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Paulson's 'stabilized' financial system destabilizes again

January 14, 2009 |  8:07 pm

Remember Treasury Secretary Henry M. Paulson insisting in mid-November that the financial system had been stabilized?

That was then, and this is now: Financial companies led Wednesday’s sell-off on Wall Street, driving an index of major bank stocks to a new 13-year low and pushing broader market indexes back to early-December levels.

Stabilization? Investors obviously don’t believe it -- not in the face of so much evidence to the contrary in recent days:

-- Citigroup, which got $45 billion in government capital last year, now appears to be in the process of disassembling itself. But the move is only serving to frighten investors, who drove the bank’s stock down 23% to $4.53 on Wednesday -- the lowest since Nov. 21, which was just before the government stepped in with a second round of money for the company, plus asset guarantees.

Bkxindexjan14 -- Bank of America Corp. is seeking more government cash to bolster its capital against potential losses at brokerage Merrill Lynch & Co., which the bank bought Jan. 1, the Wall Street Journal reported. The Treasury last fall pumped $15 billion into Bank of America and $10 billion into Merrill after they agreed to merge.

Bank of America’s shares slumped 45 cents, or 4.2%, to $10.20 on Wednesday -- a 16-year low -- before the Journal’s report, and fell further after hours.

-- Shares of Wells Fargo & Co., long considered one of the strongest U.S. banks, sank $1.31, or 5.4%, to $23.07 on Wednesday after analyst Richard Staite at Atlantic Equities in London warned that the bank may have to cut its dividend and raise more capital as it struggles to digest loss-racked Wachovia Corp. Wells’ stock is down 22% year to date, compared with a 6.6% drop in the Dow Jones industrials.

Although Staite is just one voice, he was prescient last summer in warning that Bank of America was at risk of a dividend cut -- even as the bank’s chief executive, Ken Lewis, insisted that the payout was safe. BofA slashed its dividend 50% in October.

-- Also across the Atlantic, Deutsche Bank helped trigger a sell-off in European stocks Wednesday after the German banking titan reported a larger-than-expected fourth-quarter loss of $6.3 billion.

-- Even before these bank bombs were dropped, Federal Reserve Chairman Ben S. Bernanke on Tuesday conceded that financial-system stability was a myth: He said in a speech that the government would have to provide more aid to banks before there would be any hope of a sustainable economic recovery.

The problem was, and remains, the massive load of bad loans on banks’ books, including home mortgages, other consumer debt and busted corporate loans. And the next big source of trouble is likely to be commercial real estate loans.

Benbernankedec08Until banks’ finances are stabilized -- truly stabilized -- they won’t lend. If they don’t lend, the economy can’t recover. That’s Bernanke’s point.

The Bush administration already has committed most of the first half of the $700 billion financial-system bailout Congress authorized last fall. The incoming administration of President-elect Barack Obama now wants the rest of the money to fund Bailout, Part II.

But here’s one big problem with the sequel: Obama wants to attach some serious strings to the money. For example, his top economic advisor, Larry Summers, told Congress this week that any bank getting "exceptional assistance" from the government would have to limit dividend payments to shareholders to nominal amounts.

From taxpayers’ point of view, that makes sense. But if you’re a bank shareholder -- or potential investor -- a restriction like that is going to make you run the other way.

And if private investors aren’t willing to recapitalize the banks over time, the risk is that the government will never be able to exit from that role.

Given all this, bank stocks have become radioactive once again, and they’re contaminating the rest of the market as well.

Anybody got any good ideas? I'm sure our government will be all ears.

-- Tom Petruno

Photo: Fed Chairman Ben S. Bernanke. Credit: Jose Luis Magana / Associated Press

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