Real GDP Pauses, though spending is gearing up
by Ron D’Vari, CEO, James Frischling, President, Richard Kelly, Managing Director, and Asim Ali, Director, NewOakWeekly market view from NewOak
Compared to 2013, the U.S. housing market’s recovery has slowed to a point where Federal Reserve Chairman Janet Yellen has expressed her concern. Despite historically low interest rates, there are relatively few first-time home buyers in the market, partially due to tougher mortgage underwriting standards. Further, real GDP growth has paused in the first quarter yet is expected to resume with a rebound in spending and production already underway.
Yellen thinks the recent flattening out in housing activities could prove more protracted than first thought and the market may not resume its earlier pace of recovery. Combined with heightened geopolitical risks, these factors may contribute to significant uncertainty in the baseline positive economic outlook and so bear watching closely.
Labor market conditions are still far from normal despite recent improvement. The following represent clear indicators of slack in the labor markets: 1) the number of individuals unemployed for more than six months and part-time workers who would prefer full-time jobs is at historically high levels; and 2) wages have been rising slowly. Another risk to the economy is that inflation is persistently below 2 percent, the rate that the Fed judges to be most consistent with its target.
Collectively, these conditions will lead to the Federal Reserve remaining committed to accommodative policies to restore the labor market and inflation to levels consistent with long-term sustainability. These conditions directly relate to the state of housing and mortgage finance, which have shown significant weakness recently. Therefore all eyes will remain focused on housing and housing finance as key indicators of future economic recovery.
Big and Small Banks: Same Regulatory Scrutiny?
First-quarter trading declines, fines from regulators, even criminal charges have put some of the world’s largest banks in the government’s crosshairs again. When the U.S. Attorney General is telling audiences that no bank is “too big to jail”, you know it’s not about letting the good times roll at large banks.
Smaller banks, presumably farther off the regulatory radar screen, should be thriving in this big bank-bashing environment, right? Think again.
The Dodd-Frank Wall Street Reform and Consumer Protection Act is politically correct and therefore an equal opportunity enforcer when it comes to righting the wrongs of the banking industry post financial crisis. The ensuing spike in regulation has had a direct impact on the banking industry as a third of the smaller banks report adding legal and compliance professionals in response to the increased workload.
However, adding costs isn’t the only consequence of more and tougher regulations. Some business lines are being abandoned or downsized if they’re in the regulatory line of fire. For example, litigation on legacy assets, combined with new rules for mortgage lending, is driving smaller banking firms to reduce or drop mortgage-related operations. This is happening at a time when consolidation in the banking industry is already affecting the services that these smaller institutions provide.
When the financial crisis was in full swing, the importance of maintaining banking operations throughout the country was referred to as “community continuity.” For banks fighting through the crisis, the current compliance and related burdens are threatening their profitability and therefore their survival.
With lending standards tight, it’s the small banks that represent the best opportunities for local communities to access capital by leveraging their knowledge of local borrowers and businesses. Right now, the economy needs less “rules-based” lending and more “knowledge-based” lending. This is a market where smaller banks can excel but, in order to do that, they can’t be regulated like the largest banks.
Muni Financial Reporting: Markets Requiring More Discipline?
Regulators and investors in the $3.7 trillion municipal bond market are on alert thanks to recent high-profile bankruptcies and the prospect of others following suit. The main issues center on a lack of transparency and shoddy financial reporting by municipal issuers combined with investor and regulatory complacency. However, the regime seems to be shifting to a more disciplined market. For example, the U.S. Treasury Department is establishing a monitoring unit to examine municipal issuers and assess their ability to continue to raise money, their ability to repay and the adequacy of disclosure to investors of their true financial conditions.
The U.S. Constitution limits the ability of the federal government to regulate state governments. This has been a stumbling block in the direct regulation of states and municipalities as issuers of securities. The ’33 Act, under which the SEC mandates disclosure of basic financial information by issuers, simply does not apply to state and local issuers. Thus the SEC resorted to indirect regulation: fraud enforcement actions (brought under various provisions of the ’34 Act), esoteric theories of liability and power to regulate broker-dealers to require some degree of financial disclosure by municipal issuers. However, these efforts are largely directed at the secondary market, and occasional selective enforcement actions are not an adequate substitute for a universally mandated scheme of full disclosure.
Municipal issuers have resisted mandated disclosure, arguing both political theory (increased federal regulation is inappropriate and unnecessary) and economics (full and fair disclosure can be expensive). In the end,the market will require full disclosure of material information on issuance and ongoing disclosure of material changes and developments. Municipal issuers dependent on the market to roll over their debt will eventually have to listen.
In the meantime, investors who purchase municipal securities and, especially, those who already own them should treat them like any other non-transparent investment by focusing on holistic and fundamental credit analysis, rather than a market-wide or statistical survey to assess credit risk and value.
NewOak is an independent financial services advisory firm built for today’s global markets. Led by a team of experienced market and legal practitioners, NewOak provides a broad range of services across multiple asset classes, complex securities and structured products for banks, insurers, asset managers, law firms and regulators, including financial advisory and dispute resolution, valuation, credit and compliance, risk management, stress testing, model validation and financial technology solutions. We have analyzed or advised on more than $4.5 trillion in assets to date. Visit www.newoak.com