I’m starting to have flashbacks to last September. It’s not a pleasant feeling. The banking sector is clearly still in dire straights. Financial stocks have plotted an almost unbroken decline since the first of the year. Citigroup announced this week a rather desperate plan to dismember itself. It is expected to report a staggering $10 billion loss for the 4th quarter of 2008.
Meanwhile, Bank of America has been pleading for a second bailout, and according to The Wall Street Journal, likely to get it — which would earn it the distinction of being third company in the last four months bailed out by the government twice. At stake is BofA’s commitment to purchase the distressed securities firm Merrill Lynch, which deal, if it failed, could be another Lehman-like detonation.
The excellent website Baseline Scenario reproduced a Bloomberg chart showing that credit default swaps on the banks are creeping back toward September levels. And one thing (maybe the only thing) that CDS is good for is this: predicting a company’s approaching agony.
Federal Reserve Chairman Bernanke bluntly told us Tuesday that more capital injections will probably be necessary; and even the President-elect hinted that it would be “irresponsible” not to have that second TARP tranche ready for new emergencies, so he asked President Bush to request it. The latter duly obliged.
Elsewhere, hedge fund redemptions are still accelerating. “Cry me a river,” you say? Fair enough. But I think it is also fair to conjecture that the one prominent feature of the early Great Depression which we have mercifully avoided (if the extraordinary Fed and Treasury activity did nothing else, at least it accomplished this) is massive bank runs. Our economy today is much more sophisticated than that of the 1930s — instead of bank runs we get hedge fund runs.
In a word, we’re not out of the woods yet. Not by a long shot.
UPDATE: Don’t miss Francis Cianfrocca’s post on the resurgence of the banking crisis. His succinct and mournful summary: “You just accept that the biggest moral-hazard-creating event in world history is preferable to not having a banking system at all.” He recommends revisiting the original TARP plan, specifically in the form of a “First National Bad Bank of the United States,” which would be chartered to
issue debt on a full-faith-and-credit guarantee, possibly with an agency-like imprimatur that would generate a few extra basis points of yield. It would be used to buy up maybe half a trillion dollars’ worth of asset-backed paper from banks, and simply hold to maturity. [. . .]
As with a hedge fund, the point would be to capture the risk-adjusted yield from the asset portfolio and repay the investors. Risk is simply the credit risk of the portfolio, because the purchases would be non-leveraged. (The low cost of capital makes this possible.)
Downsides? Well, there’s the moral hazard of course. The banking system will never return to full-normal because everyone will know how rigged and nationalized it is. This effect will last for at least a generation. More than a generation, if the textbooks start getting rewritten to reflect a new dogma that private enterprise doesn’t really work in banking.
That’s were we are, folks: up a creek, and our only paddle is a bizarre sort of thing that slaps you in the face every time you row.