Special Commentary

Comments Before Federal Reserve Advisory Panel

Tue, Oct 6 2009, 10:40 GMT
by John Silvia - Wells Fargo Investments, LLC | View company's profile

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I wish to thank Professor Kaufman for the opportunity to speak at this conference and with the chance to catch-up with some long-time friends.

In line with this conferences theme, I will highlight some of the ways that the rules have changed but, even more so and with great disappointment, how much the underlying economic and political forces have not changed.

First, in contrast to the views expressed by a previous speaker I see no reason why stress tests and risk simulations cannot account for the boom/bust cycles of the economy and the financial systems. Moreover, both economic and financial cycles can be and are integrated in a Bayesian Vector-Auto regression model which, in fact, we do work with at Wells Fargo. This approach to stress testing is far superior to the common approach of merely changing one input, often the federal funds rate or the unemployment rate, and then producing a scenario that represents a “valuable” test to a financial institution. Such one-variable tests are unrealistic as we know very well that the real world will often experience several economic series changes moving at the same time. For example, a (lower/higher) federal funds rate is accompanied by changes in inflation, growth, exchange rates as well.

Second, one factor in the economy that has not changed is the underlying social/political bias in public policy towards housing that has been part of our society for most of the post-WWII era. America’s overinvestment in housing has been a chronic complaint with this overinvestment being assisted from federal and state tax laws, bank regulatory policy and credit/interest rate subsidies. This has not changed in recent years and, in fact, has continued this year with the increase in Federal Housing Authority (FHA) in recent months at below market rates/very low down payment requirements even as delinquency rates rise on these same FHA loans.

Third, we have witnessed change in the short-run but without resolution in the long-run of the Fed’s role as policeman in the credit markets. Increased liquidity at the short-end of the yield curve has brought down Libor and TED spreads but are these short rates too low given that current yields are below that of the often-criticized pre-Lehman period? What about long-term rates? Currently, the Fed has indicated that they will reduce their support for Treasuries by the end of October and will gradually withdraw support for mortgage-backed and asset-backed securities by March of next year. Will the Fed’s involvement in these markets really diminish in the face of relatively high unemployment and a likely upward move for interest rates in general?

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Published On Tue, Oct 6 2009, 10:43 GMT

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Wells Fargo Investments, LLC

https://www.wellsfargo.com/

sam.bullard@wachovia.com

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For example, you place an order to buy at a stop of $50 which is above the current price of $45. If the price of the stock moves to or above the $50 stop price, the order becomes a market order and will execute at the current market price. Your trade will be executed above, below or at the $50 stop price. In a fast market, the execution price could be drastically different than the stop price. A "sell stop" is very similar. You own a stock with a current market price of $70 a share. You place a sell stop at $67. If the stock drops to $67 or less, the trade becomes a market order and your trade will be executed above, below or at the $67 stop price. In a fast market, the execution price could be drastically different than the stop price. A stop limit has two major differences from a stop order. With a stop limit, you are not guaranteed to get an execution. If you do get an execution on your trade, you are guaranteed to get your limit price or better. For example, you place an order to sell stock you own at a stop limit of $67. If the stock drops to $67 or less, the trade becomes a limit order and your trade will only be executed at $67 or better. Glossary All or None (AON) A stipulation of a buy or sell order which instructs the broker to either fill the whole order or don't fill it at all; but in the latter case, don't cancel it, as the broker would if the order were filled or killed. Day Order A buy or sell order that automatically expires if it is not executed during that trading session. Fill or Kill An order placed that must immediately be filled in its entirety or, if this is not possible, totally canceled. Good Til Canceled (GTC) An order to buy or sell which remains in effect until it is either executed or canceled (WellsTrade® accounts have set a limit of 60 days, after which we will automatically cancel the order). Immediate or Cancel An order condition that requires all or part of an order to be executed immediately. The part of the order that cannot be executed immediately is canceled. Limit Order An order to buy or sell a stated quantity of a security at a specified price or at a better price (higher for sales or lower for purchases). Maintenance Call A call from a broker demanding the deposit of cash or marginable securities to satisfy Regulation T requirements and/or the House Maintenance Requirement. This may happen when the customer's margin account balance falls below the minimum requirements due to market fluctuations or other activity. Margin Requirement Minimum amount that a client must deposit in the form of cash or eligible securities in a margin account as spelled out in Regulation T of the Federal Reserve Board. Reg. T requires a minimum of $2,000 or 50% of the purchase price of eligible securities bought on margin or 50% of the proceeds of short sales. Market Makers NASD member firms that buy and sell NASDAQ securities, at prices they display in NASDAQ, for their own account. There are currently over 500 firms that act as NASDAQ Market Makers. One of the major differences between the NASDAQ Stock Market and other major markets in the U.S. is NASDAQ's structure of competing Market Makers. Each Market Maker competes for customer order flow by displaying buy and sell quotations for a guaranteed number of shares. Once an order is received, the Market Maker will immediately purchase for or sell from its own inventory, or seek the other side of the trade until it is executed, often in a matter of seconds. Market Order An order to buy or sell a stated amount of a security at the best price available at the time the order is received in the trading marketplace. Specialists Specialist firms are those securities firms which hold seats on national securities exchanges and are charged with maintaining orderly markets in the securities in which they have exclusive franchises. They buy securities from investors who want to sell and sell when investors want to buy. Stop An order that becomes a market order once the security has traded through the designated stop price. Buy stops are entered above the current ask price. If the price moves to or above the stop price, the order becomes a market order and will be executed at the current market price. This price may be higher or lower than the stop price. Sell stops are entered below the current market price. If the price moves to or below the stop price, the order becomes a market order and will be executed at the current market price. Stop Limit An order that becomes a limit order once the security trades at the designated stop price. A stop limit order instructs a broker to buy or sell at a specific price or better, but only after a given stop price has been reached or passed. It is a combination of a stop order and a limit order. These articles are for information and education purposes only. You will need to evaluate the merits and risks associated with relying on any information provided. 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