Monthly Archives: September 2008

Lack Of Confidence, Not Capital, Is Issue

By INVESTOR’S BUSINESS DAILY | Posted Monday, September 29, 2008 4:20 PM PT

Rescue: As the financial turbulence in the U.S. spreads, we’ve heard talk, especially from overseas pundits, of a “crisis of capitalism.” But what we really have is a crisis of confidence, and the sooner it’s solved, the better.

Read More: Economy | Business & Regulation


The $700 billion rescue for the troubled global financial system foundered on a 228-205 vote Monday as both sides in the political debate feared being blamed for passing an unpopular bill.

Polls show more than 50% of Americans oppose what the pollsters call a “bailout” (but what we prefer to call a rescue). Meanwhile, a USA Today poll found that nearly a third of Americans think we’re in a depression.

Concern about the financial system is fully justified. But excessive gloom is not. In the most recent quarter, GDP rose 2.1% year over year, 3.1% excluding housing. Hardly a depression. So let’s not talk ourselves into one.

We, too, have qualms about the rescue effort. Washington under Democrat-led Congresses wrote the rules that made this mess possible, and we have little confidence in their ability to get us out of it.

We have even less confidence after watching Democrats try to insert things in the plan — from money for the radical community group ACORN to new taxes on Wall Street — that made no sense at all. We’re glad Republicans opposed these and made the bill better.

But now it’s time for all to hold their noses and vote as soon as possible on a compromise. Both the public and the investment community need to be reassured their leaders aren’t dropping the ball.

Failure won’t just cost billions; it will cost trillions — in lost output, a shrunken job market, smaller retirements and lost productivity. Is this the future we’ll choose for ourselves? We hope not.

Republicans who voted against the bill did so for legitimate reasons. They don’t like government getting too involved in the economy, and this package permits just that. But they also don’t want to be blamed, as the minority party, if the deal turns sour.

That’s already happening. Yes, more than 60% of Republicans voted against the rescue bill, but so did 40% of Democrats. That said, it’s time for Republicans to take a deep breath, pull up their pants and help pass a bill. The nation’s confidence is riding on it.

Americans must be made to realize it’s not Wall Street that’s being “bailed out,” as the media keep putting it. It’s Main Street.

The reason President Bush and Treasury Secretary Paulson moved so quickly and boldly is they fear a “seizing up” of financial markets. That means banks will stop lending to one another. It means companies that finance in the money markets — as many medium- and large-size businesses do — will be frozen out.

No lending, no business. Here’s where Main Street comes in. Thousands and maybe millions will be laid off as commerce grinds to a halt. That’s a real threat. Republicans will never get a perfect bill out of this Congress; compromises must be made by both sides.

We hope the $700 billion requested of Congress is enough to cover the problem. But we also note that on Monday, without Congress’ interference, the Fed made $630 billion available to world financial markets. That brings this rescue to $1.4 trillion.

The ability of the nation’s and the world’s financial markets to finance this shouldn’t be questioned. As the nonpartisan Congressional Budget Office noted Monday, the cost of any eventual rescue plan would likely be “substantially smaller” than $700 billion because of asset resales. And, around the world, there’s some $70 trillion or so in investment capital, according to estimates.

We’re not short on capital, as we said, but on confidence. Passing a bill, even if flawed, would go a long way to restoring the latter.



Bungle & Bust

British banking


Sep 28th 2008
From The Economist print edition

Another small bank capsizes in a storm-tossed sea

AFTER a frenetic weekend spent trying to rustle up a buyer for Bradford & Bingley, a small British bank down on its luck, Britain’s government was poised, late on Sunday September 28th, to nationalise its second bank in a year. To the last minute talks were continuing to find buyers for some parts the bank. Potential purchasers included Spain’s Santander and a clutch of big British banks. But efforts to find a buyer for all of it had foundered, leaving little choice but to take it into public ownership to prevent a run on deposits, which had already started at the weekend, gathering pace when branches reopened.

This is the fourth British bank to have crumpled in the face of ongoing turmoil in the credit markets. Northern Rock was nationalised in February and both HBOS, Britain’s biggest mortgage lender, and Alliance & Leicester, a small bank, have since sought refuge in takeovers by bigger banks amid worries that they would not be able to raise new loans to repay existing debts.

This particular failure, however, is a sign of more than just the fear and uncertainty roiling international credit markets. It also marks another worrying point in the credit crisis. For much of the past year attention has been on bad debts arising from American mortgages and how losses on them have been spread around the world’s financial system by a bewildering array of credit derivatives. Bradford & Bingley’s problems, in contrast, are largely homegrown and raise the worrying possibility that the international banking system will face a second wave of losses as housing markets and economies wilt around the world.

To some extent Bradford & Bingley’s injuries were self-inflicted. The institution was a boring mortgage lender that was owned by its members until it transformed itself into a private company in 2000. It then became an early and enthusiastic proponent of the raciest type of mortgage lending in Britain. Last year more than three-quarters of its new loans were either made to landlords or were “self-certified” mortgages, which are commonly known as “liars’ loans” because borrowers are not asked to prove their income or employment. Moreover it was a keen buyer of mortgages that other banks had written. Even so, its failure sounds a warning for large mortgage lenders and for regulators in countries such as Spain and Ireland, where housing bubbles have also been pricked.

During Britain’s long housing boom Bradford & Bingley seemed to do no wrong. Losses on its loans were trifling because borrowers, often landlords, had every reason to avoid foreclosure and could always sell their properties at a profit if they struggled with repayments. Now that Britain’s housing markets has turned, however, the bank’s strategy is unravelling. Arrears are rising with alarming speed and the values of homes underpinning mortgages are falling just as quickly. The bank has also struggled to borrow from anyone but the central bank as credit-rating agencies have repeatedly cut its rating, most recently last week, on worries about the quality of its loan book. A crucial point was reached last week when, amid worries over its ability to keep funding itself and, if needed, raise additional capital, its share price slumped. At one point the bank was valued at just £289m ($533m), less than a tenth of its peak of £3.2 billion in 2006. By Saturday depositors were bombarding its website and starting to queue at its branches.

The government’s (likely) swift action suggests that it has learned some important lessons from the failure of Northern Rock. A year ago regulators at the Financial Services Authority seemed to have been asleep at the wheel. This time they have been watching closely. The Treasury, which dithered as Northern Rock floundered, letting worries about the funding of one of Britain’s smaller lenders develop into a full-blown bank run that threatened the stability of all banks, is also moving swiftly. A quick nationalisation should halt a run on the bank and avert wider panic. Just as regulators and governments studied the Northern Rock fiasco closely as an example of how not to rescue banks, this nationalisation will also be examined in countries that may soon have to put its lessons into practice.

Covert Nationalization of the Banking System (Naked Capitalism)

Saturday, March 8, 2008

Covert Nationalization of the Banking System

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One of the upsides of blogging is sometimes other inquiring minds get to the bottom of matters that have been nagging at you.

We had warned a couple of months ago that a colleague with serious connections into the Treasury and Fed told us they were working on plans for a quasi-nationalization of the banking system. Their view was that while banks would technically be solvent, they’d have enough bad credits that they would be unable to extend new loans.

Steve Waldman, in a terrific post at Interfluidity, concludes that nationalization is underway, via the expansion of the Term Auction Facility and Fed’s new 28 day repo program.

Readers may know that there has been a lot of disquiet regarding the negative non-borrowed banking reserves that resulted form the TAF. Bond market mavens, such as commentator Caroline Baum at Bloomberg, dismissed those worries as reflecting a lack of understanding of Fed operations.

I remained troubled, not by the negative non-borrowed reserves figures per se, but by the fact that the Fed was downplaying an operation which was extraordinary. The TAF is a discount window of sorts, but with somewhat longer-term loans and no stigma. Note the TAF accepts the same types of collateral at the same haircuts as the discount windows.

But the discount window is a “break glass in case of emergency” facility. It’s when liquidity is so scarce that banks can’t borrow on normal terms, so they go to the Fed, post collateral, and get dough. The fact that a supposedly temporary operation has become semi-permanent and was increased (it was initially $40 billion, then it was quietly increased to $60 billion) was a troubling sign, yet the Fed acted as if this was business as normal.

Waldman does a thorough job of parsing the two initiatives announced Friday, the further expansion of the TAF, plus the establishment of the new repo facility.

Differences in degree can be differences in kind, and that’s what Waldman argues has happened. The US banking system is on life support. The Fed has now become a very big prop, far more significant than the highly publicized sovereign wealth fund investors.

From Interfluidity:

The Fed announced that it would auction off $100B in loans this month rather than the previously announced $60B via its TAF facility. In the same press release, the FRB announced plans to offer $100B worth of 28 day loans via repurchase agreements against “any of the types of securities — Treasury, agency debt, or agency mortgage-backed securities — that are eligible as collateral in conventional open market operations”.

The second announcement puzzled me. After all, the Fed conducts uses repos routinely in the open market operations by which they try to hold the interbank lending rate to the Federal Funds target. In aggregate, the quantity of funds that the Fed makes available is constrained by the Fed Funds target. So, what do we learn from this? Fortunately, the New York Fed provides more details:

The Federal Reserve has announced that the Open Market Trading Desk will conduct a series of term repurchase (RP) transactions that are expected to cumulate to $100 billion outstanding… These transactions will be conducted as 28-day term RP agreements.. When the Desk arranges its conventional RPs, it accepts propositions from dealers in three collateral “tranches.” In the first tranche, dealers may pledge only Treasury securities. In the second tranche, dealers have the option to pledge federal agency debt in addition to Treasury securities. In the third tranche, dealers have the option to pledge mortgage-backed securities issued or fully guaranteed by federal agencies in addition to federal agency debt or Treasury securities. With the special “single-tranche” RPs announced today, dealers have the option to pledge either mortgage-backed securities issued or fully guaranteed by federal agencies, federal agency debt, or Treasury securities. The Desk has arranged single-tranche transactions from time to time in the past.

There are a couple of differences, then, between this new program and typical repo operations:

1. The loans are of a longer-term than usual. Ordinarily, the Fed lends on terms ranging from overnight to two weeks in its “temporary open market operations”. The Fed will now offer substantial funding on a 28 day term.

2, The Fed is effectively broadening its collateral requirements by collapsing what are usually 3 distinct levels of collateral which are lent against at different rates to a single category within which no distinctions are made.

The Fed offered the first $15B of repo loans under the program today, so we can see how things are going to work. First, how did the Fed square the circle of ramping up its repos without pushing down the Federal Funds rate? Just as it had done with TAF, the Fed offset the “temporary” injection of funds with a “permanent open market operation”. The Fed purchased outright $10B of Treasury securities today at the same time as it offered $15B in exchange for mortgage-backed securities under the new program (at a low interest rate than in traditional repos against MBS collateral). The net cash injection was small, but the composition of securities on bank balance sheets changed markedly, as illiquid securities were exchanged for liquid Treasuries.

In James Hamilton’s wonderful coinage, the Fed is conducting monetary policy on the asset side of the balance sheet. This is an innovation of the Bernanke Fed. Conventionally, monetary policy is about managing the quantity of the central bank’s core liability, currency outstanding. When the Fed wants to loosen, it expands its liabilities by issuing cash in exchange for securities. When it wants to tighten, it redeems cash for securities, reducing Fed liabilities. The asset side is conventionally an afterthought, “government securities”. But the Bernanke Fed has branched out. It has sought to lend against a wide-range of assets, actively seeking to replace securities about which the market seems spooked with safe-haven Treasuries on bank balance sheets without creating new cash. By doing this, the Fed hopes to square the circle of helping banks through their “liquidity crisis” without provoking a broad inflation.

“Monetary policy on the asset side of the balance sheet” is a bit too anodyne a description of what’s going on here though. The Fed has gotten into an entirely new line of business, and on a massive scale. Prior to the introduction of TAF, direct loans from the Fed to banks, including the discount window lending and repos, amounted to less than $40B, the majority of which were repos collateralized by Treasury securities. By the end of this month, the Federal Reserve will have more than $200B of exposure in its new role as Wall Street’s genial pawnbroker. Assuming the liability side of the Fed’s balance sheet is held roughly constant, more than a fifth of the Fed’s balance sheet will be direct loans to banks, almost certainly against collateral not backed by the full faith and credit of the US government (and beyond that we just don’t know). This raises a whole host of issues.

Caroline Baum wrote a column last week poopooing concerns about the Fed taking on credit risk via TAF lending. (Hat tip Mark Thoma.) I usually enjoy Baum’s work, but this column was poorly argued. In it, she points out that the Fed has all the tools it needs to manage credit risk. The Fed offers loans only against collateral, and requires that loans be overcollateralized. If the collateral has no clear market value or if there are questions about an asset’s quality, the Fed has complete discretion to force a “haircut”, writing down the asset (for the purpose of the loan) to whatever value it sees fit. And the Fed can always just say no to any collateral it deems sketchy.

All of that is quite true, and (as Baum snarkily points out) not hard to find on FRB websites. But it fails to address the core issue. Sure the Fed has all the tools it needs to manage credit risk. But does it have the will to use those tools? In word and deed, the Fed’s primary concern since August has been to “restore normal functioning” to financial markets. The Fed has chosen to accept some inflation risk in its fight against macroeconomic meltdown. Why wouldn’t it knowingly accept some credit risk as well? No one has suggested that the Fed is being “snookered”. Skeptics think the Fed is intentionally taking on bank credit risk while still lending at very low rates. Some of us find that troubling.

Which brings us to the more postmodern issue of what credit risk even means to a lender with unlimited cash and an overt unwillingness to let those it lends to default. In a way, I agree with Baum. Until the current crisis is long past, I think it unlikely that any large bank will default and stiff the Fed with toxic collateral. Why not? Because for that to happen, the Fed would have to pull the trigger itself, by demanding payment on loans rather than offering to roll them over. Since TAF started last fall, on net, the Fed has not only rolled over its loans to the banking system, but has periodically increased banks’ line of credit as well. In an echo of the housing bubble, there’s no such thing as a bad loan as long as borrowers can always refinance to cover the last one.

The distinction between debt and equity is much murkier than many people like to believe. Arguably, debt whose timely repayment cannot be enforced should be viewed as equity. (Financial statement analysts perform this sort of reclassification all the time in order to try to tease the true condition of firms out of accounting statements.) If you think, as I do, that the Fed would not force repayment as long as doing so would create hardship for important borrowers, then perhaps these “term loans” are best viewed not as debt, but as very cheap preferred equity.

Let’s go with that for a minute, and think about the implications. One much discussed story of the current crisis is the role of sovereign wealth funds in helping to capitalize struggling banks. Will they, won’t they, should we worry? Sovereign wealth funds have invested about $24B in struggling US financials. Meanwhile, the Fed is quietly providing eight times that on much easier terms.

If we view TAF and the new 28-day, broad-collateral repos as equity, what fraction of bank capitalization would they represent? I haven’t been able to find current numbers on aggregate bank capitalization in the US. In June of 2006, the accounting net worth of U.S. Commercial Banks, Thrift Institutions and Credit Unions was 1.25 trillion dollars. Putting together remarks by Fed Vice Chairman Donald Kohn and data on bank equity to total assets from the St. Louis Fed yields a more recent estimate of about 1.6 trillion. The average price to book among the top ten US banks is about 1.3. So, a reasonable estimate for the current market value of bank equity is 2 trillion dollars. The $200B in “equity” the Fed will have supplied by the end of March will leave the Federal Reserve owning roughly 9.1% of the total bank equity. Obviously, the Fed isn’t investing in the entire bank sector uniformly. Some banks will be very substantially “owned” by the central bank, whereas others will remain entirely private sector entities. As Dean Baker points out, the Fed is giving us no information by which to tell which is which.

What we are witnessing is an incremental, partial nationalization of the US banking system. Northern Rock in the UK is peanuts compared to what the New York Fed is up to.

You may object, and I’m sure many of you will, that our little thought experiment is bunk, debt is debt and equity is equity, these are 28-day loans, and that’s that. But notionally collateralized “term” loans that won’t ever be redeemed unless and until it is convenient for borrowers are an odd sort of liability. Central banks are very familiar with the ruse of disguising equity as liability. Currency itself is formally a liability of the central bank, but in every meaningful sense fiat money is closer to equity.

I do not, by the way, object to nationalizing failing banks. There are (unfortunately) banks that are “too big to fail”, whose abrupt disappearance could cause widespread disruption and harm. These should be nationalized when they fall to the brink. But they should be nationalized overtly, their equity written to zero, and their executives shamed. That sounds harsh. It is harsh. One hates to see bad things happen to nice people, and these are mostly nice people. But running institutions with trillions dollar balance sheets is a serious business. Accountability matters. These people were not stupid. They knew, in Chuck Prince’s now infamous words, that “when the music stops… things will be complicated.”, and they kept dancing anyway.

But accountability has gone out of style. The Federal Reserve is injecting equity into failing banks while calling it debt. Citibank is paying 11% to Abu Dhabi for ADIA’s small preferred equity stake, while the US Fed gets under 3% now for the “collateralized 28-day loans” it makes to Citi. Pace Accrued Interest (whom I much admire), I still think this all amounts to a gigantic bail-out. And that it is a brilliantly bad idea from which financial capitalism may have a hard time recovering. Like a well-meaning surgeon slicing up arteries to salvage the appendix, the Federal Reserve is only trying to help.

From a corporate finance perspective, Waldmans’ argument about the Fed effectively being an equity provider isn’t as off base as it sounds. If you as a creditor are unable to call in your loans or otherwise exercise your contractual rights, your position is so badly subordinated that you are effectively equity. And there is no indication that the Fed will take any more action relative to the banks that become dependent on it beyond its normal supervisory role. To behave otherwise, after all, would make it even more difficult for those organizations to function in the marketplace, which risks damaging their ability to function even further.

Who’s Afraid of a Big, Bad Bailout? – John Mauldin’s Weekly E-Letter

Flying last Tuesday, overnight from Cape Town in South Africa to London, I read in the Financial Times that Republican Congressman Joe Barton of Texas was quoted as saying (this is from memory, so it is not exact) that he had difficulty voting for a bailout plan when none of his constituents could understand the need to bail out Wall Street, didn’t understand the problem, and were against spending $700 billion of taxpayer money to solve a crisis for a bunch of (rich) people who took a lot of risk and created the crisis. That is a sentiment that many of the Republican members of the House share.
As it happens, I know Joe. My office is in his congressional district. I sat on the Executive Committee for the Texas Republican Party representing much of the same district for eight years. This week, Thoughts from the Frontline will be an open letter to Joe, and through him to Congress, telling him what the real financial problem is and how it affects his district, helping explain the problem to his constituents , and explaining why he has to hold his nose with one hand and vote for a bailout with the other.
Just for the record, Joe has been in Congress for 24 years. He is the ranking Republican on the Energy and Commerce Committee, which is one of the three most important committees and is usually considered in the top five of Republican House leadership. He is quite conservative and has been a very good and effective congressman. I have known Joe for a long time and consider him a friend. He has been my Congressman at times, depending on where they draw the line. I called his senior aide and asked him how the phone calls were going. It is at least ten to one against supporting this bill, and that is probably typical of the phones all across this country. People are angry, and with real justification. And watching the debates, it reminds us that one should never look at how sausages and laws are made. It is a very messy process.
I think what follows is as good a way as any to explain the crisis we are facing this weekend. This letter will print out a little longer, because there are a lot of charts, but the word length is about the same. Let’s jump right in.
It’s the End of the World As We Know It
Dear Joe,
I understand your reluctance to vote for a bill that 90% of the people who voted for you are against. That is generally not good politics. They don’t understand why taxpayers should spend $700 billion to bail out rich guys on Wall Street who are now in trouble. And if I only got my information from local papers and news sources, I would probably agree. But the media (apart from CNBC) has simply not gotten this story right. It is not just a crisis on Wall Street. Left unchecked, this will morph within a few weeks to a crisis on Main Street. What I want to do is describe the nature of the crisis, how this problem will come home to your district, and what has to be done to avert a true, full-blown depression, where the ultimate cost will be far higher to the taxpayers than $700 billion. And let me say that my mail is not running at 10 to 1 against, but it is really high. I am probably going to make a lot of my regular readers mad, but they need to hear what is really happening on the front lines of the financial world.
First, let’s stop calling this a bailout plan. It is not. It is an economic stabilization plan. Run properly, it might even make the taxpayers some money. If it is not enacted very soon (Monday would be fine), the losses to businesses and investors and homeowners all over the US (and the world) will be enormous. Unemployment will jump to rates approaching 10%, at a minimum. How did all this come to pass? Why is it so dire? Let’s rewind the tape a bit.
We all know about the subprime crisis. That’s part of the problem, as banks and institutions are now having to write off a lot of bad loans. The second part of the problem is a little more complex. Because we were running a huge trade deficit, countries all over the world were selling us goods and taking our dollars. They in turn invested those excess dollars in US bonds, helping to drive down interest rates. It became easy to borrow money at low rates. Banks, and what Paul McCulley properly called the Shadow Banking System, used that ability to borrow and dramatically leverage up those bad loans (when everyone thought they were good), as it seemed like easy money. They created off-balance-sheet vehicles called Structured Investment Vehicles (SIVs) and put loans and other debt into them. They then borrowed money on the short-term commercial paper market to fund the SIVs and made as profit the difference between the low short-term rates of commercial paper and the higher long-term rates on the loans in the SIV. And if a little leverage was good, why not use a lot of leverage and make even more money? Everyone knew these were AAA-rated securities.
And then the music stopped. It became evident that some of these SIVs contained subprime debt and other risky loans. Investors stopped buying the commercial paper of these SIVs. Large banks were basically forced to take the loans and other debt in the SIVs back onto their balance sheets last summer as the credit crisis started. Because of a new accounting rule (called FASB 157), banks had to mark their illiquid investments to the most recent market price of a similar security that actually had a trade. Over $500 billion has been written off so far, with credible estimates that there might be another $500 billion to go. That means these large banks have to get more capital, and it also means they have less to lend. (More on the nature of these investments in a few paragraphs.)
Banks can lend to consumers and investors about 12 times their capital base. If they have to write off 20% of their capital because of losses, that means they either have to sell more equity or reduce their loan portfolios. As an example, for every $1,000 of capital, a bank can loan $12,000 (more or less). If they have to write off 20% ($200), they either have to sell stock to raise their capital back to $1,000 or reduce their loan portfolio by $2,400. Add some zeroes to that number and it gets to be huge.
And that is what is happening. At first, banks were able to raise new capital. But now, many banks are finding it very difficult to raise money, and that means they have to reduce their loan portfolios. We’ll come back to this later. But now, let’s look at what is happening today. Basically, the credit markets have stopped functioning. Because banks and investors and institutions are having to deleverage, that means they need to sell assets at whatever prices they can get in order to create capital to keep their loan-to-capital ratios within the regulatory limits.
Remember, part of this started when banks and investors and funds used leverage (borrowed money) to buy more assets. Now, the opposite is happening. They are having to sell assets into a market that does not have the ability to borrow money to buy them. And because the regulators require them to sell whatever they can, the prices for some of these assets are ridiculously low. Let me offer a few examples.
Today, there are many municipal bonds that were originally sold to expire 10-15 years from now. But projects finished early and the issuers wanted to pay them off. However, the bonds often have a minimum time before they can be called. So, issuers simply buy US Treasuries and put them into the bond, to be used when the bond can be called. Now, for all intents and purposes this is a US government bond which has the added value of being tax-free. I had a friend, John Woolway, send me some of the bid and ask prices for these type of bonds. One is paying two times what a normal US Treasury would pay. Another is paying 291% of a normal US Treasury. And it is tax-free! Why would anyone sell what is essentially a US treasury bond for a discount? Because they are being forced to sell, and no one is buying! The credit markets are frozen.
Last week, I wrote about a formerly AAA-rated residential mortgage-backed security (RMBS) composed of Alt-A loans, better than subprime but less than prime. About 5% of the loans were delinquent, and there are no high-risk option ARMs in the security. It is offered at 70 cents on the dollar. If you bought that security, you would be making well over 12% on your money, and 76% of the loans in the portfolio of that security would have to default and lose over 50% of their value before you would risk even one penny. Yet the bank which is being forced to sell that loan has had to write down its value. As I wrote then, that is pricing in financial Armageddon. (You can read the full details here.)
Let’s look at the following graph. It is an index of AAA-rated mortgage bonds, created by It is composed of RMBSs similar to the one I described above. Institutions buy and sell this index as a way to hedge their portfolios. It is also a convenient way for an accounting firm to get a price for a mortgage-backed security in a client bank’s portfolio. With the introduction of the new FASB 157 accounting rule, accountants are very aggressive about making banks mark their debt down, as they do not want to be sued if there is a problem. Notice this index shows that bonds that were initially AAA are now trading at 53 cents on the dollar, which is up from 42.5 cents two months ago.
Accountants might look at the bond I described above, look at this index, and decide to tell their clients to mark the bonds down to $.53 on the dollar. The bank is offering the bond at $.70 because it knows there is quality in the security. They are being forced to sell. And guess what? There are no buyers. An almost slam-dunk 12% total-return security with loss-coverage provisions that suggest 40% of the loans could default and lose 50% before your interest rate yields even suffered, let alone risk to your principal – and it can’t find a buyer.
One of the real reasons these and thousands of other good bonds are not selling now is that there is real panic in the markets. The oldest money market fund “broke the buck” last week, because they had exposure to Lehman Brothers bonds. We are seeing massive flights of capital from money market funds, including by large institutions concerned about their capital. What are they buying? Short-term Treasury bills. Three-month Treasury bills are down to 0.84%.
It gets worse. Last week one-month Treasury bills were paying a negative 1%!!! That means some buyers were so panicked that they were willing to buy a bond for $1 that promised to pay them back only $.99 in just one month. The rate is at 0.16% today. If something is not done this weekend, it could go a lot lower over the next few days. That is panic, Joe.
I don’t want to name names, as this letter goes to about 1.5 million people and I don’t want to make problems for some fine banking names; but there is a silent bank run going on. There are no lines in the street, but it is a run nevertheless. It is large investment funds and corporations quietly pulling their money from some of the best banks in the country. They can do this simply by pushing a button. We are watching deposit bases fall. It does not take long. Lehman saw $400 billion go in just a few months this summer. Think about that number. Any whiff of a problem and an institution that is otherwise sound could be brought low in a matter of weeks. And the FDIC could end up with a large loss that seemed to have come from out of nowhere.
The TED Spread Flashes Trouble
There is something called the TED spread, which is the difference between three-month LIBOR (the London Inter Bank Offered Rate which is in euro dollars, also called The Euro Dollar Spread, thus TED) and three-month US Treasury bills. Three-month LIBOR is basically what banks charge each other to borrow money. Many mortgages and investments are based on various periods of LIBOR. Look at the chart below. Typically the TED spread is 50 basis points (0.50%) or less. When it spikes up, it is evidence of distress in the financial markets. The last time the TED spread was as high as it is now was right before the market crash of 1987. This is a weekly chart, which does not capture tonight’s (Friday) change, which would make it look even worse. Quite literally, the TED spread is screaming panic.
The Fed has lowered rates to 2%. Typically, three-month LIBOR tracks pretty close to whatever the Fed funds rate is. Starting with the credit crisis last year, that began to change. Look at the chart below.
Remember, LIBOR is what banks charge to each other to make loans. Lower rates are supposed to help banks improve their capital and their ability to make loans at lower interest rates to businesses and consumers. Look at what has happened in the past few weeks, in the chart above. The spread between three-month LIBOR and the Fed funds rate is almost 200 basis points, or 2%! That is something that defies imagination to market observers. On the chart above, it looks like it has not moved that much, but in the trading desks of banks all over the world it is a heart-pounding, scare-you-to-death move. The chart below reflects what traders have seen in the past two weeks, and it moved up more today.
Now let’s look at the next chart. This is the amount of Tier 1 commercial paper issued. This is the life blood of the business world. This is how many large and medium-sized businesses finance their day-to-day operations. The total amount of commercial paper issued is down about 15% from a year ago, with half of that drop coming in the last few weeks. Quite literally, the economic body is hemorrhaging. Unless something is done, businesses all over the US are going to wake up in a few weeks and find they simply cannot transact business as usual. This is going to put a real crimp in all sorts of business we think of as being very far from Wall Street.
I could go on. Credit spreads on high-yield bonds that many of our best high-growth businesses use to finance their growth are blowing out to levels which make it impossible for the companies to come to the market for new funds. And that is even if they could find investors in this market! There are lots of other examples (solid corporate loans selling at big discounts, asset-backed securities at discounts, etc.), but you get the idea. Suffice it to say that the current climate in the financial market is the worst since the 1930s. But how does a crisis in the financial markets affect businesses and families in Arlington, Texas, where my office and half of your district is?
The Transmission Mechanism
The transmission in a car takes energy from the engine and transfers it to the wheels. Let’s talk about how the transmission mechanism of the economy works.
Let’s start with our friend Dave Moritz down the street. He needs financing to be able to sell an automobile. To get those loans at good prices, an auto maker has to be able to borrow money and make the loans to Dave’s customers. But if something does not stop the bleeding, it is going to get very expensive for GM to get money to make loans. That will make his cars more expensive to consumers. Cheap loans with small down payments are the life blood of the auto selling business. That is going to change dramatically unless something is done to stabilize the markets.
Credit card debt is typically packaged and sold to investors like pension funds and insurance companies. But in today’s environment, that credit card debt is going to have to pay a much higher price in order to find a buyer. That means higher interest rates. Further, because most of the large issuers of credit cards are struggling with their leverage, they are reducing the amount of credit card debt they will give their card holders. If they continue to have to write down mortgages on their books because of mark-to-market rules which price assets at the last fire-sale price, it will mean even more shrinkage in available credit.
Try and sell a home above the loan limits of Fannie and Freddie today with a nonconforming jumbo loan. Try and find one that does not have very high rates, because many lenders who normally do them simply cannot afford to keep them on their balance sheets. And a subprime mortgage? Forget about it. This is going to get even worse if the financial markets melt down.
We are in a recession. Unemployment is going to rise to well over 6%. Consumer spending is going to slow. This is an environment which normally means it is tougher for small businesses and consumers to get financing in any event. Congress or the Fed cannot repeal the business cycle. There are always going to be recessions. And we always get through them, because we have a dynamic economy that figures out how to get things moving again.
Recessions are part of the normal business cycle. But it takes a major policy mistake by Congress or the Fed to create a depression. Allowing the credit markets to freeze would count as a major policy mistake.
I have been on record for some time that the economy will go through a normal recession and a slow recovery, what I call a Muddle Through Economy. This week I met with executives of one of the larger hedge funds in the world. They challenged me on my Muddle Through stance. And I had to admit that my Muddle Through scenario is at risk if Congress does not act to stabilize the credit markets.
Let’s Make a Deal
Why do we need this Stabilization Plan? Why can’t the regular capital markets handle it? The reason is that the problem is simply too big for the market to deal with. It requires massive amounts of patient, long-term money to solve the problem. And the only source for that would be the US government.
There is no reason for the taxpayer to lose money. Warren Buffett, Bill Gross of PIMCO, and my friend Andy Kessler have all said this could be done without the taxpayer losing money, and perhaps could even make a profit. As noted above, these bonds could be bought at market prices that would actually make a long-term buyer a profit. Put someone like Bill Gross in charge and let him make sure the taxpayers are buying value. This would re-liquefy the banks and help get their capital ratios back in line.
Why are banks not lending to each other? Because they don’t know what kind of assets are on each other’s books. There is simply no trust. The Fed has had to step in and loan out hundreds of billions of dollars in order to keep the financial markets from collapsing. If you allow the banks to sell their impaired assets at a market-clearing fair price (not at the original price), then once the landscape is cleared, banks will decide they can start trusting each other. The commercial paper market will come back. Credit spreads will come down. Banks will be able to stabilize their loan portfolios and start lending again.
Again, the US government is the only entity with enough size and patience to act. We do not have to bail out Wall Street. They will still take large losses on their securities, just not as large a loss as they are now facing in a credit market that is frozen. As noted above, there are many securities that are being marked down and sold far below a rational price.
If we act now, we will start to see securitization of mortgages, credit cards, auto loans, and business loans so that the economy can begin to function properly.
What happens if we walk away? Within a few weeks at most, financial markets will freeze even more. We will see electronic runs on major banks, and the FDIC will have more problems than you can possibly imagine. The TED spread and LIBOR will get much worse. Businesses which use the short-term commercial paper markets will start having problems rolling over their paper, forcing them to make difficult cuts in spending and employment. Larger businesses will find it more difficult to get loans and credit. That will have effects on down the economic food chain. Jim Cramer estimated today that without a plan of some type, we could see the Dow drop to 8300. That is as good a guess as any. It could be worse. Home valuations and sales will drop even further.
The average voter? They will see stock market investments off another 25% at the least. Home prices will go down even more. Consumer spending will drop. What should be a run-of-the-mill recession becomes a deep recession or soft depression. Yes, that may be worst-case scenario. But that is the risk I think we take with inaction.
A properly constructed Stabilization Plan hopefully avoids the worst-case scenario. It should ultimately not cost the taxpayer much, and maybe even return a profit. The AIG rescue that Paulson arranged is an example of how to do it right. My bet is that the taxpayer is going to make a real profit on this deal. We got 80% of AIG, with what is now a loan paying the taxpayer over 12%, plus almost $2 billion in upfront fees for doing the loan. That is not a bailout. That is a business deal that sounds like it was done by Mack the Knife.
This deal needs to be done by Monday. Every day we wait will see more and more money fly out the doors of the banks, putting the FDIC at ever greater risk. Panic will start to set in, moving to ever smaller banks. Frankly, we are at the point where we need to consider raising the FDIC limits for all deposits for a period of time, until the Stabilization Plan quells the panic.
I understand that this is a really, really bad idea according classical free-market economic theory. You know me; I am as free market as it comes. But I also know that without immediate action a lot of people are really going to be hurt. Unemployment is not a good thing. Losses on your home and investments hurt. It is all nice and well to talk about theories and contend the market should be allowed to sort itself out; and if we have a deep recession, then that is what is needed. But the risk we take is not a deep recession but a soft depression. The consequences of inaction are simply unthinkable.
Joe, I am telling you that the markets are screaming panic. Yes, Senator Richard Shelby has his 200 economists saying this is a bad deal. But they are ivory tower kibitzers who have never sat at a trading desk. They have never tried to put a loan deal together or had to worry about commercial paper markets collapsing. I am talking daily with the people on the desks who are seeing what is really happening. Shelby’s economists are armchair generals far from the front lines. I am talking to the foot soldiers who are on the front lines.
Every sign of potential disaster is there. You and the rest of the House have to act. It has to be bipartisan. This should not be about politics (even though Barney Frank keeps talking bipartisan and then taking partisan shots, but I guess he just can’t help himself). It should be about doing the right thing for our country and the world. I know it will not be fun coming back to the district. Talking about TED spreads and LIBOR will not do much to assuage voters who are angry. But it is the right thing to do. And I will be glad to come to the town hall meeting with you and help if you like.
With your help, we will get through this. In a few years, things will be back to normal and we can all have stories to tell to our grandkids about how we lived through interesting times. But right now we have to act.
Colorado, California, London, and Sweden
It is time to hit the send button. This was personally a great week. For whatever reason, I did not suffer jet lag flying to South Africa for just two days, then overnight to London, and back the next day. It was a good trip. I will report more about South Africa in a later letter, but this e-letter is already a little long.
I leave Sunday for a quick trip to Longmont, Colorado (near Boulder) to look at a very interesting technology company (InPhase) that makes holographic memory disks, with good friend Dr. Bart Stuck of Signal Lake Partners.
I will be in San Diego and Orange County the 16th and 17th of October for back-to-back speeches, then I leave Sunday for London for two days and then on to Sweden for a conference and speeches there, a quick trip to Malta, and then back home, where I will be chained to my desk by daughter Tiffani as we do interviews and write a book.
I do enjoy traveling from time to time, seeing the rest of the world. One of my secret pleasures is reading International Living and thinking about what it would be like to have another home somewhere. Cheap thrills. You can subscribe if you like by following this link.
Have a great week. I fully believe (OK, deeply hope) that Congress will act. We can all breathe a collective sigh when they do.
Your still believing in Muddle Through analyst,

John Mauldin
Copyright 2008 John Mauldin. All Rights Reserved

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Leaders Without Followers – The Paulson Plan and the week that was.

  by Lawrence B. Lindsey
10/06/2008, Volume 014, Issue 04

The Weekly Standard

Just over a week ago the collapse in credit markets forced the secretary of the Treasury to assemble a bipartisan group from both houses of Congress to sell a record-setting government-bailout plan of the financial industry. Trouble was no such plan existed at the time of the meeting. He set off a mad scramble to come up with the barest outlines of a plan on Saturday followed by two Democratic outlines, one for the House and one for the Senate, on Sunday.

By Monday the 22nd, it was obvious to markets and most other observers that, when it came to the plans, there was not a lot of “there” there. Unintended consequences multiplied. So, when Henry Paulson and Federal Reserve chairman Ben Bernanke began their gauntlet of testimonies on Tuesday, the mood was intensely skeptical, even bordering on hostile. Equity markets crashed. Credit markets seized up again on Wednesday, even though stocks stabilized.

By Thursday stocks had rallied on expectations that Congress would pass a bill by the end of the weekend. Democrats announced they had an agreement amongst themselves, but their rank and file were decidedly not on board. Nonetheless, the president arranged a seal-the-deal ceremony for Thursday afternoon at the White House with the congressional leadership and both McCain and Obama present. It was to be followed by a photo opportunity with the current president and the two men who might succeed him collectively blessing a bailout package.

It was not to be.

Senator Richard Shelby, deeply suspicious of the Paulson plan, left the meeting early and declared there was no deal. Obama headed for the Mayflower Hotel to hold his own press conference. The Democratic leadership focused on mocking McCain, blaming him for the failure, a narrative that the media parroted, ignoring the fact that if what the Democrats claimed was true, they had the votes to pass the law.

Still, as of this writing on Friday night, a bill was almost certain to get passed. The Democratic congressional leadership and the White House have had a “Continuing Resolution” strategy in their back pocket all along. The plan was to roll goodies for the auto industry and other special interests, a “safety net” package, and the latest version of the Paulson plan in with authority for the government to spend money after midnight on Tuesday. The alternative would be a government shut down.

Thus stands the state of governance of the greatest economic power in the history of the world. And on this basis politicians claim that what is needed is more regulation by government.

The central problem of the deal was that it takes a commanding heights approach. The key beneficiaries are to be the very largest New York-based financial institutions and a few billionaires like Warren Buffett and Bill Gross. Buffet even said as much. He plunked down a cool $5 billion to buy preferred stock yielding 10 percent in Paulson’s old firm, Goldman Sachs, saying he was confident that Congress would pass the Paulson bailout bill.

The plan had a commanding heights problem in the Congress as well. The Democratic leadership, including committee chairmen Barney Frank, Chris Dodd, and Chuck Schumer, were enthusiastic. But it was hard to find an ordinary member who exuded confidence. The president gave a prime-time speech to push the bill on Wednesday night. It was a good performance, but on Thursday morning it wasn’t any easier to find Republican congressmen who supported the plan.

 But the greatest commanding heights problem was that the plan had virtually no public support. Congressmen reported record-breaking email and phone calls from constituents, running as much as 300 to 1 against. The public saw it as a bailout of Wall Street. What had not been explained was how bailing out Wall Street would also help them. There is a good case that could be made on that score, but it hasn’t been.


Ultimately the bill will be a missed opportunity. No one with experience in these matters believes the Treasury purchase plan is workable. It will take weeks, maybe months, to set up-not something that makes sense when the country is allegedly teetering on a precipice. The plan, moreover, should have been accompanied with measures that would stabilize the banking sector and prevent any possiblity of a bank run. On Thursday night the FDIC did a forced sale of Washington Mutual to J.P. Morgan just to avoid the potential disaster of the bank runs that would follow if uninsured depositors were not protected. Eighteen billion had left WaMu in the days leading up to the purchase. On Friday a similar run began on Wachovia. In this environment, not removing the deposit insurance cap could be a recipe for disaster, more than undoing any possible benefits from the legislation.

When the people atop the commanding heights of the economy think that they know best, and their followers’ concerns are ignored, problems inevitably follow. We can only hope that America will be spared relearning this lesson of history, too painfully, this time around.

–Lawrence B. Lindsey, for the Editors


© Copyright 2008, News Corporation, Weekly Standard, All Rights Reserved.

Day of Reckoning


Patrick J. Buchanan
by  Patrick J. Buchanan

How did the United States of America, the richest nation on earth, whose economy represents 30 percent of the Global Economy, arrive at the precipice of a financial panic and collapse?

The answer lies in the abject failure of both America’s financial elite and the political elite of both parties — the same elites now working together to determine how much of our wealth will be needed to bail the nation out of the crisis of their own creation.

Big Government is riding to the rescue — saddlebags full of our tax dollars — to save us from the consequences of the stupidity and folly of Big Government. New York and Washington, the twin cities responsible for the crisis, are now being hailed by the media as the 7th Cavalry, coming to rescue a beleaguered nation.


Had there not been a steady and constant infusion of easy money and credit into the U.S. economy by the Fed, for years on end, a housing bubble of the magnitude of the one that has just exploded could never have been created.

Had the politicians of both parties not coerced and pressured banks, S&Ls, Fannie Mae and Freddie Mac to make all those sub-prime mortgages, then to tie this rotten paper to good paper, convert it into securities and sell to banks all over the world, there would have been no global financial crisis.

Had they seen this coming and acted sooner, the Federal Reserve and U.S. Treasury would not today, like Henny Penny, be crying, “The sky is falling!” and the end times are at hand, unless we give them 5 percent of our gross domestic product to buy up suspect securities backed by sub-prime mortgages.

Consider what the “Paulson Plan” of Treasury Secretary Hank Paulson, against which Sen. Richard Shelby and the House Republicans rebelled, entails.

Since Americans save nothing and have to borrow from abroad to finance our trade and budget deficits, wars and foreign aid, what the secretary proposes is this: that Congress authorize the Treasury to spend $700 billion to buy up the toxic paper on the books not only of U.S. banks, but of foreign banks operating in the United States. According to The Washington Times, the Treasury would also be authorized to buy up securities backed by rotten auto loans, student loans and credit card debts.

Thus America would be borrowing from China, Japan and the Middle East to tidy up the balance sheets of the banks of China, Japan and the Middle East. And all the rotten paper will be offloaded onto U.S. taxpayers, who hopefully will be able to recoup some of their losses, because some of the paper will be good.

Why should we do this? Because otherwise there will be a financial panic, followed by a market collapse, wiping out pensions, 401Ks, portfolios and defined benefit plans of Middle America, forcing millions into bankruptcy and millions more to put off retirement and continue working until they drop.

In a democracy, it is said, you get the kind of government you deserve. But what did the American people do to deserve this? What did they do to deserve the quality of financial, corporate and political leadership that marched them into this mess — and that today postures as their rescuers?

Consider what this mess has already cost taxpayers: $29 billion to buy the rotten paper of Bear Stearns so J.P. Morgan would buy the investment bank; $85 billion for 80 percent of AIG to nationalize it; $150 billion in a stimulus package to flood the nation with cash; perhaps $300 billion to bail out Fannie Mae and Freddie Mac; and now $700 billion to begin taking the toxic paper off the hands of America’s big banks.

And even if this is passed, say Paulson and Fed Chairman Ben Bernanke, there is no guarantee this will resolve the crisis. If the $700 billion is not provided and the toxic paper is not pulled off the books of the world’s banks by U.S. taxpayers, however, we face an almost certain collapse, surging bankruptcies, rising unemployment, a shrinkage of GDP and a recession, if not worse.

Yet, the fellows who tell us we face a financial mushroom cloud over every American city if we do not act at once to provide the $700 billion did not see this coming and can make no guarantee that this will succeed and end the crisis.

Nevertheless, it must be done, and done now, as collapse is imminent.

Looking at all the money being ladled out by the U.S. government to prevent a collapse, and the diminished revenue coming in, it is hard to see how America avoids future deficits that reach $1 trillion a year. These will imperil both the dollar itself and the ability of the United States, which saves nothing, to borrow from the rest of the world. The downsizing of America is at hand.

Yes, indeed, we have arrived at the Day of Reckoning for Uncle Sam.

Mr. Buchanan is a nationally syndicated columnist and author of Churchill, Hitler, and “The Unnecessary War”: How Britain Lost Its Empire and the West Lost the World, “The Death of the West,”, “The Great Betrayal,” “A Republic, Not an Empire” and “Where the Right Went Wrong.”

Troubled Wachovia Seeks Out a Merger

Wachovia Corp. has entered into preliminary talks with a handful of possible buyers — the latest in a parade of banks to look for safety in the arms of a suitor amid concerns that the weak economy is pushing them deeper into peril.

The talks came as Washington Mutual Inc.’s late-Thursday failure rattled the shares of other troubled banks. Shares in Wachovia fell 27% on Friday as investors fretted about its massive mortgage portfolio.

[Wachovia image] Getty Images

People walk by a Wachovia branch in New York City.

Investors are growing concerned that a host of banks nationwide, both large and small, could come under fresh pressure to either raise more capital or else find someone willing to buy them. The trouble stems in part from the fact that a broad range of borrowers, not just mortgage holders, are now starting to default on their debt. For instance, about 2.4% of payments on credit cards are more than 90 days overdue, according to the Federal Deposit Insurance Corp., the highest level since 1991.

Wachovia is talking to potential buyers including Wells Fargo & Co., Banco Santander SA of Spain and Citigroup Inc., according to people familiar with the situation. Wachovia officials don’t believe they need to rush into a deal, and the bank isn’t feeling immediate pressure on its financial condition, people familiar with the company said.

Wachovia declined to comment on the discussions. Earlier Friday, a spokeswoman said the bank is “aggressively addressing our challenges.” Since June, Wachovia has opened 745,000 new checking accounts, she added, indicating confidence among its customers.

Banco Santander, Citigroup and Wells Fargo declined to comment.

In a sign of the depth of tension among financial institutions broadly, banks on Friday remained very skittish about making short-term loans to each other — a crucial ingredient in the banking business. The rate on three-month loans between banks eased slightly, to 3.7%, on Friday. Still, that’s almost double the level that would be expected if the market were more stable.

This reluctance to lend has implications for a broad swath of the business community: Interest rates on short-term loans that corporations routinely use to fund day-to-day expenses also remain extremely elevated.

For financial institutions, “the clock is ticking a heck of a lot faster today,” said Matthew Kelley, a bank analyst at investment-banking firm Sterne, Agee & Leach Inc. The federal government’s seizure of WaMu in the largest bank failure in U.S. history shows that regulators are “not going to mess around” with shaky banks and thrifts, especially given the chaos gripping financial markets.

The structure of J.P. Morgan Chase & Co.’s purchase of WaMu’s banking operations also sent shudders through the market for investment-grade bonds. In the deal, bondholders — who typically have a priority claim over common-stock shareholders — are likely to recover only between zero and 50 cents on the dollar, according to an analysis by independent research firm CreditSights. That could sour investors’ appetite for a wide range of financial-industry bonds.

Washington Mutual’s seizure by the government late Thursday helped push financial stocks lower on Friday. Some of the hardest hit stocks included BankUnited Financial Corp., of Coral Gables, Fla., which fell 21% to 79 cents on Nasdaq and Downey Financial Corp., Newport Beach, Calif., down 48% on the New York Stock Exchange.

Tom Richlovsky, chief financial officer at National City, said the Cleveland-based bank’s 44% stock-price drop Friday is “a temporary, irrational phenomenon.” The decline “ignores the fact that the difference between [National City and WaMu] is like night and day,” he said. National City’s woes relate to its abandoned push into mortgages in places like Florida, far from its home turf.

[Stress on the System chart]

Overall, stocks jumped in Friday trading, largely on renewed hopes that a proposed $700 billion government bailout of the financial sector might be back on track.

U.S. leaders and bank executives hope that the federal bailout package being hammered out in Washington will help steady the industry by giving banks a way to shed some of their most toxic mortgage assets. The vast majority of U.S. banks also remain well-capitalized, giving them a cushion against the sluggish economy and further declines in housing prices.

Across the country, WaMu’s branches opened as usual Friday morning, albeit under new owner J.P. Morgan Chase & Co., which bought WaMu’s banking operations for $1.9 billion.

At a Chicago WaMu branch on Friday, Catriona Johnson, 27 years old, said she had come intending to take out all her money. “I wanted to close my account and hold it in my bra or something,” she said. However, after being told that her account balance is federally insured, Ms. Johnson, the administrative coordinator at a Chicago company that tests homes for the presence of toxins, decided to leave the money alone for now.

WaMu’s seizure by the government eliminated one of the shakiest institutions. But the fact that no one was willing to buy its vast consumer-banking business until the institution actually failed shows how deep the industry’s woes are. In recent years, its prized network of more than 2,200 branches would likely have triggered a bidding war among suitors.

In recent weeks, Wachovia had been talks about a potential merger with Morgan Stanley. But that scenario was apparently put on hold by Morgan’s move Sunday night to convert into a bank holding company instead of an investment bank.

In addition to the problem of widening defaults on credit-card debt, delinquent loans on non-residential real estate rose 20% in the second quarter from a year earlier. Late payments on bread-and-butter business loans, which account for the bulk of the loan portfolios at many banks, jumped 15%. All those percentages are expected to keep rising.

“The housing thing is kind of behind us” in terms of the write-downs, said Ted Salter, chief financial officer of Gateway Financial Holdings Inc., a bank-holding company in Virginia Beach, Va. Now it has “moved into commercial loans, construction loans, development loans,” he said. “Next week, it’ll be something else.”

The 13 bank failures so far this year don’t come close to the savings-and-loan crisis of the late 1980s, when hundreds of shaky institutions failed, costing taxpayers about $130 billion. By other measures, though, some bank executives say the current turmoil is worse, since it is more geographically widespread and involves a broader mix of loans.

Alan Worrell, chief executive of Sterling Bank, a Montgomery, Ala.-based unit of Synovus Financial Corp., says the industry’s problems now are “far worse” because the real-estate market is so backlogged with unfinished homes and other construction projects that it will haunt lenders and borrowers for years.

After generating record profits during the housing boom, it has taken only a year for the banking industry’s profitability to evaporate. Second-quarter profit fell to just $5 billion from $36.8 billion a year earlier, its second-lowest level since 1991.

About 18% of federally insured lenders lost money in the second quarter. Dividends paid to bank-stock investors plunged by $35 billion in first six months of 2008.

Third-quarter results could show the industry’s first overall loss since the fourth quarter of 1990. One big reason: Banks need to set aside more money to cover loans that have gone sour, a move that cuts deeply into profitability.

Forced to conserve capital in order to cover ballooning losses, commercial banks are far more reluctant to lend money than they were just even a few months ago. Of 3,000 companies surveyed by RBC Capital Markets, 25% said it is harder to borrow money than 90 days ago.

There isn’t a clear way out of trouble. There aren’t many investors willing to take a bet on banks right now, particularly given WaMu’s example: In April, it received a $1.35 billion investment from the giant investment firm TPG — which lost the entire amount this week when WaMu failed.

Aside from J.P. Morgan’s purchase of WaMu, few weak banks have been snapped up by stronger ones, partly because would-be buyers have their own headaches.

Some banks are paying unusually high interest rates on deposits to replenish their capital levels. That strategy raises red flags with many bankers because it is often viewed as a sign of desperation.

It can also be a double-edged sword: Banks that don’t want to compete on rates can’t attract deposits that are critical to making loans. In any case, that strategy didn’t work for WaMu, which paid some of the highest rates in the country.

Saddled with a mountain of troubled adjustable-rate mortgages inherited through its 2006 takeover of Golden West Financial Corp., Wachovia has seen its financial condition weaken. The bank’s CEO, Robert Steel, has said the bank has ample capital, noting that it added $20 billion to its certificate-of-deposit balances last summer due in part to a high-interest-rate promotion that began in June.

“I spend a lot of time trying to lay out the fact that we believe we’re liquid,” he said earlier this month. “We believe we have the ability with our current financial position to respond to issues, and we also have some other levers to pull” to improve its financial position, he said.

—Carrick Mollencamp, Ilan Brat and Liz Rappaport contributed to this article.

Write to Robin Sidel at, David Enrich at and Dan Fitzpatrick at