Time moves fast in a crisis. It surprises me that it was only seven weeks ago that I wrote, What A Fine Mess You Have Gotten Us Into, where I commented:
- What the FDIC did with WaMu affects other banks like Wachovia. Bidders will let the holding company fail, and bid for the operating bank subsidiary assets. Holders of holding company securities get hit, as their likelihood of getting reasonable recoveries disappears.
- We are putting a lot of faith in the health of Citigroup, Bank of America, and JP Morgan. If one of them fails, the game is over. Given their complexity, and the recent takeovers, the odds of there being a significant mistake are high. Consider further that they are counterparties for more than 50% of all derivative transactions, so the synthetic leverage is high as well.
What I meant by “the game is over” is that the idea that you can keep laying off risk on increasingly large and complex banks would be over as a strategy. Also, the ability of the US Government to continue to bail out every decrepit entity would be tested, and possibly found wanting.
Or, as I noted on Friday, in my piece Broken…:
There are still more oddities to the current bond market, most of which involve parties that can’t take certain risks any more. We can expand that to banks, and toss in Citi. Citi is trading like it is going out of business. Now, Citi is one of the “too big to fail” [TBTF] banks, along with JP Morgan, Bank of America, and Wells Fargo. If they are in trouble, I’m not sure who can buy them; they would probably be too much for even a coalition of the other TBTF banks to handle. Is there a foreign bank that wants them? I doubt it. This would be another area where a new TBTF chapter of the bankruptcy code would be useful.
So now we have a bailout of Citi by the US Treasury and FDIC. At present the rescue of Citi is a plus to the markets, because it takes a short-term problem off the table, leaving behind a more ill-defined long-term problem: how much can the US Government borrow/guarantee? Also, what of their derivative exposures, and the state of the other TBTF banks? It’s difficult to get that big in a credit boom without absorbing the seeds of the credit bust.
So, I am selling a little into the euphoria. We will see where all of this leads, but my guess is that it is just one more step on the road to credit failure for the US Government.