Financial thoughts

What to make of the improbable "news" that U.S. taxpayers are profiting from the biggest government bailout of the financial system in modern times?

That it’s not true, even if the New York Times leapt on a report by the U.S. Federal Reserve Board early this week that Uncle Sam has profited to the tune of about $4 billion (U.S.) from federal bailout assistance provided to eight of the largest U.S. banks to fully repay their bailout aid. Which works out to a not-shabby return of 15 per cent on an annualized basis.

"The mere hint of bailout profits," the Times said Monday in a report widely reproduced elsewhere, "has been received as a welcome surprise."

By the Times, perhaps, but not those with their eyes on the bigger picture. Truth is, the catastrophe hatched on Wall Street has cost Americans trillions of dollars, most of which taxpayers never will recover. And highlighting the infrequent bit of good news in what remains a calamity of epic proportions serves only those fighting to preserve the pre-crash status quo on Wall Street.

To start, it’s pointless to assess the damage to U.S. taxpayers on the basis of eight of the healthiest banks to receive government aid. America’s two most troubled major banks, Citigroup and Bank of America, have yet to repay their bailout funds, and further losses in their portfolios of dubious assets might easily wipe out the ballyhooed $4 billion profit. And there are another 633 U.S. banks that owe the federal government a collective $134.2 billion, with no sense of how much of that will be repaid, either.

What we do know, from a June estimate by Ethisphere, a think-tank that monitors the controversial $700 billion federal Troubled Asset Relief Program launched last October, is that TARP remains $148 billion in the hole.

And TARP is only part of the myriad ways that Washington rushed to the banks’ rescue.

There are the trillions of dollars’ worth of suspect mortgage-backed securities, many of them notorious "subprime" loans to uncredit-worthy borrowers, that the Fed has bought and taken off the books of otherwise doomed lenders. The U.S. Treasury Department has set aside another $30 billion to induce private-equity firms to buy so-called "toxic assets" from troubled banks.

American taxpayers likely won’t ever see again any of the tens of billions of dollars Washington had to spend to effectively nationalize American International Group Inc. (AIG), once the world’s largest insurer, which guaranteed subprimes held by scores of global banks. Had the undercapitalized AIG bought the farm, its collapse would have triggered the failure of lenders from San Francisco to Frankfurt to Tokyo.

Uncle Sam further staved off a meltdown of the global financial system with its $95.6 billion nationalization of the cravenly mismanaged Fannie Mae and Freddie Mac, the hybrid private-public firms that are the ultimate buyers of half of all U.S. residential mortgages.

So why was the Fed so eager to feed this trifling good news about the eight recovered banks to the media? Because the bank bailout was sold to a hostile Congress last year by then-treasury secretary Henry Paulson as an investment in rescuing the financial system, with the emergency funds eventually to be recouped.

Even then, most Republicans in Congress were prepared to let the system crash rather than act against their ideological aversion to government intervention in a private-sector economy that had manifestly failed.

"A very dangerous misconception is taking root in the press," says Reuters analyst Rolfe Winkler, "that in addition to saving the world financial system, the bank bailout is making taxpayers money."

Quite the opposite is true, as Main Street understands. The U.S. deficit will soar into the once-unthinkable $9 trillion range over the next few years make quick cash. That’s due mostly to preventing a complete collapse of the world financial system. That and the $787 billion February stimulus package to revive a U.S. economy plunged into recession by a Wall Street-induced global credit crisis.

Still, the good news from the Fed was useful cover for a report later in the week that the top five executives at 10 financial institutions that received some of the largest government bailouts are looking at a windfall stock-market gain of almost $90 million.

Those fortunate few were granted stock options early this year when their banks’ shares were flirting with penny-stock status. Thanks to a summer rally in bank stocks, those options to buy bank shares have yielded an effortless bonanza that works out to $1.8 million for each executive.

Wall Street’s 20 largest firms have laid off 160,000 employees, foot soldiers in New York’s most important economic sector, who have been made to pay for the incompetence and reckless greed of higher-ups. There’s no way to justify that ludicrous compensation for the fortunate 50 at firms whose CEOs were paid on average 85 times more than the regulators at the U.S. Securities and Exchange Commission and the Federal Deposit Insurance Corp. who try to protect the system from itself. Even the president of the U.S. gets by on a mere $400,000, and isn’t in line for performance or retention bonuses.

Citigroup, in particular, says President Barack Obama’s Wall Street "pay czar," Kenneth Feinberg, is fretful about pay restrictions he might impose that could impair Citi’s ability to keep top employees. Feinberg appears sympathetic to Citi’s quandary. You have to wonder why. Why would Citi want to retain employees who brought the bank to the edge of the abyss? And with Citi on their resum?s, who’d hire them if they chose to defect?

This is what enrages Main Street, for good reason. The administration appears sanguine about what FDR referred to as the "malefactors of great wealth." And he seems in no mood to change the amoral "eat what you kill" and outlandish bonus culture by which Wall Street triggered an avoidable global recession worse than any downturn since the Great Depression.

"The (economic) crisis is of historic proportions by many metrics," Marc Chandler, global head of currency strategy at Brown Brothers Harriman, wrote in a recent client note. "Yet in some ways it was not strong enough to force a restructuring of the world economy onto a more balanced track. There will be regulatory adjustments, maybe some coordination and even cooperation. But the failure to take advantage of the crisis to put economies on a more balanced footing will have far-reaching consequences."

Chief among those consequences is "moral hazard," the tendency of people to act recklessly if they know they are protected from damage arising from their carelessness. By bailing out an anti-social financial system without substantive reform, Washington is leaving in place the incentives that will create the next crisis.

Recall that the dot-com and tech crashes that were said to hail a return to sanity occurred just seven years ago. And so soon the financial markets found a new and more powerful way to wreak collateral damage through the global economy.

The only thing that matters, apologists for failing to change the status quo argue, is that the system was saved. Lee Sachs, counsellor to Treasury Secretary Tim Geithner, invokes the MasterCard ad to describe a job well done: "Financial system not going into total abyss: priceless."

Which would be a comforting thought, were there any reason to think calamity – even greater calamity – won’t strike yet again seven years from now.

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Japan’s Prime Minister-elect Yukio Hatoyama said on Saturday he had picked Naoto Kan, a former health minister, to head a powerful new agency that will oversee the budget process and set policy priorities.

Hatoyama, who will take office on September 16, said that in addition to heading the National Strategy Bureau, Kan, 62, will also be deputy prime minister, and that Katsuya Okada, 56, had been chosen to be foreign minister.

Both Kan and Okada are former leaders of the Democrats and had been tipped as potential finance ministers. Hatoyama said that he will formally nominate them at a party meeting on September 7.

The Democrats come to power with ambitious spending plans to put more money in the hands of consumers, raising concerns they will inflate a public debt already about 170 percent of GDP, the highest among advanced countries.

The new National Strategy Bureau, to include both public and private sector officials, will be tasked with reforming what the Democrats have said is a cumbersome policy-making system.

Kan’s experience in tangling with bureaucrats when he exposed a scandal over tainted blood products at the health ministry could stand him in good stead.

The new strategy bureau will seek to implement a Democrats’ promise to bring elite bureaucrats to heel and put politicians back at the center of policymaking auto loans for bad credit.

Although Japanese media have reported Hirohisa Fujii, a former finance minister, is likely to be picked for that post, they quoted Hatoyama as saying on Saturday that he was not yet ready to name his choice for finance minister.

Fujii, 77, is the head of the Democratic Party’s tax panel, and he has called for funding Japan’s social welfare costs with consumption tax revenue and discussing over the next four years the issue of raising the sales tax.

He said Tokyo should not step into currency markets unless exchange rates move abnormally, adding that a strong yen is good for Japan.

Nikkei also said Masayuki Naoshima, the DPJ’s policy chief, was likely to hold one of the economic cabinet posts.

The Mainichi daily newspaper said Hatoyama picked Okada for his connections in the United States.

Hatoyama’s choice for the top diplomatic portfolio is being closely watched after concerns emerged that his party’s policy of adopting a more independent stance from the United States could damage ties with Tokyo’s biggest security ally.

(Additional reporting by Taiga Uranaka and Edwina Gibbs; Editing by Alex Richardson)

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The United States confirmed on Friday it has received a confidential World Trade Organization ruling in its multibillion-dollar complaint against European government support for Airbus.

“We are still reviewing the interim report, which is over 1,000 pages long. Because the interim report is confidential, we cannot discuss the contents,” said Debbie Mesloh, a spokeswoman for the U.S. Trade Representative’s office.

“The United States has always maintained that the European governments have provided unfair subsidies to Airbus that harm U.S. interest,” Mesloh added, alluding to Airbus’ U.S. rival Boeing, which pressed USTR to bring the case.

“In this dispute, the United States is challenging dozens of measures providing over billions of dollars in subsidies to Airbus, including launch aid to every major Airbus aircraft model,” she added free business cards.

Since the United States brought the case in 2004, the governments of France, Germany, Spain and Britain have continued to provide contested “launch aid loans” for Airbus.

The European aircraft manufacturer’s latest project is the A350 wide-body jet. Boeing officials have said they hoped Friday’s confidential decision would halt some $4 billion in European launch aid loans for that aircraft.

“The dispute has proven to be one of the most complex and lengthy disputes under the WTO,” Mesloh said.

(Reporting by Doug Palmer; editing by Paul Simao)

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Monday was a good day for the markets.

Yeah, stocks fell. But Monday’s action was a healthy sign because some of the rally’s biggest financial-sector winners finally started to cool off.

Citigroup, Bank of America, Fannie Mae (FNM, Fortune 500), Freddie Mac (FRE, Fortune 500) and AIG (AIG, Fortune 500) all dipped Monday. Meanwhile, other healthier financials rose.

JPMorgan Chase (JPM, Fortune 500), Bank of New York Mellon (BK, Fortune 500) and U.S. Bancorp (USB, Fortune 500) — three banks that have already returned bailout funds to the government — finished the day higher. So did Travelers Group (TRV, Fortune 500), the insurer that replaced Citi (C, Fortune 500) in the Dow back in June.

Among some of the lesser-known financials, Hudson City Bancorp (HCBK), Cullen/Frost Bankers (CFR) and People’s United Financial (PBCT) all rose Monday as well. And none of those regional banks ever took a dime in TARP money.

Of course, one day does not constitute a trend. But before the markets took a turn for the worse in late morning trading Tuesday, a similar pattern was unfolding.

The "weak" banks were down earlier while the "strong" were up. The only notable exception was that shares of BofA (BAC, Fortune 500) were up slightly following reports that it was looking to pay back part of the money it received from the government.

In other words, BofA is making an attempt to show that it too belongs in the group of healthy banks. Whether or not BofA will get the green light from regulators to give back some of what it took from taxpayers remains to be seen.

But one fund manager who owns BofA said he thinks the rally in its stock, as well as shares of Citi, does make sense.

Romeo Dator, manager of the U.S. Global Investors All American Equity fund, said the shares of these two banks had been priced earlier in the year as if they would fail. So he thinks the rally is simply a reflection of the fact that this is no longer likely.

As such, he said he thinks it’s still a buying opportunity for BofA and Citi, as well as JPMorgan Chase. His fund owns shares of all three. "Now’s the time to go with survivors, the long-term winners," he said,

Still maybe, just maybe, investors have tired of bidding up the stocks of some of the banks, insurers and mortgage firms in the short-term for no reason other than momentum. Instead, the higher quality financials are taking their turn leading the way. The wheat is being separated from the chaff.

It’s about time. The problem with the latter stages of this explosive market rally, particularly in financials, is that it reeks of day traders chasing momentum on light volume.

It’s still a big stretch to claim that the likes of Fannie Mae, Freddie Mac and AIG — and even Citi and BofA, which as of now still remain on the government dole — are out of the woods.

That doesn’t mean that these stocks deserve to plunge back toward their depressed levels of last fall, winter and spring. But they’ve rallied too sharply in too short a period of time.

If you want to bet on a recovery in the financial sector and credit markets, wouldn’t you prefer to own banks that never got to as much trouble in the first place. In addition to being companies that were better managed, the added bonus is that most of these stocks haven’t surged as dramatically.

Sure, this means those banks haven’t soared as much as AIG and Citi in the past five months. But it also means these stocks are less likely to take a hit if the broader market pulls back.

"We own banks that didn’t have as much exposure to the toxic assets and derivatives. Unfortunately, those banks haven’t done as well bouncing from the bottom because they didn’t go down as much," said Ted Parrish, co-manager of the Henssler Equity fund, which owns shares of Bank of New York Mellon and Cullen/Frost.

"But going forward, the stronger banks should be under less regulatory scrutiny and will have more opportunities to expand because of their stronger capital bases," Parrish added. "That puts them in an enviable position. There may still be pain to come for some of the weaker financials."

Talkback: Do you think big banks and other financials are in better shape now than they were a year ago or has little changed since last year’s credit crisis? Share your comments below. 

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The yen and dollar both rose Tuesday as fears of further U.S. bank failures overshadowed unexpectedly strong manufacturing data, boosting the two currencies’ safe-haven appeal.

On Wall Street, U.S. stock indexes were all down around 2% at the close as investors fretted that chatter from hedge funds on a bank failure could prove accurate.

The decline came despite upbeat economic news from the United States and euro zone as well as a stabilization in Chinese shares after a rout on Monday.

The hedge fund talk "is a huge driver" of currency markets, said Dan Cook, senior market analyst at IG Markets Inc. in Chicago. "When you have data like we had but the Dow drops, people are running for that safe haven."

In late afternoon trading in New York the dollar index, which tracks a basket of six major currencies, was up 0.7% at 78.747, rebounding from a session low of 77.944, according to Reuters data.

The dollar was down 0.1% against the yen at ¥92.89, above Monday’s seven-week low of ¥92.53, according to Reuters data.

But the yen was up 1% against the Canadian dollar, 0.7% against the Swiss franc, 0.9% against the euro and 0.8% against the pound.

The euro was down 0.8 percent against the dollar at $1.4212, well below a session high of $1.4377.

What recession?

The U.S. manufacturing sector expanded in August for the first time in more than a year and a half. The Institute for Supply Management’s index of national factory activity rose to 52.9 from 48.9 in July.

Separate data showed pending sales of previously owned U.S. homes raced to a two-year high in July, further evidence the housing market was on a steady recovery path.

"Clearly, the U.S. data is surprising to the upside," said Jack Iles, senior portfolio manager who helps manage $2.5 billion assets at MFC Global Investment Management in Boston.

But despite a batch of upbeat U.S. economic numbers, major currencies remained in ranges as investors continued to debate about the outlook for the global economy, analysts said.

"At the end of the day, the market is still in wait-and-see mode," said Firas Askari, head of currency trading at BMO Capital Markets in Toronto. "We’re getting jostled around by every piece of data that comes out and I don’t think there’s a consensus that this economy has legs."

Data released earlier also showed euro zone purchasing managers’ index (PMI) rose to 48.2 in August against forecasts for a 47.9 reading while German unemployment unexpectedly fell in August.

The data comes before a European Central Bank policy meeting on Thursday widely expected to keep benchmark rates steady at a historic low of 1%, with the focus on policymakers’ outlook on the economy.

Sterling erased early gains against the dollar and the euro after an unexpected dip in U.K. manufacturing in August, stoking concerns about the pace of recovery in the British economy.

Sterling was down 0.7% at $1.6155, after touching a six-week low, and was little changed against the euro at 87.96 pence.

In other trading, the Australian dollar fell 2.2% to US$0.8254, in its biggest one-day drop in more than two months. The Reserve Bank of Australia, holding its cash rate at 3.0% as expected, said the current low level of rates was appropriate, countering speculation it would adopt an explicit tightening bias. 

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Regional banks in Maryland, Minnesota and California were closed by regulators Friday, bringing the total number of failed banks this year to 84, the Federal Deposit Insurance Corporation said.

Baltimore, Md.-based Bradford Bank, which operated nine branches, will reopen Monday as part of Manufacturers and Traders Trust Company.

M&T, which is based in Albany, N.Y., agreed to assume all of Bradford Bank’s $383 million in deposits and will purchase "essentially all" of its $452 million in assets, the FDIC said.

In Minnesota, the eight branches of Mainstreet Bank of Forest Lake will be taken over by Stillwater-based Central Bank.

Central will pay a premium of 0.1% to the FDIC for the failed bank’s $434 million in deposits and will purchase its $459 million in assets, the FDIC said.

Affinity Bank of Ventura, California, operated 10 branches which will be taken over by Pacific Western Bank.

Pacific Western will assume all of Affinity’s deposits of approximately $922 million and purchase its $1 billion in assets, according to the FDIC.

The combined cost of Friday’s closures to the FDIC is an estimated $446 million.

Access to funds. Customers of the failed banks will be able to access their money over the weekend by writing checks or using ATM or debit cards. Checks will continue to be processed, and borrowers should make their payments as usual, the FDIC said.

The FDIC, the federal agency that has protected bank deposits since the Great Depression, will guarantee account balances up to $250,000 payday loans. Qualified depositors of the failed banks will retain their FDIC coverage.

A bad year. With Friday’s closures, the number of banks shut this year is more than three times the number of banks that failed in 2008, and it’s the highest tally since 1992, when 181 banks failed.

The majority of this year’s failures have been small, regional banks that fell victim to losses on real estate and consumer loans as unemployment surged to a 25-year high. But there have also been a number of large institutions closed in 2009.

Last week, regulators in Texas closed Guaranty Bank, which had about $13 billion in assets and was the third-largest bank to fail this year. That came one week after Alabama-based Colonial BancGroup became the sixth-largest bank failure in U.S. history on Aug. 15.

The wave of failures is expected to continue, raising concerns about the size of the FDIC’s insurance fund.

The FDIC said Thursday that the number of institutions on its so-called "problem bank" list reached 416 in the most recent quarter — the highest level in 15 years.

The agency also reported that its trust fund decreased by $2.6 billion, or 20%, during the quarter to $10.4 billion.

Over the next five years, the FDIC expects roughly $70 billion in losses due to the failure of insured institutions.  

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The economy appears to have stabilized and may not need all the stimulus the central bank had planned to offer, Richmond Federal Reserve Bank President Jeffrey Lacker said Thursday.

"The economy appears to have leveled out and I believe we can look forward to better times ahead," Lacker told a business group.

Even as he cautioned that "conditions remain distressed in many industries and localities," Lacker, a voting member of the Federal Reserve’s policy-setting panel this year, said the central bank would have to calibrate its purchases of long-term securities carefully to avoid providing too much economic stimulus.

Lacker said the Fed’s commitment to buy up to $200 billion in debt of government-sponsored mortgage agencies and up to $1.25 trillion in mortgage-backed securities issued by those agencies has supplied reserves to banks that reduce their need to borrow from the Fed. At a certain point, the banking system would no longer need to borrow to obtain the desired level of reserve balances, he said.

"I will be carefully evaluating whether we need or want the additional stimulus that purchasing the full amount … would provide," he added.

Lacker’s remarks suggest pressure is already building within the Fed to pull back some of its unusual measures to boost the economy as signs of recovery mount.

The Richmond Fed president said inflation is currently "right on target," but a further large decline would be unwelcome.

However, measures of inflation expectations, while imperfect, suggest consumer price pressure is more likely to rise than fall, he said.

He said the central bank’s decision to hold rates low in 2003-2004 over deflation worries will factor into his thinking about when to raise rates as the economy recovers from a painful recession.

"Looking back… some economists have made the case that we waited too long," he said. "I’m taking that on board … as we time our exit going forward."

In an interview with the Danville Register & Bee newspaper, Lacker said the housing market had picked up about five months ago and would no longer be a drag on economic growth.

Exports may be picking up and the rate of job loss is slowing, he told the paper. Lacker added that banks no longer appeared to be tightening credit and that credit conditions will ease as the job market rebounds.

"It’s a time of opportunity, even for people experiencing hard times because of the labor market," Lacker said. 

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