Forget free-market fundamentals. What matters most to the capital markets now is whether the governments of the U.S. and western Europe have the will and the wherewithal to save the global financial system from disaster yet again.
A healthy climate for the efficient allocation of capital, this is not.
By pledging to keep its benchmark interest rate near zero through at least mid-2013, the Federal Reserve succeeded (for a couple of hours) in propping up U.S. stock markets after two days of gut-wrenching declines, especially in financial stocks. The news came a day after the European Central Bank embraced the role of savior by buying sovereign debt of Italy and Spain, sending yields on those countries’ bonds plunging and offering respite to financial institutions that hold them.
The notion that the world’s governments won’t permit an economic meltdown seemed to be operative, less than two weeks after the U.S. Congress threatened to torch the nation’s full faith and credit. Then yesterday the equities markets fell out of bed again. The open question is how long investor confidence in the policy makers’ powers can last.
This has added relevance in light of one of the developments that sent Bank of America Corp.’s stock down 20 percent Aug. 8 -- the news that American International Group Inc. had accused the company of securities fraud in a lawsuit seeking more than $10 billion. Naturally the question arises: Didn’t AIG consult with anyone at the Treasury Department, which owns 76.7 percent of AIG, about whether to fire this market-sinking torpedo at a too-big-to-fail bank so soon after Standard & Poor’s downgraded the U.S. credit rating?
Bailouts at War
It would seem not. A Treasury spokesman, Mark Paustenbach, said: “As per our stated principles, Treasury does not interfere with the day-to-day management of the company.” Just when you think the government might have matters under control, we find out it can’t even keep a bailed-out company it controls from trying to blow up Bank of America, which itself needed federal bailout money to stay afloat.
One thing that’s certain is that investors aren’t feeling very good about large financial institutions’ balance sheets. As of yesterday, there were 186 U.S.-based financial-services companies trading for less than 60 percent of their book value, or common shareholder equity, including Bank of America, Citigroup Inc., Morgan Stanley, AIG and SunTrust Banks Inc. Together they had a stock-market value of $300.5 billion, compared with $686.4 billion of book value, according to data compiled by Bloomberg.
When I ran the same stock screen for a June 2008 column, a few months before the financial crisis reached full flower, it turned up 168 companies with a combined $120.3 billion market value and a book value of $270.3 billion. The way the credit crunch was playing out then, market declines were begetting writedowns, leading to more market declines and then more writedowns. A year later the cycle broke, thanks to unprecedented government intervention. The largest U.S. banks were reporting quarterly profits again.
Like a Slinky walking down a flight of stairs, though, all it may take is the slightest push for inertial energy to set the writedown cycle in motion again. For instance: Bank of America, at 33 percent of book value, finished yesterday with a $68.6 billion market capitalization. That’s less than the $71.1 billion of goodwill on its June 30 balance sheet. (Goodwill, which isn’t a saleable asset, is the ledger entry a company records when it pays a premium price to buy another).
You Gotta Believe
So, Bank of America would have us believe the goodwill by itself was more valuable than what the market says the entire company is now worth. Investors don’t buy that. They see a company that needs to raise fresh capital, judging by the discount to book value, in spite of the company’s claims it doesn’t need to. The more the stock price falls, the more shares Bank of America would need to issue to appease the markets, leading to fears of even more share dilution.
The same story is playing out in Europe, driven by the sovereign-debt crisis. The 32 companies in the Euro Stoxx Banks Index yesterday had a stock-market value of 313.2 billion euros ($444 billion) and a combined book value of 620.5 billion euros. France’s Credit Agricole SA, the index’s third-largest bank by assets, trades for just 34 percent of book.
Two years ago the central planners convinced investors that the biggest surviving financial institutions would be able to earn their way back to health, in part through low interest rates and taxpayer support. The pressing question soon may be whether there is enough money on the planet to save the system as we know it, and if so, how much longer it will be before a crisis comes along that finally swamps the ability of governments to contain it.
One-hit wonders such as Fed-induced stock-market rallies can induce euphoria momentarily. They don’t fix the big problem.
(Jonathan Weil is a Bloomberg View columnist. The opinions expressed are his own.)
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