Without a bailout, what happens next?
By Ron Scherer | 09.30.08
Congress’s rejection of a financial rescue package has sent a message to the financial community: You are on your own.
What will that mean for the US economy if Congress does not reconsider and vote for a bank rescue plan in the next few days?
Some economists predict that the credit markets will become so tight that businesses, unable to finance their operations, will have to start to lay off workers in two to three months. Others say the US may be on the road to a nationalization of the banks as yet more financial institutions go under. And some suggest that the Federal Reserve will do everything from massive infusions of liquidity to lowering interest rates to try to prevent a total collapse of the nation’s financial fabric. But many economists admit that no one really knows the answer since this is uncharted economic territory.
“To say we are in uncharted territory is a huge understatement,” says Joel Naroff of Naroff Economic Advisors in Holland, Pa.
The uncertainty has been reflected almost immediately on Wall Street where the Dow Jones Industrial Average quickly shot up more than 200 points at Tuesday’s opening after falling more than 777 points on Monday.
Without any bailout package from Congress, the Federal Reserve remains the main player. On Monday it lined up $600 billion in liquidity with other central banks. “It had to start to provide more liquidity especially at quarter end,” says Scott Brown of Raymond James & Associates in St. Petersburg, Fla.
Despite the Fed’s actions, short-term interest rates in London remained higher than normal and two percentage points above super safe three-month Treasury bills, a huge gap. “It is just indicative of the extreme strain in the credit markets,” says Mr. Brown.
However, the Fed has little choice but to remain active in the markets.
“What they can do is keep injecting money into the system,” says Doug Roberts, director of research at Channel Capital Research in Shrewsbury, N.J.
“That will keep everything moving but not fix the machine.”
However, some analysts say this will only keep the banking system from going under. It will not convince the banks to become more liberal with their loans. “Right now, the credit markets remain frozen and business will start to run out of cash soon and layoffs can begin in the next two to three months,” says Mark Zandi, a forecaster at Moody’s Economy.com in West Chester, Pa.
Already, the deepening of the credit crisis in recent weeks has prompted him to mark down his forecast for jobs and economic growth. He estimates that 450,000 more jobs will be lost in the US, above his “pre-panic” forecast of an 800,000-job decline during a recession that, by his reckoning, began late last year.
Mr. Roberts says one of his main concerns is that the rescue bill that was defeated in Congress “underestimates” the true costs. “This is a global problem, not a domestic problem,” he says. “The banks in Europe are having liquidity problems and we are counterparties to many of them…. Ultimately, we are going to have to come to grips with this.”
Roberts thinks one solution might be to nationalize the banks. “That is basically what happened when Continental Illinois went under [in May 1984]; the government took the bank over,” he says. “They can’t let the banks fail.”
However, even with Citigroup announcing it would buy parts of Wachovia on Monday, other banks remained weak, including National City Corp. in Cleveland and Sovereign Bank in Philadelphia. “I guess Congress is saying, ‘Show me the lack of money,’ ” says Mr. Naroff. “The problem is once they start seeing it, it’s too late.”
Before the stock market opened Tuesday, President Bush, for the second consecutive day, implored Congress to pass the rescue plan. “Our economy is depending on decisive action from the government,” he said. “The sooner we address the problem, the sooner we can get back on the path of growth and job creation.”
Naroff says there are lots of very good strong financial institutions but most of them are relatively small. “They have only so much capacity to lend in this economy. So now the question for any large corporation that needs money is, where will it come from?”
At the root of the problem for the banks is the continuing decline in housing prices. Sale prices for existing single-family homes for July fell a record 16.3 percent compared with a year ago, according to Standard & Poor’s/Case-Shiller 20-city index. However, the pace of the declines has slowed over the last three months.
“There are signs of a slowdown in the rate of decline across the metro areas, but no evidence of a bottom,” says David Blitzer, chairman of the Index Committee at Standard & Poor’s, in a press release. “Little positive news can be found when cities like Las Vegas and Phoenix report annual declines as large as -29.9 percent and -29.3 percent, respectively, and all 20 cities are still in negative territory on a year-over-year basis.”
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Why the bailout bill went down
By Gail Russell Chaddock | 09.29.08
Washington – A sweeping rescue plan for US financial markets foundered in the US House Monday on a combination of doubts about the plan, reelection concerns, disdain for bailing out Wall Street bankers, and a deep philosophical distaste for massive government intervention in the private sector among conservatives.
The Dow Jones stock index plunged a record 777.68 points on the day a reaction that Democrats say could pave the way for a new vote, as early as Thursday.
Despite opinion polls showing that the public was warming to the idea of a rescue plan – and efforts by congressional leaders on both sides of the aisle to round up support – the measure failed 205 to 228, with 95 Democrats and 133 Republicans voting to scuttle the proposed $700 billion bailout. Most lawmakers had been deluged with calls and e-mail from voters angry that, as they see it, taxpayer dollars would be used to bail out Wall Street fat cats.
It was clear from lawmakers’ post-vote comments, especially among conservative Republicans, that the bill represented nothing short of a repudiation of values – such as faith in small government and market mechanisms – that they have cherished since the days of Ronald Reagan.
“Inaction has never been an option, but [Treasury chief Henry] Paulson’s plan should never have been our only option,” said Rep. Jeb Hensarling (R) of Texas, who heads the conservative Republican Study Group. “I fear that under this plan ultimately the federal government will become the guarantor of last resort, and that does put us on the slippery slope to socialism.”
Despite Monday’s loss, major players in the effort to prevent the credit crisis from worsening vowed to have another try at it later this week.
“The legislation has failed. The crisis is still with us,” said House Speaker Nancy Pelosi, in a briefing after the vote. “The lines of communication remain open.”
Secretary Paulson reaffirmed the need for a rescue plan for the US financial system, pledging to keep talking to lawmakers to come up with “a plan that works.”
“We’ve got much work to do and this is much too important to simply let fail,” Paulson told reporters after meeting President Bush to discuss the bill’s rejection. “We need to work as quickly as possible.”
House conservatives had clashed last week with the White House over the shape of the proposed rescue plan, which proposed that the Treasury Department buy up “troubled assets” from financial institutions, including foreign banks. They favored charging Wall Street to fund its own bailout through a government-backed insurance program – elements of which were included in the final rescue plan.
But for most GOP conservatives, the plan would still leave the Treasury secretary picking winners and losers in the US economy.
“I’m resolute in my opposition,” said Rep. Darrell Issa (R) of California. “Today we are ending the Reagan era if we vote for this, and we can’t come back and fix it next year.” The bill was also a tough call for Democrats, who resented being seen as lining up to bail out Wall Street just before an election, as their GOP challengers claimed to side with Main Street.
“We could lose seats over this,” said Rep. Carolyn Maloney (D) of New York, who nonetheless voted for the plan.
Some Democrats on the left wing of the party repudiated the plan. “What we are considering today is still built on the Paulson-Bush premise that buying up Wall Street’s bad bets will solve the liquidity problem. I don’t buy it,” said Rep. Peter DeFazio (D) of Oregon.
There are less expensive, less risky ways to solve the problem, he said. “We can do better. We should start again on a new package.”
Rep. Emanuel Cleaver (D) of Missouri, a member of the House Finance Committee, delayed his vote until the last minute to see if GOP leaders could deliver a majority of their own caucus. They did not, and he voted against the bill. “There’s no reason for us to go in and bail Bush out if his own party rejects him,” he said.
Monday’s vote marked the sharpest repudiation ever of the Bush White House by House Republicans, who voted against the plan by a margin of 2 to 1.
In a press briefing after the bill failed, House GOP leader John Boehner said Speaker Pelosi’s floor speech before the vote “poisoned” the GOP caucus and cost as many as a dozen Republican votes that had previously been committed to the rescue plan. In her speech, Pelosi blamed America’s financial woes on eight years of the Bush administration’s “reckless economic policies.”
Responding to the bill’s failure, Mr. Bush said: “Our strategy is to continue to address this economic situation head on, and we will be working to develop a strategy that will enable us to continue to move forward.”
Meanwhile, Monday’s vote sent the US Senate back to intraparty and interparty discussions on how to proceed.
“We need to have conversations. We don’t know what the next steps are,” says Jim Manley, a spokesman for Senate majority leader Harry Reid. The Senate had planned to vote on the bill on Thursday.
“The problem is not going away. We’re going to stay here until we find a solution,” said Senate Republican leader Mitch McConnell. “It’s time to fix the problem, not the fix the blame.”
Associated Press material was used in this report.
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Will Europe need its own bailout?
By Mark Rice-Oxley | 09.29.08
London
Financial markets have brief attention spans. A few short days ago, it was all about the US bailout: Would it fly or not? Analysts predicted markets would tank today if nothing were agreed over the weekend.
Well the deal was clinched and markets still tanked – the London index is down more than 3 percent as I write. The problem is that with every day that passes, and with every bank that falters, Europe realizes that this is its problem as much as America’s.
The collapse of Fortis, a Top 20 European financial institution, brought it home for the citizens of the three countries in which it has formidable operations: Belgium, Luxembourg, and the Netherlands.
The governments of the three countries moved to partly nationalize Fortis with an injection of more than $16 billion.
As the Times (of London) reports today:
“Benelux governments are desperate to avoid a panic. The banking and insurance group is Belgium’s largest private sector employer. About half the country’s population bank with it.”
German lender Hypo Real Estate Holding – the nation’s No. 2 commercial property lender – went hat in hand today to the German government and banks for a 35 billion euro credit line. And got it.
If that wasn’t bad enough, Britain lost its third bank of the credit crisis. Bradford and Bingley joined Northern Rock and HBOS in requiring a rescue.
So British taxpayers will be exposed to the same state-funded bailout that Americans are debating, only on a smaller scale. The government will take over about $80 billion of B&B’s outstanding loans.
As Nils Pratley commented in the Guardian:
“We, as taxpayers, are now in the debt collection business. Worse, we’ve been handed a portfolio of loans that is performing badly. The proportion of B&B’s loans more than three months in arrears rose to 2.29% in the first half of this year, up from 1.48% in 2007.”
All in all, it means that Europeans, who were so obsessed by the US bailout for much of the past two weeks, are now fixating on matters closer to home.
Seasoned market commentator Richard Hunter told me: “There are other factors at play this morning in terms of what is happening with Fortis and Bradford and Bingley, so the [American] bailout certainly is not the panacea that some people were hoping for.”
The bigger question is whether Europe will have to ape the US intervention. That might prove tough given the number of diverse countries involved and the dilatory reputation of the European Central Bank. So far, authorities say they want to deal with matters on a case-by-case basis. But analysts I’ve spoken to are convinced that Fortis will not be the last victim of this crisis.
“There probably are some other Fortises out there,” says London market analyst Justin Urquhart Stewart. “I wouldn’t be surprised if there was a French bank suffering out there. I fear I can see a plume of smoke rising over Paris.”
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Asian markets look beyond the bailout
By Peter Ford | 09.29.08
Beijing
While US Congressional leaders and Treasury officials slept Sunday night – some of them for the first time in several days - Asian investors showed themselves unimpressed by the tentative $700 billion financial rescue package.
Markets from India to Japan fell on Monday despite the deal. Tokyo’s main index was down 1.3 percent and Hong Kong’s Hang Seng Index dropped 2.1 percent. It’s not so much because investors think Congress will vote down the deal - or because they don’t think it will work. Rather, market strategists suggest that investors are already looking beyond the salvation of the US financial system to think about the fundamentals of the world economy.
And the picture is not pretty. If the world economy was on the brink of recession earlier in the year, the current financial crisis seems likely to tip it over the edge.
It’s almost as if the markets have discounted the rescue package even before it has been passed. Perhaps, that is good news: At least investors are behaving as if there will still be markets in a few months’ time, rather than a complete meltdown.
But it seems probable that more banks will be going under before this mess is cleared up, and that it will be some time before the financial system regains some sort of stability.
That itself is worrisome to investors, but when they begin to think about the implications of the rescue package, some of them are also potentially troubling. For example, if the US government funds the package by issuing large amounts of Treasury debt – essentially printing money – that is bound to be inflationary.
And looking even beyond that potential problem, a recession will depress markets: On the Tokyo exchange Monday, shares in the world’s largest shipping company, Mitsui O.S.K. Lines, lost more than six percent. If global trade slows, cargo ships have less to carry.
Shares in automakers Toyota and Mazda slid too, on reports they are cutting production at their Chinese factories because of weaker demand.
So what might constitute good enough news to pull the markets up a bit? If the prospect of a $700 billion rescue doesn’t do it, what will?
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Washington Mutual’s failure: No quick fix for banking system
By Mark Trumbull | 09.26.08
The biggest bank failure in US history happened Thursday around dinner time, and … life mostly went on as usual.
Sure, the fall of Washington Mutual is a big deal. In ordinary times, it would be easily the big news story of the day or the week.
These aren’t ordinary times.
After recent collapses of other big-name financial companies – Fannie Mae, Freddie Mac, AIG, Lehman Brothers – this seems like just another day in the credit-market crisis.
Of course, the very scale of the maelstrom has reached the point where all eyes are now on Washington, as Congress considers a rescue plan designed to contain the cascade of failures.
But the failure of Washington Mutual sends a significant signal: The banking-system problems are large and defy a quick fix.
WaMu had tried in recent days to find a private buyer, but failed. With the firm’s access to credit drying up and some depositors pulling their money out, federal bank regulators decided to act this week.
The Federal Deposit Insurance Corp. decided to seize WaMu and then arranged a quick sale of the thrift institution – good assets and bad – to JPMorgan Chase for $1.9 billion.
“For all depositors and other customers of Washington Mutual Bank, this is simply a combination of two banks,” said FDIC Chairman Sheila Bair in a statement. “For bank customers, it will be a seamless transition. There will be no interruption in services and bank customers should expect business as usual come Friday morning.”
By moving when it did, the FDIC was able to deal with the problem without having to tap its Deposit Insurance Fund. That fund, built with premiums from banks and other institutions with federally insured deposits, is used when needed to protect depositor accounts. Individual accounts up to $100,000 are completely insured against losses when banks fail.
WaMu’s $307 billion in assets outstrip the $40 billion affected in the 1984 failure of Continental Illinois National Bank, until now the largest US bank failure. Earlier this year, IndyMac failure involved $32 billion in assets.
WaMu’s shareholders will be wiped out – as will bondholders. That shook some financial-company stocks and bonds Friday morning, as investors assessed the risks of other banks failing. One large bank that took a hit was Wachovia Corp., while some that are perceived as stronger were little affected. This doesn’t mean Wachovia will follow down the same slope as WaMu, but it has among the largest exposures to home loans in hard-hit states California and Florida, according to research by Oppenheimer & Co.
The WaMu deal allows JPMorgan to expand its reach westward. But its acquisition comes at a price. JPMorgan plans to mark down WaMu’s loan portfolio by about $31 billion – a sign of the costs the US Treasury may face if Congress gives the go-ahead for the government to buy troubled assets from banks.
At many banks there’s a gap between what they hope certain assets are worth and the reality. But the Treasury plan involves buying those assets – at a price where banks are willing to part with them – to relieve uncertainty about the health of the US banking system. The assets bought by Treasury might fare well or poorly in value, depending on the price they pay and where home prices head from here.
