With the changing of the US presidency, the market has been offered a new hope that Obama may be able to soften the depth of the current recession by helping the banks, getting stimulus legislation passed & generally making consumers feel better because they can feel optimistic about the future.  We have no idea whether Obama will be a good president or not, but the US people will naturally tend to hope for the best now that Bush has departed.

As ever in financial markets, this is all about confidence.  In the short term it doesn’t matter whether a US Bad Bank will make things better or not, merely the confidence that it will causes the financials to rally.  Whether the rally eventually holds depends upon how workable the scheme proves to be – there is no point killing the patient by buying dodgy assets off them at such a low price that the writedowns incurred bankrupt the bank.  This is the advantage of insuring suspect loans rather than buying them off the banks.

The evidence that the market is currently using confidence to price banks, rather than some form of expected p/e ratio, can be seen in the performance of BARC (in particular) over the past two weeks.  Its share price plunged over 20% in the last hour of trading a fortnight ago to close at 98p on Friday 16 Jan, below the prior 128p closing low of 20 Nov 2008.  This prompted the BARC Board to pre-announce 2008 earnings of £5.3 bln over the weekend.  The share price duly rallied when it opened the following Monday but this rally petered out quickly and within 2 hours the shares were back down at 100p; they then went on to halve during the rest of the week and closed at 51p on Friday 23 Jan.  The fact that the shares could not sustain a rally and fell to fresh lows after the company announced earnings were going to be better than expected was proof that the market was valuing BARC on confidence, not earnings prospects.  The BARC Board clearly had a re-think over the weekend and published an open letter, clearly spelling out the capacity of BARC to absorb future losses from bad debts without turning to anyone (shareholders, Middle East petro-dollars, the UK Government, etc.) to raise fresh equity capital, and clearly stating that BARC were talking to the Government about insuring some of their loans.  The UK Government’s proposal to provide insurance against dodgy bank assets was key in making the BARC statement believeable, and BARC have doubled in price back up to 100 this week.  The sting in the tail for BARC management is that buried in the detail of the Government’s announcement about providing insurance to banks is a statement about the Government requiring a say in remuneration policy…but I don’t think many people are going to shed a tear about Bob Diamond being paid less than 20 million this year.

 At least we can look at the 44th US President and hope he manages to instil some confidence.

Post Script:  During the week when bank share prices troughed (with BARC around 50p & RBS around 13p) Paulson & Co closed their short position in RBS.  Hats off to them for shorting high, riding the short down through two rights issues and not forgetting to close it near the bottom.