Two More Straws onto a Struggling Camel's Back?

The weekend brought to light a couple of new developments, neither of which bode well for the economy, and by extension, the market.

The first, which will have the most visible impact on John/Jane Doe, is in relation to California's financial woes and their issuance of IOUs. While certainly rare enough (fortunately), the issuance of IOUs by a state in lieu of payments isn't without prescedence. California did the same thing back in '94. What has changed between then and now, is the response of banks to the issuance. Back in 1994, the banks all accepted the IOUs as legal tender, so once the public got over the initial shock, they quickly found that they could deposit the scrip into their accounts and write checks for their rent/mortgage payments, utility bill, etc. So the only effect, actually, was possibly a step, or two, added to the mechanics of the transaction, from the banks' point of view.

This time around, the large banks (BAC, JPM, WFC) have said they will not be accepting the IOUs, which will put a large part of the population of between a rock and a hard place. Evidently, the small community banks and credit unions have been, and will be, accepting the scrip as legal tender, at least for now. I'd think that the action by the banks will place an inordinate amount of pressure on both the California legislature and the Governor to resolve the current budgetary impasse, as well as on the Federal government to do "something" (i.e. backstop California debt).

The second straw is much less visible to the public, though not to the market and its watchers. I'm referring to the FDIC's decision to not guarantee CIT Group's (CIT) bonds. CIT, a lender to roughly 950,000 businesses, has retained Skadden, Arps, Slate LLP, a top flight bankruptcy firm. CIT became a bank last December in order to qualify for government assistance and has thus far received $2.33B in funds from the Treasury. The FDIC has provided guarantees for $274B worth of CIT bonds, but is not inclined to continue doing so, given CIT's deteriorating credit quality. Unfortunately, CIT has $10B of maturing debt through 2010, and may default as early as April, when a $2.1B credit line matures, without continued access to the Temporary Liquidity Guarantee Program (TLGP).

After the implosions/meltdowns of various large financial firms late last year, and early this year, the "action", so to speak, has shifted to small banks, which are being closed down at a steadily increasing rate. Should CIT need "rescue", it would be the largest bank failure since Washington Mutual.

Sources: Bloomberg News

Comments

[Mark Bern:]

As of last week both Wells Fargo and Bank of America were accepting California IOUs. Did they change course? I realize that the SEC had made public its desire to make the IOUs regulated securities and agree with their stance. But when did WF and BAC change their minds? Did I miss something or did the author?

Now, having asked that question, I absolutely agree with the premise that unless something is done to legitimize the situation in California it could put a lot of fear into the markets if things get worse (which is bound to happen if no politicians step up to the plate, preferably those in California).

I also agree that the CIT situation is very serious and could do a lot of psychological damage to the markets if allowed to unravel. But I also suspect that the seizure of CIT assets by the FDIC is part of a greater plan that continues to concentrate more and more of the nation's financial assets in the hands of a few "too big to fail" institutions. I think that our politicians in Washington, DC have been sold a bill of goods by the power brokers on Wall Street and are following ill-conceived advice to "stablize" banking by putting as much as possible into the hands of a few "well-meaning" financial gurus who they trust.

Said gurus are going to get wildly rich and powerful at the expense of taxpayers. We may be on the brink of one of the greatest transfers of wealth in history: from the middle class to the super rich. All in the guise of stablizing the economy and helping the poor. Has anyone ever heard of a "red herring?" This Administration certainly has and it knows how to employ them as distractions better than any other in history. They may not pass a health care bill, but they certainly have a lively debate started and have us all focusing on it. Russia, Iran, saving the environment (the list could go on) are all big issues, true, but if the Administration fails on all fronts it will not be in vain; our attention was diverted from the financial "ball" whenever necessary. As the "favored" banks buy up distressed assets at bargain prices their balance sheets will be strengthened and their future profit potential will be enhanced. The big are just getting bigger. And the bigger the become, the stronger the arguement that they must always be saved by tax dollars, no matter how poorly they are managed in the future.

The only responsible answer is to break up the behemoths down to a number of smaller institutions that can be allowed to fail. Then we need to enforce laws already on the books to keep them from growing insolvent or becoming too large to fail again. We may also need to change rules about foreign ownership so that our financial markets do not become controled by powers outside the US.

I just don't buy the garbage of "too big to fail." Let the bankrupcy laws work. Let the weak die and the strong survive. That is how our economy became the greatest in the world. That is how it can stay in the lead for decades to come.

Jul 13 10:39 AM

[Old Trader:]

Mark,

As of Friday, the banks mentioned announced they'd no longer be accepting the IOUs. Of course, that's not to say that some judicious "arm twisting" behind closed doors might not have them reverse course again, but for now, that's how things stand.


On Jul 13 10:39 AM Mark Bern wrote:

> As of last week both Wells Fargo and Bank of America were accepting
> California IOUs. Did they change course? I realize that the SEC had
> made public its desire to make the IOUs regulated securities and
> agree with their stance. But when did WF and BAC change their minds?
> Did I miss something or did the author?
>
> Now, having asked that question, I absolutely agree with the premise
> that unless something is done to legitimize the situation in California
> it could put a lot of fear into the markets if things get worse (which
> is bound to happen if no politicians step up to the plate, preferably
> those in California).
>
> I also agree that the CIT situation is very serious and could do
> a lot of psychological damage to the markets if allowed to unravel.
> But I also suspect that the seizure of CIT assets by the FDIC is
> part of a greater plan that continues to concentrate more and more
> of the nation's financial assets in the hands of a few "too big to
> fail" institutions. I think that our politicians in Washington, DC
> have been sold a bill of goods by the power brokers on Wall Street
> and are following ill-conceived advice to "stablize" banking by putting
> as much as possible into the hands of a few "well-meaning" financial
> gurus who they trust.
>
> Said gurus are going to get wildly rich and powerful at the expense
> of taxpayers. We may be on the brink of one of the greatest transfers
> of wealth in history: from the middle class to the super rich. All
> in the guise of stablizing the economy and helping the poor. Has
> anyone ever heard of a "red herring?" This Administration certainly
> has and it knows how to employ them as distractions better than any
> other in history. They may not pass a health care bill, but they
> certainly have a lively debate started and have us all focusing on
> it. Russia, Iran, saving the environment (the list could go on) are
> all big issues, true, but if the Administration fails on all fronts
> it will not be in vain; our attention was diverted from the financial
> "ball" whenever necessary. As the "favored" banks buy up distressed
> assets at bargain prices their balance sheets will be strengthened
> and their future profit potential will be enhanced. The big are just
> getting bigger. And the bigger the become, the stronger the arguement
> that they must always be saved by tax dollars, no matter how poorly
> they are managed in the future.
>
> The only responsible answer is to break up the behemoths down to
> a number of smaller institutions that can be allowed to fail. Then
> we need to enforce laws already on the books to keep them from growing
> insolvent or becoming too large to fail again. We may also need to
> change rules about foreign ownership so that our financial markets
> do not become controled by powers outside the US.
>
> I just don't buy the garbage of "too big to fail." Let the bankrupcy
> laws work. Let the weak die and the strong survive. That is how our
> economy became the greatest in the world. That is how it can stay
> in the lead for decades to come.

Jul 13 10:44 AM

[John Galt:]

The state of California is issuing funny money that must be accepted as legal tender. It's like a junkie that wants another high but just doesn't have enough money. I don't have the money now, but I promise I'll pay you back...

Jul 13 10:52 AM

[sarge 907:]

"To big to fail" my butt. America, let's take our medicine now while we still have a very small chance to survive this maddness.

It may be too late to oust our new Washington manipulators and Acorn (Soros) but we better damn sure wake from this fanatical trance into which we've been placed.

I'm old and have been through this four times before, including the "big one of '29, but to let our so called elected representatives sell our future generations into perpetual slavery is un-conscionable.

This is one time I'm glad I'm not long for this life because those who remain are not going to like the run-away train headed into their future.

Jul 13 12:44 PM

[Socialism c...:]

Will we not look back on this years from now and see an engineered takedown of small business and all that stood in the way of mega-banks and mega-corps in line with the neo-Marxist and globalist regimes? Sure seems that way. A few large banks have been selected to win. Our industry is either being closed down or taken under government control. Small biz is being pillaged with taxes and having its credit withdrawn. And the individual is being subjugated by the totalitarian state with high taxation for the productive and dependence by the non-productive. We are ever less free, with fewer and fewer large business and political organizations taking the reins.

Jul 13 12:51 PM

[Jason Rines...:]

Very true Socialism Cant Compete, the strong get stronger especially with uncle sam aiding and abetting the process. Remember something. Those 'productive' become less and less productive as work becomes merely a method to have bare-bones sustinence. The opportunity to benefit is far more powerful pyschology then austerity and fear. So the current Feudalist globalism will not last (although some portions of it are worth keeping). What lack of production and revenue doesn't kill off on this model, war will.

Mankind's progress never moves in a straight line. This is an end of an era of pushed supply side economics, centralized governments and banking and 'might makes right' mentality. As this world continues to implode financially then explodes in war and societal collapse, the rebuilding will be towards decentralized government and banking system to bottom up citizen powered governments. At the end of every era are the wealthy and powerful that cause turmoil and destruction whom are resistant to mankind's progress and deter it. In any event, I do not expect a utopia on earth until man has a much better grip of genetic engineering. Meanwhile, I do expect 15 years of global economic hardship and military misadventure.


On Jul 13 12:51 PM Socialism cannot compete! wrote:

> Will we not look back on this years from now and see an engineered
> takedown of small business and all that stood in the way of mega-banks
> and mega-corps in line with the neo-Marxist and globalist regimes?
> Sure seems that way. A few large banks have been selected to win.
> Our industry is either being closed down or taken under government
> control. Small biz is being pillaged with taxes and having its credit
> withdrawn. And the individual is being subjugated by the totalitarian
> state with high taxation for the productive and dependence by the
> non-productive. We are ever less free, with fewer and fewer large
> business and political organizations taking the reins.

Jul 13 05:13 PM

[TucsonSpike:]

Is America too big to fail? Is California too big to fail? Of course not. So why is AIG too big to fail? And why is GS so privileged? The process of having the government pick the winners has turned the rest of us into losers in the great scheme of things.

It seems apparent to me that the Greater Depression has hardly gotten going, and that government action is, as Old Trader points out, making matters ever more challenging.

Jul 14 03:18 PM