Monday, February 23, 2009

US Economic Crisis: Stocks Slump on Corporate Woes; Capitalist Theorists Call For Some "Nationalization" of Banks

February 24, 2009

Stocks Slump on Corporate Woes; Indexes Fall by 3.4%

New York Times

Investors called it another day of water-torture declines on Wall Street: drop, drop, drop.

A broad sell-off sent Wall Street staggering lower in the last hour of trading on Monday as the banking system continued to worry investors. The Dow Jones industrial average was down 250.89 points at the close while the Standard & Poor’s 500-stock index, a broader gauge of the market closed at its lowest level since April 1997.

Losses piled up in technology companies like Apple, Google and I.B.M. and industrial companies like DuPont, Caterpillar and the aluminum maker, Alcoa. But in a reversal, battered shares of Citigroup and Bank of America closed higher, and the financial sector fared better than the broader market.

With worries growing about the stability and solvency of the country’s big banks, the Treasury Department tried to reassure jittery investors with a message supporting the financial system and laying out details of the coming “stress tests” of major banks. The message did not calm anyone.

After a brief rise in early trading, stock markets fell into the red and sank lower throughout the afternoon. The Dow Jones industrial average closed down 3.4 percent to 7.114.78 while the broader S. & P. 500 fell 3.47 percent, or 26.72 points, to 743.33. The technology heavy Nasdaq was down 3.7 percent, or 53.51 points, to 1,387.72 as shares of technology companies turned lower.

Shares of Microsoft, Hewlett-Packard and other technology companies fell amid concerns about how the sector would hold up as the economy spins lower. Companies that make basic materials like steel, chemicals and plastic also sank. Crude oil fell $1.59, to $38.44 a barrel, scaling back some recent gains, and gold prices also fell back slightly to $995 an ounce.

The day’s declines continued the downward momentum of a brutal week that sent the major indexes down more than 6 percent. “In lieu of anything the market sees as positive, it’s going to continue its easiest path, and the path it sees is down,” said Joseph Saluzzi, co-head of equity trading at Themis Trading. “That’s where we’re stuck right now, and who’s going to get out in front of it?”

With America’s banking system facing a round of “stress tests,” the prospect of greater governmental control and an uncertain future, the government tried to assure investors early Monday that it would stand behind the banking system, and that it would provide additional temporary aid to banks.

“The government will ensure that banks have the capital and liquidity they need to provide the credit necessary to restore economic growth,” the Treasury Department, the Federal Deposit Insurance Corporation and other agencies said in an unusual joint statement. “Moreover, we reiterate our determination to preserve the viability of systemically important financial institutions so that they are able to meet their commitments.”

The Treasury statement added that major banking institutions were “well capitalized.”

But analysts said investors remained worried about how America’s biggest banks would deal with the troubled assets on their balance sheets, and their prospects for weathering a prolonged economic contraction. Shares of Wells Fargo, Citigroup and Bank of America stayed positive, but other financial companies like Morgan Stanley and Goldman Sachs turned negative.

Analysts said that after fevered speculation last week about bank nationalization, many investors now expect the government to move in that direction, despite statements from the White House supporting a privately held banking system. Stock markets dropped on Friday amid concerns that a broad government takeover could wipe out financial shareholders.

Now, with the government set to begin the “stress tests” on Wednesday, investors want to know which banks will be deemed healthy and which will not, analysts said. Of most pressing concern are big banks including Citigroup, Bank of America, Wells Fargo and JPMorgan Chase, followed by regional chains.

“We need to know how they stand right now,” said Dave Rovelli, managing director of trading at Canaccord Adams. “The uncertainty of waiting for the results of these stress test is just killing the markets.”

Three weeks ago, stock markets tumbled after the Treasury Department announced plans to form a public-private partnership to take troubled mortgage-related assets off the balance sheets of banks. Investors said the government’s plans were short on details and left too much uncertainty about how those assets would be valued, or how private investors would be enticed to bid on them.

The losses on Wall Street came one week after the Dow sank to its lowest levels in six years on growing fears about banks across Europe and the United States.

By the end of trading on Friday, the Dow had tumbled 6.2 percent for the week, its worst since October, and had sunk to its lowest levels in six years. The S. & P. 500 fell 6.5 percent, dropping below 800, but was still slightly above its bear-market lows of Nov. 20.

Absent a detailed blueprint forward from Washington or some unexpectedly positive economic news, analysts said they expect the markets to tunnel farther down, with the S. &. P. 500 retesting its Nov. 20 lows of 752. Several analysts said they still have not seen signs of capitulation, a frenzy of high-volume selling, that often signals the bottom of a bear market.

“The technicians now have control of this market,” said Sam Stovall, chief investment strategist at Standard & Poor’s Equity Research. “People are saying, ‘Where do we go now? We don’t know what’s next.’ ”

February 23, 2009
Op-Ed Columnist

Banking on the Brink


Comrade Greenspan wants us to seize the economy’s commanding heights.

O.K., not exactly. What Alan Greenspan, the former Federal Reserve chairman — and a staunch defender of free markets — actually said was, “It may be necessary to temporarily nationalize some banks in order to facilitate a swift and orderly restructuring.” I agree.

The case for nationalization rests on three observations.

First, some major banks are dangerously close to the edge — in fact, they would have failed already if investors didn’t expect the government to rescue them if necessary.

Second, banks must be rescued. The collapse of Lehman Brothers almost destroyed the world financial system, and we can’t risk letting much bigger institutions like Citigroup or Bank of America implode.

Third, while banks must be rescued, the U.S. government can’t afford, fiscally or politically, to bestow huge gifts on bank shareholders.

Let’s be concrete here. There’s a reasonable chance — not a certainty — that Citi and BofA, together, will lose hundreds of billions over the next few years. And their capital, the excess of their assets over their liabilities, isn’t remotely large enough to cover those potential losses.

Arguably, the only reason they haven’t already failed is that the government is acting as a backstop, implicitly guaranteeing their obligations. But they’re zombie banks, unable to supply the credit the economy needs.

To end their zombiehood the banks need more capital. But they can’t raise more capital from private investors. So the government has to supply the necessary funds.

But here’s the thing: the funds needed to bring these banks fully back to life would greatly exceed what they’re currently worth. Citi and BofA have a combined market value of less than $30 billion, and even that value is mainly if not entirely based on the hope that stockholders will get a piece of a government handout. And if it’s basically putting up all the money, the government should get ownership in return.

Still, isn’t nationalization un-American? No, it’s as American as apple pie.

Lately the Federal Deposit Insurance Corporation has been seizing banks it deems insolvent at the rate of about two a week. When the F.D.I.C. seizes a bank, it takes over the bank’s bad assets, pays off some of its debt, and resells the cleaned-up institution to private investors. And that’s exactly what advocates of temporary nationalization want to see happen, not just to the small banks the F.D.I.C. has been seizing, but to major banks that are similarly insolvent.

The real question is why the Obama administration keeps coming up with proposals that sound like possible alternatives to nationalization, but turn out to involve huge handouts to bank stockholders.

For example, the administration initially floated the idea of offering banks guarantees against losses on troubled assets. This would have been a great deal for bank stockholders, not so much for the rest of us: heads they win, tails taxpayers lose.

Now the administration is talking about a “public-private partnership” to buy troubled assets from the banks, with the government lending money to private investors for that purpose. This would offer investors a one-way bet: if the assets rise in price, investors win; if they fall substantially, investors walk away and leave the government holding the bag. Again, heads they win, tails we lose.

Why not just go ahead and nationalize? Remember, the longer we live with zombie banks, the harder it will be to end the economic crisis.

How would nationalization take place? All the administration has to do is take its own planned “stress test” for major banks seriously, and not hide the results when a bank fails the test, making a takeover necessary. Yes, the whole thing would have a Claude Rains feel to it, as a government that has been propping up banks for months declares itself shocked, shocked at the miserable state of their balance sheets. But that’s O.K.

And once again, long-term government ownership isn’t the goal: like the small banks seized by the F.D.I.C. every week, major banks would be returned to private control as soon as possible. The finance blog Calculated Risk suggests that instead of calling the process nationalization, we should call it “preprivatization.”

The Obama administration, says Robert Gibbs, the White House spokesman, believes “that a privately held banking system is the correct way to go.” So do we all. But what we have now isn’t private enterprise, it’s lemon socialism: banks get the upside but taxpayers bear the risks. And it’s perpetuating zombie banks, blocking economic recovery.

What we want is a system in which banks own the downs as well as the ups. And the road to that system runs through nationalization.

February 23, 2009, 4:37 pm

A.I.G. to Seek More Government Aid

The American International Group, the battered insurance giant that is now effectively majority-owned by the federal government, is in talks to receive more government aid as it prepares to record one of the biggest losses in corporate history.

A.I.G. could take as much as a $60 billion hit when it reports earnings during the next week. It expects to disclose losses across a wide variety of holdings, from commercial real estate to credit default swaps, the private contracts that helped lead it to the brink last fall.

Among the plans being discussed include swapping some or all of the $40 billion in preferred shares held by the government into a form of capital A.I.G. can use to ward off collateral calls from its trading partners. The government has already lent A.I.G. $150 billion.

The news was first reported Monday afternoon by CNBC.

Shares in A.I.G., which had fallen nearly 1.9 percent on Monday, dropped 5.7 percent in after-hours trading to 50 cents. They have fallen nearly 98 percent over the past six months.

A.I.G.’s latest woes have emerged as the government seeks to begin “stress-testing” the nation’s banks and preparing to inject more capital into them as necessary.

Shoring up the insurer has been one of the government’s biggest headaches since September, when the Federal Reserve propped up the firm with an $85 billion high-interest loan to meet pressing capital demands from its trading partners involved in credit default swaps. That left the government with a 79.9 percent stake in the insurer.

Saving A.I.G. was considered a primary concern after the collapse of Lehman Brothers: the firm had effectively insured billions of dollars worth of mortgage-backed securities across Wall Street. If the firm were to have fallen, the pain would radiate to financial firms across the world.

But A.I.G. quickly drew down on its credit line, forcing the government to restructure its bailout. Using a combination of money from the federal bank bailout and the creation of new structures to store toxic assets like bundles of mortgage-backed securities off the firm’s balance sheet.

That appears to have failed to stem the troubles at the company, which reported $38 billion in losses last year, enough to have wiped out the preceding three years’ worth of profits. By November, the firm disclosed losses not just in the more arcane parts of its businesses, but also in its core insurance operations.

A.I.G. has raced to sell off assets in hopes of paying back its government loans, but the poor market conditions have made it nearly impossible to sell units at the prices the company had sought.

–Andrew Ross Sorkin and Michael J. de la Merced

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