Fixing The Financial Sector

George Bittlingmayer and Thomas Hazlett are at it again, criticizing the stimulus by looking at its impact on capital markets ("The markets do not believe the 'stimulus'," Chicago Tribune, March 8, 2009.). I will highlight two points from the article and make an additional observation.

It is sometimes difficult to interpret market swings. They are the combined reactions of thousands of thousands of buyers and sellers. With that caution in mind, forward looking markets would respond positively to policies or events that signal a resolution to the financial crisis and negatively to policies or events that signal continued turbulence.

Many factors move markets, but investors would respond enthusiastically to signs the government was solving the economic crisis. Indeed, news that the experienced, moderate Timothy Geithner would be Treasury chief lifted the Dow 6.5 percent Nov. 21 (and an additional 4.9 percent when the choice was confirmed by Obama Nov. 24). Geithner's glow has since dimmed; the Dow dropped 300 points when his Feb. 10 news conference revealed that little progress had been made in crafting a solution to the banking crisis. And today the evidence is that investors do not believe that the massive new debt will spur economic growth.

Event studies are a type of opinion pool by people who have money in the game and politicians realize their value in forecasting policy outcomes.

The point is not that economic policies should be crafted to benefit shareholders. It is that financial markets offer important evidence about the effect of different choices on the overall health of the American economy. Former President Bill Clinton harks back to the good times in the 1990s when equity valuations were booming. Last fall, conversely, House Republicans and Blue Dog Democrats blocked the banking bailout requested by Treasury Secretary Hank Paulson and Federal Reserve Chairman Ben Bernanke, only to see the Dow decline nearly 7 percent on Sept. 29. That was a signal. House opposition quickly collapsed and the bill passed.

The Obama administration has much to blame on its predecessor. But its own fiscal strategy is highly leveraged on a theory that has not scored well in previous runs. Markets are dubious that the "stimulus" will stimulate. And investors are losing patience with the federal fixes offered for the banking crisis. If the warning signs of the Dow are not heeded by policymakers, they will be by others. Ask Sen. John McCain.

Investors also respond to unexpected market driven events such as Citigroup turning a profit (Lepro, Sara and Paradis, Tim, AP Business Writers. "Dow ends up nearly 380 on Citigroup profit news," Yahoo Finance, March 10, 2009.)(HT Drudge.)

NEW YORK (AP) -- Wall Street has had its best day of the year, storming higher after some good news from Citigroup. Citigroup Inc. says it operated at a profit during the first two months of the year. That energized financial stocks and in turn, the entire stock market. Surprised investors drove the major indexes up more than 5.5 percent to their biggest one-day rally of the year. The Dow Jones industrials shot up nearly 380 points.