Sell-Off Is Sobering Welcome From Wall Street
Wednesday, January 21, 2009
As Washington celebrated, New York fretted.
The Dow Jones industrial average yesterday fell below 8,000, shedding 4 percent, its bleakest performance on any Inauguration Day since the index was started 124 years ago. Nasdaq and the Standard & Poor's 500-stock index both plunged more than 5 percent.
Disillusioned investors fled financial companies as fresh evidence mounted that the industry's problems are larger than previously understood, larger than the response so far mustered by the government and perhaps larger than the resources remaining in its rescue program.
The possibility of bank nationalizations, in which governments take direct control of financial institutions, is being debated in Britain and elsewhere, as some of the world's biggest banks report surprisingly dire results. The industry's plight, tightly intertwined with the ongoing recession, is among the great challenges confronting President Obama.
Problems have spread to companies that investors considered conservative and safe. Institutions including German giant Deutsche Bank, money managers State Street and Bank of New York Mellon, and even several members of the Federal Home Loan Banks system have revealed unexpected and significant problems, leaving almost no part of the financial industry untouched.
Losses at companies already tarred by the crisis also have been deeper than analysts expected. Regions Financial, a large southeastern bank, yesterday reported a fourth-quarter loss of $6.2 billion, greater than its total profits in the past five years. Citigroup said it lost $19 billion last year.
The Royal Bank of Scotland disclosed this week it may have lost $41 billion last year, leading the British government to announce a second bailout for the company that increases the government's stake in one of Britain's largest banks
The federal government's promise to prevent the failure of large U.S. banks may be exacerbating their problems. As banks sink, financial analysts increasingly are warning that government intervention is inevitable and could come at the expense of shareholders, perhaps in the form of nationalization. This appears to be driving away investors and hastening the intervention. As with the government's summer promise to save Fannie Mae and Freddie Mac, but only if necessary, the last resort has become the expected outcome.
Until banks can attract fresh capital from debt or equity investors, it will be difficult to stabilize and jump-start lending, said Binky Chadha, chief U.S. equity strategist at Deutsche Bank in New York. But the government's patchwork approach to the bailout has would-be investors sitting on the sidelines, he said.
"In each episode of financial intervention, the rules have been a little different," Chadha said. "Hopefully [the new administration] will lay out the rules, and it will be a lot clearer. In the meantime, the textbook model of wiping out the equity holders is clearly a concern, and should be a concern."
The basic problem facing the financial industry, and the new administration, is that banks lack the money to cover their losses. The capital reserves that banks are required by regulators to maintain against losses have been badly eroded.
The banking industry has acknowledged losses of roughly $1 trillion since the start of the financial crisis. Goldman Sachs last week projected that this total could more than double. Nouriel Roubini, a professor at New York University's Stern School of Business noted for his pessimism, said yesterday that losses could hit $3.6 trillion.
The Bush administration pumped almost $300 billion into U.S. banks, but the scale of investment is dwarfed by the still-emerging problem. The government's actions stemmed the market's panic in the fall, but it did not succeed in stabilizing the industry.
Investors now appear to be stampeding again. Shares of Wells Fargo have lost roughly half their value since the start of the year. Bank of America is down 64 percent. J.P. Morgan Chase is down 43 percent. Citigroup is down 58 percent. Those are the four largest U.S. banks.
Obama administration officials are considering several approaches focused on the troubled loans and other assets that are the source of the losses, including the creation of a government-owned "bad bank" that would buy troubled assets from financial firms, quarantine them and then sell them, generally at a substantial loss. The aim is to revitalize lending. Bad banks have been created by countries including Sweden, but the idea has never been tried on a comparable scale.
It is increasingly likely that any approach will require more than the roughly $320 billion remaining in the financial rescue program approved by Congress in the fall, several officials said.
The problems continue to grow.
A number of banks once considered healthy have been hobbled by the acquisitions of troubled institutions, often in deals urged by the U.S. and European governments. Investors are increasingly fearful of losses at Wells Fargo, which they viewed as the healthiest of large U.S. banks before it swallowed Wachovia. Bank of America needed more than $20 billion in additional government assistance in part to help it swallow the troubled investment bank Merrill Lynch.
Meanwhile, banks that specialize in managing money for large institutions have become the latest quiet corner of the financial industry infected by the crisis. Bank of New York Mellon reported yesterday it earned $28 million in the fourth quarter, less than a tenth of the amount Wall Street had expected.
State Street said that it had unrealized losses of about $9 billion as of the end of 2008, a massive figure that surprised analysts who previously regarded the company as relatively sheltered from the crisis. The company's shares fell by 59 percent yesterday as several financial analysts said State Street could be forced to raise capital.
Problems in Europe also grew. The Irish parliament voted yesterday to complete the nationalization of Anglo Irish Bank, the country's third-largest bank. It is the second round of government bailouts for the Irish banking industry.
The action in the markets underscored the need for Obama to set his sights on repairing the banking system before turning his attention to a broader economic stimulus package, said Brian Gardner, senior vice president for Washington research at Keefe, Bruyette & Woods.
"What gets at the core economic issues of the day is fixing the financial system," Gardner said. "This all started from a crisis in the financial system, and it's going to be solved by fixing the financial system."