American Banker  |  Friday, December 5, 2008

By American Banker Staff

Print Email Reprints Feedback

"Unprecedented" was a common qualifier used to describe the operating environment for the nation's biggest banks this year.

Everyone from long-standing chief executives to veteran analysts described a market unlike any they had ever experienced.

The word, already heavily in use early in the year, was to take on new meaning as fall arrived, bringing with it seismic shifts to the financial landscape, historic lows for bank stocks and the broader market, and extraordinary intervention by the government.

But that's not how it started. Executives ushered in the new year with cautious optimism on credit quality.

Speaking to investors in January, G. Kennedy Thompson, then Wachovia Corp.'s chairman and CEO, who was facing mounting pressure over his 2006 purchase of the California thrift company Golden West Financial Corp., defended his company's risk management.

"I feel very good about where Wachovia is," Mr. Thompson told investors.

Kerry Killinger, then Washington Mutual Inc.'s CEO, acknowledged that his ailing thrift company could "do better," and he said it would look to its retail business for help in returning to profitability.

Within months Mr. Killinger and Mr. Thompson would be ousted, and their companies would agree be sold.

By mid-January the first major casualty of the credit crisis had fallen to the year's first opportunistic buyer; Bank of America Corp. announced its deal for Countrywide Financial Corp., then the nation's biggest mortgage lender.

Despite questions about risk, B of A touted the deal as one that would make it the nation's biggest mortgage provider at a fire-sale price. It agreed to pay $4 billion of stock, just four months after paying $2 billion for a 16% stake in the California lender. B of A also started to pull back in investment banking, including collateralized debt obligations, and in June it sold its prime brokerage business to BNP Paribas SA.

Capital concerns had been dogging the entire financial sector for months by the time questions began to mount about liquidity at Bear Stearns Cos. Inc., an investment bank with significant exposure to the subprime mortgage meltdown. In March the noise reached a crescendo, and on March 14 JPMorgan Chase & Co. pledged to act as a conduit to give the cash-strapped investment bank access to the Federal Reserve Board's discount window for 28 days.

But Bear Stearns did not make it that long. Two days after the announcement, JPMorgan Chase agreed to acquire Bear Stearns for $2 a share, or $28 below the stock's previous closing price, with a guarantee by the Fed to fund up to $30 billion of Bear's "less liquid assets." A week later, after protests from Bear Stearns executives and shareholders, JPMorgan Chase raised its offer to $10 a share, and the Fed's commitment was cut to $29 billion.

The Fed-assisted deal spawned speculation that B of A might try to renegotiate with Countrywide. However, B of A continued to speak favorably of its deal. By the time it closed in July, Countrywide's declining share price had driven the price down to $2.52 billion, a 39.3% discount to the original price.

Like B of A, JPMorgan Chase would return as an opportunistic buyer later in the year.

In April the extent of the commercial banking sector's capital needs became glaringly apparent. Wamu, Wachovia, Citigroup Inc., National City Corp., and Downey Financial Corp. reported first-quarter losses, citing mounting deterioration in mortgages and mortgage-related credits. Among regional firms, souring loans to home builders were becoming problematic. A round of dividend cuts and a rush to raise capital ensued.

JPMorgan Chase and a handful of regional banking companies, including U.S. Bancorp and Wells Fargo & Co., remained in the black.

Wells continued to reiterate its intention to stay focused on fill-in acquisitions, but that stance would change within months.

Vikram Pandit, who had become Citi's CEO in December after Charles Prince's ouster, unveiled a long-awaited plan in mid-May to shore up its finances, vowing to divest up to $500 billion of noncore assets and focus efforts on the U.S. consumer banking business.

That same month, after mounting investor protests about risk management and an embarrassing slap on the wrist from the Office of the Comptroller of the Currency over its role in a telemarketing fraud, Wachovia stripped Mr. Thompson of the chairman's title. His tenure there lasted another month; he was ousted as the CEO in early June. The following month Wachovia named Robert Steel, a high-ranking Treasury official and a former Goldman Sachs Group Inc. executive, as its president and CEO.

As Wachovia announced Mr. Thompson's departure, Wamu, under similar pressure from shareholders, announced a plan to split the roles of chairman and CEO. Mr. Killinger was stripped of the chairman's title, which was given to Stephen E. Frank, its lead independent director. Mr. Killinger's tenure as CEO would last another three months.

The second quarter delivered more pain to Citi, Nat City, Wamu, Wachovia, and Downey. However, a solid earnings report by Wells, coupled with the fact that the San Francisco company felt confident enough to announce a dividend payout, prompted a huge one-day rally in bank stocks.

As if credit deterioration, thin capital levels, and dented or nonexistent profits were not enough, in August several big banking companies were hit by state and federal investigations into their participation in the auction-rate securities market. Regulators said the industry misled investors by touting the securities as safe and liquid while the credit markets were freezing up. Companies would pay large settlement fees over the following weeks and months.

By the time September arrived, the term "unprecedented" had taken on new meaning and undoubtedly had been replaced, at least privately, by other choice words to describe events.

In a matter of weeks, the financial landscape was dealt a series of deep and wounding shocks that would leave the global markets reeling.

On Sept. 7, a Sunday, the federal government seized Fannie Mae and Freddie Mac. By then months of concern about their viability had erased much of their market value.

The following day, Wamu showed Mr. Killinger the door and made public an informal enforcement action with the Office of Thrift Supervision governing risk management and compliance. The same day the OTS issued a cease-and-desist order instructing Downey to raise capital and strengthen executive management.

In September, Downey picked Charles Rinehart, a longtime thrift executive, to head the ailing institution. Wamu went with another former thrift executive, Alan Fishman, but his role as the CEO of an independent company lasted less than a month.

On Sept. 10, Lehman Brothers, one of the last remaining independent Wall Street investment banks and a company with significant mortgage exposure, reported the biggest loss in its 158-year history. It also said it would start selling pieces of itself to shore up capital and regain investor confidence.

By mid-September rumors abounded that Lehman, on the brink of failure, was shopping itself. B of A, which at this point had started to warm to investment banking again, was rumored to be among the suitors.

Over the weekend of Sept. 13, regulators summoned executives from the biggest financial firms to the headquarters of the Federal Reserve Bank of New York and told them to come up with a plan to help Lehman and the flailing financial services sector.

This time there was no offer of financial assistance, and B of A and Barclays PLC, the other Lehman suitor, walked away. But in an indication of the gravity of the financial crisis, B of A emerged from that weekend meeting with a deal to acquire Merrill Lynch & Co. Inc.

John Thain, Merrill's CEO, who was also at the New York Fed that weekend, had apparently concluded that independence was impossible, and opted to throw his lot in with a stronger company.

On Monday, Sept. 15, Lehman filed for bankruptcy protection. Barclays wound up acquiring much of its investment banking operation.

The day after allowing Lehman to fall, the government stepped in with a rescue plan for American International Group Inc. The company, whose London arm was a major seller of credit-default swap insurance, had hit its own liquidity crisis after a credit downgrade. The plan prompted many to question how the government was deciding which companies to save.

As those dramas played out, rumors were heating up that Wamu was in advanced talks to sell itself to JPMorgan Chase. A "who's next" mentality now had a firm grip on the markets. Financial stocks were down broadly, and shares of Goldman and Morgan Stanley were being particularly punished.

On Sept. 21, a week after Lehman made its bankruptcy filing and Merrill fell into B of A's arms, Goldman and Morgan Stanley announced that they had a green light from the Fed to become bank holding companies. They said the switch would give them broader access to funding sources, namely deposits.

Four days later regulators would close Wamu and sell its banking business in a government-assisted deal to JPMorgan Chase.

Wachovia, also on the brink of failure, would sign its own government-assisted deal with Citi over the weekend of Sept. 29. Days later that deal would be trumped by Wells, which swooped in with a sweeter offer that did not require government support and showed it had ended its aversion for "fixer uppers."

A legal battle between Citi and Wells ensued, though Citi agreed to step out of Wells' way and allow it to acquire Wachovia.

In October, as part of the effort to try to thaw the credit markets, the Treasury Department earmarked a chunk of a new $700 billion bailout fund for direct investments in banks.

Early that month the government took preferred stakes in several of the biggest banking companies, including Citi, B of A, JPMorgan Chase, and Wells. Smaller companies were given a chance to apply for capital infusions, and many did.

On Oct. 24, PNC Financial Services Group Inc. said it would acquire Nat City for roughly $5 billion, becoming the first company to use the government program to fund a deal.

PNC said it would issue $7.7 billion of preferred stock and related warrants to the government. Earlier in the week Nat City had reported its fifth-straight quarterly loss.

In its last report as an independent company, Wachovia laid bare the extent of the balance-sheet issues that had pushed it to the brink of failure. The Charlotte company reported a monumental third-quarter loss of nearly $24 billion in an effort to clear the decks for the Wells deal.

COMMUNITY BANKING

Any discussion about the state of community banking in 2008 begins and ends with one word: capital.

If small and regional banking companies were not busy raising capital — or trying to do so — they were focusing on preserving what they had.

Though many initially felt safe from the market turmoil because they never made subprime loans, the real estate bust threatened capital levels in ways many bankers could not have imagined. Some institutions teetered on the brink because they had bet heavily on residential construction and needed to take massive losses on loans to developers who could not sell the homes they had built.

And who would have guessed the government would seize Fannie and Freddie, forcing bankers to take hefty impairment charges on their investments in the mortgage giants? Or that the market for pooled trust-preferred securities would dry up, drastically narrowing small banks' options for raising funds from the capital markets?

Banks that are based in markets hit hardest by the real estate meltdown and needed cash the most had the hardest time raising it.

Take Federal Trust Corp. in Sanford, Fla. In late summer, a private-equity group led by Jay Sidhu, the former Sovereign Bancorp CEO, agreed to invest as much as $30 million in the thrift company, only to back out a few weeks later after not liking what it saw in FedTrust's loan portfolio. In late September the company announced it had struck a deal with another investment group (which it did not identify), but that deal collapsed days later.

Some struggling companies had so much trouble raising capital that they had little choice but to sell themselves at deep discounts. For example, PFF Bancorp Inc. of Rancho Cucamonga, Calif., agreed in June to sell itself to FBOP Corp. of Oak Park, Ill., for just $1.35 a share. Six months earlier, when its shares were trading at around $11, PFF blocked FBOP from acquiring a controlling stake.

At least PFF's shareholders got something. Investors in companies such as IndyMac Bancorp Inc. and Integrity Bancshares Inc. were wiped out when their companies collapsed over the summer.

Banks in battered markets such as Florida, Southern California, and Atlanta struggled to win over investors. Others in areas less affected by the real estate downturn were able to raise money quickly.

First Niagara Financial Group Inc. and Community Bank Systems Inc. in upstate New York, Berkshire Hills Bancorp Inc. in Pittsfield, Mass., and Towne Bank in Portsmouth, Va., sold out their stock offerings, in some cases raising far more than they needed.

All these companies talked about using the proceeds to take advantage of "opportunities" in their markets, including acquiring weaker firms or stealing business from large competitors preoccupied with either broader credit problems or integrations of their own.

The relative ease with which these companies raised capital highlights another theme from this year: Companies once viewed as laggards became stars.

Though they were hardly poor performers, First Niagara and Community Bank System had produced only average returns over the years, in large part because they operate in relatively slow-growing markets.

But as more and more companies in once high-flying Sun Belt markets flamed out, some slow-and-steady performers in parts of the Middle Atlantic and Northeast emerged as darlings of the investment community.

Still, even the healthiest banking and thrift companies came under increasing scrutiny from regulators, who appear to be changing their definition of "well capitalized."

A bank is considered well capitalized when its total risk-based capital is at 10%, but John Koelmel, First Niagara's CEO, said in September that even the most conservative lenders are under pressure from regulators to increase capital levels.

"What was 10% is now 12%," he said.

It's not just loan losses putting pressure on banks' capital ratios. Countless companies had to take huge impairment charges in their securities portfolios as the value of preferred shares of Fannie and Freddie plummeted.

The government, as part its $700 billion rescue of the financial industry, is offering tax relief to banks that lost money on their Fannie and Freddie holdings. The impact will vary according to the size of the bank's investment. Nevertheless, a number of companies that otherwise would have been profitable in the third quarter swung to a loss or barely made money after taking writedowns on the shares.

Westamerica Bancorp Inc. in San Rafael, Calif., which has consistently been one of the industry's top-performing companies, earned just $44,000 in the third quarter after taking a $24 million charge on its Fannie and Freddie holdings. A year earlier it had earned $22 million.

The government-sponsored enterprise takeover was even more devastating for Gateway Financial Holdings Inc. in Virginia Beach, the company with the heaviest exposure to Fannie and Freddie shares. Facing the prospect of raising of tens of millions of dollars in capital to cover its losses, the $2.1 billion-asset Gateway agreed in late September to sell itself to a rival.

WASHINGTON

This year is likely to be remembered as the most significant in the history of financial services regulation since the Great Depression.

An administration that began the year ruling out any kind of bailout ended up proposing and precipitating the largest government intervention in decades. It secured $700 billion from Congress to stablize financial markets, seized Fannie and Freddie, guaranteed bank debt and money market mutual funds, and consented to a big jump in deposit insurance coverage. It helped some institutions while letting others fail. Bear Stearns and AIG were rescued, while Lehman and Wamu were allowed to go down.

Even major events — the IndyMac failure, then the second-largest in history — was quickly dwarfed by succeeding problems.

The presidential campaign, which typically does not highlight financial services issues, became consumed by the housing crisis. Both sides traded blows over whose political party was responsible. The issue helped to focus voters on the economy and propel Sen. Barack Obama to the White House.

It was a year awash with plans to stop the financial crisis. Most of these plans originated under Treasury Secretary Henry Paulson, a former Goldman Sachs CEO, who embraced new ideas even before older ones were implemented.

Mr. Paulson began the year by continuing to argue that Hope Now, a coalition of servicers, investors, and community advocates formed late last year to foster loan modifications, would be enough to stem the rise of foreclosures.

As lawmakers began to push bolder ideas, including a government agreement to insure loans for struggling borrowers, both Mr. Paulson and President Bush were adamant that no bailout was necessary. But that sentiment would not hold for long.

The first sign that the government was willing to broaden its reach into financial services came March 14, when the Fed announced it would absorb some of Bear Stearns' assets to facilitate a sale to JPMorgan Chase.

The rescue drew plenty of criticism but was seen at the time as an exception — not the template for further rescues to come.

Mr. Paulson, Fed Chairman Ben Bernanke, and New York Fed President Tim Geithner defended the bailout as necessary to prevent wider problems.

Three days later the Fed said it was opening the discount window to investment banks. The decision immediately provoked calls for improved regulation of brokers, including subjecting them to Fed supervision.

That idea had been expected to be included in a regulatory revamp bill planned for next year, but it became moot by the fall when Lehman went bankrupt, B of A bought Merrill, and Goldman Sachs and Morgan Stanley became bank holding companies.

Legislation written by House Financial Services Committee Chairman Barney Frank, D-Mass., and Senate Banking Committee Chairman Chris Dodd, D-Conn., was debated through much of the spring and summer, with Democratic lawmakers pushing it as a way to stabilize housing prices. Borrowers with mortgages worth more than their homes would be able to refinance into a loan insured by the Federal Housing Administration if lenders agreed to take significant haircuts.

Senate Republicans objected, claiming the plan was a bailout for careless borrowers. Still, the measure passed the House by a vote of 266 to 154 on May 8. By that time lawmakers had opted to combine the bill with two other significant measures — legislation to reform the FHA and regulation of the GSEs.

Though the House vote was never in much doubt, the situation remained tense in the Senate Banking Committee, where Republican support would be necessary for the bill to have any chance of passing the full Senate. Sen. Dodd cut a deal with Sen. Richard Shelby of Alabama, the panel's senior GOP member. Sen. Shelby, who had been concerned about funding the new FHA refinancing program with taxpayer money, won a provision that would force Fannie and Freddie to fund the program.

The bill also included some GSE provisions Republicans had been advocating, including giving a new regulator more power over the companies' mortgage portfolios. The measure cleared the committee May 20 by a vote of 19 to 2.

However, while the House and Senate debated relatively minor provisions in the bill, the housing crisis worsened. The IndyMac failure July 11 cost the Deposit Insurance Fund $8.9 billion.

Though there had been six other failures already in the year, IndyMac's was big enough to raise concerns among depositors nationwide and display a troubling new danger for the industry. Bank runs, with their lines outside branches, were previously obvious to the public. But now more customers were withdrawing funds electronically, and these modern runs ultimately doomed Wamu and forced the sale of Wachovia to Wells Fargo. (By press time, 2008 failures totaled 22 institutions with $372 billion in assets at an expected cost to the FDIC of $15 billion.)

While failures began to pile up, shares of Fannie and Freddie began to plummet. By the week of the IndyMac failure, Freddie's stock had dropped 80% over the previous year, and Fannie's had lost 75% of its value. On July 13 the Fed announced plans to lend directly to them through the discount window, and the Treasury proposed legislation that would let it buy equity and debt in the enterprises.

That proposal jolted negotiations over the Frank/Dodd housing package. Testifying before Congress, Mr. Paulson said he did not think the Treasury would need to use its new powers — simply having them would be enough to assure restive investors worried about the health of Fannie and Freddie.

"If you've got a bazooka, and people know you've got it … you're not likely to [have to] take it out," he said.

Congress quickly incorporated the provisions, and the House passed the bill by a vote of 272 to 52 on July 23. The Senate passed it by a vote of 72 to 13 three days later.

This major piece of legislation created a new GSE regulator — the Federal Housing Finance Agency — expanded powers for the Treasury to backstop Fannie and Freddie, created a program to help borrowers, and enacted long-delayed improvements to the FHA.

Yet within weeks, the July 30 law was already considered outdated.

By Sept. 7, Mr. Paulson decided to use the bazooka. The Treasury made an initial purchase of $5 billion of mortgage-backed securities guaranteed by Fannie and Freddie and created a liquidity tool to allow direct loans to them as needed. Finally, the government became a senior preferred shareholder at Fannie and Freddie, taking an initial $1 billion stake in each.

The seizure left the GSEs' future unclear. Mr. Paulson said the business model did not work, but he did not say how it should be rebuilt. The FHFA said it expected to keep them in conservatorship for two years.

More critically, the seizure had a domino effect. Each time concerns were raised about a company, the government would step in with a rescue, and then attention would shift to the next troubled company. Over the next several weeks, that game would be played with Lehman, AIG, Wamu, and Wachovia.

Trouble spread to money market mutual funds, and on Sept. 19 the Treasury announced it would create a $50 billion fund to guarantee them. The Fed said it would provide more liquidity by lending against nearly $300 billion of asset-backed commercial paper backed by the housing GSEs.

As criticism grew louder that the government was just moving from crisis to crisis with no overarching plan, Mr. Paulson announced that the time had come to develop one. He rushed to Capitol Hill late one Thursday night and asked Congress to pass an emergency bill that would let his department purchase and hold up to $700 billion of illiquid mortgage assets.

The request was unprecedented. Congress was set to adjourn only a week later and return to campaigning for the November elections. Several lawmakers acknowledged the obvious: Major legislation would have to wait until next year.

But Mr. Paulson — backed by Mr. Bernanke — forced the Hill into overdrive. For the next two weeks it furiously debated the massive rescue package.

Ultimately, Treasury's three-page bill grew to nearly 500 pages. The Bush administration was forced to accept an oversight board, a loan modification program, and other provisions to grant credit guarantees and insure mortgage-backed securities. But the Treasury also got what it wanted: virtually unlimited power to distribute $700 billion.

While the bill was being worked out, regulators took steps to try and contain the housing crisis — and expand the pool of people able to help banks. On Sept. 22 the Fed loosened rules that limit private-equity investments in banking companies, allowing them to hold a third of total shares.

In a shocking vote, on Sept. 29 the House rejected the massive rescue bill promoted by President Bush and leaders of both parties. The 228-205 vote sent the stock market into a tailspin, and policymakers back to the drawing board.

They turned to an idea first floated eight years earlier: more than doubling deposit insurance coverage. Senate leaders added a provision that would push coverage to $250,000 per account until Dec. 31, 2009. The provision allowed skeptical members of Congress to return to their districts with something for consumers. The Senate passed the bill Oct. 1 by a vote of 74 to 25, and the House followed suit two days later with a vote of 263 to 171. President Bush signed the bill into law Oct. 3.

The new law left the Treasury with a mountain of work. To set up its Troubled Asset Relief Program, it had to hire asset mangers, identify appropriate assets, determine a way to value them, and establish an auction system for financial institutions.

But instead of doing that, the Treasury shifted gears and diverted part of the $700 billion to an entirely different program. On Oct. 14 it said it would invest $125 billion in the nine largest banking companies in return for preferred shares. Another $125 billion was to be distributed to smaller companies. Though Mr. Paulson said the extra capital would be used to lend, several observers said bankers were more likely to use the cash to buy weaker rivals or horde it to deal with future losses.

The same day, the Federal Deposit Insurance Corp. announced it would temporarily guarantee bank debt and back all deposits that do not bear interest. On Oct. 21 the Fed made its second attempt in as many months to bolster money market funds. The first program targeted asset-backed commercial paper held by the funds, but the newer plan tacked the unsecured commercial paper they hold.

AIG was re-rescued on Nov. 10 as the government extended the maturity on its loan and lowered the interest rate. The Fed also agreed to spend more than $50 billion buying the insurer's troubled assets. The next day Mr. Paulson officially closed the door on a broad asset-buying program -- the original aim of the Oct. 3 bailout law. At press time, policymakers were mulling whether to extend a lifeline to automakers, and observers predicted Treasury would have to go back to Congress for more money.

New plans to spark loan modifications were also pending at press time. Ms. Bair pressed a reluctant Treasury to tap up to $50 billion of Tarp funds to guarantee between $700 billion to $800 billion worth of mortgages. Rep. Frank and others said it would be a top priority of President-elect Obama when he takes office in January.

A revamp of the regulatory system is also high on the 2009 agenda. At least one road map already exists. In March Mr. Paulson unveiled an ambitious plan that called for a dramatic rethinking of U.S. financial regulation. His blueprint included recommendations to reduce the patchwork of federal regulators to three agencies: the Fed, which would act as a systemic risk regulator; a prudential safety-and-soundness regulator; and a business conduct regulator to monitor consumer protection. The blueprint also effectively called for the end of the dual banking system and credit unions.

This year may have been the busiest for banking oversight in decades, but it was likely only a prelude to the debates and discussions to come.

MORTGAGES

This was the year many of the mortgage industry's titans became Titanics.

Countrywide, the largest originator and servicer, sold itself to B of A at a 75% discount to book value. Fannie and Freddie, the largest buyers and guarantors of mortgages, were put into conservatorship. IndyMac, a leader in the alternative-A market back when there was one, collapsed. Wamu, saddled with a portfolio of souring option adjustable-rate mortgages, was seized by the FDIC, which sold the Seattle thrift company's banking operations to JPMorgan Chase. Wachovia, another big option ARM holder, agreed to two deals — first with Citi (which had FDIC backing) and then with Wells (whose bid ultimately prevailed).

Other financial services companies with significant mortgage-related businesses and headaches went bankrupt (Lehman), were taken over by the government (AIG), were sold through shotgun marriages arranged by regulators (Bear Stearns), or read the writing on the wall and made deals on their own (Merrill).

Those left cleaning up the messes sought to make the most of these dire situations.

For example, the FDIC started using IndyMac's portfolio as a laboratory for the kind of mass loan modifications that Ms. Bair, the agency's chairman, had long advocated.

Fannie and Freddie, once they came under the FHFA's control, no longer had to preoccupy themselves with profitability (or preserving capital, which had been their goal more recently). Their priorities shifted in favor of supporting the housing market.

Within weeks of their takeover, they canceled plans to increase the "adverse market delivery fees" they had begun charging lenders in March. By most accounts, Fannie and Freddie also greatly ramped up their loan-modification efforts, and they increased their purchases of mortgage bonds.

Herbert Allison, whom the FHFA installed as Fannie's CEO, told lawmakers in September that the steps his company was taking "may entail risks and costs in the short run" but will help to "staunch the flow of foreclosures" and "put a floor under home prices." The company posted a staggering $29 billion third-quarter loss.

B of A settled allegations that Countrywide had engaged in predatory lending practices; the Charlotte company agreed to modify hundreds of thousands of loans at a cost of $8.4 billion. The pact with the attorneys general from 13 states was praised by some as a model for other lenders.

Importantly, the vast majority of the loans covered by the settlement had been put into mortgage-backed securities. B of A said it had been authorized by bondholders to modify the loans, suggesting that securitization, widely viewed as an impediment to such efforts, need not always be.

JPMorgan Chase made a similar modification pledge Oct. 31, and Citigroup unveiled its on Nov. 10.

With the nonconforming mortgage market still moribund, government lending made a roaring comeback this year.

According to the Mortgage Bankers Association, the percentage of loan applications seeking government insurance soared from 9.4% in January to 29% in July. Most of the requests were for loans insured by the FHA, which became a centerpiece of government efforts to stem the foreclosure tide.

Similarly, the Government National Mortgage Association, which guarantees timely payments on securities backed by FHA and other government-backed loans, gained share in its market. By August, Ginnie Mae was guaranteeing more new issues than Freddie and only slightly less than Fannie.

But the new prominence enjoyed by these agencies was accompanied by problems.

FHASecure, an early program designed to refinance borrowers out of adjustable mortgages and into fixed-rate ones, helped only a few thousand people, because of its stringent requirements.

The housing legislation passed in July created the much more ambitious Hope for Homeowners program, which called for the holder of a mortgage to write it down to 90% of the home's current value. The FHA would insure a new loan, and second lien holders would get a share of the home's future appreciation. But it became clear very quickly that this idea, too, would prove tough to put into effect. Some lenders said they were having trouble qualifying borrowers, because their credit scores were lower than what prospective loan buyers would accept.

Generally, a lack of training in FHA lending among industry employees, coupled with the agency's antiquated computer systems, caused many mortgage executives to wonder if it could vet all the volume it was getting. Ginnie Mae likewise had to grapple with defaults by its servicers, which advance money to bondholders when a loan turns delinquent. The servicers had trouble doing so as liquidity dried up.

Industrywide first-half originations dropped 15% from a year earlier, to $1.25 trillion. The MBA projected that full-year production would fall 19%, to $1.86 trillion. Several times over the course of the year flurries of applications seemed to suggest a refi boom was in the offing, but it never panned out, partly because rate drops did not last, but mainly because many borrowers did not qualify for new loans.

And of course, credit quality worsened. The delinquency and foreclosure rates tracked by the MBA set records. Properties acquired by banks through foreclosure increased 29%, to $15.6 billion at midyear, according to the FDIC.

CARDS

The payment industry started the year under a troubling shadow as American Express Co., long considered the card company most insulated from credit and economic concerns, issued a profit warning, foreshadowing a prolonged downturn for the rest of the industry. By July it had suspended profit forecasts as chargeoff rates continued to mount for issuers.

The bad news was offset by Visa Inc., which joined MasterCard Inc. as a public company in March, raising more than $19 billion in its initial public offering, the largest in U.S. history. Visa then took a prolonged victory lap and devoted some of its $1 billion marketing budget to showcase its sponsorship of the Summer Olympic Games in Beijing.

Both companies started flexing their muscles beyond their traditional areas, veering into money transfers, mobile payments, and debit processing. MasterCard, which long trailed Visa in the debit market, tried to catch up by introducing a new processing system and debit-network rules for its issuers. But it lost one of its top debit issuers, Royal Bank of Scotland Group PLC, to Visa, shortly before the consolidation wave among major issuers narrowed opportunities to make up the loss.

The consolidation of power in the hands of major banking companies like JPMorgan Chase, B of A, Citi, and Wells also raised the specter of diminished network bargaining power.

Despite the resilience of Visa and MasterCard against mounting concerns about credit quality, market turmoil drove shares of both companies down and raised questions about their ability to maintain volume growth during the economic crisis.

The two companies also gave up nearly $8 billion to settle antitrust lawsuits with Amex and Discover Financial Services. In June, MasterCard joined Visa in settling with Amex, which reaped up to $4.05 billion; in October, Discover settled with both companies for up to $2.75 billion.

Issuers and network operators also faced the prospect of interchange regulation. The House Judiciary Committee narrowly approved legislation to regulate the fees in July.

For issuers, other potential regulation loomed. In September, the House voted 312 to 112 to rein in common card practices. The bill would prohibit raising rates on existing card debt except when a consumer pays a bill 30 days or more late, a promotional rate expires, or an index tied to the rate increases. The bill also would ban double-cycle billing, restrict fees, and bar minors from obtaining cards. The measure stalled in the Senate, but the Fed has proposed similar reforms.

Discover continued to close the merchant acceptance gap through deals with acquirers. Also, in a play for more international business, it bought the Diners Club International network from Citi. By the end of the third quarter, in a quiet contradiction of its less-respected reputation, Discover was reporting some of the lowest chargeoff rates among major issuers.

But those rates continued to mount across the industry, driven by the global economic downturn, deepening consumer weakness, and rising unemployment. Wamu was the first major issuer to report a double-digit chargeoff rate for credit cards.

By the end of the third quarter large issuers were ratcheting up loss projections, reporting funding disruptions in the capital markets, and approaching lending cautiously.

In November, to gain access to the capital being invested by Treasury, Amex agreed to submit to oversight by the Fed and converted to a bank holding company structure.

With unemployment rates rising and consumer credit tightened, many bankers and analysts predicted a prolonged surge in card losses.

TECHNOLOGY

The financial crisis took its toll on the banking technology market.

Many banking companies cut back on projects deemed non-essential. Some of the top vendors said sales held steady in the first half, especially for products that could help bankers cut costs or increase revenue, but by the third quarter, Metavante Technologies Inc. said prices on several products had come under pressure from beleaguered bank customers, and analysts estimated that prices in some product areas, such as banking security, could fall as much as 15% in the next year.

Failures and consolidation in the financial industry were also expected to hurt vendors by shrinking the pool of customers. In the span of just a week, Total System Services Inc. realized it faced the potential loss of two important clients that generated 4.5% of its revenue: Wamu, which sold its banking operations to JPMorgan Chase in September, and Wachovia, which agreed to sell itself to Wells a week later.

In addition to the market turbulence, there were some notable technology trends this year, including the emergence of the mobile phone as an important channel for banks and the expanding use of the Internet by nonbanks.

A small group of early movers rolled out mobile banking services last year, but the trend picked up steam this year as the financial services industry seemed to reach a consensus that the mobile phone was a critical way to reach customers.

There was plenty of debate last year over whether text messaging, downloadable applications, or services that use phones' built-in browsers would emerge as the dominant format, but many bankers now say there's room for all three. Several financial companies, notably Citi, are experimenting with multiple applications, trying to find the right way to deliver different types of banking and payment services to consumers.

Mobile transfer services also got plenty of attention. Companies such as Obopay Inc. have offered consumers the ability to send each other money with their phones for a few years, but until this year the service was seen mainly as a niche concept. Then in February, Citi said it would link its deposit account system to the Obopay transfer system. MasterCard followed suit in June by announcing that its issuers could use the Obopay system.

In October, Visa said that it would test its own person-to-person transfer service this year with U.S. Bancorp, and that the mobile device was becoming a critical part of its electronic payment strategy.

While bankers were working on the phone channel, nonbanks were busy with the Internet. The peer-to-peer lending market was particularly active. Prosper Marketplace Inc., one of the top players, said that its volume has surged this year, and that its mix has shifted heavily toward prime borrowers, as banks have tightened their lending.

Some new entrants in the market focused on niches such as student and subprime lending. These new entrants, and the emergence of a secondary market from Lending Club Corp., demonstrated strong interest in peer-to-peer lending .

Financial management Web sites also gained traction this year. Companies such as Wesabe Inc., Geezeo Inc., and Mint Software Inc. do not offer banking services, but they say the ongoing economic problems are driving users to their sites in search of help managing their money.

WEALTH MANAGEMENT

As bankers coped with the financial crisis, many wealth management companies spent this year looking to deal.

Deals involving asset managers rose during the third quarter, according to Jefferies Putnam Lovell. The global credit crisis also provided the backdrop for divestitures, which rose to almost 40% of total sales during the quarter, from 23% a year earlier, according to the investment banking unit of Jefferies & Co. Inc.

When it came to wealth management, bankers began to rely more heavily on third-party providers to outsource products, including mutual funds, unified managed accounts, exchange-traded funds, health savings accounts, and annuities.

This year it became more important to offer a wider array of products than to offer proprietary ones. This was good news for providers such as Placemark Investments Inc., BNP Paribas SA's Fundquest, and Hartford Financial Services Group Inc.

Product providers also felt their share of pain this year. Some, including Putnam Investments and BlackRock Inc., experienced heavy outflows as money market funds "broke the buck." Treasury was forced to intervene, but not before Reserve Management Corp., which launched the first money fund in the 1970s, was forced to close most of its funds.

Large trust banks, including State Street Corp., Bank of New York Mellon Corp., and Northern Trust Corp., began the year thinking about international expansion, but they began the fourth quarter thinking about cost cutting.

Northern Trust promoted Frederick H. "Rick" Waddell to CEO to succeed the retiring William Osborn.

In June, Robert L. Reynolds, a former executive at Fidelity Investments, was hired as the CEO at Putnam Investments to succeed Charles E. "Ed" Haldeman, who became the chairman of Putnam Investment Management LLC.

In August, Vanguard Group Inc. announced that F. William McNabb 3rd would succeed the retiring John J. Brennan as its CEO. Also that month, Wachovia's Evergreen Investments announced that Peter Cieszko would succeed Dennis Ferro as the unit's president and CEO.

By Niamh Ring, Alan Kline, Rob Blackwell, Marc Hochstein, Maria Aspan, Will Wade, and Matt Ackermann

More articles in National/Global