Farrell: Unchain My TARP!

The stress test results gave banks 30 days to come up with a plan for raising capital and then six months to execute on the plan. Well, no offense to Big Brother, but the banks are tripping over themselves to sell equity to be in the position to repay the double-dealing government overlords.

BB&T (BBT-rated Buy by Soleil Securities/Tenner Investment Research), US Bancorp, Principal Financial, Capital One, and Key Corp all filed offerings on Monday to raise the cash to satisfy the capital requirements but also to pay the TARP back as soon as they can. They join City National, Goldman, Morgan, Wells Fargo, Northern Trust, and others who filed last week. Who can blame them. They took the TARP funds thinking one set of rules would apply and found out a whole different ballgame awaited them. I wondered over the years why oil companies (a group I followed as an analyst forever) would form joint ventures or make investments in places like Russia or Libya or Venezuela since there was no certainty to what rule of law would apply.

I was rarely disappointed in my skepticism since sooner or later there would be no rule of law and problems always arose.

Our government has changed the TARP rules, tried to violate the rule of law and allow bankruptcy judges to alter contacts under which mortgages were granted, and attacked Chrysler bondholders for simply claiming what their covenants guaranteed them. All of this seems to be done with complete disdain and contempt for the financial world. The papers today quoted an unnamed administration official as saying "You don't need banks and bondholders to make cars." Really? How dumb is that? There is this thing called financing that gets involved in the production process. All of this might have been done with noble sentiments, but that's not the point. The road to hell is paved with good intentions. Our government is acting like Russia, Libya, or Venezuela, and the repercussions of such behavior will be profound and long-lasting. And I hope to God they don't really think that banks or bondholders are not necessary.

The good news is that the market seems to be accepting of these offerings, and that is indeed welcomed. The capital markets are functioning and even the 'stressed' banks have ready buyers. But I would guess that the flood of equity issuance will sop up some of the dollars otherwise headed for the stock market and the pressure to be in the market will be lessened. The Wall Street Journal had an article Monday saying the market isn't cheap. It's hard to figure cheap or rich with such uncertainty about projected earnings.

The bearish view has been EPS would total close to $40 for the S&P 500 for 2009. I'm feeling that, after a first quarter better than feared and with financial firms showing some life, a number more like $50 is doable. I think the consensus is still in the upper 50's but please correct me if I'm out of date on that one. If $50 is possible, then the market is at 18 times and that would be OK if this year were to be the trough in earnings. 18 times is the median multiple for stocks when inflation is less than 2%. As my partner Greg Valliere said in a note issued Monday, we think with high unemployment and significant unused productive capacity the fear of inflation should be put off a few years.

We continue to think we are in the latter stages of a bottoming process and one more downward probe is needed. A short-term top is often coincident with a flood of equity offerings like we are seeing for the banks. We are not in the "sell in May and go away" camp by any means, but we do think some softening in equity prices is inevitable.


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