If I thought everyone was talking about the banks last week, this week picked it up by an order of magnitude. First, two investment banks, Lehman Brothers and Merrill Lynch, changed their financial arrangements, the former in bankruptcy, the latter agreeing to a stock swap with Bank of America. Then the focus shifted to AIG (American International Group), which recently was considered the world’s largest insurance company.
The involvement of AIG in banking is hard to explain in a few words, but I’ll attempt it. Many of the assets held by banks are very abstract and it is hard to say what they are really worth. By selling banks another asset that is even more abstract, basically a kind of guarantee or insurance, AIG allows the banks to record these assets at a specific value. If you heard exactly what these assets are, your initial reaction would probably be along the lines of, “Does that make any sense? Is it even legal?” Yet without them, a quarter of the banks in the United States and Europe would be worth a lot less than they are, and would, at least technically, be insolvent — without enough assets to cover their obligations, they might be forced to shut down. This is why the Federal Reserve Bank was so eager to advance AIG an $85 billion loan to keep it going for a few more weeks.
This partial bailout of AIG is scary in more ways than one. First, the amount of money is not enough, by itself, to keep AIG in business. If they can’t make some further arrangements, we may have just postponed their collapse until November. And what then? Second, if this many of our banks depend for their very existence on assets so abstract they cannot be adequately explained to the average college graduate, is it good to encourage those banks to continue operating, or does that just compound the current problems? Third, is Washington’s entire strategy just to postpone the coming collapse until after the election? Fourth, if the U.S. government wants to own an insurance company, couldn’t it set up one of its own design for less than $85 billion? And finally, where will the Fed get all this money? The stock market rallied on news the Fed was bailing out AIG, then slumped when the news got out that the Fed was running out of money and would have to be bailed out by the U.S. Treasury. As one observer put it, “The Fed is running out of money? Now we’re really in trouble!”
In the middle of all this, at least two analysts called for urgent funding for the FDIC (Federal Deposit Insurance Corporation), saying if Congress doesn’t start sending money over within the next three weeks, it will be time for people to start taking their money out of the banks. Why? FDIC insurance is still valid after the FDIC runs out of money, but at this point, if you have a deposit in a failed bank, you may not get your money out until Congress appropriates the money for that purpose, and the way Congress works, that could take a year or two. So if you think you might need your funds within the next two years, is it really safe to keep it in a bank? For the measly 0.85 percent interest they pay these days? Banking customers will be far more comfortable about having money in the bank if Congress fully funds the FDIC for what’s coming, but I don’t think Congress has gotten the message yet.
Then another investment bank, Morgan Stanley, saw its stock fall off sharply as it scrambled to find a buyer. The popular rumor was that it would be Wachovia, even though that would be a stretch for that bank’s already stressed balance sheet.
Washington Mutual (Wamu) had its people on Wall Street float a rumor that it was selling itself in an auction, with Wells Fargo and Citigroup the two bidders — or was it JPMorgan Chase? This rumor stabilized Wamu’s stock price, which in a year had fallen by 95 percent, but none of the supposed buyers seemed credible. Other stocks in financial trouble tumbled on the thought that there was no one left in the world with $100 billion to sink into a foundering U.S. corporation, no matter how big its brand name might be.
Then Thursday night the White House announced that it would be proposing to let the Fed act as a sort of collection agency that would take over banks’ bad debts. The stock market soared 3 percent in less than an hour on the hope that the Fed was prepared to bail out the entire banking industry, erasing all their crazy mistakes of the past five years. The new Fed operation would be similar to the Resolution Trust Corporation (RTC). But wait — RTC took over the assets of failed banks, carrying on litigation, foreclosing on bad loans, and selling off the real estate. Maybe the return of that model is not such good news for bank stockholders after all. The White House says it has sent this proposal to Congress, but members of Congress say they have not yet seen it. If the proposal is everything that Wall Street hopes, it will cost the taxpayers $5 to 10 trillion, and that is on top of the $1 to 3 trillion that the Fannie Mae/Freddie Mac bailout will cost. This would be by far the biggest government bailout ever, far bigger than all of FDR’s Great Depression programs combined. Chances are, the bailout will be the largest ever, but it will have to be something less than what Wall Street seems to be expecting.
New emergency rules prohibit short selling of 799 financial corporations (799 was the number people on Wall Street were repeating all day). This means investors have to buy these stocks before they can sell them — they are no longer permitted to sell first and buy later. We can hope these rules will help prevent Wall Street from contributing to the list of bank failures.
If anyone thought these government interventions would stop the parade of bank failures, they were disappointed tonight when the FDIC took over Ameribank, a small bank with offices in West Virginia and Ohio. Ameribank probably qualifies as a small business by someone’s definition, with $113 million in assets at the end of June.
The Office of Thrift Supervision (OTS) says Ameribank made too many construction rehabilitation loans. These loans paid to fix up distressed real estate, and many of the projects went bad in the depressed real estate market.
The West Virginia locations are being taken over by Pioneer Community Bank. The Ohio locations are being taken over by Citizens Savings Bank. The FDIC will hold on to the bank’s other assets and figure out what to do with them later.