Debt Rattle, March 10 2008

Ilargi: I think I need to do a little explaining with regards to the margin call situation mentioned in yesterday’s Debt Rattle. In particular, there are two points I want to address right now, with more to come later.

First, I never said banks will force people to cough up the entire amount of their mortgage; the word “margin” in margin call refers to the difference between the amount borrowed vs the value of the underlying collateral. In the case of a mortgage, that is typically the house. If it drops in value to a point where it’s worth less than the outstanding loan, the bank can demand that the borrower “fill the margin”, either with cash or with other assets. A dangerous point in the current and future situation, is that the lender's assessment of that value may be way below that of the "owner". The JPMorgan margin call report that started this discussion presumes a fall of 30% across the board.

Second, I did not say the 72-hour term that is typical for margin calls in the financial world will apply automatically to residential mortgages. Margin calls are everyday business for Wall Street and beyond; the entire $325 billion call stated in the JPMorgan Chase report will not all fall inside the next 72 hours either; it will consist of thousands of separate steps.

That said, as we look at today’s developments, I would certainly venture that the great unraveling is picking up speed, and that while it’s not yet time to jump out of the window, neither is it a good idea to sit back comfortably with your eyes closed.

---

Update 5.00 pm

Ilargi: Elliot Spitzer has figured prominently in finance news the past few weeks. New York State had taken it upon itself to investigate and (re-) regulate (amongst others) Wall Street bond insurers MBIA and Ambac. If these would be downgraded, as they should, banks stand to lose many billions of dollars, so much that their survival would be threatened. This newsflash is therefore a "tad strange". It's a bit like asking :"do you believe in chance"? Sure, Spitzer went after plain organized crime as well, and that's where the source may be. But there’s much less money involved there. Weird detail: he had the girl fly from NY to DC, while he MUST have known that could trigger an investigation. He could have boinked anyone within state limits. Crossing those did it.

Spitzer apologizes to public, family; future uncertain

New York Gov. Eliot Spitzer apologized to the public and his family Monday after a newspaper reported that he arranged to meet with a high-priced prostitute in a Washington, D.C. hotel, but the state's chief executive did not disclose whether he would stay in office. Spitzer appeared before the media and issued a brief statement after the New York Times said in its online edition Monday that Spitzer was identified as a client of a prostitution ring after allegedly being caught on a federal wiretap.

Known for trying to root out corruption as governor and previously as the state's attorney general, Spitzer took no questions from reporters following his statement and did not directly address the charges outlined in the Times article. He was accompanied at the podium by his wife, Silda Wall Spitzer. "I have acted in a way that violated the obligations to my family and that violates my -- or any -- sense of right and wrong. I apologize first, and most importantly to my family. I apologize to the public, to whom I promised better," Spitzer said.

The Times first reported on its Web site that Spitzer had informed his most senior staff that he had been involved in a prostitution ring. Later, the newspaper said Spitzer traveled to Washington to meet with the prostitute, who allegedly traveled from New York to meet with him. Federal officials rarely prosecute such cases, but the 1910 Mann Act makes it a crime to transport someone across state lines for prostitution, the Times reported.

Federal prosecutors filed charges last week and arrested four people in connection with an expensive prostitution ring, according to the Times. The news comes after the first-term Democrat had pledged to bring ethics reform to New York's capital of Albany. Spitzer has been New York's governor for little more than a year, assuming office after spending eight years as the state's attorney general. During his time as the state's top law-enforcement official, he fashioned a reputation for taking on corruption in all places, particularly in the nation's financial markets.

One of Spitzer's more notable cases was taking on New York Stock Exchange Chairman Richard Grasso, alleging that Grasso received excessive compensation as the chairman of a nonprofit organization. Grasso in turn charged Spitzer with attacking him solely to boost his image in the press in advance of his gubernatorial effort. Grasso already had resigned before the Spitzer prosecution. The case remains in the courts.

Spitzer also sued a slew of major Wall Street brokerages, alleging they inflated stock prices and used brokerages to give biased investment advice. News of Spitzer's apparent troubles did little to change an already down market on Wall Street.

"Everyone is watching television. If anything, it stopped the market from going down further," said Dave Rovelli, managing director of equity trading at Canaccord Adams. Dan Hogan, head of Nasdaq trading at Keybanc Capital, was asked whether the Spitzer story had an impact on trading. "I don't think so," he said. "It's more of a sideshow, helping traders to take their minds off of a difficult market." 

---

Ilargi: Uh-oh.......

Bank, Broker Bond Risk Soars on Concern That a Firm May Fail

The cost of protecting the bonds of banks and securities firms from default soared to a record on concern that they don't have enough capital to weather the credit market turmoil. Credit-default swaps protecting against a default by Bear Stearns Cos. for the next year soared to 1,050 basis points, according to Phoenix Partners Group in New York.

That's up from 546 basis points on March 7, CMA Datavision prices show. Contracts protecting from a default by Lehman Brothers Holdings Inc. for five years jumped 63 basis points to 398, Phoenix prices show. "If liquidity is the elixir of life for any Wall Street firm, the current market certainly has the potential to be lethal," Kenneth Hackel, managing director of fixed-income strategy at RBS Greenwich Capital Markets in Greenwich, Connecticut, said in a note to clients today.

Bear Stearns fell the most since the 1987 stock market crash in New York Stock Exchange trading on speculation it lacks sufficient access to capital, said Michael Mainwald, the head of equity trading at Lek Securities Corp. in New York. Speculation about Bear Stearns comes amid rising concern that banks and securities firms will report wider losses as the collapse of subprime mortgage securities spreads to other financial markets. Former Bear Stearns Chief Executive Officer and current board member Alan "Ace" Greenberg told CNBC the rumors are "totally ridiculous."

---

Bear Stearns Shares Fall on Liquidity Speculation

Bear Stearns Cos. fell 8.4 percent in New York trading, the most since 1999, on speculation the company lacks sufficient access to capital. Bear Stearns, the second-biggest underwriter of mortgage- backed bonds, declined $5.88 to $64.20 in composite trading on the New York Stock Exchange at 12:47 p.m., the lowest level since March 2003. Earlier today it traded at $60.26.

"There's an insolvency rumor and concerns on liquidity, that they just have no cash," said Michael Mainwald, head of equity trading at Lek Securities Corp. in New York. "There's been rumors of this for the past week or two."

Bear Stearns led Wall Street shares lower in the past six months as the world's largest banks and securities firms wrote down $188 billion of assets linked to the subprime mortgage market. The company's fourth-quarter loss of $854 million was its first, and analysts in the past month have lowered expectations for earnings in the first quarter. "There is no truth to the liquidity rumors," Russell Sherman, a spokesman for New York-based Bear Stearns, said in an interview. Alan "Ace" Greenberg, the former Bear Stearns chief executive officer and current board member, told CNBC that liquidity rumors are "totally ridiculous."

Sanford C. Bernstein & Co. today advised investors against buying Bear Stearns and three of its rivals until the credit market stabilizes. More writedowns are likely for these companies as "financial leveraging that had benefited the group" since 2004 "continues to unravel," Bernstein analysts including Brad Hintz wrote in a report.

Credit default swaps on Bear Stearns, used to protect corporate bonds from default, jumped 246 basis points to 792, according to prices for one-year contracts from CMA Datavision. Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company's ability to repay debt. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. A decline indicates improvement in the perception of credit quality; an increase, the opposite.

Options traders increased their bets that Bear Stearns shares will continue to fall. The price of today's most-active contracts, which give the right to sell the stock at $60 before this month's options expire at the end of next week, more than tripled to $3.90. April $55 puts, the fourth-most active, more than doubled to $4.60. For those wagers to pay off, the shares must drop 15 percent in the next six weeks. Implied volatility, the key factor in determining the value of option contracts, rose to 98.40 after earlier surging to a record 111.33. An increase indicates traders anticipate bigger stock-price swings.

---

Bear Stearns drops on liquidity concerns

Alan "Ace" Greenberg, chairman of the New York-based company's executive committee, denied any liquidity problems, according to CNBC. Meanwhile, Moody's Investors Service downgraded 163 bits of securities issued by Bear that are backed by so-called Alt-A mortgages. The cuts came as delinquencies and foreclosures climbed higher than expected, the ratings agency said. Shares of Bear Stearns dropped as much as 14% in setting a 52-week low at $60.26 earlier in the session. They stood at $64.39 during afternoon trading, down about 8%.


Liquidity is the ability to borrow new money or raise it some other way to meet upcoming obligations and spending requirements. It also refers to the ability of brokerage firms and other market players to quickly sell assets without those holdings losing value. The mortgage crisis has sparked a broader credit crunch in which hedge funds, brokerage firms and others are being forced to cut borrowing, also known as de-leveraging. That's triggering forced selling, which makes the situation even worse, limiting liquidity.

Investment banks like Bear Stearns are at the center of this phenomenon. "The company's shares are down again today, this time because of concerns about liquidity [banks are insisting on higher-margin levels]," said Egan-Jones Ratings. "A core issue is whether Bear Stearns will be able raise capital and deal with the increased funding costs," the ratings agency, paid by investors rather than issuers, wrote in a Monday note to clients.

---

Bear Stearns hits 5-year low; Moody's downgrade Alt-A deals

Shares of Bear Stearns tumbled to a 5-year low Monday, weighed by downgrades of Alt-A deals by Moody's Investors Service, as well as a negative comment on brokers in general from Bernstein Research. The stock was down 9.9% at $63.12, the lowest price seen since March 2003. The stock has now lost 30% since the end of January.

Earlier, Moody's downgraded the ratings of 163 tranches from 15 deals issued by Bear Stearns ALT-A Trust, with 78 downgraded tranches remaining on review for possible further downgrades.

Moody's said the downgrades are based on 'higher-than-anticipated rates of delinquency, foreclosure and [repossessed foreclosures] in the underlying collateral relative to credit enhancement levels.' Separately, Bernstein said it would not recommend buying broker stocks at this time as they are still susceptible to further book value reduction.

---

Ilargi: I think the ties that used to bind no longer do:

Fitch calls MBIA info destruction request 'disingenuous'

Stephen Joynt, the chief executive of Fitch Ratings, told MBIA Inc. on Monday it seemed "disingenuous at best" that the bond insurer asked the rating agency by email to destroy non-public information while telling the public it would work with Fitch to keep a AAA rating. On Friday, MBIA asked Fitch Ratings to withdraw insurer financial strength ratings while retaining outstanding debt obligation ratings.

Joynt also told MBIA it was "considering" MBIA's request to withdraw IFS ratings, and that it was willing to waive rating fees. However, Joynt asked MBIA if it was also seeking equal concessions from the other two debt rating agencies, Standard & Poor's and Moody's.

---

Hedge Funds Reel From Margin Calls Even on Treasuries

The hedge-fund industry is reeling from its worst crisis in a decade as banks are now demanding more money pledged to support outstanding loans even when the investment is backed by the full faith and credit of the United States. Since Feb. 15, at least six hedge funds, totaling more than $5.4 billion, have been forced to liquidate or sell holdings because their lenders -- staggered by almost $190 billion of asset writedowns and credit losses caused by the collapse of the subprime-mortgage market -- raised borrowing rates by as much as 10-fold with new claims for extra collateral.

While lenders are most unsettled by credit consisting of real estate and consumer debt, bankers are now attempting to raise the rates they charge on Treasuries, considered the world's safest securities, because of the price fluctuations in the bond market. "If you have leverage, you're stuffed," said Alex Allen, chief investment officer of London-based Eddington Capital Management Ltd., which has $195 million invested in hedge funds for clients. He likens the crisis to a bank panic turned upside down with bankers, not depositors, concerned they won't get their money back.

The lending crackdown is the worst to hit the $1.9 trillion hedge-fund industry since Russia's debt default in 1998 roiled global credit markets and required the U.S. Federal Reserve to pressure the securities industry to arrange a $3.6 billion bailout of Greenwich, Connecticut-based Long-Term Capital Management LP. Today, hedge funds are being forced to sell assets to meet banks' margin calls, resulting in the dissolution of the funds.

"There has to be more in the next weeks," Allen said. "There are people who have been hanging on by their fingernails who can't hold on much, much longer."

Ivan Ross, founder of Westport, Connecticut-based hedge fund Tequesta Capital Advisors, received a call from his bankers on Feb. 22 demanding he put up more money or risk losing his loans. Ross was unable to meet the margin call as the market for mortgage- backed debt seized up, preventing him from selling securities to raise the cash. Four days later, lenders liquidated his $150 million fund.

"Because it's impossible in this environment to move among dealers, you're at the mercy of counterparties," said the 45-year- old Ross, who has managed hedge funds for 13 years, including a stint handling mortgage-backed debt for billionaire George Soros. "To the extent they want to shut you down, they can." The demise of Tequesta revealed the deathtrap for hedge funds caught in the credit maelstrom of banks selling mortgage-backed bonds as fast as they can while demanding more collateral from clients who use the securities to back loans.

---

Money Markets May Force Bank of England to Revive Cash Auctions

The Bank of England may be forced to follow the Federal Reserve in stepping up efforts to ease strains in the money markets after the cost of borrowing pounds rose to a two-month high, according to Barclays Capital. "Confidence just isn't there, liquidity is tightening," said Paul Robinson, a currency strategist at Barclays in London and a former Bank of England economist. "There is a very good chance" the bank will have to restart the auctions "as things are getting worse rather than better," he said.

Bank of England Deputy Governor John Gieve said last month the central bank is considering cash injections as conditions remain "difficult." The Fed said March 7 it will boost the amount of loans it makes to banks this month to counter a credit crunch threatening to tip the U.S. economy into a recession. The London interbank offered rate that banks charge each other for three-month loans in pounds was at 5.78 percent today, the highest since Jan. 4, according to the British Bankers' Asociation. That's 53 basis points more than the central bank's key interest rate, compared with an average of 27 basis points this year.

The Bank of England is coming under pressure to resume emergency cash auctions as central bankers meet in Basel, Switzerland today to discuss renewed tension in money markets and the global economy. While coordinated central bank action in December temporarily revived lending in short-term credit markets, borrowing costs have started to rise again.

Bank of England Governor Mervyn King will join European Central Bank President Jean-Claude Trichet and Federal Reserve Vice Chairman Donald Kohn at the bimonthly meeting in Basel. With central banks at odds on how best to cushion the global economy from higher credit costs, the scope for a coordinated response beyond additional auctions may be limited, according to Christoph Rieger at Dresdner Kleinwort.

"It's going to be very hard for them to find strong common ground apart from the usual line about `corrections are needed but in an orderly fashion' and all that," said Rieger, a fixed- income strategist at Dresdner in Frankfurt. "The ECB and the Fed are at opposite ends in terms of rates and dealing with this crisis."

---

Credit crisis spreading to other areas: Merrill

The credit crisis in the US mortgage market is not yet over, according to US investment bank Merrill Lynch, and it is spreading to other areas. In an interview with France’s Le Figaro newspaper, Merrill Lynch chief executive John Thain said that the crisis had spread from mortgages to car loans, community credit and to the commercial credit market in general.

More and more loans were not being serviced in the US, he said, and the result was “a very pronounced slow-down in economic activity.” Thain said the cause of the credit crunch was a “liquidity bubble” caused by excessive credit awards during a long period of low interest rates. “Everyone bears some responsibility: the mortgage lenders, the institutions that sold this credit on to others, the valuation agencies that evaluated the loans and the investors who bought them,” the newspaper quoted Thain as saying.

Merrill Lynch has had to write off $11.5bn as a result of the subprime mortgage crisis and made a loss of $8.6bn last year. The bank raised $12.8bn from Singapore, Kuwait and South Korea, among others. The state investors did not have seats on the board of directors and held less than 10% of the company’s total shares, Thain reassured. There was no need to raise additional funds, Thain said

---

Carlyle Capital’s $400 million Margin Calls May Spur $16 billion Securities Sale

Carlyle Group's mortgage-bond fund said creditors may liquidate as much as $16 billion of securities unless the two sides reach agreement on debt repayments. The fund has asked lenders to refrain from further sales after they liquidated collateral securing $5 billion of debt, Carlyle Capital Corp. said in a statement today. It is meeting lenders to discuss more than $400 million of margin calls and is "evaluating all options,'' the Guernsey, U.K.-based fund said.

Carlyle Capital used loans to buy about $22 billion of AAA rated mortgage debt issued by Fannie Mae and Freddie Mac, which the firm says have an "implied guarantee'' from the U.S. government. Even those bonds have slumped following the collapse of the subprime-mortgage market, leading to the failure of hedge funds led by Peloton Partners LLP.

"This particular Carlyle entity wasn't prepared,'' said Philip Keevil, a senior partner in London at Compass Advisers LLP and former head of European mergers at Salomon Smith Barney Inc. "They hadn't started selling ahead of time and now they're having trouble liquidating their positions.''

Started by David Rubenstein 21 years ago, Carlyle expanded its mortgage investments last year, selling $300 million of shares in Carlyle Capital. "Due to recent turmoil in the market for mortgage-backed securities, the company's lenders have significantly reduced the amount they are willing to lend against the company's portfolio of U.S. government agency AAA-rated residential mortgage-backed securities,'' Carlyle Capital said today.

---

Carlyle Margin Calls Soar Past $400 Million; Asks Standstill Pact

Carlyle Capital said Monday that margin calls from its lenders soared past $400 million, leading it to request a standstill agreement to prevent any further forced sales of its investments. The highly leveraged mortgage-bond fund said certain lenders may have liquidated collateral securing $5 billion of debt and added it's still in negotiations with the remaining lenders, who hold around $16 billion in securities. If a deal can't be reached, some of these lenders may sell their securities as well, it warned.

Carlyle, a Channel Islands affiliate of the Washington private-equity firm Carlyle Group, said it is "evaluating all available options to maximize value for all interested parties" and is keeping regulators informed. "Due to recent turmoil in the market for mortgage-backed securities, the company's lenders have significantly reduced the amount they are willing to lend against the company's portfolio," Carlyle Capital said. "Furthermore, since Wednesday, the company's lenders have advised the company that they believe the company is in default under financing agreements," it added.

The fund had total equity of around $670 million at the end of December, which it leveraged using short-term loans, or repurchase agreements, to fund a $21.7 billion portfolio of residential-mortgage-backed securities issued by Fannie Mae and Freddie Mac. Since the end of February, lenders have been making margin calls -- demanding more cash to cover losses as the value of the securities has fallen. On Thursday the fund said it had failed to make payments to four lenders and had received a default notice from one of them. On Friday it warned it had received another wave of margin calls, raising fears that forced asset sales could virtually wipe out its capital.

Shares in the fund were suspended Friday at 5 euros, having fallen more than 75% since going public in July. The problems for Carlyle are part of a wider deleveraging trend as investment banks -- struggling with their own subprime-related losses -- are lending less and calling in loans to hedge funds and other borrowers. The trend started with investors directly exposed to subprime loans, but then spread to intermediate risk Alt-A mortgages and is now hitting some investors who hold safer securities from Fannie Mae and Freddie Mac.

---

Ilargi: Europe does not yet recognize the impact of the credit tightening on its markets; it will soon.

Markets rattled by signs of renewed credit crisis

Tight money markets, tumbling stocks and the dollar are expected to heighten worries for investors this week as pressure mounts on central banks facing what looks like the third wave of a global credit crisis. Last week, money markets tightened to levels not seen since December, when year-end funding problems pushed lending costs higher across the board.

In response, the U.S. Federal Reserve Board unveiled new measures to ease liquidity strains Friday, injecting $200 billion into the banking system, and said it was in close consultation with central bank counterparts. However, the Fed failed to lift the mood much.

The European Central Bank president, Jean-Claude Trichet, is expected to hold a news conference in Basel, Switzerland, on Monday after a meeting of the Group of 10 central bankers. "It's another round of the credit crisis," said Jesper Fischer-Nielsen, strategist at Danske Bank. "Some markets are getting worse than January this time. There is fear that something dramatic will happen and that fear is feeding itself. "Central banks have shown great resolve to try to solve the problems and I'm sure they will do again."

The vice chairman of the Swiss National Bank, Philipp Hildebrand, warned last week that the world might be in a new, more dangerous phase of the crisis. If that is the case, the latest wave is the third one. The first round began in August when interbank lending dried up as banks started to realize they were dangerously exposed to the meltdown in the U.S. subprime mortgage market. Then, late last year, pressure intensified again in the money markets after some of the world's biggest banks began writing off colossal sums of money, prompting top central banks to inject billions of dollars into the system.

Renewed problems in the credit market and concerns about slowing global economic growth led to a sell-off in stocks last week. World stocks, as measured by MSCI , fell more than 3 percent on the week. Also reflecting investor jitters, two-year U.S. Treasury yields hit a four-year low below 1.5 percent as investors flocked to government bonds.

The cost of corporate bond insurance hit record high levels Friday and parts of the debt market that had previously escaped the turmoil were also hit. Many intra-euro zone government bond spreads widened to levels not seen since the euro was introduced in 1999, with investors shunning bonds in Italy, Spain and Portugal and rushing into German government bonds.

"A funding freeze by lenders, that appears already in progress, could cause first-round casualties in Spain, Italy, Ireland, Portugal, Greece and Austria - countries collectively identified as the euro zone liability group," a UBS note said.

The G-10 policy makers, when they met in November in Cape Town, came up with a cash injection plan, with the top five central banks injecting liquidity. That provided life support to banks in desperate need of funds to bolster their balance sheets hit by losses on U.S. subprime mortgages. However, after weeks of calm, stress is building up again in money markets.

---

Uncle Sam – Master Mortgage Pusher

The financial system is coming apart at the seams. When historians set the starting date of the first depression of this century, it will be very close to now. Huge amounts of privately-issued debt securities have fallen seriously in price. More will be doing so. Stock markets are in bear markets, with financial stocks taking simply amazing nose-dives. Residential real estate tanked some months ago and is still falling in price. Commercial real estate prices fell in the last six months of 2007. The economy is in recession. The severity of the financial explosion suggests that the recession will be severe. A second Great Depression may occur, especially if our leaders make further policy mistakes.

Policy-makers and potential Presidents are behind the recognition curve. They are hardly even talking about the problems. They see some flames, but they don’t realize they are bonfires turning into rampaging wildfires. We hear the usual calming words that all is well and the economy is sound. We witness the usual actions, such as a tax cut and the Federal Reserve lowering its target interest rates. But these measures cannot and will not stop that which we are starting to experience: Deflation. The bubbles of 2000–2007 have burst. Asset prices are going lower. Debt defaults are coming out of the woodwork from every direction. In the words of Al Jolson, "You ain’t heard nothin’ yet."

The [political] leaders can see in part what’s going on. Who cannot? But they under-estimate its severity because they don’t know why it’s going on. Worse, they often have the wrong explanation for the deflation. And because they don’t know the reasons for the problems, they don’t know what to do or say about them. Speculators will sell assets even harder whenever they witness such high-level confusion. Band-aids and ritual motions won’t stop a severe hemorrhage.

The U.S. is experiencing a tidal wave of deflation, and it is hitting all sorts of credits. Every week a new category is swept along by the wave. Every week, we learn a new acronym for some financial instrument. Nothing can stop this wave, it appears. The market players are finally coming to terms with the risks they have for so long ignored. Risk premiums have risen very sharply and steeply.

The rating agencies can maintain the high bond ratings of the monoline insurers, but that will not fool the markets for long. It will merely give sellers and short-sellers a chance to liquidate more stocks. The banks can dream up plans of merging with their own providers of credit default swaps, but this will not fool anyone for long. If an insurance company that insured homes against fire was insolvent, would the homeowners be any better off by taking over the company? These proposals are acts of desperation. They only serve to underscore the severity of the problem as the bankers try to hide their insolvency.

The asset price deflation is evident, but the extraordinary commodity price rises (commonly called inflation) of the last six months or so confuse the recognition of the deflation. Like stocks and commercial real estate, commodities have been rising in price since 2004. That is simply part of the bubble economy, with the worldwide global monetary inflation contributing to this price rise. If the severe declines in asset prices we are seeing in bond and stock markets are any indication, commodities may simply be the last of the bubbles. Their prices will pursue a downward course at some point.

The Fed is powerless to stop the deflation. Bernanke is fighting the last war with the weapons of the last war if he thinks helicopters armed with greenbacks can curb the deflation. The existing bad debts are too large. They are held by too many large banks. It is not a case of one institution that is too large to fail. It is a case of too many institutions that are too large to save.

---

California, New York Dump Auction Debt; States Push on Ratings

California, New York City and the owner of the World Trade Center site will replace auction-rate debt this week, as lawmakers hold hearings on how turmoil in the credit market is raising costs for local governments. The House Financial Services Committee will hold hearings on March 12 into the municipal bond market after yields on tax- exempt debt rose to the highest ever relative to Treasuries last month, according to data compiled by Bloomberg and Municipal Market Advisors. The market was rattled by deteriorating finances at bond insurance companies and credit rating companies that use different standards for municipalities and companies.

States, cities and agencies are pulling out of the $330 billion auction-rate market, where costs almost doubled since January, according to the Securities Industry and Financial Markets Association. Municipal borrowers plan to sell about $22.5 billion of fixed-rate, tax-exempt bonds in the next 30 days, the most in five months, according to data compiled by Bloomberg. "We've never seen this type of dislocation,'' said Paul Brennan, who helps manage about $12 billion of bond funds at Nuveen Asset Management in Chicago. "We have a potential to see a tremendous amount of issuance,'' he said. "We're going to see a tidal wave.''

The flood of sales may jeopardize a rally sparked by the highest yields since 2004. Municipal bonds rose the most in six months last week. "We're seeing some buyers rushing in, but in reality, we're still working through this auction-rate debacle,'' said Scott Edmonds, who oversees about $3 billion of municipal bonds at Wilmington Trust in Delaware. California and New York City, the largest sellers of municipal bonds, are reducing their dependence on floating-rate debt. California's Department of Water Resources will sell $1.03 billion this week to replace auction and variable-rate bonds.

New York plans to sell $448 million to refinance debt, including auction-rate securities. The Port Authority of New York and New Jersey is refinancing $700 million of auction-rate debt after interest costs jumped as high as 20 percent. The California Statewide Communities Development Authority may offer as much as $10 billion of notes to help cities and non-profit organizations refinance their floating-rate debt as soon as this month. The state will consider hospitals' requests to refinance some $4.6 billion, according to California's treasurer.

---

As Good as Cash, Until It’s Not

Investors across the nation are finding themselves in Wall Street’s version of the Hotel California: they have checked into an investment they can never leave. The investments, which Wall Street peddled as a cash equivalent, are known as auction-rate notes. They’re debt instruments carrying rates that reset regularly, usually every week, after auctions overseen by the brokerage firms that originally sold them. They have long-term maturities or, in fact, no maturity dates at all.

But because the notes routinely traded hands at auctions, Wall Street convinced investors that they were just as good as cold, hard cash. Lo and behold, the $330 billion market for auction-rate notes ground to a halt in mid-February when bids for the securities disappeared. Investors who thought they could sell their holdings easily are now stuck with them. It turns out that the only thing that’s really just as good as cash is, well, cash.

While investors pray for a resurrection in the auction market, they are receiving a fixed interest rate outlined in offering documents. Historically, these securities have paid approximately one percentage point more than money market funds. Many purchasers of these notes are relatively small individual investors; several years ago, banks dropped the minimum investment in them to $25,000 from $250,000.

Municipalities and other tax-exempt institutions have issued most of the current crop of auction-rate notes. But closed-end mutual funds issued $65 billion worth. Such borrowings provide leverage to the funds, letting them generate slightly higher yields for their common stockholders. Closed-end funds that issue auction-rate notes typically sell them in amounts worth one-third the value of their underlying assets. For example, the John Hancock Tax-Advantaged Dividend Income fund, with $1.17 billion in assets, has issued $380 million in auction-rate notes.

Owners of notes issued by closed-end funds are faring far worse than investors stuck with municipal issues. That’s because the interest rates paid on municipal notes when auctions fail are capped at as much as 12 percent, much higher than the caps on closed-end fund notes, which are currently around 3.25 percent.
In other words, holders of closed-end fund notes receive little to no premium for being stranded.

---

Ilargi: Excellent article from Barron’s:

Is Fannie Mae the Next Government Bailout?

On the surface, Fannie's balance sheet looks fine. At year end, the company reported regulatory net worth of $45.4 billion, some $3.9 billion higher than the expanded minimum capital of $41.5 billion required by federal regulators. But with its extreme leverage -- assets stand at 20 times net worth -- Fannie has little room for error. And there appear to be significant problems with the way Fannie has valued both its assets and liabilities.

For example, some $13 billion of its $45.4 billion in net worth consists of deferred tax assets that have value only if Fannie can earn enough money in the near future (say $36 billion) to employ them. That hardly seems likely. During the housing boom of 2002 to 2006, this tax asset only climbed -- from zero to $8 billion as Fannie reported $23 billion in income from 2003 to 2006.

Last year's $2.6 billion loss compounds the problem, pushing the tax asset to $13 billion. At a minimum, accountants may require the company to sharply write down the value of this asset, thus slashing net worth. Bank regulators, for example, limit the amount of deferred tax assets for regulatory purposes to the lesser of the amount expected to be used within one year or 10% of regulatory capital. So if Fannie were a bank, this entire asset would be wiped out. Fannie maintains the value of the asset will be realized over time.

Another soft asset is Fannie's $8.1 billion of Lower Income Housing Tax Credit partnerships. The partnerships' only value, other than helping fulfill Fannie's housing affordability requirements, are the rich tax credits they generate from their intended operating losses. The problem is that Fannie hasn't made enough money to employ these tax credits. Thus the asset is apt to dwindle away to zero without providing Fannie any benefit. Fannie makes no predictions on the future values.

The story is much the same for the liability side of Fannie's balance sheet. There's an item called guaranty obligation, which represents the company's best estimate on what it will have to pay out to make good on any mortgage defaults in its $2.4 trillion guaranty book. On its regular balance sheet, Fannie carries the item at $15.4 billion, but on its "fair value" balance sheet, which attempts to mark every asset and liability to current market value, the guaranty obligations are pegged at $20.6 billion.

The problem was, as Morgan Stanley analyst Kenneth Posner discovered, Freddie went through the exact same drill with its guaranty obligations' fair value and chose to mark them much more aggressively. It valued them at 1.5% of its guaranteed book, double the 0.74% of total book that Fannie saw fit to use, even though Freddie's delinquency rate is lower than its rival's. Had Fannie taken a similar hit, its fair-value net worth would've shrunk by some $20 billion to a paltry $16 billion, compared with its juiced-up regulatory capital of $45.4 billion. Fannie stands by its estimate and says it doesn't know how Freddie arrived at its own.

---

Ilargi: The next person to use “next shoe to drop” in an article title will have to measure themselves against the reasonably formidable squeezing ability of my bare hands. Fleckenstein is the last to get away unchallenged.

Next shoe to drop: Prime mortgages

Several years ago, I sketched out a thesis called "The Next Time Down." Its onset took a bit longer than I had expected (like about three years) due to the lunacy in the credit markets. However, "the next time down" is essentially the situation in which we now find ourselves.

According to a friend I've dubbed the "Lord of the Dark Matter," credit is rapidly being withdrawn across a broad spectrum -- especially for the major brokers, giants like Goldman Sachs and Citigroup, which have served as enormous financial intermediaries. This is now raising the costs for nearly all credit-oriented hedge funds. And, my friend said, the pace of massive de-leveraging could accelerate further. That in all likelihood would feed on itself.

Lift a rock, find more schlock
I believe the next area of the credit sector to implode will likely be Alt-A -- loans granted to people who didn't want to document their income, also known as liar loans -- which will help illuminate the fact that our mortgage problems were never just subprime. Rather, they sprang from one big credit bubble, thanks to which mortgages were handed out to anyone who could fog a mirror. Most people took on more than they should have. In time, it will be clear that prime mortgages are also vulnerable.

"You can almost draw (the credit unwind) out in a diagram," said a managing director at the Economic Outlook Group in Princeton, N.J. "With home prices going down, consumers cut back on spending. If consumers cut back on spending, the economy weakens further. If the economy weakens further, fewer people are able to afford mortgages, so home foreclosures increase." Meanwhile, the problems in the municipal market have been well-chronicled in the media. And, since the plain-vanilla money funds have already flirted with trouble, I wouldn't be shocked to see liquidity or credit issues in that arena, also.

---

Credit Suisse sets up hedge fund clones

Credit Suisse will today unveil a plan to muscle in on the nascent, but potentially highly lucrative, hedge fund replication industry. The Swiss bank has teamed up with three of the leading academics in the field, Professors William Fung and Narayan Naik of the London Business School and David Hsieh of Duke University, to create a suite of products designed to replicate mechanically the returns of the major hedge fund strategies.

Investment banks have scrambled to launch hedge fund clones in the past 18 months, with Merrill Lynch, Goldman Sachs and Deutsche Bank among those seeking to provide cheap, generic hedge fund returns. Credit Suisse said its experience running the CS/Tremont family of hedge fund indices, allied to the link with messrs Fung, Naik and Hsieh, would give it an advantage over its rivals.

"They have been among the leading academics in the field going back to the 1990s. We felt it would be a strategic advantage to align ourselves with individuals of such knowledge and stature," said Oliver Schupp, head of beta strategies at Credit Suisse.
Replication, or cloning, is based on the view that the performance of hedge funds is largely driven by movements in underlying assets, such as the S&P 500 or the US dollar, rather than the intrinsic skill of managers.

If so, it should be possible to replicate hedge fund returns by mechanically recreating the industry's exposure to these underlying assets. This would yield many benefits; investing in real hedge funds is expensive with managers levying a 2 per cent annual charge and a 20 per cent performance fee, if not more. It is also opaque and illiquid, with lengthy lock-up periods the norm. The risk of an Amaranth-style blow-up is ever present while diversification via a fund of hedge funds adds a second layer of fee

---

Doubts over value of the hedge fund

Almost a third of listed companies believe hedge funds have a negative impact on market valuations, new research indicates. And companies broadly believe corporate governance regulations have questionable value in enhancing their transparency. More than 30pc of quoted businesses polled by company law firm DLA Piper said the influence of hedge funds on overall valuations in debt and equity markets was negative.

But the funds play a key financing role, with 55pc of companies saying they helped improve access to capital.
DLA Piper head of capital markets Alex Tamlyn said the findings underlined how capital markets were "increasingly being shaped by private equity strategies and hedge funds".

Almost 170 companies were polled. Asked about corporate governance regulations, just 18pc of companies rated them as highly valuable in enhancing transparency. DLA Piper's report says that, while most companies are satisfied with their primary listing, "the seeds are being sown for an increase in exchange shopping".

---

U.S. Mortgage Market Needs $1 Trillion, Analysts Say

The $11 trillion U.S. home-mortgage market needs about $1 trillion in new investment to halt a slide in prices that began last year, according to analysts at Friedman, Billings, Ramsey & Co. "There is an imbalance between housing debt and the capital base and the quick way to return to equilibrium is for asset prices to adjust downward,'' the Arlington, Virginia-based analysts led by Paul J. Miller Jr. wrote in a report today.

Mortgage-asset prices are tumbling partly because investors are borrowing less, as banks rein in both how much they lend and how much they borrow for their own investments, the analysts wrote. Carlyle Capital Corp., Carlyle Group's mortgage-bond fund, is among investors saying bond-secured lending is tightening.

As the amount of leverage, or borrowed money, used to boost investment returns decreases, the yields and extra yields over borrowing costs on mortgage assets need to increase to allow buyers to earn the 15 percent returns they typically target, the analysts wrote. Higher yields and spreads also reduce the amount of assets their investments must soak up to achieve the returns.

A big increase in capital isn't occurring and probably won't for months, the analysts wrote, which is why AAA rated "non- agency'' mortgage securities can't be sold for more than the "mid 70'' cents per dollar, while the extra yields demanded on "agency'' mortgage bonds backed by government-chartered Fannie Mae and Freddie Mac and federal agency Ginnie Mae have surged.

---

Institutional investors target Chinese real estate

A significant portion of institutional investors expect to increase their exposure to real estate in the next few years, with China among the most popular markets following a slowdown in other regions, according to the findings of a survey. Around 41% of the investors surveyed expect to increase their asset allocation to real estate, making it the alternative asset class in which investors are most likely to ramp up exposure, the survey by PricewaterhouseCoopers found.

John Forbes, U.K. real estate leader at the audit and advisory firm, said longer-term investors are looking to invest in emerging markets, and particularly China, where they believe changing demographics could drive up the market. The population isn't going to grow significantly in China, but as people get richer there will be an increasing demand for better housing and new retail and office space, he said.

"The rise of the middle class is going to be a phenomenon over the next 20 years," Forbes said. Other investors still see opportunities in the U.K. and other markets where valuations have dropped back sharply. U.K. commercial real estate values are down as much as 20% to 25% from their level in the summer, Forbes said. Investors that got out of the market two or three years ago because they thought valuations were too high are therefore starting to see opportunities to reinvest, he added.

There are also, however, a significant number of investors that have been discouraged by the recent real estate downturn, with 21% of the respondents saying they expect to reduce their allocations to the sector. Among other asset classes, 40% of institutional investors are likely to pump more money into private equity and 33% planning to increase their exposure to hedge funds, the survey found.

---

TIPS' Yields Show Fed Has Lost Control of Inflation

Bond investors have never been so sure that the Federal Reserve will lose control of inflation. They're so convinced that they're giving up yields just to buy debt securities that protect against rising consumer prices. The yield on the five-year Treasury Inflation-Protected Security due in 2012 has been negative since Feb. 29, ending last week at minus 0.16 percent. The notes, which were first sold in 1997, have never before traded below zero. Even so, firms from Deutsche Asset Management to Vanguard Group Inc., the second-biggest U.S. mutual fund company, say TIPS are a bargain.

For the first time in a generation, money managers must come to grips with a central bank that's more intent on spurring the economy than restraining price increases. With oil above $100 a barrel, gold approaching $1,000 an ounce and the dollar at a record low against the euro, TIPS show investors aren't convinced Fed Chairman Ben S. Bernanke will be able to tame inflation once policy makers stop cutting interest rates.

"The way TIPS are trading now, investors believe headline inflation will stay lofty and are willing to give up the real yield for that," said Brian Brennan, a money manager who helps oversee $11 billion in fixed-income assets at T. Rowe Price Group Inc. based in Baltimore. Prices for the securities indicate "a real concern of a recession and high headline inflation," he said. Because TIPS pay a principal amount that rises in tandem with the consumer price index, buyers accept lower yields in a bet the inflation adjustment will make up the difference.

Investors typically determine what they are willing to receive in interest by deducting the rate of inflation expected over the life of the securities from the rate on a comparable Treasury. Investors can still earn money from TIPS with sub-zero rates because the principal rises with the CPI. Five-year TIPS yielded 2.35 percentage points less than similar-maturity Treasuries as of 2:45 p.m. in Tokyo. The so- called breakeven rate has risen from a four-and-a-half-month low of 1.89 percent on Jan. 23, the day after policy makers cut their target lending rate by three-quarters of a point to 3.50 percent in an emergency move.

The last time investors were so worried about faster inflation amid slowing growth, Paul A. Volcker presided over a Fed that would raise rates as high as 20 percent to end the stagflation crisis of the 1970s, according to Seth Plunkett, a bond fund manager at American Century Investment Management in Mountain View, California.

---

Bank of America Plans to Proceed With Countrywide Bid

Bank of America Corp., the largest U.S. bank by market value, plans to press ahead with its $4 billion takeover of Countrywide Financial Corp., the mortgage lender under FBI investigation for possible securities fraud.

The Federal Bureau of Investigation, based in Washington, is scrutinizing whether Countrywide officials misrepresented the company's financial position and the quality of its mortgage loans in regulatory filings, said a person with knowledge of the probe on March 8. Bank of America spokesman Scott Silvestri said the acquisition of Calabasas, California-based Countrywide remains on track.

"Nothing I've seen suggests that Bank of America is backing off,'' says Tom Atteberry, a partner at Los Angeles- based First Pacific Advisors LLC, which oversees $2 billion. "It's in everyone's best interest that Countrywide avoid bankruptcy and it's hard to believe that there isn't some kind of agreement to help Bank of America avoid some of these legal problems.''

Countrywide has fallen 20 percent through last week in New York trading since Bank of America offered to buy the biggest U.S. mortgage lender on Jan. 11 in a stock swap. Investors have speculated the Charlotte, North Carolina-based bank may seek a lower price or walk away because the housing slump has deepened, with record foreclosures and falling home prices.

---

The Face-Slap Theory

One consequence of the crisis is that while the Fed has been cutting the interest rate it controls — the so-called Fed funds rate — the rates that matter most directly to the economy, including rates on mortgages and corporate bonds, have been rising. And that’s sure to worsen the economic downturn. What’s going on? Mr. Geithner described a vicious circle in which banks and other market players who took on too much risk are all trying to get out of unsafe investments at the same time, causing “significant collateral damage to market functioning.”

A report released last Friday by JPMorgan Chase was even blunter. It described what’s happening as a “systemic margin call,” in which the whole financial system is facing demands to come up with cash it doesn’t have. The Fed’s latest plan to break this vicious circle is to turn itself into Wall Street’s pawnbroker. Banks that might have raised cash by selling assets will be encouraged, instead, to borrow money from the Fed, using the assets as collateral. In a worst-case scenario, the Federal Reserve would find itself owning around $200 billion worth of mortgage-backed securities.

Some observers worry that the Fed is taking over the banks’ financial risk. But what worries me more is that the move seems trivial compared with the size of the problem: $200 billion may sound like a lot of money, but when you compare it with the size of the markets that are melting down — there are $11 trillion in U.S. mortgages outstanding — it’s a drop in the bucket.

The only way the Fed’s action could work is through the slap-in-the-face effect: by creating a pause in the selling frenzy, the Fed could give hysterical markets a chance to regain their sense of perspective. And to be fair, that has worked in the past. But slap-in-the-face only works if the market’s problems are mainly a matter of psychology. And given that the Fed has already slapped the market in the face twice, only to see the financial crisis come roaring back, that’s hard to believe.

---

Banks and their shareholders facing leaner times

The subprime meltdown marks the final chapter in the financial sector's golden age of the past 25 years, Bank Credit Analyst says. Banks are facing far leaner times ahead and so are their shareholders, the Montreal-based research firm says in a new report. "The blow-up in the markets for subprime paper and other structured products represents a watershed event in the financial markets," said Martin Barnes, managing editor of Bank Credit Analysis. "Financial shares will likely lead the next equity market upleg, but any outperformance will be fleeting.

The financial sector's share of corporate profits and market capitalization is set to shrink significantly in the coming years." Although Canadians may have been preoccupied by with their own equity bull market this decade, the financial markets' golden age was already drawing to a close south of the border, Mr. Barnes argues.

The 18 years from 1982 to 2000 witnessed the greatest combined bull market in stocks and bonds on record. A balanced portfolio of 60% stocks, 35% U.S. treasury bonds and 5% cash delivered average real returns of 14.3%, compared with an average of 3.4% during the previous 80 years. There was an enormous boom in the financial services industry.

But stock market gains came to a screeching halt with the bursting of the technology bubble in 2000. From 1998 to the end of 2007, compound real returns for the S&P 500 were only 0.8% a year, compared with 15% from mid-1982 to the end of 1998. The number of stocks, equity mutual funds and the volume of shares traded on the New York Stock Exchange all levelled off or declined from 2000.

The financial sector turned its attention to securitization and creating complex financial instruments instead. This allowed them to generate fees, shifted default risk off their balance sheet and freed up capital to originate more loans. The value of pooled securities -- mortgage-backed and other asset-backed securities -- overtook that of outstanding bank loans in 2001. The market value of derivative contracts surged to US$11-trillion by June 2007 from US$2.6-trillion in June 2000.

The financial sector's share of corporate profits rose to 40% from 10% in the early 1980s, while its share of market capitalization rose to 19% from 6%. The subprime securitization market has now also come to a screeching halt. While the securitization model itself is not dead, it will no longer be a source of easy fees, Mr. Barnes said.

---

Yen Bulls Test Bank of Japan's Indifference to Rally

For the first time in more than a decade, foreign exchange traders are confident that the Bank of Japan won't intervene in the currency market, paving the way for the yen to extend its biggest rally since 2000.

Japanese authorities sold the currency on all four occasions since 1995 when the yen approached the 100 mark in a bid to support exporters from Toyota Motor Corp. to Sony Corp. When the yen strengthened to a eight-year high of 101.43 last week, Finance Minister Fukushiro Nukaga stopped short of signaling that officials are concerned, only saying the government needs to watch currency moves "carefully.''

An attempt to influence exchange rates would bring Japan into conflict with the U.S., which relies on a weak dollar to underpin an economy on the verge of a recession. Citigroup Inc. and Royal Bank of Scotland Group Plc, the third- and fourth- biggest traders, say Nukaga will let the yen break 100 because it's 40 percent weaker than its peak in 1995 on a trade-weighted basis.

"When I intervened, the U.S. agreed to it,'' said Eisuke Sakakibara, dubbed "Mr. Yen'' for his ability to influence the foreign exchange market as Japan's top currency official from 1997 to 1999. "The U.S. now welcomes a gradual decline in the dollar and Treasury takes the position of Detroit. This is affecting how Japan is responding now.'' Japan increasingly relies on Asia for growth, making the country less sensitive to a U.S. slowdown. Shipments to the U.S. accounted for about 20 percent of exports last year, down from about 30 percent in 2000. Asia consumes half of Japan's exports.

---

Bear Stearns Announces the Launch of the First Actively Managed Exchange Traded Fund

Bear Stearns Asset Management today announced the launch of the Bear Stearns Current Yield Fund, the first actively managed exchange traded fund (ETF).

YYY, or Triple-Y, is composed of a variety of short-term fixed income instruments. The Fund aims to generate higher returns than an average money market fund by investing in diversified, high-quality securities, including governments, municipal securities, bank obligations, corporate and securitized debt. Triple-Y Shares can be purchased and sold intraday, with portfolio holdings fully disclosed each day via BSAM's website www.yyyfund.com. Triple-Y is the first product launched by the Bear Stearns Active ETF Trust.

"We are excited to be introducing the first actively managed ETF into the marketplace," said Jeff Lane, Chairman and CEO of Bear Stearns Asset Management. "The Bear Stearns Current Yield Fund is an innovative vehicle which allows investors to manage short-term fixed income. Through Triple-Y, investors have access to a talented management team, with a long and successful track record in this space. In addition, the Fund offers full transparency of holdings every day on the internet, liquidity via exchange trading and institutional class fees for all investors."

Triple-Y is managed by a team of fixed income professionals at BSAM, led by senior portfolio manager Scott Pavlak. Mr. Pavlak has more than 20 years of investment experience and has been managing portfolios similar to Triple-Y for over 15 years. "Utilizing a disciplined investment process, we seek to add value through sector allocation, security selection, yield curve positioning, and duration management," said Mr. Pavlak. "We use a conservative approach which aims to maximize income for our investors, while preserving capital."

---

Impact of Economic Stagflation with Asset Price Deflation

To date declared losses of $163 billions has devastated many of the major banks balance sheets with stock prices down well over 50% in most cases, Sovereign Wealth Funds have stepped in to take advantage of the distressed state of many major banks by injecting capital at usually punitive rates of return, as the SWF's attempt to pick up major stakes in large financial institutions that in other circumstances would have drawn a great deal of political protest.

The problem that we have today is that the credit crunch contagion is still spreading, rather than expectations that by now much of the bad news would be out, we are perhaps not even 1/5th the way there.

From sub prime mortgage borrowers defaulting on loans they should never have been given, to the collapse of Bear Stearn hedge funds, to mortgage banks going bust, to SIV rescue packages to monoline bond insurers requiring billions in capital injections to prevent Rating agency downgrades and next in the pipe line are the Variable Interest Entities. Despite deep cuts in US interest rates, with further cuts in the pipeline all the way to below 2%, coupled with central banks pumping in excess of a trillion dollars into the financial system by offering to lend money against bad debts as collateral.

The US tax payer is being asked to step forward and finance the $168 billion stimulus package to boost the US economy. This is perhaps the tip of the eventual bailout iceberg which a year or two down the road may total well over $1 trillion dollars in tax payer dollars, much of which will go to support Wall Street banks. A trillion dollar bailout ? Never ? Ask the UK government which was forced to nationalize Northern Rock Bank to the tune of over $100 billion, and may have to repeat the process at least once more as the UK housing market tracks the Market oracle 2 year forecast for at least a 15% decline as of August 07

---

UK: Energy bills rise 50% for low use

Energy companies have increased the bills of low power users, including second home owners and young professionals, by more than 50%, three times their headline increases. Npower has hiked gas bills for 30,000 customers by an average of 40%.

The worst hit customers are in the East Midlands, London and the northwest with increases of more than 50%.
British Gas raised its charges for people using low amounts of power by an average of 44% for gas and 46% for electricity. Its worst-hit customers in Kent and the Midlands have suffered an increase of 70% for electricity.

Eon raised its bills for 30,000 households using only a low amount of energy, which is charged at a higher rate, by 41%.
Allan Asher, chief executive of Energywatch, the consumer watchdog, said: “They are effectively penalising people for conserving energy.”

---

British firms join queue as Russia plans to spend £250bn on new roads

British companies are set to make hundreds of millions of pounds in revenue from the Kremlin's ambitious plans for a £250 billion roadbuilding programme. Russian roads are in a parlous state. The Soviet Union invested much more money into the nation's railways and the country still lacks motorways between big cities - between Moscow and St Petersburg, for example - or to nearby European capitals, such as Minsk. In rural areas, many villages have little more than dirt tracks.

The bad roads cost the economy an estimated 10 per cent of GDP, according to VTB Europe, the investment bank. It also costs lives: 34,000 people a year die on the roads in Russia, ten times more than in the UK. The Kremlin wants to start one of the most ambitious roadbuilding programmes ever, building 50,000km of roads in the next six years, at a cost of £2 million per kilometre. The plan includes tunnels, bridges and motorways between big cities and to borders with neighbouring countries.

The Kremlin has earmarked about £80 billion for the programme, but wants to attract at least that much in private financing, using the kind of public-private partnership (PPP) deals pioneered in Britain. British consultancy and law firms have won contracts advising the Government. For example, Ernst & Young have advised on the £5 billion Moscow ring road project, for which bids are in tender, while Freshfields helped St Petersburg to put together a PPP deal for the region.

British banks and consultancy firms are also in consortiums bidding for some of the biggest deals. HSBC is working with Gazprombank and Basic Element, the investment firm led by Oleg Deripaska, the billionaire, in bidding for a contract to build a £4 billion toll road around St Petersburg.

---

How's the economy in your hometown?

On the campaign trail and in homes across the USA, the debate is underway about whether the U.S. economy in 2008 will see its first downturn in seven years. Despite the recent onslaught of negative news, it remains unclear whether the current state of affairs meets the economists' definition of a recession: a widespread decline in economic activity lasting more than just a few months. As in politics, all economics is local.Mark Zandi, chief economist at Moody's Economy.com, for example, believes the U.S. economy is in recession.



But the contraction is far from uniform. Zandi's firm estimates that in January, 30 state economies were expanding while 15 were "at risk" of slipping into recession. Arizona, California, Florida, Michigan and Nevada were already in a recession at the start of the year. Those states account for one-quarter of the nation's total economic output. While business owners and workers in parts of the country for months have weathered recession-like conditions — job losses, home foreclosures and slumping consumer and business spending — others have been doing well. Some areas are likely to feel very little effect from the slowing economy.

That's mainly because a marked contraction in housing is leading the overall economy down this time. Housing had been instrumental in boosting many regions, particularly the Southwest, in recent years. During the housing expansion, job growth in related industries flourished, and consumers tapped their growing home equity to buy everything from cars to couches.

But in many parts of the country, housing never boomed, so now there's not likely to be a corresponding bust. And a number of other elements of the economy are still doing well, helping to keep some regional economies above water.

---