Digesting Clouds

Story Highlights:

• US markets rose for two consecutive days, but uncertainty still reigns.
• Treasury Secretary Timothy Geithner announced initiatives to revive the asset-backed securities market, but potentially faces the same execution problems plaguing previous financial rescue programs.
• Federal Reserve Chairman Ben Bernanke urged a sweeping system overhaul of the US financial system. Some proposals are reasonable and others seem questionable, especially if they become politicized.
• The Securities and Exchange Commission (SEC) said Tuesday it's considering reinstating the "uptick rule." This could benefit markets and is worth watching.
• As long as the government's financial muddling doesn't interfere with other economic areas improving, the economy should recover.

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US markets edged higher Wednesday following Tuesday's charge. But this doesn't necessarily signify a meaningful turn in markets. Snap-back rallies are common when pessimism is extreme and stocks are extremely oversold (which they are). Uncertainty is still the name of the game as clues—but not specifics—continue to drop about the US financial system's future.

In an interview Tuesday, Treasury Secretary Timothy Geithner announced a two-pronged approach to revive the asset-backed securities market. One, the government will directly inject capital into banks as an incentive to get them to sell distressed securities to investors. Two, the government will give federal financing to private investors to buy the assets. Geithner said more "precise" details will be revealed in a few weeks and the program will be implemented over the following weeks and months.

The plan sounds all well and good, but potentially faces the same execution problems as the Troubled Asset Relief Program (TARP). (The phrase, "the devil's in the details" will no doubt haunt Geithner to his grave if this program proves unfeasible.) The Federal Reserve's Term Asset- Backed Securities Loan Facility (TALF) is already facing hurdles, so we will see what happens.

In his corner, Federal Reserve Chairman Ben Bernanke scored jabs against the US financial system in prepared remarks on Tuesday. Bernanke emphasized the importance of stabilizing the financial system, but noted problems with regulatory policy, accounting rules, capital requirements, "too big to fail" firms, mark-to-market accounting, money-market funds, the tri-party repo market, etc., etc.— essentially urging a broad, sweeping system overhaul.

Advocating greater transparency and visibility is good, but it seems Bernanke is trying to amass even more power for the central bank. Maybe it's news to Ben, but the Fed already controls all banks—how much more can it chew? We've long thought having more of the financial system under one regulatory roof is a splendid idea, but an attentive eye should be kept on the extent this body becomes politicized and overburdened with regulations.

Not to be outdone, the Securities and Exchange Commission (SEC) said Tuesday it's considering reinstating the "uptick rule" or related measures. The uptick requires a stock price to move higher before the stock can be sold short. This rule may benefit stocks in cases when investors create instability by purposefully driving down prices below levels warranted by the company's fundamental value. It's unclear what impact reinstating the rule will have, but there's little chance reinstating the uptick rule will be a meaningful negative.

Markets certainly have a lot to digest. The financial system has a lot in store as regulators react to last year's financial crisis—increased regulation, more scrutiny, additional government infusions, and further government intervention. So far, nothing is concrete. And we know now plans can change like shape-shifting clouds as soon as details prove difficult to execute. Market volatility is likely to continue until investors finally see material steps and tangible results. But as long as the government's financial muddling doesn't interfere with other economic areas, the overall economy should recover just fine.