MarketView for October 6

Summary

 

Wall Street chalked up its fourth consecutive trading day of losses on Monday, leaving the Dow below 10,000 for the first time in four years, on fears the global economy was hurtling into recession despite government efforts to contain the fast-spreading financial crisis, as lending came to a virtual halt and the Street began to consider in earnest the crumbling outlook for the economy and profits.

 

To its credit, the markets did manage to reduce losses by almost half in the final hour of the session, on speculation that the sell-off may trigger a coordinated global response to thaw credit markets. The Dow was down as much as 800, a record intraday point drop for the blue-chip average. However, by the closing bell, though, the Dow had recovered 430.18 points to end down 3.6 percent. Year to date, the Dow is down about 25 percent, the S&P 500 is down 28 percent and the NASDAQ is down 29.8 percent.

 

Wall Street's drop was part of a breakneck global sell-off, which led to trading being halted in Russia, Brazil and Peru. The emergency rescue of two big European banks and a move by several European governments to guarantee bank deposits intensified fears that the credit crisis can not be contained.

 

After the closing bell, there was more tough news for the banking sector. Bank of America cut its dividend in half, unveiled plans to sell $10 billion of new stock and said third-quarter profit was cut in half from a year ago.

 

Bank of America warned that credit quality continued to weaken during the quarter and said the economy has moved to a "recessionary environment." Shares of Bank of America, which had fallen 6.6 percent to $32.22 during the regular session, fell another 7 percent in after-hours trading.

 

The energy sector skidded as the price of oil dropped to an 8-month low below $88 a barrel on expectations that a recession will further hamper global fuel demand. Among shares of energy companies, Chevron lost 3.2 percent, closing at $76.84. An index of oil services companies fell 7.8 percent.

 

Technology companies, which often have significant overseas exposure, were down sharply. Shares of Oracle, the world's third-largest software maker, ended the day down 6.1 percent to close at $18.30, after German rival SAP AG said it saw business drop off at the end of the third quarter.

 

Shares of eBay Inc fell 5.5 percent to $17.89 after the company said it plans to cut 10 percent of its work force and spend about $1.3 billion on acquisitions to bolster its online payment and classified units as it tries to counter the weak economy. 

 

Citigroup and Wells Fargo Battle It Out

 

Wells Fargo & Co and Citigroup Inc are in talks to end their battle over Wachovia on Monday, with a top regulator forecasting a resolution by the end of the day on Monday. The increasingly bitter dispute, which flared through the weekend, has drawn in government officials in an attempt to broker a compromise. Sheila Bair, chairman of the Federal Deposit Insurance Corp (FDIC), said she expected an agreement "that serves the public interest" to be reached Monday.

 

Citigroup, which announced a preliminary agreement to buy Wachovia's banking assets for $2.2 billion a week ago, is apparently considering an offer for the entire bank. However, Citigroup also is not interested in buying Wachovia assets without some sort of government guarantee, unlike Wells Fargo, which made a $15 billion counterbid for the entire bank on Friday.

 

In its latest courthouse volley against Wells Fargo, Citigroup said it was seeking more than $60 billion in damages from Wells Fargo. Citigroup also pointed out that in its opinion, Wachovia would have collapsed on September 30 without its agreement to acquire most of its assets.

 

Wells Fargo, the seventh-largest U.S. bank by assets, has managed to remain profitable during the credit crunch, while Citigroup is looking to turn around its ailing business after posting about $60 billion in write-downs and losses.

 

Crude Down 6 Percent

 

The price of crude oil fell more than 6 percent to below $88 a barrel on Monday as a global market rout churned concerns that faltering fuel demand could slow further. Domestic sweet crude settled down $6.07 per barrel at $87.81 after hitting an eight-month low of $87.56. London Brent settled down $6.57 per barrel at $83.68. Crude prices have plummeted as high fuel prices and the growing financial crisis slow oil demand in top consumer the United States and other industrialized nations.

 

Analysts are watching oil demand from China, which helped fuel a 6-year rally in commodities, for signs the crisis is hitting consumption. The world's second largest consumer will not import gasoline for the second straight month and instead export the fuel due to heavy domestic stockpiles and a dip in demand.

 

Ecuadorean Oil Minister Galo Chiriboga said OPEC will analyze the impact of the global financial crisis on oil demand and set production levels in accordance. Iran said $100 a barrel was too low and urged members to respect their output targets to prevent oversupply from worsening. OPEC President Chakib Khelil said OPEC would seek to balance the market when it meets in December.

 

FDIC Prepares For More Failures

 

The FDIC is working aggressively to implement higher deposit insurance limits and to ensure that there will be sufficient reserves to cover losses from more bank failures, the chairman of the Federal Deposit Insurance Corp said on Monday.

 

"We're working hard to assure that our industry-funded reserves will be sufficient to cover projected losses from more bank failures," Sheila Bair said in remarks to a business economics conference. "The fund has decreased as a result of recent bank failures."

 

Bair said legislation passed last week that raised the deposit insurance limit to $250,000 per account from $100,000 "does not solve all of the problems in the industry" but will give depositors critically important confidence in the safety of their money.

 

The temporary increase in deposit insurance was part of a $700 billion government plan to purchase soured mortgage-backed assets and unfreeze credit markets. Meanwhile, regulators will carefully watch for any risks associated with raising the deposit insurance limits, especially if the guarantee encourages banks to engage in more risky lending, Bair said.

 

Bair also said the FDIC will on Tuesday consider an increase in insurance premiums that banks must pay, bolstering the deposit insurance fund which stands at some $45 billion. The premium proposal shifts a greater share of any increase to banks that engage in more risky practices, such as accepting short-term "broker deposits."

 

Bair reiterated that the deposit insurance guarantee is absolute and that the FDIC has authority to borrow from the U.S. Treasury Department if it needs to.

 

She also laid out principles to guide mortgage finance reform. She said consumers must be protected from loans that are not affordable or too complex. Further, she said financial institutions need to restrain their leverage and not seek higher returns without proper regard for the associated risks.

 

Bair said the incentive structure needs to be revised so that mortgage originators and underwriters are not rewarded for actions that don't serve the long-term interests of borrowers and investors.

 

Lastly, she said banks need to not take liquidity for granted.

 

"At the end of the day, liquidity is only as stable as our institutional practices, and the public's confidence in those practices," Bair said.

 

She said tougher regulation is "absolutely needed" to enact these principles. "We especially need to plug the gaps that allowed regulatory arbitrage, which is one of the root causes of the explosion in subprime lending that triggered the housing meltdown," she said.

 

But she stressed that the financial system does not necessarily need more regulation, just smarter regulation.

 

Fed Keeps Trying

 

The Federal Reserve on Monday announced a series of steps to funnel massive amounts of liquidity through clogged credit markets, including boosting the sizes of cash auctions and offering banks interest on reserves.

 

"The Federal Reserve is substantially increasing the size of the Term Auction Facility (TAF) auctions," the central bank said in a statement. Specifically, the Fed will boost its 28-day and 84-day TAF auctions to $150 billion each.

 

The Fed will also begin paying interest on reserves held by the central bank with required reserves receiving a larger payment than excess balances.

 

Required reserves will be paid interest at a rate of 0.10 percentage point below the federal funds rate. Excess balances held by the Federal Reserve will be paid 0.75 percentage point below the funds rate - although the Fed said that it might yet tinker with that formula.

 

"Together, these actions should encourage term lending across a range of financial markets in a manner that eases pressures and promotes the ability of firms and households to obtain credit," the Fed said in a statement.

 

Bank of America Forced To Finally Cave In

 

Bank of America, the largest U.S. bank, reported a 68 percent drop in quarterly earnings on Monday, cut its dividend in half and said it would seek to raise $10 billion in additional capital. The weaker-than-expected third-quarter profit, announced two weeks early, sent the bank's shares down 9 percent in after-hours trade.

 

Bank of America has been seen as one of the industry's pillars of strength and most recently made headlines with its plan to acquire Merrill Lynch. However, the stalwart finally caved in with the results and accompanying moves to bolster capital, indicating that it too is suffering from the credit crisis.

 

"These are the most difficult times for financial institutions that I have experienced in my 39 years in banking," said Kenneth D. Lewis, its chairman and chief executive officer, in a statement.

 

Bank of America warned that credit quality continued to weaken during the quarter, and Lewis said he expected higher credit losses and depressed earnings ahead. Third-quarter earnings fell to $1.18 billion, or 15 cents per share, from $3.70 billion, or 82 cents per share a year ago.

 

The weaker earnings were driven by higher credit costs resulting largely from two of its most recent acquisitions, Countrywide Financial, which had been the country's largest independent mortgage lender, and Chicago-based LaSalle Bank.

 

Bank of America said it was cutting its quarterly payout to 32 cents a share from 64 cents, which will add more than $1.4 billion in capital per quarter. In addition, it has undertaken to sell $10 billion in new common stock.

 

According to the earnings release, consumer credit card business saw a decrease in purchase volumes, slowing repayments and increased delinquencies during the quarter. On a conference call with analysts and investors, Lewis said credit quality would continue to be an issue over the next several quarters.

 

The bank said it was benefiting from a "flight to quality," with retail deposits up $56 billion from the previous quarter to $586 billion. That included the addition of $35 billion from Countrywide. Revenue from its capital markets and advisory services was hit hard by charges related to collateralized debt obligations (CDOs), which totaled $952 million, while write-downs on leveraged loans and commercial mortgages totaled $327 million. CDOs are securities backed by a pool of bonds, loans or other assets.

 

Equity investment income was hit by $320 million in write-downs on preferred stock of Fannie Mae and Freddie Mac. Lewis said he believed it was important for Bank of America to be at or near its 8 percent Tier 1 capital ratio target, given the recessionary conditions and outlook for still weaker economic performance. Tier 1 is a measure of a bank's capital strength.

 

Lewis said on a conference call the recent events had been "breathtaking." He said it would take time before any increased liquidity from the just-passed $700 billion U.S. financial bailout is seen.