15 banks passed Fed’s stress tests

15 of 19 banks passed stress tests, but Citigroup, Suntrust Banks, Ally and Metlife failed!

The Federal Reserve said 15 of the 19 largest U.S. banks pass stress tests, or Comprehensive Capital and Analysis Review (CCAR), as they could maintain adequate capital levels even in a recession scenario in which they continue paying dividends and buy back stock. Four banks, including Citigroup, have more work to do and need more capital.

Under the stress scenario, unemployment rate of 13 percent, a 50 percent drop in stock prices and a 21 percent decline in prices would produce aggregate losses of $534 billion over nine quarters. Even with that blow, the 19 banks would see their tier one common capital ratio fall to 6.3 percent in the fourth quarter of 2013 in the hypothetical scenario, above the 5 percent minimum the Fed required. The ratio was 10.1 percent in the third quarter of last year.

It was the first time the Fed had released a thorough test of the banks' financial health since the early days of the financial crisis. The Fed has conducted the stress tests each year since 2009. The Fed did not publicize the results of its tests in 2010 or 2011. After the first round of tests, in 2009, the Fed ordered 10 banks to raise a total of $75 billion. Bank of America Corp. alone was told to raise $34 billion.

The Fed pumps $1.2 trillion to the economy

The U.S. central bank would pump $1.2 trillion into economy to combat the worst global slowdown in decades, the Fed announced Wednesday, Mar. 18. The central bank’s plans to buy up to $300 billion long-term government bonds and some $750 billion in mortgage-backed securities, which would help revive the U.S. sagging housing market.

The Fed hasn't set out to influence long-term interest rates by buying long-term bonds since the 1960s.

By buying Treasurys and lifting the size for its programs to buy mortgage-backed securities and agency bonds, the Fed will boost money supply available for borrowing to combat the recession. The moves aims to lower mortgage rates and reduce the premium companies have to pay over the federal government to secure funding from the capital markets. The lower borrowing costs for consumers and companies are expected to prop up demand and spending in the U.S.

The Federal Reserve has been moving toward this quantitative easing policy since mid-September 2008. The policy is essentially required the Fed to print money to put the financial system back on its feet and jump-start the economy. But economists warned that such efforts could lead to long-term inflation, and could drive down the value of the dollar.

The Fed’s Open Market Committee also announced it would keep interest rates near zero, and said it expected its target interest rates to remain exceptionally low “for an extended period.” Interest rates in the U.S., the fed-funds target rate, has been in the range of 0%-0.25%. In all major economies, the interest rates have been pushed to ultra-low levels.

Moments after the Federal Reserve announced its plans, yields on the benchmark 10-year Treasury note posted their biggest drop in years as investors welcomed a big new buyer to the market for government debt. The central bank’s decision to fire up $1.2 trillion continued to sweep over world financial markets on Thursday, pushing the price of government bonds higher and dragging down the value of the dollar.

The Fed’s plan follows similar actions taken by central banks across the globe. The Bank of England is buying government securities, while the Swiss is selling francs to try to push down the value of their currency. The Bank of Japan announced Wednesday that it would also expand its purchase of government debt by almost 30 percent.

The markets are responding favorably to the U.S. Federal Reserve's bold $1.2 trillion spending plan. On Wall Street, stocks advanced on the day, but slipped on the next day. World stock markets were mostly higher the next day, Mar. 19.

The dollar has been sold off aggressively across the board in the wake of the Federal Reserve's decision. The dollar extended its decline against the euro, the yen and other major currencies on Thursday.

Third attempt in bailing out Citigroup

The government will swap the $25 billion in Citigroup’s preferred stock from its earlier bailout money into common stock. The Treasury Department said the swap is contingent on private investors making a similar swap. The deal announced Friday, Feb. 27 represents the third rescue attempt in the past five months for Citigroup, which has been struggling under the weight of losses tied to bad bets on mortgages.

This will boost the taxpayers' stake and risk in the struggling bank from 8 percent to 36 percent. The government's big stake in the common stock means taxpayers will share in future gains or losses in the company's share price. The stock conversion will make the government the largest shareholder in Citigroup

Citigroup said it has offered to swap up to $27.5 billion of its existing preferred stock held by private investors at a conversion price of $3.25 share. The Government of Singapore Investment Corp., Saudi Arabian Prince Alwaleed Bin Talal, Capital Research Global Investors and Capital World Investors are among the private investors that said they would participate in the exchange. The U.S. government will match this exchange up to a maximum of $25 billion face value of its preferred stock at the same conversion price.

The conversion of the government's Citigroup stock will give the bank more capital reserves to withstand mounting losses on its holdings of mortgages and other loans, as well as to survive further economic weakness, satisfy regulators, and eliminate the need to pay dividends. The transaction also frees Citigroup from having to buy back the preferred shares from the government. The preferred shares are similar to debt, and the banks were under pressure to essentially pay back the government in five years.

The arrangement inflames some investors' worries of bank nationalization. They think that this is another step toward creeping nationalization. Federal Reserve Chairman Ben S. Bernanke said Feb. 25 he wants to avoid nationalizing Citigroup and other large banks in a way that would wipe out shareholders and leave the U.S. in full control. Bernanke said the government might end up owning a “substantial minority” of the bank.

Investors were unhappy with the Citigroup deal, sending its shares plummeting 39 percent to a new 52-week low of $1.50 on Friday, Feb 27. The Dow Jones industrials average fell 119 points to 7,063. Sour market reaction was understandable given that the government is taking a bigger role in Citigroup and the shares of common stock are being diluted.

Highest loan delinquency rate since 1992

Loan delinquency rate of U.S. banks stood at 4.6 percent in the last quarter 2008. That's the highest delinquency rate since 1992 in the aftermath of the savings & loan crisis. The seasonally adjusted delinquency rate rose from 3.7 percent in the third quarter 2008. A year ago, the delinquency rate was 2.4 percent.

The delinquency rate for residential real estate spiked up to a record 6.3 percent in the fourth quarter from 5.2 percent in the third quarter and 3 percent a year earlier. Delinquencies for commercial real estate loans increased to 5.4 percent in the fourth quarter from 4.7 percent in the third, and double the rate a year earlier.

Consumer credit card delinquencies jumped to a record 5.6 percent from 4.8 percent in the third quarter.

Banks charged off a record $35.5 billion in the fourth quarter 2008, up from $24.2 billion in the third quarter and $13.9 billion in the fourth quarter a year earlier. The charge-off rate increased to 1.9 percent from 1.5 percent in the third quarter.

Double bubbles trigger U.S. financial crisis

Current economic mess in America is steamed from and centered in the financial mess, and then spill over to other sectors of economy. This crisis, like most others in rich countries, emerged from double bubbles: property bubble and a credit boom.

House prices doubled only in five years. The scale of the bubble was about as big in America’s ten largest cities as it was in Japan’s metropolises. But nationwide, house prices rose further in America and Britain than they did in Japan. So did commercial-property prices.

In absolute terms, the credit boom on top of the housing bubble was unparalleled. In America private-sector debt soared from $22 trillion (or the equivalent of 222 percent of GDP) in 2000 to $41 trillion (294 percent of GDP) in 2007.

Judged by standard measures of banking distress, such as the amount of non-performing loans, America’s troubles are probably worse than those in any developed-country crash bar Japan’s. A recent estimate by Goldman Sachs suggests that American banks held some $5.7 trillion-worth of loans in “troubled” categories, such as sub-prime mortgages and commercial property. That is equivalent to almost 40 percent of GDP. As a comparison, non-performing loans in Japan they hit 35 percent of GDP at the peak of the crisis, according to the IMF. In Sweden reached 13 percent of GDP.

Today’s financial crash is not just in regulated banking sector. America also faces simultaneous collapse of the shadow banking system, the universe of investment banks and hedge funds responsible for much of the recent securitization boom as well as for the sharp rise in financial leverage.

As a result, standard measures of banking distress, such as the level of non-performing loans, understate the contraction pressure. So far most of the credit collapse in America has come from the demise of securitization. In 2007, for instance, $668 billion of non-traditional mortgages were securitized. Last year that figure dropped to $40 billion. Rapid deleveraging outside traditional banks also means that cleaning up banks’ balance-sheets may not break the spiral that is driving down asset prices and stalling financial markets. Financial-sector debt was the fastest-growing component of private-sector debt in recent years. Many of those excesses are being unwound at warp speed.

$787 billion package to revive U.S. economy

Senators voted to approve a $787 billion economic stimulus package on Friday, Feb. 13 following an earlier vote in the House.

The bill is a mixture of tax cuts, government spending, aid to states, and relief to the unemployed that Obama says will create 3.5 million jobs.

The Senate vote was 60 to 38; three Republicans voted for it.

The House had approved an earlier $825 billion version of the package without any Republican support last week. On Tuesday, Feb. 10, the Senate voted to approve a different $838 billion version with few Republicans opting to back it. The two versions had to be reconciled in a joint House-Senate committee before facing final votes in the two chambers.

U.S. senate approves economic recovery package

Senate approved an $838 billion economic stimulus bill on Tuesday, 02/10/09. The bill backed by the White House survived a key test vote in the Senate Monday despite strong Republican opposition. Monday's vote was 61-36, one more than the 60 needed to advance the measure toward Senate passage on Tuesday.

The bill is a mixture of tax cuts, targeted spending on infrastructure projects and money to cash-strapped states. The stimulus is desperately needed to tackle the worst economic crisis in more than a generation.

The measure must now be reconciled with a $819 billion House version before being sent to Obama for signature. The president has warned of economic "catastrophe" without the bill.

New chapter for ultra low Fed funds rate

The Federal Reserve Tuesday, Dec. 16 switched to a range for its key target rate from 1 percent to a historically low range of zero to 0.25 percent, effectively cutting its key rate for overnight lending to banks by between 0.75 percent and 1 percent. The Fed also cut the interest it pays on reserves to 0.25 percent in an effort targeted at the traded fed funds market, where rates have been hovering close to zero.

Prior the announcement, the actual funds rate, which is charged on excess reserves banks lend to each other overnight, had already fallen to below 0.2%, well below target, in part because the banking system is awash with unneeded reserves. Therefore the FOMC is now aiming at a range rather than a level because of the difficulty of hitting the latter.

The Fed committed to keeping the target rate there for some time. It also said it will seek to support financial markets and the economy by measures that sustain the size of its balance sheet at a high level, listing a range of programs, from purchases of agency debt to mortgage-backed bonds to the possible purchases of Treasuries.

The central bank's policy panel, Federal Open Market Committee decision (FOMC), signals the end of interest rate cuts as a way to promote economic growth and points to the start of a new period in which expansion of the money supply has become the Fed’s primary tool. Having used up its conventional monetary firepower, it promised an unconventional strategy, such as the buying of mortgage-related securities and, possibly, Treasuries to lower long-term borrowing costs. Unconventional monetary policy is often called “quantitative easing” because its effect is felt through the quantity rather than the cost of credit. Through an array of lending programmes, the Fed’s balance-sheet has soared from below $900 billion to more than $2 trillion, and is about to grow further.

The Fed move is unlikely to have a huge impact for the repo market, a key secured lending market for banks and other financial institutions, as rates there have already plunged to low levels.

The Fed’s move should bring further relief to unsecured interbank lending markets. The London interbank offered rate has been falling since mid-October amid aggressive Fed efforts to provide liquidity to the financial system, and the key three-month Libor will likely plunge further. That’s good news for corporations and consumers, as Libor is the benchmark for adjustable-rate borrowing, including ARMs.

For money market funds, particularly those that invest mostly in Treasurys, the low level of fed funds and the Fed’s commitment to keep rates low for an extended period could create problems. Net yields, the returns these funds make on investments minus their expense ratios, could fall to zero or turn negative, forcing the funds to either waive fees or cut expenses to retain investors. Recently yields on Treasurys have fallen to historic lows. Just last week, three-month bill yields turned negative and an auction of four-week bills yielded zero.

The dollar fell sharply, particularly against the euro, after the Fed’s action. That may weaken the European Central Bank’s reservations about cutting rates again. Similarly, if the weaker dollar takes pressure off sterling, the Bank of England may be more willing to ease again.

Banking system is flooded with money

Since mid-September the Federal Reserve has been moving toward a new policy called quantitative easing, or commonly called "printing money”, which essentially pumps enormous amounts of funds to the banking system beyond what the system need. The policy is intended to stabilize the markets, maintain the Fed's interest rate target, and affect the rates on other types of credit. The ultimate goal is to support financial markets and revive the economy.

As a result, the excess reserves in banking system exploded to unprecedented amount. The challenge is that the banking system is still reluctant to lend under the current condition. While the policy didn’t work well in Japan from 2001 – 06, it comes with risk of sparking inflation.

Here is what BusinessWeek said about the policy.

… Until the Sept. 15 bankruptcy of Lehman Brothers, excess reserves, or those funds available for trading between banks in the overnight markets, had typically averaged about $2 billion a week. Since then they have exploded to an unprecedented $605 billion a week on Nov. 19. As a result, interbank funds are already trading well below the Fed's 1% target rate. That means actual policy is even looser than the target rate indicates…

… The Fed's Nov. 25 decision to begin buying up to $600 billion in mortgage debt and mortgage-backed securities from Fannie Mae (FNM), Freddie Mac (FRE), and the Federal Home Loan Banks is the biggest step yet in this new strategy…

… This program, plus the Fed's plan to lend up to $200 billion to holders of securities backed by credit-card debt, auto loans, and small business loans should breathe some life into the moribund securitization process that is so crucial to the flow of credit.

… Japan's experience showed the strategy did little to boost lending. Right now in the U.S. there is little desire to lend or borrow. There's also the long-term risk that flooding the system with money will spark inflation.

Factors behind the dollar's surprising strength

The dollar has been up 19% against the euro and 24% against the British pound since July. What’s driving up the dollar? Businessweek provided three factors behind the dollar move.

Fear Factor

During tough economic times, investors often flee foreign currencies and other risky assets for safe havens like the U.S. dollar. The demand drives up the price relative to other currencies.

Foreign Economic Pressures

The euro, the pound, and emerging-market currencies may also have been inflated after a six-year runup…

… But earlier this year some investors started betting the bubbles would burst, driving down the price of the currencies and conversely benefiting the dollar.

Fund Redemption

U.S.-based hedge funds and mutual funds that own international stocks have played a part as well. Both groups are getting hit with a wave of redemptions. Investors yanked $39 billion out of international stock funds run by U.S. firms through the first nine months of the year…

… managers have had to dump foreign assets and buy U.S. dollars to pay back investors. Those purchases boost the greenback.

Too big to fail: Government rescues Citigroup

U.S. government agreed to rescue Citigroup by shouldering as much as $306 billions in possible losses of troubled assets of the stricken bank and to inject a fresh $20 billion into the company. The agreement also gives the government control of executive bonuses and places limits on dividend payments. This move was announced late Sunday by the Treasury Department, the Federal Reserve and the Federal Deposit Insurance Corp.

The Rescue Plan

The $20 billion cash injection by the Treasury Department will come from the $700 billion financial bailout package. The capital infusion is on the top of an earlier one of $25 billion provided to the Citigroup in which the government also received an ownership stake.

Treasury and the FDIC will guarantee against the "possibility of unusually large losses" on up to $306 billion of risky loans and securities backed by commercial and residential mortgages. Citigroup Inc. will assume the first $29 billion in losses on the risky pool of assets. Beyond that amount, the government would absorb 90 percent of the remaining losses, and Citigroup 10 percent. Money from the $700 billion bailout and funds from the FDIC would cover the government's portion of potential losses. The Federal Reserve would finance the remaining assets with a loan to Citigroup.

The government will get $7 billion in preferred shares of Citigroup with an 8 percent dividend in exchange for the guarantees.

Citi will also issue warrants to the U.S. Treasury and the FDIC for about 254 million shares of the company's common stock at a strike price of $10.61.

As a condition of the rescue, the government must approve all executive compensation, including bonuses. In addition, Citigroup is barred from paying quarterly dividends to shareholders of more than 1 cent a share for three years unless the company obtains consent from the three federal agencies. The bank is currently paying a dividend of 16 cents, halved from a 32-cent payout in the previous quarter. The agreement also places restrictions on executive compensation, including bonuses.

The agreement calls on Citigroup to take steps to help distressed homeowners. Specifically, Citigroup will modify mortgages to help people avoid foreclosure along the lines of an FDIC plan that was put into effect at IndyMac Bank, a major failed savings and loan based in Pasadena, Calif.

The rescue plan represents the first time the government has absorbed bad assets rather than injecting money directly into financials. Switzerland's government recently crafted a similar agreement with UBS AG.

Too Big to Fail

Citigroup is too big to fail because it is such a large, interconnected player in the financial system. The company, with some 200 million customers, has operations stretching around the globe in more than 100 countries.

The government action is aimed at shoring up a huge financial institution whose collapse would wreak havoc on the already fragile financial system and the U.S. Economy. Citigroup failure would have seized up still fragile lending markets and caused untold losses among institutions holding debt and financial products backed by the company.

The action is the latest in a string of high-profile government bailout efforts. The Fed in March provided financial backing to JPMorgan Chase's buyout of ailing Bear Stearns. Six months later, the government was forced to take over mortgage giants Fannie Mae and Freddie Mac and throw a financial lifeline to insurer American International Group.

Citigroup was especially hard hit by the meltdown in risky, subprime mortgages made to people with tarnished credit or low incomes. Foreclosures on those mortgages spiked, leaving Citi and other financial companies wracking up $20 billion losses over the last year on the soured investments. The company has failed to turn a profit during the past four quarters and has announced plans to slash thousands of jobs.

A year ago, the stock market valued the company at about $180 billion. As of Friday morning, its market capitalization stood at $20 billion and its share price had shriveled to $3.75, a 16-year low.

Citigroup shares has plunged 60 percent of their value in the past week to a 16-year low, reflecting a crisis of confidence among skittish investors. They are worried all the risky debt on Citigroup's balance sheet will turn into losses as the economy worsens and the markets stay turbulent.

Market After Closing Bell

U.S. stocks Monday rallied for a second consecutive day after the government agreed to rescue Citigroup Inc. and as President-elect Barack Obama directed his new economic team to get to work.

Citi shares closed up 58%, at $5.94. Financial stocks in the S&P 500 posted their biggest one-day percentage gain ever on Monday, closing up about 17%. The Dow Jones Industrial Average, of which Citi shares are a component, rose 5%, extending Friday's late rally.

Useful finance and economic links: Dollar community on mixx, Money and Economy group on Ma.gnolia, smartinmoney.blog

Scary U.S. retail sales and economy; global markets sank

As shoppers cut back, U.S. retail sales fell 1.2 percent in September, the Commerce Department reported Wednesday. The 1.2 percent decline was the biggest in three years since August 2005 and was the first time sales had fallen three months in a row since early 1991.

Retail sales were down 1 percent compared with a year earlier, the first time sales had been down year-over-year since 2002. Sales were weak in almost all kinds of stores. Excluding the 3.8 percent drop in auto sales, retail sales fell 0.6 percent.

Retail sales represent about a third of final sales in the economy and about half of consumer spending. U.S. consumer spending had been the engine of U.S. and global growth for most of the decade, but high debt loads, falling home prices, rising energy prices, flat income growth and poor job prospects have taken their toll on the American consumer.

Federal Reserve snapshot showed Americans are spending less and manufacturing is slowing around the country. Fed Chairman Ben Bernanke, speaking in New York, warned that the economy was facing a "significant threat" from credit-market turmoil and said a recovery would not be swift even if aggressive government measures stabilized markets.


Global Market Sank

Scary retail sales report, worries about the economy, and Bernanke's downbeat economic assessment spooked equities markets, sending the Dow Jones industrials down a staggering 733 points Wednesday. The Dow ended the day down nearly 8 percent, its steepest drop since one week after Black Monday in 1987. The Dow has wiped out all but about 127 points of its record-shattering 936-point gain on Monday of this week.

The broad Standard and Poor's 500 Index plunged 9 percent, its worst one-day drop since the 1987 stock market crash.

The selling spree carried over to Asia, where stocks fell sharply Thursday. Japan's key stock index plummeted more than 11 percent, South Korean shares shed 9.25 percent, and Hong Kong's Hang Seng Index was down 4.8 percent.

Following Asia's lead, benchmarks in Britain, Germany and France slipped about 3 percent. Russia's RTS also fell.

Earlier this week, after governments around the world announced plans to use trillions of dollars to prop up banks, including a U.S. plan to buy about $250 billion in bank stocks. The market appeared to be turning around after the news, sending the Dow to its greatest daily point jump ever and its biggest one-day rally since 1933.

U.S. stocks continued sinking, Dow dived under 9,000

Marking one-year anniversary of record high, the Dow has lost 39.4 percent.

U.S. stocks stumbled again Thursday with the major indexes down for seventh consecutive days as credit worries continued to roil. The sell-off was exaggerated by news that a major credit ratings agency was considering cutting its rating on General Motors Corp.

The Dow Jones Industrial Average dropped 678.91 points, or 7.3 percent, closing at 8,579.19. This is for the first time the Dow sank under the 9,000 level since late August, 2003.

The S&P 500 fell 75.02 points, or 7.6 percent, to 909.92, while the Nasdaq Composite dropped 95.21 points, or 5.47 percent, to 1,645.12.

The declines marked the one-year anniversary of the closing highs of the Dow and the S&P. The Dow has lost 5,585 points, or 39.4 percent, since closing at 14,164.53 on Oct. 9, 2007. It's the worst decrease for the Dow since 1974. Over the nearly two-year bear market that ended in December 1974, the Dow lost 45 percent.

The S&P 500 is off 655 points, or 41.9 percent, since its record high of 1,565.15 on Oct. 9, 2007.

The federal fund rate cut Wednesday didn’t ease pressure on stocks.

Global central banks jointly cut interest rate to fight financial crisis

The world’s major central banks joined together to cut interest rates Wednesday to fight a spreading panic, which is endangering the flow of credit and the world’s economies. The Federal Reserve, European Central Bank and Bank of England cut interest rate by one-half percentage point. The move was joined by central banks in Canada, Switzerland, and Sweden and blessed by the Japanese, whose rates are already so low. Although the Fed didn’t mention China in its announcement, China cuts its benchmark one year lending rates by 0.27 percent and suspended the withholding tax on interest income.

These unprecedented coordinated interest cuts were taken after financial crisis spread around the globe and major world stock markets tumble on Monday. Lower rates may do little to cure the epidemic, but do help offset the unwelcome credit squeeze caused by banks reluctance to lend even to each other. Given central banks’ role as a lender of last resort the interest cut will lower bank borrowing costs e.g. those borrowing from the Fed’s discount window. That means home equity loans, credit cards and other floating-rate loans will become cheaper as they all fluctuate depending on what the central bank does.

The Fed actions

In these joined efforts, the U.S. Federal Open Market Committee has decided to lower its target for the federal funds rate 50 basis points to 1.5 percent. The slash took the rate to its lowest level in more than four years.

Incoming economic data suggest that the pace of economic activity has slowed markedly in recent months. Moreover, the intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit. Inflation has been high, but the Committee believes that the decline in energy and other commodity prices and the weaker prospects for economic activity have reduced the upside risks to inflation.

Stocks dropped again

Despite of the Fed interest cut, the Dow Jones industrial average lost another 189 points, or 2 percent, to close at 9,258. It was the sixth straight day of losses for the Dow. The index has shed more than a third of its value, nearly 5,000 points, since its all-time high, set one year ago Thursday.

The day's losses were lighter; the Nasdaq composite index fell 0.83 percent and the Standard & Poor's 500 dropped 1.13 percent.

Chart: WSJ.com


Related story:
Global stock markets tumbled, Dow fell below 10,000 since 2004

Congress approved $700 billion bailout of financial industry

Congress approved a historic $700 billion government bailout of the battered financial industry on Friday. The final vote was 263-171 in the House, ended two weeks of uproar in Congress and on Wall Street. The bailout bill was quickly signed President Bush.

The approval marked a sharp turn from Monday, when the initial bailout bill was rejected by congress, largely by angry conservative Republicans.

Treasury Secretary Henry Paulson originated the bailout plan when he urged Congress to immediately give him almost unchecked legislative authority to take action in preventing the spread of economic turmoil. The plan was initially a three-page request for unlimited power to use $700 billion any way the administration saw fit to stabilize markets. When the bill was approved, it had swelled to more than 450 pages as negotiators added restrictions for the administration and sweeteners for anxious members of Congress.

Lawmakers added greater supervision over the $700 billion to the approved bill, including a process where Congress could vote to block half the money to protect taxpayers and steps to crack down on "golden parachutes" for corporate executives whose companies benefit from the bailout.


Financial markets expectation

The rescue bill that Congress finally passed will limit panic in the financial markets, since it gives the government vast new authority to remove toxic securities that have damaged and clogged the credit system and already brought down some of America's biggest companies. A consistent set of bailout rules will prevent the wild swings in the stock markets in September. With the feds stepping into the bloodbath, the bleeding should stop.

While there will probably be more bank failures, the bill makes it clear that depositors don't need to worry about their money. The bill raises the amount of deposits guaranteed by the FDIC from $100,000 to $250,000.

Although the bailout is supposed to ease the "credit crunch," it will probably be a while before relief reaches consumers when banks loosen consumer loans. For one thing, the government will focus first on freeing money for banks and businesses so they are able to keep their operations humming and meet payroll expenses.

Until banks recover from credit default losses, they are going to apply more stringent lending standards. Banks may still have to digest defaults on mortgages, car loans, and credit cards as default rates rise in a year a head.


Stocks market reaction

Congressional approval of the financial rescue plan did little to lift the stock markets from their growing gloominess over the obstacles still facing the economy. Wall Street ended an intensely volatile week with the Dow Jones industrials falling 157 points and the major indexes all suffering big losses.

Stocks free-fall as House knocks down bailout plan

Stocks plunge and Dow falls more than 777 at lows as financial bailout plan fails in House vote.

Wall Street's worst fears came to pass Monday, when the government's financial bailout plan failed in Congress and stocks plunged precipitously, hurtling the Dow Jones industrials down nearly 780 points in their largest one-day point drop ever.

The Dow index passed by far its previous record for a one-day drop, 684.81, set in the first trading day after the Sept. 11, 2001, terror attacks.

The $700 billion plan's failure means no one knows how the financial sector hobbled by hundreds of billions of dollars in bad mortgage bets will recover. While Wall Street didn't believe that the plan was a panacea, understanding that it would take months for its effects to be felt, most investors and analysts believed it was a start toward setting the economy right after a credit crisis that began more than a year ago and that has spread overseas.

Before trading began came word that Wachovia Corp., one of the biggest banks to struggle due to rising mortgage losses, was being rescued in a buyout by Citigroup Inc.
According to preliminary calculations, the Dow fell 777.68, or 6.98 percent, to 10,365.45. Still, in percentage terms, the decline remained well below the more than 20 percent drops seen on Black Monday of October 1987 and the Depression.

Broader stock indicators also tumbled. The Standard & Poor's 500 index declined 106.85, or 8.81 percent, to 1,106.42.

The technology-heavy Nasdaq composite index fell 199.61, or 9.14 percent, to 1,983.73.

WaMu failure: Largest bank collapse in U.S. history

In the largest bank failure in U.S. history, Washington Mutual Inc. (WaMu), with $307 billion in assets, was seized by federal regulators; and its asset was swiftly acquired by J.P. Morgan Chase for $1.9 billion Thursday.

The federal Office of Thrift Supervision said it closed WaMu on Thursday and appointed the Federal Deposit Insurance Corp. as receiver. The FDIC in turn conducted the bidding process that led to the purchase by J.P. Morgan.

J.P. Morgan purchase included all of WaMu's deposits, assets and some liabilities. All deposit accounts with Washington Mutual Bank have been transferred to J.P. Morgan Chase Bank. Those deposit accounts include checking, savings, money market, CDs and retirement accounts. J.P. Morgan purchase excluded senior unsecured debt, subordinated debt, and preferred stock of Washington Mutual's banks. J.P. Morgan said it would not be acquiring any assets or liabilities of the bank's holding company.

After the purchases of WaMu and the investment bank Bear Stearns Cos. in March, JPMorgan Chase is now the second-largest bank in the United States after Bank of America Corp., which recently bought Merrill Lynch.

WaMu is expected to declare bankruptcy as soon as Friday, putting stock holders at the end of a long line of claimants and leaving them empty handed.

On Wednesday, a Standard & Poor's ratings downgrade further pushed the bank toward collapse. Its stock price had plummeted some 95% to its close of $1.69 a share Thursday.

Seattle-based WaMu, which was founded in 1889, is the largest bank failure in U.S. history with $307 billion in assets. The magnitude surpasses the $40 billion of Continental Illinois National Bank & Trust, which failed in 1984, and the $32 billion of IndyMac, which the government seized in July 2008.

WaMu, long one of the nation's largest mortgage lenders, was hit hard by the subprime crisis that has widened to threaten U.S. financial markets and led to the current financial crisis.

WaMu ran into trouble after it got caught up in the once-booming subprime mortgage business. Troubles then spread to other parts of WaMu's home loan portfolio, namely its "option" adjustable-rate mortgage (Option ARM) loans. Option ARM loans were offered to borrowers for very low introductory payments. Those loans often included the option to defer some interest payments until later years or to pay only interest, which caused the borrowers debt to grow with each payment, becoming negative amortization loans.

When housing prices began to fall just at the time rates were adjusting higher on those loans, borrowers began defaulting at alarming rates, leading to big losses for WaMu and others who had extended the credit or purchased securities based on the credits. The bank stopped originating those loans in June.

The Darkest Week of Wall Street

A dramatic, shocking series of events that forever changed the U.S. financial markets.

In the past week Wall Street's landscape was transformed and the U.S. government made an unprecedented intervention to bolster chaotic financial markets. The following is a chronology of key events in probably Wall Street's most tumultuous week in U.S. financial history since the Great Depression.


Rescue Attempt [Friday Sept 12]

Lehman Brothers was on the brink of collapse and scrambling for a buyer first surfaced.

The New York Federal Reserve Bank president, Timothy Geithner, convenes an emergency meeting with Treasury Department officials and top executives at all the major Wall Street banks, including Citigroup, JP Morgan & Chase, Merrill Lynch, in an attempt to rescue ailing investment bank Lehman Brothers. A sticking point is the government's reluctance to provide financial support for a deal.


Survival Fights [Saturday, September 13]

Discussions continue at the New York Fed's Lower Manhattan building, and British bank Barclays plc emerges as a leading contender to buy Lehman, even as other major banks drop out of the running.

A few blocks away, troubled insurer American International Group, which insured billions of dollars worth of collateralized debt obligations, begins talks with New York State's insurance superintendent as it fights for its survival.


Trouble Gathered Force [Sunday, September 14]

There were still no suitors for the 158-year-old investment bank, and Lehman Brothers bankruptcy seemed inevitable.

Bank of America unleashed the news that it would pay $50 billion to buy Merrill Lynch, another iconic Wall Street name. Merrill was forced into the deal because of fears that it might also fail because of a loss of investor confidence. The fears center on toxic debt remaining on Merrill's balance sheet and its difficulty in raising new capital.

As if that weren't enough, American International Group, the nation's largest insurer, said that it planned to sell some of its troubled assets in order to raise cash and boost investor confidence.

Concerns about the credit crisis grew increasingly dire, even though the government had already pledged to backstop Fannie Mae and Freddie Mac up to $200 billion just one week ago, and six months earlier engineered JP Morgan's purchase of Bear Stearns with a $29 billion guarantee.

But it looked like that wouldn't be enough, so Sunday afternoon the Federal Reserve, along with a group of 10 global banks and securities firms, including JP Morgan Chase and Goldman Sachs, announced a $70 billion pool of funds that they can tap to help ease a credit shortage and to aid troubled financial firms. The U.S. central bank also loosened its lending restrictions.


The Collapse [Monday, September 15]

As Just after midnight, in Monday's early hours, 158-year-old Lehman files for Chapter 11 bankruptcy.

The Dow Jones Industrial Average tanked more than 500 points in its biggest drop since Sept 17, 2001, the first day of trading following the 9/11 attacks. This is the worst day on Wall Street in seven years after Lehman Brothers' epic collapse and the buyout of Merrill Lynch. Meanwhile the FTSE 100 fell to its lowest level since June 2005.

By night, AIG was in fact hit with a downgrade, as Fitch bumped the insurance group down a notch. With $1.1 trillion in assets and 74 million clients in 130 countries, investors feared AIG's collapse would severely hurt consumers and further tighten already strangled credit.

Also news cropped up that the nation's largest savings bank, Washington Mutual, was in search of a white knight.


The Intervention [Tuesday, September 16]

Several rock-solid money market funds began to falter, dipping below the $1 per share benchmark, which is known as “break the buck”.

In the afternoon meeting, the central bank chose not to succumb to panic and unanimously decided to hold rates steady at 2%.

Markets cheered the decision, and the Dow jumped 140 points at the close after sharp drop in morning as worries mounted that the financial system was broken beyond repair. Investors poured money into bonds resulted in the yield on the benchmark 10-year Treasury note fell to a 5-year low.

After the bell, British bank Barclays agreed to buy up $2 billion worth of Lehman's prime assets, including its Manhattan skyscraper and North American investment banking and capital markets businesses.

Later that night AIG was taken over by the federal government by taking a 79.9 percent stake in the company in exchange for a staggering $85 billion bailout revolving loan it has two years to pay off. New York state would lead a task force to oversee AIG's sale of assets as it pays off that loan


The Free Fall [Wednesday, September 17]

Investors gave an enormous rebuff to the AIG news, sending stocks plummeting, while traders piled funds into safer havens. The Dow dropped 450 points by the end of the day, dragged down by bank stocks in a tail-spin. Despite reporting better-than-expected results, Goldman Sachs shares slipped by 14 percent, dipping below $100 a share for the first time since 2005. Morgan Stanley took a tumble 24 percent as well, as rumors circulated that it would merge with troubled bank Wachovia.

Gold rose $70, a new record. Oil rose $6, its second-largest jump ever. And the yield on the three-month Treasury sank to 0.02%, the lowest level since 1940.

The U.S. Securities and Exchange Commission stepped in and banned naked short selling. Many Wall Street analysts blamed the stock market's collapses on so-called "naked" short sellers, who short stocks without ever buying the security.


The Bailout [Thursday, September 18]

The Fed convinced five other central banks around the world to invest a total of $180 billion in global financial markets.

Meanwhile, AIG was tossed out of the Dow Jones Industrial Average and replaced with food giant Kraft.

U.S. Treasury Secretary Henry Paulson shopped around a plan to Congress that would create an independent federal agency similar to the Resolution Trust Corporation, which was created in 1989 to absorb bad debt in the Savings and Loan. The fund would likely acquire hundreds of billions of dollars of toxic mortgage debt off of bank balance sheets.

The move helped the U.S. stock market to rise 3.9 percent, recover from three-year lows.


The Confidence Boost [Friday, September 19]

The U.S. Securities and Exchange Commission took what it called "emergency action" and temporarily banned investors from short-selling 799 financial institutions to calm the financial markets. The measure was set to end on October 2, but can be extended by another 10 days. Market watchdogs in France, Portugal and Ireland take similar steps to crack down on short-selling.

The Treasury also said it would insure up to $50 billion in struggling money market fund investments at financial companies, guaranteeing that the funds' value will not fall below the standard $1 a share. The Fed also said it would make unlimited funds available to banks to finance purchases of asset-backed commercial paper from money market funds.

In a press conference, Treasury Secretary Paulson outlined the government's plan to put up hundreds of billions of dollars to help stem the crisis, saying "the financial security of all Americans ... depends on our ability to restore our financial institutions to a sound footing".

Investors cheered the moves, sending stocks soaring throughout the day. The FTSE rises 8.8 percent, its biggest surge ever.

SmartInMoney.com

Rescue plan seeks $700B to buy bad mortgages

The Bush administration is asking Congress to let the government buy $700 billion in toxic mortgages in the largest financial bailout since the Great Depression, according to a draft of the plan obtained Saturday by The Associated Press.

The plan would give the government broad power to buy the bad debt of any U.S. financial institution for the next two years. It would raise the statutory limit on the national debt from $10.6 trillion to $11.3 trillion to make room for the massive rescue. The proposal does not specify what the government would get in return from financial companies for the federal assistance.
- AP -

Remarkable rescue of U.S. largest insurer, AIG

The U.S. government late Tuesday agreed to rescue insurer American International Group (AIG) with an $85 billion loan from the New York Federal Reserve in exchange for a nearly 79.9 percent stake in the nation’s largest insurer. The rescue came just two days after the government refused to save Wall Street icon Lehman Brothers, which filed for bankruptcy on Monday, and is the latest in a series of government and private sector steps that have remade the U.S. financial system.

The government's deal dilutes current shareholders by giving the government a 79.9percent stake in the insurance company, with the power to veto asset sales and payment of dividends to shareholders. The line of credit to AIG comes with steep interest rate of 3-month Libor plus 8.5percent. AIG has two years to pay back the loan, and is likely to sell assets. An eventual liquidation of the company is most likely, senior Fed officials said. But with the government loan, the company won't have to go through a tumultuous fire sale.

The effort was aimed to stave off a bankruptcy that many feared would spark a global financial chaos. A disorderly failure of AIG could have caused unprecedented global ripple effects since AIG has $1.1 trillion in assets and 74 million clients in 130 countries. AIG is a major player in the market for credit default swaps, which are insurance-like contracts that guarantee against a company defaulting on its debt. Also, it is a huge provider of life insurance, property and casualty insurance and annuities.

The bailout marks the most dramatic turn yet in an expanding crisis that started more than a year ago with the mortgage meltdown. The resulting credit crunch is now toppling not only mainstay Wall Street players, but others in the wider financial industry.

The insurer has been hit hard by the housing crisis and credit crunch because its sales of credit default swaps and its subprime mortgage-backed securities holdings. Its derivatives unit sold guarantees on mortgage-related securities known as collateralized debt obligations, or CDOs, using credit-default swaps. As house prices fall and the credit crunch deepens, the market for these CDO exposures is disappearing, forcing AIG to report big write-downs of the value of the credit default swaps by $14.7 billion, pretax, in the first two quarters of this year. It also has had to write down the value of its mortgage-backed securities. The company has lost more than $18 billion in the past nine months as it wrote down these exposures and has seen its stock price fall more than 91percent so far this year.

Shares of AIG plunged more than 40percent Wednesday after the government's takeover of the insurance giant failed to assuage investors' fears about its troubles or soothe broader concerns about the health of the financial markets.

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