Voter Turnout and TARP

State Street Corp. (STT) has had a horrendous day of trading thus far as its shares are off by more than 50%. The Boston based bank which handles custodian responsibilities for many institutions and mutual funds, as well as other money management services, reported before the open of business on Tuesday that there are substantial mark-to-market losses on the company’s balance sheet. The losses from the last quarter are in the billions and much of these are related to a secondary business of State Street, managing money-market funds. These losses are as yet unrealized, but more than doubled in the quarter. The market is obviously skittish about financials right now and up until now State Street was thought to be fairly insulated from the credit crisis. After all, the company does not lend money, it manages assets. However, this is further proof that there is no such thing as a safe stock among the financials.

State StreetWe wrote about State Street (State Street Slashes Six Percent) as a possible beneficiary of the increasing move of institutional money managers to branch off on their own and thus need a custodian for the assets that they are able to gather. This trend does seem to bode well for State Street in the future, but as today’s announcement demonstrates the entire firm can be brought crashing down by a business line that is not their core business. The trouble arose from money market funds that were being reported to have NAV’s of $1 per unit, while the underlying assets were actually worth less. As State Street’s SEC filing says:

“We may be exposed to customer claims, financial loss, reputational damage and regulatory scrutiny as a result of transacting purchases and redemptions relating to the unregistered cash collateral pools underlying our securities lending program at a net asset value of $1.00 per unit rather than a lower net asset value based upon market value of the underlying portfolios…At December 31, 2008, the net asset value based upon market value of our unregistered cash collateral pools ranged from $0.908 to $1.00, with the average weighted net asset value on such date being $0.955.”

In discussions around our office concerning the latest out of State Street, we couldn’t help but wonder, as bad as these results are, are they substantially worse than those of Bank of America (BAC) or Citigroup (C)? In our assessment, while the situations are quite different, the results actually pale in comparison to the underlying business model failings of Citigroup or the due diligence mismanagement at Bank of America. However, we have a sense that the market fears State Street does not meet this all too important “Too Big to Fail” mantle and thus actually stands a chance of being held liable for its mismanagement. Of course, Bank of America and Citigroup are (or were) two of the largest banks by assets, but they also have significant exposure to the general voting public. State Street on the other hand is fairly unknown outside of financial circles as it caters to institutions far more than individuals.

So, while State Street may have lost somewhere in the range of $5 to $6 billion (unrealized) in the last quarter, there is little doubt that bailouts of their bigger competitors would be prioritized ahead of the smaller custodial bank. So, as far as we are concerned, State Street and all other financials carry with them the systemic risk of being a part of a broken financial system, but State Street may have the additional risk of not being as sexy to the politicians who now are charged with repairing our broken system.

Voter turnout can certainly be measured for any business or company. It can relate, as in the case of Bank of America (BAC), to the massive number of individuals it serves on a daily basis, or the huge number of union members or employees that will suffer should a collapse occur, as in the case of the automakers. Regardless of how it is tallied, direct voter pain is a major portion of access to TARP funds. Politicians do not operate, regardless of their respective party, out of the sheer benevolence of their souls. They are pragmatic and will identify the greater good, as the greatest voter turnout. Firms like State Street may suffer more volatile trading swings because of this, as Wall Street knows that companies not “too big to fail”, just may indeed.

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Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

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