Roubini, Obama, and the Road to Market Recovery

| About: Wells Fargo (WFC)
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Investors interested in timing the stock market’s recovery to make money are tempted to track the opinions of key commentators, whose words can affect markets. In that connection, Nouriel Roubini’s opinion can move the major market averages, possibly as much as the opinions of economist Henry Kaufman—the “Dr. Doom” of his era—who arguably ignited the 80’s bull market with his 1982 announcement that interest rates would fall. (See my post on Dr. Doom (Nouriel Roubini) Himself May Hold Key to Market Recovery.) Having predicted the financial meltdown, Roubini has special credibility with the markets right now, buttressed by his status as an economics professor at NYU’s Stern School of Business and head of his economic consulting firm RGE Monitor.

However, making investment choices based on reports of Roubini’s pronouncements is precarious, as demonstrated on July 16 when Roubini explained that comments he reportedly had made—precipitating a market rally—quoted him out of context.1 This shows that if you’re going to make investment choices based on Roubini’s opinions, it’s better to do so based on developments that relate to his underlying perspectives rather than on second-hand reports of his outlook.

Hence, my point that monitoring the progress of the Obama administration’s financial regulation package with regard for Roubini’s opinions may help identifying good buying opportunities to capitalize on a sustained market recovery. Wall Street groans about regulation since it threatens profits. Paradoxically, however, passing new laws to regulate the financial sector is necessary for sustained market recovery since key figures like Roubini will likely continue to profess doom and gloom until the regulatory weaknesses that enabled the crisis are adequately addressed.

Roubini has identified what he sees as two key weaknesses in the administration’s package. First, the number of U.S. regulating authorities is still too high—he counts them as 6 federal and 50 state regulators—with only 1 eliminated (the Office of Thrift Supervision). Second, Roubini asserts that the proposal does not address more stringent liquidity, capital and leverage requirements for organizations too big to fail.2

Fully addressing the issue of the number of regulators is not likely to happen in the current financial oversight push. While some additional consolidation could occur, particularly at the federal level, the separate existence of state bank regulators is deeply entrenched in U.S. history since interstate banking was largely prohibited until 1994. Moreover, poorly conceived efforts for federal law to overtake state banking laws may have helped precipitate the crisis by making national banks and their state-chartered subsidiaries immune from state consumer protection and fair lending provisions.3 Case in point is Wachovia’s 2007 victory in the U.S. Supreme Court to free its mortgage unit from state regulation, opening the door to riskier lending and probably contributing to Wachovia’s eventual demise and takeover by Wells Fargo (NYSE:WFC).4 For now, this would likely forestall any aggressive effort to dissolve U.S. state banking regulators. The Obama proposal does, however, advocate harmonizing regulations applicable to banks, which implicitly means harmonizing state and federal regulations.5

Concerning higher standards for too-big-to-fail institutions, the Obama plan contains extensive discussion on capital and liquidity requirements of large, interconnected firms; the need for special regulation of financial holding companies meeting certain benchmarks, including the degree of leverage and reliance on short-term funding; and the protection of systematically important payment, clearing, and settlement systems.6

So what’s going on here? Is Roubini complaining about one issue that isn’t ripe to be solved and another that already is? Not likely. Roubini knows that the Obama proposal is far from being actual legislation—what really counts is the language that becomes law.

Rather, at this point, Roubini has a strong incentive to hold out on supporting the administration’s proposal even if it is headed in the general direction he favors. From the standpoint of his economic agenda to argue for tighter financial regulation, he has little incentive to support anything other than specific proposals that address his concerns to a degree that he deems adequate within current policy constraints. In other words, he can produce pressure for government players to advance stronger regulatory proposals by criticizing general ideas that are floated as too weak. And he maximizes his visibility as an arbiter of the debate by maintaining a position independent from both the Obama administration and the financial institutions.

So for investors looking for a Roubini statement that things are on the mend, there’s still a ways to go. Even if new economic numbers are encouraging, getting the financial regulation passed is likely to take the rest of the year or longer,7 and it’s hard to imagine Roubini giving an overall positive assessment without the regulatory weaknesses that allowed the crisis to brew being addressed. However, in the interim, reports about the legislative process may provide good buying opportunities as the market dips in response to Wall Street’s fear of increased regulation. And the greater the fear instilled, the more likely that Roubini and commentators with similar concerns will eventually forecast a sustained recovery.

Disclosure: The author does not hold a position in Wells Fargo as of the original date of this post.


  1. “Roubini: Views on Economy Unchanged Despite Reports,” CNBC, July 16, 2009
  2. CNBC Video, June 22, 2009
  3. See Chicago Fed Letter (.pdf), September 2006, No. 230a, pp. 1-2
  4. See Watters v. Wachovia (.pdf), 550 U.S. ___ (2007)
  5. See U.S. Department of the Treasury (.pdf), “Financial Regulatory Reform: A New Foundation,” updated July 24, 2009, p. 33
  6. See U.S. Department of the Treasury (.pdf), “Financial Regulatory Reform: A New Foundation,” updated July 24, 2009, pp. 5, 19-27 & 54
  7. Paletta, Damian, “Flexibility Is Signaled on Financial Oversight,” Wall Street Journal, July 25, 2009, p. A4.