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The Dow Jones industrial average yesterday fell below 8,000, shedding 4 percent, its bleakest performance on any Inauguration Day since the index was started 124 years ago. Nasdaq and the Standard & Poor’s 500-stock index both plunged more than 5 percent.

Disillusioned investors fled financial companies as fresh evidence mounted that the industry’s problems are larger than previously understood, larger than the response so far mustered by the government and perhaps larger than the resources remaining in its rescue program.

The possibility of bank nationalizations, in which governments take direct control of financial institutions, is being debated in Britain and elsewhere, as some of the world’s biggest banks report surprisingly dire results. The industry’s plight, tightly intertwined with the ongoing recession, is among the great challenges confronting President Obama.

Problems have spread to companies that investors considered conservative and safe. Institutions including German giant Deutsche Bank, money managers State Street and Bank of New York Mellon, and even several members of the Federal Home Loan Banks system have revealed unexpected and significant problems, leaving almost no part of the financial industry untouched.

Losses at companies already tarred by the crisis also have been deeper than analysts expected. Regions Financial, a large southeastern bank, yesterday reported a fourth-quarter loss of $6.2 billion, greater than its total profits in the past five years. Citigroup said it lost $19 billion last year.

The Royal Bank of Scotland disclosed this week it may have lost $41 billion last year, leading the British government to announce a second bailout for the company that increases the government’s stake in one of Britain’s largest banks

The federal government’s promise to prevent the failure of large U.S. banks may be exacerbating their problems. As banks sink, financial analysts increasingly are warning that government intervention is inevitable and could come at the expense of shareholders, perhaps in the form of nationalization. This appears to be driving away investors and hastening the intervention. As with the government’s summer promise to save Fannie Mae and Freddie Mac, but only if necessary, the last resort has become the expected outcome.

Until banks can attract fresh capital from debt or equity investors, it will be difficult to stabilize and jump-start lending, said Binky Chadha, chief U.S. equity strategist at Deutsche Bank in New York. But the government’s patchwork approach to the bailout has would-be investors sitting on the sidelines, he said.

“In each episode of financial intervention, the rules have been a little different,” Chadha said. “Hopefully [the new administration] will lay out the rules, and it will be a lot clearer. In the meantime, the textbook model of wiping out the equity holders is clearly a concern, and should be a concern.”

The basic problem facing the financial industry, and the new administration, is that banks lack the money to cover their losses. The capital reserves that banks are required by regulators to maintain against losses have been badly eroded.

The banking industry has acknowledged losses of roughly $1 trillion since the start of the financial crisis. Goldman Sachs last week projected that this total could more than double. Nouriel Roubini, a professor at New York University’s Stern School of Business noted for his pessimism, said yesterday that losses could hit $3.6 trillion.

The Bush administration pumped almost $300 billion into U.S. banks, but the scale of investment is dwarfed by the still-emerging problem. The government’s actions stemmed the market’s panic in the fall, but it did not succeed in stabilizing the industry.

Investors now appear to be stampeding again. Shares of Wells Fargo have lost roughly half their value since the start of the year. Bank of America is down 64 percent. J.P. Morgan Chase is down 43 percent. Citigroup is down 58 percent. Those are the four largest U.S. banks.

Obama administration officials are considering several approaches focused on the troubled loans and other assets that are the source of the losses, including the creation of a government-owned “bad bank” that would buy troubled assets from financial firms, quarantine them and then sell them, generally at a substantial loss. The aim is to revitalize lending. Bad banks have been created by countries including Sweden, but the idea has never been tried on a comparable scale.

It is increasingly likely that any approach will require more than the roughly $320 billion remaining in the financial rescue program approved by Congress in the fall, several officials said.

The problems continue to grow.

A number of banks once considered healthy have been hobbled by the acquisitions of troubled institutions, often in deals urged by the U.S. and European governments. Investors are increasingly fearful of losses at Wells Fargo, which they viewed as the healthiest of large U.S. banks before it swallowed Wachovia. Bank of America needed more than $20 billion in additional government assistance in part to help it swallow the troubled investment bank Merrill Lynch.

Meanwhile, banks that specialize in managing money for large institutions have become the latest quiet corner of the financial industry infected by the crisis. Bank of New York Mellon reported yesterday it earned $28 million in the fourth quarter, less than a tenth of the amount Wall Street had expected.

State Street said that it had unrealized losses of about $9 billion as of the end of 2008, a massive figure that surprised analysts who previously regarded the company as relatively sheltered from the crisis. The company’s shares fell by 59 percent yesterday as several financial analysts said State Street could be forced to raise capital.

Problems in Europe also grew. The Irish parliament voted yesterday to complete the nationalization of Anglo Irish Bank, the country’s third-largest bank. It is the second round of government bailouts for the Irish banking industry.

The action in the markets underscored the need for Obama to set his sights on repairing the banking system before turning his attention to a broader economic stimulus package, said Brian Gardner, senior vice president for Washington research at Keefe, Bruyette & Woods.

“What gets at the core economic issues of the day is fixing the financial system,” Gardner said. “This all started from a crisis in the financial system, and it’s going to be solved by fixing the financial system.”

An Extract from the Washington Post, Wednesday January 21, 2009

By Binyamin Appelbaum and Heather Landy

Washington Post Staff Writers

One may recall optimistic proclamations made in 2008 that Trinidad and Tobago (T&T) would not be affected by the global financial crisis; however, to date we see evidence that the T&T is by no means insulated from the global financial and economic turmoil. To an extent, the premise that the Caribbean was insulated from the global crisis was somewhat understandable. This is because Caribbean financial markets are typically small, underdeveloped and largely unsophisticated, with tightly regulated commercial banks and generally risk-averse managers; as such US mortgage-backed securities were not dumped in this region. However, we all live in a global village and the financial sector contagion was bound to take a toll on these vulnerable economies!

For the most part, the region weathered the financial crisis quite well in comparison to global counterparts. Banks within the Caribbean tend to transact business with commercial banks in the US and, as a result, were not exposed to most of the liquidity woes of the investment banks. Furthermore, legislated reserve requirements, which are deposit-based, provided regional banks with the necessary cushion for liquidity demands. One exception would be Jamaica where exposures to US investment banks resulted in margin calls on investments. This had the effect of squeezing liquidity in the country’s financial sector. As both the private sector and the government struggled to access US dollars, the Jamaican dollar (JMD) fell precipitously (against the US dollar) by about 13% during the second half of 2008, and the Bank of Jamaica in efforts to address the liquidity issues and stem the JMD decline drew down international reserves by USD600 million.

The problem is that policy makers in the region did not recognize that the financial crisis would have an indirect impact on economies, which caused the run-up to a full scale economic crisis. The financial crisis basically choked-off credit, which started strangling GDP growth through declining industrial production, consumer spending, manufacturing etc. Naturally, the economic crisis followed hard and fast as one by one, major economies fell into recession. Commodity highs unravelled rapidly as speculators recognised the potential for significant losses stemming from the falloff in global demand.

Despite the fact that lower commodity prices have generally led to falling inflation in most economies, the fall in fuel prices does not bode well for Trinidad’s economy as the energy sector accounts for more than 50% of GDP and approximately 90% of exports.

Reality Check

If there are any doubts that the Caribbean is being affected by the global contagion, one has only to look at what is happening with the tourism industry, remittance flows, export revenues, foreign direct investments and by extension, economic growth. Caribbean economies are predominantly dependent on inflows from tourism and remittances. An exception would be Trinidad, which is the world’s largest supplier of methanol, and a producer of urea, ammonia, steel and natural gas. Even Jamaica’s bauxite industry is suffering, with plans to lay off even more workers this year. Notably, the region’s tourism and remittances are fuelled by the US and UK markets, both of which are currently in a recession.

The tourism outlook is gloomy with projections for a 20% downturn in Barbados, which, according to the Vice President of the Barbados Hotel and Tourism Association, would have a detrimental impact on that country’s tourism sector.

Additionally, the Jamaica Hotel and Tourism Association (JHTA) proclaimed that Jamaica is already a whopping 30% off target for the season and higher up the islands, the Atlantis Resorts in the Bahamas have laid off almost 800 workers already. To add insult to injury, the British government announced plans to introduce a new tax, the Air Passenger Duty, as part of a drive to reduce carbon emissions. Under the new law, which is expected to take effect in November 2009, passengers flying within 2,000 miles of London will have to pay incremental taxes on their ticket fare. This will place further strain on tourism revenues as Europeans would opt to vacation closer to home in light of tight economic conditions.

Regional goods being exported are typically made up of products such as sugar, cocoa, citrus, bananas, vegetables, food and beverages. The high elasticity of demand for these goods, together with the fact that the US is one of the major export destinations for the region, does not bode well for the trade balance of these economies. Notably, we see that approximately 37.2% of Jamaica’s exports and 57.5% of Trinidad’s exports are US bound. In particular, Trinidad’s exports comprise mainly industrial supplies such as oil, natural gas, steel and given the dramatic fall in commodity prices, Trinidad should expect to see drastically reduced export earnings.

Once again, we see how the US is intertwined with the Caribbean as it is a major source of Foreign Direct Investments (FDI) for the region. Because the US is currently in a recession with its major industries in consolidation mode, investor confidence stuck at all time lows, and credit conditions persistently tight; it is unlikely that investors would consider large investment projects as viable in present times.

Across the region, GDP growth has been falling. Estimated growth rates for all of the major economies in the region have shown significant weakness. Annualised GDP growth projections at the close of 2008 for Jamaica, Barbados, and Trinidad and Tobago are 0.5%, 1.5%, and 3.5% respectively. In 2009 these figures are expected to fall further to 0%, 1%, and 1.5%-2% for the respective economies. With inflation cooling, most economies are expected to start cutting interest rates in order to support their faltering economies. It may be some time before Trinidad uses this approach as inflation is still very much a concern; however, Barbados has already declared a 100 basis point cut to its Minimum Savings Rate (MSR), bringing it to 3%, effective 1 February 2009. Jamaica will most likely have no choice but to cut rates by the end of the year in the face of weak economic conditions. Receding growth has become the issue of the day and generally monetary policy is employed by dropping interest rates to stimulate credit and by extension the proponents of growth such as consumer expenditure. However, in some cases, banks are hoarding cash and have simultaneously made the borrowing process more stringent. In light of such deterrents, lowering the policy rate may not have the desired effect.

Nap Time is Over

Caribbean economies tend to be reactive rather than proactive. Only when a crisis unfolds do we seem to shake our sedate demeanour and spring to action in a typical ‘knee-jerk’ manner. Instead of being in a state of denial, the region needs to engage in more thorough strategic planning; this should take into consideration worst-case scenarios and actual plans for them so that any impact would be limited. There is no denying that our economies face challenging times ahead with no road map for the unchartered territory in which the global economy now finds itself. So the question is, what can we do to mitigate the negative factors impacting our region?

Caribbean governments and the private sector, individually and collectively, need to go back to fundamentals. Specifically, the focus needs to shift to measures such as the following:

- Careful consideration of what constitutes appropriate fiscal measures together with prudent and timely implementation. For example, it would have been more appropriate for the government of Trinidad & Tobago to have restrained expenditure over the past 4 years rather than doubling their expenditure. If this was done, the government would have been better positioned to increase expenditure in 2009 to offset the slowdown in the private sector, rather than being forced to cut as it is currently doing.

- Improving operational efficiencies to minimise wastage or redundancies to mitigate the expected decline in revenues.

- Attention should be paid to the inherent vulnerabilities of being overly dependent on a few trade partners for exports. The Caribbean needs to start looking at Central and South America as export markets, sources of tourists, etc.

- Greater focus should be paid to becoming self-sufficient in as many sectors as possible to mitigate external shocks such as the recent commodities bubble. Incentives for agriculture and fisheries should be emphasized.

- Ensure access to multilateral funding, should liquidity concerns arise.

- Crafting strategic plans that include aggressive steps aimed at reducing the region’s high level of exposure to exogenous shocks. Governments must as a matter of routine, use medium and long term development plans as a tool that provides the context for policy formulation. These plans must be reviewed and revised if necessary as conditions change.

- Actively seeking out ways to resolve deterrents to the Caribbean Single Market and Economy (CSME). Given the level of individual country vulnerability, a collaborative effort should strengthen resilience and permit members to leverage each other’s competitive advantages. For example, a country with surplus capital such as Trinidad can invest in another that has viable projects that require funding. United we stand, divided we fall. These are unprecedented times and they call for new and drastic measures to chart a course in unknown territory. It is time to put differences aside and work together for a common good. Global leaders understand the need for international support as their economies are inextricably linked and dependent on each other. The Caribbean would do well to wake up and learn a thing or two on survival.

Article submitted by

Juliana Davis

Analyst

CMMB, Trinidad and Tobago