Interest Rate Roundup

Friday, January 16, 2009

A few pre-vacation thoughts ...

I'll be heading out on the high seas with the family for vacation soon. So you can expect limited posting over the next few days. But I had a few quick thoughts to share before then ...

First, the rumored Bank of America bailout is confirmed. The company is getting a $138 billion government lifeline in the form of a $20 billion capital injection (in the form of 8% preferred shares issued to the government) and a $118 billion guarantee of assets. More specifically, BofA will take the first $10 billion in losses on the asset pool, with all losses beyond that being split between BofA (covering 10%) and the Treasury and FDIC (90%).

According to the term sheet (PDF link), the assets include "financial instruments consisting of securities backed by residential and commercial real estate loans and corporate debt, derivative transactions that reference such securities, loans, and associated hedges."

As a refresher, the combined Merrill Lynch/BofA entity already soaked taxpayers for $25 billion. Meanwhile, in the fourth quarter, BofA lost $1.79 billion, or 48 cents a share. That compared to a profit of $268 million, or 5 cents per share, in the year-ago quarter. Those results didn't include the separate Merrill numbers, which were downright awful: $15.3 billion in red ink.

Second, even more bailouts will now likely be forthcoming given that the Senate voted to approve the second batch of TARP funds. It's likely that any institution receiving taxpayer money will have to accept tougher terms, however. More from the Wall Street Journal:

"The Obama team hasn't detailed where it will direct the next $350 billion beyond foreclosure efforts. It is expected to continue purchasing equity in financial institutions and might also buy troubled assets clogging the financial system.

"Mr. Obama is trying to turn public sentiment toward the financial bailout, which has become politically toxic in the hands of the Bush administration. Lawmakers and much of the public say they are upset at how the money has been spent and accounted for, and the lack of conditions placed on those receiving aid.

"Lawrence Summers, Mr. Obama's pick to head the National Economic Council, said in a letter to Congress that healthy banks with good capital will be required to increase their lending and that Treasury will track such activity. Firms that receive money would also be precluded from using government funds to buy healthy firms instead of lending the money.

"In a nod to concerns about how the bailout has expanded beyond financial firms to include the U.S. car business, Mr. Summers said the second half of the funds would be used to help prevent "systemic consequences in the financial and housing markets," not to implement an "industrial policy" that would aid various troubled industries. To assuage Republican concerns, the Obama team also agreed to provide additional support to the auto industry only "in the context of a comprehensive restructuring."

Third, the U.S. slipped closer to outright deflation in 2008, with the cost of goods and services rising just 0.1%. That was the smallest gain since 1954. The Fed believes that deflation is the root of all evil and has declared it will do everything in its power to avoid it. We'll see if it can succeed in 2009.


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