Saturday, September 27, 2008

 

Banks in US in serious problem

Things have been happening in the US finance sector that have not happened before for a long time. The US Federal Government is proposing that it is the essential guarantor of most mega-finance companies; only allowing some of them such as Lehman Brothers to fail. The US Government has so far saved or intervened in the affairs of Bear Stearns, AIG, Fannie and Freddie, Merrill Lynch (no direct financial involvement), and the latest domino, Washington Mutual. It is the case of Washington Mutual that is different from the others since the others are involved either directly in investment banking or exposed to the mortgage industry; WaMu was a clear Main Street bank, and yet it collapsed like a house of cards, following the same script as the others (exposure to mortgage industry, liquidity problems, and then a sudden downgrade to 'junk' status by credit rating agencies that decimated its ability to raise more funds). It is also the way of takeover of WaMu that is seemingly setting a precedent. Given its precarious existence and risk of failure, Federal regulators seized the bank without even consulting with the board, and sold it off to JLMorgan Chase & Co for a much lower price than they would have to pay just a few months back. The Federal Deposit Insurance Corp. (FDIC) benefited from this transaction since JPMorgan is now responsible for the bank liabilities, and not the FDIC. However, given the method employed in this case, banks looking to get hold of another ailing bank, Wachovia, may be looking for a similar process (it proves much cheaper to buy through this method rather than an open purchase):


Wachovia Corp.'s suitors may use a template honed by JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon last week: Wait to see whether regulators will seize the bank, then buy the best assets and let the government sort out the rest, according to analysts. The bidders may try that tactic again at Charlotte, North Carolina-based Wachovia following its 27 percent plunge in New York trading yesterday, according to analysts at Goldman Sachs Group Inc. and Egan-Jones Ratings Co. They may get help from regulators, who said the U.S. benefited from seizing and selling WaMu because the Federal Deposit Insurance Corp. didn't have to tap its $45 billion insurance fund.
Wachovia dropped $3.70 to $10 in New York Stock Exchange composite trading yesterday and lost $1.50 more in extended hours. Yields on Wachovia's bonds soared to 24 percent, from 7.5 percent on Sept. 5, an indication that investors are concerned about default. Analysts questioned Wachovia's ability to stay independent after seeing loan losses tied to WaMu. JPMorgan is taking on $176 billion in mortgage-related assets and taking writedowns of about $31 billion, the New York bank said. Some of those were option ARM loans, which are prone to default because they let borrowers defer some interest and add it to the principal.


Given that Wachovia also has huge exposures to mortgage loans, other banks are licking their chops at the sidelines, waiting for the Bank to run into more problems, and begin the downward spiral of liquidity problems -> credit problems -> credit rating downgrades -> unable to raise funds. And given the financial deal to take on the massive bad mortgage assets of depressed companies is under active discussion among the politicians, but no immediate solution yet seems to be coming out, sentiment will only go worse.
What does this mean for Indian markets ? As liquidity problems arise among top US companies, they will try and get funds from wherever they can, including liquidating their stock holdings in the Indian market, causing more downturns.

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