Stocks slumped Friday, in a broad-based selloff that was especially hard on the leaders of the most recent leg of the rally — banks, energy shares and transportation companies.
The Dow Jones industrial average (INDU) lost 109 points, or 1.1%. The S&P 500 (SPX) index lost 13 points or 1.2%. The Nasdaq composite (COMP) lost 11 points or 0.5%.
Stocks had risen in the morning after upbeat results from Microsoft and Amazon.com, and an encouraging reading on existing home sales. But the tone turned negative in the afternoon.
The three major indexes all ended lower for the week, after two weeks of gains amid a bigger multi-month advance.
"After seven months of mostly rallying, the buyers weren’t really here this week and the bears took that as an opportunity," said Paul Brigandi, vice president of trading at Direxion Funds.
Investors getting tired?: Since bottoming at a 12-year low on March 9, the S&P 500 has surged over 62% through its rally high earlier this week.
Although repeated predictions for a big 10% to 15% selloff haven’t materialized, smaller selloffs of 1% to 3% have popped up periodically during the past 7 months. Friday appeared to be an extension of that trend.
While the S&P 500 lost 1.1% Friday, for individual sectors, the declines were bigger.
The Dow Jones Transportation (DJT) average, which includes railroads, truckers and airlines, had surged 88% through its rally high earlier this week. On Friday it lost 3.5%.
Some market pros have said the rise in the transports is a good indicator of the economic recovery. But downbeat comments Friday from railroads Union Pacific and Burlington Northern put that optimism into question. It also gave investors an opportunity to cash out after the massive rise in the sector.
The KBW Bank (BKX) index, which tracks 20 financial firms, including Bank of America (BAC, Fortune 500), Citigroup (C, Fortune 500) and Wells Fargo (WFC, Fortune 500), has rallied over 140% between March and its peak this week. The bank sector slumped as well Friday, losing 1.6%.
A strong U.S. dollar — bouncing back from one-year lows against a slew of other currencies — added to the downturn Friday. A strong dollar pressures dollar-traded commodities including oil, which in turn drags on energy shares. Big multinationals that benefit from a weak dollar also slipped.
Stocks had rallied Thursday following upbeat earnings from 3M (MMM, Fortune 500), AT&T (T, Fortune 500) and other blue chips. The advance propelled the Dow back above 10,000 and the S&P 500 closer to 1,100. But that advance proved unsustainable Friday, even though corporate news was upbeat.
"Investors know that the earnings for the third quarter are going to be better than expected," Brigandi said. "That’s no longer going to be a catalyst. They are going to want to see something else."
Results: Microsoft (MSFT, Fortune 500) reported weaker quarterly sales and income Friday morning that easily surpassed analysts’ estimates. Cost cutting and strong sales of its Windows operating system fueled the advance.
On Thursday, Microsoft rolled out its new Windows 7 operating system, expected to boost PC sales in the coming months.
Shares of Microsoft, a Dow component, rose over 9% Friday morning, touching a one-year high, before giving up nearly half of that advance.
Late Thursday, Dow component American Express (AXP, Fortune 500) reported weaker quarterly sales and earnings that beat analysts’ forecasts. Shares fell 5% Friday.
Also late Thursday, Amazon.com (AMZN, Fortune 500) reported a big surge in earnings and revenue, thanks in part to strong sales of its e-reader, Kindle. Shares jumped 27% Friday, hitting a ten-year high.
So far, 199 companies, or 40% of the S&P 500, have reported results. Profits are currently on track to have fallen 18.2% versus a year earlier, according to the latest from Thomson Reuters. Revenue is expected to have dropped over 10% from a year ago.
Bernanke: The Federal Reserve chairman, speaking Friday, said that the financial turmoil is abating, but that lawmakers have to reform the system to help prevent a crisis of this magnitude happening again.
On Thursday, the Federal Reserve proposed a broad overhaul of pay policies at 28 of the largest U.S. banks. Also Thursday, White House "pay czar" Kenneth Feinberg called for the seven biggest recipients of federal bailout money to cut in half what they pay their top executives.
Economy: Existing home sales jumped to a 5.57 million unit annual rate in September, according to a National Association of Realtors report released Friday morning. Sales were expected to have risen to a 5.35 million unit annual rate from 5.1 million unit annual rate in August.
World markets: Global markets were mixed. In Europe, London’s FTSE 100 gained 0.7%, France’s CAC 40 lost 0.3% and Germany’s DAX gave up 0.4%. Asian markets ended higher.
Bonds: Treasury prices tumbled, raising the yield on the 10-year note to 3.48% from 3.42% late Thursday. Treasury prices and yields move in opposite directions.
Currency and commodities: The dollar gained versus the euro, after falling to a 14-month low earlier in the week. The dollar gained versus the yen.
U.S. light crude oil for December delivery fell 69 cents to settle at $80.50 a barrel on the New York Mercantile Exchange, edging off a one-year high.
COMEX gold for December delivery fell $2.20 to settle at $1,056.40 an ounce. Gold has surpassed records repeatedly this month due to the weak dollar and longer-term worries about inflation.
In the past, Bank of America Chief Executive Officer Ken Lewis has received an annual salary of $1.5 million. But this year he will get nothing.
That means no salary, no bonuses. In fact, he will have to repay Bank of America Corp. (BAC, Fortune 500) the more than $1 million he has already earned in his final year on the job.
Lewis agreed to the deal on Thursday after the Treasury department’s pay czar, Kenneth Feinberg, "suggested" it to him, said Bob Stickler, a spokesman for the bank.
Stickler added that Lewis "felt it was not in the best interest of Bank of America or him to get into a dispute with the pay master."
Lewis, who announced last month that he will retire at the year’s end, will still have $53 million in pension benefits waiting for him. The outgoing chief will also have other stock awards and deferred compensation for a total $69 million payout, said Stickler.
Feinberg does not have authority to modify compensation awarded before 2009, which includes Lewis’ retirement package and stock holdings from a four-decade career at the bank.
But Stickler asked, "Since when does law apply to this administration?" As a result, he said Bank of America is unsure whether or not Lewis’ retirement package is under review by the government.
Wall Street has been waiting for Feinberg to announce rules on compensation at the seven firms that have received large government loans last year as the financial system neared collapse. And while firms are expecting Feinberg to crack down on payouts, a complete cut is bold.
The deal comes before the Charlotte, N.C.-based bank announces its third-quarter earnings on Friday morning. Analysts polled by Thomson Reuters expect earnings per share to decrease by 21 cents from a year ago when they were flat.
The possibility of securing a mortgage rate below 5% has greatly improved in recent weeks, in a positive sign for would-be home buyers.
Home mortgage rates fell for the sixth straight week, according to two key measures, with one of them pointing to a sub-5% rate for the 30-year fixed loan for the second week in a row.
Freddie Mac’s (FRE, Fortune 500) weekly report said the 30-year rate slipped to 4.87% for the week ended Thursday, the lowest since May. According to the mortgage backer, last week’s rates stood at 4.94%.
Mortgage tracker Bankrate.com said the average 30-year fixed loan slipped to 5.22% from 5.25% the previous week. The 15-year fixed rate also fell, Bankrate said, to 4.6% from 4.64% the week before.
The 30-year rate is influenced by the benchmark 10-year note’s yield, which moves in the opposite direction of its price. Treasury prices have risen over the past week as $78 billion worth of auctions received above-average demand.
"Another disappointing employment report had investors questioning the strength and sustainability of the economic rebound," the Bankrate report said. "The resulting uncertainty drove investors into the safety of government and mortgage-backed bonds."
"Not even a substantial auction of government debt has been enough to derail the streak of declining mortgage rates," the Bankrate report said.
Rates are returning to levels not seen since the spring when, in an effort to cap mortgage rates, the Federal Reserve began a campaign to buy back $300 billion in Treasurys easy pay day loans. The Fed hoped that it would spark demand and keep yields — and therefore, mortgage rates — in check.
Mortgage rates fell as refinancings abounded. But those benefits seemed to wear off, as rates started on a tear in the summer. By June, the benchmark 10-year bond’s yield had increased steadily to hover around 4%.
Now the central bank has less than $15 billion left to spend on its buyback program, which led some investors to worry that yields would soar again. So far, that’s not the case.
On Wednesday, reports said Democratic congressional leaders were working to extend a $8,000 tax credit for first-time home buyers past the Nov. 30 expiration date and could even make it available to current homeowners who buy a new house.
Homeowners have received a boost from both the tax credit and the lower rates — last year, the average 30-year fixed mortgage rate was 6.2%, according to Bankrate.
To translate the difference in mortgage rate into dollars, consider a $200,000 loan. At last year’s rate of 6.2%, the monthly payment would be $1,224.94, or $124 higher than the monthly payment at the current rate.
The low rates helped mortgage applications surge by 16.4% last week, according to a separate report.
For General Motors, the road out of bankruptcy isn’t proving to be as smooth as its quick trip through it.
In the past week, the company’s plans to sell its Saturn brand to auto retailer Penske Auto Group fell through, forcing GM to start winding down a network of about 350 dealerships.
But that’s not the only post-bankruptcy problem for GM. Its plans to sell Hummer to a Chinese industrial company missed a target date of closing by Sept. 30.
GM is also trying to close a deal to sell two-thirds of GM’s European Opel brand to a joint venture between Canadian auto parts maker Magna International (MGA) and Russian automaker GAZ Group. Despite ongoing losses at Opel, the decision to sell that stake was a difficult one for GM. Many experts are concerned that the Opel sale will weaken GM by limiting its global reach.
"It hurts their global capabilities," said Tom Libby, president of the Society of Automotive Analysts. "They can’t draw on this major source of engineering resources that they’ve used for years. If they had had the money they needed, they wouldn’t have done it."
Libby said it’s not surprising that the Saturn deal fell through, that Hummer is behind scheduled, or that the Opel deal has raised questions. But he said these are all signs that turning around GM for the long run will be a significant challenge.
"They made assumptions during the bankruptcy process and that’s why the process was so quick," he said, referring to the company’s six-week trip in and out of bankruptcy court. "But it was always going to be difficult to meet those expectations."
Saturn closure comes with costs
The Saturn deal with Penske (PAG, Fortune 500) was never going to raise a large amount of money for GM. But it would have allowed GM to supply a Penske-run Saturn with vehicles for two years while it found a new contract supplier. That plan would have helped GM keep factories running more efficiently.
In addition, GM will now have to pay Saturn dealers between $100,000 and $1 million each to wind down, which will cost the company more than $100 million. Libby said those payments, while modest in comparison to the company’s ongoing losses, still will hurt GM.
"They have no excess funds. It’s going to affect something in the organization significantly," he said.
GM spokesman John McDonald said that the company never counted on avoiding payments to dealers through a Saturn sale. So the collapse of the Saturn deal is not a setback, he said.
McDonald added that the company hopes to produce the same number of vehicles for its other brands that it would have if it was still making Saturns no fax pay day loans. GM has Chevrolet and Buick offerings that are similar to most Saturn models.
Saturn’s industrywide market share has fallen to a record low of less than 1% this year as buyers avoided the endangered brand and GM cut back on marketing efforts. But Saturn still accounted for about 4% of GM’s total sales in 2009. So any slip in sales could hurt GM at a time when it is struggling to end a period of market share declines in the U.S.
Opel deal critical. Hummer? Not so much.
The Opel deal could affect GM’s competitiveness not just in Europe but in North America as well. Some of GM’s most critically acclaimed vehicles in recent years, including the Chevrolet Malibu and the Buick Lacrosse, are built on an Opel platform.
The Opel sale was temporarily put on hold by GM’s new board as it studied whether it was the best move for the company following bankruptcy. But the need for short-term cash and political pressure from the German government, which had loaned the company money to keep Opel afloat, left GM little choice than to proceed with the sale.
"It wasn’t negotiating from a position of power," said Subroto Banerjee, a partner with business consultant Frost & Sullivan. "In a time of being forced to sell something, you’re in deep trouble. You’re going to give up more than they’d like."
Still, the Opel deal could benefit GM even though some worry about the impact it will have on sales. The keys to whether the deal will be good or bad for GM depends on how much access GM will have to Opel’s engineering resources going forward and the limits on Opel’s new owners being able to compete against GM in markets outside of Europe.
"From GM’s position, those two things are critical," said David Cole, chairman of the Center for Automotive Research, a Michigan think tank.
Then there’s Hummer. The decision to get rid of Hummer, while arguably attracting the most attention because a Chinese company wants to buy the brand, will likely have the least impact on GM. Hummer is small even in comparison to Saturn and it has a much smaller dealer network.
GM’s McDonald insists that missing the target date to close the deal is not necessarily a sign that there are problems. "Especially when dealing with an international buyer, missing a deadline is not uncommon," he said.
Nonetheless, Hummer has been another drain on GM’s limited resources, and experts say they need to resolve the future of the brand sooner rather than later. Libby said that keeping Hummer is not an option for GM.
Chevron Corp’s David O’Reilly will hand Vice Chairman John Watson the reins as the second-largest U.S. oil company brings several big projects online and navigates through a massive, potentially damaging lawsuit in Ecuador.
Watson, 52, becomes chairman and chief executive at the end of this year, Chevron (CVX, Fortune 500) said Wednesday. He has been at Chevron since 1980, in roles such as chief financial officer and head of exploration and production outside North America. He also led the integration of Texaco after the deal closed in 2001.
The California native, who currently oversees strategy and development, will take the helm at a time when oil majors face increasing competition from state-run oil companies for access to the largest untapped reserves. Two-thirds of the world’s top 20 oil companies are backed by governments.
O’Reilly, a 62-year-old from Dublin, has worked for the San Ramon, California-based company for 41 years and served in the top two roles for the past decade.
A new CEO is just the latest change at the top of Chevron in the past year, which has seen a new chief financial officer take over and the appointment of a new chief in-house lawyer.
While O’Reilly made headlines in June by debating the head of the Sierra Club, an environmental group, his public profile was lower than that of many top executives.
"We really like that O’Reilly wasn’t real outspoken and on a lot of different boards," said Alan Brochstein, senior energy analyst at Management CV, which rates executive teams.
"We sure hope Watson won’t be either because quite frankly we think Chevron has had, over the long term, one of the higher returns for its shareholders," he added, noting that Watson had "major skin in the game" with $30 million of Chevron stock.
Ecuador threat
Watson faces a potential crisis from a $27 billion claim in a lawsuit in Ecuador, where indigenous people blame Texaco for polluting the areas where they live and damaging their health.
A ruling in the 16-year-old case had been due in the coming months, but that is now complicated by the judge’s replacement amid allegations he was involved in a $3 million bribery plot.
The CEO change is a "mild positive" for Chevron shares by setting up a smooth transition, said James Halloran, consultant with Financial America Securities in Cleveland, Ohio.
But he said the road ahead looks tough since oil companies largely occupy a second tier after national oil companies.
"They can no longer show up at the doorstep of countries and get access to the oil," Halloran said.
In the face of this challenge, Chevron in January dropped its target for 3% compound annual production growth from 2005 to 2010, although in July it did bump up its 2009 output growth target to 5% from 4%.
O’Reilly will depart as a number of sizeable projects come online from Brazil to the Gulf of Mexico to Australia, where the $37 billion Gorgon gas project just got the green light.
"He’s left him with a well-stocked pond," said Fadel Gheit, analyst at Oppenheimer & Co, who also identified access to new reserves as Watson’s biggest challenge.
Chevron’s board elected George Kirkland, 59, to succeed Watson as vice chairman. Kirkland will retain responsibility for Chevron’s global oil and gas exploration and production.
Chevron shares were trading 0.8% lower at $70.32, in line with peers. Shares of larger rival Exxon Mobil Corp (XOM, Fortune 500) were down 0.7% at $68.61.
LaGuardia Airport is the smallest of the three major airports in the New York area, with just two main runways. Planes often sit in long lines on the tarmac, waiting their turn to take off.
So why would Southwest Airlines, a carrier that boasts about its on-time prowess, want to go there? In many ways, because it has to.
Southwest prospered by offering low fares to leisure travelers whose only other affordable option was a car trip. It flew primarily to America’s secondary airports where costs are low and productivity is high because incoming planes can land, drop off passengers, take on the next group and get back in the air quickly.
Today, Southwest starts service at LaGuardia, one of the nation’s most congested airports. This should bring cheaper ticket prices to New York area vacationers flying to Chicago, Baltimore and beyond. But the move is also part of a risky transition to win the loyalty of business travelers who increasingly will dictate Southwest’s future prospects for success.
Southwest started flying in 1971 with three planes. Herb Kelleher, the garrulous, chain-smoking co-founder, fought in court and in the air against bigger airlines that tried to run him out of business.
Southwest didn’t offer the amenities found on other airlines, but it outlived early rivals by sticking to a core philosophy: Give people low fares and great service.
The Dallas-based carrier still sees itself as an underdog today, even as it serves 65 cities, including St. Louis, and carries more than 100 million U.S. passengers per year, more than any other airline.
There are still no first-class cabins and no assigned seats on Southwest, giving it the air of a carrier for penny-pinching vacationers.
"We’re very dependent on business travelers, so we’re not a leisure airline like some of our smaller competitors are," CEO Gary C. Kelly countered in an interview. He says company surveys show that in normal times at least 40 percent of his customers are traveling on business.
Airlines covet business travelers because they make repeat trips and often pay higher fares for booking at the last minute free car insurance quotes.
Southwest needs that revenue now. The airline has been profitable for 36 straight years but has been in the red since last fall. Traffic is down and costs are rising.
While it’s cutting flights across its system, Southwest is also entering New York and three other big cities, including Boston’s Logan Airport.
Kelly has been fine-tuning the Southwest model since becoming CEO in 2004. In pursuit of business travelers, he bent the traditional "first come, first serve" seating rules with "Business Select." Passengers pay a few bucks more to get a spot at the front of the boarding line, an extra frequent-flier award and a free drink. He also pushed Southwest into the kind of huge airports it once spurned, such as Denver and Philadelphia.
Now it needs the big Eastern cities to buttress its service at Chicago’s Midway Airport, Southwest’s second-busiest hub, with more than 200 daily flights.
Despite the notorious delays in New York, Southwest officials believe they can turn around incoming planes in 30 minutes, close to its nationwide average. That’s important because Southwest keeps costs down by getting the most use out of its planes — on average, they make six flights and spend 12 hours in the air each day.
The New York-Chicago route pits Southwest against long-standing rivals American and United, which have many more daily flights between the two cities.
Southwest officials brag about forcing competitors to cut fares. In 1993, government analysts called this phenomenon "The Southwest Effect." Fare experts say Southwest still strongly influences ticket prices in markets it enters.
Rick Seaney, chief executive of FareCompare.com, studied fares in Denver before and after Southwest returned to the market in January 2006. He said United, then the dominant carrier there, cut its average cheapest round-trip fare out of Denver by one-third in the first year after Southwest said it would serve the same airport.
BlackRock Inc. said on Thursday it will buy British bank Barclays Plc’s investment arm BGI for $13.5 billion in a blockbuster deal that will create the world’s biggest asset manager.
For BlackRock, a 21-year old company which relied heavily on acquisitions to grow from a one-room bond investment firm into the largest publicly traded U.S. money manager, the deal will more than double assets to roughly $2.7 trillion.
It will also give New York-based BlackRock, well-known for working with governments and institutional clients, access to retail investors and the hugely popular exchange traded funds San Francisco-based Barclays Global Investors offers.
BGI, which has operations in 15 countries and ranks as Europe’s largest hedge fund manager, will help expand BlackRock’s reach around the world and into new products spanning actively and passively managed portfolios.
“This gives BlackRock a global footprint which is a substantial thing to have in these markets,” said Geoff Bobroff, who advises mutual fund companies as president of Bobroff Consulting Inc.
For Barclays the deal will strengthen its balance sheet after the bank refused aid from the British government that some of its rivals accepted as the global financial crisis engulfed the industry.
BlackRock will pay $6.6 billion in cash and the rest in stock to acquire BGI and Barclays’ iShares unit, which had been promised to private equity firm CVC Capital Partners for $4.4 billion in April.
Barclays was allowed to keep shopping for a better deal until the middle of June and will owe CVC a $175 million break-up fee if it sells iShares to another bidder. CVC has until next week to come up with a counter offer absolutely free credit report.
TRANSFORMATIONAL DEAL
“This is a transformational transaction” for the investment management industry Laurence Fink, BlackRock’s chief executive officer, said on a hastily arranged conference call late on Thursday.
Fink said BlackRock has received commitments from a global network of institutional investors and clients to purchase 19.9 million shares at the closing of the transaction for a total of $2.8 billion. He would not disclose the investors.
The combined companies’ market capitalization will be roughly $34 billion, Fink said.
BlackRock’s share price, which has climbed 36 percent since January, shot up 11.5 percent this week to close at $182.60 on Thursday as speculation about a possible deal heated up. Bank of New York Mellon was also said to have been interested in buying BGI, but several people briefed on the deal said the company’s more tepid stock price rise hurt its chances.
Together BlackRock and BGI — or BlackRock Global Investors as the new company will be called — will be the industry’s single biggest player, zooming past rivals State Street Corp, which manages $1.4 trillion, and Fidelity Investments, which oversees $1.25 trillion. The company will also outpace PIMCO, its chief fixed-income rival, which is building up a presence in exchange traded funds.
The deal also further shakes up an already battered money management industry where firms lost billions in assets and thousands of jobs during the financial crisis by eliminating a possible bidder for other firms that are up for sale.
The dollar rose against the euro on Wednesday after data suggesting a slowdown in housing markets has yet to bottom gave support to the U.S. currency as a safe haven.
U.S. blue chips stocks fell after the housing data, which showed the inventory of unsold homes in the U.S. rose last month, while prices fell.
The dollar had sold off recently in part on growing optimism about the outlook for the U.S. economy.
"This is a mixed bag of data," said Omer Esiner, senior market analyst at Travelex Global Business Payments in Washington. "More likely the dollar will probably firm on the fact that inventories are rising and prices are falling."
The pace of sales of existing homes in the United States climbed 2.9% in April, according to an industry survey. However, the National Association of Realtors said the inventory of existing homes for sale rose 8.8% and the median national home price fell 15.4%.
"Things are still not that great out there, so we are a little skeptical of the ‘green shoots’ optimism on the economic side," said Robert Blake, senior currency strategist, at State Street Global Markets, in Boston. "It’s going to be a long, slow recovery and we will have more bad news to come."
In midday New York trading, the euro was 0.5% lower at $1.3924 , after hitting a session low of $1.3872. The dollar was 0.2% higher against a basket of six major currencies at 80 low fee payday loans.286. It hit a five-month low on Friday just below 80.00.
Comments by a European Central Bank policymaker suggesting further interest rate cuts could not be ruled out also weighed on the single currency.
ECB Governing Council member Erkki Liikanen said on Wednesday that the bank’s current key interest rate of 1% isn’t necessarily the lowest it can go.
Pound hits 7-month high
But the dollar fell against the British pound, which traded above $1.60 for the first time in almost seven months.
The pound was propelled by rising optimism about the U.K. economy and financial sector. It was last up 0.8 % at $1.6059 , having traded as high as $1.6075, according to Reuters data.
Gains in the British pound also pushed the euro below a 200-day moving average. The euro was last down 1.2% against the pound at 86.73 pence, trading below a 200-day moving average at 86.77 pence, according to Reuters data.
Investors will focus now on a U.S. Treasury auction later on Wednesday, in which the government will sell $35 billion of five-year debt.
Moody’s Investors Service on Wednesday affirmed the AAA credit rating of the United States, assuaging fears about U.S. creditworthiness that have been creeping up in financial markets and weighing on the dollar.
Ecuador’s President Rafael Correa said on Saturday that key sectors of the economy, including oil and mines, must be in government hands.
During his first two years in office Correa has taken a tough stand with mining and oil companies, pushing for new contracts more favorable to the state, but has so far shied away from nationalizing any firms.
“We will fulfill the goal of having strategic sectors in government hands,” Correa said.
The U.S.-educated economist has recently said he will not nationalize foreign oil companies, but will push for more state control in the key industry via new contracts.
During a joint news conference with his Ecuadorean counterpart, Venezuelan President Hugo Chavez said his drive to nationalize strategic sectors of his own country’s economy would continue.
Many sectors of Venezuela’s economy, including energy and telecommunications, have passed into state hands since Chavez took office 10 years ago electronic check payday advance. In recent weeks he has nationalized oil service companies and iron producers.
Chavez also said that Venezuela and Brazil were in talks to create a joint fund worth billions of dollars. It is likely it would be for infrastructure investment.
“One of the subjects we will discuss is the creation of a joint strategic fund … worth billions of dollars,” said Chavez, adding the fund will have funds from the Brazilian Development Bank, BNDES. He said he will meet with Brazilian President Luiz Inacio Lula da Silva next week.
He said earlier his country and Ecuador had signed a deal for a joint fund for investment in energy projects.
(Reporting by Alonso Soto; Writing by Frank Jack Daniel; Editing by Eric Walsh)
With the stress tests behind them, banking regulators now face the potentially thornier issue of deciding which banks, if any, should be allowed to repay government funds.
Since regulators unveiled a long-awaited blueprint for returning money from the Treasury Department’s Troubled Asset Relief Program last week, lenders have been scrambling to raise cash so they can pay back TARP funds.
Four companies that were among those included in the stress test — BB&T (BBT, Fortune 500), U.S. Bancorp (USB, Fortune 500), Capital One (COF, Fortune 500) and Bank of New York Mellon (BK, Fortune 500) — all announced plans Monday to raise capital which would go towards buying the preferred stock and warrants associated with the government’s stake.
Before they can return taxpayer funds, banks first have to prove that they can issue debt without having to rely on the Federal Deposit Insurance Corp.’s debt guarantee program.
Even if they are able to do that, many experts contend that regulators may be tempting fate by allowing banks to carry out their TARP repayment plans.
Consider the issue of compensation. As a result of legislation passed earlier this year, banks that participate in TARP are required to rein in outsized bonuses for senior executives and top earners.
Goldman Sachs (GS, Fortune 500) and JPMorgan Chase (JPM, Fortune 500) are two financial firms widely believed to very close to getting out from under the TARP program. Should they get approval to pay back taxpayer funds, they would no longer be subject to those compensation restrictions.
As a result, they may have a huge advantage over rivals given their ability to lure top earners away from banks that still have to place limits on salaries and bonuses. That could make it even tougher for some of the struggling banks to remain competitive.
"If you let a big firm out, they can hire the best 200 people on Wall Street at a discount," said one compensation consultant who could not speak publicly on the subject.
There is also the potential impact on bank stocks. Even though shares of many banks have rallied in the past two months, Jeff Davis, director of research at investment bank Howe Barnes Hoefer & Arnett, said some investors may now steer clear of lenders that are operating under heightened government and taxpayer scrutiny classic car insurance.
"All other things being equal, over time, [banks that have paid back TARP] are going to have substantially better valuations than those that remain semi-wards of the state," he said.
But perhaps the biggest risk in scaling back the program remains the fact that the government could very well sabotage what the TARP program was originally designed for: to keep credit flowing in the nation’s economy.
Until last week, federal officials had offered few indications on how they would respond to the growing chorus of larger banks like JPMorgan Chase and Goldman Sachs that are looking to pay back government funds.
So far, a dozen TARP recipients have managed to repurchase their shares from the Treasury Department, according to agency transactions records.
But many of those firms have been community banks - institutions that provide just a small amount of credit to the overall economy.
Part of the problem is that regulators may be worried about allowing a big bank to repay the money, only to find that the economy takes a severe turn for the worse, notes Kevin Petrasic, a former Office of Thrift Supervision official who is now an attorney in Washington at the law firm Paul Hastings.
"The last thing you want to have is a company pay the money back and find out 3, 6 or 9 months later they really shouldn’t have," Petrasic said.
In theory, the stress tests should solve that problem since most of the big banks eager to pay back TARP were found to not need more capital.
Still, some think regulators may only be willing to allow community banks or other non-traditional banks like asset manager Northern Trust (NTRS, Fortune 500) to be among those institutions that return taxpayer money in the weeks and months ahead.
But for the major financial players like JPMorgan Chase that are responsible for making billions of dollars of loans every quarter across the country? Don’t be surprised if regulators drag their feet a little longer in order to prevent them from quickly returning TARP funds, experts warn.
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