Now we know why the Obama administration asked President Bush to go ahead and request the remaining $350 billion of TARP funds: Bank of America needs another bailout. No details are available yet, but everyone's assuming that the BofA deal will be roughly similar to the deal Treasury struck with Citi in November. The Treasury has already committed the first $350 billion of TARP funds, so it's essentially committing money that it doesn't have yet. They'll get the money eventually, of course, though with tighter restrictions on its use.
This episode just goes to show that Treasury and Fed officials have to be really careful about what they say and do in public. Ever since the Lehman/AIG failures, there have been Treasury and Fed officials at every major bank, constantly monitoring their books. Everyone in the market knows this. So when the Obama administration asked President Bush to go ahead and request the second half of the TARP funds, rather than waiting until Obama is sworn in on Jan. 20, the market was seriously spooked. Everyone interpreted the move to mean that one of the major banks was in trouble again, and will need another bailout to survive. Since everyone knows that Treasury and Fed officials are constantly monitoring the major banks' books, the move to request the second half of the TARP funds sent a signal to the market that something is wrong at one of the major banks, and the problem is urgent (otherwise why not wait until after the inauguration to request the funds?).
As soon as Obama had Bush request the funds, the race was on to figure out which bank was in trouble. At first everyone thought it was Citi, since it had just announced plans to raise capital by breaking itself up, including spinning off Smith Barney in exchange for $3bn from Morgan Stanley. To give you a sense of the fear that gripped the market after the Obama administration's ominous move, CDS spreads on Citi jumped an unheard of 100bps today (spreads don't usually move more than 5-10bps in a single day). Deutsche Bank's announcement this morning that it had lost $6.3 billion in Q4 just added fuel to the fire.
Now we know that the bank that's in trouble is BofA, not Citi. It's now clear that the BofA Bailout 2.0 is the reason Obama had Bush request the rest of the TARP funds, but that just confirms that the market was right to interpret Obama's move as a signal that one of the major banks was in trouble.
Felix Salmon is calling for nationalisation:
I can't see a solution to this problem short of nationalizing both Citi and BofA, and summarily firing the hapless Vikram Pandit along with the overambitious Ken Lewis. Lewis thought he could buy his way out of trouble, by acquiring Merrill Lynch; instead, he was simply tying his own already-troubled institution to an even more troubled institution. Pandit, it's worth noting, tried the same hail-Mary technique, when he put together a deal to buy Wachovia, but that didn't last long.
Citigroup, at $3.50 a share, simply doesn't have the time to implement its new plan to get smaller slowly. And Bank of America, at $7.75 a share, doesn't have the capital needed to absorb Merrill Lynch. Both are now trading at option value: on the hope, essentially, that somehow equity holders won't be wiped out entirely. But they should indeed be wiped out, as part of a nationalization, along with preferred shareholders, including the government. TARP will show an immediate loss on its investments, which will serve as a salutary reminder for whoever's in charge of disbursing the second tranche.
Nationalization is a messy solution, and one which will make no one happy. But it's better than desperately trying to kick the ball down the field until the banks come back in a few weeks for even more money.
I'm tempted to agree. One of the most valuable institutions to come out of the Great Depression was the FDIC, which is possibly the best regulator in the world at orderly winding up failed banks.
The problem is, the FDIC was born in an era when branch banking laws meant most banks were very small, and grew up in an environment of small banking, and mostly stable banking. It's good at dealing with failures, even big failures, in an environment of overall stability. But what to do with gigantic bank failures in the current situation? The FDIC's standard actions--wrap up the worst operations, sell off the remaining pieces, pay off depositors out of government coffers--are hard to pull off here. Who is there with the capital to absorb the struggling operations of BofA and Citigroup?
That leaves nationalization, or liquidation. And a fire sale of two of the country's biggest banks would be, she said with dramatic understatement, very bad for the health of the financial system. It's simply not strong enough to absorb the losses.
In the past few days, I've spoken to a few economics people who are feeling a little perkier about the economy's prospects. I tend to think we're in a lull before the storm gets a second wind.
Do the economists whom you interviewed really know what they are talking about? Have these economics people right about the scope and degree of our economic travails in 2008?
I note that just because I ask the question doesn't mean that I dismiss the efforts of economists--I just look upon any of their predictions with a skeptical eye.
Megan, it's worth noting that in this cycle of bank failures the FDIC has been pretty successful in selling a failed institution's deposits to the highest bidder, rather than relying on the deposit insurance fund exclusively to cover them. Often even the uninsured deposits -- accounts with balances above the insurable limit, some brokered accounts (I think) -- don't end up with losses.
If I'm not mistaken, the FDIC has a mandate to pursue the "least costly" resolution to taxpayers, which means that to the extent someone else is willing to step up and pay something for the branches and deposits, they'll sell.
It sounds to me like BofA is just trying to get us to pay for the 2nd half of ML. Whatever we do, we have to make sure they feel some pain.
I tend to agree with you when it comes to the storm getting a second wind; we're just beginning to see the huge layoffs and shrinkage in what folks can due to lack of funds.
But within that storm I also see the roots of the path to sunshine; It's a path I know well, here in my home state. People often start businesses to create jobs for themselves here. Sure, they stay small, typically employing only a handful of folks. But the lack of employment opportunity brings out the folks inner entrepreneur.
I'm betting there are a whole lot of folks out there with great ideas for thriving businesses that wouldn't have considered it a year ago, being too secure in their comfortable lives, who will consider it now out of necessity.
Look for some of the results of this on the informercials you watch.
Additionally, I've started noticing a lot of ads on cable stations for reverse mortgages; thought I'd ask you 2-cents on the topic.
"Lull"???
Bank stocks are heading toward their Nov lows, and likely will go lower. This is an inexorable unwind of the bloated overleveraged financial system-- with a couple small countertrend rallies mixed in.
"It sounds to me like BofA is just trying to get us to pay for the 2nd half of ML. Whatever we do, we have to make sure they feel some pain."
That's exactly what's happening, and BofA will get it's money, because of three things: 1) the BofA side of the books is doing OK--the problem is with ML and its liabilities; 2) BofA agreed to buy ML almost sight unseen at Treasury's request--Lewis' message to the feds is basically, "you owe us"; and 3) there's no alternative--the feds can't possibly allow the ML deal to collapse. Whatever Obama is planning on financial reforms can't possibly come into effect before April, at the earliest, and even then would take a while to sort out. The feds have to ensure that BofA survives until then.
"TARP will show an immediate loss on its investments, which will serve as a salutary reminder for whoever's in charge of disbursing the second tranche."
Really? It would seem that the gov't went from owning some warrants that may be worth something to owning the whole thing outright. In 5 years, when everything is looking up, the gov't can do an IPO and sell off it's state in BofA and Citi for a very tidy profit.
Investment banks are not unlike the auto makers. No one wants to buy their product, not least because they are not able to. Like it or not, the economy has to undergo a couple of years of unwinding the various bubbles and bad deals before people want to buy cars again, no matter who makes them. Until consumers want to consume there will be no takers for investment banking services to lubricate the economy.
The difference is that when people want to buy autos again, someone will make them, even if the company's HQ is not in Detroit. There is a real danger, though, that the recovery will be delayed if the investment banking infrastructure disappears.
The bottom line is that ordinary people have lost significant home equity and financial assets. They are going to live within their means for some time to come. The wealth effect that supported the credit binge is gone, and a lot of jobs are gone as well.
My fear is that the stimulus xmas tree and the Fed's helicoptering of liquidity will not do much and ultimately prolong the recovery by saddling the public sector with debt and the private sector with inflation.
You're tempted to agree???
Gee, Megan_McArdle, what about that whole "Don't worry, the government will make a profit!" thing?
And who needs this "reminding"? The general public knew all along the money was as good as gone. Like another article pointed out in December (don't remember where), even if a new stadium will bring in government revenue, it's cost is still called a "cost" rather than than investment that will pay itself back.
So, first, Congress was rooked into going along with a $700 billion bailout on the grounds that, "don't worry, it'll all be payed back, maybe even make a profit", and then within months, NOPE, a large chunk of that gets converted into a pure cost, which normal people realized would happen the whole time.
And if it's *really* going to be a "fire sale" of two big banks' assets, why not let the common man actually benefit from this for once? Why not allow ordinary people to bid for pieces of the assets? I mean, if it's totally certain to be sold at under its "true" value, why not give taxpayers a chance to be earning those 26% returns in a few years?
Oh, I remember: because the "fire sale" prices *are* the true value!
Missmarketcrash reporting from London writes on the banks and a London perspective today -
http://missmarketcrash.blogspot.com/2009/01/reframing-probability-dimension.html
nationalize, absorb the losses, sell the remains.
we need to avoid having zombie banks. Zombie banks make for a poorly performing economy due to the lack of interest in exposing yourself to counterparty risk to that bank and zombie banks cannot or will not lend.
We let banks get too large for the FDIC to step in - great point.
Another interesting point is that we are now seeing the end result of deregulation. What happens in any environment is something bad. In regulated environments, we have tend to have anticipated this and usually can avoid this bad event, but we pay for it with slighly lower but stable growth. In unregulated environments bad things happen, we have to clean up the mess after, and usually it costs a huge amount of money and a one time shock to growth.
We need to add the trillions we are spending to the costs of deregulation. We are approaching 15% of GDP in total spending, and it is going to be much, much higher by the end.
You should talk to your friend Winterspeak and see what he thinks about Warren Mosler now.
BofA is in itself a conglomeration of smaller banks that were swallowed up in a ridiculous buying binge, why can't it be unwound the same way?
Also, since now we are seriously considering dumping even more funds into these terribly run institutions, why don't we just give the same amount of money to healthy institutions instead, and have them deal with it. Wouldn't Wells Fargo do a better job of tearing BofA apart than, say, Bob the Bureaucrat? How is this not a win/win?
The $60 trillion market of CDS swaps etc. is gone. Dead. No need for BoA or any of the big banks.
Citi is shedding jobs, maybe not fast enough. If BoA is allowed to die, as it should be?, then other banks will have better chances at picking up the profitable bits of BoA business.
(I left Wells for BoA as a small depositer).
If there's no contract for the Treasury to give more help to BoA, then Treasurey does NOT owe the 'speculators' at BoA.
The Fed should be ready to loan cash to any prior customer of BoA who needs additional money, thru commercial paper. What else does BoA do that other banks can't take over?
There's far too many banks and bankers. Let those with biggest losses lose first.
The bigger banks may have outgrown the FDIC, but the FDIC is designed for an era of closing small town agricultural banks (1930s-1985) and - via RTC - closing middling sized thrifts and savings banks.
I get really tired hearing people extol the virtues of the FDIC, since they do things the hard way and generally (literally) sell assets for pennies on the dollar. In their glory days of the 1990s the RTC and FDIC were part of a monstrous wealth transfer from failed banks to the buyers of the assets. I cringe when I hear people laud Bill Seidman and now Sheila Bair is a hero to the muddled masses.
Sheila wants to give away money by modifying even the worst deadbeat/fraud's mortgage. She - like all FDIC types - thinks she's not playing with real money. Once, say half of deadbeat's mortgages are modified then that many more banks will fail since the yields on the loans will be 3% ( a deadbeat can get refi'ed at 3%, and decent borrower gets refi'ed at 4.75%, go team!)
The sooner Treasury or the Fed starts buying assets rather than dumping them on the market as the FDIC types would have us do, then the sooner the swoon in asset prices will stop. Hold the assets to term; let the foreclosures proceed apace, and we will return to reality.
I will buy into the argument that BoFa is Asking the Treasury to make good on the implicit back room arrangement between them, made when Bear Stearns was doing the burning part of it's crash, and Treasury asked BoFa to step up to the plate despite the opacity of ML's toxicity.
BUT, the ML deal was the second punch after BoFa itself greedily gobbled down what was obviously a really rotten Countrywide carcass at an inflated price. Even from my amoeba perspective, that deal looked ridiculous.
I'm incredulous that we are to pay for such shortsightedness...go to any swap meet in America on a saturday, and watch better negotiators in action, for pennies and dollars.
MEMO TO TREASURY: create a good bank, buy all the good assets, capitalize it with good taxpayers money, and start lending to good creditworthy borrowers. let the market sort out the rest. Grab each others hands, start singing...KUMBAYA MY LORD, KUMBAYA!!!