Obama's Gloomy Bailout Inheritance

Includes: BAC, C, CCTYQ
by: Rick Newman

The last days of the Bush/Paulson bailout regime reveal just how tough it's going to be for new President Barack Obama to rescue the right companies - while letting the rest go under.

Let's start with Bank of America (NYSE:BAC), the latest Wall Street ward of the state. Just three months ago, the bank’s CEO, Ken Lewis, seemed indignant about being forced to take $25 billion in bailout money from the Treasury Dept. Unlike a bunch of other wastrel banks, B of A was supposedly healthy, and didn't need the money. It even had the wherewithal to purchase teetering Wall Street titan Merrill Lynch, the kind of opportunistic deal-making Lewis is known for.

[See the bright side of Bank Bailout 3.0.]

It’s turning out, however, that the financial rescue has more sequels than Friday the 13th – and they might be more scary. Merrill Lynch was even more wrung out by bad investments than B of A realized last September, so Lewis came asking for an extra $20 billion courtesy of the taxpayers.

It’s bad enough that the banking system has become a black hole. What’s more alarming about Bank of America’s Round 2 is that Lewis was one of the "survivors" of the carnage on Wall Street, one of the sensible bankers smart enough to avoid the worst abuses of the housing bubble. But now he’s actually bought into those abuses. And so have we.

[See why there's nothing new about this recession.]

This helps explain why Obama will inherit a banking crisis that might actually be worsening instead of getting better. The housing bust has been playing out for well over a year, yet Lewis still couldn’t predict the huge, ongoing losses at Merrill. Why should anybody have confidence in a bank like this? Or do business with it? And if Bank of America is having problems like this, what about the other big banks? Those that are left, anyway?

Giant Citigroup (NYSE:C), already 7 percent owned by the government, lost $19 billion in 2008, and there’s no sign its woes are over. It's still looking for ways to work through its huge mortgage-related losses – like splitting itself into a “good bank” and a “bad bank” – while losses on credit cards, car loans, and other consumer defaults are likely to spike in coming months as the recession deepens. Citi’s stock price is now below $4, well inside the danger zone that signals the fate of the entire company is shaky. Even JP Morgan Chase (NYSE:JPM), not long ago considered the White Knight of the Wall Street meltdown, lost money in the fourth quarter, when analysts were hoping for a small profit.

For awhile, it seemed reasonable to hope that the $350 billion Bush has already spent on financial bailouts might do the trick and stabilize the system. But now it looks like that money might only have been a down payment. Obama will clearly have to continue the transfusions, and maybe find a more radical form of surgery.

[See why letting Lehman Brothers fail might have been the best move of 2008.]

Barely noticed amidst Bank Bailout 3.0 was a $1.5 billion government loan for Chrysler Financial, the automaker’s lending arm, which brings the total federal investment in Chrysler (so far) to $5.5 billion. Just as important is the bailout that didn’t happen: Circuit City (OTC:CCTYQ).

In more normal circumstances, the big retailer, which filed for Chapter 11 protection in November, probably would have been able to get special financing allowing it to restructure and emerge from bankruptcy as a smaller, healthier company. But with lenders hoarding money, Circuit City was out of luck. It’s liquidating all of its holdings and closing more than 500 stores.

Unfortunately, we're just at the beginning of a wave of bankruptcies and liquidations that will become one of the sad recurring themes of 2009. And Obama will have to make painful decisions about which companies get treated like Chrysler, and which like Circuit City. Both companies belong to industries where there’s overcapacity, so you could argue that neither is vital to the U.S. economy. Circuit City employs about 30,000 Americans, Chrysler a bit more. They’re both established brand names. Yet one gets a lifeline, the other, nada.

[See why more failure in 2009 might be healthy.]

Obviously the government can’t save every troubled company, and it shouldn’t. But as failures mount in 2009, Obama will have to offer one important thing that Bush hasn't: A convincing explanation for who deserves to be saved, and who doesn’t.

Disclosure: no positions