Outlook: Housing is weakest link as more banks falter

The U.S. banking industry, both the cause of much of the nation's economic malaise and its greatest victim, was left reeling yesterday.

A horrid day on Wall Street and in the international markets ended with experts predicting even more carnage for banks and other financial institutions. The topics were largely limited to "how much more" and "who else." The range of assessments was huge.

Treasury Secretary Henry M. Paulson Jr., attempting to calm investors, said the American people could remain confident in the "soundness and resilience in the American financial system." But, Paulson added, "until we stem the housing correction . . . we will continue to have turmoil in the financial markets."

Bankruptcy guru Wilbur Ross predicted on CNBC that 1,000 regional banks could fail. Other economists pegged the looming failures at 50 to 300 regional banks.

On a day when renowned Wall Street firm Lehman Bros. Holding Inc. declared bankruptcy and Merrill Lynch & Co. Inc. surrendered its independence to Bank of America, which bought it, concerns were raised about a number of other banks.

Bank stocks in particular were hammered as the stock market tumbled.

Negative attention, and not for the first time, fell on certain financial institutions, among them the largest bank in the Philadelphia area. Wachovia Corp. shares fell 25 percent and so did another troubled big bank, Washington Mutual Inc..

Speculation and anxiety focused on American International Group Inc., or AIG, the giant insurance company that has exposure to insurance claims from Hurricanes Ike and Gustav, but far more pressing concerns. Some observers said AIG could be the next big financial institution to falter.

AIG shares lost 61 percent of their value in regular trading, and New York authorities loosened rules to allow the company to tap $20 billion in subsidiary assets to stay in business. AIG, which operates the National Union Fire Insurance Co. in Pittsburgh, closed at $4.76, down $7.38. The company's shares recovered slightly in after-hours trading.

"It's not like they have excessive [insurance] claims," said Tony Plath, an associate professor of finance at the University of North Carolina at Charlotte. "What's going on is the same thing that's going on in the banking industry. They are writing down their assets because they've got assets that are not worth what their balance sheet says they're worth."

The United States had avoided a complete meltdown on Main Street and, by most measures, a recession. Commodity prices are deflating, and consumer confidence seems to be rebounding because of cheaper gas.

But the great unknown, and the largest threat, is housing. The housing market is weak, home prices are sinking, and the number of unsold homes remains intractably high.

The foreclosure rate appears to be slowing, but some experts say this could be temporary because of local measures to slow the foreclosure process and give homeowners more time to work out financial difficulties.

"I would feel a whole lot better if the housing market stabilized so that financial institutions could value these things," William Stull, chair of the economics department at Temple University, said of mortgage-backed securities.

On a Sunday talk show, former Fed Chairman Alan Greenspan said it was the worst crisis in his memory and was "not resolved, and it still has a way to go."

The government has made several attempts to prevent this financial train wreck. In the spring, the Federal Reserve helped bail out Bear Stearns Cos. Inc., the first New York investment bank to be grievously imperiled by the subprime mortgage crisis.

Last week, the government seized Fannie Mae and Freddie Mac, two government-sponsored institutions that insure mortgages. The government now appears content to let financial institutions fail, or merge. Some believe that is what the sector needs.

As part of that process, Bank of America agreed to purchase Merrill Lynch in an all-stock deal that could be worth $50 billion. Merrill's stock rose one cent; Bank of America's fell almost 20 percent.

Wachovia, Philadelphia's biggest bank with about a fifth of the region's deposits, has been dogged by mortgage-related losses stemming from its 2006 purchase of mortgage-lender Golden West Financial for $24.2 billion.

Since the beginning of the financial crisis, Wachovia has recorded losses of $22.7 billion and has raised $11 billion, according to Bloomberg News. "Wachovia is a strong and financially sound company," spokeswoman Christy Phillips-Brown said. "We are well-capitalized and have a prudent liquidity market."

In the current environment, commercial banks have an advantage over investment banks in raising capital because they rely heavily on consumer, government and business deposits to fund operations.

In the first eight months of the year, Wachovia has signed up more than a million customers - including 54,500 in the Philadelphia region - for a new account that transfers $1 from checking into savings every time a customer uses a check card or makes an electronic payment, the bank said.