Credit taps running dry in the U.S.
Businesses, consumers and even state governments left in the lurch
BARRIE MCKENNA
With files from reporter Tara Perkins
October 4, 2008
WASHINGTON -- In the chaotic two weeks it took to get a monster bank rescue through the U.S. Congress, the credit crisis has spread like a virus, infecting people and companies far beyond its epicentre in U.S. housing.
Many Americans can't get car loans. Companies of all kinds are struggling to secure operating cash. Banks and brokerages are too afraid to lend to each other. And many state and local governments are facing financial ruin because they can't issue bonds to pay for roads, schools and other essential services.
California Governor Arnold Schwarzenegger, the former tough-guy actor, sounded like a frightened man as he begged U.S. Treasury Secretary Henry Paulson this week for a $7-billion (U.S.) emergency loan.
"Absent a clear resolution to this financial crisis, California and other states may be unable to obtain the necessary level of financing to maintain government operations and may be forced to turn to the federal treasury for short-term financing," the Governor wrote to Mr. Paulson. "California is so large that our short cash-flow needs exceed the entire budget of some states."
California is big, but it isn't alone. U.S. states are required by law to balance their budgets every year. So they typically borrow cash at the start of the year, paying off those loans when sales and property tax revenues come in later in the year. But with fear gripping lenders, that kind of arrangement isn't available at a reasonable cost, if at all.
The situation in the commercial paper market is particularly worrisome. Otherwise solvent companies risk going into default because they can't roll over their maturing debt.
Indeed, outstanding commercial paper fell by more than $97-billion in the week ended Oct. 1, the U.S. Federal Reserve said this week.
Commercial credit markets have begun to take on the atmosphere of a back-alley, loan-shark operation. On Thursday, nearly 100 corporate treasurers from across the United States joined in an emergency conference call to complain of problems renewing lines of credit, including exorbitant fees and interest rates, driven higher by fear as much as fundamentals.
"It is now clear that the U.S. financial system is in cardiac arrest," economist Nouriel Roubini of New York University warned ominously yesterday.
Some U.S. companies are now looking in unconventional places to avoid the less palatable alternatives in the dysfunctional credit market.
Without explanation, Xerox Corp. said yesterday it would tap into excess cash available in its Canadian subsidiary, Xerox Canada, to secure a $300-million (Canadian) loan.
U.S. authorities warned of economic Armageddon without a monster bank rescue. The danger now is that the worst-case scenario may happen anyway.
Compounding the problem, the world's largest economy is almost certainly in recession, and the rest of the planet may not be far behind.
The latest in a wave of grim economic news was a report yesterday that 159,000 jobs vanished in September - the most in five years.
"Beyond the attention-grabbing crisis in financial markets, the long-running crisis in the real economy continues," said Jared Bernstein, senior economist with the Economic Policy Institute in Washington.
U.S. factories are gearing down, consumers are pulling back and the housing market has yet to find a bottom. Consider that lenders in the three counties that make up South Florida have foreclosed on residential properties worth more than $14-billion (U.S.) so far this year, according to a new report by consultant Peter Zalewski of Condo Vultures, and that's just one of dozens of key U.S. real estate markets.
The theory, according to the bailout's boosters, is that if the Treasury can relieve financial institutions of toxic mortgage assets, like those in South Florida, banks will then have more capital to resume normal lending - to businesses, consumers and each other.
More importantly, the sheer size of the package is designed to re-establish confidence that the government is on top of the problem.
Not everyone is convinced.
Mark Loewenstein, an associate professor of finance at the University of Maryland, said the details of the proposed bank bailout remain as murky as its ultimate impact.
"I don't think anyone can say if this will work," Prof. Loewenstein said.
That's because the rescue is intended to be as much a psychological boost as a liquidity injection. The program's success will depend to a large extent on peoples' "expectations" of what's happening, Prof. Loewenstein said.
"By showing a lot of money up front, maybe people start participating in credit markets again," he explained. "But it's impossible to know whether all the other lending channels will unclog."
Billionaire investor Warren Buffett of Berkshire Hathaway Inc. said the bailout provides "some tools" to deal with the country's economic woes, but he insisted the crisis isn't over.
"This is not a panacea," Mr. Buffett told CNBC after the vote. "This does not solve all our problems."
Mr. Buffett's behaviour, however, suggests the notoriously astute investor believes the bottom may not be far off. In recent weeks, Berkshire Hathaway has scooped up $8-billion worth of investment bank Goldman Sachs and industrial giant General Electric at fire-sale prices.
The program could help unleash a wave of capital that is poised to buy distressed subprime mortgage debt and other assets, bringing new liquidity to the system.
While the credit crunch has been sucking money out of the banking system, enormous pools of capital, including foreign pension funds, sovereign wealth funds, and private family institutions have been building up.
"These pools of capital are waiting on the sidelines and preparing to deploy," CIBC chief financial officer Gerald McCaughey said in an interview yesterday.
The U.S. bailout program could be one of the catalysts that tells them "it is time to get moving if they want to invest," he said.
Original Post