The noose around U.S banks' neck: the unknown
TARA PERKINS AND BARRIE McKENNA
Friday, February 20, 2009
Except for the temperatures outside, bankers could be forgiven for thinking it's September all over again.
Panic about the fate of U.S. financial titans has led to concern that one might not survive the weekend. A high degree of uncertainty about the U.S. government's next move is only fanning the flames. And suddenly, the spectre of nationalization is gaining credulity among investors, economists and policy makers.
The already jittery market fled from bank stocks this week as the drumbeat for nationalizing the two largest U.S. institutions — Bank of America Corp. and Citigroup Inc. — grew louder by the day. The list of luminaries endorsing at least partial and temporary nationalization now includes former U.S. Federal Reserve Board chief Alan Greenspan, Nobel Prize-winning economists Joseph Stiglitz and Paul Krugman, and former Fed vice-chairman Alan Blinder, a professor at Princeton University.
Even prominent members of Congress, including Senate banking committee chairman Chris Dodd, acknowledge a seizure of one of more banks may eventually be necessary.
The industry, already fighting for its survival, is now also fighting for its independence.
"We believe that the whole discussion about nationalization is impairing the financial sector and making the credit situation worse," said American Bankers Association chief executive officer Edward Yingling. "Investors will remain on the sidelines if there is continued speculation that the government may step in and undercut their investment."
Bank of America chief executive officer Ken Lewis said he sees "no reason" for nationalization. Shares of his bank opened the week at $5.57 (U.S.) and closed at $3.79, erasing more than $10-billion in market value. Shares of Citigroup went to $1.95 from $3.49 over the course of the week, shaving more than $8-billion off the company's market value, which now stands at about $10.6-billion.
The negative sentiment wasn't contained in the United States. In Toronto, the S&P/TSX capped financials index fell roughly 5 per cent yesterday. Shares of the country's biggest bank, Royal Bank of Canada, closed the day at $27.07 (Canadian), well off their 52-week high of $51.50. But Canada's banks remain a standout on the global scene, with Royal Bank's current market value nearly threefold that of Citigroup's. There are growing fears about the health of European banks, many of which lent aggressively in the now-faltering economies of the former Soviet Union. Britain has already moved to nationalize several banks, and this week Germany passed legislation to begin the takeover of Hypo Real Estate Holding AG.
The White House tried to rein in some of the damage yesterday, insisting a direct government takeover is not on the table.
"This administration continues to strongly believe that a privately held banking system is the correct way to go, ensuring that they are regulated sufficiently by this government," White House spokesman Robert Gibbs told reporters.
But the reality is that the U.S. government may already be the de facto owner of Citigroup and Bank of America. The Treasury Department has already injected $45-billion into each bank, receiving preferred shares in return. If converted into common stock, the government stake in the banks would easily eclipse their depressed market value.
Fears of a government takeover are adding to the banks' problems when they least need the additional headache. "Increasing talk of bank nationalization could be a self-fulfilling prophecy," UBS analyst Matthew O'Connor wrote in a note to clients this week. "We continue to believe the best option is not to nationalize the banks — in part because nationalization of weak banks may cause strong banks to weaken, potentially increasing the size of the problem."
The risk is that the more investors speculate about nationalizing the banks, the further the shares of the banks tumble, worries Ricardo Caballero, head of economics at the Massachusetts Institute of Technology. Taking over the banks won't solve the problem of toxic assets and could trigger a massive flight to quality, Mr. Caballero points out.
"It is time … to stop proposing ideas that only add fuel to the fire," he said.
The Obama administration is promising to release new details of its bank rescue plan next week. The vagueness of the plan, released by U.S. Treasury Secretary Tim Geithner last week, compounded fears in an already spooked market. Investors are not convinced that his scheme to leverage private capital will clean up the massive pile of toxic loans on bank balance sheets.
"Geithner's plan was pretty much just a plan to have a plan," said John Diamond, a fellow in tax policy at the James Baker Institute for Public Policy at Rice University in Houston, who recently worked on John McCain's presidential campaign. "There were just no real details, and that just leaves the market more uncertain."
Others worry Mr. Geithner's promised "stress tests" for the largest banks will reveal that many are effectively insolvent.
At the same time, banks are reluctant to sell the assets in this environment, and "more and more political people are starting to think that maybe we should force their hand," Mr. Diamond said.
While the U.S. government continues to search for a workable plan to clean up toxic assets, banks have been facing a new tsunami because of the deteriorating economy.
"How a bank does is, by and large, a reflection of the economies in which it operates," notes Lindsay Gordon, chief executive of HSBC Bank Canada.
The operating environment surrounding U.S. banks is ugly. Losses on loans such as credit cards are spiking. And deposits, which banks use to fund much of their business, are harder and harder to come by.
But the real noose around the banks' necks right now is the unknown.
"I've been around financial services for 30 years and I've lived through a number of recessions, and I can't ever recall an environment where there was as much uncertainty about what the future in the next couple of years holds," Mr. Gordon said. The market is punishing bank stocks because of growing pessimism about the economy, uncertainty about the future, and a lack of clarity about the transparency and quality of assets on bank balance sheets, he said.
Overhanging all this uncertainty are worries that President Barack Obama's $787-billion (U.S.) economic stimulus package might take too long to work its way through the system, while the recession continues to spread.
"It's fine to announce big plans but it's only going to work if the money finds its way through to consumers and we're a long way from that yet," Mr. Gordon said.
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