As the United States celebrates the coronation, (oops, we mean inauguration), of President Obama, we remain amazed that there is a misguided view that a new Presidency and New Year are going to magically cure the severe economic crisis the world is facing today. To be fair, President Obama has staffed his administration with some of the most brilliant economic minds of both past and present, and we applaud his choices thus far. We are also happy to hear that President Obama has completely backtracked on his campaign promises of raising taxes, and is now solely focusing his team’s efforts on restoring confidence and growth in the economy through some form of stimulus package. It is our belief that the market was waiting for details of Obama’s stimulus package and when none were announced yesterday in his speech combined with the announcement of more dire economic data the stock market lost 330+ points closing below the 8000 mark. It is our hope that this stimulus package once detailed will create jobs, temper inevitable inflation and that the administration, unlike the failed TARP, will require banks to write down their bad loans and make banks lend again.
However, one of the myriad of major economic challenges facing the new administration is its ability, or lack thereof, to say no to companies who come to the trough asking to be bailed out. The US financial crisis may reach $3.6 trillion in losses which is a serious problem as the US banking system only has $1.4 trillion in capital. We continue to have two of the largest financial institutions lining up for handouts. On one hand, there is Citigroup which has already received $45 billion of government capital and a US guarantee on $306 billion in troubled assets while unwinding its once famed “supermarket” financial model with the impending sale of its brokerage division to Morgan Stanley, another bailed out bank. Bank of America, on the other hand, said that it will need more government aid to help absorb its pending purchase of Merrill Lynch blaming what they are saying are “previously undisclosed losses” from the Merrill Lynch transaction and have threatened to kill the purchase altogether. The Treasury Department, which we have renamed “The Shoot, Fire, Aim Department” went ahead and made an emergency injection of $20 billion, on top of the $15 billion and $10 billion Bank of America and Merrill has already received respectively. From our financial simpleton perspective, both Citibank and Bank of America have received MORE government money than the current market capitalization of each company. Citibank’s market capitalization is approx $19 billion, yet it has received $45 billion in aid thus far; Bank of America’s market capitalization is $36 Billion, and it has received $45 billion.
The situation with Bank of America may prove to be uglier than that of Citigroup. When the news came out in September that Bank of America had agreed to purchase Merrill Lynch, we could tell that there would be problems down the road. A quick view of a chart of Merrill Lynch’s stock at the time showed that the company was on the verge of imploding just the way Bear Stearns and Lehman Brothers did. Yet Ken Lewis, the CEO of Bank of America, believed there was value in Merrill Lynch and made a decision, along with his Board of Directors, to step in and purchase Merrill Lynch. Did we all forget that back in 2006, at the very height of the housing boom, Bank of America purchased Countrywide Financial and is now stuck with its pool of highly toxic mortgage assets? Or should we say the US taxpayer is now stuck with? Maybe Ken Lewis was purchasing Merrill Lynch with the hope that people would forget about Bank of America’s previous blunder. Now, only three months after the announcement of the Merrill Lynch deal and in the shadow of the Countrywide Financial mess, Bank of America has successfully stuck taxpayers with the bill again.
In our opinion, the charade at Bank of America has gone too far and is borderline illegal. It was only the mammoth size of the company that gave it the leverage to put pressure and basically threaten the US government by saying that if the company did not receive aid, the risks to the economy would be unthinkable (doesn’t that sound familiar?). It is time for Ken Lewis and the Board of Directors at Bank of America to step aside. The ideal situation would have been an orderly liquidation of both Bank of America and Citibank letting the incompetent banks fail, rather than having the Fed prop them up, creating “zombie banks” owned by the US taxpayer. Lets not kid ourselves, taxpayers clearly already own Citibank and at this rate will probably soon own Bank of America as well. The excessive risk-taking and greed by the banks and their executives must be accounted for.
Governmental and financial industry blunders aside, one of the most frightening things about the situation we are facing today is that there is still very little understanding of how we got into this mess. The lack of understanding, in both the public and private sector, is hurting our chances of recovery. We do not believe Americans know where their tax dollars are being spent. For example, Citigroup is now using supertankers to store oil off the coast to profit from a commodity trading phenomena called “contango”, where buyers pay more for delivery of crude oil in this case, later in the year. With this action, Citigroup is not only blatantly risking more capital, but the company is also using taxpayer capital to store oil which is taking supply off the market, which in turn raises the prices of oil causing taxpayers to pay higher gas prices. And naturally, anything one bailed out bank can do others will follow: Morgan Stanley is now seeking a similar oil storage arrangement.
If spending, borrowing and inflating too much money got us into this mess, it’s hard to believe that the same things can get us out. The Federal Reserve has become too involved in central planning through, amongst other things, the manipulation of interest rates and nationalization of various US industries when what we need right now is too restore confidence that a market economy works. The 20th century proved that central planning doesn’t work but here we are printing more money, taking on more debt and nationalizing our banking and other industries. The Federal Reserve is trying to prop up the bad debt and dump it on the taxpayer and they don’t realize by borrowing more and more money they will be crowding out the same consumers that they are trying to induce to borrow long before they can ever repay them. The longer we delay the liquidation and write down of outstanding debt, the longer the agony will be. Had the Fed just decided to stay out of the market, and let the market find its own equilibrium, a new private sector banking system would have emerged by now that could have filled the void the Fed has decided to fill on its own.
We hope that the Obama stimulus package will create an economic environment of saving, job creation at home and outpace inevitable inflation, rather than borrowing from abroad to finance spending. We believe that it will take two to three years of pain and depressed economic activity before we see an increased level of savings and a recovering US consumer. We have to remember that we are working through the wreckage of what is the biggest credit bubble in history and the shock to the financial system is severe but we will be better off for it in the long run. The less the Federal Reserve and Treasury interfere with markets and private sector, the quicker we can begin the recovery process. We are hopeful that President Obama and his staff, unlike the previous administration, will do the right thing for the American people. God Bless!
