In the same week two of the nation’s largest banks narrowly avoided a meltdown of colossal proportions. As the smoke cleared on Friday, both escaped the worst, however Bank of America cut its dividend to a penny and both it and Citibank reported dismal fourth quarter earnings while continuing to write off mega billions of bad loans. Bottom line: I have been negative on the financial sector for over a year and I expect more bad news in the future.
In the meantime, Citibank is being “reorganized” which is financial speak for selling off what they can to whoever will buy it. This way, the Treasury can argue that Citi is still in the banking business (even if it is a mere shadow of its former self). This, the government hopes, will maintain the fiction that the billions we have already invested to keep it afloat have not been spent in vain. Wait, it gets worse.
Bank of America just received another $20 billion bail-out on top of the $25 billion it received in the first Tarp giveaway. They claimed they needed the money in order to prop up Merrill Lynch. The government is also going to guarantee $120 billion worth of the bank’s assets. Investors may recall that the bank bought the nation’s largest broker back in September for $50 billion in a rescue operation. Since then, Merrill has continued to hemorrhage, piling up losses at an alarming rate.
Finally, last month, Bank of America was forced to return to Washington for an emergency capital injection. Unfortunately by then all of the $350 billion TARP money that Congress approved had already been spent. But never fear, both President Bush and President-elect Obama tagged-teamed the Senate into agreeing to release the second half of the $700 billion financial rescue fund. So the only question remaining is how fast the rest of our billions will disappear down this rabbit hall that we call our banking system?
The problem we face is that our financial institutions are like a house of cards that is so fragile that even the slightest pressure could collapse the entire structure. If one bank topples it could take one, two, three or more down with it because all their loans are interconnected. The pros call it counter-party risk: I loan to you, you loan to her, she loans to him and back to me. This week investors confronted that risk yet again.
Readers may recall that I had been looking for an extension of the rally that started in November of last year. I had hoped the markets would continue to move higher into Inauguration Day and possibly beyond. This week’s problems with the banks precipitated a sharp decline and threw a monkey wrench into my expectations. I take some consolation in my warning to investors that this rally was nothing more than a Bear Trap.
But the markets are volatile and anything could happen. I wouldn’t be surprised to see the market move higher again, possibly next week, but don’t be fooled. I still believe we have not seen the lows.