Stocks had a strong showing today, with the Dow Jones Industrial Average (^DJI +0.04%) and the broader S&P 500 (^GSPC +0.47%) gaining 0.6% and 0.7%, respectively. In fact, the S&P 500 closed at its highest value since Election Day and just 2.6% below the post-2007 closing high of 1,465.77 achieved on Sept. 14. Who would have thought we're less than three weeks away from a "fiscal cliff"?
Fed watch: According to a Bloomberg survey, 48 of 49 economists expect the Federal Reserve to announce tomorrow that it will replace Operation Twist, which ends this month, with a new program of monthly Treasury bond purchases of $45 billion that would add to the existing QE3 bond-buying program. Needless to say, if the same degree of consensus is embedded in stock prices, the market will have a rough day tomorrow if the Fed doesn't announce this. The Fed made this market; we just invest here.
The micro view: While we're on the topic of the risks associated with the Fed's post-crisis policies, the Financial Times reported over the weekend that FDIC data shows that U.S. banks' structured finance investments are now at their highest level since mid-2009, the earliest date at which the FDIC began breaking these numbers out. Under the FDIC's definition, these investments include an alphabet soup of securitizations, including collateralized loan obligations (CLOs) and collateralized debt obligations (CDOs). However, holdings of collateralized mortgage obligations (CMOs), which are presented as a separate, much larger item, have actually fallen since the end of last year.
Today, banks face the same challenge investors do: earning a return in an ultra-low yield environment. The concern is how much risk are they taking on to capture incremental yield. It's impossible to answer that question for any one institution from any data that is publicly available, let alone a consolidated balance sheet. Still. there are clues that can be found in a bank's risk culture, in the way its leaders talk about risk, and in its track record through the credit cycle.
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