Obama Becomes Banker-in-Chief as Credit Market Freeze Persists
Jan. 20 (Bloomberg) -- The U.S. economy has little chance of recovering from what may prove to be its worst recession since World War II unless President Barack Obama shows he can get banks to lend money again.
Since the Bush administration and Congress last year approved the $700 billion Troubled Asset Relief Program that injected capital into Bank of America Corp., Citigroup Inc. and JPMorgan Chase & Co., individuals and companies aren’t getting any of it as fourth-quarter lending by the biggest banks by assets plummeted. The asset-backed market, which is supposed to enable banks to keep lending by transforming loans into tradable securities, remains frozen, leaving would-be lenders unable to package and sell mortgages, credit-card debt and auto loans.
After reporting more than $1 trillion of market losses and writedowns, banks are adding billions of dollars to reserves amid a 16-year high in unemployment and two years of falling home prices. Investor confidence has waned, sending an index of bank stocks to a 13-year low last week. Obama, 47, can’t expect relief from the Federal Reserve, which already cut its main interest rate to as low as zero. All eyes will be on the 44th president today in anticipation that he may unveil a sweeping recovery plan.
“It’s a day-one, minute-one problem for the new administration,” said Stuart Eizenstat, deputy U.S. Treasury secretary from 1999 to 2001 and now a partner at Covington & Burling LLP in Washington. “It’s difficult to understand with the degree of oversight exactly how those banks got into such deep water. The point now is to keep them liquid, get the balance sheets in order and to get them to start lending.”
Real Rates
The mortgage market has contracted even as the Fed reduced interest rates, according to Freddie Mac. While the average 30- year fixed mortgage rate fell below 5 percent this month for the first time since the McLean, Virginia-based company started keeping records in 1971, the real rate that banks charge customers is the highest in more than two decades.
That’s because the spread between 30-year mortgage rates and 10-year Treasury yields is about 2.6 percentage points today, up from 1.6 percentage points in 2003 and 1.5 percentage points in 1993, data compiled by Bloomberg and Freddie Mac show. The difference was about 3.3 percentage points in June 1986.
The failure of banks to pass along savings is hurting a U.S. economy that’s already in the deepest recession since the 1980s, based on the decline in U.S. manufacturing, exports and consumer spending.
‘Economic Pearl Harbor’
Companies slashed payrolls in 2008 by almost 2.6 million, the most since 1945, the Labor Department reported. The unemployment rate climbed to 7.2 percent in December, the highest level in almost 16 years, and the rate may climb to 8.4 percent in the fourth quarter, a survey of economists compiled by Bloomberg shows.
Analysts have been reducing growth forecasts. The economy will contract 1.5 percent this year, a half percentage point more than projected last month, according to the average estimate of economists surveyed by Bloomberg last week.
“We are in the middle of the economic Pearl Harbor right now,” said billionaire investor and Berkshire Hathaway Inc. Chairman Warren Buffett during an interview late last week with Tom Brokaw of Dateline NBC. “Now we have to get mobilized to win the war, which we will.”
With lenders tightening standards, as few as 50 percent of applications are resulting in mortgages this month, compared with an average of about 70 percent during the past 18 months, according to data compiled by analysts at Zurich-based Credit Suisse Group AG.
Frozen Markets
Unfreezing credit “is the single most important thing,” said Kenneth Rosen, chairman of the Fisher Center for Real Estate and Urban Economics at the University of California, Berkeley, in an interview.
Only government-supported programs, with stricter standards than private lenders once required, have kept home-mortgage lending from shutting down in the U.S., according to newsletter Inside MBS & ABS, published in Bethesda, Maryland.
The securitization rate, or amount of new mortgage securities relative to new loans, rose to 78 percent in the first nine months of 2008, the newsletter’s data show. Issuance of bonds with government backing accounted for 99 percent of the total. In 2006, lenders such as banks kept 32 percent of loans and private mortgage securities accounted for 56 percent of sales.
Sales of bonds backed by auto-loan and credit-card payments plummeted 40 percent in 2008 as investors fled to the safety of U.S. government debt, New York-based Merrill Lynch & Co. reported. There have been no public sales of such debt in 2009. The gap, or spread, on top-rated credit card-backed debt maturing in three years is about 4.75 percentage points more than one- month Libor, compared with 0.5 percentage point a year ago, Merrill data show.
‘Cheap Capital’
Banks have been able to raise cash by selling government- backed bonds through the Federal Deposit Insurance Corp.’s Temporary Liquidity Guarantee Program. About $115 billion of such debt has been sold since Nov. 25, according to Bloomberg data.
The average yield, or spread, investors demand to own investment-grade company debt has shrunk to 5.6 percentage points from a record 6.56 percentage points on Dec. 5, according to Merrill, the biggest U.S. brokerage, which is now owned by Charlotte, North Carolina-based Bank of America.
“All of these new banks and old banks that are issuing FDIC-backed bonds are getting what I feel is cheapity-cheap capital,” said Marilyn Cohen, president of Envision Capital Management Inc. in Los Angeles, which oversees $175 million in fixed-income assets. “So what are they doing with that money?”
Obama, an Illinois Democrat who spent four years in the U.S. Senate, began proposing policies to restart the economy while campaigning against Republican candidate John McCain in the presidential election.
Toxic Clean-Up
As the George W. Bush presidency entered its final days earlier this month, Obama unveiled an economic stimulus package calling for corporate tax breaks to encourage hiring, a request that sparked dissent from some Democrats. The president-elect plans to save or create as many as 4 million jobs, in part through investments in alternative energy and infrastructure projects like roads and new schools.
“Hopefully that helps in the first two years or so,” Paul Krugman, the Princeton University professor who won the 2008 Nobel Prize for economics, said in a Jan. 14 interview with Bloomberg Radio. “Hopefully, we find some private sector drivers for recovery beyond that.”
Obama probably will back a bank-rescue effort that combines capital injections and steps to deal with toxic assets clogging lenders’ balance sheets, people familiar with the matter said on Jan. 16.
Bank of America
He scored a victory last week in the Senate, gaining access to the $350 billion in bailout funds, the second half of the Troubled Asset Relief Program, designed to ease the foreclosure crisis and support banks. The vote, after the close of trading on Jan. 15, followed a plunge in financial stocks that sent the 24- company KBW Bank Index, already at its lowest since 1995, down another 8 percent.
Obama’s economic team will use some of the $350 billion to help homeowners avoid foreclosure, according to people with knowledge of the plan. He also may assist cash-strapped cities and states that have trouble selling bonds, the people said.
“We’ve started this year in the midst of a crisis unlike any we’ve seen in our lifetimes,” Obama said in a Jan. 16 speech in Ohio. “It’s not too late to change course, but only if we take action as soon as possible.”
Bank of America, the largest U.S. bank by assets, fell to an 18-year low on Jan. 16, after reporting a $1.79 billion fourth- quarter loss. The figures exclude a record $15.3 billion deficit posted by Merrill Lynch, caused by errant mortgage trading before the Bank of America takeover was completed on Jan. 1.
Record Foreclosures
Chief Executive Officer Kenneth Lewis, 61, agreed to buy Merrill on Sept. 15, two months after the purchase of foundering mortgage lender Countrywide Financial Corp. He struck the Merrill Lynch deal the same day New York-based Lehman Brothers Holdings Inc., once the largest underwriter of mortgage-backed bonds, filed the biggest bankruptcy case in U.S. history.
Citigroup reported an $8.29 billion fourth-quarter loss, with more than half coming from writedowns on subprime home loans and related bonds. The New York-based company, which has lost more than 85 percent of its market value in the past year, was forced to obtain $45 billion of government rescue funds and announced last week it will split in two.
Home prices in 20 U.S. cities dropped a record 18 percent in the 12 months through October and have fallen every month on a year-on-year basis since January 2007, according to the S&P/Case- Shiller index. Foreclosure filings reached a record 3.2 million last year, RealtyTrac Inc. of Irvine, California, reported, pushing down property values and increasing the number of borrowers who owe more on their mortgages than their properties are worth.
TED Spread Narrows
“The challenge that no one has really addressed is the fundamental core problem and that’s the declining housing market,” said Gregory Habeeb, who oversees about $7.5 billion in fixed-income assets at Calvert Asset Management Co. in Bethesda, Maryland. “Everybody’s just addressing the casualties of the problem. If there is some more spent on solving the core problem, we might start seeing the end of the decline.”
Obama plans to tackle the problem with the help of his nominee for Treasury secretary, Timothy Geithner, and Lawrence Summers, whom the president picked to direct the National Economic Council.
They also face the task of stimulating credit markets that seized up after the Lehman bankruptcy and have since started to loosen.
The difference between what banks charge each other for three-month loans and the rate that the Treasury pays, the so- called TED spread, has narrowed to about 1 percentage point, the tightest in five months. The spread, a measure of banks willingness to lend, peaked at 4.64 percentage points in October.
Bleak Prospect
The credit market is “sick, but still ambulatory,” said Envision’s Cohen, who has worked in the bond market since 1979. “There are transactions that are being done.”
The financial crisis has seeped into the rest of the economy, forcing companies to slash jobs and lifting unemployment to it highest since 1993. Motorola Inc., the No. 2 U.S. seller of mobile phones, Schlumberger Ltd., the world’s largest oilfield- services company, and drugstore chain Walgreen Co. are among companies that have announced job cuts this year.
Obama faces “problems all across the horizon,” said Nobel laureate economist Robert Solow, 84, a professor emeritus at the Massachusetts Institute of Technology in Cambridge. “His initial focus really has to be on the real economy, on getting the recession turned around as soon as he can manage it, which is not going to be very soon.”
‘Little Blind’
Profit at companies in the Standard & Poor’s 500 Index has dropped for the past five quarters, matching the longest losing streak on record. Declines are forecast for the last three months of 2008 and first three quarters of this year, according to estimates compiled by Bloomberg.
Rebecca Blank, an economist at Brookings Institution in Washington and once a member of former President Bill Clinton’s Council of Economic Advisers, said it all adds up to the worst economy since at least World War II. The only comparable period was the back-to-back recessions of 1980 to 1982, she said. Then, Obama was an undergraduate at Columbia University in New York.
“It’s been 25 years since economists and politicians in the United States have had to engage seriously about what you do when employment collapses and your financial markets collapse and you’re in a full-economy recession,” Blank, 53, said in an interview. “That means you’re flying a little blind on this.”
To contact the reporters on this story: Caroline Salas in New York at csalas1@bloomberg.net Ari Levy in San Francisco at alevy5@bloomberg.net
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