Friday, January 23, 2009

Despite billions, banks still teeter on the brink

Despite billions, banks still teeter on the brink

Wall Street waits on Obama, but no clear solution to the crisis exists

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Wall Street is losing faith in Washington's efforts to fix the financial crisis. As bank losses pile up and bank stocks plunge, investors have an urgent question for the new Obama administration: What's the plan?

Timothy Geithner, Obama's pick for treasury secretary, had few answers as he began confirmation hearings Wednesday. He told lawmakers that two goals were to "get credit flowing again" and overhaul the $700 billion bailout, but he offered few details.

There's a lot riding on the new administration. Several of the largest U.S. banks, saddled with soured mortgage-backed assets, are edging toward the danger zone despite injections of billions of dollars from the government last year.

At the same time, the recession is gathering force, chewing up jobs by the hundreds of thousands and ruining many consumer and business loans that were once thought to carry little risk.

The first half of the federal bailout came with no requirement that the banks lend more. But even keeping the cash as a cushion hasn't stopped banks from sliding toward the precipice.

"The size of the problem is growing faster than the banks' ability to handle it," said Joe Battipaglia, market strategist at Stifel Nicolaus. "We're halfway through the bailout money, and the banks are in worse shape than they were six months ago."

Investors expect Obama's team to consider a range of options, including pumping more money into banks and creating a government entity to buy up bad bank assets so they'll start lending again.

But those prospects all raise troubling questions: Would stockholders be wiped out? How much taxpayer money would ultimately be needed? What could happen if the government takes an even bigger role in the banking system? And perhaps the biggest unknown: Would a bigger bailout get banks to start lending again and help pull the country out of recession?

For now, the focus is simply on keeping the banks alive.

Experts say household names like Citigroup and Bank of America, which have already received two government cash infusions apiece — will need even more to offset future losses and stay afloat.

The fear is that both banks are so big, so blended into the global financial system, that their collapse could trigger a catastrophe.

The most troubled banks are "going to definitely go down" without more government help, said Jonathan Macey, a law professor at Yale University who wrote a book about a bailout of Sweden's banking system during the 1990s.

"And they may go down with it," he added. "The pace of these bank losses is outrunning the infusions by the government."

Sheila Bair, chairman of the Federal Deposit Insurance Corp., sought to allay those worries Wednesday in an interview with The Associated Press. Still, she acknowledged investors' concerns.

"There's a lot of fear out there," Bair said. "We're going to work through this. It's going to be hard. It's going to take time. But we will work through it."

In the meantime, investors are agonizing. Citigroup's stock fell 20 percent to below $3 a share Tuesday. Bank of America shares tumbled 29 percent. Both banks rebounded some Wednesday, but experts say their troubles are far from over.

So why hasn't the bailout worked?

Experts say one big problem is it hasn't addressed the root cause of the trouble: the mortgages and other bad assets sitting on the banks' books.

When the government announced the bailout three months ago, the plan was to buy those bad assets so banks could start lending again. But that approach was quickly scrapped, partly over concerns it would take too long to work.

Plan B, injecting banks with cash, hasn't worked as Wall Street had hoped.

The government has so far provided $192.3 billion to 257 large and small financial institutions in 42 states and Puerto Rico. But banks are mainly sitting on the money, not ramping up lending.

"The capital injections haven't worked," said Edward Yardeni, an independent market analyst. "It's been like giving blood thinner to a patient who needs to have their wounds clotted. The bleeding hasn't stopped."

Some lawmakers want to force banks to boost lending if they accept taxpayer money, but none of the leading plans being debated on Capitol Hill include such requirements.

If Washington decides to give banks more money, the question is how much.

Bert Ely, an independent banking analyst in Alexandria, Virginia, has estimated the price could swell to as much as $1.5 trillion. "There's no reason why it couldn't go that high," Ely said.

But many on Wall Street are uncomfortable with the government's giving banks more money, believing it would amount to a federal takeover of the U.S. banking system that could wipe out shareholders.

"What we're heading for is the dirty word of de facto nationalization of U.S. banks if we continue on the current path," Chuck Gabriel, managing director of Capital Alpha Partners in Washington. "How are you going to attract private capital to the banking system? That's the question they haven't come close to answering."

One alternative to giving banks more cash is setting up a government-run bank to buy banks' bad assets. The idea is that by removing the assets weighing down the banks, they'll stop hoarding cash and start lending again.

Gabriel said that could assure nervous investors that Obama's team is pursuing a new course of action.

"They need to come out and do something that's a departure" from only capital infusions, he said. "You could spend another $700 billion and some folks might think that's not enough."

Experts say there's no option guaranteed to spur more lending.

For one thing, banks have tightened lending standards, shrinking the pool of qualified borrowers. That makes it much harder for the government to "force-feed credit into the economy," Ely said.

So what if the government decides not to give the banks more money? Experts say the consequences could be dire.

In a report last week, Goldman Sachs estimated that financial institutions and investors worldwide will ultimately absorb $2 trillion in losses on U.S. loans — but have recognized only half those losses so far.

Unless the banking sector has a way to offset those losses, troubled banks could fall — possibly triggering a panic.

"You could see a total erosion of confidence among the government's ability to stave off another crisis," said Richard Sparks, senior equities analyst at Schaeffer's Investment Research in Cincinnati. "I can't conceive of the government not doing anything."

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