Did Campaign Contributions Influence the House Vote on the Bailout?

Interesting correlation between the receipt of campaign contributions from the financial sector and the level of support for the bailout bill in the House.

We have not looked at this study closely yet, and probably won't bother to be truthful, because the level of campaign cronyism in Washington is so pervasive that we feel the point is almost moot. Campaign and lobbying reform is a must have. And we don't.

If we did we'd carefully sort out congressmen who are from states in which the insurance industry is a heavy constituenncy. We also question the inclusion of the entire FIRE segment and would look at the breakdowns of the Financial, Insurance and Real Estate components, since this bill was so heavily targeted to the financial industry.

And as always the campaign contributions are a nice data source, but unless you are looking at the registered lobbyist activity one really has no clue. Soft money is everything these days in the Beltway.

Capital Eye
Finance Sector Gave 51 Percent More to House Bailout Backers
September 29, 2008

WASHINGTON -- Members of the House of Representatives who supported bailing out the financial sector with $700 billion in taxpayer money have received 51 percent more in campaign contributions from the finance, insurance and real estate sector in their congressional careers than those who opposed the emergency legislation, the nonpartisan Center for Responsive Politics calculated following the 228-205 vote on Monday that defeated the House bill.

Examining campaign contributions from the industries that were most eager to see the Emergency Economic Stabilization Act of 2008 passed, the Center found that the gap between lawmakers who supported the bailout and those who successfully opposed it was especially wide among House Democrats. ...

The Coming Collapse of US Treasuries and the Dollar and the Role of the G7

Brad Setser nicely illustrates the increasingly artificial foundation of the US dollar. We read his site every day and find his analysis to be original and well founded, even if we do not always agree with his conclusions.

The parallels of our current situation to 1929-33 seem valid and disconcerting, although this is our view and not Brad's, which is more finely focused for now.

At some point the contrived demand for Treasuries will subside, and the bubble in US debt and the dollar will deflate, not in a monetary deflation which is the fantasy of so many, but in a shocking devaluation of the dollar and a collapse in Treasuries.

The clock is ticking.

Do not doubt that this is a real crisis: more on Fed’s balance sheet
Brad Setser
Tuesday, September 30th, 2008

My colleague at the Council on Foreign Relations, Paul Swartz, has graphed the shift in the composition of the Fed’s balance sheet. The Fed has extended a lot of credit to the financial system — and supplied even more liquidity by letting the investment banks borrow some of its Treasuries.

The amazing thing about this graph is that it doesn’t capture all the credit central banks extended to the financial system last week (Paul used the weekly average numbers, not the data for the end of the week) or the new credit that will be provided by the programs that were expanded today. Those programs should allow the Fed to increase its lending even further.

This graph also does not capture the $500 billion the Fed has lent to other central banks through various swap lines — dollars that other central banks have lent to their own troubled institutions.

Right now, the world’s central banks are truly providing the short-term financing to host of troubled banks that are having trouble raising funds in the market. Laurence H Meyers of Macroeconomic Advisers notes:

“The liquidity measures are a stopgap … You’re funding the banks’ balance sheets, but nobody wants to lend money to them because they’re all afraid of insolvency.”

That sounds right to me. Right now, the US is relying a bit too heavily on the Fed to keep this crisis from spiraling truly out of control. That avoids hard political choices –notably hard choices about how best to recapitalize the financial system — but it also creates some long-term risks for the Fed. (What we are avoiding is the downsizing of a financial sector that is still remarkably oversized, and a capital allocation system that is an unsustainable mutation of a free market. We can waste resources recapitalizing banks but without systemic reform we have accomplished nothing except to feed the instrument of our duress. - Jesse)

I fully recognize the risk that the US government eventually could flood the market with unwanted Treasuries, driving interest rates up — and thus there are limits on how much support the US government can supply the financial system. But as of now, there isn’t much evidence that there is a shortage of demand for Treasuries — indeed, recent market moves suggests a shortage of Treasury bills in the market rather than a surplus. And that certainly is not because the US government has been scaling back its bill issuance. (Demand for Treasuries is strong but not for the 'right reasons.' This is the same phenomena we saw in 1929 when excess liquidity fled the equity markets and corporate debt for Treasuries, and then the weakened dollar collapsed taking Treasuries with it. - Jesse)

By my calculations, the supply of marketable Treasury bills not held by the Fed –i.e. the bills actually in the market — increased from $738.4 to $1200.2b between August 2007 and August 2008. That is a net increase in supply of around $462b. The Treasury was issuing more bills, and the Fed was reducing its holdings to “sterilize” or offset the credit it extended to private financial institutions. The US data on foreign holdings only runs through July, but it suggests that foreign central banks only snapped up $50b or so of this increase: central bank holdings of bills rose from around $180b to $232b. There was a huge surge in private holdings of Treasury bills, with the stock in private hands nearly doubling in 12 months.

And that was before the big surge in bill issuance in September.

Yet judging from market yields, there is no shortage of demand for T-bills despite the huge increase in supply — an increase in supply that is primarily in private not central bank hands. The New York Times reports:

Yields on three-month Treasury bills shrank to just 0.29 percent on Monday, a sign that investors were fleeing from any kind of risk, even if it meant earning a return far lower than the inflation rate.

The outstanding stock of notes (coupon paying bonds with a maturity of between one and ten years) not held by the Fed rose by $280b from August 2007 to August 2008, so there wasn’t just an increase in bill supply. And again, there doesn’t seem to be a shortage of demand. Here though central banks have been big buyers.

One other interesting side note: I would estimate that foreign central banks now hold well around 70% of the outstanding $2265b stock of marketable Treasury notes not held by the Fed. To get that estimate I have to assume that central banks account for most of the $260b or so of private purchases of Treasury bonds over the past year bringing their , and that central banks hold few bonds over ten years and few TIPs — so total central bank holdings of notes are in $1650-$1700b range. Central bank holdings are actually fairly concentrated in certain market segments.

When this artificial demand from the Central Banks subsides the dollar and the US sovereign debt will utterly collapse unless the world is ready to accept the dollar as the fiat currency above all others. And do not think for one minute that the US does not see this outcome. One ring to rule them all...

This is what our bankers do; keep borrowing until you become their problem, and they finally own you by 'default.' This is the blackmail under which the US public is being held today. - Jesse

G7 was 'Staring Into the Abyss'

Interesting interview, and a peek into the bureaucratic mind.

Denial runs deep, although it should be noted this is a career politician speaking, and compared to many of our politicians he is a savant. Unfortunately he is no match for the current schemes emanating from the world's banks.

The German government seems to be in a state of self-delusion, if one can judge from this interview.

To friends and colleagues in Europe: protect yourselves, otherwise your fate will be solely in the hands of well-intentioned but misguided, old-fashioned officials who are operating well behind the financial learning curve.

Der Spiegel
'We Were All Staring into the Abyss'
09/29/2008

SPIEGEL spoke with German Finance Minister Peer Steinbrück about the roots of the US credit disaster, whether Germany is in grave danger and what the future has in store for world banking.

SPIEGEL: Mr. Steinbrück, Wall Street is imploding. The government of the United States wants to establish a $700 billion (€480 billion) bailout program for its banks and their bad loans. How serious is the situation for the rest of the world?

Steinbrück: We are experiencing the most severe financial crisis in decades, although one should be careful about historic comparisons with 1929. One thing is clear: After this crisis, the world will no longer be the same. The financial architecture will change globally.

SPIEGEL: Could you be more specific, please.

Steinbrück: There will be shifts in terms of the importance and status of New York and London as the two main financial centers. State-owned banks and funds, as well as commercial banks from Europe, China, Russia and the Arab world will close the gaps, creating new centers of power in the financial world.

SPIEGEL: In other words, we are experiencing the beginning of a tectonic shift…

Steinbrück:... but not one that is abrupt and jarring. It will be an evolutionary process that will take several years.

SPIEGEL: The current thunder is certainly deafening. We have just seen all US investment banks disappear in one fell swoop.

Steinbrück: Three of them were either taken over or went bankrupt. The two others, because they abandoned their business model to save themselves. No one would have thought this possible until recently. Meanwhile, 25 financial service providers have disappeared from the market in the United States. All of this is illustrative of an earthquake. In addition, many institutions are still fundamentally lacking liquidity.

SPIEGEL: And is the United States completely to blame?

Steinbrück: The source and focus of the problems are clearly in the United States. There are many causes. After 9/11, a great deal of cheap money was tossed into the market. Apparently some of that money went to people with poor creditworthiness. This led to the growth of the real estate bubble. The banks embarked on a race over profit margins. Then speculation spun completely out of control.

SPIEGEL: …which also benefited German banks for a while.

Steinbrück: But they didn't invent these transactions. The stokers on the financial markets were responsible for that. (There are benefits to being well behind the innovation curve apparently - Jesse)

SPIEGEL: And how is the US patient doing now?

Steinbrück: It's in the ICU with pneumonia. This means that here in Europe, we can at least expect to get a bad cold. The US patient lacked legislation, a regulatory framework that could have helped avoid this development. That's the key issue for me. The financial products became more and more complex, but the rules and safeguards didn't change. I don't know anyone in New York or London who would have asked for a stronger regulatory framework 18 months ago. They were always saying: The market regulates everything. What a historic mistake!

SPIEGEL: Your US counterpart, Treasury Secretary Henry Paulson, began by essentially nationalizing the two US mortgage giants, Fannie Mae and Freddie Mac. But then he allowed investment bank Lehman Brothers to plunge in bankruptcy before saving the insurance giant AIG with an $85 billion (€58 billion) bailout. This doesn't exactly look like a clear course of action.

Steinbrück: In the case of Lehman, the US government wanted to send a signal to the market that they are not prepared to offer a bailout under any circumstances. In the case of AIG, we had direct talks at the G7 level and implored them to stabilize the situation. An AIG bankruptcy would have triggered shock waves around the world. We were all staring into the abyss at that point.

SPIEGEL: What role does the US election campaign play in resolving the crisis?

Steinbrück: I hope that my US counterpart will be capable of taking action for as long as possible. We cannot have a six-month vacuum until the next president takes office and his administration is ready to get to work.

SPIEGEL: Paulson headed the investment bank Goldman Sachs for a long time. Does this make him part of the problem?

Steinbrück: He is undoubtedly doing a good job. And at least Goldman Sachs still had the option of making its own decision to transform itself into a bank holding company.

SPIEGEL: That same Paulson snubbed you a year and a half ago. You arrived late for a meeting with him in Washington and he gave you all of 11 minutes of his time -- standing up.

Steinbrück: You don't seriously believe that such trivia plays any role whatsoever in my assessment of a counterpart and of the situation!

SPIEGEL: We are alluding to arrogance and a way of thinking that Paulson may have shared with many major players on Wall Street.

Steinbrück: The way of thinking on Wall Street was quite clear: "Money makes the world go round!" The logic went like this: The government should stay out of our business! And when we Germans began -- and perhaps it was even too late by then -- to ask for controls, for more transparency and equity guidelines, they laughed at us at first.

SPIEGEL: When did those initiatives begin?

Steinbrück: Back in the days of Gerhard Schröder's chancellorship. It was reinforced when Germany assumed the G-7 presidency in early 2007. The first real debate on the subject happened in February 2007, during a meeting of the G-7 finance ministers at Villa Hügel in Essen. Then British Chancellor of the Exchequer Gordon Brown was not very amused by our call for more transparency for hedge funds. The talks have been significantly more constructive since last fall.

SPIEGEL: What, specifically, will you call for?

Steinbrück: A few agreements were already reached with the British and Americans within the G-7 in April. They include imposing new rules on the conduct of the rating agencies, tightening equity regulations and gaining a better handle on cross-border bank supervision. But as far I am concerned, it isn't enough for the industry to develop its own code of conduct. I also want to see the banks no longer allowed to sell all of their risks as they see fit. I think it as a dangerous systemic design flaw that not only loans, but also credit risk is 100-percent marketable. This can lead to uncontrollable wildfires, as we are now seeing.

SPIEGEL: How much government does capitalism need? How much can it tolerate?

Steinbrück: Overall, we have to conclude that certain elements of Marxist theory are not all that incorrect.

SPIEGEL: And you, of all people, are saying this?

Steinbrück: Every exaggeration creates, in a dialectic sense, its counterpart -- an antithesis. In the end, unbridled capitalism with all of its greed, as we have seen happening here, consumes itself…

SPIEGEL: …because it creates an unbridled state?

Steinbrück: That would the wrong development. And I don't believe in it, either. Fortunately, we in Germany have done quite well for ourselves with a happy medium, the social market economy.

SPIEGEL: The German government is unwilling to participate in America's $700 billion bailout package. Is this your final word?

Steinbrück: I see neither the need for nor the possibility of taking on the responsibility for American banks. Besides, our situation is more robust.

SPIEGEL: But the United States will certainly bail out US banks first -- a distortion of competition that could put European institutions under more pressure than ever.

Steinbrück: That's an issue, of course. But I can't give you a shoot-from-the-hip solution. First we have to see what exactly the Americans intend to do.

SPIEGEL: And if things became serious in Europe, you would also have to butt heads with Brussels over intervention options.

Steinbrück: You couldn't be more right! And I have already pointed this out. The Americans are clearly faster when it comes to crisis management, because they aren't hampered by these aid procedures.

SPIEGEL: Nevertheless, you do have worst-case scenarios on the back burner.

Steinbrück: It doesn't make any sense to speculate publicly over something like this. A crisis can easily become a self-fulfilling prophecy that way.

SPIEGEL: You recently met with the top executives from the German banking and insurance industries. What was the mood like?

Steinbrück: Very serious and open. But discretion is needed to achieve any progress on this front.

SPIEGEL: The German state-owned banks, at any rate, are a prime example of a case in which government influence does not automatically guarantee more security. On the contrary. The amount of gambling that took place at institutions like SachsenLB was unbelievable. And taxpayers are the ones who end up footing the bill.

Steinbrück: The responsibility lies with the respective shareholders. Some of them, however, are showing signs of wanting to pass this responsibility on to the government. That's when I stop playing Mr. Nice Guy. They should kindly solve their own problems.

SPIEGEL: Some, it would seem, have failed to apply the rules that already exist in the German system.

Steinbrück: I cannot confirm that. The auditors can only examine what is in the financial statements and what is presented to them. IKB and SachsenLB simply outsourced tremendous risks. I also caution against taking a stop-the-thief approach. In one case, for example, a former department head from the finance ministry who was on the supervisory board of one of these banks has been severely criticized. In an effort to pass some blame on to me, it has been conveniently forgotten that half of the who's who in the German economy was on this same board.

SPIEGEL: Perhaps you should have simply allowed something like IKB to go bankrupt, instead of bailing it out with billions from the state-owned bank KfW and then essentially giving it away to an American financial investor.

Steinbrück: And what would have happened then? We had less then five weeks to conduct a thorough audit. We had 36 hours to decide what would be more costly -- stabilization or insolvency. That was the situation on July 28 and 29 of last year. What happens to the €25 billion ($36 billion) worth of deposits at the IKB? Are they supposed to vanish into thin air? What would have been the consequences for the overall German financial economy? The damage would have disproportionately higher. It's easy to be critical now.

SPIEGEL: And what about the fact that KfW just happened to transfer €319 million ($463 million) to Lehman Brothers, the US investment bank that declared bankruptcy that very same day? This sort of thing doesn't exactly create confidence in state-owned banks.

Steinbrück: That was an awful mistake, of course. A grotesque error. But it was a mistake made by bank executives, not the administrative board, which includes politicians among its members.
SPIEGEL: It proves that normal risk management procedures failed completely -- directly under the nose of the finance minister.

Steinbrück: No, it proves that an inexcusably wrong decision was made. Do you think I wasn't livid about this? The entire crisis we are talking about here is incomprehensible for the normal citizen. But such an idiotic transfer -- even my 89-year-old mother is outraged about it. All 80 million German citizens understand this…

SPIEGEL: …and suddenly you had the tabloid Bild calling the KfW "Germany's stupidest bank."

Steinbrück: Okay, okay. But it's also worth noting that KfW passed all tests and checks regarding its risk management procedures that were performed by the federal audit court and auditors last year. (LOL - Jesse) Of course, I know that the bottom line is that what happened was completely ridiculous. But even that has to be carefully examined. We cannot simply start shooting at random, just to flush out a few executives and keep the public happy.

SPIEGEL: At any rate, the failures and breakdowns among many state-owned German banks show that the government isn't exactly an effective banker.

Steinbrück: I never claimed that it was. The government is neither better nor worse as a banker. Financial transactions are not its core field of operations. The fact that many bankers working for state-owned banks clearly miscalculated is partly the result of their having lost sight of the relationships between risks and profitability. But let me say this once again: Lehman was no state-owned bank, nor was Bear Stearns, Northern Rock or IKB.

SPIEGEL: How dramatic will the effects of the financial crisis be on the German economy?

Steinbrück: So far, the only obvious outcome is that numbers are getting worse. At this point, no one can provide a credible estimate of how bad they will become. Of course, this crisis will also affect growth. However, some developments are currently moving in the opposite direction. The employment market is still strong. And we are still pleased with our tax revenues.

SPIEGEL: You were optimistic only two weeks ago. You said that there was no reason to expect cataclysmic scenarios, and that growth for the year would remain at 1.7 percent.

Steinbrück: I object to your criticism. I have always been on the cautious side, and at the beginning of the year I stated that 2009 will be worse than 2008. I have no reason to revise my predictions for 2008. But 2009 will be significantly worse than the previous estimate of 1.2 percent growth.

SPIEGEL: Should German depositors be concerned about their savings?

Steinbrück: No. No one should be worried about savings accounts. We will see a tectonic shift in the global financial system. Entire types of banks and their business models will disappear, but that doesn't mean that anyone in Germany should be worried about their savings.

SPIEGEL: Is capitalism currently undergoing a general crisis?

Steinbrück: I don't think so. But the behavior of some elites is worth criticizing. We have to be careful not to allow enlightened capitalism to become tainted with questions of legitimacy, acceptance or credibility. This isn't merely an issue of excessive salary developments in some areas. I'm talking about tax evasion and corruption. I'm talking about scandals and affairs of the sort we have recently experienced, although one shouldn't generalize these occurrences. But they are the sort of thing the general public understands all too well. And when they are allowed to continue for too long, the public gets the impression that "those people at the top" no longer have to play by the rules. There have been times in Germany when these elites were closer to the general population. Some things have gotten out of control in this respect.

SPIEGEL: One cannot regulate morality. (The point is not to regulate morality, the point is to circumscribe the effects of those who make free choices, and in some cases to limit those choices. - Jesse)

Steinbrück: No, but that too is dialectics. The elites must understand that it is a matter of self-protection, of developing a sense of the right balance or allowing judgment to prevail.

SPIEGEL: Mr. Steinbrück, thank you very much for taking the time to speak with us.

Interview conducted by Wolfgang Reuter and Thomas Tuma

Translated from the German by Christopher Sultan

Peer Steinbrück, born January 10, 1947, has dedicated his entire professional life to politics.

Steinbrück studied macroeconomics and social sciences in Kiel. Beginning in 1974, he works in various functions for the federal government, among others as a consultant within the Federal Ministry of Research and in the Office of the Chancellor.

In 1985, he switches to the Düsseldorf State Government, where he is, among other things, Chief of Staff for then-Prime Minister Johannes Rau.

Steinbrück went to Schleswig-Holstein in 1990, where he first served as Secretary of State, later as Minister for Economics and Transportation.

In 1998, he returns to North Rhine-Westphalia, becomes Economics Minister, then in early 2000 Finance Minister.

At the end of 2002, the sitting Prime Minister Clement left for Berlin to serve as the Economics and Labor Minister in the federal government. On November 6, 2002, Steinbrück is elected Prime Minister of North Rhine-Westphalia.

Ireland Guarantees Banks for More than Twice GDP

Hard to believe, but the US is still looking like the bastion of capitalism and free markets. We suppose everything is relative.

WSJ Europe
Irish Government Moves to Safeguard Banking System
By QUENTIN FOTTRELL
SEPTEMBER 30, 2008, 6:04 A.M. ET

DUBLIN -- The Irish government Tuesday announced a surprise decision to safeguard the Irish banking system for two years, guaranteeing all deposits, covered bonds, senior debt and dated subordinated debt of the four main banks.

The government said it aims "to safeguard the Irish financial system and to remedy a serious disturbance in the economy caused by the recent turmoil in the international financial markets."
Finance Minister Brian Lenihan said the guarantee will cover €400 billion ($577.64 billion) of the €500 billion of bank assets involved. That is more than Ireland's gross domestic product of €190 billion and national ...

Raymond James Applies to Become a Bank Holding Company

This has the look of a trend. First Goldman and Morgan Stanley and Now RJ. When the going gets tough, the Masters of the Universe slither over to their safe haven at the Fed.

Bring back Glass-Steagall.

The Bond Buyer
Raymond James Financial Will Apply for Bank Holding Company Status
By Patrick Temple-West
September 29, 2008

Raymond James Financial Inc. confirmed Thursday that it will apply for bank holding company status, following the course taken last week by the larger investment banks, Goldman Sachs Group Inc. and Morgan Stanley.

The firm's management stressed that the move comes as part of a long-term strategy and does not indicate any immediate capital needs. The conversion "will have little impact" on the firm's operations and management structure, officials said in a financial statement filed with the Securities and Exchange Commission.

"It's an unfortunate misperception that Goldman Sachs, Morgan Stanley, and now Raymond James are fundamentally changing their business models," Thomas A. James, the firm's CEO and chairman, said in the filing. "In fact, these changes are more form than substance in that regard."

Raymond James ranked 24th among municipal underwriters and was senior manager on 54 issues this year through Sept. 25, according to Thomson Reuters. The firm ranked 34th among financial advisors, serving as FA on 12 issues for the same period. With $40.8 billion in assets under management as of June 30, Raymond James would rank 32nd among bank holding companies, according to the Federal Reserve.

The conversion to a bank holding company is the first step toward eventually becoming a financial holding company, the firm said. If approved by the Fed, the St. Petersburg, Fla.-based Raymond James will convert its thrift, Raymond James Bank, into a state-chartered commercial bank.

The conversion of the bank, which had $7.7 billion in deposits as of June 30, would allow it to engage in more corporate lending, which historically has been more profitable and bears less interest rate risk, the firm said. A financial holding company is a subset of a bank holding company that allows a firm to engage in investing, insurance, and other activities when its commercial bank meets the regulatory standards set by the Fed.

The conversion would lead to greater regulation by the Federal Reserve. Under Regulation Y, the Fed may regulate non-banking activities of the parent company, including mergers and acquisitions. The parent is also expected to maintain the capital and leverage requirements the Fed places on the commercial banks. Subsidiary commercial banks are limited by how much they can lend to the parent company.

Once the conversion for Raymond James takes place, oversight of the Raymond James Bank will be transferred from the Office of Thrift Supervision to the Office of the Comptroller of the Currency.

Goldman Sachs and Morgan Stanley received Fed approval on Sept. 22 to convert to bank holding companies on an expedited basis. The five-day waiting period the Fed requires to examine antitrust concerns before beginning the conversion status was waived for both firms because "emergency conditions exist that justify expeditious action," the Fed said.

Raymond James said it is not looking for emergency funding and that it expects the conversion to a banking holding company to be completed by summer 2009.

The shift to bank holding companies signifies a change in the financial sector. Investment banks like Raymond James rely on short-term borrowing to fund its businesses. Large bank holding companies like Citigroup Global Markets Inc. and JPMorgan Chase & Co. have weathered the liquidity crisis better than the investment banks because they are perceived as being safer under Fed regulations.

Largest One Day Declines in the DJIA by Percentage

Charts in the Babson Style for Blue Monday 29 September 2008

$630 Billion Helicopter Drop from the Fed

"These capitalists generally act harmoniously and in concert to fleece the people, and now that they have got into a quarrel with themselves, we are called upon to appropriate the people’s money to settle the quarrel."

Abraham Lincoln, speech to Illinois legislature, January 1837

Fed Pumps Further $630 Billion Into Financial System
By Scott Lanman and Craig Torres

Sept. 29 (Bloomberg) -- The Federal Reserve will pump an additional $630 billion into the global financial system, flooding banks with cash to alleviate the worst banking crisis since the Great Depression.

The Fed increased its existing currency swaps with foreign central banks by $330 billion to $620 billion to make more dollars available worldwide. The Term Auction Facility, the Fed's emergency loan program, will expand by $300 billion to $450 billion. The European Central Bank, the Bank of England and the Bank of Japan are among the participating authorities.

The Fed's expansion of liquidity, the biggest since credit markets seized up last year, came hours before the U.S. House of Representatives rejected a $700 billion bailout for the financial industry. The crisis is reverberating through the global economy, causing stocks to plunge and forcing European governments to rescue four banks over the past two days alone.

``Today's blast of term liquidity will settle the funding markets down, and allow trust to slowly be restored between borrowers and lenders,'' said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York. On the other hand, ``the Fed's balance sheet is about to explode.'' (As Dr. Greg House might say, "Cooool.." - Jesse)

The MSCI World Index of stocks in 23 developed markets sank 6 percent, the most since its creation in 1970. Credit markets deteriorated further as authorities tried to save more financial institutions from collapse.

European Rescue

European governments have rescued four banks in two days and the Federal Deposit Insurance Corp. said today it helped Citigroup Inc. buy the banking operations of Wachovia Corp. after its shares collapsed. The Standard & Poor's 500 Index fell 3.8 percent and the cost of borrowing dollars for three months rose to the highest since January. The rate for euros hit a record.

``If people think the authorities may give in to fears, they are wrong,'' Financial Stability Forum Chairman Mario Draghi said today in Amsterdam, where the international group of regulators and finance officials is meeting. ``There is willingness and determination on winning the battle to restore confidence and stability.'' (Yes, manipulate the markets until confidence is restored - Jesse)

Banks and brokers have slowed lending as they struggle to restore their capital after $586 billion in credit losses and writedowns since the mortgage crisis began a year ago. The bankruptcy of Lehman Brothers Holdings Inc. also sparked fears among banks they wouldn't be repaid by counterparties, driving up the cost of short-term loans between banks.

Bailout Bill Fails in the House

The Bailout Bill has failed in the house.

The popular voice has been heard as sentiment was running 99 to 1 against.

There was a motion to reconsider, but the vote has failed 205 to 228.

They cannot bring back the exact bill as it has been defeated, but they can reintroduce the bill with changes if they believe they can obtain the votes.

Now we'll take this to the next level, and most likely a Plan B. We would like to see an approach that better targets aid and does not give Wall Street a blank check. For once we would like to see a government plan that provides for more of a 'trickle up' approach that takes care of the people and allows the corporations to profit by adding legitmate value, not obtaining sincecures through devious maneuvers.

Keep providing your opinions and wishes to your elected representatives, because now the pressure from inside the Beltway will be more intense than ever. Whatever you wish, whatever your opinion, make yourself heard.

And be sure to vote in November.

SP Weekly Chart Updates - At the Brink

So far this looks like simple blackmail in a controlled descent.

We think there will be a snapback rally if the House votes for the bailout.

The pressure will remain on until the Senate votes on Wednesday.

Expect anything.

Global Central Banks Attempt to Provide LIquidity and Rescue the Dollar

Federal Reserve Bank
Release Date: September 26, 2008

Central banks have been employing coordinated measures designed to address the pressures in global money markets. Most recently, central banks have acted together to inject dollars into the overnight markets. Using their reciprocal currency arrangements (swap lines) with the Federal Reserve, the Bank of England, the European Central Bank (ECB), and the Swiss National Bank today are announcing the introduction of operations to provide U.S. dollar liquidity with a one-week maturity. These operations are designed to address funding pressures over quarter end. Central banks continue to work together closely and are prepared to take further steps as needed to address the ongoing pressures in funding markets.

Federal Reserve Actions

To assist in the expansion of these operations, the Federal Open Market Committee has authorized a $10 billion increase in its temporary swap facility with the ECB and a $3 billion increase in its facility with the Swiss National Bank. These expanded facilities will now support the provision of U.S. dollar liquidity in amounts of up to $120 billion by the ECB and up to $30 billion by the Swiss National Bank.

In sum, these changes represent a $13 billion addition to the $277 billion previously authorized temporary reciprocal currency arrangements with other central banks. In addition to the swap lines with ECB and the Swiss National Bank, temporary swap lines previously have been authorized with: the Bank of Japan ($60 billion), the Bank of England ($40 billion), the Reserve Bank of Australia ($10 billion), the Bank of Canada ($10 billion), the Bank of Sweden ($10 billion), the National Bank of Denmark ($5 billion), and the Bank of Norway ($5 billion).

These arrangements have been authorized through January 30, 2009.

Roubini Pans the Bailout as a "Disgrace and Ripoff" and Most People Agree

Something needs to be done because of the errors, deceptions, regulatory lapses, and mismanagement of the Bush and Clinton administrations which allowed the unbridled greed of Wall Street to bring the global economy to the brink of ruin.

The priority of this plan is to preserve the status quo. This will not work. This plan will fail and more money will be urged.

Building from the bottom up, protecting the savings of depositors is paramount while liquidating the prime actors in this colossal financial fraud. Balance must be returned to the economy. A simple bailout will not accomplish this.

Restoring the confidence of the public after 16 years of pathological deceit will not be easy.

The Democratic leadership has shown itself to be vacuous, unimaginative and mechanical; the Republicans are pigmen through and through.

Any approach that maintains Morgan Stanley and Goldman Sachs as major players in the banking industry is a disgrace.

RGE Monitor
Is Purchasing $700 billion of Toxic Assets the Best Way to Recapitalize the Financial System?
No! It is Rather a Disgrace and Rip-Off Benefitting only the Shareholders and Unsecured Creditors of Banks
Nouriel Roubini
September 28, 2008

Whenever there is a systemic banking crisis there is a need to recapitalize the banking/financial system to avoid an excessive and destructive credit contraction. But purchasing toxic/illiquid assets of the financial system is not the most effective and efficient way to recapitalize the banking system. Such recapitalization – via the use of public resources – can occur in a number of alternative ways: purchase of bad assets/loans; government injection of preferred shares; government injection of common shares; government purchase of subordinated debt; government issuance of government bonds to be placed on the banks’ balance sheet; government injection of cash; government credit lines extended to the banks; government assumption of government liabilities.

A recent IMF study of 42 systemic banking crises across the world provides evidence on how different crises were resolved. First of all only in 32 of the 42 cases there was government financial intervention of any sort; in 10 cases systemic banking crises were resolved without any government financial intervention. Of the 32 cases where the government recapitalized the banking system only seven included a program of purchase of bad assets/loans (like the one proposed by the US Treasury). In 25 other cases there was no government purchase of such toxic assets. In 6 cases the government purchased preferred shares; in 4 cases the government purchased common shares; in 11 cases the government purchased subordinated debt; in 12 cases the government injected cash in the banks; in 2 cases credit was extended to the banks; and in 3 cases the government assumed bank liabilities. Even in cases where bad assets were purchased – as in Chile – dividends were suspended and all profits and recoveries had to be used to repurchase the bad assets. Of course in most cases multiple forms of government recapitalization of banks were used.

But government purchase of bad assets was the exception rather than the rule. It was used only in Mexico, Japan, Bolivia, Czech Republic, Jamaica, Malaysia, and Paraguay. Even in six of these seven cases where the recapitalization of banks occurred via the government purchase of bad assets such recapitalization was a combination of purchase of bad assets together with other forms of recapitalization (such as government purchase of preferred shares or subordinated debt).

In the Scandinavian banking crises (Sweden, Norway, Finland) that are a model of how a banking crisis should be resolved there was not government purchase of bad assets; most of the recapitalization occurred through various injections of public capital in the banking system. Purchase of toxic assets instead – in most cases in which it was used – made the fiscal cost of the crisis much higher and expensive (as in Japan and Mexico).

Thus the claim by the Fed and Treasury that spending $700 billion of public money is the best way to recapitalize banks has absolutely no factual basis or justification. This way of recapitalizing financial institutions is a total rip-off that will mostly benefit – at a huge expense for the US taxpayer - the common and preferred shareholders and even unsecured creditors of the banks. Even the late addition of some warrants that the government will get in exchange of this massive injection of public money is only a cosmetic fig leaf of dubious value as the form and size of such warrants is totally vague and fuzzy.

So this rescue plan is a huge and massive bailout of the shareholders and the unsecured creditors of the financial firms (not just banks but also other non bank financial institutions); with $700 billion of taxpayer money the pockets of reckless bankers and investors have been made fatter under the fake argument that bailing out Wall Street was necessary to rescue Main Street from a severe recession. Instead, the restoration of the financial health of distressed financial firms could have been achieved with a cheaper and better use of public money.

Indeed, the plan also does not address the need to recapitalize those financial institutions that are badly undercapitalized: this could have been achieved by using some of the $700 billion to inject public funds in ways other and more effective than a purchase of toxic assets: via public injections of preferred shares into these firms; via required matching injections of Tier 1 capital by current shareholders to make sure that such shareholders take first tier loss in the presence of public recapitalization; via suspension of dividends payments; via a conversion of some of the unsecured debt into equity (a debt for equity swap). All these actions would have implied a much lower fiscal costs for the government as they would have forced the shareholders and creditors of the banks to contribute to the recapitalization of the banks. So less than $700 billion of public money could have been spent if the private shareholders and creditors had been forced to contribute to the recapitalization; and whatever the size of the public contribution were to be its distribution between purchases of bad assets and more efficient and fair forms of recapitalization (preferred shares, common shares, sub debt) should have been different. For example if the private sector had done its fair matching share only $350 billion of public money could have been used; and of this $350 billion half could have taken the form of purchase of bad assets and the other half should have taken the form of injection of public capital in these financial institutions. So instead of purchasing – most likely at an excessive price - $700 billion of toxic assets the government could have achieved the same result – or a better result of recapitalizing the banks – by spending only $175 billion in the direct purchase of toxic assets. And even after the government will waste $700 billion buying toxic assets many banks that have not yet provisioned for such losses/writedowns will be even more undercapitalized than before. So this plan does not even achieve the basic objective of recapitalizing undercapitalized banks.

The Treasury plan also does not explicitly include an HOLC-style program to reduce across the board the debt burden of the distressed household sector; without such a component the debt overhang of the household sector will continue to depress consumption spending and will exacerbate the current economic recession.

Thus, the Treasury plan is a disgrace: a bailout of reckless bankers, lenders and investors that provides little direct debt relief to borrowers and financially stressed households and that will come at a very high cost to the US taxpayer. And the plan does nothing to resolve the severe stress in money markets and interbank markets that are now close to a systemic meltdown. It is pathetic that Congress did not consult any of the many professional economists that have presented - many on the RGE Monitor Finance blog forum - alternative plans that were more fair and efficient and less costly ways to resolve this crisis. This is again a case of privatizing the gains and socializing the losses; a bailout and socialism for the rich, the well-connected and Wall Street. And it is a scandal that even Congressional Democrats have fallen for this Treasury scam that does little to resolve the debt burden of millions of distressed home owners.

Charts in the Babson Style for the Week Ending 26 September 2008

These charts are incredibly bearish, and were it not for the bailout being cooked up by the Federals we would be looking to get short and stay short until we burn a thousand points to the downside at least.

However, that is not the case. It does look like the government 'will do something' and this may have a powerful short term impact on the markets.

We want to be ready and capable of taking advantage of a volatile situation.

Fed Puts Pedal to the Metal - Adjusted Monetary Base Rises at Record Levels

It will be interesting to see how the lagged effects of this begin to exhibit in the broader monetary supply measures over time.

Recall that after each of these spikes in the adjusted monetary base there was a resultant bubble in techs and then in housing. Will there be another bubble? Where will it be?

And the presses go rolling along....

Investment Banks Help Drive Discount Window Lending to a Record $262 Billion This Week

Tell us again why we need to give $700 Billion of taxpayer money to Wall Street?

The report attached references the 'investment banks.' We hear that Goldman and Morgan are the only remaining investment banks while they are in the five day 'waiting period' to be bank holding companies.

While we obviously cannot be sure the implication is that they are both insolvent in the hundreds of billions of dollars, and without support would be bankrupt.

Goldman Sachs and Morgan Stanley and the other investment banks are among the prime actors that caused the problems that have been plaguing us since the 1990's.

They devastated multiple industrial sectors in the US through the distortions of asset bubbles while stuffing hundreds of millions of dollars into their pockets.

They corrupted the financial and political systems with their unbridled greed and shameless pursuit of excess and ego.

And now they need three quarters of a trillion dollars to maintain the lifestyle to which they have become accustomed.

Their spokespuppets tell us if we don't give it to them, they will crash the global economy.

The deal on the table is that they sell us nearly worthless assets and derivatives for $700 Billion dollars, and then they loan that money back to us at interest.

Would you like to buy a vowel?

We'd rather give the money to every family that made less than five million dollars on a sliding scale last year. what would that be, about $36,000? And let you wait for it to trickle up.

Oh no, we couldn't do that, it would be inflationary. It would be socialism. But if we give it to the Bush crony capitalists that is good business.

The best Wall Street should hope for is a head start, if there is any justice left in this land.


American Banker
Discount Window Borrowing Jumps to $262 Billion
By Steven Sloan
September 26, 2008

WASHINGTON — During another turbulent week on Wall Street, lending through the Federal Reserve Board's discount window skyrocketed to $262.3 billion on Wednesday, thanks to new lending programs unveiled during the week.

It was the second record in as many weeks and more than double from the previous high water mark.

The heaviest lending was centered on the primary dealer credit facility, which was established in March to give investment banks access to the discount window. The Fed eased terms on the facility on Sunday when it approved requests from Goldman Sachs and Morgan Stanley to convert to bank holding companies.

The Fed said Goldman and Morgan, the last of the major investment banks, could borrow on the same terms as commercial banks and with the same collateral. In response, lending through the PDCF totalled $105.662 billion on Wednesday, from $59.8 billion a week earlier.

Commercial banks were also very active at the discount window. Loans to banks increased 17.7%, to $39.9 billion, a new record.

Meanwhile, the Fed issued loans to weak banks for the second week in a row. These loans increased 5.6%, to $19 million on Wednesday.

The Fed's efforts to backstop the market for money market mutual funds appears to have been met with initial success. The Fed said Friday it would lend against asset backed commercial paper held by the funds. It distributed $72.7 billion by Wednesday.

The central bank also said American International Group Inc., the insurance giant the Fed bailed out on Sept. 16, drew $44.6 billion of its $85 billion government loan by Wednesday. A week earlier, the company had tapped $28 billion of the loan.

As the Fed continues to boost and widen its lending programs, concern has grown that too much of its balance sheet is being dedicated to helping banks survive the credit crunch. With these concerns in mind, the Fed grew its balance sheet by 22%, to $1.2 trillion.

The Fed was helped in these efforts by the Treasury Department, which began a program earlier this month to sell Treasury bills and send the cash generated to the Federal Reserve Bank of New York. The central bank said it received $159.8 billion from the Treasury through this program.

Bipartisan Senator Group Calls for Special Investigator to Oversee Bailout Operations

This could be useless smoke, or it could have some teeth and be useful.

If this position was filled by Eliot Spitzer it might be interesting, maybe for no pay as a community service deal. He would surely be up for that. Payback is a bitch after all. Probably a little outré for Washington.

Maybe George Soros, Nouriel Roubini, or Paul Krugman? No their knuckles are not hairy enough for this task. Karl Denninger of Tickerforum or Gata's Bill Murphy could do it if they had strong staff support. There would not be a bank left unscathed after they hit their stride. The press briefings would be fun.

The most significant talent for a Special Inspector General in addition to being able to build and organize a large administrative problem with loads of special influence-peddling interference would be to sniff out fraud and roll the small fry over on the heavy hitters.

The Senate would probably want to consider someone NOT nominated by short-timer Bush. As they say in boxing that nominee would be a 'tomato.' Someone like Tom Kean, Rudy Giuliani or Phil Gramm. Hey, Sara Palin is a reformer and knows finance; she has a checkbook.

It would best be someone with significant experience in RICO investigations and a serious lack of sympathy for Wall Street, but with a familiarity with their methods and a spotless reputation.

Does such a person exist?

RTT Global Financial News
32 Senators Call For Creation Of Special Investigator General To Oversee Bailout
9/25/2008 3:50 PM ET

(RTTNews) - A bipartisan group of 32 senators is calling for a special auditor for any federal bailout program for financial institutions.

The group, led by Finance Committee Chairman Max Baucus, D-Mont., says a special investigator general for the program would be an important step to preventing waste, fraud and abuse.

In a letter to House and Senate leaders of both parties, the 32 senators said the program should be modeled after the Special Investigator General investigating problems in Iraqi reconstruction efforts.

"But this Special Treasury Inspector General would be on the job long before waste, fraud, and abuse has a chance to take hold in the Treasury program," they said in the letter. "Proper oversight will require not only our constant effort, but the full time attention of an office with only one task: to monitor this extremely complex effort with a team of expert personnel who will not be distracted by other duties."

The letter calls for the new IG to be nominated within 30 days of approval of a bailout plan and demands that the inspector have full power to investigate, audit and issue subpoenas.

"I don't like bailouts, and I certainly wasn't okay with the blank-check request that first came to Congress from the Treasury. If Congress does pass legislation - and I will have to look at it closely - creating a Special Inspector General will make any program more accountable to taxpayers," Baucus said in a statement.

China Admits to Currency Manipulation, Dictates Terms for Support of US Sovereign Debt

Anyone care to remember the many economists, talking heads and government hacks who provided lengthy explanations why China was not manipulating the currency markets to provide a de facto set of subsidies and tariffs in the international markets?

Now China is dictating the terms.

This started with the Clintons and was brought to full flower under Bush.

The Wall Street bailout will probably pass under duress. Why not? The Congress cannot hear their constituents, and have been increasingly ignoring them for years. We need to vote out all incumbents in November.

It is merely another step in the systematic betrayal of the markets and the public and all holders of the US dollar.

The reason why the government will give trillions to the banks and not the people is because of fear of making a mistake and campaign donations from Wall Street.

The reason that the Treasury and Fed wish to pay more than junk assets are worth and give it to the banks rather than the people is that the banks will take the money and put it in the multiplier machine x10 through fractional reserve accounting and inflate us out of our debt problems. They are counting on countries like China and Japan to help them hide it for as long as possible while they think about another plan to prevent hyperinflation.

What does not kill the dollar makes it.... stranger.

Asia Needs Deal to Prevent Panic Selling of U.S. Debt, Yu Says
By Kevin Hamlin

Sept. 25 (Bloomberg) -- Japan, China and other holders of U.S. government debt must quickly reach an agreement to prevent panic sales leading to a global financial collapse, said Yu Yongding, a former adviser to the Chinese central bank.

``We are in the same boat, we must cooperate,'' Yu said in an interview in Beijing on Sept. 23. ``If there's no selling in a panicked way, then China willingly can continue to provide our financial support by continuing to hold U.S. assets.''

An agreement is needed so that no nation rushes to sell, ``causing a collapse,'' Yu said. Japan is the biggest owner of U.S. Treasury bills, holding $593 billion, and China is second with $519 billion. Asian countries together hold half of the $2.67 trillion total held by foreign nations.

China, Japan, South Korea and others should meet soon to seal a deal, said Yu, a former academic member of the central bank's monetary policy committee. The talks should involve finance ministers, central bank governors and even national leaders, he said.

``Whether some kind of agreement between them to continue to hold Treasury bills is viable, I'm not sure,'' said James McCormack, head of sovereign ratings at Fitch Ratings Ltd in Hong Kong. ``It would be unusual. If it became apparent that sovereigns in Asia were selling Treasuries the market would take that quite badly, it's something to be avoided...''

China's huge holdings of U.S. debt means it must bear a large proportion of the ``burden of sorting things out'' in the U.S., Yu said. China is not in a hurry to dump its U.S. holdings and communication between the two nations every ``couple of days'' is keeping Chinese leaders informed and helping to avoid a potential panic, he added.

``China is very worried about the safety of its assets,'' he said. ``If you want China to keep calm, you must ensure China that its assets are safe.''

Currency Manipulator

Yu said China is helping the U.S. ``in a very big way'' and added that it should get something in return. The U.S. should avoid labeling it an unfair trader and a currency manipulator and not politicize other issues, he said.

``It is not fair that we are doing this in good faith and are prepared to bear serious consequences and you are still labeling China this and that, accusing China of this and that,'' he said. ``China knows what to do. We don't need your intervention.''

The U.S. financial crisis had taught China a lesson and that was: ``Why are we piling up these IOUs if they may default?'' China's economic expansion strategy, which emphasizes export growth that has led to trade surpluses and the accumulation of $1.81 trillion in foreign-exchange reserves, is the main problem, said Yu.

``Our export-growth strategy has run its natural course,'' he said. ``We should change course.''

China should stop intervening in the foreign currency markets and thus allow rapid appreciation of the yuan, he said. While this would cause pain for exporters, China could ease the transition by using its strong fiscal position to aid those who lose their jobs. It also should stimulate domestic demand to offset lower income from overseas sales.

Without yuan appreciation, China will continue to accumulate foreign reserves, which means further accumulating ``IOUs from the U.S.,'' said Yu. ``This is paper and it may default and it will not increase China's national welfare.''

If China doesn't allow the yuan to appreciate and continues to promote export-led growth it will lead to confrontation with the U.S. and Europe, Yu said.

China Regulator Bans Lending to US Banks Because of Default Risk

South China Morning Post
China banks told to halt lending to US banks
by Alan Wheatley and Langi Chiang
Sep 24, 2008 9:52pm EDT

BEIJING, Sept 25 (Reuters) - Chinese regulators have told domestic banks to stop interbank lending to U.S. financial institutions to prevent possible losses during the financial crisis, the South China Morning Post reported on Thursday.

The Hong Kong newspaper cited unidentified industry sources as saying the instruction from the China Banking Regulatory Commission (CBRC) applied to interbank lending of all currencies to U.S. banks but not to banks from other countries.

"The decree appears to be Beijing's first attempt to erect defences against the deepening U.S. financial meltdown after the mainland's major lenders reported billions of U.S. dollars in exposure to the credit crisis," the SCMP said.

A spokesman for the CBRC had no immediate comment.

American Public to Wall Street Banks: Drop Dead

“Most illiquid bond assets are illiquid because they are not worth anything.” - Ron Paul

When this was forecast below was written a few weeks ago it was not with the idea that the 'offer' would be coming so quickly. But with McCain lagging badly in the polls, it looks like the money powers decided it was time to act just ahead of a congressional recess.

"When the banks make us an offer they think that we cannot refuse, we will be at the crossroads and will decide what we wish to be: slaves [to fear] or free men. Yes, it really is that simple."

Death of Capitalism: Financial Tsunami Incoming - 8 Sept 2008

How did we know this was coming? Because the setup really is that obvious. These guys are not clever, they are shameless.

What is most surprising has been the enormous response from the public to the Congress since Paulson's Treasury made their arrogant proposal to the country last week on behalf of Wall Street. Aides report that it is running solidly 99 to 1 against. The common sense of the people is a sleeping giant and has apparently been awakened by this outrage. Not completely, but stirring. We don't have any illusions. Its hard to stand up to the Big Lie. The Banks will get something.

The banks have mispriced assets on their books. They will never be worth what they thought they would be, where they marked them with the cooperation of the ratings agencies, if they hold them until kingdom come.

This is why they do not wish to hold them on their books. They want to sell them, but they do not wish to accept the price that an informed market will offer, now or in the near future.

Its hard to understand this unless you accept the inherently fraudulent nature of much of the paper that was packaged and put together for sale to others. This latest bubble fell apart prematurely when the market for this junk collapsed and the banks were left holding the bag.

Provide liquidity to the banks at a price. Put four hundred billion dollars into the FDIC to insure the savers' bank accounts and increase it to one million dollars per person. Put another three hundred billion in the Small Business Administration and Office of Thrift Supervision and the FHA if necessary to make loans to small businesses and consumers that cannot obtain market liquidity through the regional banks, which should be the key to the rebuilding of our financial system. Provide large amounts of liquidity to the healthy banks in the quantities required to support economic activity.

But do NOT buy this junk from the Wall Street banks, especially the investment banks. Allow the tide to continue to go out and let's see who is wearing what. If we provide a bailout to this crowd while they continue to pay out fat dividends and capital gains and outrageous salaries we deserve what we will most surely get in return.

"Last year Goldman paid its employees $20 billion, 44 percent of the firm's revenue. Chief Executive Officer Lloyd Blankfein took home $68.5 million, and many otherwise ordinary human beings took home $10 million or more.

This inspired young people everywhere, many of whom may have privately wondered whether it was still worth their time to become investment bankers. Torn between a future in, say, the law and the manufacture of mezzanine CDOs they sucked up their courage and plunged onto Wall Street. And thank God for that: we needed the best and the brightest to get us into this mess, and we'll need the best and the brightest to get us out of it."

America Must Rescue the Bonuses at Goldman Sachs - Michael Lewis

The Wall Street banks are an inefficient, manipulative, overly-expensive, oversized, and a hopelessly broken mechanism for the rational allocation of capital. A number of those banks need to be broken apart and liquidated, not replenished with increasingly scarce public capital. We need to cut out the parts that are hopelessly rotten, save what is good, and rebuild together from there.

What would we do if the oil companies said "Give us the Artic Wildlife refuge and 700 billion in public money to develop it or we won't give you any gas starting next month. We'll send it all to China and Europe."

What if the drug companies said, "Give us free malpractice insurance and accelerated drug approvals and scrap the FDA and 700 billion for research and development or you won't get any more medicine next week."

Or GM and Ford said "Give us 700 billion to retool to meet industry standards and pay off our healthcare and pensions or we stop fixing and shipping cars and crash the manufacturing industry."

Why is it when it comes to Wall street that people lose all perspective?

What would you do if your your teenager said they wanted a $7000 home entertainment system or they would throw themselves on the ground and make an embarrassing scene?

What are we going to do when the Big Banks come back in six months and say, "the 700 billion was not enough, we ran through it already. We need another 700 billion or the markets will crash and we will stop lending money."

Decisions made under the duress of dire threats and political blackmail never work out as intended, and never stop there, because appeasement does not work.

If we do not invade Iraq the first warning we will get about their WMDs will be a mushroom cloud. If you do not pass the Patriot Act immediately hidden sleeper cells will rise up and bomb the shopping malls.

We need to fix this problem, not just throw money at it and hope it goes away. Maybe there is a good case to be made for a capital infusion but we certainly have not heard it explained. So far all we have are demands and threats as this site predicted we would receive weeks ago.

ProPublica - History of US Government Bailouts

Nasdaq Composite Long Term Logarithmic Chart

This is a logarithmic long term chart of the Nasdaq Composite.

Quite a bit of these gains simply reflect the effects of dollar inflation which has a significant compounding effect over time.

But it does suggest that the potential downside is profound.

The indicators on the bottom of the chart are the volume-based money flows.

AIG Takes 85 Billion Fed Loan, Agrees to be Nationalized

AIG signs up for $85 billion Fed loan
By Alistair Barr,
MarketWatch
1:25 p.m. EDT Sept. 24, 2008

Insurer effectively 'nationalized' after failing to raise capital in private market

SAN FRANCISCO (MarketWatch) -- American International Group shares fell more than 10%on Wednesday after the giant insurer agreed to be effectively nationalized late Tuesday.

AIG narrowly avoided bankruptcy last week after the Federal Reserve stepped in with a massive bailout.

Some big AIG shareholders have reportedly been trying to raise capital in private markets to avoid the government seizing control of the company.

But late Tuesday AIG said it signed a definitive agreement with the Federal Reserve Bank of New York for a two-year, $85 billion revolving credit facility.

As part of the deal, AIG will issue a series of Convertible Participating Serial Preferred Stock to a trust that will hold the new securities for the benefit of the Treasury. The Preferred Stock will get almost 80% of any dividends paid on AIG's common stock and will give the government almost 80% of the voting power. The securities will then be converted to common stock at a special shareholder meeting, AIG said.

The agreement leaves "AIG essentially nationalized," Bijan Moazami, an analyst at Friedman, Billings, Ramsey, wrote in a note to investors on Wednesday. "Shareholder efforts to prevent the government from taking an equity stake in AIG will prove fruitless."

Indeed, AIG's new chief executive Edward Liddy said the company made an "exhaustive effort" to borrow money in the private market, but failed.

"This facility was the company's best alternative," Liddy added in a statement late Tuesday
.
AIG shares dropped 13% to $4.36 during afternoon trading on Wednesday.

Asset sales, dilution

Liddy said AIG is developing a plan to sell assets and use the proceeds to repay the government loan, hopefully emerging later as a smaller but profitable company.

FBR's Moazami expects AIG to borrow all the $85 billion immediately, partly because the company will have to pay hefty fees and interest on the money it doesn't use. The agreement with the Fed requires the insurer to pay an annual interest rate of 8.5% on the money it doesn't borrow from the loan facility.

AIG has to pay back the $85 billion from the proceeds of certain asset sales and the issuances of new debt and equity, the company said.

AIG has "little to no" capacity to borrow more money in private markets, so if it has to raise capital to repay the Fed the insurer will probably have to sell more common shares, diluting current investors even more, Moazami warned

The Failed Bankers Rescue of 1929 Redux

“This is scare tactics to try to do something that’s in the private but not the public interest,” said Allan Meltzer, a former economic adviser to President Reagan, and an expert on monetary policy at the Carnegie Mellon Tepper School of Business. “It’s terrible.”

Alan Meltzer of Carnegie Mellon just finished excoriating the Bernanke-Paulson plan on Bloomberg television and he is right. We need to allow the markets to work through this longer, to use the facilities we have in place, to allow the Fed if necessary to add liquidity to the markets if they feel the need and the situation calls for it.

But purchasing specific bad debt from specific banks with no strings attached is crony capitalism, with dividends to be paid, stock gains to be taken, management compensation to remain at lofty levels. It is a repugnant to the republic and free markets.

And it is increasingly difficult to believe that this proposal is being made in good faith with the intentions and objectives as stated.

...several leading Wall Street bankers met to find a solution. The group included Thomas W. Lamont, acting head of Morgan Bank; Albert Wiggin of the Chase National Bank; and Charles E. Mitchell, of National City Bank. They chose Richard Whitney, vice president of the Exchange, to act on their behalf.

With the bankers' financial resources behind him, Whitney placed a bid to purchase a large block of shares in U.S. Steel at a price well above the current market. As amazed traders watched, Whitney then placed similar bids on other blue-chip stocks.
Although a similar such tactic had ended the Panic of 1907, this action halted the slide that day and returned stability to the market only temporarily.

We may have finally figured out Ben's game and connected some of the dots that did not seem to make any sense in isolation. It was in his explanation of why the Treasury should pay well over market prices for the toxic bank debt held by Wall Street. (We're not willing yet to speculate on Hank's game yet.)

This morning in response to a question about why the Treasury should not penalize or demand anything in return from the banks for buying distressed assets in return for the risk, and pay closer to hold to maturity prices, Ben said that this would not be fair since all the banks stand to benefit from this action.'

The point of this exercise is not to help two or three banks or ten banks which are in trouble.

The point of this exercise is to try and support the debt markets by buying assets at prices well above the market, and to do it quickly and in size in the hope of forestalling a likely debt market and stock market crash. They are going to give the money to the banks for worthless assets because they want to gear up x10 using the fractional reserve money multiplier. Its a helicopter drop to the Wall Street banks. They will take a hefty cut for themselves for taking the package and doling it out like third world warlords handing out Red Cross aid.

This is eerily similar to the actions taken by the Morgan's Lamont and the NY banks in putting together a pool of money, and halting the Crash of 1929 by having Dick Whitney walk across the street, and loudly start buying stocks at above market prices to "restore confidence" in the markets. This did work, for a day.

It is also similar to a tactic Morgan himself and the bankers used in 1907 to halt the liquidity panic caused by some specific bank failures caused by overextension in bad assets.

Why are these policy failures? It presumes that the markets are wrong, and that they are pricing risk incorrectly. Further, it does nothing to change the dynamics and fundamentals underlying the markets assumptions except to hold out a federal subsidy at an above market price. The traders will come back and hit that subsidy over and over until it is exhausted, as the currency traders hit sterling when the Bank of England tried to support it above the market.

We think this will not work, is a policy error, because buying assets above market price will not stop this juggernaut of a collapsing bubble, and will merely throw 700 billion of capital we will sorely miss later down a hole, specifically benefiting a remarkably few individuals who will skim most of it before it is obliterated. It will inflate the currency and soon be exhausted. It will accomplish nothing and only make it worse for many who fail to take action to protect themselves, being deceived by this market manipulation.

In short, Bernanke's proposal fixes NOTHING. It provides some getting out of town money for some of the worst of the insiders of this financial fiasco.

That's why he needs this today or tomorrow. Because the US equity markets are in the process of crashing. And he is attempting the same type of banker's rescue that was attempted in 1929.

Sweeping actions will not work. We cannot fix this by reflating the bubble and pricing the assets back up to bubble levels. This would buy a little time at best.

We need to get in and tie off the bleeding parts, the truly insolvent banks, sort out which are good and which are foul, and cut them off in bankruptcy like Lehman. This cannot be done by banking insiders because of the obvious conflicts of interest which are profound, even in self-proclaimed purely objective Ben.

One last thing to think about. We are having these discussions about the fate of our biggest banks. Which ones to save and how? Which ones to take into conservatorship and manage their affairs as a major creditor. Which ones to fail and liquidate. How best to firewall the side effects.

What are our creditors overseas saying about us? About the US and the sovereign debt and our impending insolvency? And don't think they are not having these discussions, perhaps without our direct involvement.

There came a Wednesday, October 23rd, when the market was a little shaky, weak. And whether this caused some spread of pessimism, one doesn't know. It certainly led a lot of people to think they should get out. And so, Thursday, October the 24th -- the first Black Thursday -- the market, beginning in the morning, took a terrific tumble. The market opened in an absolutely free fall and some people couldn't even get any bids for their shares and it was wild panic. And an ugly crowd gathered outside the stock exchange and it was described as making weird and threatening noises. It was, indeed, one of the worst days that had ever been seen down there."

"There was a glimmer of hope on Black Thursday...About 12:30, there was an announcement that this group of bankers would make available a very substantial sum to ease the credit stringency and support the market. And right after that, Dick Whitney made his famous walk across the floor of the New York Stock Exchange.... At 1:30 in the afternoon, at the height of the panic, he strolled across the floor and in a loud, clear voice, ordered 10,000 shares of U.S. Steel at a price considerably higher than the last bid. He then went from post to post, shouting buy orders for key stocks."

"And sure enough, this seemed to be evidence that the bankers had moved in to end the panic. And they did end it for that day. The market then stabilized and even went up."

"But Monday was not good. Apparently, people had thought about things over the weekend, over Sunday, and decided maybe they might be safer to get out. And then came the real crash, which was on Tuesday, when the market went down and down and down, without seeming limit...Morgan's bankers could no longer stem the tide. It was like trying to stop Niagara Falls. Everyone wanted to sell."

"In brokers' offices across the country, the small investors -- the tailors, the grocers, the secretaries -- stared at the moving ticker in numb silence. Hope of an easy retirement, the new home, their children's education, everything was gone."

Warren Buffet Goes Dumpster Diving and Gets the Gold, Man

Goldman is paying Warren a pretty rich return for his buy-in.

Did they give up hope on Hank and Ben for a government handout?

Or did Warren just decide to get a place at the table with the new ruling power in the US?

American Banker
Berkshire to Buy $5B of Preferred Stock from Goldman Sachs
By Jack Herman
September 23, 2008

Berkshire Hathaway Inc. will buy $5 billion worth of perpetual preferred stock from Goldman Sachs Group Inc. in a private offering, Goldman Sachs announced today.

The preferred stock will pay a 10% dividend and will be callable any time at a 10% premium. Berkshire will also receive warrants to purchase $5 billion worth of common stock within five years and a strike price of $115 per share.

Along with Morgan Stanley, Goldman Sachs announced Sunday it would convert into a bank holding company.

"We are pleased that given our longstanding relationship, Warren Buffett, arguably the world's most admired and successful investor, has decided to make such a significant investment in Goldman Sachs. We view it as a strong validation of our client franchise and future prospects," Lloyd C. Blankfein, chairman and chief executive officer of Goldman Sachs Group Inc., said in a statement. "This investment will further bolster our strong capitalization and liquidity position."

"Goldman Sachs is an exceptional institution," Warren Buffett, chairman and CEO of Berkshire Hathaway, said in a statement. "It has an unrivaled global franchise, a proven and deep management team, and the intellectual and financial capital to continue its track record of outperformance."

FBI Looking for Financial Misdeeds on Wall Street

May as well throw a cordon around Manhattan and bring in everyone wearing a power tie, suspenders, or designer shoes from Bergdorf's.

"...the FBI's hunt for culprits in the nation's subprime mortgage crisis focused on accounting fraud, insider trading, and failure to disclose the value of mortgage-related securities and other investments."

Associated Press
FBI investigating companies at heart of meltdown
By LARA JAKES JORDAN
09.23.08, 8:09 PM ET

WASHINGTON - The FBI is investigating four major U.S. financial institutions whose collapse helped trigger a $700 billion bailout plan by the Bush administration, The Associated Press has learned.

Two law enforcement officials said Tuesday the FBI is looking at potential fraud by mortgage finance giants Fannie Mae and Freddie Mac, and insurer American International Group Inc. Additionally, a senior law enforcement official said Lehman Brothers Holdings Inc. also is under investigation.

The inquiries will focus on the financial institutions and the individuals that ran them, the senior law enforcement official said.

The law enforcement officials spoke on condition of anonymity because the investigations are ongoing and are in the very early stages.

Officials said the new inquiries bring to 26 the number of corporate lenders under investigation over the past year.

Spokesmen for AIG, Fannie Mae and Freddie Mac did not immediately return calls for comment Tuesday evening. A Lehman spokesman did not have an immediate comment.

Just last week, FBI Director Robert Mueller put the number of large financial firms under investigation at 24. He did not name any of the companies under investigation but said the FBI also was looking at whether any of them have misrepresented their assets.

Over the past year as the housing market cratered, the FBI has opened a wide-ranging probe of companies across the financial services industry, from mortgage lenders to investment banks that bundle home loans into securities sold to investors. Mueller has previously said the FBI's hunt for culprits in the nation's subprime mortgage crisis focused on accounting fraud, insider trading, and failure to disclose the value of mortgage-related securities and other investments.

The investigations revealed Tuesday come as lawmakers began considering whether to approve emergency legislation that would give the government broad power to buy up devalued assets from troubled finance....

Additionally, the FBI is investigating failed bank IndyMac Bancorp Inc. for possible fraud. Countrywide Financial Corp., formerly the nation's largest mortgage lender and now owned by Bank of America Corp., is also under scrutiny.

Buddy Can You Spare $5,000,000,000,000.00?

Noted Japanese business strategist Kenichi Ohmae suggests that the entire world scrape together $5 Trillion from their forex reserves and savings and give it to the Wall Street banks.

It would be much easier to just print it, and let the dollar devaluation be spread out evenly over every holder of US dollars in the world.

Actually, that's the obvious plan and we're already rolling the presses. Ohmae just has not figured that out yet.

Lions, and tigers and bears, Ohmae!

$5 Trillion Cash Pool Needed to Stop Rout, Ohmae Says
By Bei Hu

Sept. 23 (Bloomberg) -- Treasury Secretary Henry Paulson's $700 billion plan to buy devalued assets from financial companies is ``a joke'' because it doesn't go far enough to calm markets, said Kenichi Ohmae, president of Business Breakthrough Inc.

Ohmae, nicknamed ``Mr. Strategy'' during his 23 years as a McKinsey & Co. partner, called for a $5 trillion ``international facility'' to be made available to financial institutions. The system could be modeled on one used by Sweden during its banking crisis in the early 1990s, he said.

``This is a liquidity crisis,'' Ohmae said at an investor forum hosted by CLSA Asia-Pacific Markets, the regional broking arm of Credit Agricole SA, in Hong Kong yesterday. ``The liquidity has to be so big that people won't get panicky.''

Paulson's proposal to remove hard-to-sell assets clogging the financial system marks the broadest intervention since at least the Great Depression. Asian stocks fell today, following U.S. shares lower as investors questioned whether the effort is enough to prevent a recession.

The plan came after the collapse of 158-year-old Lehman Brothers Holdings Inc. and the government takeover of insurer American International Group Inc. caused financial markets to seize up last week. The calamity was the culmination of a year during which the U.S. housing market slump left banks and securities firms with more than $520 billion of asset writedowns and credit losses.

Yesterday, Paulson and lawmakers narrowed their differences on the plan and agreed that the U.S. should get equity in participating companies.

Hard to Coordinate

Ohmae, 65, is the author of management books including ``The Mind of The Strategist,'' ``The Borderless World'' and ``The End of the Nation State.'' Business Breakthrough, founded in 1998, provides online management training.

One way of funding the $5 trillion facility would be through contributions from foreign exchange reserves in China, Japan, Taiwan, the Gulf states, the European Union and Russia, Ohmae said.

An international relief effort on that scale might be difficult to coordinate, said Robert Howe, founder of Hong Kong- based hedge fund manager Geomatrix (HK) Ltd., which oversees $32 million. ``I doubt the practicality of getting international cooperation on something like this,'' he said.

Ohmae compared the current financial crisis with Japan's 15- year economic decline that began in 1989. Both started with a property bubble, which wiped out companies' equity when it burst, and like in Japan, the current one could lead to escalating bankruptcies as banks worried about their own survival rein in lending, he said.

`Viagra' Economy

The financial-market upheaval may lead to slower growth in China and the reversal of the commodity boom as ship orders are canceled and steel supply dumped, said Ohmae. What Ohmae called Japan's ``Viagra'' economy and Australia's ``dig and deliver'' boom may also fizzle as China weakens, he said.

Against the backdrop of a potential global market panic, Paulson's plan is insufficient, said Ohmae. Paulson is a former chief executive of Goldman Sachs Group Inc., the world's biggest securities firm.

``He wants to fix problems one by one as if he were still the chief executive officer of Goldman Sachs,'' he said. ``He has to take his CEO hat completely off and come up with a systemic solution as opposed to a one-by-one solution.''

Charts in the Babson Style for Tuesday 23 September

A Modest Proposal. Show Us the Money.

Is it too much to ask for a prioritized estimate of the banks which will be participating in this program, and what amounts they might require?

Yes it would be difficult to do, it might take a few days and some serious arm twisting, but in any organization we've ever seen there are no blank checks when there are discrete projects and businesses with varying degrees of needs and returns, probabilities of success and failure.

As we recall there was a course at university called "Finance." When you primarily deal with Other People's Money that sort of hard tack decision making is not naturally used, especially when you are a cost plus organization, but anyone who has been a manager in business will tell you that they do it all the time. We'll bet Hank knows all about it. He doesn't want to show us who needs what.

The banks won't want to disclose their problems. To participate in the program, they must, even if that particular knowledge is kept discreet. One of the Senators proposed an initial sum of $50 billion while the Fed and Treasury get their act together with a more reasonable process, and report back to the Congress with the results. That is a good idea. Certainly better than demanding a figure like $700 billion under duress with the haziest of details. How did they arrive at $700 billion?

Or as another Senator proposed, why not just loan the money to the banks in any amounts required to get their balance sheets in shape, but at some interest rate?

Are there one or two banks that require 400 of the 700 Billion? What if there are a few 'bad apples' that really are insolvent,that overreached to some extreme like Countrywide for example.

Should we save them all equally? Or make an intelligent cost-benefit decision on whom to save and on what terms?

Remember, this is not making loans available at market rates. This is a subsidy we are discussing. Like most welfare we need to understand who is getting what, and where the benefits and costs fall out.

The pushback of course is that this is a Gordian knot, resistent to any unraveling., hopeless entangled. Then perhaps what we need is someone with the strength and the courage to cut it, as gracefully as is possible. Otherwise this subsidy may drag on endlessly as it did in Japan, draining the entire economy.

Why is it that these fellows keep returning to the public trough asking for enormous sums, and now that the days of the Bush administration are closing, with ever more dire threats of financial conflagration? Remember not all that long ago that the Bush Administration kept pushing for the Social Security trust to be placed into stocks with Wall Street? Can you imagine what this situation would be like now if we had agreed to that?

Lehman failed, and the market is digesting the failure. We might be able to afford a few more, but we won't know unless we look at the data, and quit playing games of chicken and hide the losses with Wall Street.

How are George W. Bush and Hugo Chavez Alike?

"I nationalize strategic companies and get criticized,but when Bush does
it, it's OK," Chavez said on weekly television program Sept. 21. "Bush is turning
socialist. How are you, comrade Bush?"

Hugo Chavez

Like many people, Hugo Chavez is directionally correct is thinking that George W. Bush is acting excessively in the manner of a socialist, but wrong in one particular that may not be incidental.

Granted both men are statists. That is, they hold the power of the government, the state, of the few, to be pre-eminent over the rights of the individuals, of the worth of the human being when compared to their will to power.

Therefore both men would support the subordination of individual rights and wealth and distributing them as they see fit, as the state decides, outside of the normal process of taxation and public pursuits.

There is something inherently social in society, because some common purpose is the reason that societies exist. It is the limitations on that commonality with regard to individual rights that makes the difference between a social democracy and socialism.

Chavez decides to give favors and wealth putatively to the people, therefore he is a socialist. To the extreme, a socialist is one or two failures away from communism and then Stalinism, when the government fails so badly it must continually beat the people into submission because it has nothing productive to give.

Bush gives it to his friends and powerful corporations through no-bid contracts, selective tax cuts, and de facto or actual deregulation and decriminalization of the familiar frauds and schemes. He is a corporatist, one or two emergency orders removed from fascism, in which the people must be reduced to a form of debt peonage and service to the state and its surrogates, the corporations.

Is it an accident that the Bush administration sanctioned torture, illegal wiretapping, invasions of personal privacy, almost unprecedented secrecy, and executive actions? Is there any wonder Paulson would have the nerve to submit a proposal demanding $700 billion for a few Wall Street banks without any oversight and the suspension of the due process clause of the Bill of Rights?

Here is a chart that helps one to understand how little difference there can be between the approaches at the extremes. Both are unacceptable when measured by laws that respect the rights of individuals with the context of society. This is why it has been so easy for the neo-cons to move from the far left to the extreme right.



Rather than choosing socialism or fascism based on how well we think we might do, at some point the individual must stand for the principles that made America what it has been, or be consumed fear and greed, and then by the state.

We must agree to protect uphold and defend the Constitution of the United States of America.

The 'how' of that is not so straightforward, and has led to many interesting confrontations and evolutions throughout our history. But we have never abandoned it completely, never said it was worthless or outmoded, and always returned to it over time. This is what makes America what it has been, what it is, what it still can be.

Let's return to a government of the people, by the people, for the people, and renew the enduring commitment to freedom.

Whitney Cuts Banks and GDP Outlook, Senators Preen and Posture

The Senators ask this morning how to regain the public's confidence in the financial system, and we would like to add, in the government, the Senators themselves.

They don't want to hear the answer, but here it is.

Stop lying. Stop manipulating. Stop deceiving. Stop taking things that are not yours. Stop trying to defraud people. Stop favoring people who give you money and favors. Stop selling things under false pretenses. Stop manipulating the news and the markets as you are doing this morning once again.

The Lehman bankruptcy proceedings seem to be moving forward reasonably well. Let's assess how that is going, and if it is appropriate, let's try it again and see what happens. We'd vote for Goldman Sachs, and then Morgan Stanley.

Start acting transparently, openly, honestly.

Some of you are deeply complicit in this fraud that was perpetrated on the American public and the world. Do the right thing and step aside. Resign. No one will trust you now. Sorry but that is how life works. We are a forgiving people, maybe a little distracted at times, but not completely stupid.

Then we might begin to move forward again, but slowly.

And let's take a minute to feel good about the fact that the Senators office were flooded with calls, emails, and personal visits from their constituents almost universally opposing the Paulson plan. They noticed. Now we must see what they do, and act accordingly in the elections.

But we cannot move forward without a reasonable appreciation of the facts. Here is what a factual outlook on the economy looks like, not the dissembling of Paulson and Bernanke.

Analyst Whitney sees "little hope" from bailout plan
Tue Sep 23, 2008 8:42am EDT

Sept 23 (Reuters) - The credit crisis that began last summer has intensified so much that any U.S. government bailout plan has "little hope" of improving core fundamentals over the near and medium term, said analyst Meredith Whitney, who expects the country's GDP to take a hit from likely moves by state governments to cut costs.

The Oppenheimer & Co analyst cut her outlook on U.S. banks and expects further dividend cuts and capital raises.

Whitney also said home prices were not close to bottoming and expects prices to ultimately be at least 25 percent lower from current levels. She expects homeownership rate to decline further.

The analyst also noted that unemployment was up over 40 percent year-on-year in key states, and said unemployment is "headed materially higher."

Given that over 12 percent of the U.S. GDP is driven by state and local government spending, and with many key states' 2009 budgets being under-funded, governments will be forced to cut costs and this will weigh significantly on GDP, Whitney said.

"Credit market disruption has had underappreciated consequences on the economy... A virtual suction of liquidity has occurred in the credit and lending markets, and consumer and corporate credit is already showing the effects," Whitney wrote in a note to clients.

"Since the onset of the credit crisis, over $2 trillion less liquidity has flown through the U.S. domestic capital markets than during the same time period a year prior," she added.

Q3 OUTLOOK

Analyst Whitney forecast a third-quarter loss of 36 cents a share for Citigroup Inc. She had a prior profit view of 8 cents a share.

Whitney widened her third-quarter loss forecast for Wachovia Corp to 31 cents a share from 15 cents.

She cut third-quarter earnings estimates for Bank of America Corp to 40 cents a share from 75 cents, for JPMorgan Chase & Co to 21 cents a share from 40 cents a share, and for Wells Fargo & Co to 13 cents a share from 17 cents.

Shares of Citigroup closed at $20.01 Monday on the New York Stock Exchange, while those of Bank of America closed at $34.15.

Shares of JPMorgan closed at $40.80, Wachovia's at $18.75 and Wells Fargo's at $35.18. (Reporting by Tenzin Pema in Bangalore; Editing by Jarshad Kakkrakandy)

Putin Joins China in a Call for a New Global Financial Structure Not Based on the Dollar

China Calls for a New International Financial System Not Dependent on the US

Tass
Putin calls for changing the architecture of the international financial system
20.09.2008, 17.56

SOCHI, September 20 (Itar-Tass) -- Prime Minister Vladimir Putin called for changing the architecture of the international financial system.

“We all need to think about changing the architecture of international finances and diversifying risks. The whole world economy cannot depend on one money-printing machine,” Putin said at the final press conference after a meeting of the Russian-French bilateral commission on cooperation in Sochi on Saturday.

“This is a very serious issue that should be addressed in a calm, attentive and working manner without haste together with our colleagues from Europe and America,” Putin said. “This issue should be considered not in a confrontation-like way but very benevolently in order to find the most acceptable ways for the development of the world economy and world finances.”

French Prime Minister Francois Fillon said he would put forth several initiatives within days for dealing with the world financial crisis.

He said it was not possible yet to say whether France or Europe has survived the financial crisis. He believes it necessary to strengthen control and bring more transparency into cooperation between fiscal authorities of different countries.

“We will be working on this together in the next couple of weeks,” he said.

Goldman Sachs and Morgan Stanley May Be Primary Beneficiaries of the Bailout

The Bailout Program as it is currently proposed by the Treasury may not be much more than a windfall profits package for a few Wall Street investment banks such as Morgan Stanley and Goldman Sachs.

One of the most significant obstacles to the financial markets is the lack of transparency, confidence and trust. One of the ways to restore trust is to stop lying, show your cards, take the losses, and then move forward with an honest game.

The government would be doing the markets a favor if they forced the banks and especially the newly formed bank holding companies to show their positions, open their books, to stop allowing them to game the system and make profits through practicing deception and the manipulation of markets and information.

Paulson Debt Plan May Benefit Mostly Goldman, Morgan
By Jody Shenn

Sept. 22 (Bloomberg) -- Goldman Sachs Group Inc. and Morgan Stanley may be among the biggest beneficiaries of the $700 billion U.S. plan to buy assets from financial companies while many banks see limited aid, according to Bank of America Corp.

''Its benefits, in its current form, will be largely limited to investment banks and other banks that have aggressively written down the value of their holdings and have already recognized the attendant capital impairment,'' Jeffrey Rosenberg, Bank of America's head of credit strategy research, wrote in a report today, without identifying particular investment banks.

Many banks may not participate in the Troubled Asset Relief Program because they haven't had to write down many assets under accounting rules, meaning decisions to sell into the program would cause them to lose capital, Rosenberg wrote. Investment banks operate ''under a mark-to-market accounting model while commercial banks hold assets at cost until realizing a loss (or until they reasonably expect one),'' he wrote.

Rosenberg assumed the government will use a reverse auction in which banks submit the lowest prices they are willing to sell certain types of assets for and then the government buys the cheapest ones, with the goal of ''protecting the taxpayers,'' the report said.

Treasury Secretary Henry Paulson's push for the program, which is being now considered by lawmakers, is designed to remove ''illiquid assets'' clogging the financial system, reverse declining asset values and prevent the freezing of lending for U.S. financial firms, companies and consumers. The intervention into the financial markets would be the broadest since at least the Great Depression.

Japan's Failure

In the 1990s, a Japanese government effort to buy troubled assets from banks to free up lending failed because sellers weren't willing to accept the prices offered, said L. William Seidman, a former chairman of the Federal Deposit Insurance Corp. He said that wasn't a problem he had as chairman of the Resolution Trust Corp. in the U.S., which sold off failed lenders' assets after the savings-and-loan crisis of the 1980s.

''If you're talking about institutions that haven't failed, then you have the question of whether they want to sell at a low price, particularly if that price depletes their capital,'' Seidman said in a telephone interview today.

''In Japan, we did all kinds of things, trying to have a mediator who would set a price and other kinds of methods to get around that,'' he added. ''It never really got done, so it was not successful, but here we probably have a more urgent need for more institutions to do something.''

'Hasten the Pace'

While Goldman and Morgan Stanley, both based in New York, were yesterday granted permission to transform themselves into bank holding companies, the companies so far have operated mostly under investment-bank accounting rules, logging almost $21 billion of asset writedowns and credit losses. Paulson is a former chairman and chief executive officer of Goldman.

Charlotte, North Carolina-based Bank of America, which has reported $21 billion of losses, is seeking to buy New York-based Merrill Lynch & Co., which has had $52.2 billion in losses.

Even without sales by commercial banks and savings-and-loans under the program, the companies may be harmed as the disclosure of prices paid in the troubled-debt auctions force them to ''hasten the pace'' of their own losses, Rosenberg wrote in his report. Banks and insurers mark down certain securities and derivatives to market prices in their earnings reports, avoiding losses on others unless they deem the declines to not be temporary and provisioning against loans as they go bad.

Fair Value

Bank lobbying groups today asked Congress and the U.S. Securities and Exchange Commission to suspend a rule that forces companies to put a price on difficult-to-value assets such as subprime mortgages.

''We are suggesting that the SEC issue a temporary order to negate the negative impact'' of the so-called fair-value rule when the economy slumps, Scott Talbott, senior vice president of government affairs at the Washington-based Financial Services Roundtable, said in an e-mail.

Companies including American International Group Inc., the insurer that accepted $85 billion in a U.S. takeover, have said the rule by the Financial Accounting Standards Board requires them to record losses they don't expect to incur. The world's largest banks and brokers have reported more than $520 billion in asset writedowns and credit losses since last year.

G7 Vows to Do What It Takes to Support the 'International Financial System'

The Economic Times
G7 vows to guard financial system
23 Sep, 2008, 0000 hrs IST, REUTERS

WASHINGTON: The Group of Seven finance ministers and central bank governors are maintaining ‘heightened close co-operation’ and pledged on Monday to take necessary actions to safeguard the international financial system. (And what is the international financial system exactly? - Jesse)

The G7 finance ministers and central bank governors said they held a conference call to discuss global financial markets and welcomed ‘extraordinary’ US actions to take illiquid assets off of bank balance sheets.

“We pledge to enhance international cooperation and to address the ongoing challenges in the global economy and world markets and maintain heightened close co-operation between finance ministries, central banks and regulators,” the G7 said.

“We are ready to take whatever actions may be necessary, individually and collectively, to ensure the stability of the international financial system.”

While the G7 welcomed the $700-billion US asset purchase plan, it stopped short of saying other countries would implement similar actions to mop up bad loans and securities choking the financial system.

Separately, German finance minister Peer Steinbrueck said that the G7 countries apart from the United States, Canada, Britain, France, Germany, Italy and Japan, do not plan any measures comparable to the US package to support the banking sector.

Meanwhile, Britain’s finance minister Alistair Darling said that the government would introduce a bill to reform the banking sector in two weeks' time.

US Dollar Charts for Monday 22 September

NYMEX Oil Trading Halted at $116 as Crude Goes "Limit Up," Reopens and Rockets to $130 in Ten Minutes

Time for a 'no buy' zone?

After the "limit up" trading halt oil trading reopened and is now $130 four minutes before the close. This was in the October contract which was set to expire. The new front month is November. There was an obvious short squeeze occurring in the near month.

Part of the reason for this is obviously dollar weakness. The DX index is now testing the 76 area. Also since the hedges cannot short financials, they need some way to arb the Treasury recklessness, so they appear to be running into harder currencies and commodities.

Just peeled off some of the oil trade positions we put on for ourselves yesterday as a contra dollar play. We're keeping the high yield oil stocks/trust because this seems to be more than just a technical trade with almost all commodities rising in concert.


Oil spikes $25 a barrel on anxiety over US bailout

(AP:NEW YORK) Oil prices spiked more than $25 a barrel Monday - the biggest one-day price jump ever - as anxiety over the government's $700 billion bailout plan battered the dollar and touched off frenzied buying of safe-haven investments including crude.

Light, sweet crude for October delivery jumped as much as $25.45 to $130 a barrel on the New York Mercantile Exchange before falling back somewhat to trade at $122.60,up $18.05. The contract was set to expire at the end of the day, adding to the volatility; the October price began accelerating sharply in the last hour of regular trading.

The November contract, scheduled to become the front-month contract at the end of Monday's session, was trading at $108.80, up $6.05.

Crude has gained about $40 in a dramatic four-day rally that has at least temporarily halted oil's steep two-month slide below $100. At this rate, crude is within striking distance of its all-time record of $147.27, reached in July.

"We're off to the races again in crude," said Jim Ritterbusch, president of energy consultancy Ritterbusch and Associates in Galena, Ill. "There's a renewed scramble for commodities because of a general weakness in the dollar."

The Nymex temporarily halted electronic crude oil trading after prices breached the $10 daily trading limit. Trading resumed seconds later after the daily limit was increased.

The huge rally was poised to shatter crude's previous one-day price jump of $10.75, set June 6.

Oil's sharp gains came as energy traders grappled with the implications of the government's proposed $700 billion initiative to stem the U.S. financial crisis by absorbing billions of dollars of banks' bad mortgage-related securities. Anxiety over the plan also sent stocks sharply lower Monday; the credit markets were calmer than they were last week, but still showing the effects of investors' nervousness.

"They're going to have to continue auctioning off a whole lot of Treasurys to finance these projects, so the dollar is going to suffer," said Matt Zeman, head trader at LaSalle Futures in Chicago. "Right now it's fear and anxiety driving people who want tangible assets.

The 115-nation euro rose to $1.4781 in afternoon trading, up from the $1.4470 on Friday. A weak greenback was a catalyst for the commodities boom of the past year, and analysts said large investment funds were expected to pour money back into the sector.

"That trade was very successful in past so if the dollar keeps weakening, a lot people are going to want to own hard assets like crude," said Andrew Lebow, senior vice president and broker at MF Global in New York.

But there is still much uncertainty about what impact the U.S. rescue plan will have on energy demand. Oil's run-up near $150 a barrel in July and a weak U.S. economy has forced Americans to cut back on their driving and led business to scale down operations. Though pump prices have eased from record levels above $4 a gallon, they remain expensive, and more softening in the economy would likely further curtail energy use in the world's thirstiest consumer.

"There are a lot of issues to be filled in. It's an extraordinarily complex situation," said David Moore, a commodity strategist at Commonwealth Bank of Australia in Sydney. "The market is digesting how the (rescue) package will work and the implications for the U.S. economy."

U.S. congressional leaders endorsed the plan's main thrust, saying passage might occur in a matter of days. But they also want independent oversight, protections for homeowners and constraints on excessive executive compensation, House Speaker Nancy Pelosi said Sunday.

Treasury Secretary Henry Paulson pushed lawmakers, who received the package on Saturday, to approve the proposal as soon as possible....

TDAmeritrade Freezing All Reserve Money Market Funds Including "Treasury Funds?"

Read from a usually responsible poster on a financial web site here. here.

Most of my swept cash at TDAMeritrade has been frozen, and removed from funds available for trading.

The Treasury Money Market Fund that was my swept funds destination apparently is a Reserve Fund, the family which has been in the news. As nearly as I can figure, it had zero exposure to Lehman, but apparently the big review underway has frozen all Reserve Funds until review is complete.

How can a Treasury fund have any exposure to Lehman?? Then why would they freeze it and put it under review???

Someone has suggested that this is because of 'heavy redemptions' and/or a mutual support agreements among fund families.

We'd like to believe that this will turn out to be a mere inconvenience and will probably work out all right in the end.

But the more general lesson here perhaps is that you might think you own Treasuries, gold, silver, oil, forex or whatever through a fund, but at the end of the day you own the fund, and have only a claim on the asset or instrument of your intentions itself.

Unintended Consequence: the US Finally Gets a Decent Soccer Team

The Manchester United football team is sponsored by AIG, and have the letters AIG across the chest of their jerseys.

Now that AIG has been acquired by the government, the Treasury intends to replace the "AIG" designation with "USA" and the appropriate logo changes.

The use of the term "football" which is the exclusive property of the NFL is going be replaced with the more descriptive term "soccer" to avoid confusion in the target audience, the American public.

As the Dollar will be the exclusive currency accepted within the stadium, a special facility has been created to build bureaux de change at the entrances. Barclays is said to be bidding for the exclusive operating rights.

The European Union is expected to support these modifications at the request of the Treasury.

The NY Fed is considering rules changes to make the games more exciting.

Hank Paulson has hired Morgan Stanley to assess the sponsors of some of the better German and Italian clubs to see if Wall Street's expansions plans to dominate the soccer world are feasible.

The SEC, having misplaced its traditional charter, has proposed to be renamed the Sports Expropriation Commission. Their first task will be to determine what the Chinese do with their leisure time in addition to gymnastics, mahjong, and eating remarkably unusual items.

Goldmans Sachs and Morgan Stanley To Become Bank Holding Companies

If the banks were able to bend all the rules, hijack the real economy, and grow to unprecedented percentages of GDP over the past twenty years, why are you surprised that they and their friends would not arrange to save them, replenish them, keep them free from harm from the monstrous calamity which they created?

The first rule is "once you have their money, never give it back."

American Banker
Goldman, Morgan Become Bank Holding Companies, Ending Era
By Steven Sloan
Sunday, September 21, 2008

Last two major investment banks to be regulated like commercial rivals

WASHINGTON — A week after Lehman Brothers collapsed and Merrill Lynch put itself up for sale, the two remaining investment banks — Goldman Sachs and Morgan Stanley — won approval Sunday from the Federal Reserve Board to convert to bank holding companies.

The Fed said its approval was subject to a five-day antitrust waiting period but the announcement effectively ends the business of standalone investment banking and dramatically changes the landscape of Wall Street. (Time for the confidence men to cash in their chips and either leave town or go straight, more or less - Jesse)

To help Goldman and Morgan transition to traditional banking — which carries with it, among other things, tougher capital standards — the Fed said it would allow the firms to pledge the same types of collateral at the discount window as their commercial counterparts. Since the Fed opened the discount window to investment banks in March, the firms have mostly only been able to post highly rated securities as collateral. Now, Goldman and Morgan can send a broader range of collateral to the Fed, including mortgages.

The Fed said the same rule will now also apply to Merrill, which made a deal last week to sell itself to Bank of America Corp. (That makes sense - Jesse)

In addition to the broader collateral rule, the conversions could also be beneficial by allowing Goldman and Morgan to raise money by taking in insured deposits. The move also subjects them to more oversight from the Fed, which regulates bank holding companies. (That's FDIC coverage baby. Think the banks that have been toeing the line all these years will be jealous and pissed off? You bet. - Jesse)

In a release Sunday night, Goldman said that since spring the Fed has been reviewing the firm’s "liquidity and funding profile, capital adequacy, and overall risk management framework." Goldman said its Tier 1 capital ratio at Sept. 30 was 11.6%.

Goldman did not say what sort of banking charter it would use, but Morgan Stanley said it plans to convert its Utah industrial bank to a national bank charter. Morgan Stanley said it had more than 3 million retail accounts and $36 billion in bank deposits as of Aug. 31. It did not reveal its Tier 1 capital ratio.

Morgan said it would "pursue initiatives to expand the retail banking services it offers its retail clients and build a stable base of core deposits."

Traders Say: "the Dollar Will Get Crushed"

The Dollar has been in a decline thanks to the profligate stewardship of Greenspan and Bernanke. Paulson and Rubin helped Wall Street to hijack the US economy and twist it to serve the enrichment of the financial sector.

Now that it is unraveling we ought not to underestimate the lengths that the Treasury and Fed will attempt to forestall the collapse itself. They have had and will continue to receive help from complicit central bankers, vassal states and protectorates like Japan and Saudi Arabia.

But US debt can only be defaulted or forgiven. It cannot be repaid. Without the backing of a world government or the confiscation of the savings of most of the world the dollar is in a death spiral to failure.

Bloomberg News
Dollar May Get `Crushed' as Traders Weigh Up Bailout
By Bo Nielsen and Anchalee Worrachate

Sept. 22 -- Treasury Secretary Henry Paulson's plan to end the rout in U.S. financial markets may derail the dollar's three-month rally as investors weigh the costs of the rescue. (The rally was a technical bounce given some extra strength from manipulation. - Jesse)

The combination of spending $700 billion on soured mortgage-related assets and providing $400 billion to guarantee money-market mutual funds will boost U.S. borrowing as much as $1 trillion, according to Barclays Capital interest-rate strategist Michael Pond in New York. While the rescue may restore investor confidence to battered financial markets, traders will again focus on the twin budget and current-account deficits and negative real U.S. interest rates.

``As we get to the other side of this, the dollar will get crushed,'' said John Taylor, chairman of New York-based International Foreign Exchange Concepts Inc., the world's biggest currency hedge-fund firm, which manages about $15 billion...

Dollar `Downdraft'

``The downdraft on the dollar from the hit to the balance sheet of the U.S. government will dwarf the short-term gains from solving the banking crisis,'' said David Woo, London-based global head of foreign-exchange strategy at Barclays, the third- biggest currency trader, according to a 2008 survey by Euromoney Institutional Investor Plc...

`Huge New Supply'

The rescue comes as the U.S. budget deficit and the current-account balance, the broadest measure of trade, grow. The Congressional Budget Office projects the spending shortfall will increase to $438 billion next year from $407 billion. The current account deficit is up from $167.24 billion in December.

``Investors may start to worry about the amount of debt the U.S. is taking on and its impact on the dollar,'' said Geoffrey Yu, a currency strategist in London at UBS AG, the second- largest foreign-exchange trader. ``The fact that they mentioned taxpayer money implies that they're going to issue debt. If there's going to be a huge new supply of Treasuries, this will be dollar negative. It's too much for the dollar to take.''

Traders are also concerned the bank bailout will spread to other U.S. industries suffering from the credit crunch that's holding back an economy growing at its slowest pace since 2001. Detroit-based General Motors Corp., the world's biggest automaker, said last week it will tap the remaining $3.5 billion of a $4.5 billion credit line to pay for restructuring costs.

`Damaged' Currencies

Lower interest rates may also weigh on the dollar. Futures on the Chicago Board of Trade show there's a 38 percent chance policy makers will lower their target rate for overnight lending between banks to at least 1.75 percent by January from 2 percent currently. A month ago, they showed a 46 percent chance of an increase to 2.25 percent.

Rates in the U.S. are already the lowest of any the Group of 10 industrialized nations except Japan, where they are 0.5 percent. The European Central Bank's benchmark is 4.25 percent.

Another drawback for the dollar is that the Fed's key rate is 3.4 percentage points less than the rate of inflation, the most since 1980, so investors lose money by investing in short- term U.S. fixed-income assets.

``People thought that the Fed was done cutting,'' said Andrew Balls, an executive vice president and member of the investment committee of Newport, California-based Pacific Investment Management Co., which oversees almost $830 billion. ``In the longer term the diversification away from the dollar will remain intact. The U.S. hasn't done itself any favors in making its assets attractive to foreign investors...''

Black Monday: Unintended Consequence from the Short Selling Ban?

We had this in an email from a trading friend George Slezak regarding unintended consequences of the ban on shortselling that the SEC enacted unexpectedly on the markets last Thursday evening.

Our reaction was more optimistic because we suspected that the markets would adjust fairly quickly since it is temporary, affects only 800 stocks, and can be arbed out in the case of the broader indexes most affected. We respect George's experience and have a watchful eye out however.

It would be ironic indeed if the crony capitalists managed to crash the economy and kill off free markets as we have known them, after capitalism won the Cold War. But as we have pointed out here in the past, their defense and attachment to economic freedom is only a thinly masked rationale for privilege, patronage, and pilfering.

As a trader on the trading floors of both the CBOE trading stock options and the CME trading S&P futures for more than 15 years, I want to explain that the short sale ban will have a dramatic impact on the liquidity of the stock market futures and options. When there are more sellers than buyers in the option and futures pits, the prices of the futures and options drop to a level where index arbitrage provides liquidity by shorting a basket of stocks and then buying the futures or option.

In a competitive market, the arbitrage of the futures versus the underlying basket of stocks is done for fractions of a point versus fair value. Losing the ability to short stocks to transfer the selling in the futures and options to the underlying equity market will, in my opinion, result in the futures and options trading at severe discounts to the fair value.

This overhang will drive buyers away from the markets. For example, imagine the S&P futures trading 36 points (3%) under fair value. Will you step up and buy stocks when you see the futures forecasting that the entire index is being sold in the futures market 3% lower than the current market?

Liquidity for ETFs is provided in a similar manner to the Index futures and options. Normally when ETFs trade at a small discount to fair value, arbs would short stocks and buy the ETFs locking in generally a fractional spread. Now, the short side arbitrage cannot be done and if we see index ETFs trade at substantial discounts to fair value, I think those EFTs, by their own rules, begin liquidation of the underlying basket of stocks they hold.

On Friday evening the December S&P futures settled 9 points lower than the S&P 500 index. Fair value is several points higher than the index close. If this discount to fair value persists DURING in the trading day on Monday, I expect we will see the market to start to go into a spiral decline....

Time to Put Away Childish Things

When I was a child, I spoke as a child, I understood as a child, I thought as a child: but when I became a man, I put away childish things. 1 Cor 13

'Childish things' in this context refers largely to the level of political discussion about the fall elections that is going around these days, although the behaviour of the US financial system and our government is a close second.

(Before the usual wiseguys chime in, this site is intended to include parody and exaggeration as comic relief and an instrument of satire, in addition to seriously dispassionate commentary, unlike the White house and the Congress and Keith Olbermann and Fox News. - Jesse)

Its all personalities, frivolities, simplistic slogans, appeals to the lowest common denominator, avoidance of the serious issues, and not so subtle propaganda. Its time to start acting like this country is in serious difficulty, and the decisions that we make could affect the world for a generation. We are at a crossroads, a moment in history, and we will now decide the fate of the legacy of freedom granted to us by the blood of our forefathers.

This thoughtful piece by Yves Smith expresses the concerns many have over the Treasury proposal fairly well.

Why You Should Hate the Treasury Bailout Proposal

One thing is of special concern if you think about it a bit. How could the Bush administration have had even the arrogance to put this clause in the draft in the first place? If you think this is some poor wording or just overreach by Henry Paulson you have not been paying attention to current events for the past eight years.

Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.

If this proposal passes, we need to vote out all Republicans and the Democratic leadership, and anyone who votes for this, in the November elections.

"When bad men combine, the good must associate; else they will fall one by one, an unpitied sacrifice in a contemptible struggle..."
Edmund Burke

Time to step back, out of the day to day push and pull of arguments, fears, petty jealousy, prejudice, complacency, sloth, greed and envy. Time to take a stand, to do something. This applies equally to America and to the rest of the world.

As in past moments of history, ultimately there will be no bystanders.

When Pyramid Schemes Collapse

Its just an opinion, but some think that Wall Street has looked at the tea leaves and realized that they are going to lose control of the White House in addition to the Congress, and the next four years are going to be about rebuilding and reform, restoration and maybe retribution.

So with a new sheriff coming perhaps its time for the confidence men to cash in their chips and leave town.

NY Times
Hoping a Hail Mary Pass Connects
By JOE NOCERA
September 20, 2008

It was the end of the worst week for financial markets since 1929, and Treasury Secretary Henry M. Paulson Jr. looked sleep-deprived.

He had begun the week agreeing to let Lehman Brothers go bankrupt, arguing that the government had to stop putting taxpayers’ money at risk. Then, midweek, he brokered a deal to rescue the American International Group with an $85 billion loan from taxpayers — arguing that the risk to the financial system was too high to allow the world’s biggest insurer to fail.

Neither move had done anything to stop the financial tsunami. So on Friday morning, just as the markets were opening, Mr. Paulson unveiled the government’s latest attempt to stop the bleeding. Maybe it was because he was so tired, but there was none of the glass-half-full blather that is de rigueur for a cabinet secretary. Instead, his flat, just-the-facts-ma’am voice and weary body language conveyed an unusual sense of urgency.

The core issue, he said — the mistake that had led to all the other mistakes — was that “lax lending practices earlier this decade led to irresponsible lending and irresponsible borrowing.” True. As for Wall Street, toxic mortgage-backed securities had become “frozen on the balance sheet of banks and financial institutions.” He added, “The inability to determine their worth has fostered uncertainty about mortgage assets and even about the financial condition of the institutions that own them.” True again.

And that really is the crux of the matter — the financial system has seized up. But so far, the government’s actions haven’t helped. Letting Lehman go bust may have sounded good at the time, but it has had disastrous consequences.

It has led to complete chaos in the multitrillion-dollar market for credit-default swaps and was a crucial reason Morgan Stanley was forced to scramble to stay alive this week. It is also why questions were raised about the viability of Goldman Sachs, a firm with a pristine balance sheet and almost none of the bad assets that are bringing down other firms. (Is it really pristine? How do we know? - Jesse)

The rescue of A.I.G. further undermined confidence because, within the space of several days, the government did a complete about-face. The bailout suggested the Treasury Department was as confused about what to do as the rest of us.

So rather than help solve the crisis, the Treasury Department has actually contributed to the biggest problem in the market right now: an utter lack of confidence. (This is a common symptom when Ponzi schemes start to unravel. That's why they call them confidence men. - Jesse)

Nobody understands who owes what to whom — or whether they have the ability to pay. Counterparties have become afraid to trade with each other. Sovereign wealth funds are no longer willing to supply badly needed capital because they no longer know what they are investing in. The crisis continues because nobody knows what anything is worth. You simply cannot have a functioning market under such circumstances. (The wages of sin often include a lack of the good regard of others. - Jesse)

Will this latest round of proposals end the crisis? I know the stock market reacted joyously on Friday, but I’m not hopeful. One solution being promoted by the Securities and Exchange Commission — to make life more difficult for short sellers — is a shameful sideshow. A second solution, which Mr. Paulson announced Friday morning, requires money market funds to create an insurance pool to cover themselves against losses.

That may provide comfort to investors who equate money funds with savings accounts, but it is fraught with moral hazard.

And the third solution — the big megillah — is Mr. Paulson’s plan to create a new government mechanism to buy mortgage-backed securities from big banks and investment houses. Once they are off those companies’ books, life can return to normal — or so Mr. Paulson hopes.

He acknowledged that it would likely cost taxpayers “hundreds of billions of dollars.” I think it will cost more than $1 trillion. (The Bush Administration fired Lawrence Lindsay for saying that the Iraq war would cost more than $100 billion. Jesse)

It is a weird tribute to the scale of this crisis that Mr. Paulson felt he had no choice but to rush this proposal out, because as the day progressed it became increasingly clear that the Treasury Department didn’t yet know how this mechanism was going to work. It is an idea of a plan more than an actual plan. In football, they would call it a Hail Mary pass. Sometimes, of course, a Hail Mary pass is completed for a touchdown. But most of the time they fail.

Let’s take a closer look at the government’s latest response.

KILL THE SHORT SELLERS It’s understandable why people get upset at short sellers in tough times. As President Bush put it Friday, short sellers are “intentionally driving down particular stocks for their own personal gain.” But that perception is more myth than fact, and in any case, it’s not the dynamic here. Stocks are falling because companies made huge mistakes that have caused them a heap of trouble. Indeed, in July and August, short interest in financial stocks declined by 20 percent. Why did the stocks continue to go down? Because there were too many sellers and not enough buyers: it’s that confidence thing again. Blaming the shorts is classic blame-the-messenger behavior.

The S.E.C. jihad against short sellers, which includes the banning of short selling on 799 stocks and forcing disclosure of large short positions, is nothing more than playing to the crowd. It is simply appalling that as one firm after another vaporizes — firms, let’s remember, that the S.E.C. was supposed to be regulating — the only thing the agency can think to do is flog the shorts.

There were so many better moves it could have made. After Bear Stearns fell, it could have sent SWAT teams into all the other financial firms to assess their mortgage-backed paper. It could have then announced to the world the health of each firm, which would have helped the market regain some confidence. It could have forced firms to disclose their mortgage-backed holdings so that counterparties could evaluate them. It did none of these things.

Then again, maybe the S.E.C. is trying to cover up its own culpability in this crisis. Four years ago, the agency pushed through a rule that allowed the big investment banks to take on a great deal more debt. As a result, debt ratios rose from about 12 to 1 to more like 30 to 1. Guess what Lehman’s debt ratio was when it went bust? Yep: 30 to 1.

SAVE THE MONEY MARKET FUNDS The precipitating event here was the news that the Reserve Fund, a money market fund that caters to institutions, had “broken the buck” and was paying investors 97 cents on the dollar. That is only the second time that’s ever happened, and it had to scare investors, because most of us have come to think of money market funds as being the equivalent of bank savings account — perfectly safe.

In the aftermath, investors in the various Reserve money market funds pulled $58 billion out in the space of a week, leaving the firm with only $7.1 billion. If that same fear had spread across other money funds, it could well have led the funds to stop accepting short-term commercial paper. That would have been a disaster, because big companies rely on the commercial paper market to finance their day-to-day needs.

Under the circumstances, insuring the money market funds probably makes sense. It will calm investors and keep the commercial paper market functioning. But think about the moral hazard! It bails out poorly managed money funds — the ones most likely to break the buck — at the expense of funds that haven’t taken the extra risk that causes a sudden drop in value.

And then there’s this: If you have your money in a bank account, only $100,000 is insured. But if you have it in a money market fund — which usually has a slightly higher yield precisely because it has a small element of risk — you now have unlimited insurance. It’s the world turned upside down.

THE BIG MEGILLAH For the last few weeks, a growing chorus of voices has called for the establishment of a new Resolution Trust Corporation, the entity the government devised in the wake of the savings and loan crisis to take over, and eventually sell off, the assets of failed S.& L.’s. On Wednesday, that chorus got its most powerful voice, when Paul Volcker, a former Federal Reserve chairman, co-authored an op-ed article in The Wall Street Journal.

That crisis, however, was very different from this one. Most of the assets in the S.& L. crisis were real estate — which are always going to have value. And the government didn’t have to acquire them; it simply took them over and, over time, sold them. This time, the assets are complex derivatives of uncertain value that the big firms will actually be selling to the government.

But how is the government going to assess these securities — and what price will it pay for them? In many cases, these securities aren’t being sold because they are still overvalued on a firms’ books. That is, their mark-to-market price is unrealistically high. Will the government buy it at the too-high price? If it does, the firms won’t have to take additional write-downs — but it will constitute a huge, unjustified bailout of Wall Street. (More moral hazard.)

But what if the government drives a hard bargain, and gets the securities for what they are really worth — 20 cents on the dollar, say, instead of 50 cents? In that case, the firms would have to take yet more enormous write-offs, which would further damage their balance sheets, and they would have to raise billions more in capital. Maybe the removal of these bad assets would allow the firms to raise the capital. But maybe not — meaning one or more could conceivably have to file for bankruptcy, creating yet another spasm of financial turmoil. It’s a huge roll of the dice by the government.

Finally, there is the question of how much it will ultimately cost. “Institutions so far have written down $550 billion globally of bad debt,” said Daniel Alpert, managing director of Westwood Capital. “We think that when you add up all the problems in the residential housing market still to come — further erosion of housing prices, mortgage foreclosures and so on — we are going to need another $1 trillion of write-downs.”

In other words, for all the toxic securities that Wall Street has acknowledged holding, there will be yet more mortgage-backed paper that will go bad as the housing market continues to fall. As much as we all hope the worst is over, it’s probably not.

And as much as we might hope that the government finally has the answer, it probably doesn’t.

NY Times: Ben and Hank Scare the Congress Speechless

But don't worry everything will be just fine.

Just go about your daily work and trust the Congress and the Administration to save us. If we give Wall Street everything they want and open up the Treasury everything will probably be fine.

But if they should happen to overlook something make sure you have plenty of firewood, beans and drinking water in cans available. Probably no more than three or four years worth should be sufficient.

And don't forget the plastic sheets and duct tape.

"There are no accidents in politics" Joseph P. Kennedy 1960

NY Times
Congressional Leaders Stunned by Warnings
By DAVID M. HERSZENHORN
September 19, 2008

WASHINGTON — It was a room full of people who rarely hold their tongues. But as the Fed chairman, Ben S. Bernanke, laid out the potentially devastating ramifications of the financial crisis before congressional leaders on Thursday night, there was a stunned silence at first.

Mr. Bernanke and Treasury Secretary Henry M. Paulson Jr. had made an urgent and unusual evening visit to Capitol Hill, and they were gathered around a conference table in the offices of House Speaker Nancy Pelosi.

“When you listened to him describe it you gulped," said Senator Charles E. Schumer, Democrat of New York. (Funny we'd heard most Congressmen are spitters - Jesse)

As Senator Christopher J. Dodd, Democrat of Connecticut and chairman of the Banking, Housing and Urban Affairs Committee, put it Friday morning on the ABC program “Good Morning America,” the congressional leaders were told “that we’re literally maybe days away from a complete meltdown of our financial system, with all the implications here at home and globally.”

Mr. Schumer added, “History was sort of hanging over it, like this was a moment.” (Until W broke the ice and asked Ben to "pull my finger." - Jesse)

When Mr. Schumer described the meeting as “somber,” Mr. Dodd cut in. “Somber doesn’t begin to justify the words,” he said. “We have never heard language like this.”

“What you heard last evening,” he added, “is one of those rare moments, certainly rare in my experience here, is Democrats and Republicans deciding we need to work together quickly.” (Like piranhas swarming to strip a carcass - Jesse)

Although Mr. Schumer, Mr. Dodd and other participants declined to repeat precisely what they were told by Mr. Bernanke and Mr. Paulson, they said the two men described the financial system as effectively bound in a knot that was being pulled tighter and tighter by the day.

“You have the credit lines in America, which are the lifeblood of the economy, frozen.” Mr. Schumer said. “That hasn’t happened before. It’s a brave new world. You are in uncharted territory, but the one thing you do know is you can’t leave them frozen or the economy will just head south at a rapid rate.”

As he spoke, Mr. Schumer swooped his hand, to make the gesture of a plummeting bird. “You know we’d be lucky ...” he said as his voice trailed off. “Well, I’ll leave it at that.”

As officials at the Treasury Department raced on Friday to draft legislative language for an ambitious plan for the government to buy billions of dollars of illiquid debt from ailing American financial institutions, legislators on Capitol Hill said they planned to work through the weekend reviewing the proposal and making efforts to bring a package of measures to the floor of the House and Senate by the end of next week.

Lawmakers in both parties described the meeting in Ms. Pelosi’s office on Thursday night with Mr. Paulson and Mr. Bernanke as collaborative, and that they were prepared to put politics aside to address the needs of the American people.

While Democrats initially said after the meeting that they planned to use the administration’s proposal of a huge rescue effort to win support for an economic stimulus package, they pulled back slightly on Friday morning, saying that their top priority was to help put together the bailout package and stabilize the economy.

But it was clear they continued to examine ways to make clear that the government was stepping up not just to help the major financial firms but also to protect the interests of American taxpayers and families by safeguarding their pensions and college savings, and by preventing any further drying up of consumer credit.

In addition to potential stimulus measures, which could include an extension of unemployment benefits and spending on public infrastructure projects, Democrats said they intended to consider measures to help stem home foreclosures and stabilize real estate values.

Among the potential steps Congress can take include approving legislation to allow bankruptcy judges to modify the terms of primary mortgages — authority that the bankruptcy laws do not currently allow and that the banking industry has strenuously opposed.

But the Democrats said it was too soon to discuss such details, and that they were awaiting a draft of the proposal from the Treasury Department... (Yeah Treausury will send it over right it over. Who's writing it for them, Morgan Stanley or Goldman Sachs? - Jesse)

US Dollar Weekly Charts

This week the Treasury used the Dollar to pull the financial sector out of trouble.

Monetizing the bad debts of Wall Street is possible only until the US Bond is in default, and the Dollar fails.

Charts in the Babson Style for Week Ending 19 September 2008

The markets may have stepped back from the abyss thanks to the unprecedented and enormous promise of federal monetary assistance and an emergency ban on short selling, but it is still looking into it.

The models are broken for our outsized financial sector. It was a Ponzi scheme as it turns out with bad debt piled higher on bad debt thanks in large part to Alan Greenspan who kept the game going long after it would have stopped otherwise.

And now Paulson and Bernanke promise a fresh infusion of new capital to what? Why to keep the game going as it was before?

Will this work? Hell no. It only will buy time for a real lasting solution, a serious fundamental fix, to be crafted and the terrible task of adjusting our economy to begin.

Did Bernanke Panic? And Where Are We Going?

"We have lost control," said Hale, quoting Bernanke. "We cannot stabilize the dollar. We cannot control commodity prices."

Chicago Tribune September 17, 2008

When there is panic amongst the thinkers and planners like Bernanke, men of quick action and of less thoughtful inclination start promoting 'strong measures.' All too many in the Congress will sign anything in their panic and confusion, as long as they see some advantage either personal or for their backers, or an absolution from personal accountability in the deal.

And when those measures do not succeed, there is the temptation to take even stronger measures, even more radical action. Men sneer that outmoded laws and useless principles must fall to vital expediency so that we might be saved. The will to power begins to erode and overthrow justice and the rule of law.

And at certain times in history, in their fears and insensible numbness, people concede first the discretionary choices, then their moral outrage, then the weak, then their wealth, their freedom, and finally comes madness, and then the deluge.

"The overwhelming majority of Germans did not seem to mind that their personal
freedom had been taken away.... a newly arrived observer was somewhat surprised
to see that the people of this country did not seem to feel that they were being
cowed.... On the contrary, they supported it with genuine enthusiasm. Somehow it
imbued them with a new hope and a new confidence and an astonishing faith in the
future of their country."

The Rise and Fall of the Third Reich, by William Shirer

SEC Issues Emergency Order - Bans Short Selling of Financial Stocks

These bailouts miss the point.

An entire economy was created to irrationally slingshot the US economy to this tipping point. The economy is based on the activity of gearing up to create, finance, market and exploit malinvestment.

That doesn't mean that malinvestment can continue, and it doesn't mean that this malinvestment is going to become valuable. Losses will have to be realized - nothing is going to magically give this house of cards real world economic value.

From the trenches.

Hank Paulson is saying "get this toxic debt off the banks' books."

Well, what is going to prevent them from putting new toxic debt back on as soon as they have the opportunity? Did they suddenly grow wisdom? Learn from experience? Become chaste and humble?

And when this latest plan fails, because they are still only treating symptoms, and enriching the bankers, and manipulating markets, what will they do next?

Forced buying of Treasuries? Currency controls on the dollar? Production quotas for industries? Government lists of patriotically favored stocks and commodities from homeland security?

When the banks and the government become trading partners we are beyond simple moral hazard.

SEC Halts Short Selling of Financial Stocks to Protect Investors and Markets
FOR IMMEDIATE RELEASE
2008-211

Commission Also Takes Steps to Increase Market Transparency and Liquidity

Washington, D.C., Sept. 19, 2008 — The Securities and Exchange Commission, acting in concert with the U.K. Financial Services Authority, today took temporary emergency action to prohibit short selling in financial companies to protect the integrity and quality of the securities market and strengthen investor confidence. The U.K. FSA took similar action yesterday.

The Commission’s action will apply to the securities of 799 financial companies. The action is immediately effective.

SEC Chairman Christopher Cox said, “The Commission is committed to using every weapon in its arsenal to combat market manipulation that threatens investors and capital markets. The emergency order temporarily banning short selling of financial stocks will restore equilibrium to markets. This action, which would not be necessary in a well-functioning market, is temporary in nature and part of the comprehensive set of steps being taken by the Federal Reserve, the Treasury, and the Congress.”

Today’s decisive SEC action calls a time-out to aggressive short selling in financial institution stocks, because of the essential link between their stock price and confidence in the institution. The Commission will continue to consider measures to address short selling concerns in other publicly traded companies.

Under normal market conditions, short selling contributes to price efficiency and adds liquidity to the markets. At present, it appears that unbridled short selling is contributing to the recent, sudden price declines in the securities of financial institutions unrelated to true price valuation. Financial institutions are particularly vulnerable to this crisis of confidence and panic selling because they depend on the confidence of their trading counterparties in the conduct of their core business. (Some animals are more equal than others - Jesse)

Given the importance of confidence in financial markets, today’s action halts short selling in 799 financial institutions. The SEC’s emergency order, pursuant to its authority in Section 12(k)(2) of the Securities Exchange Act of 1934, will be immediately effective and will terminate at 11:59 p.m. ET on October 2, 2008. The Commission may extend the order beyond 10 days if it deems an extension necessary in the public interest and for the protection of investors, but will not extend the order for more than 30 calendar days in total duration.

The Commission notes today’s similar announcement by the U.K. FSA. The SEC and FSA are consulting on an ongoing basis with regard to short selling matters and will continue to cooperate in carrying out regulatory actions.

The Commission also has taken the following steps to address the recent market conditions:

Temporarily requiring that institutional money managers report their new short sales of certain publicly traded securities. These money managers are already required to report their long positions in these securities.

Temporarily easing restrictions on the ability of securities issuers to re-purchase their securities. This change will give issuers more flexibility to buy back their securities, and help restore liquidity during this period of unusual and extraordinary market volatility.


http://www.sec.gov/news/press/2008/2008-211.htm

This Is the Credit Crisis

The problem with our economy and our markets is not short selling. It is not liquidity. And it is not because of an awkward regulatory structure.

The problem is that the banks have engaged in an orgy of financial speculation, having undermined major sections of our regulations and institutions, aided and abetted by one of the most incompetent and corrupt presidential administrations in history, thereby exposing the public to significant financial risk with a reckless disregard for fiduciary responsibility.

Again and again the government was co-opted into overturning long standing safeguards to allow a small group of greedy men to bring our economy to the brink of ruin for their own personal power and wealth. Ex-SEC Official Blames Agency for Blow-Up of Broker-Dealers

The people are responsible for allowing themselves to be manipulated into a state of fear and ignorance.

Freddie Mac Suffers Losses - Was Making Large Loans to Lehman

The implicit guarantee of Freddie Mac was being extended to fronting cash to investment banks to support speculation?

Freddie Mac Discloses Large Exposure to Lehman
By JAMES R. HAGERTY and APARAJITA SAHA-BUBNA
SEPTEMBER 19, 2008
Wall Street Journal

Among the creditors stung by this week's bankruptcy filing of Lehman Brothers Holdings Inc. is another casualty of the credit crunch: Freddie Mac.

Freddie disclosed in a securities filing Thursday that it hasn't received principal payments of $1.2 billion plus interest on short-term loans to Lehman that were due Monday. A Freddie spokesman said the loans were part of the mortgage company's routine management of cash reserves and were made in late August.....

Oversold Indicators

The equity market was very short term oversold, as one could see from the McClellan Oscillator, and the sentiment chart shown below.

In the sentiment chart the top graph is the Bullish Percent Index with moving averages which is used for picking tops and bottoms. The middle chart is just the SP500 with Bollinger bands showing statistical variation at extremes, and most important is the bottom section which is the NYSE Highs and Lows. This almost never fails to flag oversold conditions. It does not call bottom, but does indicate oversold very well especially if the McClellan Oscillator confirms it.

Its not clear to us that a bottom has been made despite the moonshot after hours on the euphoria that the Federal government will wave a printing press and make our problems all go away.

Thursday Night Jazz at Jesse's

Mes Dames et Monsieurs, Senor y Senora, Signores e Signora und mein Herren und Damen, Ladies and Gentleman,
s'il vous plait... le premier Jazz at Jesse's

Miles Davis - So What (1959)



Things to Come - Dizzy Gillespie




Dave Brubeck Take five



Take the A Train Brubeck



Charlie Parker
with Buddy Rich and Ella Fitzgerald


Thanks and Have A Good Evening

Encore, mais pas jazz. Pour l'occasion...


La Vie En Rose
et pour mon ami, Docteur Marrone


Merci, bonsoir et bonne chance.

Washington Mutual - No Bid

We are hearing a slightly different story from the Bloomberg that there *might* be bidders, unnamed, from an undisclosed source.

Opaqueness, manipulation, influence-peddling, and deceit are the new hallmarks of American business, so it is difficult to determine what is genuine and what is rumour.

The Financial Times
No bidders come for Washington Mutual
By Saskia Scholtes in New York
September 18 2008 20:19

Hopes of finding a buyer for Washington Mutual dimmed on Thursday as an auction for the beleaguered US bank had yet to attract any bids.

Shares in WaMu got a 14 per cent boost after news it had put itself up for sale, but interest from prospective buyers remained thin on the ground because of reluctance to take on WaMu’s portfolio of risky mortgage debt.

Goldman Sachs is conducting the auction for Seattle-based WaMu, which is the sixth largest US bank, with $310bn (€215bn, £170bn) in assets and more than $140bn in deposits.

Goldman has approached a number of banks, including Citigroup, JPMorgan Chase and Wells Fargo, according to people close to the situation.

The banks declined to comment, but people close to the talks said JPMorgan was not planning to bid for WaMu, while San Francisco-based Wells Fargo generally focuses on small acquisitions. Citi is also believed to be wary of expanding its US retail operations.

Fred Cannon, analyst at Keefe, Bruyette & Woods, said that while WaMu’s franchise and retail branch network on the west coast of the US made it an attractive prospect for banks such as JPMorgan, a buyer would have to take up to a $37bn accounting hit from the deteriorating mortgage portfolio.

The lack of interest means that Goldman may soon have to evaluate other options for the bank. These could include raising capital by selling off the attractive assets, which would still leave WaMu holding the mortgage portfolio, or raising fresh capital to allow the bank to stand alone – a challenge in the current environment. (Never fear, the Chuck Schumer Memorial Financial Welfare Hospital is under construction - Jesse)

TPG, the private equity firm, on Wednesday tried to facilitate a sale of ailing Washington Mutual, waiving its right to be compensated for dilution from any future capital-raising.

TPG led an investor group that put $7bn into WaMu in April, with $2bn coming from TPG.

Since then, TPG has sold down its exposure to the nation’s largest savings-and-loan company and now has about $1.3bn spread across three of its funds.

TPG’s right to a so-called “reset” – originally meant to safeguard the value of its minority investment in WaMu – made it difficult to attract new capital and effectively functioned as a poison pill.

WaMu’s troubles have accelerated over the last week after downgrades to junk status from both Standard & Poor’s and Moody’s rocked investor confidence.

The bank said the downgrades have no immediate impact on its liquidity position.

UK Bans All Short - Selling of Financial Shares Until 2009

This appears to be a complete ban on all short-selling of financial stocks in the UK until next year, according to the Financial Services Authority. This is not limited to 'naked short-selling.'

The new regulations will be enforced by the Ministry of Ineffeciency and Preserving the Status Quo.

UK puts ban on short-selling of financial shares
The Associated Press

LONDON --Britain's Financial Services Authority says it is temporarily banning short-selling of shares in publicly-traded financial companies.

The FSA says the new rule will take effect at midnight local time.

The rule will remain in place until Jan. 16, 2009, but the FSA said it would review the situation again after 30 days and may extend the ban to other sectors.

FSA chief executive Hector Sants says his organization still regards short-selling as a legitimate investment technique, but he says "extreme circumstances" have required new rules to protect against further financial turmoil.

A Run on Money Market Deposits Takes Down Two More Funds

BNY Mellon Institutional Cash Fund Hit by Lehman Debt Losses
By Christopher Condon

Sept. 18 (Bloomberg) -- An institutional fund run by Bank of New York Mellon Corp. designed to work like a money-market account fell to less than $1 a share after losses on debt issued by bankrupt Lehman Brothers Holdings Inc.

The $22 billion BNY Institutional Cash Reserves fell to $0.991 a share on Sept. 16, according to an e-mail sent by a bank representative to one client. BNY Mellon has ``isolated the Lehman assets in the fund into a separate structure,'' Ivan Royle, a spokesman for the New York-based company, said today in an e-mailed statement.

The fund invests cash deposited as collateral by clients who borrow securities from BNY Mellon, the world's largest custody bank. Lehman debt represented 1.13 percent of the fund's holdings, according to the statement. Royle declined in an interview to say whether investors withdrawing money from the fund would realize losses.

The BNY Mellon fund, while not a registered money-market fund, is ``generally managed to be compliant with the investment-related provisions of'' U.S. law governing the accounts, according to a bank brochure.

Reserve Primary Fund, the oldest U.S. money-market fund, on Sept. 16 became the first in 14 years to fall below the $1 a share price, known as ``breaking the buck.'' Investors pulled 60 percent of their money from the $62.6 billion fund on Sept. 15 and 16 before withdrawals were delayed.

Money-market funds, considered the safest investments after bank deposits and Treasury debt, strive to preserve a $1-a-share net asset value, meaning that investors can always get back their principal. Companies including Wachovia Corp. have pledged to support their money-market funds with losses linked to Lehman....

Putnam shuts $15 billion money market fund
Thu Sep 18, 2008 1:14pm EDT

BOSTON (Reuters) - Asset manager Putnam Investments said on Thursday that it had closed its $15 billion Prime Money Market Fund due to redemption pressures.

Putnam, a unit of Canada's Great-West Lifeco said in a statement that the board of trustees of its funds had voted to close the institutional money market fund as it faced "significant redemption pressure" on September 17.

"The trustees' action was not related to the portfolio's credit quality, but was instead a reaction to marketwide liquidity issues," the fund company said.

Roll the Presses - $160 Billion For the Fed

Treasury tees up $160 Billion in new debt to add to the Fed's Balance Sheet.

Pure monetization of debt for the banks and financial sector.

Treasury sells $30 billion in bills for Fed at 0.25%
By Deborah Levine
1:15 p.m. EDT Sept. 18, 2008

NEW YORK (MarketWatch) -- The Treasury Department sold $30 billion in 76-day cash management bills at a rate of 0.25% on Thursday.

The auction garnered $2.45 in bids for every dollar offered. The Treasury also sold $30 billion in 20-day bills today at a rate of 0.10% and announced another $100 billion to be issued Friday and next week.

The sales are part of a supplementary financing program the government announced Wednesday to issue debt to deposit directly at the Federal Reserve to finance the central bank's recent programs to enhance liquidity and stability in financial markets.

The US Dollar Will Require a Subsidy of Epic Proportions

And that no man might buy or sell, save he that had the sign, or the authority of the beast, or the currency of his name.
Revelation, 13.17

Although Ken Rogoff does not specify it, if it is delivered the subsidy required to support the US dollar will be taken from the savings and living standards of its domestic underclasses and client states in neo-colonial style: an empire of symbiotic elements ruled by a nationless elite.

It's an old spectre from the depths of human ambition that is possible but not probable.

Rather, a shift from the last sixty years of dollar hegemony is more likely although it will pass neither quickly nor easily. The dollar is increasingly backed by nothing but coercion, of the ability to tax its citizens and to receive tribute from its protectorates. This is its strength, and its weakness.

When someone says "Things cannot change, there is no other alternative" we ask, 'Did nothing come before the dollar hegemony? Will the dollar be the world's currency in five hundred years?"

Therefore it is a matter of timing and the particulars, of probabilities, of the ability to think beyond the familiar to what has been and what will be coming from the flux of human events.

Empires designed to last a thousand years more often do not extend beyond a century due to the overreach of hubris and the fallibility of human designs.

History has a way of returning for a visit, and often at the most unexpected moments, with unanticipated developments.


The Financial Times
America will need a $1,000bn bail-out
By Kenneth Rogoff
September 17 2008 19:06

One of the most extraordinary features of the past month is the extent to which the dollar has remained immune to a once-in-a-lifetime financial crisis. If the US were an emerging market country, its exchange rate would be plummeting and interest rates on government debt would be soaring. Instead, the dollar has actually strengthened modestly, while interest rates on three- month US Treasury Bills have now reached 54-year lows. It is almost as if the more the US messes up, the more the world loves it.

But can this extraordinary vote of confidence in the dollar last? Perhaps, but as investors step back and look at the deep wounds of America’s flagship financial sector, the public and private sector’s massive borrowing needs, and the looming uncertainty of the November presidential elections, it is hard to believe that the dollar will continue to stand its ground as the crisis continues to deepen and unfold.

It is true that the US government has very deep pockets. Privately held US government debt was under $4,400bn at the end of 2007, representing less than 32 per cent of gross domestic product. This is roughly half the debt burden carried by most European countries, and an even smaller fraction of Japan’s debt levels. It is also true that despite the increasingly tough stance of US regulators, the financial crisis has probably already added at most $200bn-$300bn to net debt, taking into account the likely losses on nationalising the mortgage giants Freddie Mac and Fannie Mae, the costs of the $29bn March bail-out of investment bank Bear Stearns, the potential fallout from the various junk collateral the Federal Reserve has taken on to its balance sheet in the last few months, and finally, yesterday’s $85bn bail-out of the insurance giant AIG.

Were the financial crisis to end today, the costs would be painful but manageable, roughly equivalent to the cost of another year in Iraq.

Unfortunately, however, the financial crisis is far from over, and it is hard to imagine how the US government is going to succeed in creating a firewall against further contagion without spending five to 10 times more than it has already, that is, an amount closer to $1,000bn to $2,000bn.

True, the US Treasury and the Federal Reserve have done an admirable job over the past week in forcing the private sector to bear a share of the burden. By forcing the fourth largest investment bank, Lehman Brothers, into bankruptcy and Merrill Lynch into a distressed sale to Bank of America, they helped to facilitate a badly needed consolidation in the financial services sector.

However, at this juncture, there is every possibility that the credit crisis will radiate out into corporate, consumer and municipal debt. Regardless of the Fed and Treasury’s most determined efforts, the political pressures for a much larger bail-out, and pressures from the continued volatility in financial markets, are going to be irresistible.

It is hard to predict exactly how and when the mega-bail-out will evolve. At some point, we are likely to see a broadening and deepening of deposit insurance, much as the UK did in the case of Northern Rock. Probably, at some point, the government will aim to have a better established algorithm for making bridge loans and for triggering the effective liquidation of troubled firms and assets, although the task is far more difficult than was the case in the 1980s, when the Resolution Trust Corporation was formed to help clean up the saving and loan mess.

Of course, there also needs to be better regulation. It is incredible that the transparency-challenged credit default swap market was allowed to swell to a notional value of $6,200bn during 2008 even as it became obvious that any collapse of this market could lead to an even bigger mess than the fallout from subprime mortgage debt.

It may prove to be possible to fix the system for far less than $1,000bn- $2,000bn. The tough stance taken by regulators this past weekend with the investment banks Lehman and Merrill Lynch certainly helps.

Yet I fear that the American political system will ultimately drive the cost of saving the financial system well up into that higher territory.

A large expansion in debt will impose enormous fiscal costs on the US, ultimately hitting growth through a combination of higher taxes and lower spending. It will certainly make it harder for the US to maintain its military dominance, which has been one of the lynchpins of the dollar.

The shrinking financial system will also undermine another central foundation of the strength of the US economy. And it is hard to see how the central bank will be able to resist a period of allowing elevated levels of inflation, as this offers a convenient way for the US to deflate the mounting cost of its private and public debts.

It is a very good thing that the rest of the world retains such confidence in America’s ability to manage its problems, otherwise the financial crisis would be far worse. (It is more likely that they are numb, paralyzed by fear, unable to deviate from the status quo because the pain has not become acute enough to encourage them to move forward - Jesse)

Let us hope the US political and regulatory response continues to inspire this optimism. Otherwise, sharply rising interest rates and a rapidly declining dollar could put the US in a bind that many emerging markets are all too familiar with.

The writer is professor of economics at Harvard University and former chief economist of the International Monetary Fund

Can Morgan Stanley and Goldman Sachs Survive?

"We need a merger partner or we’re not going to make it," Mr. Mack told Mr. Pandit...

Too bad Bush and Company were not able to 'privatize' Social Security a few years back. Wall Street could have ravaged the life savings of the nation for at least a few more years before the music stopped.

NY Times
As Fears Grow, Wall St. Titans See Shares Fall
By BEN WHITE and ERIC DASH
September 18, 2008

Even Morgan Stanley and Goldman Sachs, the two last titans left standing on Wall Street, are no longer immune.

To the surprise of executives within those firms, and their rivals, the stocks of these powerful companies were drawn into the crisis of investor confidence on Wednesday. Morgan Stanley, whose stock fell almost 25 percent, was considering a merger with Wachovia or another bank to help shore up its finances. Goldman Sachs’s stock fell almost 14 percent, and it had to rebuff rumors that it was seeking a capital infusion.

The assault on these two companies underscored how quickly a sense of fear is spreading through Wall Street. Both firms just reported respectable profits on Tuesday, and were considered in a separate class from weaker banks like Bear Stearns and Lehman Brothers that saw the value of their businesses evaporate....

A tie-up with a bank would restore Morgan Stanley to its structure during the Depression, when the firm split from the Morgan banking empire. It would also leave Goldman Sachs as the last major American investment bank after a global financial crisis that has gripped markets for more than a year snowballed last week, forcing the most risk-taking industry in the world to get back to basics.

Only a day ago, Morgan Stanley defended itself from growing doubts about its future, issuing a fairly positive earnings report to ward off concerns about its health. But the fear that gripped markets after Lehman Brothers failed also enveloped the firm.

Seeking to avoid the kind fate that led Lehman and Bear Stearns to collapse, John J. Mack, Morgan Stanley’s chief executive, made an unsuccessful effort on Tuesday evening to persuade Citigroup’s chief executive, Vikram S. Pandit, to enter into a combination, according to people briefed on the talks.

“We need a merger partner or we’re not going to make it,” Mr. Mack told Mr. Pandit, according to two people briefed on the talks. Mr. Pandit, a former senior investment banker at Morgan Stanley, said Citigroup was not interested. It is thinking of deals it can strike with consumer banks, like buying the struggling Washington Mutual out of bankruptcy if its reported efforts to auction itself should fail, that would provide it with cheaper deposit funding. A Citigroup spokeswoman declined to comment.

Having failed at that, Mr. Mack entered into discussions on Wednesday with Wachovia and several other banks, people briefed on those discussions said. The talks with Wachovia are preliminary and a deal may not emerge. The banks declined to comment.

Goldman Sachs may be under less pressure given its recent history of outperforming its peers. The bank made $11.6 billion last year and has not posted a loss during the credit crisis. Morgan Stanley has also performed well, but has suffered more write-downs and had a loss of $3.6 billion in the fourth quarter of last year.

Still, many specialists say they believe that the monumental events of the last four days herald a new period of painful change for the American financial industry — one that speculators are rushing to pounce on. While Wall Street has gone through tough times before, only to emerge bigger and stronger, some financial specialists question whether the industry can rebound quickly after using high levels of leverage, or borrowed money, to binge on risky investments. Those investments have proved to be disastrous. Worldwide, financial companies have reported more than $500 billion in charges and losses stemming from the credit crisis — a figure some specialists say could eventually exceed $1 trillion.

Merrill Lynch rushed into the arms of Bank of America this week in a deal that in some ways harked back to the past. During the Depression, Congress separated commercial banks, which take deposits and make loans, from investment banks, which underwrite and trade securities. The investment banks were allowed to do business with less oversight, while commercial banks operated with tighter supervision.

But after Congress repealed those Depression-era laws in 1999, commercial banks began muscling in on Wall Street’s turf. As the new competition whittled down profit margins, investment banks used more of their capital to trade securities and also began developing financial derivatives to fuel profits.

Now, executives like John A. Thain, the chief executive of Merrill and a former Goldman executive, say investment banks will need large bases of deposits to shore up their capital....

Charts In the Babson Style At Midweek 17 September 2008

The equity markets are very short term oversold.

VIX is sky high. This Friday is the quad witching expiration for options. The McClellan Oscillator is in crash or rebound territory.

Stocks could breakdown and plunge, but its more likely we will get some sort of bounce and consolidation, that could last until the weekend or the next major financial default. We *might* see a major relief rally ahead of expiration.

After the Bell: Morgan Stanley Talking Merger with Wachovia

Breaking news from Bloomberg.

Wachovia considering merger with Morgan Stanley.


TweedleDumb meets TweedleDoomed.

This Is What a "Flight to Quality" Looks Like

Some guys are trying to brush this off as a forced unwinding of positions from the Lehman and AIG failures. Just trading action.

This is a classic 'flight to quality' and anyone who doesn't recognize that has no clue about the macro moves behind this.

"We think that gold is also being used as a carry trade 'currency' as well,
as the central banks lease their gold bullion cheaply to the commercial banks,
similar to the low interest rates carried by the yen and Swiss franc.

The gold is sold off, probably to the ETFs and the metals markets, and is largely not
returnable to the central banks in many cases.

This is one of the reasons why the gold price is becoming so volatile; the 'printing'
of gold by central bank leasing does not really create anything, it only distorts the market longer term.

Some day that volatility may become breath-taking."

Jesse's Cafe Americain The Carry Trade Currencies 15 Sept 2008

China: "The World Urgently Needs a Financial System...Not Dependent on the United States"

Sounds like China would like to change the US dollar rating to "Good Bye"

These historic changes happen more slowly than most would think but they tend to move with an irresistible force.

China paper urges new currency order after "financial tsunami"
By Chris Buckley
Reuters
Tuesday, September 16, 2008

BEIJING (Reuters) - Threatened by a "financial tsunami," the world must consider building a financial order no longer dependent on the United States, a leading Chinese state newspaper said on Wednesday.

The commentary in the overseas edition of the People's Daily said the collapse of Lehman Brothers Holdings Inc "may augur an even larger impending global 'financial tsunami'."

The People's Daily is the official newspaper of China's ruling Communist Party, and the overseas edition is a smaller circulation offshoot of the main paper.

Its pronouncements do not necessarily directly reflect leadership views, but this commentary by a professor at Shanghai's Tongji University suggested considerable official alarm at the strains buckling world financial markets.

China's central bank earlier this week cut its lending rate for the first time in six years, a move analysts said was aimed at bolstering the economy and the battered stock market.

"The eruption of the U.S. sub-prime crisis has exposed massive loopholes in the United States' financial oversight and supervision," writes the commentator, Shi Jianxun.

"The world urgently needs to create a diversified currency and financial system and fair and just financial order that is not dependent on the United States."

But Vice Premier Wang Qishan, on a visit to the United States, told U.S. trade officials in a meeting on Tuesday that China and the United States needed to maintain close economic ties with global markets going through such turbulence.

"The Chinese government is well aware of the fact that the United States, which is the world's largest developed country, and China, which is the world's largest developing country, should have constructive and cooperative economic and trade relations," he said.

China is a major buyer of U.S. Treasury bonds, and through its sovereign wealth fund it has taken stakes in two large U.S. financial institutions.

In July 2005, China revalued the yuan and freed it from a dollar peg to float within managed bands. But the yuan and China's trade remains tightly linked to the fortunes of the dollar.

The commentary suggested China must brace for grave economic fallout and look to alternatives, saying the crisis brings to mind the Great Depression of the 1930s.

"Lehman Brothers announced bankruptcy will not only have a domino effect on the global financial world, it will bring a shock to the world economy," the front-page comment stated. (If they don't like the Lehman bankruptcy they are really going to hate the rest of the year - Jesse)

The Last Bubble in this Credit Cycle

The US Dollar

Washington Mutual: Dead Man Walking

U.S. regulators try to find WaMu buyer
by Ajay Kamalakaran in Bangalore
Wed Sep 17, 2008 12:07pm EDT

Reuters) - U.S. federal regulators recently called a number of banks asking if they would consider buying Washington Mutual Inc should it eventually falter, the New York Post said, citing sources.

Federal banking regulators, in recent days, contacted Wells Fargo & Co, JPMorgan Chase & Co, HSBC and several other financial institutions to gauge their interest in a possible acquisition of WaMu, the paper said.

No merger discussions are currently under way between the Seattle-based bank and anyone else, the sources told the paper.

Washington Mutual could not be immediately reached for comment.

German Bank KfW Handed Lehman €300 Million Hours Before Bankruptcy

Eile mit Weile.

Germany angered at last-minute loss in Lehman crash

Sep 17, 2008, 8:55 GMT Reports that Germany's federal-government bank KfW handed over 300 million euros (420 million dollars) to Lehman Brothers only hours before the US investment bank failed, a newspaper said Wednesday.

The Frankfurt Allgemeine Zeitung said KfW passed the money to Lehman as part of a swap arrangement on Monday, the day the US firm declared insolvency. The impending collapse had been world news since the previous day.

The Finance Ministry in Berlin, which controls KfW, said there would be an inquiry to find who was to blame. KfW's in-house auditors would study how it was possible for the payment to have been released.

KfW conceded that it had an exposure of hundreds of millions of euros from the insolvency after the 'improperly released payment,' according to the newspaper. KfW was set up as a reconstruction bank and handles most federal-government investments.

Fed to Treasury: More Power!

The Treasury acts to put more 'top end' on the Fed's printing presses.


Treasury to Sell Bills to Bolster Fed Balance Sheet
By John Brinsley and Rebecca Christie

Sept. 17 (Bloomberg) -- The U.S. Treasury said it will sell bills to allow the Federal Reserve to expand its balance sheet, a day after the government agreed to take over American International Group Inc.

``The Treasury Department announced today the initiation of a temporary Supplementary Financing Program at the request of the Federal Reserve,'' the department said in a statement today. ``The program will consist of a series of Treasury bills, apart from Treasury's current borrowing program.''

Yesterday the Fed announced an $85 billion loan to AIG, in exchange for a 79.9 percent government stake in the largest U.S. insurer. The Fed also has set up several other emergency lending programs to provide Wall Street firms with ready access to funding.

The new bill program ``will provide cash for use in the Federal Reserve initiatives,'' the Treasury said.

The Treasury said it will sell the new bills using its existing auction procedures, giving ``as much advance notification as possible.'' The bills will not have a uniform fixed term, giving the Treasury the same duration flexibility that it has with cash-management bills.


NY Federal Reserve Bank
Statement Regarding Supplementary Financing Program
September 17, 2008

Today, the Treasury Department announced the initiation of a temporary Supplementary Financing Program.

The program will consist of a series of Treasury bill auctions, separate from Treasury's current borrowing program, with the proceeds from these auctions to be maintained in an account at the Federal Reserve Bank of New York.

Funds in this account serve to drain reserves from the banking system, and will therefore offset the reserve impact of recent Federal Reserve lending and liquidity initiatives.

TED Spread Rises to New High for the Credit Crisis

For an explanation and analysis see: Demystifying the TED Spread

Russian Stock Market Halts Trading After a 17% One Day Decline

Shock and awe.

Russia halts trading after 17% share price fall
By Catherine Belton and Charles Clover in Moscow
and Rachel Morarjee in London
The Financial Times

September 16 2008 19:11

Russian shares suffered their steepest one-day fall in more than a decade on Tuesday, losing up to 20 per cent, as a sharp slide in oil prices and difficult money market conditions triggered a rush to sell....

Russian Stock Markets Halts Trading After 17% Decline

So What's the Deal with the Fed?

Most news sites, taking their cue from the Fed NY Press Release, are reporting that AIG will be receiving a loan of $85 billion which will be paid back in two years with an interest rate of LIBOR + 850 basis points.

The loan will be collateralized by AIG's assets including its subsidiaries.

In return, the Fed will receive an equity interest of 79.9% of AIG immediately. It will have the right to suspend dividend payments to common and preferred shareholders. It will replace top management.

AND it owns and will maintain ownership of 79.9% of the company AFTER being paid back in full at a 10+% rate of interest over two years.

What, no penalty clause for prepayment?

Seriously, doesn't something seem a little wrong in that description? Who negotiated for the Fed? Tony Soprano?

Is it a purchase or a collateralized loan? The way people are describing it is a purchase for 79.9% of the company, and AIG repays the full purchase price to the Fed in two years for with 10+% annual interest, AND the Fed keeps the ownership.

We suspect the press release was written hurriedly and the newswires and bloggers are running with it without questioning what it really means, and details will be forthcoming.

We admit we do not understand the deal as it is being explained. It does not make sense. We suspect that the ownership is really warrants with either a strike price or exercisable upon some prearranged condition of non-payment.

The change in management can be a negotiated item in the note, and does not require actual majority share ownership control.

Its not a trivial question because it speaks to existing shareholder dilution and the stock price. We are sure Hank Greenberg knows the answer, but we can't seem to find his phone number.

But like everyone else we are tired and in news overload, so let's call it a night and let the market decide what's what.

Fed to Make an $85 Billion Bridge Loan to AIG

AIG will receive its bridge loan, will have a limited time in which to sell assets to pay it back, the top management is replaced. Fed Considering Loan Package for AIG

We still don't quite understand the Fed's 79.9% stake in AIG. If AIG pays back the loan, with interest, does the Fed (Treasury?) still own 79.9% of the company? Is this a purchase or does that stake represent a kind of warrant should the terms of the loan not be met? Is this a purchase with an 'option to return' like a repo, or is the stake a form of collateral?

The obvious question is the amount of dilution to the shareholders. The details will like be released and clarified over time.

This may be a solution to the AIG crisis, but with regard to the US credit crisis it is more likely the end of the beginning.

For release at 9:00 p.m. EDT

The Federal Reserve Board on Tuesday, with the full support of the Treasury Department, authorized the Federal Reserve Bank of New York to lend up to $85 billion to the American International Group (AIG) under section 13(3) of the Federal Reserve Act. The secured loan has terms and conditions designed to protect the interests of the U.S. government and taxpayers.

The Board determined that, in current circumstances, a disorderly failure of AIG could add to already significant levels of financial market fragility and lead to substantially higher borrowing costs, reduced household wealth, and materially weaker economic performance.

The purpose of this liquidity facility is to assist AIG in meeting its obligations as they come due. This loan will facilitate a process under which AIG will sell certain of its businesses in an orderly manner, with the least possible disruption to the overall economy.

The AIG facility has a 24-month term. Interest will accrue on the outstanding balance at a rate of three-month Libor plus 850 basis points. AIG will be permitted to draw up to $85 billion under the facility.

The interests of taxpayers are protected by key terms of the loan. The loan is collateralized by all the assets of AIG, and of its primary non-regulated subsidiaries. These assets include the stock of substantially all of the regulated subsidiaries. The loan is expected to be repaid from the proceeds of the sale of the firm’s assets. The U.S. government will receive a 79.9 percent equity interest in AIG and has the right to veto the payment of dividends to common and preferred shareholders.

Here is the relevant section of the Federal Reserve Act referenced in the press release.

In unusual and exigent circumstances, the Board of Governors of the Federal Reserve System, by the affirmative vote of not less than five members, may authorize any Federal reserve bank, during such periods as the said board may determine, at rates established in accordance with the provisions of section 14, subdivision (d), of this Act, to discount for any individual, partnership, or corporation, notes, drafts, and bills of exchange when such notes, drafts, and bills of exchange are indorsed or otherwise secured to the satisfaction of the Federal Reserve bank: Provided, That before discounting any such note, draft, or bill of exchange for an individual, partnership, or corporation the Federal reserve bank shall obtain evidence that such individual, partnership, or corporation is unable to secure adequate credit accommodations from other banking institutions.

And the most important question of all: Is the NY Fed really going to replace AIG in the Dow Jones Industrial Average tomorrow?

Are they going to have options?

AP
Stocks stabilize, but critical insurer teeters
September 16, 8:56 pm ET
By Ellen Simon

NEW YORK (AP) -- The Federal Reserve resisted a cut in interest rates Tuesday and then forged a plan to take over American International Group Inc. and rescue the insurance giant from the brink of bankruptcy with an extraordinary $85 billion loan.

The moves, along with a slight rebound on Wall Street, offered some respite after the chaos that shook the financial system Monday when investment house Lehman Brothers declared bankruptcy and the Dow Jones industrials suffered its biggest point drop since the 2001 terrorist attacks.

Investors worried that a failure by AIG, the world's largest insurer, would set off even more financial turmoil.

AIG is little known off Wall Street but does business with almost every financial institution in the world. It insures $88 billion worth of assets and plays an outsized role insuring mortgages and corporate loans, but even more threatening was its integral role in the murky world of hedge funds and credit derivatives.

People with knowledge of the situation, who asked not to be identified because of the sensitive nature of the negotiations, said bankers and federal officials had decided a government bailout of AIG was the best solution to save it from collapse. An announcement of the takeover was expected late Tuesday.

The plan called for the government to seize up to 80 percent of the company and remove its management, similar to the way it took control of mortgage giants Fannie Mae and Freddie Mac.
All three major credit rating agencies had cut AIG's ratings at least two notches late Monday night, and while the new ratings were still considered investment grade, they added pressure on AIG as it sought tens of billions of dollars to strengthen its balance sheet.

New York Gov. David Paterson said Monday he would support allowing AIG to use $20 billion of assets held by its subsidiaries to pay for its business -- essentially giving it a bridge loan from itself.

A collapse of AIG would force Wall Street to untangle the complex credit derivatives markets and send the market scrambling to figure out who owes what to whom -- or even who owns what.

"Regulators knew that if Lehman went down, the world wouldn't end," money manager Michael Lewitt wrote in an op-ed column Tuesday in The New York Times. "But Wall Street isn't remotely prepared for the inestimable damage the financial system would suffer if AIG collapsed."

The Fed stepped in hours after it decided, in its first unanimous vote this year, to keep the closely watched federal funds rate unchanged at 2 percent. At the same time, however, the Fed noted that strains on the market have "increased significantly" and said it was ready to act if needed.

Stocks slumped immediately after the Fed announcement. The Dow initially dropped about 100 points but rallied to finish the day up 141, and back over 11,000.

As AIG teetered, central bankers around the globe scrambled to revive credit markets. The Fed injected $70 billion into the American financial system. The European Central Bank pumped one-day financing of nearly $100 billion into the 15-nation zone. The Bank of Japan added $24 billion, and England's central bank almost $36 billion.

Cash left world markets Monday like an outgoing tide. The interest rate banks charge each other for overnight loans soared as high as 6 percent -- far above the Fed's target rate of 2 percent and a sign banks didn't trust each other enough to make even 12-hour loans...

New York Times
Fed Readies A.I.G. Loan of $85 Billion for an 80% Stake
By MICHAEL J. de la MERCED and ERIC DASH
Published: September 16, 2008

In an extraordinary turn, the Federal Reserve was close to a deal Tuesday night to take a nearly 80 percent stake in the troubled giant insurance company, the American International Group, in exchange for an $85 billion loan, according to people briefed on the negotiations.

All of A.I.G.’s assets would be pledged to secure the loan, these people said, and in return, the Fed would receive warrants that would give it an ownership stake. Stock of existing shareholders would be diluted, but not wiped out.

If the Fed takes a controlling stake, it is likely that it would want to replace A.I.G.’s board as well as its chief executive and chairman, Robert B. Willumstad.

The Fed’s action came after Treasury Secretary Henry M. Paulson and Ben S. Bernanke, president of the Federal Reserve, went to Capitol Hill on Tuesday night to meet with House and Senate leaders. Mr. Paulson called the Senate majority leader, Harry Reid, Democrat of Nevada, about 5 p.m. and asked for a meeting in the Senate leader’s office, which began about 6:30 p.m.

The Federal Reserve and Goldman Sachs and JPMorgan Chase had been trying to arrange a $75 billion loan for A.I.G. to stave off the financial crisis caused by complex debt securities and credit default swaps. The Federal Reserve stepped in after it became clear Tuesday afternoon that the banking consortium would not be able to complete the deal.

Without the help, A.I.G. was expected to be forced to file for bankruptcy protection.

The need for the loans became necessary after the major credit ratings agencies downgraded A.I.G. late Monday, a move that likely to have forced the company to turn over billions of dollars in collateral to its derivatives trading partners worsening its financial health.

Until this week, it would have been unthinkable for the Federal Reserve to bail out an insurance company, and A.I.G.’s request for help from the Fed of just a few days ago was rebuffed.

But with the prospect of a giant bankruptcy looming — one with unpredictable consequences for the world financial system — the Fed abandoned precedent and agreed to let the money flow.

AIG Said to Accept Federal Takeover, Replace Managers
By Hugh Son

Sept. 16 (Bloomberg) -- American International Group Inc., the biggest U.S. insurer by assets, has accepted a deal to turn over control in exchange for an $85 billion loan from the Federal Reserve, a person familiar with the situation said.

AIG will replace management as part of the deal, said the person, who declined to be named because no public announcement has been made. AIG spokesman Peter Tulupman had no immediate comment.

The agreement would keep New York-based AIG in business, averting a collapse that could have threatened more financial companies and caused $180 billion in losses, according to RBC Capital Markets. AIG needed the loan to stave off a collapse after its credit ratings were cut and shares plunged 79 percent since Sept. 11.

The federal lifeline will allow AIG to sell assets in an orderly fashion, the person said. Proceeds from the divestments may be used to help pay back the two-year loan, the person said.

``The alternatives are much worse,'' said U.S. Senator Charles Schumer, Democrat of New York, in a statement after lawmakers met with U.S. regulators.

Money Market Fund "Breaks the Buck" on Lehman Losses

Money Market Fund Says Customers Could Lose Money
By DIANA B. HENRIQUES
September 16, 2008

In a new sign of market turbulence, managers of a multibillion-dollar money market fund said on Tuesday that customers might lose money in the fund, a type of investment that has long been considered as safe and risk-free as a bank savings account.

The announcement was made by the Primary Fund, which had almost $65 billion in assets at the end of May. It is part of the Reserve Fund, a group whose founder helped invent the money market fund more than 30 years ago. .

The fund said that because the value of some investments had fallen, customers now have only 97 cents for each dollar they had invested.

This is only the second time in history that a money market fund has “broken the buck” — that is, reported a share’s value below a dollar.

This year alone, big banks and fund management companies have pledged more than $10 billion to rescue affiliated money funds that were caught holding mortgage market securities that were deteriorating rapidly in value. As a result, consumers have felt confident in the safety of money funds, and have been moving assets into such funds as markets have grown more turbulent.

The Investment Company Institute, the mutual fund industry’s trade group, issued a statement Tuesday assuring investors that “the fundamental structure of money-market funds remains sound.” It noted, too, that in the only previous case of a fund breaking the buck, investors nevertheless were paid 96 cents on the dollar.

But the Reserve Fund’s announcement may shake investors’ confidence. Moreover, institutional markets that are already under severe stress could be further shaken if this giant fund, and others like it, are forced to sell some less-liquid holdings to meet redemption demands from nervous customers in coming weeks.

The Primary Fund allowed its share price to fall below a dollar “after reviewing the unprecedented market events of the past several days and their impact” on the fund, the company said in a statement.

Specifically, the fund’s management, which boasted as recently as July about its cautious approach to the current crisis, determined that its stake in debt securities issued by Lehman Brothers Holdings, with a face value of $785 million, was essentially worthless, given the investment bank’s filing for bankruptcy protection. As a result, the fund said, its per-share value fell to 97 cents a share.

The fund’s financial records also show that more than half of its portfolio on May 31 consisted of asset-backed commercial paper and notes from a host of issuers besides Lehman, few of them names likely to be familiar to the financial markets.

If these arcane investments had to be sold or cashed out quickly to meet redemptions, it is unclear what prices they would fetch or whether the issuers would be able to return the fund’s money promptly, said Keith Long, of Otter Creek Management, a hedge fund based in Palm Beach, Fla.

The Primary Fund reported that, until further notice, it would delay paying redemptions to customers for up to seven days, as permitted under mutual fund law. That delay will not apply to debit-card transactions, automated clearinghouse transactions or checks written against the assets of the Primary Fund, provided that the transactions do not exceed $10,000 from single or affiliated investors.

The fund is part of the complex run by Bruce R. Bent, who invented the money market fund concept with Henry B. R. Brown in 1970.

Since their inception, money market funds increasingly have been seen by individual investors as a safe harbor in turbulent times. According to industry statistics, the assets of money funds have grown sharply since the credit crisis began to intensify last summer.

But, as prospectuses and regulators make clear, money funds are not legally required to keep their share prices at or above a dollar, or to redeem investors’ shares immediately. Like all regulated mutual funds, their share prices are determined solely by dividing total portfolio assets by the number of shares outstanding, and they have seven days to meet redemption demands.

Those facts would probably surprise most money fund investors, who have come to think of money funds as being “just like cash, just like a checking account,” a fund industry lawyer, Jay Baris, said.

Whenever money funds have run into trouble, they were propped up by parent banks and investment managers that provided the necessary cash. The single exception was in 1994, when one small regional money fund reported a share price below a dollar, according to the Investment Company Institute.

The continuation of this informal bail-out policy “is much-discussed in the fund industry, because funds are so much bigger today,” said Barry P. Barbash, a fund industry lawyer with Wilkie Farr & Gallagher and a former senior mutual fund regulator at the Securities and Exchange Commission.

In the past, regulators tended to focus on banning money funds from buying inappropriate investments in the first place, he said. “But now,” he added, “we’re talking about instruments that were completely appropriate for a money fund when they were purchased. That’s what makes this so much harder.”

Not only are funds bigger, markets are more turbulent. A host of mutual funds have found their portfolios battered by investments in commercial and investments banks that were long considered close to bedrock on Wall Street. Money funds, too, suddenly found that some of their blue chips were tarnishing.

But with individual mutual fund investors showing little sign of panic, most funds have simply ridden out the current turbulence.

However, several industry analysts said on Tuesday that the Reserve Fund’s action came after its Primary Fund had been hit by heavy redemption demands that intensified the impact of the Lehman losses.

“We’re really in uncharted territory here,” said Peter Crane, the president of Crane Data, a fund industry newsletter.

Conservatorship Is an Option Being Considered for AIG

Reuters
Futures fall on report conservatorship eyed for AIG
Tuesday September 16, 5:06 pm ET

NEW YORK (Reuters) - U.S. stock index futures fell after the market closed on Tuesday on a Bloomberg report that the United States was considering conservatorship as an option for troubled insurer American International Group.
The report, citing two people briefed on the talks, caused a 48 percent drop in AIG shares after the bell...

Treasury Said to Be Considering AIG Conservatorship
By Craig Torres and Elizabeth Hester

Sept. 16 (Bloomberg) -- The U.S. Treasury is considering taking over American International Group Inc. under a conservatorship as one option to address the insurer's crisis, according to two people briefed on the discussions.

Executives from AIG, bankers and Treasury and Federal Reserve officials are meeting today on the company's situation at the New York Fed. A number of options are under being discussed to fill a shortfall of $75 billion to $100 billion in funding one of the people said. The talks are continuing, he said.

Goldman Sachs Group Inc. and JPMorgan Chase & Co., which have been leading efforts to find a private-sector solution, informed the Fed that such an effort would be difficult, the person said. Under another option, the Fed would extend a loan to New York-based AIG, according to a person informed of the matter.

Treasury Secretary Henry Paulson earlier this month seized Fannie Mae and Freddie Mac and put them into conservatorships, where officials will oversee the firms and aim to protect their assets...

Feds Considering Loan Package for AIG

If they can make it a short term bridge loan with tough, even draconian, conditions it might be a reasonable solution. The current top management should get tossed out, and tight time limits and a forced unwinding of certain positions should be stipulated.

Its hard to render a strong opinion without better access to the data, unless you're just tossing off ideological viewpoints. How much of the problem is true insolvency versus a short term liquidity squeeze? What are the costs of a failure, and how much of a loan for how long is required?

Why can't AIG reach terms with the banks? Are we seeing brinksmanship at play? Are the lines of liquidity to the markets being manipulated by the Wall Street banks? They are in a position of privilege and obligation in this process by using the special facilities.

The Fed is the lender of last resort. AIG is not a bank, but this is part and parcel of the muddying of the waters we have seen with the erosions in the aftermath of the repeal of Glass-Steagall.

The impact of an AIG bankruptcy on the banking system would be profound. We cannot have this both ways with regard to the definition of the risks banks can take, and with whom they can mingle their interests.

We need to restore some sanity and a better defined charter to the banking system or get used to this sort of non-traditional action and crises.

AIG reportedly may get loans from Fed
By Alistair Barr
3:02 p.m. EDT Sept. 16, 2008

SAN FRANCISCO (MarketWatch) -- The Federal Reserve is considering extending a loan package to American International Group Bloomberg News reported on Tuesday, citing an unidentified person familiar with the negotiations.

AIG has been hammered by derivatives exposure to the housing bust and mortgage meltdown. Ratings downgrades have left it struggling to raise capital in private markets.

Without government support, the giant insurer may have to file for bankruptcy. With roughly $1 trillion in assets and a huge derivatives business, some analysts worry such a collapse may trigger the demise of other financial institutions.

AIG shares fell 12% during afternoon trading. They were down more than 50% earlier.

Fed Says: Rough Seas Ahead, Steady As She Goes

Release Date: September 16, 2008

For immediate release:

The Federal Open Market Committee decided today to keep its target for the federal funds rate at 2 percent.

Strains in financial markets have increased significantly and labor markets have weakened further. Economic growth appears to have slowed recently, partly reflecting a softening of household spending.

Tight credit conditions, the ongoing housing contraction, and some slowing in export growth are likely to weigh on economic growth over the next few quarters.

Over time, the substantial easing of monetary policy, combined with ongoing measures to foster market liquidity, should help to promote moderate economic growth.

Inflation has been high, spurred by the earlier increases in the prices of energy and some other commodities. The Committee expects inflation to moderate later this year and next year, but the inflation outlook remains highly uncertain.

The downside risks to growth and the upside risks to inflation are both of significant concern to the Committee. The Committee will monitor economic and financial developments carefully and will act as needed to promote sustainable economic growth and price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Christine M. Cumming; Elizabeth A. Duke; Richard W. Fisher; Donald L. Kohn; Randall S. Kroszner; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh. Ms. Cumming voted as the alternate for Timothy F. Geithner.


For comparison, here is the statement from the last FOMC meeting in August.

Release Date: August 5, 2008

For immediate release:

The Federal Open Market Committee decided today to keep its target for the federal funds rate at 2 percent.

Economic activity expanded in the second quarter, partly reflecting growth in consumer spending and exports. However, labor markets have softened further and financial markets remain under considerable stress. Tight credit conditions, the ongoing housing contraction, and elevated energy prices are likely to weigh on economic growth over the next few quarters. Over time, the substantial easing of monetary policy, combined with ongoing measures to foster market liquidity, should help to promote moderate economic growth.

Inflation has been high, spurred by the earlier increases in the prices of energy and some other commodities, and some indicators of inflation expectations have been elevated. The Committee expects inflation to moderate later this year and next year, but the inflation outlook remains highly uncertain.

Although downside risks to growth remain, the upside risks to inflation are also of significant concern to the Committee. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Elizabeth A. Duke; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh. Voting against was Richard W. Fisher, who preferred an increase in the target for the federal funds rate at this meeting.

The Lady or the Tiger?

Its not that Paulson and Bernanke are following a 'liquidationist" philosphy in the spirit of Hoover and Mellon. Hardly, given the enormous amounts of liquidity that the Fed and Treasury are making available to the banks in many innovative and non-traditional ways.

Rather, we have a 'selective liquidity crisis' because the situation has not become broadly dire enough to frighten the bankers out of their usual gamesmanship and maneuvering for quick profits. Thinking longer term and for the greater good is not a natural reflex with this crowd.

The Fed and Treasury will have to make the pain great enough for the system to move forward without becoming more dependent on subsidies than they already have been. There has been little downside under Greenspan's long reign, and the bankers have been able to keep what they kill.

The failure here was the government's, in allowing the banks to subvert the system through influence-peddling and the dismantling of the regulatory process. We think the NY Fed would have a stronger hand to play if he were able to throw a file of wiretaps, bank records, and subpoenas on the table when lecturing the US banks on mutual benefits.

The governments of the world are also responsible for this because of their monetary policies for so many years, pandering to the sole superpower, and their artificial support for the dollar. They turned the world's economy into an artificial construct hopelessly addicted to easy credit, weak regulations and market manipulation.

Things change slowly. Ben and Hank have a tough job. If they take the patient off too quickly in a cold turkey, and put it into systemic shock.

There is a profound difference between insolvent and illiquid. Let's hope wisdom prevails. And let's never forget who and what caused this problem in the first place.


Who's next after Lehman Brothers is fed to the wolves?
By Ambrose Evans-Pritchard
Last Updated: 2:47pm BST 16/09/2008
UK Telegraph

One can date the onset of the Great Depression from December 1930 with the collapse of the Bank of the United States, a mid-size lender to the Jewish community in New York.

It is often alleged that the Anglo elites let the bank fail from motives of anti-semitic malice.

True or not, the consequences were dire for almost everybody. The failure set off a worldwide run on US gold deposits (ie, the dollar), and forced the Federal Reserve to raise interest rates into the slump. Some 4,000 lenders were ultimately driven to the wall.

We will find out soon enough whether the decision to throw Lehman Brothers to the wolves over the weekend was any wiser. Princeton economist Paul Krugman has accused the US Treasury and the Fed of playing "Russian roulette" with the financial system, warning that the shadow banking network could disintegrate within days.

The hunting packs switched instantly to AIG yesterday, driving down its shares by 70pc in early trading. The world's biggest insurer is suddenly on the brink of collapse as well. The killer virus is striking deep into a whole new sector of the financial system.

"This is a potentially very dangerous situation," said Professor Tim Congdon from the London School of Economics.

"Banking system capital is being wiped out. The risk is that this could lead to a contraction of credit and set off a self-reinforcing downward spiral, leading to the sort of debt-deflation we saw in the 1930s.

"It is already clear that money growth has ground to a halt over the past three months. We must prevent it from actually contracting. If the Fed and European Central Bank don't cut interest rates soon, it is going to be a problem," he said.

When creditors cut off funding to Bear Stearns in March, the Fed reacted with dramatic speed. It invoked nuclear powers under Article 13 (3) of its charter, allowing it - in "unusual and exigent circumstances" - to take credit liabilities on to its own books for the first time since the Roosevelt era.

It was fiercely criticised for rescuing Wall Street from its own folly, but the risk was a meltdown in the vast, untested market for derivatives. Bear Stearns alone had over $13 trillion in contracts, with heavy exposure to the turbo-charged CDS credit swaps that so terrify the New York Fed.

Nobody was ready for a derivatives shock at that time. This time, hopefully, they are. The Bear Stearns bail-out gave the banks an extra six months to clean up their positions and lower exposure. Hence the orderly unwinding of trades at an emergency session of the International Swaps and Derivatives Association on Sunday afternoon.

With the tail risk of a derivatives Chernobyl out of the way, the Fed and the Treasury at last feel safe enough to strike a blow against moral hazard. The line has to be drawn somewhere.

Unlike mortgage giants Fannie Mae and Freddie Mac, broker dealers are not crucial pillars of the US housing market. Lehman is an optimal candidate for ritual sacrifice.

While the appearances of free market discipline have been upheld, the reality of the weekend events is a further lurch towards socialism, or state capitalism if you prefer.

The Fed's lending window has been widened, allowing all forms of investment grade paper to be used as collateral in exchange for taxpayer credit.

Even equities are now admitted, though under a disguised formula. "With investment banks falling like ninepins, the Fed may have decided that it would be prudent to provide some official underpinning for equity market values and hope to avoid a stockmarket collapse," said Stephen Lewis, chief economist at Insinger de Beaufort.

Yet the dangers remain acute, even after the move to shield Merrill Lynch from contagion by orchestrating a shotgun wedding with Bank of America.

The credit crunch is about to bite deeper. The interest rate on Tier 1 debt for typical banks has jumped by 125 basis points since Friday. "This is a violent effect," said Willem Sels, credit strategist at Dresdner Kleinwort.

The closely-watched Libor/OIS spread on three-month money in the US has risen to 105 basis points, pointing to a lending crunch over the winter. Europe's iTraxx Crossover index measuring default risk on junk debt has surged to over 600.

"There is a flight to quality. People are hoarding liquidity and this is going to prove very damaging. What concerns me is that the banks refused to take on Lehman's bad assets even at a low valuation, and that tells you they still don't know where the clearing level is for this mortgage debt," he said.

As this newspaper has long feared, the world is now faced with both a tightening credit squeeze and a synchronised hard-landing across most of the world economy.

The eurozone and Japan are almost certainly in recession already. Britain will follow soon.

America is plummeting into a second downward leg as the fiscal stimulus package fades and the exports mini-boom stalls. China cut interest rates yesterday following a sharp fall in property prices over the summer.

Superficially, one can blame Lehman and its ilk for the excesses that led to this crisis.

However, the root cause lies in the actions of governments across the Western world. They held interest rates too low for much of the past two decades, and encouraged the debt burden to explode to unprecedented levels.

This reckless experiment has left our societies acutely vulnerable to a sudden reversal of debt issuance, or ''deleveraging" as it is known. The ferocious purge now under way will come at a high human cost. Millions in Britain, Europe, the US, and the rest of the world will lose their jobs over the next two years, through no fault of their own.

Having caused this crisis, it would now be remiss for governments to pursue a policy of strict debt liquidation in the name of capitalist purity.

As the bankruptcies mount, the state will have an obligation to step in to preserve social stability. If that means the temporary nationalisation of large chunks of the Western economy, so be it.

This is too grave a crisis for ideological preening and free market infantilism. May those calling for debt liquidation ''a l'outrance" be the first in line to lose their jobs.

Safe Havens

We are seeing a significant unwinding of positions for the sake of liquidity, a selective liquidity crisis.

Certainly there is an ample supply of liquidity available to a select few market players who can access it via the Fed's special facilities.

But for those who need that liquidity to work out solvency problems there is apparently a pound of flesh to pay for it in the sale of assets at distressed prices, or so we have heard.

And the hedge funds are being slowly strangled.

This is the flaw in the Fed and Treasury scheme to support the overall economy, as has been learned over and over in the Third World. They are giving their relief supplies to warlords and mercenaries to distribute to the rest of the country.

Perhaps that image is overdone. We'd have to ask those who are sitting across the table from Goldman Sachs.

Better to be independent we think, than to rely on the rational judgement of these sharks. But what price independence? And where is safety?


From today's Daily Pfennig, Chris Gaffney at Everbank:

I just don't get those that say the dollar will be a "safe haven" during this time, how can the country that is causing the Tsunami, have a "safe haven currency"? I would think the currencies of Japan, Singapore, Switzerland, and China would be the safe havens... With the euro experiencing perceived problems, investors are a little skittish toward the euro... But, remember this, the euro is the offset of the dollar...

Gold started to move back off its recent lows, but the move to hard assets wasn't as dramatic as I thought it would be. After all, if investors are looking for a 'safe haven', how much safer can you get than gold? One argument which I have heard against gold is that you can't get paid any interest on your gold holdings, but if you are willing to earn a negative real yield on US treasuries, an investment in gold actually becomes even more attractive. Logically, events like those that occurred this weekend should set off a buying frenzy in the metals markets...

So precious metal prices are down, just when you would expect them to be rising. And judging from the calls to the desk, supplies of minted coins for both Gold or Silver are getting harder to find. Our metal dealers tell us that the mints just haven't been able to keep up with demand for gold and silver coins, but prices for these commodities continue to slide. Just doesn't make any sense to me... Investors should have a portion of their investments in gold or silver, as a hedge against inflation, and against a possible meltdown of the current financial system.

AIG Cut Two Levels by Rating Agencies Precipitating Fresh Concerns

Duck and cover. Watch out for curveballs tomorrow.

We're seeing a lot of forced selling for liquidity. At some point it will abate, and we could see a spectacular turn in the markets. Whether it will stick is another matter altogether.

Stay frosty.

Rating agencies downgrade AIG, more cuts possible
Sep 15, 2008 10:29pm EDT
Reuters

HONG KONG, Sept 16 - The rating on embattled insurance giant American International Group Inc. was slashed by at least two notches by the three top global rating agencies, who also warned more downgrades could follow.

The triple strike jolted the insurer even as it is struggling to find funding sources at a time of global financial tumult which has brought two of the biggest Wall Street investment banks to their knees.

Moody's Investors Service cut AIG's rating to A2 from Aa3, a two-notch downgrade. Standard & Poor's Ratings Services lowered the rating to A-minus from AA-minus, a three-peg reduction and Fitch Ratings reduced its standing to A from AA-minus, a two notch cut.

AIG's ratings are still investment grade, although all three agencies said more downgrades could follow.

The announcements were made during Asia time on Tuesday, hours after New York state officials pieced together a $20 billion lifeline which would give the company temporary respite.

AIG's troubles, much like those of some of its Wall Street peers, stem from guarantees it wrote on mortgage-linked derivatives that have left it with a total of $18 billion in losses over the past three quarters.

In recent days, AIG has explored a wide range of options to shore up capital and avoid rating cuts.

JPMorgan and Goldman Sachs are exploring putting together a syndicated $70 billion to $75 billion credit facility for AIG, among other options.

This additional funding is critical for the insurer's survival in the longer term.

Another Soiree at Tim's Crib - NY Fed Hosts Session on AIG

Fed holds fresh AIG crisis talks
By Francesco Guerrera in London, Aline van Duyn
and Julie Macintosh in New York, and Krishna Guha in Washington
September 15 2008 21:54

The New York Fed is hosting a fresh set of crisis talks to deal with the problems at AIG, the troubled insurer. JPMorgan Chase, representing AIG, and Goldman Sachs, representing potential principal investors, are in the building working to come up with some kind of funding facility for AIG.

The Fed has convened the parties and is facilitating their discussions. But it has not asked JPMorgan and Goldman to provide $70bn in funding for the company, and at this stage has not discussed itself lending indirectly to AIG via back-to-back transactions intermediated by the investment banks, one possible way of channeling liquidity to AIG.

US authorities earlier on Monday threw a $20bn lifeline to AIG, one of the world’s largest insurers, just hours after the collapse of Lehman Brothers, and Bank of America’s $50bn rescue takeover of Merrill Lynch. (US Authorities = State of NY and they just altered the regulations to allow AIG to throw itself $20bn - Jesse)

The deal between AIG and New York State insurance regulators allows the company to access $20bn of capital from its own subsidiaries in a desperate attempt to stave off a liquidity crisis and credit downgrades.

The move came as fears over AIG’s financial health sent its shares into a tail-spin on Monday. The stock fell as much as 70 per cent in morning trading in New York to an intra-day low of $3.50. By the close of trading it was 56 per cent lower at $5.15.

The move announced by the New York governor, David Paterson, is designed to give AIG, whose balance sheet has been savaged by billions of dollars in writedowns and credit losses, some time to clinch a deal to raise capital through a share sale and asset disposals.

AIG and its advisers spent the weekend hammering out plans to raise up to $40bn in capital, which the insurer needs to shore up its balance sheet and prevent crippling ratings downgrades... (and what happened?... Jesse)

The US central bank is putting intense pressure on weak financial institutions to strengthen their financial positions, if necessary by accepting a takeover.

It emerged on Monday that Fed and Treasury officials encouraged Merrill’s tie-up with BofA, telling John Thain, its chief executive, on Friday that his bank would be next to come under attack once Lehman failed and it had to find a solution quickly. (Did anyone not who was following the action NOT figure this one out? - Jesse)

Mr Thain, who had been party to an intense round of discussions with the Fed over the fate of Lehman, said: “Over the course of those discussions it became clear that it would make sense to explore options for us.” (Maybe it was when Hank Paulson did his Sam Kinison imitation for John that he got the message. Hey John. You know why you are going to do this deal with BofA? Because if you don't you're FUUUUUUUUUUUUUUUUUUUUUCCCCCCCCCCKKKKEEEEEDDDDDDDDDDD!!!- Jesse)

At Lehman’s European headquarters in London, Tony Lomas, PWC’s partner leading the administration, said: “It seems amazing that a business as huge as this can fail in this way.” (Tony has subsequently been seconded to the Britsh Tourist Authority as Director of Australian services, Earl's Court Exhibition Center. - Jesse)

Charts in the Babson Style for 15 September 2008

Some signficant carnage for the bulls, but not over the brink just yet.

Goldman reports tomorrow morning, and we also get the CPI which looks like a low and outside number.

Ben and his Merry Prankster at the Fed might be trimming interest rates a bit to help the banks.

VIX did a moon shot today so we are in 'dead cat bounce' territory. It can go higher.

FOMC Rate Decision Tomorrow

The Fed has quite a bit of incentive to cut at least 25 basis points tomorrow, and a rationale to cut 50 basis points if they make noises about last one before the elections unless the ecnomy dramatically worsens.

CPI out tomorrow will be lowballed if they can do it to rationalize the cut.

The economy is sinking rapidly and the banks need a steeper rate curve on the very short end. The rally in the Two Year Treasury today was breath-taking.

VIX is quite high. Start watching for a dead cat bounce at least.

Long Term Volatility Index - VIX

Time to start thinking about short term oversold and a dead cat bounce.

NY Fed Hires Morgan Stanley to Evaluate AIG Alternatives. Who Will Evaluate Goldman?

Is the NY Fed going to hire Morgan Stanley to develop solvency options for Goldman Sachs when its day of reckoning arrives?

You could put those meetings on Pay-Per-View for the investment community.

Ok, Floyd, er Lloyd and you too Dave, let's see your books, chop chop. Oh yeah and top off my Chivas would'ya? We've got a VIP table reserved at Scores for a conference tonight and YOU'RE paying for it. Oh yeah and we need a list of the recent comps for your traders too. We're drawing up a short list for some special overseas clients.

We'd suggest it take place at Madison Square Garden, in a cage match.

Fed Hires Morgan Stanley to Evaluate A.I.G. Options
September 15, 2008, 1:56 pm
Dealbook

The Federal Reserve has hired Morgan Stanley to advise it on potential lifelines for the American International Group, the large insurance company, people briefed on the matter said Monday.

The investment bank will help evaluate the risk that A.I.G. poses to the already battered financial system, and help the Fed negotiate possible solutions, which may include a $20 billion bridge loan to the insurer, these people said.

The Fed’s move may signal that it considers A.I.G.’s faltering financial health a significant threat to Wall Street. It would also be a remarkable move for the Fed after it declined to extend additional help to Lehman Brothers.

A.I.G. has already won approval from New York regulators to borrow $20 billion from its subsidiaries, as it seeks to shore up its capital base for the possibility that its vital credit ratings will be downgraded.

The firm has become one of the largest providers of insurance to complex mortgage securities, leaving it heavily exposed to the sagging housing market. Major credit ratings agencies have threatened to downgrade A.I.G.’s debt, a move that could prompt its trading partners to demand more capital in their transactions — and threaten the firm’s solvency.

A.I.G. has already raised $20 billion this year. But even that amount of capital has not averted a crisis.

Beyond seeking help from the Fed, A.I.G. is also considering selling off assets like its auto business. It rejected an offer by the private equity firm J. C. Flowers & Company to buy $8 billion in preferred shares — a bid that included an option to buy the whole firm at a discounted price. And two other buyout firms, Kohlberg Kravis Roberts and TPG, withdrew offers to buy preferred shares on Sunday because a Fed backstop seemed unlikely to materialize.

The firm’s sickly financial health was a prominent topic in weekend talks among Wall Street chieftains who gathered at the Federal Reserve Bank of New York to discuss the potential collapse of the investment bank Lehman Brothers. A.I.G. had become one of the biggest underwriters of complex debt securities known credit default swaps, used as insurance for a wide range of products, including the mortgage instruments that have been the bane of Wall Street for the past year and a half.

PIMCO, Vanguard and Japanese Banks Face Billions in Losses on Lehman Bonds

Many firms are holding hurried meetings today over these losses, to assess the impacts with respoect to money market funds, mutual funds, and pension plans. Legg Mason, Fidelity, Axa SA, Franklin Advisers, Vanguard and Pimco are among the largest stakholders.

This is minor compared to what some other failures might look like such as Goldman, Morgan Stanley, AIG, or a major bank like Washington Mutual and Wachovia.

The thing about commercial banks is that there is a well established mechanism for sweeping them into the money bin as long as the dollar and Treasury bonds hold up. Not so for insurance companies and investment banks, which are messy.

Interesting as well that it was Lehman and Bear that took it in the necks, as they were the two big bond houses.

If it is true that they are allowing banks to use depositor's funds to recapitalize their investment activities, then we have come full circle back to 1929 and all that implies.


Pimco, Vanguard Are Biggest Lehman Bond Fund Losers
By John Glover
Bloomberg News

Sept. 15 (Bloomberg) -- Pimco Advisors LP, Vanguard Group Inc. and Franklin Advisers Inc. are among investment companies that may face losses of at least $86 billion stemming from the collapse of Lehman Brothers Holdings Inc., the biggest bankruptcy in history.

Mutual fund companies' filings show they hold more than $143 billion of bonds, led by Newport Beach, California-based Pacific Investment Management Co., manager of the world's biggest bond fund, and Valley Forge, Pennsylvania-based Vanguard, according to data compiled by Bloomberg as of June 30.

``The losses look set to be widespread, hurting the public through their mutual and pension funds,'' said Ciaran O'Hagan, a credit strategist at Societe Generale SA in Paris. ``It's clearly a disaster for public confidence.''

While bond investors will recover different amounts based on their ranking in Lehman's capital structure, models of credit-default swaps assume lenders will recoup 40 percent of their loans overall in a bankruptcy. Investors may receive less than that, based on prices for Lehman's senior bonds of as little as 35 cents on the dollar from price provider Trace.

Pimco holds Lehman bonds in at least 12 of its funds, including the $134 billion Total Return Fund. Bill Gross, manager of the fund and co-chief investment officer of Pimco, was buying Lehman bonds as recently as June, Bloomberg data show. ...

Vanguard holds Lehman bonds among the $450 billion of fixed income it manages, spokesman John Woerth said. An outside spokeswoman for Pimco in London, who asked not to be named, said the company had no immediate comment, Lisa Gallegos, a spokeswoman for Franklin in San Mateo, California, wasn't immediately available.

New York-based Lehman, which filed for protection from creditors today, owes its 10 largest unsecured creditors more than $157 billion, according to the Chapter 11 filing in U.S. Bankruptcy Court in New York. The largest single creditor is Aozora Bank Ltd. in Tokyo, with $463 million in a bank loan. Other top creditors include Mizuho Corporate Bank Ltd., owed $382 million, and a Citigroup Inc. unit based in Hong Kong, owed an estimated $275 million, according to the filing.
Lehman listed total debts of $613 billion and $639 billion of assets in the filing.

Axa SA, Europe's second-biggest insurer, and unnamed affiliates, own 7.25 percent of Lehman's equity, according to the filing. Clearbridge Advisers LLC, the asset manager that Baltimore-based Legg Mason Inc. acquired from Citigroup Inc. in 2005, held 6.33 percent, according to the filing. Boston-based FMR LLC, the parent of Fidelity, the world's largest mutual fund company, held 5.9 percent, the filing said.

Wall Street Journal
Several Japanese Banks Are Top Lenders to Lehman
By YUKA HAYASHI
September 15, 2008 11:29 a.m.

TOKYO -- Several Japanese banks -- flush with cash and relatively unscathed by the global credit crisis -- are among the top bank lenders to Lehman Brothers Holding Inc., which filed for bankruptcy protection on Monday with $613 billion in debt.

Aozora Bank, a mid-sized Tokyo bank, was No.1 on the list of largest bank lenders with a loan of $463 million, followed by Mizuho Corporate Bank, with a $289 million loan, according to court documents submitted with Lehman's Chapter 11 bankruptcy filing. Mizuho Corporate Bank is the wholesale banking unit of Mizuho Financial Group, Japan's third-largest bank by market value. Other big Japanese lenders to Lehman included Shinsei Bank, another mid-sized Tokyo bank, and Mitsubishi UFJ Financial Group, Japan's largest bank.

For big Japanese banks like Mitsubishi UFJ and Mizuho, which have huge balance sheets, the loan losses related to Lehman may appear modest.

But smaller banks like Aozora and Shinsei may have a tougher time absorbing the losses. The two banks have been turned around by private-equity investors after collapsing during Japan's bad-loan crisis. But their performance has been weak in recent quarters. Faced with powerful competition from Japan's giant banks, they have forayed deeper into riskier business areas.

On Friday, Aozora said it expects to swing to a net loss of four billion yen in the fiscal first half ending Sept. 30, compared with a previous forecast of a 15.5 billion yen profit, as it changed the timing of write-downs related to its investment in GMAC LLC, the unprofitable finance arm of General Motors Corp. Aozora invested in this business alongside Cerberus Capital Management, its largest investor.

The long list of Japanese names on the list of bank lenders underlines how these banks are playing an increasingly important role as providers of capital in the global financial market battered by a credit crunch. Unlike many of their U.S. and European peers that have been forced to scale back lending because of big losses related to risky mortgage securities, Japan's top banks like Mitsubishi UFJ and Sumitomo Mitsui Financial Group still enjoy healthy balance sheets and have been vying to expand their presence overseas recently. These banks have stayed shy of investing in risky securities, in part due to a lesson learned from their own bad-loan crisis during the 1990s and early 2000s.

The filing doesn't necessarily mean the loans extended by these banks would go sour. Lehman said it had $639 billion in assets, which will be liquidated and eventually distributed among creditors during the process of liquidation. Aside from billions of dollars in loans borrowed from banks, the Wall Street firm owes over $150 billion to bond holders, who tend to come behind bank lenders when collecting debts in bankruptcy cases.

The Carry Trade Currencies

From Chris Gaffney in The Daily Pfennig:

The best performers over the weekend were the Japanese yen and Swiss franc, both traditional funding currencies of the carry trade. As Chuck [Butler] has explained several times in the past, when market volatility increases, traders typically start to exit the carry trades which are only profitable during times of relative calm in the markets.

The reversal of the carry trades means investors sell the emerging markets and high yield currencies and use the funds to pay down loans which they had taken out in the low yielding 'funding' currencies of Japanese yen and Swiss francs. The Japanese yen strengthened as much as 3.4% vs. the US dollar overnight, and the Swiss franc had the biggest one day gain in six months.

We think that gold is also being used as a carry trade 'currency' as well, as the central banks lease their gold bullion cheaply to the commercial banks, similar to the low interest rates carried by the yen and Swiss franc.

The gold is sold off, probably to the ETFs and the metals markets, and is largely not returnable to the central banks in many cases. This is one of the reasons why the gold price is becoming so volatile; the 'printing' of gold by central bank leasing does not really create anything, it only distorts the market longer term.

Some day that volatility may become breath-taking.

Chris Gaffney continues:

I have to say I am surprised Treasury Secretary Paulson stayed away from helping another bunch of his Wall Street buddies. I read where Paulson said Wall Street has been aware of Lehman's troubles for a long time and had time to prepare for any crisis at the company. I know we closed out all of our currency trades with Lehman a couple of months ago, and hopefully most other prudent companies did the same.

I hope this weekend's events are an indication that some sanity has returned to the Treasury department, and a line has been drawn after the widest expansion of federal safety nets to the financial system since the Great Depression. Its about time we quit guaranteeing the losses at these huge financial firms.

More likely Lehman was a token gesture to free markets as we had suggested last week it might very well be. Paulson and Company appear to be willing to do whatever it takes to control the situation and the markets, to 'inspire confidence' in the system, to feed the bull market in insensible complacency.

In the short term this is a viable strategy, but at the cost of a disabling of the free market system, and significant unintended consequences down the road.

We wish them well, but don't think they have the right motivation and character to achieve a sustainable solution hat would involve systemic reform. They are creatures of the status quo.

Underperforming Banks and Thrifts Most Likely to Fail, ex-Bailouts

CyclePro has updated his list of banks and thrifts which he feels are most likely to fail. You can view his methodology here: CyclePro

The inclusion of Bank of America and Goldman Sachs among the big banks is surely a gutsy call. But remember this list is ex-bailouts and Federal support. Both banks seem to have reserved place settings at the public trough.

His analysis is always interesting, but alas like most good things infrequently available. We have it among the links on this site's sidebar.

His blog is worth watching, and scrolling down through prior posts to see some of the gems there. We have referenced his long term chart and analysis of the deflated DJIA before. Its a pretty grim picture.

Central Banks Soothe Nervous Markets

Kumbaya My Lord, Kumbaya

Someone's cratered Lord, Kumbaya

Need a Rate Cut Lord, Kumbaya

Oh Lord Kumbaya


ECB, Bank of England Join Fed in Soothing Markets After Lehman
By John Fraher

Sept. 15 (Bloomberg) -- The European Central Bank and the Bank of England joined the Federal Reserve in taking action to sooth financial markets spooked by Lehman Brothers Holdings Inc.'s bankruptcy filing.

The ECB said it awarded banks 30 billion euros ($43 billion) in a one-day money-market auction that was more than three times oversubscribed. The Bank of England loaned banks 5 billion pounds ($9 billion) for three days. Earlier, the Federal Reserve widened the collateral it accepts for loans to securities firms.

Stocks plunged and bonds surged after Lehman became the latest victim of a yearlong credit squeeze. Financial institutions worldwide have reported more than $500 billion in losses and writedowns and the credit-market turmoil has erased $11 trillion from global stocks in the past year.

``It remains to be seen whether today's operation will be sufficient to restore market confidence,'' said Jacques Cailloux, chief euro-area economist at Royal Bank of Scotland Group Plc. ``The ECB will likely wait for the U.S. open to consider more aggressive action. Key will be how credit and equity markets develop in the coming days.''

ECB President Jean-Claude Trichet told reporters in Frankfurt as he arrived for an award ceremony that he had nothing to add to today's statement. The ECB said it injected the funds at a marginal rate of 4.30 percent. The Swiss central bank offered liquidity through its overnight facility for the first time since Feb. 22.

The ECB and the Bank of England may nevertheless hold off cutting rates right away as they seek to curb inflation. The ECB has spent much of the past year arguing that it can use its money market operations to tackle the credit crisis and doesn't need to resort to rate cuts.

``Rate cuts are only likely to be forthcoming if financial markets melt down in the coming days or weeks,'' said David Mackie, chief European economist at JPMorgan Chase & Co. ``For the time being, European policy makers look like they will continue to hold the line on the separation of powers. At some point though, that line could be reached.''

The cost of borrowing on money markets may also jump. The so- called OIS spread, the gap between three month dollar funds and traders' bet on the Fed's daily effective federal funds will rate, widened to 105 basis points today, the most since Dec. 6. That compares with 87 basis points at the end of last week.

Story of a Firm Offer for Merrill Lifted Stock Index Futures Off Lows

No source and the companies refuse to discuss, but it looks a little more likely than it did two hours ago. Its hard to believe that the WSJ would print this as fact without qualification if they did not have it from good sources.

But then again....

Keep an eye on the progress with Lehman and Merrill, but don't forget about AIG and Washington Mutual, aka Fatman and Little Boy. And then there's Morgan Stanley and Goldman Sachs....

Wall Street Journal
Bank of America Reaches Deal for Merrill
By MATTHEW KARNITSCHNIG, CARRICK MOLLENKAMP and DAN FITZPATRICK
September 15, 2008

In a rushed bid to ride out the storm sweeping American finance, 94-year-old Merrill Lynch & Co. agreed late Sunday to sell itself to Bank of America Corp. for roughly $44 billion.

The deal, which was being worked out in 48 hours of frenetic negotiating, could instantly reshape the U.S. banking landscape, making the nation's prime behemoth even bigger. The boards of the two companies approved the deal Sunday evening, according to people familiar with the matter.

Driven by Chief Executive Kenneth Lewis, Bank of America has already made dozens of acquisitions large and small, including the purchase of ailing mortgage lender Countrywide Financial Corp. earlier this year. In adding Merrill Lynch, it would control the nation's largest force of stock brokers as well as a well-regarded investment bank.

A combination would create a bank of vast reach, involved in nearly every nook and cranny of the financial system, from credit cards and auto loans to bond and stock underwriting, merger advice and wealth management.

It would also show how the credit crisis has created opportunities for financially sound buyers.At $44 billion, or roughly $29 a share, Merrill would be sold at about two-thirds of its value of one year ago, and half its all-time peak value of early 2007. Merrill shares changed hands at $17.05 each on Friday, after falling sharply in the wake of Lehman's looming demise.

"Why would Bank of America do this?" said analyst Nancy Bush at NAB Research LLC in Annandale, N.J. "Ken Lewis always likes to buy the biggest thing he can. So why not this? You are master of the universe, basically."

Bank of America and Merrill Lynch wouldn't comment on any discussions.

Merrill would give Bank of America strength around the world, including emerging markets such as India. And Merrill is also strong in underwriting, an area Bank of America identified last week at an investors' conference where it would like to be more aggressive. ...

AIG to Sell Assets, Seeks $40 Billion to Avoid Bankruptcy, Bridge Loan from the Fed

Yves Smith of Naked Capitalism tees this one up beautifully:

This is truly unbelievable. Even as little as a week ago, the idea that AIG, the world's biggest insurer, would go begging the Fed for help would have seemed daft. But that's now an element of the meltdown in progress.

And AIG is a major credit default swaps writer, bigger than Bear. If Bear could not be allowed to fail, AIG certainly can't go asunder. But how can the Fed extend a lifeline to a party it doesn't regulate, or even have as a counterparty? The Primary Dealer Credit Facility was a clever move, but was not in place soon enough to save Beasr. This is even more of a stretch, and on an even more pressured timetable.

AIG May Seek Help From Federal Reserve, WSJ Says
By Hugh Son

Sept. 14 (Bloomberg) -- American International Group Inc., the insurer seeking to stave off credit downgrades, may seek help from the Federal Reserve, the Wall Street Journal said.

The insurer has turned down a private-equity investment because it would have meant turning over control of the company, the Journal said on its Web site, citing unnamed people familiar with the situation.

Chief Executive Officer Robert Willumstad, 63, is under pressure to raise capital after three quarterly losses totaling $18.5 billion and a 79 percent stock slide this year. Investors are concerned the New York-based insurer can't raise enough cash to cushion against future writedowns from credit-default swaps, which are contracts AIG sold to protect fixed-income investors.

A ratings cut may have ``a material adverse effect on AIG's liquidity'' and trigger more than $13 billion in collateral calls from debt investors who bought the swaps, the insurer said in an Aug. 6 filing. AIG has already posted $16.5 billion in collateral through July 31. A downgrade could also set off early termination of swaps that may cause $4.6 billion in payments, AIG said.

AIG spokesman Nicholas Ashooh didn't immediately return a phone call seeking comment.

September 15, 2008
Rush Is On to Prevent A.I.G. From Failing
By GRETCHEN MORGENSON and MARY WILLIAMS WALSH
NY Times

The American International Group, the insurance company, is planning a major reorganization and a sale of its aircraft leasing business and other units to stabilize its finances, a person briefed on the company’s strategy said on Sunday.

A.I.G. became one of the focuses at an emergency gathering of Wall Street executives over the weekend, and was trying to arrange a capital infusion in the face of possible credit downgrades.

It was unclear whether A.I.G. would succeed in its capital search, but a person briefed on the discussions said it was seeking more than $40 billion even as it tried to sell assets to shore up its financial footing. Among the businesses likely to be sold is A.I.G.’s aircraft leasing business, the International Lease Finance Corporation. Founded in 1973, the business has nearly 1,000 planes in its fleet.

Investors, afraid that A.I.G. would have to absorb further write-downs in its already damaged mortgage securities and collateralized debt obligations, have driven down the company’s shares in recent days. The stock closed Friday at $12.14 a share, a decline of 46 percent for the week.

Several private equity firms were at A.I.G.’s headquarters in downtown Manhattan on Sunday, and may inject billions of dollars in capital into the firm, a person briefed on the matter said.

A.I.G.’s problems are not new. The company lost $13.2 billion in the first six months of 2008, largely owing to declining values in mortgage-related securities held in its investment portfolio and collateralized debt obligations it owns.

But the company’s outlook grew grimmer last week when Standard & Poor’s warned that it was considering downgrading the company’s debt as a result of further write-downs it might have to take....

Lehman to Declare Bankruptcy with Backstops Insuring "Orderly Liquidation"

Lehman to File for Bankruptcy Protection
September 14, 2008, 5:55 pm
Dealbook

Lehman Brothers will file for bankruptcy protection on Sunday night, according to people briefed on the matter, in the largest failure of an investment bank since the collapse of Drexel Burnham Lambert 18 years ago.

Lehman will seek to place its parent company, Lehman Brothers Holdings, into bankruptcy protection, while its subsidiaries will remain solvent while the firm liquidates its holdings, these people said. A consortium of banks will provide a financial backstop to help provide an orderly winding down of the 158-year-old investment bank. And the Federal Reserve has agreed to accept lower-quality assets in return for loans from the government.

But Lehman’s filing is unlikely to resemble those of other companies that seek bankruptcy protection. Because of the harsher treatment that federal bankruptcy law applies to financial-services firm, Lehman cannot hope to reorganize and survive as a going concern. It will instead liquidate its holdings.

It was not clear whether the government would appoint a trustee to supervise Lehman’s liquidation, or how big the financial backstop would be.

Lehman’s broker-deal subsidiaries would not be a part of the bankruptcy filing. Those entities must file under Chapter 7 rules, which are the procedures for liquidation, under the assumption that it is the best way to protect customers. The Securities Investor Protection Corporation would handle the liquidation of such brokerages, and bankruptcy lawyers say that customers are likely to receive their holdings back.

Moreover, changes to the bankruptcy code mean that counterparties to Lehman’s credit-default swaps can seize their collateral at any time, posing an enormous potential risk to the entire financial markets. Investment banks, hedge funds and other financial players labored throughout Sunday to offset their exposure to Lehman, moving their contracts to other firms.

Lehman has retained the law firm Weil, Gotshal & Manges to prepare its bankruptcy filing. The firm’s restructuring head, Harvey Miller, also worked on Drexel’s bankruptcy back in 1990.

Eric Dash, Ben White and Michael J. de la Merced

Circuit Breakers, Curbs, and Down Limits

Circuit Breakers and Other Market Volatility Procedures

The major stock and commodities exchanges have instituted procedures to limit mass or panic selling in times of serious market declines and volatility. These mechanisms are known as Circuit Breakers, the Collar Rule, and Price Limits. Circuit Breakers establish whether trading will be halted temporarily or stopped entirely. The Collar Rule and Price Limits affect the way trading in the securities and futures markets takes place.

Circuit Breakers

The securities and futures markets have circuit breakers that provide for brief, coordinated, cross-market trading halts during a severe market decline as measured by a single day decrease in the Dow Jones Industrial Average (DJIA).




Trading Collars

If the DJIA moves up or down two percent (2%) from the previous closing value, program trading orders to buy or sell the Standard & Poor’s 500 stocks as part of index arbitrage were restricted in response to the Crash of 1987.

On November 2, 2007, the NYSE scrapped this rule. The reason given for the rule's elimination was its ineffectiveness in curbing market volatility.


Price Limits

The futures exchanges set the price limits that aim to lessen sharp price swings in contracts, such as stock index futures. A price limit does not stop trading in the futures, but prohibits trading at prices below the pre-set limit during a price decline.

Intra-day price limits are removed at pre-set times during the trading session, such as ten minutes after the thresholds are reached or at 3:30 p.m. (all times are Eastern), whichever is earlier.

Daily price limits remain in effect for the entire trading session. Specific price limits are set by the exchanges for each stock index futures contract. There are no daily price limits for U.S. stock index options, equity options, or stocks.

Sources: Securities and Exchange Commission, Chicago Mercantile Exchange and NYSE/Euronext

BAC Dumps Lehman, Said to Be Courting Merrill

Are these guys meeting at the NY Fed or Plato's Retreat?

Odd man out can be the towel boy.

Bank of America Said to Walk Away From Lehman Talks
By Margaret Popper and Yalman Onaran

Sept. 14 (Bloomberg) -- Bank of America Corp. abandoned talks to buy Lehman Brothers Holdings Inc., according to a person with knowledge of the matter, less than three hours after Barclays Plc said it wouldn't buy the faltering investment bank.

Bank of America, Merrill Lynch In Merger Talks
By MATTHEW KARNITSCHNIG, SUSANNE CRAIG and DENNIS K. BERMAN
September 14, 2008 4:08 p.m.

Bank of America and Merrill Lynch & Co. Inc. are in merger discussions, according to people familiar with the matter.

The talks come amid a Wall Street scramble to sort out a potential liquidation of Lehman Brothers Holdings Inc.

Bank of America had considered buying Lehman, but when those talks failed to result in a deal, BofA turned its attention to Merrill, which is considered a better fit for the bank.

Much remains uncertain and conditions were fluid.

Wall Street Braces for Lehman Bankruptcy with Special Trading Session

Wall Street Prepares for Potential Lehman Bankruptcy
By Craig Torres
September 14, 2008 15:19 EDT

Sept. 14 (Bloomberg) -- Wall Street prepared for a potential Lehman Brothers Holdings Inc. bankruptcy after Barclays Plc said it pulled out of talks to buy the firm and the government indicated it wouldn't provide funds in a resolution.

Banks and brokers today held a session for netting derivatives transactions with Lehman, or canceling trades that offset each other, in case the New York-based firm files for bankruptcy before midnight New York time.

``The purpose of this session is to reduce risk associated with a potential Lehman Brothers Inc. bankruptcy filing,'' the International Swaps and Derivatives Association said in a statement today. The ISDA includes 218 banks, brokerages, insurance companies and other financial institutions from the U.S. and abroad.

The step indicates that Wall Street lacks confidence that three days of talks to find a buyer for Lehman, held at the Federal Reserve Bank of New York, will be successful. Treasury Secretary Henry Paulson, who has led the talks with New York Fed President Timothy Geithner, was adamant two days ago against using taxpayer funds in a resolution.

The fourth-largest securities firm until the past week, Lehman has thousands of such trades in credit, equity, commodity, interest rates and currency derivatives.

``ISDA confirms a netting trading session will take place between 2 p.m. and 4 p.m. New York time for over-the-counter derivatives,'' the ISDA said. ``Trades are contingent on a bankruptcy filing at or before 11:59 p.m. New York time, Sunday, Sept. 14, 2008. If there is no filing, the trades cease to exist.''

The announcement came after Barclays, the U.K.'s third- biggest bank, said it abandoned talks to buy Lehman, contending it couldn't obtain guarantees to protect against potential losses at the U.S. securities firm.

Barclays Pulls Out of the Lehman Talks

Barclays walks away from deal to rescue Lehman Brothers
By James Quinn in New York
6:28pm BST 14/09/2008
UK Telegraph

British bank Barclays has decided to walk away from talks to buy some or all of troubled US investment bank Lehman Brothers.

Barclays, whose negotiating team is led by Barclays Capital chief Bob Diamond, is in the process of informing Lehman and the Federal Reserve Bank of New York that it no longer wants to take part in the discussions because of the US government's unwillingness to guarantee Lehman's assets.

Although Barclays is understood to be happy that the New York Fed was leading discussions for Lehman's $41.8bn of troubled property assets to be ring-fenced, it is unhappy with the fact that its balance sheet would still be exposed to all the remaining counter-party and other risks within Lehman.

Under UK Listing Authority rules, the third-largest British bank would have to hold a full shareholder vote if it were to provide such a guarantee itself, something that is impossible to do given the race to secure a buyer as quickly as possible.

The decision by Mr Diamond, who has been looking for ways to catapult Barclays' into Wall Street's top tier, has been taken with the full knowledge of Barclays group chief executive John Varley and the rest of the board.

The surprise decision leaves a consortium led by Bank of America as the only potential buyer for Lehman, whose fate remains precarious. One sourrce suggested that the move could be merely a negotiating tactic by Barclays to force US Treasury Secretary Hank Paulson to offer a guarantee.

A team of senior Barclays executives, including Bob Diamond and Jerry del Missier, the chief executive and co-president of Barclays Capital respectively, have been locked in talks aimed at finding an appropriate structure for a takeover of Lehman.

Bob Diamond, is an American born in Massachusetts. He has been with Barclays since 1996, and caused a stir in 2006 by becoming the highest paid CEO among the FTSE 100, taking home an estimated £22,000,000, up slightly from the £21m he earned in 2005. He is an avid supporter of the Boston Red Sox.

Greenspan Says Its a "Once in a Century Crisis"

Perhaps its because we just had the worst federal reserve chief in a century leave office after a lengthy tenure.

Greenspan: Economy in 'once-in-a-century' crisis
September 14, 2008: 1:08 PM EDT

In an interview Sunday, the former Federal Reserve chairman said that more financial firms will fail and that housing won't stabilize until 2009.

WASHINGTON (CNN) -- The U.S. credit squeeze has brought on a "once-in-a-century" financial crisis that is likely to claim more big firms before it eases, former Federal Reserve chief Alan Greenspan said Sunday.

Greenspan told ABC's "This Week" that the situation "is in the process of outstripping anything I've seen, and it still is not resolved and it still has a way to go."

"Indeed, it will continue to be a corrosive force until the price of homes in the United States stabilizes," Greenspan said. He predicted that would not happen until early 2009, and said the odds of U.S. recession have gone up in recent months. (early 2009? In your dreams econo-weenie, not unless we have a market-clearing event and houses drop another 25%. Credit is tight and real wage growth is nil - Jesse)

"I can't believe we could have a once-in-a-century type of financial crisis without a significant impact on the real economy globally, and I think that indeed is what is in the process of occurring," he said.

While recent declines in the prices of oil and food may help avert a recession, he said, "I wouldn't put my money on it."

The financial crunch already has claimed investment bank Bear Stearns, spurred the federal seizure of mortgage giants Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500) and left century-old Wall Street institution Lehman Brothers (LEH, Fortune 500) clinging by its fingernails after suffering nearly $7 billion in real estate-related losses.

Federal regulators and Wall Street executives were holding weekend crisis talks aimed at resolving the Lehman situation without further shock to the financial sector.

Greenspan, who left office in 2006, said he expected more failures before the crisis eases. While regulators "shouldn't try to protect every single institution," he said, companies should be kept from failing "in a sharply disruptive manner" to prevent further shocks.

Greenspan's critics say he helped inflate the housing bubble by keeping target short-term rates too low for too long, leading to reckless lending and borrowing in the housing market. But Greenspan has said the problem lay not in the loans themselves, but in their repackaging as securities and sale to investors. (Greenie you lying old whoremaster - Jesse)

"Unless Something Is Settled It's Going to be a Bloodbath Monday"

The Persecution and Assassination of the Global Economy as Performed by the Inmates of the Island of Manhattan Under the Direction of the Federal Reserve Bank of NY.

Wall Street is playing hardball for a backstop.

Monday could be interesting.

WSJ
No Deal Reached Yet to Decide Lehman's Fate
By CARRICK MOLLENKAMP, DEBORAH SOLOMON,
AARON LUCCHETTI, SERENA NG and SUSANNE CRAIG
September 13, 2008 7:56 p.m.

The outlines of plans to determine the fate of Lehman Brothers Holdings Inc. emerged today even as it became increasingly clear that a clean sale of the entire firm to a big bank would be too difficult to execute.

A sense of optimism that a rescue could be arranged today dimmed as a growing sense of gloom descended on Wall Street. Executives from top banks in the U.S. and Europe huddled with federal regulators in an attempt to come up with plans to either buy pieces of Lehman or prepare for an orderly winding down of the firm in a manner that would minimize the collateral damage for the ailing global financial system.

After 6 p.m., the formal meeting ended for the day with no resolution, though some participants stayed behind to continue talking. "Senior representatives of major financial institutions reconvened on Saturday with U.S. officials at the New York Fed. Discussions are expected to continue tomorrow," said a spokeswoman for the Federal Reserve.

At about 8 p.m., New York Fed President Timothy Geithner was still at the bank's headquarters. Officials from the New York Fed and various banks were expected to continue working through the night.

Under one plan, either Barclays PLC or Bank of America Corp. would buy Lehman's "good assets", such as its equities business, people familiar with the matter say. Lehman's more toxic, real-estate assets would be ring-fenced into a "bad" bank that would contain about $85 billion in souring assets. Other Wall Street firms would try to inject some capital into the bad bank to keep it afloat for a period of time so that a flood of bad assets don't deluge the market, damaging the value of similar assets held by other banks and insurers. The banks are also looking for the government to somehow financially backstop the bad bank. (If the bad assets get ring-fenced, the government will support it, the only question is how. - Jesse)

The problem, though, is getting enough banks to back that plan. While teams of bankers are working through structures, it's clear that only a handful of banks are in a position to provide enough funding. Many banks are inclined to preserve capital ahead of third-quarter and year-end cash preservation moves. Also, banks aren't keen to see a big rival such as Barclays or Bank of America walk away with valuable assets by only paying a pittance.

As of Saturday afternoon, Barclays, the U.K.'s third-largest bank in terms of market value, appeared to have more interest in pulling off a deal for Lehman's good assets. At about 3 p.m. on Saturday, Barclays President Robert E. Diamond Jr. was seen entering the New York Fed's employee entrance on Maiden Lane, carrying a briefcase.

Bank of America, an obvious buyer, appeared to be cooling toward a deal, people familiar with the matter. Of course, some of this could be the posturing that happens in any auction. Neither Barclays nor Bank of America wants to buy all of Lehman without some government assistance, and so far the government has been reluctant to do so.

Both Bank of America and Barclays remain fixated on the disposal of the bad real estate assets, and are less focused on evaluating Lehman's investment bank, said one person involved in the due diligence process. Things were moving so quickly Saturday that there was little time to do extensive employee interviewing that typically happens in company auctions. "It's all triage," said this person.

The real fear in the discussions, this person added, was that the fire-sale prices, or "marks" of Lehman's real estate book could set off a cascade of problems for other Wall Street firms. If those marks were made against other banks' portfolios, it could eventually force those firms to raise more capital, too. For firms' considering funding the bad bank, the calculation has thus become the price of that contribution against the price of a widescale markdown.

There could be further effects to such an event, with the banks calling in loans from hedge funds and other clients, in turn setting off more forced selling that further depresses asset and securities prices.

"Unless something is settled, it's going to be a bloodbath Monday," said this person.

In a meeting at the Federal Reserve Bank of New York in lower Manhattan, some participants also were discussing insurer American International Group Inc. and thrift-holding company Washington Mutual Inc. While those two financial firms aren't the focus of the emergency meeting, participants also are weighing the potential implications of their problems.

One person leaving the building said at least 100 people were gathered inside trying to settle the fate of Lehman, which has been staggered by its exposure to soured real-estate-related assets. By 5:15 pm, some Wall Street executives started to leave the New York Fed one at a time, getting in their cars inside a garage so they can't have their photos snapped.

Outside the Fed's downtown headquarters, a fleet of black towncars waited for bankers who were inside. At one point, the towncars blocked the narrow streets around the building, causing a traffic jam that had to be broken up by the Fed's uniformed guards. Meanwhile, bankers and Fed staffers milled around outside, smoking cigarettes and talking on their cell phones about subjects like counterparty risk.

"Everybody is hoping there will be a Wall Street solution to deal with Lehman's toxic assets," said one senior executive at a major bank. "It is a cheaper alternative than having everything unravel."

With it unclear whether the gap between the federal government and potential buyers can be bridged, a second group at the New York Fed is focusing on the possibility that there might be no alternative to liquidating Lehman and winding down its operations in an orderly fashion.

On Saturday afternoon, the credit-trading heads of major investment banks gathered at the meeting to discuss how to deal with their exposures to Lehman in the intertwined credit-default-swap market. The lack of a central clearinghouse in this market means that dealers, hedge funds and others are directly facing each other in insurance-like contracts that are tied to trillions of dollars in debt instruments.

Credit derivative traders at some firms were asked to come to work over the weekend to help quantify their exposures to Lehman and compile lists of outstanding contracts they have with the investment bank.

One person familiar with the matter said large dealers are trying to decide if they should show each other all their credit default swap trades with Lehman. Disclosing their positions could enable dealers to offset their positions with each other wherever possible. For example, if one dealer has bought a swap from Lehman and Lehman sold a similar swap to another bank, the two banks could agree to face each other directly.

Such moves could also help prevent individual firms from scrambling to find new counterparties to re-hedge their positions with when the markets reopen on Monday, potentially unleashing turmoil in the credit markets. They could also help facilitate an orderly wind-down of Lehman's derivative positions, if that becomes necessary.

It is not known how much in CDS contracts Lehman has. In a survey last year by Fitch Ratings, Lehman was listed among the 10 largest CDS counterparties by number of trades and the amount of debt to which the contracts were tied.

Wall Street traders poured into their offices Saturday for emergency meetings to consider the actions they would take if Lehman is forced into liquidation. They broke into teams to evaluate their positions and exposure to Lehman in everything from energy trades to equity derivatives to credit,

One trader said conditions in the credit default swap market and the short-term repo markets are more stable today than they were in March, when Bear Stearns nearly collapsed, but still, "if they go into liquidation," it is going to be a bad situation on Monday.

A disorderly unwind of Lehman's derivatives trades is only one worry. Another worry is that if Lehman collapses, its distressed assets -- such as commercial real estate -- could suddenly hit Wall Street for sale, forcing prices even lower and potentially forcing other dealers to mark down once again the value of their own holdings.

Lehman has hired law firm Weil, Gotshal & Manges LLP to prepare a potential bankruptcy filing, according to a person familiar with the situation. The New York-based Weil has a leading bankruptcy practice and advised Drexel Burnham Lambert on its 1990 bankruptcy filing.

In a Lehman bankruptcy, the firm's brokerage units would have to enter a Chapter 7 liquidation, in which a court-appointed trustee would take over, liquidate the firm's assets and get Lehman customers back their money. In general, securities that a customer holds at a brokerage firm are legally the investor's property and aren't exposed to the claims of the firm's creditors.

In trying to hold firm to their no-bailout stance even while pressing for a deal, federal officials could try to pit Bank of America and Barclays against each other. But that leverage can work only if both banks stay in the discussions...

Lehman Emergency Meeting Resumes the Long Day's Journey into Night

AP
Emergency Meeting on Lehman Rescue Resumes
By JEANNINE AVERSA

WASHINGTON - With the global financial system holding its collective breath, the U.S. government scrambled Saturday to help devise a rescue for Lehman Brothers and restore confidence in Wall Street and the American financial structure.

An official from the Federal Reserve Bank of New York, who asked not to be named due to the sensitivity of the talks, said deliberations have resumed with leading Wall Street executives and top U.S. financial officials.

They include Treasury Secretary Henry Paulson, Timothy Geithner, president of the New York Fed, and Securities and Exchange Commission Chairman Christopher Cox. They were meeting on the heels of an emergency session convened Friday night by Geithner — the Fed's point person on financial crises.

Participants in Saturday's discussions also include executives from Goldman Sachs, JPMorgan Chase, Morgan Stanley, Citigroup and Merrill Lynch.

Federal Reserve Chairman Ben Bernanke is actively engaged in the deliberations but wasn't in attendance.

Fed and Treasury officials are aiming to engineer a private-sector rescue for the troubled firm that doesn't involve government money. Options include selling Lehman outright or breaking it up into pieces to be sold to private firms. (The most likely outcome is the latter unless Fuld and the shareholders oppose it. Then it will get interesting - Jesse)

Potential buyers could include Bank of America Corp., Britain's Barclay's Plc, Japan's Nomura Securities, France's BNP Paribas and Deutsche Bank AG. All have declined to comment.

Global fears intensified Saturday that the collapse of the country's fourth-largest investment bank would stagger markets and undercut confidence in the U.S. financial system.

U.S. regulators face growing pressure from abroad to find a way out ahead of Monday's reopening of Asian markets. Germany's Finance Minister Peer Steinbrueck urged that a resolution be found before then, warning ominously, "the news that is coming out of the U.S. is bad."

Lehman Brothers Holdings Inc. put itself on the block earlier this week. Bad bets on real-estate holdings — which have factored into bank failures and taken out other financial companies — have thrust the 158-year-old firm in peril. Its stock has been hammered and it has been dogged by growing doubts about whether other financial institutions would continue to do business with it.

Leviathan: Children of the Vortex

Turning and turning in the widening gyre
The falcon cannot hear the falconer;
Things fall apart; the centre cannot hold;
Mere anarchy is loosed upon the world,
The blood-dimmed tide is loosed, and everywhere
The ceremony of innocence is drowned;
The best lack all conviction, while the worst
Are full of passionate intensity.

The darkness drops again; but now I know
That twenty centuries of stony sleep
were vexed to nightmare by a rocking cradle,
And what rough beast, its hour come round at last,
Slouches towards Bethlehem to be born?

W. B. Yeats 1817

Westwärts
schweift der Blick:
ostwärts
streicht das Schiff.
Frisch weht der Wind
der Heimat zu:
mein irisch Kind,
wo weilest du?

Richard Wagner, Tristan und Isolde, Act III, Sc. 1

NY Fed Holds Emergency Meeting to Discuss the Fate of Lehman

Crunch time as the rumoured deals prove ephemeral, contingent on substantive support. Lehman staggers into the weekend.

If a deal is created, keep an eye out for subtle government support through a lower profile mechanism such as the special facilities or the FHLB.

Based on this attendance list, there is probably a significant discussion of counterparty risk, and possible impacts should Lehman be allowed to fail, including potential CDS impacts

If they were ever going to let a bank fail to achieve some credibility, Lehman would be the one.

The financial dons must have the chance to speak their minds, discuss the pros and cons of the alternatives, as the jackals and vultures circle to pick the carcass.

The Wall Street Journal
New York Fed Holds Emergency Meeting On Lehman's Future
By DAMIAN PALETTA and SUSANNE CRAIG
September 12, 2008 9:01 p.m.

The Federal Reserve Bank of New York held an emergency meeting Friday night with top Wall Street executives to discuss the future of venerable firm Lehman Brothers Holdings Inc. and the parlous state of U.S. financial markets.

In attendance were Treasury Secretary Henry Paulson, Securities and Exchange Commission Chairman Christopher Cox, Morgan Stanley Chief Executive John Mack and Merrill Lynch Chief Executive John Thain, among others.

Talks about a sale of Lehman or many of its parts are taking place in other forums and will likely continue through the weekend.

The meeting began at 6 p.m. but precise details about what was discussed could not be learned. The meeting appeared similar to one a decade ago when the New York Fed pulled together top Wall Street executives to prevent the collapse of hedge fund Long-Term Capital Management.

One big issue: Most of the firms at the meeting have themselves been hit with big losses and may not have the excess capital to step in...

As of late Friday, Bank of America Corp. was seen as the likeliest buyer, but Lehman and its investment bankers also were meeting with other potential bidders, including Barclays PLC and HSBC PLC, both of the U.K. Other parties were looking only at pieces of Lehman, with Goldman Sachs Group Inc. interested in some of the securities firm's huge real-estate portfolio.

But suitors like Bank of America, worried about the risk of buying an ailing financial institution like Lehman, want the government to step in with a package similar to what was offered to J.P. Morgan when it bought Bear. Then, the federal government agreed to absorb as much as $29 billion in losses. In seeking a Lehman deal, Bank of America Chairman and Chief Executive Kenneth D. Lewis is likely to face a tough sell to investors if he doesn't secure some federal government backing...

US Dollar Weekly Chart with Commitments of Traders

Charts in the Babson Style for Week Ending 12 September 2008

Dow Industrial Component AIG Getting a Share-Cut

Probably the most overlooked story of the day is the implosion of insurance giant AIG. The probable reason for this is their exposure to mortgage related insurance AND their CDS exposure to failures in the corporate bonds markets.

There are rumours swirling of some major failures that are imminent. And the Fed and Treasury cannot backstop them all.

Reuters
AIG shares fall almost 30 percent on mortgage worries
September 12, 1:33 pm ET

NEW YORK (Reuters) - Shares of American International Group Inc fell almost 30 percent on Friday as investors grew increasingly concerned that its large exposure to mortgages is backing it into a corner. (That's not a corner, that's the edge of a cliff - Jesse)

The large global insurer, a component of the 30-stock Dow Jones Industrial Average index saw its shares fall as low as $12.40 in trading on the New York Stock Exchange, 29 percent off the prior's day close, before easing back to $12.53.

The stock has fallen more than 70 percent since it earlier this year warned investors that it could be hit by large, unrealized losses on credit default swaps it wrote to guarantee securities linked to subprime mortgages.

Since, the insurer has taken write-downs on these investments totaling about $25 billion, leaving it in the red by a cumulative $18 billion over the past three quarters.

"We attribute this (the share fall) to concerns about AIG's ability to shed its troubled mortgage-related assets and we expect the shares to remain volatile as investors await news from the company," said Standard & Poor's analyst Catherine Seifert, in a research note on Friday.

Citigroup analyst Joshua Shanker, in a research note, said he was cutting his target price for the stock to $25.50 a share from $40, citing marketplace fears over the insurer's financial condition. (Is this the same Citigroup analyst that had buy ratings all the way down on Fannie? Speaking of ratings, did you know that not one analyst has had a sell on LEH, even now? - Jesse)

Will the Fed Cut Rates Next Week?

Our bias had been that the Fed will do nothing until next year, just holding rates steady and tossing the markets an occasional jawbone.

But there is a good case to be made for a 25 basis point rate cut when the Fed meets next week on Tuesday 16 September. We now make the odds 55-45 for a cut.

How come?

The Fed has been given a short term gift by the dollar rally and commodities smackdown. Whatever the actual inflation rate may be, and we think its much higher than the official statistics allow, the perception is that inflation is waning because of the price drops in materials, especially oil. So they have more latitude for a cut than they had say in early July when all this started. And the bonds have rallied comfortably. A much stronger dollar is going to start dampening exports, which is the only thing the real economy has going for it lately.

There is a strong case to be made that the economic outlook has worsened in the jobs reports and unemployment levels. The credit crisis is also becoming more of a problem for the non-marquee financial names. The Fed needs to steepen the rate curve and a lower short end would be a little extra vigorish for the boys.

Lastly, this is probably the last chance the Fed will have to cut this year with a comfortable margin ahead of the November elections. The October meeting is just about a week beforehand and the Fed will be sensitive to accusations of political favoritism, especially if the polls are close. The Fed is many things, and among them it is a self-perpetuating bureaucracy.

The Fed and Treasury have been heavily targeting their liquidity adds to financial institutions with insolvency problems because of illiquid debt. The problem is that the write offs are coming too slowly because of a preoccupation with bonuses and stock prices, so the 'trickle down' to the real economy is not happening and credit flows are seizing again. A rate cut will be viewed as relief for the whole economy and not just the elites of the Street.

The case against a rate cut is twofold. First, there could be some concern about scaring the markets. We think a 25 bp cut spun as a "one and done" for 2008 is no problem there.

The other negative is a little more pointed. A stronger dollar encourages inflows of financial investments, which could be a factor in the desire of Wall Street banks to recapitalize. The Fed would probably like to keep the dollar away from that breakdown level it was bouncing along earlier this year.

The question now is how resilient will the dollar be? Can it hold its rally? Can the Fed cut rates and maintain the illusion that the US will be coming out of its problems first among developed nations? The answer here is similar to the first difficulty. The spun "one and done" can work to dampen fears for the dollar as well as the equity markets.

So there it is. Let's see what happens with Lehman over the weekend and the FOMC decision on Tuesday.

China Seeks to Reduce Its Exposure to Dollar Assets

Japan and India are already on this trend.

Is this a little nag from China ahead of next week's FOMC meeting?

Don't they realize that the Bankers' motto is 'what does not kill them makes us stronger' to paraphrase Nietzsche?

China may cut its dollar holdings
China Daily
2008-09-12 07:32

China, which holds a fifth of its currency reserves in Fannie Mae and Freddie Mac debt, may cut the portion held in US dollars, according to China International Capital Corp (CICC), one of the nation's biggest investment banks.

The US government this week seized control of the two mortgage-finance companies, which account for almost half of the home-loan market in the world's biggest economy, to prevent defaults from crippling them. China holds up to $400 billion in the two firms' debt, CICC Chief Economist Ha Jiming said in a report Thursday.

"The crisis has made Chinese officials realize it's a bad idea to put all their eggs in one basket," wrote Hong Kong-based Ha. "This will likely lead to greater diversification of foreign exchange reserve investments."

China held $447.5 billion of US agency bonds as of June 2008, according to the CICC calculations using disclosures by the US Treasury. It is likely to reduce the portion of reserves in dollar assets from the current 60 percent by purchasing more non-dollar assets with new reserves, he said.

Countries in Asia have stockpiled foreign exchange reserves since the 1997-98 financial crisis to act as a cushion against a run on their exchange rates. That in turn has increased pressure on policymakers to ensure higher returns from more than $4 trillion in assets.

China will expand its investments in corporate bonds and equities, according to Ha. Treasury and agency bonds account for 50 percent and 40 percent of total dollar assets held by the central bank, he wrote.