Bank stocks tumbled with the rest of the market Thursday, as unfavorable economic news and questions about bank performance reports stoked investor fears about a near-term interest rate hike and chipped away at confidence in the bigger banks.
Hawkish comments about interest rates from Federal Reserve Governor Edward Kelley and several reports indicating that the economy is surging caused a stampede out of bank stocks. A rash of headlines about money laundering and fraud in U.S. banks also may have contributed to the selling atmosphere.
"Concern about interest rates is the biggest reason why bank stocks are down," said Sung Won Sohn, chief economist of Wells Fargo & Co. "But these other problems (can be seen as) the straw breaking the camel's back."
Those factors include the sweeping investigation into money-laundering activities at Bank of New York Co., and another probe into the securities unit of Republic New York Corp. for allegedly inflating net asset valuations for a client. HSBC Holdings of London said that the troubles with Republic New York could delay its acquisition plan.
These situations harm the credibility of U.S. banks, said Robert Albertson, who heads Pilot Financial, a New York hedge fund focusing on financial stocks.
Mr. Albertson attributed most of the downward pressure to the surprise disclosure last week by Bank One Corp. that its 1999 earnings projection would be 8% lower because of problems in its First USA credit card unit.
"Bank One really shook everybody's faith in the sector," said Mr. Albertson. "It is the second big bank to disappoint this year, the first one being First Union. And the suddenness of it and the drama of it really did rub off on some of the other banks."
Larger banks were particularly hurt in Thursday's market downturn. The Standard & Poor's bank index, which includes 31 of the nation's largest banks, hit a 10-month low. Shares of Citigroup Inc. fell 93.75 cents, or 2.09%, to $43.9375; Bank of America Corp. fell 75 cents, or 1.25%, to $59.0625; Chase Manhattan Corp. was down $1.31, or 2.38%, to $80.75; and J.P. Morgan & Co. fell $3.6875, or 2.84%, to $125.9375.
Fears about rate hikes are doing the most damage, economists and analysts say. The Federal Reserve has raised interest rates 50 basis points since June. Fed Governor Kelley fanned the fears with remarks reported Thursday by Market International News Inc., a newswire for traders, salespeople, and economists focusing on fixed-income securities. Mr. Kelley was reported to have said it would be "premature" to assume that the central bank will wait until next year to raise interest rates further.
Anxieties were further heightened after government reports released Thursday showed a higher-than-expected monthly rise in factory orders in July, and U.S. retailer sales climbed in August. Another report showed that productivity gains fell to 3.6% in the first quarter from 4.3% in the fourth quarter.
The three reports indicate that the economy is surging and increase the likelihood that the Federal Open Market Committee will try to slow the growth by raising rates at the next policy meeting in October, said Mr. Sohn.
Higher short-term interest rates in almost any scenario do not bode well for banks because they tend to flatten, or in some cases may invert, the yield curve, said Thomas F. Carpenter, chief economist at ASB Capital Management in Washington. A flattening of the yield curve means that the difference between long- and short-term rates is shrinking. Generally, short-term rates should be lower than long-term rates; when that pattern reverses, the yield curve is inverted.
"Whenever you have a curve that is flattening, the monetary policy brakes are on," said Mr. Carpenter. "An inverted yield curve is a forecast of a slowing economy and a signal of a recession."
Higher rates would hurt banks that underwrite bonds, stocks, and initial public offerings because there will be fewer deals as the economy slows, said Mr. Carpenter. Slower economic growth also means declining loan demand and rising nonperforming assets.
"There is no place for banks to hide in these scenarios," said Mr. Carpenter. "A flattening yield curve is a device which hurts all sectors of the economy, and the banking industry is certainly not immune." ?