New York Stock Exchange and Wilks Building at Wall and Broad Streets
Turning and turning in the widening gyre
The falcon cannot hear the falconer;
Things fall apart; the centre cannot hold;
Mere anarchy is loosed upon the world,
The blood-dimmed tide is loosed, and everywhere
The ceremony of innocence is drowned;
The best lack all conviction, while the worst
Are full of passionate intensity.
Yeats: The Second Coming
Ilargi: The US government and the Federal Reserve pulled out all the stops last night, laid all their weapons on the table, and stripped naked.
As noted yesterday, all the politicians that matter in Congress and Senate were present at the meeting that resulted in the AIG bail-out. They were there to make sure any illegal steps could be made legal in the wink of an eye.
Paulson and Bernanke have played havoc with the law lately, most recently when deciding stocks could be dumped at the Fed credit windows, and when allowing BoA to use its client deposits to go play in the casino.
So everybody was there, and the deal got done. Big sigh of relief, right? Well, no. The Dow is falling off a cliff, and the next group of financial institutions are lined up to be the fastest to fall. Do note, please, that today can be pinned down as the first day that the financial crisis spills over into corporate America for real.
Allow me to quote myself from last night:
"What this means is the start of what you might call finance anarchy. The US government has lost control, that much is clear to everyone now, or at least those who've been paying attention. As I've said, the companies will now be picked off one by one through shorting and swapping. The free market reaches its self-chosen and inevitable climax.
AIG has liabilities that run into the hundreds of billions of dollars, if not thousands. The vultures know this, make no mistake about it. So an $85 billion rescue is but a joke. It won't lift nothing for more than a few hours, probably not even long enough to last till the Dow opens tomorrow. There is blood in the water, and it's feeding time."
There are two converging problems at play here. One: the AIG deal doesn’t solve any of the issues that have built the crisis. Two: the US government is now out of ammunition, and it’s plain for everyone to see (not that everyone does see it). The emperor has nothing left to wear.
That means we can now conclude that the financial crisis has become a corporate and overall economic crisis. But there is more. We are witnessing the beginning of a political crisis as well.
There is no way that the financial downfall can be stopped, even temportarily, before the US elections. The government can now only try to negotiate mergers and private buy-outs. Its power and authority as a force in the markets is gone.
And as people see the world around them crumble, with mass-lay-offs, disappearing pension benefits and bank-runs, they will want to know who’s responsible. And that, of course, is the government: White House, Congress and Senate.
Hence, when Americans go to the polls in November, they can only vote for candidates that are directly, as senators, responsible for the crisis. They try hard to distance themselves from it, but that is mere posturing.
This is the sort of responsibilty that in a functioning democracy forces politicians to step down. This goes right to the heart of issues such as trust and legitimacy: people need to be able to call their elected representatives on their mistakes, whether they are honest ones or not.
I’ve long said that before the cascading failures start, we will see a round of consolidations. We have today arrived at that point. Wachovia and Morgan Stanley are in merger talks, the US government seeks a buyer for WaMu, Lloyds buys UK mortgage lender HBOS (HSBC wants in, but refuses to pay a single penny for HBOS shares).
Not all these talks will presumably be concluded in time to avoid bankruptcies, events are accelerating too fast. There is no trust whatsoever left in the system. For every successful deal, three more problems will emerge. It has to wind down till all the funny money has gone.
I said yesterday that Morgan Stanley looked to be under siege. It’s down over 40% this morning. It has entered the emergency room. And when Goldman gets under attack (down 25%), the picture is complete: Wall Street as a whole is crumbling.
There were bank runs at AIG affiliates yesterday in SIngapore. They won’t be the last, and they will hit closer to home. I wouldn’t be surprised if the Fed and Treasury will, in a sort of last gasp, bail out the FDIC as early as this weekend.
The Dow lost 4.06% today. Don't it make you wonder what would have happened without the AIG deal? And where is the next upshot supposed to come from this time?
All major banks have huge losses, a total of at least $70 billion. That takes another $700-800 billion in available credit out of the system. In one day. It seems a lot, but it'll be a trifle soon when it all really starts to unfold and unwind. Kind of like how the Bear Stearns buy-out looked huge 6 months ago.
Treasury Plans Special Auctions of Debt to Help Fed Manage Balance Sheet
The U.S. Treasury said it will sell bills to allow the Federal Reserve to expand its balance sheet, a day after the government agreed to take over American International Group Inc.
"The Treasury Department announced today the initiation of a temporary Supplementary Financing Program at the request of the Federal Reserve," the department said in a statement today. "The program will consist of a series of Treasury bills, apart from Treasury's current borrowing program."
Yesterday the Fed announced an $85 billion loan to AIG, in exchange for a 79.9 percent government stake in the largest U.S. insurer. The Fed also has set up several other emergency lending programs to provide Wall Street firms with ready access to funding. The new bill program "will provide cash for use in the Federal Reserve initiatives," the Treasury said.
The Treasury said it will sell the new bills using its existing auction procedures, giving "as much advance notification as possible." The bills will not have a uniform fixed term, giving the Treasury the same duration flexibility that it has with cash-management bills.
Pressure building on US Government AAA rating
Pressure is building on the pristine "AAA" rating of the United States after a federal bailout of American International Group Inc, Standard & Poor's sovereign ratings committee chairman said on Wednesday. The $85 billion bailout of AIG on Tuesday by the U.S. Federal Reserve "has weakened the fiscal profile of the United States," S&P's John Chambers told Reuters in an interview.
"Lack of a pro-active stance could have resulted in further financial stress and put pressure on the U.S. triple-A rating," Chambers said. "There's no God-given gift of a AAA rating, and the U.S. has to earn it like everyone else."
S&P earlier this month affirmed the "AAA" sovereign rating of the United States, noting risks to the U.S. credit profile including the deteriorating credit profiles for most U.S. financial institutions over the past 12 months, S&P said in a September 3 statement.
Potential up-front costs to the government of maintaining financial stability could reach 24 percent of gross domestic product in the case of a "deep and prolonged recession," the report said. Chambers on Wednesday compared the U.S. rating to a lobster cooking in a pot of cold water.
"The lobster is still in the AAA pot and still moving," Chambers said. "The heat is turning up, but the water is still AAA stable." Chambers also called the AIG bailout "a signal event without precedent," adding: "This will be case studied for decades to come."
Ilargi: Think they’d let up? Nah, DOUBLE OR NOTHING!!! It gets crazier by the day.... They're not paying, you are. Gambling with other people's money: favorite sport.
Some Seek Agency to Buy Bad Debt as Long-Term Answer
As the Bush administration has lurched from pillar to post in the financial crisis, some lawmakers and experts were considering a longer-term legislative solution that would create a new agency to dispose of the mortgage-related assets at the core of Wall Street’s woes.
Proponents of a more systematic government role to help relieve financial institutions of their toxic securities range from Lawrence H. Summers, the former Treasury secretary under President Clinton, to former Federal Reserve chairmen Paul A. Volcker and Alan Greenspan.
In Congress, the idea that is gaining traction centers on the creation of a new agency that would buy troubled assets from hobbled companies. The idea was floated on Tuesday by Barney Frank, Democrat of Massachusetts, who heads the House Financial Services Committee. Among those signaling that it merited serious consideration were Senate Majority Leader Harry Reid and the House speaker, Nancy Pelosi.
With seven weeks until the presidential elections, no one expects Congress or the White House to move quickly to create a new federal agency that puts taxpayers at risk for hundreds of billions of dollars in bad assets. Steny H. Hoyer, the House majority leader, said there was no time to consider any new proposals in the two weeks before Congress adjourns.
But in its ad hoc approach to the crisis, the Treasury Department and the Federal Reserve have, in effect, already embarked on a course similar to the proposals in Congress. In the case of Bear Stearns, the Fed took $29 billion of the investment bank’s mortgage-related assets as collateral for a Fed loan to JPMorgan Chase, which then agreed to acquire Bear Stearns.
In the case of Fannie Mae and Freddie Mac, the Treasury Department placed the companies in a conservatorship and explicitly backed the $5.3 trillion of mortgages they own or guarantee. Treasury also agreed to buy an unspecified amount of Fannie’s and Freddie’s mortgage-backed securities on the open market, starting with a $5 billion purchase this month.
Those securities are to be managed and ultimately sold for the government by an investment house on Wall Street. But federal officials remain concerned about the plight of other institutions, including Washington Mutual, the nation’s largest savings association. Experts estimate that a government bailout of Washington Mutual could cut in half the size of the federal deposit insurance fund, which protects bank depositors at thousands of banks and savings and loan institutions.
Mr. Frank was among the House and Senate leaders who were hastily called to a meeting Tuesday with the Federal Reserve chairman, Ben S. Bernanke, and Treasury Secretary Henry M. Paulson Jr. to hear about the Fed’s latest rescue plan, this time of the American International Group.
Mr. Frank said that one of the issues discussed in the meeting was a potential need for broader, longer-term federal action in the marketplace. “We have had a series of ad hoc interventions; this is one more ad hoc intervention,” he said. “I do think, because you can’t be sure this is the last one, the question of a broader more systemic action in which the government tries to help resolve these things is very important.”
In concept, the proposal would resemble the Resolution Trust Corporation, which disposed of bad assets held by hundreds of crippled savings institutions. Created in 1989, Resolution Trust closed or reorganized 747 institutions holding assets of nearly $400 billion. It did so by seizing the assets of troubled savings and loans and then reselling them to bargain-seeking investors.
By 1995, the S.& L. crisis abated and the agency was folded into the Federal Deposit Insurance Corporation, which Congress created during the Great Depression to regulate banks and protect the accounts of customers when they fail.
But the parallels to Resolution Trust are inexact. The federal government, unlike now, had no choice but to acquire the assets from savings associations because they were backed by federal deposit insurance. The mortgages now at the heart of Wall Street’s woes are not backed by federally insured deposits. Moreover, the mission of the corporation was to dispose of the assets as quickly as possible for maximum value. Its goal was to reduce taxpayer exposure.
In the current crisis, the goal is more debatable. Should the government be helping homeowners, housing or financial markets, or large companies in trouble? Moreover, policy makers already have been seeking ways to reduce the impact of hard-to-sell assets on the books of companies by encouraging healthier institutions to acquire troubled ones.
The issue is whether Congress, after the election, should create a more formal and accountable mechanism, such as a federal agency, that would provide a relief valve for the troubled assets now causing havoc on Wall Street.
“The question is, and it’s just a question, is, ‘Are we at the point where the private market has made so many bad decisions and is so depressed that it can’t get out from under?’ “ said Mr. Frank, who is planning to hold a hearing next week to explore whether Congress should create an agency to help the markets dispose of hard-to-sell assets.
“The question we have to address is, ‘Is it the case that market psychology has so depressed assets that no entity has capacity to buy and hold these assets except for the government?’ “ Mr. Frank said it would be more appropriate for a new agency, rather than the central bank, to be relieving the markets of the troubled assets. “It is not appropriate for the Federal Reserve either in a financial sense or in a democratic sense to take on this role,” Mr. Frank said in an interview.
But Senator Christopher J. Dodd of Connecticut, the chairman of the Senate banking committee, said at a news conference announcing hearings later this week on the crisis that he wondered whether such an agency was necessary if Treasury and the Fed were already performing such a function and had the authority to continue to do it.
“I’m not opposed to it,” he said of Mr. Frank’s proposal. “I’m anxious to hear what the administration would have to say about this.” Administration officials said they had no plans to make such a proposal, and that they would leave it to the next administration.
Mr. Frank emphasized that any legislation creating a new agency would have to be accompanied by “tough new regulations” to discourage companies from making more risky investments. He acknowledged that the decision about such an agency would be in the hands of the next Congress and the next president.
In recent days, aides to the presidential campaigns of John McCain and Barack Obama have said it would be premature to consider creating a new agency. But after the election, the political imperatives could significantly change, particularly if the housing markets remain depressed and Wall Street continues to choke on the billions of dollars in mortgage-backed assets.
Morgan Stanley and Goldman shares under pressure
Anxious investors continued to hack away at Morgan Stanley and Goldman Sachs Group Inc Wednesday, sending the two largest investment banks' shares lower and boosting default-insurance prices higher amid lingering worries about their ability to survive.
In early trade, shares of Morgan Stanley sank 13 percent to their lowest level in a decade, while Goldman Sachs fell 8 percent to a three-year low. So far this year, Goldman shares have fallen by 43 percent and Morgan's have lost half their value.
More distressing was the rise in the cost of protecting against a default in debt issued by the banks. The cost of protecting $10 million of Morgan debt against default for five years rose to $796,000 a year, up $40,000, according to CMA DataVision. Insurance policies on the debt, known as credit default swaps, were trading as though the firm were rated deep in junk territory at "B2" by Moody's, or 10 steps below its actual rating of "A1."
The cost of Goldman debt default insurance rose to $462,000 a year, up $16,000, trading as if the firm were rated "Ba3," nine steps below its actual "Aa3" rating at Moody's. The two remaining major Wall Street investment banks posted better-than-expected third-quarter results on Tuesday, but the news was not enough to slow the spreading fire.
"The credit crunch and credit contraction is intensifying," said Peter Boockvar, equity strategist at Miller Tabak & Co in New York. "The action in Morgan Stanley in light of what was better-than-expected numbers last night is disconcerting."
Morgan Stanley on Tuesday rushed to release its quarterly results after investors pushed its shares down 11 percent and led to widening swap spreads. Morgan out-earned the larger Goldman, which also exceeded analysts' expectations. Executives from both firms insisted their businesses remain vibrant and have performed well in unprecedented turmoil. Both argued they do not want or need to merge with a commercial bank.
Yet contraction in the capital markets has convinced some analysts that investment banks need to combine with big deposit-rich banks so they can tap pools of deposits for funding when debt and stock markets grow jittery. Yet the same panic that pushed Lehman Brothers Holdings Inc into bankruptcy and prompted Merrill Lynch & Co to seek a merger with Bank of America Corp continues to weigh on Goldman and Morgan Stanley.
U.S. to Take Over AIG in $85 Billion Bailout;
Central Banks Inject Cash as Credit Dries Up
The U.S. government seized control of American International Group Inc. -- one of the world's biggest insurers -- in an $85 billion deal that signaled the intensity of its concerns about the danger a collapse could pose to the financial system.
The step marks a dramatic turnabout for the federal government, which had been strongly resisting overtures from AIG for an emergency loan or some intervention that would prevent the insurer from falling into bankruptcy. Just last weekend, the government essentially pulled the plug on Lehman Brothers Holdings Inc., allowing the big investment bank to go under instead of giving it financial support. This time, the government decided AIG truly was too big to fail.
The U.S. negotiators drove a hard bargain. Under terms hammered out Tuesday night, the Fed will lend up to $85 billion to AIG, and the U.S. government will effectively get a 79.9% equity stake in the insurer in the form of warrants called equity participation notes. The two-year loan will carry an interest rate of Libor plus 8.5 percentage points. (Libor, the London interbank offered rate, is a common short-term lending benchmark.)
The loan is secured by AIG's assets, including its profitable insurance businesses, giving the Fed some protection even if markets continue to sink. And if AIG rebounds, taxpayers could reap a big profit through the government's equity stake. "This loan will facilitate a process under which AIG will sell certain of its businesses in an orderly manner, with the least possible disruption to the overall economy," the Fed said in a statement.
It puts the government in control of a private insurer -- a historic development, particularly considering that AIG isn't directly regulated by the federal government. The Fed took the highly unusual step using legal authority granted in the Federal Reserve Act, which allows it to lend to nonbanks under "unusual and exigent" circumstances, something it invoked when Bear Stearns Cos. was rescued in March.
As part of the deal, Treasury Secretary Henry Paulson insisted that AIG's chief executive, Robert Willumstad, step aside. Mr. Paulson personally told Mr. Willumstad the news in a phone call on Tuesday, according to a person familiar with the call. Mr. Willumstad will be succeeded by Edward Liddy, the former head of insurer Allstate Corp.
AIG's bailout caps a tumultuous 10 days that have remade the American financial system. In that time, the government has engineered rescues that insert it deep into the housing and insurance industries, while Wall Street has watched two of its last four big independent brokerage firms exit the scene.
The U.S. on Sept. 6 took over mortgage-lending giants Fannie Mae and Freddie Mac as they teetered near collapse. This Sunday, the U.S. refused to bail out Wall Street pillar Lehman Brothers, which filed for bankruptcy-court protection and is now being sold off in pieces. That same day, another struggling Wall Street titan, Merrill Lynch & Co., agreed to sell itself to Bank of America Corp.
The AIG deal followed a day of high drama in Washington. The Treasury's Mr. Paulson and Federal Reserve Chairman Ben Bernanke convened in the early evening an unexpected meeting of top congressional leaders. Late in the trading day Tuesday, anticipation that the government might assist the insurer helped propel the Dow Jones Industrial Average to a 1.3% gain.
In bailing out AIG, the Federal Reserve appeared to be motivated in part by worries that Wall Street's financial crisis could begin to spill over into seemingly safe investments held by small investors, such as money-market funds that invest in AIG debt.
Indeed, on Tuesday the $62 billion Primary Fund from the Reserve, a New York money-market firm, said it "broke the buck" -- that is, its net asset value fell below the $1-a-share level that funds like this must maintain.
Breaking the buck is an extremely rare occurrence. The fund was pinched by investments in bonds issued by now collapsing Lehman Brothers. Money-market funds are supposed to be among the safest investments available. No fund in the $3.6 trillion money-market industry has lost money since 1994, when Orange County, Calif., went bankrupt. A number of money-market funds own securities issued by AIG. The firm is also a big insurer of some money-market instruments.
After AIG rescue, Fed may find more at its door
In one $85 billion fell swoop, the U.S. Federal Reserve may have wiped out what credibility it won resisting Lehman Brothers' rescue plea and opened its door to countless other companies to come calling for cash.
By providing a massive loan to American International Group on Tuesday, just two days after refusing to use public funds to save Lehman Brothers from bankruptcy, the central bank also invited tough questions on how exactly it determined whether a company was too big to fail.
Between the $29 billion the Fed pledged to swing the Bear Stearns sale to JPMorgan in March, $100 billion apiece to rescue mortgage finance firms Fannie Mae and Freddie Mac, up to $300 billion for the Federal Housing Authority, Tuesday's $85 billion loan to insurer AIG and various other rescue deals and loans, taxpayers are potentially on the hook for more than $900 billion.
"They pretended they were drawing a line in the sand with Lehman Brothers but now two days later they're doing another bailout," said Nouriel Roubini, a professor at New York University's Stern School of Business. "We're essentially continuing a system where profits are privatized and...losses socialized," Roubini said, adding that auto makers, airlines and other struggling businesses would no doubt be asking for government help too.
The government was hard pressed to say no to AIG because of concerns that its collapse would harm thousands of companies around the world and cause chaos in the $62 trillion market for credit default swaps, where it is a big player.
Many on Wall Street were clamouring for a rescue earlier on Tuesday, and AIG's share price swung wildly throughout the day as rumours swirled of an on again, off again government rescue.
But Roubini said instead of handing out money to firms that made bad bets -- which could inadvertently encourage more risky behaviour if companies think they have a safety net -- the government should be buying up mortgages and rewriting the terms so that households are not buried in debt.
To be sure, the Fed attached quite a few strings to its AIG funding deal. The loan carries a high interest rate, the government can veto any dividends, and AIG is expected to sell assets over the next two years to repay its debt. Senior management will be replaced.
But the central bank also followed a pattern established with Bear Stearns in March and repeated with Fannie and Freddie earlier this month of essentially wiping out shareholders while protecting those who held debt.
Some economists warned that investors had caught on and were betting on future bailouts by selling stock and buying bonds in struggling firms. That ends up pushing down a company's share price, which can exacerbate its troubles.
"If the message is that any time something like this pops up we're going to wipe out the equity and coddle the bondholders, that is its own sort of moral hazard," said Michael Feroli, an economist with JPMorgan in New York. "I don't think you have to be a die-hard free market advocate to be at least a little bit concerned."
Fed officials said that they needed to act because of AIG's extensive involvement in financial markets. Through its insurance, risk and asset management businesses, AIG has dealings with many thousands of companies all over the world, so a bankruptcy would have had huge global repercussions.
RBC Capital Markets analyst Hank Calenti pegged the market impact of an AIG failure at more than $180 billion, or about half of the total capital that financial firms have raised since the beginning of the credit crisis last year. But JPMorgan's Feroli said the Fed could have chosen to let AIG fail, just as it had done with Lehman.
"We don't know if the disease would have been worse than the medicine," he said. "We'll never know. But we know we lived through Lehman." He said the central bank needed to clearly explain when and why it would act to salvage a company in jeopardy or face the prospect of a long line of companies seeking bailouts.
Fed Chairman Ben Bernanke, who has stayed out of the public eye during the Lehman and AIG drama, is due to testify before a congressional committee next week and can expect some pointed questioning, Feroli said. "He needs to provide some sort of clear demarcation of what is or is not a systemic risk." "Of the many unconventional actions taken by the Fed in the current crisis, this may likely prove to be the most controversial and should make Bernanke's...testimony on Capitol Hill an interesting event."
AIG Falls on Speculation Takeover Will Wipe Out Shareholders
American International Group Inc. fell 30 percent on speculation the government's takeover will ultimately wipe out shareholders. AIG dropped $1.14 to $2.61 at 9:39 a.m. in New York Stock Exchange composite trading.
The U.S. plan to save the New York- based company, the nation's largest insurer by assets, may give the government an 80 percent stake in return for an $85 billion loan, and dividends may be halted to common and preferred stockholders. They're already reeling from a 94 percent drop in the common shares this year.
The "punitive" interest rate on the two-year loan "makes it extremely clear that this is not a subsidy extended to keep the company afloat but rather a stranglehold that makes AIG unviable while ensuring that its obligations will be met," said Marco Annunziata, an analyst at UniCredit SpA, in a note to clients. "This is to all extents and purposes a controlled bankruptcy."
AIG unraveled as the worst housing crisis since the Great Depression led to more than $18 billion of losses in the past year. A meltdown could have cost the financial industry $180 billion, according to RBC Capital Markets, because AIG provided insurance on more than $441 billion of fixed-income investments held by the world's biggest institutions, including $57.8 billion in securities tied to subprime mortgages.
The U.S. reversed its opposition to a bailout of AIG, after private efforts collapsed and the Federal Reserve concluded that "a disorderly failure of AIG could add to already significant levels of financial market fragility," according to a Fed statement late yesterday.
"It's an enormous relief," said David Havens, credit analyst for UBS AG in Stamford, Connecticut. "Nobody really knows what it would have meant if they would have been allowed to fail, but there was an enormous amount of systemic risk. The problem was, nobody really knew how bad it could have been."
The agreement will give the company, which sells insurance in more than 130 countries, time to sell assets "on an orderly basis," AIG said in a statement. Chief Executive Officer Robert Willumstad, 63, will be replaced by former Allstate Corp. CEO Edward Liddy, 62, according to a person familiar with the plans, who declined to be identified because the change hadn't been formally announced.
AIG's $2.5 billion of 5.85 percent notes due in 2018 jumped 8.25 cents to 53 cents on the dollar as of 9:29 a.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The debt yields 15.6 percent, or about 12 percentage points more than similar-maturity Treasuries, Trace data show.
The survival of the 89-year-old insurer fell into doubt when Standard & Poor's and Moody's Investors Service cut its credit ratings on Sept. 15. The reductions threatened to force AIG to post more than $13 billion in collateral when the company was already short on cash. AIG couldn't raise money by selling shares after the stock plunged to less than $4 a share from $70.11 in October of last year.
"There could be a greater need for capital" beyond the $85 billion, New York Insurance Superintendent Eric Dinallo told CNBC today, adding that the loan will give AIG time to sell units. The loan will "be sufficient to handle AIG's collateral needs" and allow the insurer to refinance debt as it comes due, said Wachovia Corp. analyst John Hall in a note today.
The Fed's loan doesn't require asset sales or the company's liquidation, though these are the most likely ways AIG will repay the Fed, central bank staff officials told reporters on condition of anonymity. Blackstone Group LP advised AIG on the transaction. The Fed doesn't have an expectation of whether AIG will be smaller, nonexistent or similar to its current form at the end of the loan's term, the staffers said.
The Fed or Treasury will end up holding the AIG stake, the staffers said. The Fed bailed out AIG while refusing aid to Lehman Brothers Holdings Inc., which collapsed earlier this week, because financial markets were more prepared for a Lehman failure, a Fed staff official said.
The Fed stepped in after JPMorgan Chase & Co. and Goldman Sachs Group Inc., which were brought in to help assess AIG, failed to come up with a solution, according to a person familiar with the talks. Liddy is currently on the board of Goldman, the company Henry Paulson ran as CEO before becoming the U.S. Treasury secretary in 2006.
Can Bailout Capitalism Work?
Is the government planning on backstopping the entire economy in order to prevent a recession? How far is the government willing to go with respect to the degree of their overall involvement (financial resources, governance and oversight, etc) with troubled companies?
How far is the government planning on going with respect to getting into the "risk mitigation" business, in terms of constantly stepping into rescue Corporate America from its own incompetence? How far is the government willing to go in order to protect the economy from risk (or capitalism depending on your interpretation), in order to create a faux economy where nothing bad ever happens?
When it comes to the questions posed above, your guess is as good as mine. The only "line" we know much about (at this point) is the one that defines who the government will help, and that line seems to be drawn in terms of how entrenched a particular company is into the larger economy.
Because the bailouts/rescue/back-stops of Bear Stearns, the Mortgage GSEs and now AIG seemed to have been motivated more by the desire to protect their bond-holders, derivative holders, etc, etc, from facing significant financial risk (if not failing themselves) then it was about saving the companies receiving bailouts.
Of course, this scenario is arguably worse than a bailout (in of itself) as you're not only bailing out a bad company, you're also backstopping the risk of those who invested in an insolvent company/allowed themselves to get overexposed to same.
Think about it: AIG will have to pay back the loan in order to free itself of partial government ownership, whilst the bond holders will simply get to enjoy the backstopping of their risk without having to pay the government one red cent for the privilege. Doesn't that smell fishy to you?
At the very least, anyone who holds AIG bonds, derivatives, et al, should be forced to surrender some of their gains to the government in exchange for the government protecting their investment. Furthermore, if the government is going to engage in these sorts of activities more thought needs to be given towards how to funnel some of the financial benefits (assuming any exist) from these interventionists machinations back to the tax payers (special refunds, etc).
It's absurd that the taxpayer provides the cash to rescue these malaise ridden companies, protect bond holders, etc, but isn't even in line to receive any of the benefits. It's also not a bad idea to force bailed out companies to provide some sort of free or discounted service to low income Americans either. Just think about it: we have millions of Americans in need of health insurance, whose tax dollars were just used to bailout an insurance company.
Yes, I know AIG doesn't provide primary care insurance products, only supplemental and accidental injury ones, however the irony of uninsured taxpayers funding the bailout of an insurance company is highly disturbing to say the least.
Final Thought: American economic policy appears to be evolving to a place where we allow the financial sector to run amuck via minimal restrictions, and the Government is the ultimate parachute that removes risk from the equation. How can our economy survive if this is the way things are going to be on a go-forward basis?
I'm not so much questioning the government's rescue of AIG as I am the policies that got us to this point, policies that I don't see the government making any move to fix. Without a marked change to the way we regulate the financial sector, manage the economy, etc, we're just going to keep winding up back in these situations. I.e. "minimal regulation/bailout capitalism" isn't exactly a sustainable economic model.
Housing Starts Lowest in 17 Years, Current Account Deficit Widens
Home construction tumbled a second month in a row during August, falling below expectations to the lowest level in 17 years. Separately, the U.S. current account deficit widened in the second quarter, pushed higher by rising oil imports.
Housing starts decreased 6.2% last month to a seasonally adjusted 895,000 annual rate, the Commerce Department said Wednesday. Single-family home groundbreakings also declined, and building permits fell sharply. Economists surveyed by Dow Jones Newswires expected August starts to drop by 1.6% to a 950,000-unit annual rate. The level of 895,000 was the lowest since 798,000 in January 1991.
July housing starts decreased 12.4% to 954,000, revised down from the originally reported drop of 11.0% to 965,000-unit annual rate. The July tumble reflected a payback for a surge the month before caused by a change to New York City building codes. The city had enacted a set of construction codes effective for apartment building permits authorized as of July 1, and builders rushed for permits during June to beat the deadline; that served to drive up U.S. starts and permits in June.
Wednesday's data showed housing starts year over year in August were 33.1% below the level of construction in August 2007. Building keeps retreating because inventories of unsold homes are so high. A report Tuesday by the National Association of Home Builders showed the trade group's latest monthly survey of builders' thoughts on market prospects rose, yet remained weak. The NAHB's September index measuring builder confidence climbed to 18 from a record-low 16.
The index gauges builder perceptions on new-home sales. The latest government data showed new-home sales were down 35% over the 12 months from July 2007. Analysts attributed the increase in the NAHB index to higher expectations for sales over the next six months because of the recent decline in mortgage rates.
"The main message here is that homebuilders still see extremely poor conditions in the housing market, and their expectations remain low despite some improvement," said Abiel Reinhart, an economist at JPMorgan Chase. Building permits fell by 8.9% to a 854,000 rate in August. July permits plunged 17.7% to 937,000. Permits are a sign of actual building in the future. The level of 854,000 was the lowest since 853,000 in February 1991.
August single-family housing starts decreased 1.9% to 630,000. Construction of housing with two or more units fell 15.1% to 265,000; within that category, groundbreakings of homes with five or more units -- or multi-family -- were 16.6% lower. Regionally, housing starts decreased 7.4% in the South, 14.5% in the Northeast, and 13.6% in the Midwest. Starts increased 10.8% in the West. Nationwide, an estimated 79,300 houses were actually started in August, based on figures not seasonally adjusted. An estimated 73,500 building permits were issued last month, also based on unadjusted figures.
The current account deficit increased to $183.1 billion during April through June from a revised $175.6 billion in the first quarter, the Commerce Department said Wednesday. The first-quarter deficit was originally reported as $176.4 billion. The current account balance combines trade of goods and services, transfer payments, and investment income. About 90% of the deficit is accounted for by the balance in goods and services.
The second-quarter shortfall of $183.1 billion amounted to 5.1% of gross domestic product, which was last reported at $14.313 trillion in current dollars for the three months ending June 30, 2008. The first-quarter gap of $175.6 billion represented 5.0% of a GDP of $14.151 trillion during January through March 2008. The deficit last spring was wider than expected. Economists forecast a current account deficit of $181.0 billion for the second quarter.
A $180.6 billion second-quarter shortfall in goods and services trade was bigger than the first-quarter's revised $177.1 billion; the first-quarter gap was originally seen at $174.9 billion. Second-quarter imports of goods rose to $553.6 billion from $528.8 billion; nearly half the increase resulted from an increase in petroleum and products. Exports of goods rose to $337.3 billion from $317.8 billion; more than half that increase resulted from an increase in industrial supplies and materials, including energy products. Oil prices likely affected the increases in value of petroleum trade.
SEC Stiffens Short-Selling Rules Amid Market Turmoil
The U.S. Securities and Exchange Commission stiffened rules against manipulative short-selling after a market rout pushed American International Group Inc. to the brink of collapse and triggered Lehman Brothers Holdings Inc.'s bankruptcy.
The SEC adopted two regulations today forcing traders and brokers to close out short sales on all stocks, amid concern investors are driving down prices by flooding markets with sell orders. A third rule makes it a securities fraud when sellers deceive brokers about delivering borrowed shares to buyers.
"These several actions today make it crystal clear that the SEC has zero tolerance for abusive" short-selling, SEC Chairman Christopher Cox said in a statement on the rules that take effect tomorrow. Lawmakers and regulators are questioning whether short sellers have contributed to a crisis by spreading false information and using abusive tactics to attack companies. Hedge funds and other investors argue that poor business strategies are to blame, not short sellers.
In traditional short sales, traders borrow shares that they then sell. If the price drops, they profit by buying back the stock, repaying the loan and pocketing the difference. The SEC rules approved today target so-called naked short- selling, in which traders never borrow shares from their brokers. The agency is concerned that such a strategy can free investors to manipulate prices by placing unlimited sell orders.
One SEC regulation eliminates an exemption for options market-makers to deliver shares of companies placed on so-called threshold lists. Companies are listed when they have a high number of borrowed shares that haven't been delivered. The rule will make it harder for options market-makers to hedge trades when they sell put contracts, said Stephen J. Nelson, a securities lawyer in White Plains, New York.
"If you want to short the stock you're going to have to deliver it, and the only way to really do that is to pre- borrow," Nelson said. `Professional traders are not in the business of taking that kind of risk. They would be very reluctant to face the five-day window because buy-in can be very expensive."
A second SEC rule imposes penalties on brokers if their clients haven't delivered shares to buyers three days after a short sale. For the specific security that hasn't been delivered, the mandate restricts brokers from conducting additional short sales on behalf of all their customers. The SEC will seek public comment on the change for 30 days.
The SEC also approved a rule drafted in March that would make it a fraud for investors to lie to their broker about locating shares to sell short. Currently, brokers are able to rely on their customers' assurance that they had located shares that could be used to cover a short sale.
The SEC rules don't reinstitute an "emergency" order that expired last month, which placed restrictions on short-selling in Lehman, Fannie Mae, Freddie Mac and 16 securities firms. The order required investors betting on a decline in stock prices to arrange to borrow the shares before completing a sale.
The SEC also declined to bring back the so-called uptick rule, which allowed short sales only if a preceding trade boosted a company's stock price. Lawmakers such as U.S. Senator Charles Schumer, a New York Democrat, have questioned the agency's June 2007 decision to remove the rule.
Feds Try To Find A Buyer For WaMu
The fate of Washington Mutual remained in question yesterday as federal regulators recently called a number of banks asking if they would consider buying the nation's largest savings and loan should it eventually falter, sources told The Post.
In recent days, federal banking regulators have reached out to Wells Fargo, JPMorgan Chase, HSBC and several other financial institutions to gauge their interest in a possible acquisition of WaMu, but no merger discussions are currently under way between the Seattle-based bank and anyone else, sources said.
The move comes as investors worry that WaMu's customers could begin pulling their money, which totals about $143 billion, out of the bank should its stock fall further. That doesn't appear to be happening now, but several WaMu customers in the New York area told The Post yesterday that they were worried about their cash.
"Should I be in panic mode?" asked one Brooklyn-based customer who recently bought a $250,000 13-month CD from the bank.
At the end of June, WaMu customers had 42.4 million accounts, almost all with less than the federally insured maximum of $100,000. WaMu's shares traded down as much as 25 percent yesterday before rallying to end the day up 16 percent to $2.32.
Standard & Poor's cut WaMu's credit rating to junk status late Monday citing "increasing market turmoil," but at the same time acknowledged that WaMu's deposit base appears to be stable and the company has enough liquidity to meet all fixed obligations through 2010. Rumors about a pending takeover by JPMorgan also resurfaced yesterday, but sources close to both companies said no talks are happening.
WaMu's deposits could buy the company's new boss Alan Fishman time to seek a deal or more capital should it lose more on bad mortgages than expected. In April, private equity giant TPG led a group of investors that pumped $7 billion into WaMu. TPG invested a total of about $1.5 billion into the company at an average price of $8 a share, according to a letter to the firms' investors obtained by The Post.
Those investors are unlikely to take a loss and would want JPMorgan or any other buyer to pay at least $8 a share before they accept a deal, sources said.
Wachovia merger speculation heats up on share price, CEO’s remarks
Speculation that Wachovia Corp. will ultimately decide to team up with another partner picked up again this week.
Wachovia, with its dominant Eastern U.S. franchise, is seen as a promising merger partner for a company with big banking ambitions. Trading in the bank’s shares Sept. 15 fueled sales talk as Wachovia saw its shares decline 25 percent to $10.71. The shares came back 7.5 percent to $11.51 in New York trading on Sept. 16.
Wells Fargo has long been seen as a merger partner given the San Francisco bank’s dominance in the West. But Morgan Stanley and Goldman Sachs might find themselves seeking to combine with a commercial bank, especially following this week’s buyout of Merrill Lynch by Bank of America.
Perhaps investors took to heart comments made by new Wachovia CEO Robert Steel on CNBC’s Mad Money show with Jim Cramer after the close of trading Monday. Steel outlined the bank’s challenges in its residential mortgage portfolio, which it picked up by buying Oakland-based Golden West Financial in 2006 — when the housing boom was in full swing across much of the country.
Steel said the bank has a big advantage in working through its problems because it has a direct relationship with mortgage borrowers that allows the bank to work out problem loans with borrowers. “We have lots of flexibility to figure out how to do this,” Steel said. “If we just owned securities, we would have two choices: hold or sell. “We have lots of choices,” he said.
Of Wachovia’s $500 billion in loans, only $10 billion are “problematic,” Steel said. “We have a lot of very good loans that are doing well, and we’re going to focus like crazy” on those problem loans. Perhaps the most interesting portion of Steel’s CNBC interview was when Cramer asked whether all the bank’s work is to prepare Wachovia to be sold.
“We have a great future as an independent company, but we’re a public company,” Steel said. “So we’re going to do what’s right for shareholders. I can promise you that. But we’re also focused on the very exciting prospects when we get things right going forward.”
Morgan Stanley weighing possible merger
Investment bank Morgan Stanley is weighing whether it should remain independent or merge with a bank, give the recent turbulence in the company's share price, broadcaster CNBC reported on Wednesday. Morgan Stanley officials were not in merger talks as of late Tuesday, CNBC said, citing unnamed people close to the matter.
"But senior people at Morgan concede that further zig-zags in the company's stock price could and possibly will force the company to change course and seek a merger partner, probably a well capitalized bank," CNBC reported on its Website. Morgan Stanley shares closed down 10.8 percent at $28.70 on Tuesday, having fallen 46 percent so far this year.
In an interview with Reuters on Tuesday, Morgan Stanley's Chief Financial Officer Colm Kelleher said the No. 2 U.S. investment bank remains confident in its broker-dealer model and dismissed the need to merge with a deposit-taking bank, even as he maintained a cautious stance about the markets.
Traders in Asian said the report weighed on share markets, which pared early gains made on the U.S. government rescue of troubled insurer AIG. "The U.S. government's rescue of AIG helped the markets to avoid the worst case scenario, but the fact that only the government was willing to help indicated the gravity of U.S. credit problems," said Choi Seong-lak, an analyst at SK Securities in Seoul.
"Reports that Morgan Stanley is considering a merger with a commercial bank confirmed such fears, and market participants are now wondering if even Goldman Sachs is safe. Sentiment is extremely fragile.
Lloyds TSB In "Advanced" Talks to Buy Mortgage Lender HBOS
Lloyds TSB Group Plc, the bank that considered buying Northern Rock Plc before it collapsed, is in talks to acquire HBOS Plc after the mortgage lender lost three- quarters of its stock market value this year.
The banks are in "advanced talks," Edinburgh-based HBOS said in a Regulatory News Service statement today, without disclosing any details. A combination with Lloyds, based in London, would create a lender with a 28 percent share of the U.K. mortgage market, according to the Council of Mortgage Lenders.
HBOS's market value has plunged 80 percent from its 2007 peak to 9.4 billion pounds ($16.8 billion) on concern it might be the next bank to succumb to the funding shortage that forced the government to bail out Northern Rock. Prime Minister Gordon Brown's office said today it was ready to intervene in the banking market to avoid another collapse.
"People are very concerned about HBOS's ability to fund itself, and this would be a massive boost to Lloyds," said Simon Maughan, an analyst at MF Global Securities Ltd. in London. "Everybody has been wondering what Lloyds is going to do next. It would give Lloyds a hugely dominant franchise." Lloyds would ensure its capital ratios aren't eroded by HBOS, Britain's largest mortgage lender, two people familiar with the situation said earlier today. They didn't disclose terms and declined to be named because the talks are confidential.
HBOS, down as much as 52 percent earlier in the day, recovered after the British Broadcasting Corp. reported that Lloyds was considering a takeover. The shares were down 2 percent at 178.3 pence at 1:41 p.m. in London. Lloyds may pay less than 300 pence a share for HBOS, valuing an acquisition at no more than 15.8 billion pounds, said Ian Gordon, a London-based analyst at Exane BNP Paribas.
Lloyds rose as much as 18 percent and traded up 10 percent at 308.75 pence at 1:39 p.m., valuing the bank at 17.8 billion pounds. More than 62 million shares changed hands in the first two hours of trading, beating the daily average in the past three months, Bloomberg data show.
HBOS, which has about 20 percent of the U.K. mortgage market, gets almost half of its funding from capital markets. That compares with about 70 percent at Newcastle, England-based Northern Rock, which was nationalized in February after the first run on a British bank in more than a century.
HBOS "continues to fund its business in a satisfactory way," the U.K. banking regulator, the Financial Services Authority, said today in a statement. "A deal has to be done in the next couple of days, otherwise we are back to an untenable wholesale funding position for HBOS," said Martin Kinsler, a London-based fund manager who helps manage about $125 billion at Henderson Group Plc including Lloyds and HBOS stock.
Together Lloyds, the U.K.'s biggest provider of checking accounts, and HBOS would leapfrog Barclays Plc as the third- largest British bank by stock market value. "It's a very obvious deal," said Ken Murray, chief executive officer at Blue Planet Investment Management in Edinburgh. He has no holdings in any U.K. banks. "The cost savings would be enormous because the overlap is so vast and they would end up with a very dominant position."
HBOS, which employs about 72,000 people in the U.K., was formed in 2001 in the 9.7 billion-pound merger of Yorkshire-based mortgage lender Halifax Plc and Bank of Scotland in Edinburgh. Lloyds, which gets most of its funding from customer deposits, has skirted the worst of the credit turmoil compared with peers. HBOS and Edinburgh rival Royal Bank of Scotland Group Plc were forced to sell shares and pull back lending this year to replenish capital reserves eroded by credit losses.
Lloyds CEO Eric Daniels, 57, said in July the bank will consider acquiring weakened lenders. The bank weighed a bid for Northern Rock before the lender called on the Bank of England for emergency funding last September. Any potential takeover of HBOS would have no problem clearing government or antitrust hurdles, according to Simon Adamson, a credit analyst at CreditSights Inc. in London. "In more normal times, a tie-up between Lloyds and HBOS wouldn't even have been considered because of the competition issues," said Adamson. "These aren't normal times."
HBOS merger with Lloyds TSB may cost 40,000 UK jobs
A merger of HBOS and Lloyds TSB could lead to as many as 40,000 UK job losses and 1,000 branch closures, rival bankers estimated, because of the huge overlap between the two banks. Unite, the trade union, rushed out a plea for no compulsory redundancies today in the face of what could be the biggest private sector cull in living memory.
HBOS employs 72,000 people while Lloyds has 70,000, in both cases almost entirely in the UK. In mergers of such similarly positioned organisations, as many as one third of the combined workforce can lose their jobs. The potential job cuts emerged as new figures showed that UK unemployment has risen to a nine-year high of 1.72 million after increasing by 81,000 in August. At the same time, the number of people claiming jobless benefits rose by 32,500 - the highest rate since 1992.
When Royal Bank of Scotland took over National Westminster Bank in 2001, 6,800 jobs were eventually lost. But there was much less overlap in that case because RBS was predominantly in Scotland and NatWest in England and Wales. One banker said: "There's massive overlap between Lloyds and HBOS. It's going to be unbelievably messy."
However, there is no certainty a deal would be done and it is not clear the extent of intervention by Government, which might insist on a soft approach to cost-cutting as the price of helping get the deal done. Job losses could be severe in branches, call centres, processing centres and the head offices of the two banks.
Lloyds operates one of the biggest networks in the country with 1,900 branches under the Lloyds and Cheltenham and Gloucester brands. HBOS has 1,100 branches, in many cases on the same high street. "Staff working in financial services must not pay the price for corporate greed," said Graham Goddard, Unite deputy general secretary.
Barclays snaps up Lehman business for $1.75 billion
Barclays said Wednesday it's paying $1.75 billion to acquire the U.S. investment banking and capital markets operations of Lehman Brothers in a cash deal that will safeguard thousands of jobs.
Most of the bill -- around $1.5 billion -- is to pay for Lehman's New York head office at 745 Seventh Avenue and two data centers in New Jersey. The remaining $250 million will pay for all of Lehman's U.S. fixed income and equity sales, trading and research as well as the investment banking businesses, which employ around 10,000 people.
The businesses being acquired have trading assets estimated at around $72 billion and trading liabilities of around $68 billion, but they include very little exposure to mortgages. Finance Director Chris Lucas told analysts that majority of the assets are in holdings such as quoted equities, government and agency paper and money-market instruments.
Less than 5% is in mortgage holdings and those assets are already written-down to the current market value. Barclays' President Bob Diamond described the deal as "a once-in-a-lifetime opportunity." The U.K. bank has previously said it wanted to take advantage of the credit crisis to grow its presence in the U.S. and it said Wednesday that the deal will give it a top-three position in U.S. capital markets.
The deal still needs the approval of the U.S. bankruptcy courts and CEO John Varley said it would be "impertinent" to speculate on whether that approval would be granted.
Federal bank insurance fund dwindling
Banks are not the only ones struggling in the growing financial crisis. The fund established to insure their deposits is also feeling the pinch, and the taxpayer may be the lender of last resort.
The Federal Deposit Insurance Corp., whose insurance fund has slipped below the minimum target level set by Congress, could be forced to tap tax dollars through a Treasury Department loan if Washington Mutual Inc., the nation's largest thrift, or another struggling rival fails, economists and industry analysts said Tuesday.
Treasury has already come to the rescue of several corporate victims of the housing and credit crunches. The government took over mortgage finance companies Fannie Mae and Freddie Mac, and helped finance the sale of investment bank Bear Stearns to J.P. Morgan Chase & Co. Eleven federally insured banks and thrifts have failed this year, including Pasadena, Calif.-based IndyMac Bank, by far the largest shut down by regulators.
Additional failures of large banks or savings and loans companies seem likely, and that could overwhelm the FDIC's insurance fund, said Brian Bethune, U.S. economist at consulting firm Global Insight. "We've got a ... retail bank run forming in this country," said Christopher Whalen, senior vice president and managing director of Institutional Risk Analytics.
Treasury Secretary Henry Paulson said Monday that the country's commercial banking system "is safe and sound" and that "the American people can be very, very confident about their accounts in our banking system." FDIC officials also have said 98 percent of U.S. banks still meet regulators' standards for adequate capital. But fear is growing on Main Street as well as Wall Street about the likelihood of multiple bank failures and the strain that would put on the FDIC.
The fund, which is marking its 75th anniversary this year with a "Face Your Finances" campaign, is at $45.2 billion — the lowest level since 2003. At the same time, the number of troubled banks is at a five-year high.
FDIC Chairman Sheila Bair has not ruled out the possibility of going to the Treasury for a short-term loan at some point. But she has said she does not expect the FDIC to take the more drastic action of using a separate $30 billion credit line with Treasury — something that has never been done.
The FDIC's fund is currently below the minimum set by Congress in a 2006 law. The failure of IndyMac Bank in July cost $8.9 billion. Next month, Bair plans to propose increasing the premiums paid by banks and thrifts to replenish the fund. That plan is likely to be approved by the FDIC board, which consists of her, Comptroller of the Currency John Dugan, Thrift Supervision Director John Reich and two other officials.
Bair also is considering a system in which banks with riskier portfolios would be charged higher premiums, raising the possibility those costs could be passed on to consumers. A Washington Mutual failure would dwarf the largest bank collapse in U.S. history — Continental Illinois National Bank in 1984, with $33.6 billion in assets. By comparison, WaMu and its subsidiaries had assets of $309.73 billion as of June 30 and IndyMac had $32 billion when it shut down.
Arthur Murton, director of the FDIC's insurance and research division, said that when large institutions have failed in recent years, the hit to the fund has been about 5 to 10 percent of the company's assets. Standard & Poor's Ratings Service late Monday cut its counterparty credit rating on WaMu to junk, action that followed downgrades by both Moody's and Fitch last week.
Concern about the Seattle-based thrift, which has significant exposure to risky mortgage securities and other assets, has grown in recent weeks, and the company's stock price has plummeted. WaMu responded Monday by saying that it did not expect the S&P downgrade to have a material impact on its borrowings, collateral or margin requirements. The bank said its capital at the end of the third quarter on Sept. 30 is expected to be "significantly above" required levels and that its outlook for expected credit losses is unchanged.
Some analyst estimates put the cost of a WaMu failure to the FDIC at more than $20 billion, but other experts say it is very difficult to predict. Unknown, for example, is the amount of advances that institutions may have taken from one of the regional banks in the Federal Home Loan Bank system. Banks and thrifts have significantly increased their requests for advances, or loans, from the 12 regional home loan banks since the mortgage crisis began last year.
These amounts aren't publicly disclosed but must be repaid if a bank or thrift fails, notes Karen Shaw Petrou, managing partner of Federal Financial Analytics. If the FDIC doesn't have enough cash to cover the initial costs of a bank or thrift failure, one option would be short-term loans from the Treasury. That last happened in 1991-92, during the last part of the savings and loan crisis, when the FDIC borrowed $15.1 billion from the Treasury and repaid it with interest about a year later.
Based on projections of possible scenarios of bank failures, "between the (insurance) fund that we have now and our ability to draw on the resources of the industry ... we do have the resources" needed, Murton said Tuesday.
Though short-term borrowing from Treasury for working capital may be possible, he said, tapping the long-term credit line is unlikely.
But Whalen said the Federal Reserve, the Treasury and Congress should "immediately devise" and announce a plan to backstop the FDIC with up to $500 billion in borrowing authority to meet cash needs for closing or selling failed banks.
"While the FDIC already has a credit line in place and this figure may seem excessive — and hopefully it is — the idea here is to overshoot the actual number to reinforce public confidence," Whalen wrote in a note to clients. "Simply having Treasury Secretary Hank Paulson or Ben Bernanke making hopeful statements is inadequate. Like it says in the movies: 'Show us the money.'"
Before Congress passed the law overhauling deposit insurance in 2006, about 90 percent of all insured banks and thrifts — considered to have adequate capital and to be well managed — paid no premiums to the FDIC. Today, all of them do.
There were 117 banks and thrifts considered to be in trouble in the second quarter, the highest level since 2003, according to FDIC data released last month. The agency doesn't disclose the names of institutions on its internal list of troubled banks. On average, 13 percent of banks that make the list fail. Total assets of troubled banks tripled in the second quarter to $78 billion, and $32 billion of that coming from IndyMac Bank.
Last month, Bair called those results "pretty dismal," but said they were not surprising given the housing slump, a worsening economy, and disruptions in financial and credit markets. "More banks will come on the (troubled) list as credit problems worsen," he said. "Assets of problem institutions also will continue to rise."
Banking turmoil hurts 401(k)s and pensions
The 401(k) fund you've been dumping pretax earnings into for retirement may have shed a little heft. When the monthly update arrives from your brokerage, mutual fund holdings may seem like they have been on the South Beach diet. And the pension fund maintained by your employer could end up lighter as well.
Those are ways in which the collapse of investment bank Lehman Brothers Holdings Inc. and related turmoil on Wall Street on Monday could affect average investors, experts said. Stocks and bonds issued by Lehman, Merrill Lynch & Co. and troubled insurer American International Group are widely held by mutual funds, pension funds and individual investors.
"This is an extreme sort of event, and it will take days and months to figure out the precise consequences," said Amiyatosh Purnanandam, assistant professor of finance at the University of Michigan. But it will have an impact, he said. Problems in the banking sector will spill into the broader economy. If you want a business loan, a car loan, a home loan, a student loan, or virtually any other kind of loan, banks are hesitant to lend, and that in turn could hurt car and home sales.
People with 401(k) retirement savings accounts may be unaware of their exposure to problems at Lehman and other firms swept up in the turmoil, especially if they are unfamiliar with the holdings of stock and bond funds in which the retirement stash is invested, Purnanandam said. For example, the Fidelity and Vanguard families of mutual funds, as of June 30, were two of the largest owners of Lehman stock, holding 6% and 3%, respectively. Many pension funds also hold the stock.
But the State of Michigan Retirement Systems did not hold Lehman stock, said Terry Stanton, spokesman for the Michigan Department of Treasury. He said the $57-billion state retirement system had investments in insurer American International Group Inc. The system had 7.9 million AIG shares and is looking at a loss of about $66 million, based on AIG shares' closing at $3.75 on Monday.
He said it is important to note that the state retirement system has a diversified portfolio and going into Friday, AIG represented less than 2/10ths of 1% of the retirement system's assets. He said the system continues to perform well in comparison with other public pension funds around the country. As of June 30, the one-year return was a negative 4%, slightly better than other public plans. The three- and five-year rates of return are 8.8% and 10.2% respectively.
AIG is widely held by individuals and mutual funds. The nation's largest insurer has scrambled to find new capital. Holders of shares in Merrill Lynch, another Wall Street financial powerhouse scheduled to disappear in the current turmoil, will fare better. Each of the firm's shares will be exchanged for 0.8595 shares of Bank of America, which is taking over Merrill. In situations where brokerages go bankrupt, the government's Securities Investor Protection Corp. covers losses up to $500,000 in most instances.
JPMorgan (or the Fed?) Gave Lehman $138 Billion After Bankruptcy
JPMorgan Chase & Co. gave $138 billion this week in Federal Reserve-backed advances to the broker dealer unit of Lehman Brothers Holdings Inc. to settle Lehman trades and keep financial markets stable amid the biggest bankruptcy in history, according to a court filing.
One advance of $87 billion was made on Sept. 15 after the pre-dawn bankruptcy filing, and another of $51 billion was made today, Lehman said in court documents. Both advances were made to settle securities transactions with customers of Lehman and its clearance parties, according to the filing. The advances were necessary "to avoid a disruption of the financial markets," Lehman said in the filing.
The first advance was repaid by the Federal Reserve Bank of New York on the night of Sept. 15, Lehman said. JPMorgan said in a statement that the $51 billion advance was also repaid and the process will zero out the advances at the end of each day. U.S. Bankruptcy Judge James Peck in Manhattan approved an order confirming that advances JPMorgan is providing are covered by existing collateral agreements with Lehman and its affiliates.
JPMorgan holds about $17 billion in collateral to secure the money it advances to clear the trades, Lehman attorney Richard Krasnow said. "I believe the comfort order for the benefit of JPMorgan Chase under these clearance agreements, while unusual in my experience, is entirely appropriate," Peck said. There were no objections to the request. Requests to obtain a bankruptcy loan and schedule the sale of Lehman assets were postponed until tomorrow.
JPMorgan said in a statement before the hearing that it would "be unable to continue" making future advances needed to settle trades unless the court granted its claims special status. Both advances were "guaranteed by Lehman" through collateral of the firm's holding company under an agreement reached in August, according to the filing. The advances were made at the request of Lehman and the Federal Reserve, according to the filing.
Lehman disclosed the advances in a motion seeking court permission to give JPMorgan's claims special status in its bankruptcy and to certify they are guaranteed by Lehman's collateral. Lehman also said JPMorgan may make future advances at its sole discretion, all of which would be guaranteed by Lehman under the August agreement to pledge collateral. JPMorgan said the August accord, as well as a separate agreement made Sept. 9, guaranteed its advances. Both update a June 2000 clearance agreement between the companies.
Investment banks have been aiding or buying peers since the U.S. Treasury Department and the Federal Reserve established that its rescue of Bear Stearns Cos. in March hadn't set a precedent and declined to save Lehman before it filed for bankruptcy with debt of more than $613 billion.
JPMorgan is also reported to be working with American International Group Inc., along with Goldman Sachs Group Inc., after AIG was told not to expect a loan from the central bank. Merrill Lynch & Co. agreed to be acquired by Bank of America Corp., leaving Goldman Sachs and Morgan Stanley as the two largest remaining investment banks.
Huge money market fund ‘breaks the buck’
Signaling the depth of the current financial crisis, the money market industry, once considered to be a safe haven for investors, took a hit yesterday when the nation’s oldest money market mutual fund, The Reserve Primary Fund (RPRXX), lost value and “broke the buck.”
The fund fell below $1 in net asset value yesterday because of its exposure to debt from Lehman Brothers Holdings Inc., which filed for bankruptcy Monday. The event marked only the second time a money market fund has broken the buck.
The Reserve Management Co. Inc. of New York announced in a statement that redemptions could be delayed for up to seven days, but said those requests that came in prior to 3 p.m. yesterday would be redeemed at $1 per share. As of 4 p.m. yesterday, the firm’s board of trustees determined that the Lehman holdings had no value.
Shares of the money market fund are now valued at 97 cents. The fund had $62.6 billion in assets as of Sept. 12 and held $785 million in Lehman Brothers short-term debt, representing about 1.2% of total assets. “It’s likely to be an anomaly where The Reserve didn’t have deep pockets like everybody else [to offer support for the fund],” said Peter Crane, president of Crane Data LLC of Westborough, Mass., a money market research firm.
“I wouldn’t expect anyone else to follow this, though the hits keep coming. People need to keep it in perspective. Losing three cents on the dollar is not the end of the world.” In the only previous instance of a money market fund breaking the buck, Community Bancshares paid investors 96% of their principal in 1994, the Investment Company Institute reported.
Fallout From Lehman Bankruptcy Trimming Hedge Funds
Like a bad cold, Lehman Brothers' woes are starting to spread. Yesterday, New York investment firm Reserve Management Corp. told investors the value of one of its money-market mutual funds dropped below $1 a share due to losses on debt issued by Lehman.
Investors who want their money risk getting less than $1 a share - the first time this has happened with a money-market fund in over a decade. Other money-market funds - including ones run by Wachovia's Evergreen Investments and Russell Investments - are also feeling heat due to bad Lehman debt. But unlike Reserve, which brags of creating the world's first money-market fund, they have promised to make investors whole.
It may be weeks before the full impact of the contagion is known, but signs of infection are already cropping up. And it's not just stockholders, bondholders and employees who are getting sick. Since Monday, a host of groups, from insurance companies to hedge funds, have come out of the woodwork to explain to clients, shareholders - and occasionally, the public - what kind of fallout to expect.
There are growing concerns about contracts, known as swaps or derivatives, where Lehman is responsible for making a payment.
And firms ranging from insurance company AXA to Houston-based Copano Energy have stepped up in recent days to explain their potential losses to Lehman as a result of these complicated contracts.
"Mutual funds, hedge funds, individual investors . . . it's very widely dispersed in terms of the pain that will be felt," said one hedge fund manager. When Lehman sells hard-to-value assets to raise cash, for example, it could hurt funds invested in similar assets - not unlike when a house being sold on the cheap drags down values of neighboring houses, he said.
Hedge funds that rely on Lehman to provide them with financing are also worried. The bankruptcy could force them to sell securities at losses. GLG yesterday announced it had transferred "substantially all" of its money away from Lehman to other prime brokerages. The "residual expose," wouldn't likely "be material," it said.
EU policymakers say banks hit by credit crunch need at least $350 billion in fresh capital
Global banks will have to raise at least $350bn (£195bn) in fresh capital to recoup their losses from the credit crunch, the head of the Financial Stability Forum (FSF) warned at the weekend. Mario Draghi, Italy's central bank governor and FSF chairman, said the protracted turmoil on financial markets would plunge more banks into difficulties and force the pace of consolidation in the sector.
His comments, at an informal meeting of EU finance ministers and central bank governors, came as reports said the Swiss bank UBS, the biggest European casualty of the sub-prime crisis, would write off a further $5bn this year.
UBS has already written down about $43bn, while global banks have suffered write-downs and losses of $350bn in the past year.
Of these, €120bn have been absorbed by European banks, which may account for half of the estimated $1tn of asset-backed securities issued by banks. Draghi told reporters that banks had already raised $350bn to counter the crunch and would need to raise at least as much, if not more, in future - a figure far higher than previously anticipated.
"Various banks, within a sector that is basically well capitalised overall, will be in difficulty," he said. "The conclusion is that there will be a series of consolidations in the world banking system." Over the weekend, the former US Federal Reserve chairman Alan Greenspan said the credit crunch was "a once-in-a-half-century, probably once-in-a-century type of event" and called it the worst "by far" in his career.
"There's no question that this is in the process of outstripping anything I've seen, and it still is not resolved and it still has a way to go. And indeed, it will continue to be a corrosive force until the price of homes in the US stabilises. That will induce a series of events around the globe which will stabilise the system," he added. His best guess for that happening was in early 2009.
Draghi, meanwhile, insisted that banks in the 15-strong eurozone were not as exposed to reckless lending as others but the severe troubles at Northern Rock and several German banks have prompted serious concerns among EU policymakers.
The EU finance ministers and central bank governors, dominated by fears of contagion from the potential insolvency of the US investment bank Lehman Brothers, met to agree on new rules to regulate and supervise European banks. But sharp differences soon emerged.
Christine Lagarde, the French finance minister who chaired the "ecofin" meeting, said ministers had agreed that a single reporting system for banks and insurance companies would be in place by 2012. But this was disputed by EU diplomats.
The EU does, however, want banks and insurance companies to give full details of their exposure to securitised assets and any liquidity problems by the time they report their first-quarter figures next year. Common guidelines are due to be adopted soon. Lagarde said 80% had so far complied but 100% transparency was required to restore confidence among investors.
"It is vital to enhance work on the valuation of assets, particularly where the current market is still illiquid," she said.
A French paper calling for a fresh group of senior financial officials to draw up new proposals for valuing asset-backed securities - more sophisticated than the current "mark to market" process - is understood to have met with a dusty response.
Alistair Darling, chancellor of the exchequer, questioned the need for fresh discussions, instead he urged action on implementing the "roadmap" set by the EU last autumn. Peer Steinbrück, the German finance minister, backed Darling's intervention in favour of sticking to the proposals for a global approach to stricter supervision established by the FSF.
Russian Markets Suspended as Rumors Rule
Russia's Finance Ministry failed to calm the bedlam on the country's markets Wednesday despite aiding the banking system with extra liquidity.
At 0810 GMT, the Federal Financial Markets Service suspended trading on the Moscow Interbank Currency Exchange for the second consecutive day. The trading on the RTS benchmark also stopped after falling 6.4% in the first two hours, a day after its stocks saw one of their worst meltdowns in a decade, falling 11.5%.
Shares of OAO Sberbank plummeted 17.3% while OAO VTB were down 11.5% before the suspension of trading. This came after the finance ministry's earlier announcement that it was extending the terms for depositing federal budget funds with the banks to three months from one month and increasing the total amount of the funds it was willing to put on deposits with commercial banks to RUB1.514 trillion ($59.35 billion), from RUB1.232 trillion.
Concerns have grown that the current liquidity chaos will surpass the mini-banking crisis of 2004. Confidence in the banking system has deteriorated sharply and lending has become scarce.
"We are receiving numerous calls from investors inquiring about some rumors going around in the market...about the collapse of Russian names, going from third-tier banks to ...Gazprom," said Trust Investment Bank analysts in a note. They added, however, that they advise to take all those rumors with "a lot of caution."
The central bank allotted a RUB340.28 billion rubles during the first repo operation Wednesday -- a record for the morning auction. The bank usually offers a second auction later in the day. Meanwhile, the finance ministry said it placed RUB118.68 billion of one-week deposits with commercial banks. The ministry said earlier that it was willing to place up to RUB350 billion.
Russian bourses halt trading for second day
Russia’s two main bourses, RTS and MICEX, said on Wednesday they were suspending trade until further notice from the state’s main market regulator as shares continued to tumble one day after their steepest decline in more than a decade.
Russian stocks had continued to slide on Wednesday morning even as the government unveiled new anti-crisis measures to pump up to $29.5bn in extra budget funds into the three main state-controlled banks.
The dollar-denominated RTS was down 6.4 per cent and the rouble denominated MICEX was down 3.1 per cent when the suspension was enforced with the two main state-controlled banks, Sberbank and VTB leading the slide. Analysts said state cash being pumped into state banks was not being filtered into the rest of the system, which is being hammered by a liquidity squeeze as domestic investors faced margin calls on loans collateralised by shares.
”Russia doesn’t have a liquidity problem. It has an intermediation problem,” said Roland Nash, head of research at Moscow investment bank, Renaissance Capital. ”You can’t borrow on the interbank market,” he said.
Brokers have been pulling credit lines amid widespread fears of defaults as local clients saw leveraged shareholdings wiped out by the market slide. One Moscow investment bank, KIT Finance, said on Tuesday night it had failed to meet payments on several financial obligations because clients had failed to meet payments to it. The bank said on Wednesday that it was in talks with a strategic investor on stake sale. One potential suitor, VTB, however declined to comment.
In a sign of how the liquidity crunch in Russia is exacerbating the problem on local bourses, Russian depositary receipts traded in London were up on Wednesday morning. ”They have access to funding,” Mr Nash said. Russian shares suffered their steepest one-day fall in more than a decade on Tuesday, losing up to 20 per cent, as a sharp slide in oil prices and difficult money market conditions triggered a rush to sell.
The heads of the Russian central bank, the finance ministry and the financial market regulator met on Tuesday night for an emergency discussion on ways to halt the crisis. Earlier, trading had been suspended on both the Micex and RTS stock exchanges as investors ignored assurances by Russian officials and a cycle of distrust set in amid liquidity fears.
Margin calls forced domestic traders to liquidate positions and brokers pulled credit lines. At least one Moscow bank failed to meet payments. The rouble-denominated Micex Index closed 17.75 per cent down, the sharpest one-day drop since the August 1998 financial crisis, while the dollar-denominated RTS index closed down 11.47 per cent, its lowest lvel since January 2006. Interbank money market rates climbed to 11 per cent, their highest since a mini-banking crisis in summer 2004.
Chris Weafer, chief strategist at Uralsib investment bank: “We’re in completely uncharted territory where the prevailing emotion is of fear and numbnes. No one knows where this could stop”. Alexei Kudrin, finance minister, insisted that the financial system was not in a systemic crisis but the central bank injected a record $14.16bn in one-day funds into the money market.
The finance ministry also placed an additional R150bn ($5.8bn) in one-month deposits into the banking system. Konstantin Korishchenko, central bank deputy, told Russian news agencies that the bank and the finance ministry could provide a total of $117.6bn in liquidity to the banking sector.
But market players said banks were ceasing to lend to second and third-tier companies and brokers were pulling credit lines. KIT Finance, big Moscow investment house confirmed rumours that it had been unable to make payment on a series of short-term loans. It said: “In connection with the fact that a series of our clients did not meet their obligations to our bank, we have not met our obligations to our counterparties.
“We recognise our responsibility to our counter-parties and to the market and we are working intensively to resolve the situation.”
Andrei Sharonov, managing director of Troika Dialog, a Moscow investment bank, and a former deputy economic minister, said: “This is a vicious circle,” said , . “It is a situation of total mistrust. The liquidity crisis is being caused by a crisis of confidence in which people are frightened to borrow and frightened to lend.”
Shares in Russia’s biggest state-controlled banks led the slide with Sberbank, the state-controlled savings bank, closing 21.72 per cent down and VTB losing 29.26 per cent. The bank was suffered on investor fears about its securities portfolio, which makes up about 10 per cent of its assets.
Nerves jangle in emerging economies
Argentina’s bond markets were savaged on Tuesday as credit risk rose to all-time highs amid a broader surge in risk aversion towards emerging markets. The move came as Russia’s stock market suffered its biggest one-day fall since the financial crisis of 1998, the South Korean won dropped by its most in a decade and the Ukrainian stock market fell 14 per cent.
Emerging market assets have been at the forefront of investor selling in the wake of the Lehman Brothers collapse because of fears over slowing world growth and increasing stresses in the global financial system. Nick Chamie, head of emerging markets research at RBC Capital Markets, said: “Emerging markets are reeling from a significant rise in risk aversion. We have seen this trend pick up since the start of the week.”
Argentina’s credit default swaps, the best gauge of credit risk, increased to 1,070 basis points, or $1.07m to protect $10m of debt over five years – the highest level since the Argentina CDS prices were first recorded in 2002. This was 120bp higher than Monday and 260bp higher than the start of last week as investors sold any assets considered risky. Investors fear that Argentina’s runaway inflation and spending plans could wreck its economy.
Venezuela, which also has high inflation and growing economic woes, saw its CDS jump to record levels. It rose to 1,083bp, a rise of 245bp on the day and 550bp since the start of last week. The selling pressure was just as intense on stock markets. The MSCI Emerging Markets Index fell 6 per cent to 776, its lowest level since October 2006.
Russian authorities were forced to halt trading after the benchmark rouble-denominated Micex index fell 17.5 per cent to 881.17, while the dollar-denominated RTS index dropped by 11.5 per cent to 1,131.12. Steven Dashevsky, head of research at UniCredit said: “The ferociousness of the decline we have seen is comparable only with the collapse of 1998. but you cannot ignore the fact that the underlying fundamentals are infinitely better than they were 10 years ago”.
Ukraine’s PFTS Index fell 14 per cent amid investor concerns over tensions with Russia and the collapse of the ruling coalition.
Among emerging market currencies, the South Korean won tumbled 4.3 per cent against the dollar. The Turkish lira dipped to a four-month low against the dollar. The Brazilian real continued a fall that has seen it lose 7 per cent since the start of August.
Ford Chair Seeks To Distance Car Makers From Financial Crisis
Bill Ford Jr. came to Capitol Hill Tuesday to make sure that lawmakers don't confuse the loans that U.S. automakers are seeking with discussions of bail outs for the companies in the troubled financial services sector. Ford, the executive chairman of the auto company founded by his great grandfather, met with several members of the Michigan House delegation, as well as members from the five other states the company has factories in.
"I really think this is a very separable thing from Wall Street," said Ford, speaking to reporters after the meeting. "This is something that was already passed but unfunded. There was great familiarity among the membership long before we got into the" last few days, he said. Ford's message was echoed by lawmakers representing states that have significant auto industry presences.
"What's happening with the financial markets this week is, I'm sure, raising questions," said Rep. Candice Miller, D-Mich., who arranged the meeting. "This is not a bail out, this is a loan program." "It's a clear distinction between what's happening in the marketplace and what we're asking for," said Rep. Betty Sutton, D-Ohio. "They're not asking for a handout, this is about being able to move forward."
Auto makers are seeking $25 billion in low-cost loans from the federal government to help them invest in the next generation of cleaner vehicles. Several senior lawmakers have indicated in recent days they hope to fund the loans before Congress goes into recess at the end of next week.
Senior executives at the major U.S. car makers had been seeking an increase in the loans to $50 billion, citing the deteriorating credit markets as a reason why. But after the lukewarm response from lawmakers, they quickly backed away and focused their efforts on getting funds for the $25 billion.
The loan facility was created as part of an energy bill last year, but separate legislation is required to appropriate funds for the loans.
The collapse of Lehman Bros. (LEH) and the forced sale of Merrill Lynch & Co. (MER) to Bank of American Corp. (BOA) sent the markets into a tailspin on Monday.
Ford said that the difficulties in the financial services industry should not be confused with the issues facing the auto companies.
He did acknowledge that the events of this week had served to further tighten the credit markets, making it more difficult for companies to borrow money. "It's a very separate issue, but clearly an issue our country is facing," said Ford.
Schwarzenegger to Veto Budget and Other Bills
Gov. Arnold Schwarzenegger said Tuesday that he would veto a long-overdue state budget, and he threatened also to veto hundreds of other pieces of legislation, as the state’s 78-day budget crisis dragged on. The California Legislature finally passed a $104 billion general fund budget by potentially veto-proof two-thirds majorities early Tuesday morning, after setting a record for tardiness.
But Mr. Schwarzenegger, a Republican, said he would not sign it, or very little else, until a “good budget” was passed.
“I say enough is enough,” he said at a news conference in Sacramento. “Californians have been put through this rollercoaster ride too many times.”
In particular, the governor asked for guarantees regarding contributions to a so-called rainy day fund, something he regards as critical to budget reform, which has become central to his second term in office. Mr. Schwarzenegger said he expected the Legislature to override his veto, but promised to return the favor by sending back most of the laws it passed in the last legislative session. “Every bill will be carefully evaluated and hundreds of bills will be vetoed,” he said.
Lawmakers on both sides of the aisle said they were prepared to override any budget veto. “Not getting your way is no reason to veto the state budget,” said Mike Villines, a Republican. “It is disappointing that he would take this unnecessary step that will only prolong our budget stalemate and cause more pain for many Californians.”
Karen Bass, a Democrat and speaker of the state’s Assembly, said a vote to override the governor’s veto could come as early as Wednesday. Leaders on both sides admitted that the budget that was passed was a disappointment and that lawmakers were likely to face similar problems next year. “We tried,” Ms. Bass said. “But we weren’t able to do anything better.”
Under the bill, the state would close a $15 billion budget gap with about $9 billion in cuts and additional revenue essentially borrowed from future tax payments. Some tax exemptions, including business losses, would be temporarily suspended, and some loopholes would be closed.
Republicans in the Legislature had refused to consider new taxes desired by Democrats. And because California law requires two-thirds majorities for tax increases, several proposals, including a one-cent increase in the sales tax, were nonstarters.
All of which led to more than a little frustration.
“This is not a budget the Democrats or the governor wanted,” said Don Perata, a Democrat and Senate president pro tem. “It’s a failure. But Republicans had the final say — and they said no.” Tens of thousands of businesses, from child care to nursing homes, have been missing payments from the state as the crisis dragged on. Mike Danneker, executive director of the Westside Regional Center, a state-financed medical services organization in Culver City, said that his center ran out of money last Friday.
“These guys have been playing with this stuff for 77 days,” Mr. Danneker said. “They should have done this in May.”
While Mr. Schwarzenegger’s veto announcement set the stage for a showdown with the Legislature, some experts said it was likely to be a lonely fight.
“Everybody has the votes to override him, so he doesn’t really matter anymore,” said John Ellwood, professor at the Goldman School of Public Policy at the University of California at Berkeley, “If I was a Democrat or Republican leader, I would say, “What has this guy given me?’ ” On Tuesday, at least, the governor seemed to be asking the same thing. “They are three months late with the budget” he said. “And this is what we get on the desk.”
Canada's Flaherty Says Central Banks to Carry Weight
Canadian Finance Minister Jim Flaherty said central banks will need to carry the weight of easing the global financial turmoil, while governments can do more to enforce better disclosure of losses.
"These are tools that are in the hands of the central bankers," Flaherty said in a telephone interview today when asked what can be done to alleviate the crisis. Group of Seven finance ministers and central bankers have been in "steady communications" over the past several days and agreed that policy makers may have to act in a coordinated fashion.
Central banks around the globe pumped emergency funds into money markets yesterday and today. The European Central Bank awarded $70 billion euros ($99.8 billion) today in a one-day money market auction, while the U.S. Federal Reserve added $50 billion in temporary reserves to the banking system. China opted to lower its interest rate for the first time in six years late yesterday.
Stocks and bond yields tumbled after Lehman Brothers Holdings Inc. became the latest victim of a yearlong credit squeeze yesterday, and on concern that American International Group Inc. won't be able to raise funds to keep that company afloat. Financial institutions worldwide have reported more than $500 billion in losses and writedowns.
Flaherty said governments from the world's richest economies must do more to ensure financial institutions fully disclose losses they've incurred. Canadian lenders have been transparent and forced to raise capital, he said. "The market and the regulators and the departments of finance and the central banks need to know that that assurance is there that we will not have further significant negative events," he said, declining to single out any country or institution.
Exposure in Canada to Lehman's collapse is "limited," Flaherty said. The finance minister also said the slowing U.S. economy hasn't undermined the federal budget surplus, which is "slightly ahead" of projections. Canada has forecast a budget surplus this year of C$2.3 billion, down 77 percent from the previous year.
Manulife May Have $1.27 Billion in AIG, Lehman Bonds
Manulife Financial Corp., Canada's largest insurer, may hold as much C$1.36 billion ($1.27 billion) in debt sold by American International Group Inc. and three other "troubled" U.S. financial institutions, according to BMO Capital Markets.
The holdings, based on 2007 filings, represent about 0.8 percent of Manulife's invested assets, BMO Capital Markets analyst John Reucassel wrote today in a note to investors. The figure includes investments in Lehman Brothers Holdings Inc., Washington Mutual Inc. and Wachovia Corp., he said.
Canadian banks plunged for a second day following the bankruptcy of Lehman Brothers and the credit downgrade of AIG, the country's biggest insurer. Canadian insurers including Manulife, Sun Life Financial Inc. and Great-West Lifeco Inc. also declined, though the Canadian firms have escaped with few debt writedowns. "While the Canadian lifecos cannot avoid all of these problems, we continue to expect them to outperform their global peers," Reucassel wrote in the note.
Manulife's debt holdings at Dec. 31 included C$196 million with AIG, C$328 million with Lehman and C$727 million at Wachovia.
Sun Life, the country's third-largest insurer, disclosed yesterday it may report a charge in the third quarter from C$334 million in bond securities and C$15 million in derivatives contracts linked to Lehman. Toronto-based Sun Life also owns about 400,000 Lehman Brothers shares and about 1 million AIG shares through its MFS unit, while Great-West, based in Winnipeg, Manitoba, holds 12 million Lehman shares and 14 million AIG shares through its Putnam Investments unit, the BMO Capital analyst said.
Toronto-Dominion Bank, the country's second-largest lender by assets, said its investments tied to AIG won't impact the Toronto-based bank. "Our exposure is within reasonable limits and a potential failure of AIG would have no material impact" on the overall operations, spokesman Nicholas Petter said in an e-mailed statement.
Royal Bank of Canada, the country's largest lender, had its biggest decline in almost a month, dropping C$1.60, or 3.3 percent, to C$46.50. The stock earlier plunged as much as 6.2 percent. "We manage and diversify our exposures in a variety of ways, including limiting our exposure to any single name and to any single sector," Royal Bank spokeswoman Beja Rodeck said in an e-mailed statement.
Toronto-based Manulife and other Canadian insurers may be in a position to buy assets disposed by AIG, Lehman Brothers and others, RBC Capital Markets analyst Andre-Philippe Hardy said yesterday. "Manulife is in a strong position to acquire these assets, in our view, given its existing expertise and scale in the market, and would likely be interested," Hardy wrote.
Still, Canadian insurers may be in no rush to buy troubled U.S. assets, said Gavin Graham, director of investments at BMO Asset Management in Toronto, which manages about C$54 billion in assets, including insurers. "I can't imagine there's any urgency on the part of any potential purchaser," Graham said. "Especially if things continue to unwind, you might be able to buy those in a few weeks anyway."
Tar sands - the new toxic investment
Shell and BP have been warned by investors that their involvement in unconventional energy production such as Canada's oil sands could turn out to be the industry's equivalent of the sub-prime lending that poisoned the banking sector and triggered the current financial crisis.
The criticism came as a report was released yesterday warning of the potential financial risks of tar sands, and members of the UK Social Investment Forum met in London to consider a Co-op Investments campaign on halting oil industry involvement in the carbon-intensive oil projects.
The report, BP and Shell, Rising Risks in Tar Sands Investment, co-authored by Greenpeace and fellow campaign group Platform, argues that oil majors are trying to make up a shortfall in conventional reserves by an irresponsible dash to extract oil from bitumen and other sources.
Mark Hoskin, senior partner at the ethical investment advisers Holden & Partners, expressed concern about the increasing focus on tar sands at a time when oil companies are being shut out of traditional drilling areas such as Russia and Venezuela.
"The recent banking crisis has shown how the financial markets can totally misjudge both the risks and values inherent in company balance sheets," he said. "Oil companies depend on oil reserves for their market values. BP and Shell are two of our most trusted UK stocks, but it is a shocking fact that 30% of Shell's oil reserves are in tar sands. "This report unveils how dangerous this approach is. There is a good chance that tar sands could be to the oil industry what sub-prime lending was to the banking sector."
The report lists trends moving against investment in this area, not least the decline in the price of oil at a time when the cost of developing tar sand schemes is rising, something highlighted recently by the boss of French oil group Total. The price of crude has plunged on world markets, with Brent blend briefly yesterday below $90 a barrel, down from nearly $150 in July, as traders fear that ructions on Wall Street following the collapse of Lehman Brothers will spread into the mainstream economy and drag down oil demand.
The report by the environmental campaigners also claims that low-carbon fuel standards under consideration by US presidential candidate Barack Obama and already implemented in California threaten to shut down sections of the American market to products derived from tar sands.
John Sauven, executive director of Greenpeace, said his organisation had always known that tar sands were a risk to the climate "but now it's becoming clear that they're a risk to the bottom line as well". Platform called on BP and Shell to
rethink their entire energy strategy.
The criticism came as 20 members of the UK Social Investment Forum, a group of ethical investors, attended the Co-op Investments-backed meeting. The Co-op has called for a halt to new licensing of tar sands projects which, it believes, will tip the world into an irreversible process of global warming.
Paul Monaghan, head of social goals and sustainability at the Co-op, said the group was drawing increasing support and talks were planned with a wider group of investors. He expressed concern that BP and Shell had declined to attend yesterday and hoped they would be at future meetings.
Greenpeace and Platform say in their report that other risks to tar sands developments come from elections being held in Canada that could affect the regulatory climate, given that the opposition Liberal party is a strong supporter of a carbon tax. The NGOs also point to an "unrealistic" reliance on untested carbon capture and storage technology, which has been highlighted by Shell as a means for reducing CO2 emissions.
The Canadian tar sands are estimated to contain as much as 180bn barrels of oil but the environmental groups warn that extracting bitumen and upgrading it to synthetic crude oil is three to five times more greenhouse gas intensive than conventional oil extraction.
Upgrading a single barrel of tar sand bitumen for use in a conventional refinery also requires 14 cubic metres of natural gas, leading to huge demand for gas and supply infrastructure in remote regions of Canada. Enormous amounts of water are also needed in the process.
Shell argues that growing world demand for energy leaves society with little choice other than to exploit new forms of oil such as tar sands. BP, which insists it is still committed to the greener agenda set under former chief executive Lord Browne, said unconventional sources had the advantage of being located in politically stable countries such as Canada and it remained confident of the economics even at an oil price of $90 a barrel.
The company, now led by Tony Hayward, believes it can reduce its overall carbon footprint by keeping away from surface mining and being careful about the way it brings oil out of the ground. It insists it factored in the future costs of carbon in its tar sands projects.