The overall market as measured by the Dow Jones Industrial Average lost approximately 450.89 points, or approximately 5.3% last week to finish at 8,046.42 last week. The overall market appears to continue to be suffering from a loss of confidence in just about everything. The rally that followed the announcement of Timothy Geithner as Treasury Secretary can somewhat be viewed as a sign of confidence in the handling of the financial crisis, which I believe can somewhat summed up as a loss of confidence. This brings us to an interesting question: if the current financial crisis involves a widespread loss of confidence in almost every asset class, what will it take to restore that confidence? Think about this for a second, the financial crisis started with rising defaults and declining home prices, then spread to the financial sector when the assets they held were forced to be written down in value, and now we are seeing funds and other investment groups taking losses because no one really wants to own debt assets that can be drastically written down because someone else is forced to sell a tiny amount of the securities when trading volume has dramatically shrunk. Why would anyone buy a new issue CMBS or pool of credit card debt when a triple A rated security could be written down by 40-50% just because someone else was forced to sell? It's just not worth the risk to your firm and your career. Now the financial crisis has morphed into a guessing game of which financial institution will be forced to write down its portfolio of these assets due to a freezing up of the market. This creates a lack of confidence in the health of these financial institutions, see Citigroup 'C' as an example.
The root cause of a lot of these problems is FASB 157, which requires firms to market the value of these securities to market for valuation purposes on their balance sheet and record the changing value as a gain or loss on their income statement. Theoretically companies can use an alternate valuation method to value these assets on their balance sheet. However there is a problem with this "alternate valuation," Sarbanes Oxley holds the public accountants who audit these firms personally liable for any harm or losses caused as a result of these "alternate valuation" methods. Think about that for a second, any accountant or accounting firm that would say for example allow Citigroup 'C' to place an alternate valuation (other than a market to market valuation) of CMBS or other assets on its books would then become both professionally and personally liable for any losses under Sarbanes Oxley. There is not an accounting firm in the world that is going to take that risk. I know what I am talking about on this; I consult for several small cap companies regarding their SEC compliance and I've spoken with the senior partners at the audit firms on these projects and there is not one of them that is willing to risk their careers, homes, and families for any company on the planet.
There is a lot of blame to go around for the cause of the current financial crisis, but at the end of the day most of blame lies with structural and systemic issues, and what is needed to correct these issues is not money being thrown at the problem, but reform. Remember, Bull Markets are caused by either technological breakthroughs or deregulation; excess liquidity creates asset bubbles.
Even after the recent rallies in the market, it still remains in an oversold condition. I am looking for the market to trend sideways to lower until something is done more than just throwing money at the problem.
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