings Inc. (LEHMQ) on Sept. 15 precipitated the latest chapter of the 14-month-old credit crisis, causing banks to stop lending to each other out of concern they may not get their money back.
Direct investments of this magnitude represent a new approach for Treasury Secretary Paulson, who initially advocated a bailout targeted at illiquid mortgage-related assets. When the markets didn’t respond positively to earlier plans, the Treasury Department shifted gears – in a big way.
“They've decided they need to do something drastic and this is drastic,” Gerard S. Cassidy, a bank analyst at RBC Capital Markets (RY) in Portland, Maine, told Bloomberg.
The proposed cash injections in exchange for preferred shares are said to be destined for Citigroup, Goldman Sachs, Wells Fargo & Co. (WFC), JP Morgan Chase & Co., Bank of America Corp., Merrill Lynch & Co. Inc. (MER), Morgan Stanley, State Street Corp. (STT), and Bank of New York Mellon Corp. (BK).
“The government has gone to ‘Plan B’ and it packs a big wallop," Frederic Dickson who helps oversee $25 billion as chief market strategist at D.A. Davidson & Co. in Lake Oswego, Oregon, told the financial news service.
The Treasury plans to spend $25 billion each for stakes in Citigroup and JPMorgan, people said. Another $25 billion will be divided between Bank of America and Merrill, which agreed last month to be acquired by Bank of America. Wells Fargo is to get at least $20 billion, Goldman and Morgan Stanley will each get $10 billion, and State Street and Bank of New York will get about $3 billion each, people said.
The government will obtain its stakes with a type of security designed not to dilute the value of common shares.
None of the nine banks getting government money was given a choice about it, said people familiar with the plans. All of the banks involved will have to submit to compensation restrictions as mandated by Congress, people said.
The remaining $125 billion will be used to recapitalize other financial institutions around the country, the people said., the U.S. Treasury official overseeing the rescue of the financial system, yesterday said the equity purchases would be aimed at "healthy" firms.
News and Related Story Links:
- Bloomberg News:
U.S. Stocks Rally Most Since 1930s on Bank Plan; Dow Gains 936.
Filling in the blanks on plans to rescue banks.
- Voice of America:
Stocks Soar on Wall Street as Markets Bounce Back from Worst Rout in 20 Years.
U.S. stocks join global rally on government plans.
International Monetary Fund.
- The Associated Press: .
The World Bank.
- Money Morning Special Report:
Heads They Win, Tails You Lose: Why the Bailout Plan Will Fail U.S. Taxpayers.
- Bloomberg News:
Treasury Said to Invest $125 Billion in U.S. Banks.
- U.S. Treasury Department Biography:
About the Author
Before he moved into the investment-research business in 2005, William (Bill) Patalon III spent 22 years as an award-winning financial reporter, columnist, and editor. Today he is the Executive Editor and Senior Research Analyst for Money Morning at Money Map Press. With his latest project, Private Briefing, Bill takes you "behind the scenes" of his established investment news website for a closer look at the action. Members get all the expert analysis and exclusive scoops he can't publish... and some of the most valuable picks that turn up in Bill's closed-door sessions with editors and experts.