A plan by President Barack Obama's administration to guarantee or possibly buy illiquid assets might give some financial stocks a bit of a boost, but a true sector rally is far from around the corner, experts said.
Instead, any additional government aid would likely result in a further dilution of the equity of those financial institutions in need of help.
Treasury Secretary Timothy Geithner is expected to unveil a financial-recovery strategy on Feb. 9.
“Equity holders understand that the government is in the driver's seat in terms of deciding what they want this package to look like,” said Owen Fitzpatrick, managing director and head of equities for Deutsche Bank Private Wealth Management, New York, which has $268 billion in assets under management.
“Current equity holders are concerned. This is why we see the stock prices of those institutions being the way they are. There is concern that any (government) equity will result in dilution,” Mr. Fitzpatrick added. “There is so much uncertainty around the dilution levels because people know whether it comes in the form of preferred or convertible stock, it's all going to be dilutive.”
Such concerns have hit stocks such as banking giant Bank of America Corp., Charlotte, N.C., which already has received about $45 billion in government aid and $118 billion in asset guarantees but might need more, according to analysts.
“Some financial stocks are down 30% this year — I mean just in January — on top of having sold off (more than 50%) last year, because there is a feeling that no plan will really help them,” Stuart Plesser, equity research analyst for Standard & Poor's in New York, said in an interview.
“Financial stocks spiked on a specific day and have sold off every day since, on the complexity of the plan, which may not help banks as much as it was first perceived,” added Mr. Plesser, referring to the Jan. 28 one-day, momentum-driven spike in financial stocks tied to market talk that the government would buy illiquid assets.
Using the remaining half of the $700 billion Troubled Asset Relief Program to create a “bad bank” aggregator would fall well short of mopping up the avalanche of depressed securities, estimated in the trillions of dollars, according to experts such as Simon Johnson, a senior fellow at the Peter G. Peterson Institute for International Economics, Washington, and a former chief economist at the International Monetary Fund.
Kurt Schacht, managing director at the CFA Institute Centre for Financial Market Integrity in New York, agreed that the “bad bank” plan is not particularly reassuring to investors and would thus not be very supportive of financial issues.
A CFA Institute survey released Feb. 2 showed that 44% of 4,112 investment professionals polled thought toxic asset purchases would help the financial sector. Instead, 62% favored direct government backing of financial institutions' portfolios.
“There is a great deal of skepticism about the plan to buy toxic assets now, after it was rejected in the initial TARP stages. What has changed, investors ask,” Mr. Schacht also said.
Regardless of what path the government takes, it will not cure all ills. The economic fundamentals for the financial sector remain weak because of a steep drop in lending and fee-based services tied to the recession.