Optimism doesn’t last long in the US

The $326-billion rescue of Citigroup was, some investors hoped, a turning point.

It prompted a concerted rally on Wall Street last week as shareholders were reassured that the United States authorities would not allow another major bank to collapse.

The Dow Jones gained more than five straight days for the first time in more than a year; the S&P 500, considered a barometer of the domestic economy, had its best week in 34 years.

“The government pretty much came out and said it would not let Citigroup fail and it was not going to wipe out the equity holders either,” said Pri de Silva, analyst at Creditsights, a Wall Street research group.

Then, on Monday, came the rout. US recession was confirmed and the Dow showed its second largest fall this year. The question now is how resolute is the government’s determination to soak up the cost of holding up the system. With recession under way, analysts fear more home loans, credit card debt and even private equity deals will go bad.

“The worry is that unemployment will rise and people will not be able to service their consumer borrowings as well as their mortgage,” says Brian Gendreau, an investment strategist with ING Investment Management in New York.

The cost so far to nationalise mortgage providers Freddie Mac and Fannie Mae, and fund the troubled asset relief programme (Tarp) for recapitalising banks is more than $1-trillion.

“The problem is bigger than anybody has admitted so far,” warns Nariman Behravesh, chief economist at forecaster IHS Global Insight. “The government is going to have to do more. The Tarp will have to be expanded and the Federal Reserve might have to become the lender of first resort.”

The assumption markets appear to have made last week, that the US authorities will step in, will have alarmed any US taxpayer who read a note last week by Meredith Whitney, the Wall Street analyst who predicted the near-collapse of Citigroup.

The banks are forecast to incur $44-billion in impairment charges and credit-card-related provisions in the final quarter this year.

There is $350-billion left in the Tarp, but will that be enough? Whitney warns that other off balance-sheet debts held by the big banks, as well as credit card loans, will also have to start coming back on to the accounts by the end of next year. Yet more capital will have to be held against those debts to protect customers’ savings.

Including credit card debts, Citigroup is exposed to $1,2-trillion of off-balance-sheet debt, JP Morgan to $735-billion and Bank of America to $73-billion.

Not all of it will be dumped back on to profit and loss accounts, but Whitney warns her estimates do not include off-balance-sheet mortgages. “We are unclear what the magnitude of that will be.”

Last week’s optimism is giving way, once again, to uncertainty. —

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