The past week has been a stark reminder that the situation in the US banking system is still far from normal, and that more capital will likely have to be in-jected into struggling banks. On Wednesday the US banking sector was shaken by revelations that Citi-group's financial health is dependent on further capital injections from the government. And on the same day news broke that Bank of America's (BofA) takeover of Merrill Lynch (which took place on the weekend when Lehman collapsed) will depend on new government loans. Sources said BofA last month wanted to cancel the takeover when it realised the full depth of the Q4 losses in Merrill Lynch. Apparently the government had to promise BofA the capital it needed to avoid BofA pulling out of the deal, as this would most likely cause severe systemic damage.
The government has also been pushing to get access to the second tranche of USD 350bn TARP money aimed at helping the banking system - and on Thursday a Senate vote paved the way for its release. A major portion of the money will likely be aimed at reducing foreclosures and improving affordability for homeowners, but a large portion will also be needed to inject more capital into the banks. Barack Obama will be in-augurated in the coming week, and one of his key chal-lenges will be to get the financial system working again in order to turn the economy around.
In Euroland, tensions in the government bond market rose as several countries (Spain and Portugal) were put on negative watch by Standard&Poors, while Greece was downgraded from AA to A–. Worries are rising about increasing deficits and the large scale of the supply coming to the market this year. This has led to a substantial widening of government bond spreads. As such, market discipline has been re-imposed on in-dividual countries. Unfortunately it comes too late, and will only deepen the economic crisis in countries like Spain, Greece, Ireland and Portugal.
