House Defeats Bailout

Reuters Staff
Sep 29, 2008 18:31 UTC

The bailout was defeated in the house a few minutes ago. Short-term this is very bad news as confidence in the worldwide financial system is quickly reverting to zero.  The Dow was off as much as 700 but has come back to down 500 as I write this.

Longer-term, I actually think this is positive since it protects the Federal Government’s balance sheet to some degree. Don’t get me wrong, the Federal Government through FDIC, Fannie, Freddie, the Federal Reserve and the Federal Home Loan Banks may already be on the hook for multiple trillions of losses here.

And before long you could see a worldwide run on the dollar.  Right now people are running TO the dollar, buying treasuries at a fantastic rate as these are perceived to be the safest investment in the world.  But when it becomes clear that the U.S. government may have to print a fantastic amount of currency in order to pay off its debts, dollar assets could fall in value very quickly.

Can the worldwide financial system be saved?  It’s looking more doubtful.  I’m recommending that readers take physical cash out of a bank before the panic arrives “on Main Street.”  Keep it in a safe place in your house.  A fireproof lockbox that’s well-hidden probably makes most sense.  Have enough for a couple months expenses.

I know that sounds crazy.  But clearly these are crazy times….

(Here’s A Picture of the Apocalypse)

Wachovia…gone

Reuters Staff
Sep 29, 2008 14:07 UTC

I didn’t even get a chance to write a post about WaMu being the largest bank failure in history.  Continental Illinois, which failed during the S&L crisis, had held the record for 14 years until last Friday, when the FDIC took out WaMu and forced a sale to JP Morgan.  Continental had $30-$40 billion of assets when it failed.  WaMu had $310 billion of assets as of June 30th.  But WaMu only held the record for a single business day.

Wachovia, with $812 billion of assets on the balance sheet, blows WaMu out of the water.  Today the FDIC seized the bank and forced a sale to Citigroup.  (Not all of those are banking assets, but you get the point that Wachovia is massive.)

Citigroup will acquire the banking operations of the Wachovia Corporation, the Federal Deposit Insurance Corporation said Monday morning, the latest bank to fall victim to the distressed mortgage market.

Citigroup will pay $1 a share [in Citigroup stock], or about $2.2 billion, according to people briefed on the deal.

The F.D.I.C. said that the agency would absorb losses from Wachovia above $42 billion and that it would receive $12 billion in preferred stock and warrants from Citigroup in return for assuming that risk.

“Wachovia did not fail,” the F.D.I.C. said, “rather it is to be acquired by Citigroup Inc. on an open-bank basis with assistance from the F.D.I.C.”

Under the deal, Citigroup will acquire most of Wachovia’s assets and liabilities, including $400 billion in deposits and will assume senior and subordinated debt of Wachovia, the F.D.I.C. said. Wachovia Corporation will continue to own the retail brokerage firm AG Edwards and the money management arm Evergreen.

“There will be no interruption in services and bank customers should expect business as usual,” the F.D.I.C. chairman, Sheila C. Bair, said.

Points to FDIC for saving taxpayer dollars on this and the WaMu deal.  In the case of Wachovia, FDIC will be sharing losses with Citigroup, which agrees to absorb the first $42b of losses on Wachovia’s loan portfolio.  WaMu’s failure apparently won’t cost FDIC anything.  Some think the deal put in place to protect FDIC was borderline illegal.

Ever larger banks are failing as the confidence crisis grows larger.  Citigroup will try to raise $10b of capital by selling stock today, which it will need to repair its own balance sheet.  Only a few months ago, Citigroup was thought to be in deep trouble.  Now it looks relatively strong compared to WaMu and Wachovia.

The hope now must be that Treasury will pump capital back onto Citigroup’s balance sheet, buying back Wachovia’s (and Citi’s) toxic loans at above-market values.

A picture of the Apocalypse

Reuters Staff
Sep 28, 2008 16:27 UTC

Average Americans may be forgiven for not understanding why Congress is moving so quickly to pass this massive bailout package.  Sure the economy isn’t great—gas prices are still high, it’s harder to get a home loan, some folks have lost jobs—but why are guys close to Paulson saying things like this (from the Times of London):

“the economy is dropping into the john. We could see falls of 3,000 or 4,000 points on the Dow [it's at 11,000 currently]. That could happen in just a couple of days.

“What’s being put around behind the scenes is that we’re looking at 1930s stuff. We’re looking at catastrophe, huge, amazing catastrophe. Everybody is extraordinarily scared. It’s going to be really, really nasty.

Whoa!  Didn’t the economy grow last quarter?  We haven’t even determined that we’re in a recession.  You’re telling me we’re going to skip right over that and go straight into a Depression?!  In a matter of weeks!?!?!

I’m here to tell you they’re not kidding.  It could be that bad.  And it could happen VERY quickly.  Indeed, the scariest thing about this crisis is that those who really know what’s going on are the most frightened.

What is an economic catastrophe?  Besides a precipitous fall in the price of stocks and other assets, we may also see a global run on banks.

Here’s a very famous movie scene to help us understand what we’re potentially facing…..

(more…)

OptionARMageddon on the radio Thursday, tune in at WBAL.com

Reuters Staff
Sep 24, 2008 15:32 UTC

Psyched to be invited onto Baltimore’s #1 “news/talk” station, WBAL, Thursday afternoon at 5:05PM Eastern.

Readers can tune in over the internet by going to WBAL.com and clicking on the Listen Live link.  (The radio feed doesn’t seem to be optimized for Firefox, so you should log in with IE or Safari for best quality)

I’ll be discussing the op-ed I published on Sunday.

Be sure to tune in!

Paulson’s 0% Balance Transfer!

Reuters Staff
Sep 24, 2008 14:17 UTC

Yesterday Warren Buffett said he’s investing $5 billion in Goldman Sachs. (11/6 update: the stock is now 33% the exercise price on Buffett’s warrants)  The market is interpreting this as a show of confidence from the world’s savviest investor.  But why now?  Is Goldman (or any other hammered financial stock) really a great value on the company’s merits?  Warren’s own commentary suggests not.  This morning on CNBC he said very clearly that he made the investment in Goldman only after it became clear Paulson’s $700 billion bailout package would pass.  Paulson is riding to everyone’s rescue and Buffett wants in on the ground floor.

At yesterday’s hearings in the Senate, more details about Paulson’s plan emerged.  Bernanke said very clearly that the plan is to overpay for bad assets in order to recapitalize bank balance sheets.  Overpay with taxpayer dollars.

“Are you a bank?  Did you make a pile of bad loans and are now stuck with them on your balance sheet?  No problem!  Hank and Ben will ride to the rescue, buying your bad loans near their “held-to-maturity” value!”

(more…)

Money Market Mayhem

Reuters Staff
Sep 22, 2008 04:34 UTC

Is it over the top to be predicting the end of the financial world?  I would have thought so two months ago…

Last week there was a run on money market funds: According to AP: “investors pulled $224 billion…in the seven-day period ended Thursday. On Wednesday alone, about $89 billion was taken out, and another $56 billion was withdrawn on Thursday…”  The industry has a total asset base of $3 trillion according to that AP article.

Money market assets are constantly rolled over in the commercial paper market, providing the short-term working capital that AAA-credits like GE and IBM need to make payroll.  The Journal:

Without [money market] funds’ participation, the $1.7 trillion commercial-paper market, which finances automakers’ lending arms or banks credit-card units, faced higher costs. The commercial-paper market shrank by $52.1 billion in the week ended Wednesday, according to data from the Federal Reserve, the largest weekly decline since December.

Without commercial paper, “factories would have to shut down, people would lose their jobs and there would be an effect on the real economy,” says Paul Schott Stevens, president of the Investment Company Institute mutual-fund trade group.

It seems this may have scared the Feds more than anything to date. Instantly, Paulson offered deposit insurance on money market assets in order to prevent further flight.

This may have been a big reason why Paulson explained to lawmakers “that we’re literally maybe days away from a complete meltdown of our financial system, with all the implications here at home and globally.” (Hat tip CR)

In all the talk about the mother-of-all-bailouts, no one seems to be mentioning that Treasury has committed yet more taxpayer dollars to insure risky assets.  And he did it up to $50 billion per fund.  I haven’t had time to dig in, but I wonder how that would work.  So if there is a run on assets in any money fund, whatever cash investors aren’t able to pull out will be backstopped by Treasury?

While the move is stabilizing short-term (i.e. Friday), it may be destabilizing long-term (the next few weeks).  Folks with money in FDIC-insured banks may feel they can go shopping for money market yields now that such funds come with their own guarantee.  That could cause capital to bleed off the balance sheets of banks that sorely need it.

Any fire Paulson puts out seems to ignite another.

Is The Worst Yet to Come?

Reuters Staff
Sep 22, 2008 00:28 UTC

Below is a reprint of the Op-Ed I published in today’s Baltimore Sun.

“Is the Worst Yet to Come?”

Will it ever end? For more than a year, the financial system has struggled to function, stricken as it is with economic Ebola. Cash is the only cure, and banks have raised almost $400 billion. That’s not nearly enough, however, so the federal government has committed to various bailouts that will cost hundreds of billions over time. The most expensive yet – a new super-agency to buy bad debt – may eventually cost north of $1 trillion.

As bad as the situation is, we’re in deeper trouble than most realize. The virus infecting banks – too much debt – is spreading to the federal government. If Washington falls victim, we could be headed for another Great Depression.

Trillions of dollars in bad loans infected bank balance sheets during the housing bubble. As house prices started to decline nationwide, those loans turned virulent, dropping in value and robbing banks of the capital they need to stay in business. The disease spread so quickly because banks have little uncommitted capital to defend against losses.

During the housing bubble days, bankers lent as much as possible, confident that housing prices would never go down. Consequently, they were left vulnerable to even a small decline.

Understanding why too much “leverage” can kill a bank is crucial to understanding why the credit crisis is dropping major financials like flies, and why the federal government is vulnerable.

Like all businesses, banking involves risk. If, for instance, borrowers default on their mortgages, the bank may struggle to pay back its lenders. So it keeps cash in reserve. But reserves earn no profits for the bank, so it minimizes them.

Assets make money, and reserves provide protection. Putting the first in the numerator and the second in the denominator, a bank’s “leverage ratio” measures how much risk a bank is taking to make money. A higher ratio means more potential for profit but also less protection against loss. A sound bank should have a leverage ratio around 10-1. The major Wall Street banks operated with leverage ratios north of 30-1.  And when you consider that much of their capital was bogus “deferred tax assets,” Fannie and Freddie has leverage ratios near 250:1.

If leverage gets high enough, even small losses will cause a bank’s creditors to panic. Worried that cash in reserve won’t be sufficient to pay them back, they cancel credit. When a bank loses access to credit, it is put out of business.

Fannie Mae, Freddie Mac, AIG, Lehman Brothers, Bear Stearns and even Baltimore’s Constellation Energy Group all relied on credit in order to do business. When their credit disappeared, they ceased to function independently.

At this point, much of the U.S. financial system would be out of business without taxpayer support. Banks need credit to operate, and Uncle Sam has stepped in as creditor of last resort. In addition to the trillion dollars of bailout money on the way, taxpayers have pumped another trillion-plus into the banking system via the Federal Home Loan Banks and the Federal Reserve.

Before the credit crisis, the Fed only accepted the highest quality paper as collateral for its loans. Now it accepts risky mortgage-backed securities and even equities, exposing taxpayers to significant risk. The FHLBs – off-balance-sheet entities of the federal government such as Fannie and Freddie – have advanced more than $900 billion to banks, up nearly $300 billion since the credit crisis hit.

If the U.S. financial system relies on government funding to borrow, what will happen if the federal government’s creditors take a walk? Consider Argentina, which in 2002 devalued its currency to pay off a crushing debt burden. Foreign capital fled the country, the banking system collapsed, inflation hit 80 percent and unemployment reached 25 percent as the economy sank into a depression.

That could never happen here, argue some. The $10 trillion national debt is “only” 70 percent of GDP, leaving the government plenty of borrowing capacity. But that ignores $60 trillion of projected liabilities for Medicare and Social Security, according to economist John Williams.

What’s true of companies is true of countries: The more they borrow, the more they operate at the mercy of creditors. The more they borrow, the more violent their inevitable failure.

Under no scenario can Uncle Sam raise the trillions it needs to meet all these obligations. No tax rate is high enough, no discretionary spending cuts draconian enough. And there is no creditor of last resort for the U.S. Treasury. If default implies an Argentina-like scenario, that would leave us with only two options. The first is to print money; Mr. Williams says this would lead to “hyperinflation on the order of 1920s Germany.”

The other option is to eliminate Medicare and Social Security.


Rolfe Winkler, chartered financial analyst, is publisher of OptionARMageddon.com.

.

The Greatest Ever Short Squeeze?

Reuters Staff
Sep 20, 2008 00:05 UTC

Hi folks.  Back after a long couple days drafting an op-ed for this Sunday’s Baltimore Sun.   Thought I’d contribute my two cents about today’s rally. The reason the market spiked had nothing to do with fundamentals.  The shorts got squeezed.

Here’s a basic tutorial for you.  To sell a stock short—that is, place a bet that it is going to go down—you borrow the stock and then sell it.  Say I borrow 100 shares of IBM from my buddy Jim today and sell them for $115.  I have $11,500!  Yippee!

Even though I get to decide when, at some point I have to give Jim back his shares.  That means eventually, I’ll have to buy 100 shares of IBM and give them back.   I profit if the stock goes down and I can buy them back cheaper.  Say it goes down to $100 and I buy the shares back for $10,000.  My net profit = $1,500.

But say the stock gets to $130 and I decide I was wrong, maybe IBM is going to keep going up.  Well then, I plunk down $13,000 for the 100 shares and return ‘em to Jim.  So my loss is -$1,500.

What would happen if LOTS of people were short a particular stock and they ALL decide to close out their position at the same time?  All those people would have to buy shares in order to exit their short positions.  And lots of buyers buying simultaneously will drive a stock up.

The short interest on financials was astronimical leading into today.  Some huge companies with millions of shares outstanding had no shares available to borrow.  Virtually every share that was available to borrow had been.

Overnight the Feds rolled in and said they were going to save the banks with a new trillion-dollar bailout (more in my next post).  Also the SEC took the extraordinary step of banning short-selling of financial companies.

Both put immense pressure on short-sellers to cover their positions.  So they all bought en masse, squeezing to get through the exit at the same time and driving up financial stocks spectacularly.

If you want to see a picture of how violent a stock’s price can fluctuate during a short squeeze. Check out today’s chart for ZION.  Yesterday it jumped $10 on news something was coming.  In the first 10 minutes of today’s trading day, the stock went from $45 to $107 and then back to $50.

All in ten minutes.

My point is that I don’t think today’s rally was based on fundamentals.  The shorts were squuezed out of financial stocks, that’s all.

We’re still in a very deep pile of you know what.

Buffett’s buying, but not financials

Reuters Staff
Sep 18, 2008 17:11 UTC

Yesterday I wondered if Buffett would put some cash to work buying distressed assets.  Today we got the answer.  From Bloomberg:

Warren Buffett’s MidAmerican Energy Holdings Co. agreed to buy Constellation Energy Group Inc. for about $4.7 billion, snapping up the largest U.S. power marketer at less than half its market value prior to this week.

The cash deal is worth $26.50 a share, the companies said today in a statement. That’s 7 percent higher than yesterday’s close. The stock plunged 58 percent this week on concern turmoil in financial markets would wreck Baltimore-based Constellation’s energy-trading business.

“Warren’s got the cash and he’s got the platform to fold it into at MidAmerican Energy,” said Greg Phelps, who oversees $3.5 billion at MFC Global Investment Management in Boston.

It’s good news that Buffett sees value somewhere in this market.  (Not sure I agree.  I still think the financial carnage has a ways to go and that the economy will suffer substantially as a result.*)  Still, Buffett is a very smart guy and his move suggests there are good assets to be had.

One great asset going cheap right now: people.

If there’s one thing Wall St. isn’t short of, it’s talented traders, bankers, and other financial types.  With their banks in disarray and their ’08 bonuses gone, you have to think most of these folkss are sending out resumes.

The Journal had a headline today that JP Morgan has stopped trading with giant hedge fund Citadel in retaliation for poaching its talent.  Haven’t seen the story yet.

By the way, the run is on at Goldman Sachs and Morgan Stanley.  Goldman is now down $25 today to $88.  Near the end of ’07, the stock got to $250.  Morgan is down a huge $9 to $13.  That stock was at $90 in mid ’07.  Morgan knows if they don’t find a buyer, they are gone.  They are talking to Wachovia and the Chinese.  According to CNBC, MS is saying GS is trying to raise money from the same guys…

……………..

*My macro thesis: The banking system has taken hundreds of billions of write downs.  There are hundreds of billions left to take.  Money in our economy is created by banks through credit.  Bank writedowns destroy balance sheets and loan production.  The money multiplier means that for every dollar of equity/reserves lost on a bank balance sheet, another $9 or $10 of loans is lost to the economy. (or in the overleveraged case of Wall St. banks $30)   No credit, no money.  No money, no corporate earnings.  No corporate earnings, declining share prices.

Barclays buys Lehman for a song

Reuters Staff
Sep 17, 2008 23:37 UTC

The British bank Barclays scooped up Lehman’s good assets for a song the day after it filed bankruptcy.  From the Journal:

Barclays PLC agreed to acquire the bulk of [Lehman] for $1.75 billion.

Barclays is buying a stripped-clean version of Lehman’s North American business, which will include most of its people, franchise, brand name, technology and clients but won’t include the risky trades and liabilities that had hurt Lehman in the markets before its Chapter 11 bankruptcy-court filing.

Barclays also gets Lehman’s headquarters and data centers.  They are paying $1.5 billion for that real estate and getting the rest of Lehman’s franchise for a cool $275 million.

Two years ago, Lehman’s market cap was $45 billion.  According to Bloomberg (via SWF Radar) Lehman turned down $6.40 per share from Korea Development Bank two weeks ago.  That would have valued the biz at between $4 and $5 billion.  They got $1.75 billion.  Oops.

This is why I question B of A’s move to buy Merrill so soon.  Had B of A waited a couple days, the crisis of confidence would likely have driven Merrill’s equity value to zero.  At that point, B of A could have bought Merrill’s valuable assets for peanuts.  AND they wouldn’t have had to absorb Merrill’s toxic balance sheet.

Warren Buffett also has billions of free cash.  He may pull of a deal like Barclays’ in the near future.

Contingency Plans

Reuters Staff
Sep 17, 2008 20:37 UTC

Today’s top headline on Drudge is this: Federal Bank Insurance Fund Dwindling.

The article itself reads like a repeat of the one I posted here two weeks ago.  In a nutshell, the FDIC doesn’t have enough money to bail out depositors if WaMu and any other large banks fail.  Luckily, Bernanke and Paulson are staying ahead of events as best they can.  Right now, WSJ.com is reporting that Citigroup and Wells Fargo are in discussions to take over WaMu.  The NYTimes is saying its JPM, Wells and HSBC.  Any of the above would likely get a huge chunk of change from the Feds for taking on WaMu’s nasty balance sheet.

I’m torn over moves like this, actually.  On the one hand, Bernanke and Paulson are moving with alacrity.  On the other, they are digging us into a very deep hole of debt while failing to arrest the spread of this financial contagion.  Seems to me the most prudent thing is to let bad companies go bankrupt.

In any case folks, we’re entering a new stage of this crisis every day.  Fannie, Freddie, AIG, Lehman and Bear failed.  Merrill would have if not saved by B of A.  The way Goldman Sachs and Morgan Stanley are trading, the market thinks there will be a run on those two next.  These institutions made it through the Great Depression.  All are collapsing over the course of a few weeks.

In essence they suffered a sudden and very violent bank run.  And now that Drudge is leading with stories about stricken commercial banks, that bank run threatens to spread to Main Street.

Regular readers of this blog know that we’re in a financial crisis like we haven’t seen since the Great Depression.  Most people still aren’t aware anything’s wrong.  Sure, the stock market is down and it’s tougher to get a mortgage.  But they don’t grasp that the financial system as a whole is collapsing with great speed and ferocity.

So what to do?  I can’t pretend to know what’s happening next, hopefully Bernanke and Paulson succeed in putting out this financial fire.  But they’ve been totally unable to at this point and there exists the outside possibility—I figure odds no greater than 10%—that we could see nationwide bank run.

  • With that in mind, I’ve taken my checking and savings accounts and moved them to Bank of America and JP Morgan.  Both have some bad legacy assets, but they are likely far safer than the likes of WaMu and Wachovia right now.  And if anything, BofA and JP might benefit from a bank run as you see a flight to quality banks among the general population.  Citigroup I don’t like.  Their investment banking arm engaged in the same risky trading with the same toxic mortgages just like the rest of the Wall St.  That puts depositors in their commercial bank at greater risk in my mind.
  • I would also take some cash out just in case.  Enough for a couple months expenses.  Keep it at home, in a waterproof/fireproof lockbox that’s well-hidden.
  • Another idea is to pay off those long-standing credit card balances.  I don’t know how the credit card system would handle a widespread bank run, but it can’t hurt to be well under your credit line in case plastic is your only payment option.  (Take out cash first, however.  There’s no guarantee that credit cards will actually work if the shit really hits the fan.)
  • Lastly make sure you STAY INFORMED.  My preferred way is to check the top stories on WSJ.com 3-5 times per day.

I’m not trying to spread panic here folks.  And I’m not saying we ARE going to have a nationwide bank run.  Like I said, I think the odds of that are still low.  But I want my readers to prepare themselves just in case.

(I will update this post with other ideas as events warrant)

UPDATE 1:  a reader asks about whether online bill pay will continue to function if banks run low on money.   I have no idea, frankly.  But one thing you might consider is prepaying some of your important utility bills.  Electricity, gas, water, phone.  Not cable.  ;)

UPDATE 2: “But holding dollars in cash doesn’t protect me from inflation.”  True enough.  While I think the first problem is DEflation as the money supply craters amidst a global bank run, the second problem may be inflation as the Fed prints whatever cash is necessary to rescue the system.  To protect against inflation, I’d consider buying physical gold.  Probably Canadian Maple Leafs and, if you can find ‘em, American Eagles.  Both are minted gold coins that are easily traded at gold dealers around the world.

WaMu lowered to junk

Reuters Staff
Sep 16, 2008 04:24 UTC

Per Bloomberg (via CR):

Washington Mutual Inc., the biggest U.S. savings and loan, had its credit rating cut to junk by Standard & Poor’s because of the deteriorating housing market….”Increasing market turmoil and the related impact from managing its concentrated mortgage franchise in this troubled housing and credit cycle led to the downgrade,” S&P wrote.

On a “more positive note” S&P said:

The bank is operating with adequate capital positions from a regulatory perspective and has demonstrated funding resilience as the deposit franchise has remained stable.

One wonders how stable the deposit base will be in the wake of this downgrade and other market turmoil.

Remember, FDIC’s Deposit Insurance Fund has only $45 billion of assets while WaMu has $140 billion of insured deposits.  At a loss rate similar to the one FDIC experienced with IndyMac, the Deposit Insurance Fund may be wiped out by WaMu’s failure.  Necessitating The Next Bailout.

Buffett (update: not) interested in AIG

Reuters Staff
Sep 15, 2008 16:34 UTC

UPDATE 1:50 PM.  CNBC NOW REPORTING BUFFETT IS NO LONGER IN TALKS WITH AIG.

Story at Bloomberg:

Billionaire investor Warren Buffett’s Berkshire Hathaway Inc. “is thought to be in talks” with American International Group Inc. about a possible investment, the Insurance Insider reported, citing unidentified sources.

AIG got below $4 but is now back to $6.  I’d be interested to hear what, specifically, is being discussed.  What’s Buffett going to buy?  Some of AIG’s insurance business is certainly a good fit for Buffett’s insurance operations at Berkshire Hathaway.  Aircraft leasing is still a good business.

But much of AIG is still a “black hole,” as Steve Leesman on CNBC likes to say.  Buffett likes to buy at the bottom, but only stuff he understands.  AIG’s balance sheet is both massive and opaque.

If Buffett is indeed talking to AIG, he’s likely focused on AIG’s good assets.

In other A.I.G. news, NY Governor David Paterson has said the state will allow the company to access capital in its subsidiaries:

American International Group Inc. will be allowed to access $20 billion of assets held by its subsidiaries, New York State Governor David Paterson said during a press conference on Monday. The move will allow AIG to use those assets as collateral to borrow cash to fund its day-to-day operations, Paterson explained.

This is not good news for AIG policy-holders.  NY State regulates AIG’s NY insurance business, including the amount of capital the company’s insurance subsidiary must have on hand.  That capital is meant to protect policy-holders, not AIG corporate.  And an insurance policy is only as good as the balance sheet of the company that writes it.  Theoretically, the insurance biz is walled-off in order to protect policy-holders from exactly the kind of panic hitting the company today.

New lending facilities (and why they won’t help)

Reuters Staff
Sep 15, 2008 03:19 UTC

(Complete coverage of yesterday’s events in the posts below)

CalculatedRisk is reporting that the Fed has expanded the types of collateral it is willing to except in exchange for loans.  A year ago it only accepted the highest-quality (least risky) collateral in exchange for a loan. Treasury bonds, for instance.  Now it will be accepting equities(!).

Moreover, 10 major Wall St. banks have announced a new $70 billion loan program to help banks get through the latest chapter of the Credit Crisis.

A group of global banks and securities firms announced late Sunday a $70 billion loan program that financial companies can tap to help ease a credit shortage that threatens global financial markets.

The ten banks, which include JPMorgan Chase & Co. and Goldman Sachs Group Inc., said they were committing $7 billion each for the pool. The pool would act as a signal to the marketplace that banks, brokerages, and other financial companies can lean on the fund to take care of borrowing needs.

First of all, you thought we were going to get through the weekend without another Fed bailout?  Well, you thought wrong.  Over the past year the Fed has offered up its balance sheet to banks that are in need of cash to fund their operations.  Theoretically, it’s just making loans to the banks.  Loans that have to be paid back.  But as the Fed loosens its own lending standards, allowing riskier institutions to put up riskier collateral, its putting taxpayers at greater risk of loss.

It’s not an overt bailout, as with Bear/Fannie/Freddie, but a bailout nonetheless: putting taxpayers at risk to help “stabilize” markets.  Besides the Fed taking additional risk onto its balance sheet, you also have the Federal Home Loan Banks that have lent hundreds of billions to some of the weakest banks (Countrywide and WaMu, for instance).  Such banks lost most of their private sources of capital (other than deposits) and the FHLB system saved them.  Is it any wonder that the Fannie/Freddie credit line announced last week also includes the FHLBs?  They may need a bailout before all is said and done….

Will all of these lending facilities help?  Probably not.  As Economist Nourial Roubini (aka Dr. Doom) has long and correctly argued, the fundamental problem confronting the American financial sector isn’t illiquidity.  It’s insolvency.

An illiquid bank may simply have a short-term funding problem.  Say for instance your local community bank experiences more withdrawals than anticipated on a particular day, so many that by the end of the day it doesn’t have enough funds on hand to meet withdrawal requests.  For the moment, the bank is illiquid.  It needs a loan to meet withdrawal demand.  But the bank will be able to pay back ITS loan once the bank’s borrowers pay back the principal and interest they owe the bank.

An insolvent bank is in deeper trouble.  Its problem is that its borrowers aren’t paying back their loans.  Perhaps it lent its depositors’ money to a real estate developer who’s gone bust.  A temporary loan from another bank in order to meet unexpectedly high withdrawals won’t do any good since this bank has no funds coming in to pay back its loan….

The sickest American financial companies aren’t merely illiquid.  After years of pumping depositors’ money into loans or securities for worthless(?) real estate projects, they are insolvent.

AIG: The downward spiral continues

Reuters Staff
Sep 15, 2008 02:22 UTC

The news just keeps getting worse.  AIG was said to be in trouble, but not facing the same sort of crisis as the investment banks.  Sure it has exposure to toxic mortgage assets, but it also has real businesses it can sell to raise capital:  an automobile insurance business, an annuities business and an aircraft-leasing unit.

Now this from the NYT: “Rush is On to Prevent AIG from Failing.”

Uh.  Come again…

Ratings agencies threatened to downgrade the insurance giant’s credit rating by Monday morning, allowing counterparties to withdraw capital from their contracts with the company. One person close to the firm said that if such an event occurred, A.I.G. may survive for only 48 hours to 72 hours.

AIG got itself into trouble selling protection to buyers of subprime and other toxic mortgage assets.  Hurricane Ike over the weekend certainly didn’t help; the Journal is reporting that the company may face significant claims.

Anyway, talks to sell some of their businesses to private-equity firms faltered, according to the Journal:

“The numbers are too daunting,” said a senior executive at a large private-equity firm. Given AIG’s huge balance sheet, “we just don’t have enough capital to fill the hole.”

This is scary stuff folks.  And it will only get scarier if depositors decide to make a run on weak banks like WaMu.

AIG has contacted the Fed for help.  They’re aren’t even a bank and they want the Fed to lend them money….

During a weekend scramble to shore up its finances, AIG turned down a capital infusion from a group of private-equity firms because it would have effectively given them control of the company, an 89-year-old giant that does business in nearly every corner of the world.

When AIG’s board rejected the capital infusion, the company’s recently appointed chairman and chief executive, Robert Willumstad, took the extraordinary step of reaching out to the Federal Reserve for help. The Fed usually deals with banks and brokers, and it wasn’t clear what it could do.

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