Debt Rattle, March 15 2008

Updated 4.00 pm

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Ilargi: It’s funny but true: for a company like Bear Stearns, leveraged to the tune of $hundreds of billions, the loss of a mere $1 billion is the final nail.

China's CITIC says may not invest in Bear Stearns

CITIC Securities said on Saturday it might not proceed with a deal to invest about $1 billion in Bear Stearns because of the U.S. investment bank's financial crisis. China's largest listed brokerage said it would "conduct an overall evaluation" of the deal after Bear, saying its liquidity position had worsened, obtained on Friday an emergency funding arrangement with the U.S. Federal Reserve and JPMorgan Chase.

Any cancellation of the CITIC deal would be another blow to Bear, the smallest of the major New York investment banks and the most reliant on slumping U.S. mortgage markets. It has been counting on the investment to boost its capital. "Our company has noticed the recent financing arrangement between Bear Stearns, JPMorgan Chase and other financial institutions, and we have also considered factors including the sharp fall in Bear Stearns' share price," CITIC Securities said.

"We cannot guarantee reaching a final agreement in the future," it said in a statement emailed to Reuters in response to media enquiries. Last October, Bear and CITIC Securities announced plans to invest about $1 billion in each other and form a joint banking venture in Asia. CITIC Securities was to obtain a stake of about 6 percent in Bear, with the U.S. bank getting about 2 percent of the Chinese firm.

But since then, Bear's share price has plunged 74 percent. CITIC Securities' shares have tumbled 45 percent as China's stock market has slumped, hurting the Chinese firm's earnings outlook. "We acknowledge that the subprime mortgage crisis in the U.S. capital markets is continuing, so we will closely monitor the impact of the crisis on the investment deal," CITIC Securities said. "At present, the two parties are still negotiating major terms of the deal and we have not completed due diligence on Bear Stearns. We haven't signed any formal agreement and we haven't paid any money."

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Ilargi: Could Washington Mutual be the next to go?

Moody's Cuts WaMu Rating: One Step Above Junk

Moody's Investor Service cut Washington Mutual Inc.'s debt rating to one step above junk status due to the "the rapid deterioration of the residential housing sector in the first quarter." Banks' credit ratings are very important because they affect how cheaply banks can access capital on the debt markets, which in turn affects margins on the interest they charge borrowers. WaMu's shares recently traded down $1.25 cents, or 10%, to $10.88.

The New York ratings agency said the rating could fall even further if housing losses eat up even more of Washington Mutual's capital and force even higher loan-loss provisions. WaMu in January reported a $1.87 billion net loss in the fourth quarter that was fueled by a sharp increase in the reserve for loan-related losses and a write-down on its home-loan business.

"Although in the fourth quarter the company raised a significant amount of hybrid capital and reduced its dividend, we believe WaMu's necessary provisioning could reduce capital to a point that would lead to further downgrades in 2008," said Moody's Vice-President Craig Emrick. Washington Mutual in December cut its dividend by 73%, announced plans to raise $3.7 billion by selling convertible preferred stock and cut more than 3,000 jobs to address "unprecedented challenges in the mortgage and credit markets."

"WaMu is a sound financial institution, but like other companies we are impacted by the lack of market liquidity," spokeswoman Olivia Riley said in an email Friday. Moody's believes that remaining lifetime losses on residential-mortgage loans will be higher than previously expected and that WaMu will need to set aside more than $12 billion for potential losses. It added the firm's 2008 net loss "could eliminate the company's approximately $6 billion capital cushion above regulatory well-capitalized minimums."

Emrick added that Moody's negative outlook reflects "uncertainty around the company's ability to replenish capital" going forward. Riley said the company has several funding sources in addition to the capital markets, including the Federal Home Loan Bank and deposits generated through its retail bank. She also said the company has "limited holding company debt maturities in 2008 and 2009." Moody's said a return to a stable outlook would require indications that asset quality deterioration will be within expectations and that appropriate capital ratios will be maintained.

Standard & Poor's cut its counterparty rating on WaMu last week and warned of more downgrades. Credit analyst Victoria Wagner said the reduction reflects S&P's "expectations for a more severe residential mortgage credit cycle than we had anticipated at the start of 2008," with weakening in some of WaMu's key markets -- like California and Florida -- "accelerating more quickly than previously anticipated." Coupled with increased recessionary pressures, she said WaMu's loan losses and delinquencies will be "much higher than we previously factored into" the company's credit ratings.

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Ilargi: Inevitably, today is filled with -at times lengthy, I know- contemplations of the Bear Stearns bail-out, as well as attempts to look forward and construct solutions to the upcoming failures that nobody doubts will occur. Bear will be sold within days, whole or in parts. But what's next?

The quintessential question is who will pay for it all. A good look at the, in my view, stunningly overriding consensus on the answer tells me I’m still on course with my predictions, steady as she goes.

Nationalization, or what I dubbed the Bulgaria model, in one covert or overt form or another, is right around the corner. Making it politically palatable is the sole remaining hurdle. I don't think Wall Street or the Fed feel they can afford to wait any longer; it's a matter of days now.

The beyond-bankrupt world of finance thinks it’s a good idea to save itself with public funds, and cares not for the fact that the public is already getting poorer every single day. The money mongers convinced themselves a long time ago that they are indispensable.

We’ll put it on the tab of our children, just like we’ve been doing for the past 25 years and more. Still, if we would take more than a fleeting glance at what's already on that tab, we'd realize there's no way our children can afford it. Ah, well, that's their problem, not ours.

Bear Stearns exposed as a bank saddled with toxic sub-prime debt

Big American finance houses have collapsed before. Continental Illinois required a $4.5bn (£2.25bn) bail-out in 1984 after coming to grief in Texas as the oil boom deflated. The giant hedge fund Long Term Capital Management was saved by a club of banks in 1998 under the guidance of the New York Federal Reserve. On both occasions the US economy was in rude good health. The damage was quickly contained. The implosion of Bear Stearns is more dangerous.

A host of other banks, broker dealers, and hedge funds have played the same game, deploying massive leverage at the top of the credit bubble to eke out extra yield. Dozens of them are saddled with the same toxic debt - sub-prime property, credit cards, auto loans, and mountains of unsold paper from the merger boom. This time the market for default insurance is flashing bright red warning signals across the entire spectrum of US finance.

The swap spreads on Lehman Brothers rocketed to 465 yesterday, mirroring the moves in Bear Stearns debt days before. Fannie Mae and Freddie Mac - the venerable agencies created by Roosevelt that underpin 60pc of the $11 trillion mortgage market - had a heart attack on Monday. Their bonds were in free-fall, threatening to set off another cascade of bank writedowns.

These are not sub-prime outfits. They sit at the apex of the US mortgage credit industry. Hence the dramatic move by the Fed this week to offer a $200bn lifeline, agreeing to accept Fannie Mae and Freddie Mac issues as collateral. Had the Fed delayed, many traders believe Wall Street would have plunged through resistance levels risking a full-fledged crash.

You have to go back to the banking crisis of the Great Depression to find a moment when the financial system as a whole seemed so close to the precipice. Although 4,000 US banks failed in the early 1930s (mostly small ones), it was a long-drawn out affair. The bank runs began in the Prairies as falling food prices caused farmers to default in 1930. It seemed to be a local problem.

The crisis reached New York in December 1930 when the Bank of the United States succumbed to panic withdrawals. Legend has it that the 'WASP' clearing banks refused to back a rescue because of the bank's Jewish links. In those days the contagion spread slowly to the rest of the world. It is much swifter now. The Swiss bank UBS has suffered US sub-prime losses on a scale to match Merrill Lynch and Citigroup, thanks to the curse of mortgage securities.

"We are now experiencing the first truly major crisis of financial globalisation," said the Swiss central bank governor Philipp Hildebrand this week. "Never before have banks seen such destruction of their balance sheets in such a short time. Moreover, there are signs that the problems are spreading. The risk premiums on commercial property, consumer credit and corporate loans have risen sharply," he said.

Debt levels have been much higher than in the Roaring Twenties; the new-fangled tools of structured credit are more opaque: the $415 trillion nexus of derivative contracts is untested. Nobody knows for sure if the counter-parties are able to deliver on vast IOUs, or whether the construct is built on sand. What keeps Federal Reserve officials turning at night is fear that the "financial accelerator" will now set off a vicious downward spiral. There is a risk of "very adverse economic outcomes," said Fed vice-chair Don Kohn.

Albert Edwards, global strategist at Societe Generale, said the toppling banks are merely a symptom of a deeper rot. "The banks are not the problem. Nor even the grotesquely leveraged funds. The problem is that an economic bubble financed by ridiculously loose monetary policy is unravelling," he said.

"US house prices have a lot further to fall, which will simply crush the global economy. The lesson from Japan in the early 1990s is that the death dance goes on and on and on," he said.

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Uncle Sam Nears a Massive Banking, Housing Bailout

Of course, the irony of today's Federal Reserve bailout of investment bank Bear Stearns is that the firm has a reputation as being among the most free-market loving on Wall Street—and that's saying something about a company located smack in the middle in America's financial capital. But just as there are no atheists in foxholes, there are no libertarians during financial crises, at least not if it's their dough at stake.

And while there are plenty of economists out there who are advocating a hands-off approach to the credit crisis and housing implosion—echoing Andrew Mellon's infamous advocacy of "liquidate...liquidate...liquidate"—they will be disappointed. Uncle Sam will probably continue to intervene during this financial turmoil. And not just the Fed. More and more, it looks as though Congress, followed by a reluctant White House, will move ever more boldly to stop the hemorrhaging in housing and unfreeze the credit markets.

Richard Bove, banking analyst at Punk Ziegel, says in a note this morning that it's "more certain than ever" that there will be a housing bailout to stop the increasing rate of foreclosures and the continuing drop in home prices. And political analyst Alec Phillips of Goldman Sachs says that he sees "a high likelihood that some type of housing measure is enacted this year." Most of the legislative energy seems to be swirling around a plan put forward by Democratic Rep. Barney Frank. The plan, as outlined by Bove:

• FHA provides up to $300 billion in new guarantees to help refinance at-risk borrowers into viable mortgages.
• The terms of the first mortgage are set at a level that the borrower can afford.
• A second mortgage is put in place, which pays off on sale of the house and allows the government to recover the losses absorbed by creating the first mortgage at below market rates.
• The existing lender agrees to accept a reduced payment, which could be substantial since the new loan is based on the house's current appraised value.
• Gets the existing lender free of all obligations and exposure to the borrower.
• Refinance between 1 and 2 million homes.
• Provide funds to refurbish empty homes and put them back on the market.

Phillips thinks that while President Bush might prefer a more free-market approach, the White House is "not likely to come out strongly against the proposal initially. Given our expectation for Democratic gains in the upcoming election, such proposals are likely to become law by mid-2009 in the event that they fail to gain support this year. For this reason, Republicans may seek a compromise in 2008."

Indeed, President Bush has almost gone out of his way not to rule out a bailout. Nor did he do so in a speech to the Economic Club of New York this morning. And in an interview on CNBC today with Lawrence Kudlow, the president basically said that in extraordinary situations, extraordinary action is required. Now, don't expect a financial miracle or a relaunch of the housing boom here. Instead, a bailout would give clarity to investors by shifting the price and foreclosure risk of the tumbling housing market to the government and taxpayers.

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Debt Reckoning: U.S. Receives a Margin Call

The U.S. is at the receiving end of a massive margin call: Across the economy, wary lenders are demanding that borrowers put up more collateral or sell assets to reduce debts. The unfolding financial crisis -- one that began with bad bets on securities backed by subprime mortgages, then sparked a tightening of credit between big banks -- appears to be broadening further. For years, the U.S. economy has been borrowing from cash-rich lenders from Asia to the Middle East. American firms and households have enjoyed readily available credit at easy terms, even for risky bets. No longer.


Recent days' cascade of bad news, culminating in yesterday's bailout of Bear Stearns Cos., is accelerating the erosion of trust in the longevity of some brand-name U.S. financial institutions. The growing crisis of confidence now extends to the credit-worthiness of borrowers across the spectrum -- touching American homeowners, who are seeing the value of their bedrock asset decline, and raising questions about the capacity of the Federal Reserve and U.S. government to rapidly repair the problems.

Global investors are pulling money from the U.S., steepening the decline of the U.S. dollar and sending it below 100 yen for the first time in a dozen years. Against a trade-weighted basket of major currencies, the dollar has fallen 14.3% over the past year, according to the Federal Reserve. Yesterday it hit another record low against the euro, falling 2.1% this week to close at 1.567 dollars per euro.

Lenders and investors are pushing up the interest rates they demand from financial institutions seen as solid just a few months ago, or demanding that they sell assets and come up with cash. Banks and Wall Street firms are so wary about each other that they're pulling back. Financial markets, anticipating that the Fed will cut rates sharply on Tuesday to try to limit the depth of a possible recession, are questioning the central bank's commitment or ability to keep inflation from accelerating.

There are other symptoms of declining confidence. Gold, the ultimate inflation hedge, is flirting with $1,000 an ounce. Standard & Poor's Ratings Services, a unit of McGraw-Hill Cos., predicted Thursday that large financial institutions still need to write down $135 billion in subprime-related securities, on top of $150 billion in previous write-downs. Ordinary Americans are worried: Only 20% think the country is generally headed in the right direction, nearly as low as at any time in the Bush presidency, according to the latest Wall Street Journal/NBC News poll.

"Clearly, the whole world is focused on the financial crisis and the U.S. is really the epicenter of the tension," says Carlos Asilis, chief investment officer at Glovista Investments, an advisory firm based in New Jersey. "As a result, we're seeing capital flow out of the U.S." That is a troubling prospect for a savings-short, debt-heavy economy that relies on $2 billion a day from abroad to finance investment. It is raising the specter of the long-feared crash in the dollar that could further rattle financial markets and boost U.S. interest rates.

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Financial system must tap the taxpayer

A “financial accelerator” is taking hold as banks react to losses and falls in the value of collateral backing loans by pulling back on their capital at risk, intensifying the credit crunch and aggravating the economic downturn. The pull-back in credit lines is transmitting distress from the banking sector to hedge funds – which are being forced to reduce leverage and sell assets into markets at firesale prices to meet margin calls in a classic case of financial contagion.

As hedge funds cut leverage they are amplifying the effect of the contraction in bank balance sheets on the economy. This “great unwinding” is putting enormous stress on the financial system, including the market for mortgages guaranteed by Fannie Mae and Freddie Mac. Mortgage rates are much higher now than they were when the Fed resorted to emergency interest rate cuts in January. The Fed cannot halt this negative spiral through monetary policy, even if it can mitigate its severity. Interest rate cuts have been largely offset by the rise in risk spreads. And there are limits to how much further rates can be cut amid concerns about inflation.

The good news is that as long as inflation pressures remain, the US cannot get stuck in an outright debt-deflation trap as Japan did in the 1990s. Indeed, the more inflation, the less nominal house prices will have to fall to deliver a required change in real house prices. But asset prices could still fall far enough to generate a vicious contraction in credit – at a time when wealth is declining and inflation is eating away at real income growth. That could be a recipe for a severe contraction in demand. Moreover, the US has structural vulnerabilities that Japan did not have: low household savings, untested derivative markets, and a large current account deficit.

What needs to be done? There is no silver bullet. Whatever happens, house prices will have to fall further to reach a fundamental equilibrium. But the key challenge now is to stop the financial accelerator in its tracks. That means one thing above all: additional capital for the financial system to stop the process of balance sheet contraction. That capital can come from one of two places – the private sector or the public sector.

Many financial sector executives apparently believe that likely losses are greatly exaggerated by mark-to-market accounting in dysfunctional markets. Meanwhile, their cost of capital is very expensive. It may be in their shareholders’ interest to hunker down, preserve capital and ride out the storm rather than raise expensive new capital to provide additional cover for losses that may never fully materialise.

If this is the case, the new capital will have to come from somewhere else: the public sector and ultimately the taxpayer, as the International Monetary Fund pointed out this week. The public sector could provide capital to the private financial system – for instance, by purchasing preference shares on terms more favourable than those available in the market. Or it could deploy its own balance sheet directly: intervening either in the mortgage securities market or the housing market itself.

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It Is Tough to Value Bear, But It Had Better Sell Fast

Bear Stearns Cos.' best asset may be the one where the firm resides: its 43-story Madison Avenue headquarters in New York City. On Friday, traders and bankers inside the securities firm were glumly assessing the firm's value, which had fallen by 47% to just $3.48 billion in overall market capitalization. It was a sign of the times that much of their attention fell on their seven-year-old home, a 1.2-million-square-foot hub steps away from Grand Central Terminal. These buildings have been selling for as much as $1,000 a square foot, putting its value at $1.2 billion or more.

The focus on 383 Madison reveals just how difficult it has become to value Bear Stearns amid market upheaval. Its best hope remains a sale to J.P. Morgan Chase & Co., which extended the original lifeline Friday. The Street was abuzz that other suitors, including hedge funds and private-equity firms, may jump in, but those options still appeared to be long shots. One participant invoked the bank run featured in the classic movie "It's a Wonderful Life." "Today is just that day at the Bailey Building & Loan. Looking at the clock, just trying to get to 4 p.m."

Both Bear and its advisers, Lazard Ltd., were moving as quickly as they could Friday, with hopes of finding a potential buyer within the next few days, according to people familiar with the matter. But to do so, they will have to untangle the question of whether to sell Bear in whole or in pieces. They will also have to assign a value for Bear all the while that its businesses are shrinking around it. Complicating matters: A credit environment that has left most other possible buyers -- from Citigroup Inc. to Lehman Brothers Holdings Inc. to Société Générale -- too worried about their own situation.

Investment banks are generally judged by their book value, which is a relatively simple accounting of assets minus liabilities. Bear's last public balance sheet was in November, and the markets don't have a good hold on where the bank stands. Bear's chief financial officer, Sam Molinaro, said on Friday's conference call that Bear's book value was worth a stock price somewhere in the $80-a-share range, a level stock investors don't agree with.

In the event of a split, Bear has four businesses that could interest buyers: the investment-banking business, which underwrites stocks, bonds and advises on mergers; the fixed-income and capital-markets businesses, which trade stocks, bonds and other securities; the clearing unit, which settles trades and also services and lends to hedge funds via a prime brokerage; and the high-net-worth group, which advises the rich on investments. The first two would have trouble attracting buyers, because of their exposure to volatile markets.

The clearing business, with the prime brokerage, would probably attract the most attention, and several bankers said it might be attractive to rivals including Morgan Stanley, Goldman Sachs Group Inc., UBS AG, J.P. Morgan Chase or Bank of New York Mellon Corp. However, the prime-brokerage business has its risks, and on a conference call today, Bear Stearns executives acknowledged that some of the business hits they have taken were because of prime brokerage.

If the firm were forced to split itself up, one banker believed it would have to be a liquidation. "They don't have enough time to do an orderly sale. That would take months. Telling people that they're selling the clearing business in a month wouldn't encourage anyone to be a counterparty now." That is why Bear Stearns's best bet is to be sold in its entirety, say a number of people working on the deal and who have advised Bear Stearns in the past.

People involved in the matter say J.P. Morgan remains the party most likely to complete a deal. The bank -- whose headquarters sits just around the corner from Bear's -- is keen to get a hold of Bear's prime-brokerage business. The clearing unit in which it resides is the only Bear business to turn a profit last year -- about $566 million on revenue of $1.2 billion. But J.P. Morgan isn't very interested in Bear's investment-banking force, say people close to the bank. In essence, if J.P. Morgan were to buy Bear, its hope would be to pay for prime brokerage, and get the rest of the company free.

Chicago hedge fund Citadel Investment Group presents an intriguing possibility, in large part because it has been trying to build out a broader infrastructure across the financial-services industry. Buying Bear Stearns would be a way for Citadel to acquire a public-stock listing, much as the New York Stock Exchange did when it bought Euronext NV. Another possibility is New York private-equity firm J.C. Flowers & Co., which has built its reputation investing in troubled financial firms. Last year, it balked at completing a $25 billion purchase of student lender Sallie Mae, formally known as SLM Corp. Such a suitor might not be as acceptable to federal regulators as a larger bank.

London-based HSBC Group is perennially described as a good fit because of the lack of overlap between the two businesses: HSBC's European strength would balance Bear's strength in the U.S., where it draws more than 70% of its revenues. In addition, HSBC doesn't have a large advisory business in the U.S. to compete with Bear Stearns, and it could use Bear Stearns's valuable "high net worth," or wealth-investor, business. HSBC declined to comment. Chapter 11 remains so unappetizing that "to threaten it is almost laughable; it would be like a person holding a gun to their own head and yelling, 'Stop or I will shoot,'" said one person involved in the matter.

Bear Stearns may have trouble if it wants to sell its headquarters building quickly. The sales market for all commercial property has seized up as a result of the credit crunch. There have been few deals since SL Green Realty Corp. closed on its $1.6 billion sale-leaseback acquisition of two downtown Manhattan buildings late last year from Citigroup.

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Wall Street Ponders Extent Of the Woes At Other Firms

Behind the swift decline of Bear Stearns Cos. is a deepening worry on Wall Street that some financial institutions might not be able to make good on their commitments. Such angst about the health of an institution holding somebody else's money is an age-old worry in finance. The federal government created the Federal Deposit Insurance Corp. in 1933 to give bank depositors confidence they would never again face such concerns.

Wall Street's modern version of what is known as "counterparty risk" has taken on a highly complex face. An explosion of derivatives instruments has potentially bound financial institutions with each other in ways and magnitudes they might not yet fully understand. And it has made confidence in the system -- now fraying -- especially important. Some hedge-fund clients had demanded that Bear come up with cash as collateral on trades they had done with the firm or had withdrawn funds from their accounts with the firm, further straining its finances. Taken together, it was like a modern version of a bank run.


One example was Renaissance Technologies Corp., the hedge fund run by James Simons. It shifted its assets away from Bear Stearns in the past week, according to people close to the matter. In the case of Renaissance, which oversees more than $30 billion, the hit on Bear was big because the transfer involved several billion dollars of assets into the hands of Wall Street rivals, the people said.

Debt investors said Bear's problems underscored the fragility of the financial markets and the vulnerability faced by broker-dealers to changes in market perceptions. While commercial banks can fall back on stable customer deposits for cash, investment banks rely on the faith of financial markets. "The nature of financial companies is that they are pretty much a black box," said Jeff Houston, a bond-fund manager at American Century Investments in San Francisco. "If people start to worry about what's in the box, there's not much the firms can do to demonstrate that they are not as weak as they appear to be."

In the past few months, the market's concerns about counterparty failures mainly centered on the solvency of bond insurers that sold credit protection on complex mortgage securities to banks and brokerages. Those concerns subsided a little when bond insurers MBIA Inc. and Ambac Financial Group Inc. raised capital to protect their top financial strength ratings. In recent weeks, the focus has shifted to hedge funds and brokerages that have engaged in billions of dollars of credit derivative and other long-term trades with funds and institutions all over the world.

Trading in credit-default swaps, in which financial institutions agree to make payments to a counterparty if different kinds of bonds default, has exploded in recent years. Among commercial banks alone, the notional value of such swaps outstanding hit $14.4 trillion in the fourth quarter, up 58% in the past year and more than triple the amount outstanding since mid-2005, according to data provided by Bianco Research.

If a major Wall Street firm goes out of business, investors and financial institutions who have long-term derivatives contracts with it could find themselves exposed to risks they thought they had offloaded. In some cases, they may find themselves exposed to counterparties they didn't even know. Analysts say Bear's troubles illustrate how speculation can lead to very real problems at a major financial institution, which can be exacerbated by market turmoil.

"We moved $25 billion of our clients' assets in the last three months to other prime brokers," said Robert Sloan, a managing partner of New York-based S3 Partners LLC, a financing specialist that advises hedge funds on prime-brokerage relationships. Overall the firm advises on about $100 billion in hedge-fund assets. Friday, some debt investors also became more cautious about Lehman Brothers Holdings Inc., another Wall Street firm that has substantial mortgage and fixed-income exposures.

If a major financial institution goes under, that could have "ripple effect among counterparties and a cascading effect on security prices for investors," said Carlos Mendez, senior managing director at Institutional Credit Partners, a boutique investment firm in New York. "There is a distinct possibility of more failures in the $45 trillion derivatives market and that's scary to think about."

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Bear Stearns seeks investors to keep it afloat

Bear Stearns seeks investors to keep it afloatBear Stearns is actively seeking long-term funding from a number of sovereign wealth funds in a bid to stay afloat. The Daily Telegraph understands that Gary Parr, deputy chairman of advisory bank Lazard, is working closely with Bear chief executive Alan Schwartz to pinpoint potential investors willing to fund the bank in spite of its current problems.

Mr Parr is seen by many as one of the few sovereign wealth experts on Wall Street, having been instrumental in advising China Investment Corp on its $5bn (£2.5bn) investment in Morgan Stanley, and working with the China Development Bank on its potential investment in Citigroup. Lazard confirmed that it is advising Bear, but declined to comment further. Mr Schwartz said only that he and the board are looking at a number of strategic options to ensure the business continues in the long-term, saying he preferred a strategy that protects customers and maximises shareholder value.

It is understood that Lazard is also involved in approaching rival banks with a view to selling all or part of Bear's business. Mr Schwartz confirmed yesterday that the bank's net asset per share value remains in the mid-$80's, even though the share price now languishes around the $33-mark. One senior banker with knowledge of the situation said that a full trade-sale of the business is unlikely, but there may be interest in certain parts, such as the derivatives book. JP Morgan Chase is one obvious contender, given its role to date, as is Barclays Capital, particularly as chief Bob Diamond is keen to expand its presence in the US.

If some form of alternative cannot be found within the 28-day time frame the Fed's funding facility provides, Bear may be simply wound up, and its name to be added to the list of credit crisis victims.

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Bear Essentials

The overriding public interest at the current moment is to maintain a functioning financial system, and regulators clearly felt this was at risk from a Bear failure. Just once we'd like to see what would happen if a big bank did fail, but the current general market panic arguably isn't the best time to have that experiment. Presumably Bear will now be shopped to private buyers.

On the other hand, the financial system also can't function properly if every institution believes it is "too big to fail." That's an invitation for everyone to behave the way Bear Stearns did in the mortgage securities market. This means that if taxpayer funds are going to be used to rescue Bear, then Bear's private actors need to accept their own form of discipline.

This includes Bear's equity owners, who deserve to endure major losses, if not lose their entire stake, in any sale. The discipline should also apply to Bear managers who got the bank into this mess. They should be fired, without bonuses and golden parachutes to the extent that is contractually possible. If bankers believe they can make bad investments and still emerge with enough cash to buy another beach house, the financial system will never have enough discipline.

Looking ahead, regulators need to anticipate these liquidity bank runs, not merely react to them. The larger danger is that even this temporary Bear rescue could set a precedent that the Fed will find hard to resist. Wall Street is already demanding that the Fed do more in this crisis than its traditional duty as a lender of last resort, and start buying up mortgage-backed securities and other troubled paper as a way to entice more buyers into frozen credit markets. This means the banks would be able to dump their worst paper on the Fed, which ultimately means the taxpayer.

We'll have more to say about that idea at a later date, but we trust the Fed understands the risks to its credibility that such a decision would pose. Does the Federal Reserve want to become a buyer of first resort?

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Bear Stearns gets transfusion

Venerable Bear Stearns Cos., thrust into a sudden, surprise, life-and-death struggle yesterday, fought to prevent collapse with a last-minute bailout from a rival bank and from the U.S. central bank. The Federal Reserve Board responded swiftly to pleas from Bear Stearns that its coffers had "significantly deteriorated" within a 24-hour period as rumours fuelled the Wall Street version of a run on the bank.

Central bankers tapped a rarely used Depression-era provision to provide loans and promised extra resources to combat an erosion of confidence in the country's biggest financial institutions. Nearly half the value of Bear Stearns, or about $5.7 billion (U.S.), was wiped out in a matter of minutes as investors showed they felt the bailout signalled that the credit crisis has reached a more serious stage, and now threatens to undermine the broader financial system – and the U.S. economy.

"My guess is, by next week, there will be rumours of other large, familiar institutions" that might be in financial trouble similar to Bear Stearns's, said Anil Kashyap, a professor at the Graduate School of Business at the University of Chicago. Bear Stearns, the fifth-largest investment bank in the United States, made a fortune dealing in opaque mortgage-backed securities, but the strategy backfired amid the worst housing slump in a quarter century. The bank has racked up $2.75 billion in writedowns since last year, and releases first-quarter results on Monday that could show more losses.

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Bear Stearns May Lose Independence After Fed-JPMorgan Bailout

Bear Stearns Cos.'s 85 years as an independent Wall Street firm may be coming to an end as JPMorgan Chase & Co. considers buying the crippled company. Teetering on the brink of collapse from a lack of cash, Bear Stearns got emergency funding yesterday from the Federal Reserve and JPMorgan in the largest government bailout of a U.S. securities firm.

The move failed to avert a crisis of confidence among Bear Stearns's customers and shareholders, who drove the stock down a record 47 percent. After denying earlier this week that access to capital was at risk, Bear Stearns Chief Executive Officer Alan Schwartz said yesterday that the company's cash position had "significantly deteriorated" in the past 24 hours. The Fed agreed to provide financing through JPMorgan for up to 28 days, the bank said in a statement yesterday.

Now JPMorgan, led by Chief Executive Officer Jamie Dimon, is considering buying Bear Stearns, according to three people briefed on the matter. No agreement has been reached and it's possible no deal will be completed, said the people, who declined be identified because the discussions are confidential. A person close to JPMorgan said the bank may also be interested in buying Bear Stearns's prime brokerage unit, which provides loans and processes trades for hedge funds.

Dimon, whose firm has suffered fewer losses than rivals during the credit-market contraction, has said he's open to making an acquisition. The bank has "plenty of capital," he told the audience at a dinner hosted by the Economic Club of Washington on March 12, the day before his 52nd birthday.

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Bernanke Discards Monetary History With Bear Stearns Bailout

Federal Reserve Chairman Ben S. Bernanke is being forced to throw out four decades of monetary history by a financial system choking on miscalculated risks and a deepening recession. Bernanke and the four Fed governors voted yesterday to become creditors to Bear Stearns Cos., a securities firm that isn't a bank, by invoking a law that hasn't been used since the 1960s. Three days earlier, the Fed said it would swap Treasury notes on its balance sheet for privately issued mortgage-backed securities held by Wall Street firms.

"It's a re-drawing of the relationship of the Federal Reserve with the rest of the financial system," said Vincent Reinhart, former director of the Division of Monetary Affairs at the Board. Risks of so-called moral hazard, where firms will now come to count on bailouts by a federal agency, "are considerable," he said. The cost of doing nothing may have been even greater, say other former Fed officials.

Bernanke is attempting to keep the nation's financial machinery working as record home foreclosures make investors reluctant to hold even bonds backed by Fannie Mae and Freddie Mac, government-chartered firms. The 54-year-old Fed chairman is also trying to contend with a worsening economic slump: Reports this week showed that retail sales unexpectedly fell and consumer confidence slid to a 16-year low.

"As a governor, you never want to be placed in this position," said former Fed governor Laurence Meyer, who served during the central bank's coordination of the rescue of hedge fund Long-Term Capital Management LLC in 1998. "Everybody has to be uncomfortable with this. But it is always, compared to what? Just imagine what would have happened today if this action hadn't been taken."

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The Fed is butchering its currency

The year-old financial crisis is acting like a monster from a bad horror movie, briefly reeling from whatever blows are thrown at it and then coming back scarier and angrier to claim more victims. The latest victim seems to be the hedge fund Carlyle Capital, which is seeing its assets seized just two days after the boldest move yet by the Federal Reserve Bank to stem the financial panic. Global equity markets plunged at the open, whittling away much of their gains from Tuesday's effort to halt what analysts at JPMorgan dubbed a "systemic margin call".

With futures markets now pricing in a 94 per cent probability that overnight rates will drop to 2.25 per cent in five days' time, down three full percentage points since September, the Fed is like the terrified character in the movie who first tried a two-by four, then an axe, a gun and finally a bazooka, all in vain. It seems the only hope is to stun the creature long enough to regain our nerve, since fear is a big part of the problem. "The market was beginning to believe that the Fed was impotent even before this," said Peter Boockvar, equity market strategist at Miller Tabak. "It doesn't matter where interest rates go if people won't lend money."

Not everyone in the market has thrown in the towel. Seeing the glass half full, some view the Fed's willingness to take such bold action as a positive sign for equities, though perhaps not for the greenback. "My perception is that a lot of this is because the Fed has been behind the curve, is willing to get in front of it and is willing to do what it will take to calm markets and improve liquidity," said Robert Stimpson, an equity portfolio manager at Oak Associates. "While the rally was short-term, it's more about the willingness of the Fed, and that's a good sign."

But the financial markets encompass much more than equities and fixed income. The very hope that the Fed's aggressive move gave to equity investors like Stimpson is striking fear into the holders of dollars around the world, pushing the Japanese yen below 100 to the dollar for the first time in almost 13 years, and sending gold futures above $1,000 an ounce for the first time ever. The notion that the Fed is keeping all options open has sapped confidence in the integrity of the world's major reserve currency as visions of the turbulent 1970s or, even worse, the 1930s, come to mind.

"The dollar index is just in freefall, down 13 out of 16 days," said Boockvar "The Fed's just printing money – they're like a butcher slicing the Fed funds rate."

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Depression-Era Loan For Bear Stearns

Four Federal Reserve governors voted unanimously to approve a 28-day secured Fed loan facility to Bear Stearns Friday using a rarely used Depression-era provision of the Federal Reserve Act that normally requires five governors’ approval, Fed officials said.The Fed normally has seven governors but two seats are currently vacant and one governor was traveling and unavailable to vote.

Officials said while the loan is being made via J.P. Morgan Chase, the risk is being borne by the Fed. That means if Bear Stearns fails and the collateral is insufficient to repay the loan, the Fed would incur a loss. In that respect, the credit risk is similar to what the Fed assumes during its daily money-market lending operations with its 20 primary dealers, which include Bear. However, the exposure to Bear could be larger than what the Fed would normally have with any single firm during regular money market operations.

Bear may also be at the moment a higher-risk counterparty than the banks to which it normally lends through its discount window, which must have regulators’ highest ranking for safety and soundness. (Less safe banks pay a higher penalty rate.) The maximum size of the loan isn’t predetermined but is limited by how much collateral Bear can provide to satisfy the Fed’s requirements, officials said.

The Fed can normally only lend through its discount window to banks. Under Section 13-3 of the Federal Reserve Act, added in 1932, it can lend to “individuals, partnerships, or corporations” with the approval of not less than five governors, provided “such individual, partnership, or corporation is unable to secure adequate credit accommodations from other banking institutions.”

However, under Section 11(r)(3)(ii)(I), approval can be granted with fewer than five governors in office if the “available members unanimously determine that … unusual and exigent circumstances exist and the borrower is unable to secure adequate credit accommodations from other sources” and “despite the use of all means available (including all available telephonic, telegraphic, and other electronic means), the other members of the Board have not been able to be contacted on the matter.”

Officials said the Fed used its authority to lend to nonbanks several times during the Depression. It was invoked at times during the 1960s but it wasn’t clear if money was ultimately lent in those latter instances.

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After Bear bailout, who's next?

The U.S. Federal Reserve's unprecedented intervention on behalf of Bear Stearns Cos. Inc. was intended to ease fallout from the credit crunch, but experts fear it augurs more U.S. government bailouts as the crisis worsens. The move also reignited debate yesterday about how big a role the central bank should play.

Several banking experts were dubious about the Fed's plan to save Bear Stearns, saying it sets a bad precedent at a time when other investment banks could wind up in similar trouble because of bad mortgage-linked investments.
“There's a limit to how many of these entities they can bail out,” said Franklin Allen, a finance professor at the University of Pennsylvania's Wharton School.

“It is the first bailout of an investment bank by the Fed,” said Charles Geisst, a Wall Street historian and finance professor at Manhattan College. By contrast, investment bank Drexel Burnham Lambert Inc. was allowed to fall into bankruptcy in 1990. If the Fed bailout fails, taxpayers would wind up being on the hook, said Lawrence White, an economics professor at New York University's Stern School of Business.

“I know things are a little dicey out there, but we can't have the Fed going around protecting everybody in sight,” Mr. White said. “You take risks and you lose, you're supposed to be shown the door, and these guys are not being shown the door.” Federal Reserve officials likely were worried about a domino effect if Bear Stearns were to fall into bankruptcy, leaving other companies who have lent money to the investment bank in the lurch. That could cause a chain reaction, potentially threatening the financial system.

Indeed, fears have grown that other financial firms could be at risk. “It's the cockroach theory: There's never [just] one,” said Joan McCullough, an analyst with East Shore Partners Inc. in New York. Christopher Whalen, managing director of consulting firm Institutional Risk Analytics and a former Bear Stearns banker, said his former employer was exposed to two lines of business – mortgage-linked investments and hedge funds – that have been socked since last summer. Compared with other investment banks, he said, “they're small and they don't have very great diversity in terms of their business.”

Joseph Mason, a finance professor at Drexel University, had little sympathy for Bear Stearns' problems. “Once an institution is insolvent, the only responsible thing to do is to unwind it in an orderly fashion,” Mr. Mason said. “It's not a business enterprise worth saving.”

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Hedge funds fleeing Bear's prime broker business

Even the backing of the New York Federal Reserve and JPMorgan Chase can't keep hedge funds from fleeing Bear Stearns' once-vaunted brokerage division. Some hedge funds that have regularly traded with Bear over the years say they are shifting to other prime brokers, fearing they won't be able to get their cash and securities out of the bank if it were to be forced to file for bankruptcy.

"To the extent that we had balances at Bear, we moved them away in the last 10 days," said a senior executive at a $1 billion New York-based hedge fund, who like others asked to remain anonymous. "If they fail, we will have trouble getting out our cash and securities, and we are not alone in doing that."

Hedge funds use prime brokerage divisions to execute trades, borrow money and other services with larger funds using multiple brokers. Bear has long been among the top prime brokers, along with Goldman Sachs and Morgan Stanley. Lately, UBS, Citigroup, Deutsche Bank and others have been making big inroads into the lucrative market for serving growing legions of hedge funds.

But since rumors of liquidity problems at Bear Stearns, began circulating in recent weeks, large hedge funds say they have been moving their business elsewhere. Several cited the example of Refco, the futures broker that abruptly went bankrupt in 2005, leaving thousands of clients scrambling for cash and securities held in margin accounts.

"There is no one in their right mind who is primed with Bear would keep their money there," said a portfolio manager at a $6 billion New York hedge fund. "The risk (of a Bear failure) is pretty low, but if something goes wrong all of a sudden you can't get your money out."

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Bear Stearns' No. 1 foe: Fear itself

With no counterparties willing to lend Bear short-term credit - the lifeblood of a securities firm - the firm's ability to function independently appears to be over. The firm hinted at the need to find a more lasting solution on the call when Schwartz said he viewed the JPMorgan financing as "a bridge to permanent strategic alternatives." Rumors have Bear Stearns talking with firms, including JPMorgan and China's Citic, which bought a big stake in the firm last year. But the stock market action Friday suggests few investors believe a deal is near.

In short, the Fed is allowing J.P. Morgan - a commercial bank - to act as a conduit for pumping cash into Bear Stearns. The bank is being permitted to give Bear Stearns collateral at the Fed's emergency-lending discount window to secure 28-day financing, which in turn is lent back to Bear Stearns in order to finance its business. The Fed's role in the deal suggests federal officials fear a systemic collapse of the U.S. financial system were Bear Stearns to fail. The fear stems from Bear central role in a multitrillion-dollar web of interconnecting derivative contracts.

Rumors that Bear Stearns was on the verge of collapse started buzzing around Wall Street trading desks on Monday. Schwartz - who took over as CEO in early January from longtime chief Jimmy Cayne - appeared on CNBC Wednesday afternoon to reassure the markets that the firm was stable. Schwartz was right in one respect: The firm had about $17 billion in short-term capital available as of Nov. 30 and had a net cash position of $8.2 billion - more than it had previously.

Schwartz's problem was that none of Bear Stearns' counterparties cared about its ability to pay off debts in the long term. With the value of debt securities in a nosedive, lenders care only about recovering on the loans they have out now. And starting late last week, they began to call in those loans. This played directly upon Bear's biggest weakness relative to many of its competitors: It is the smallest of the investment banks and doesn't have a consumer banking or retail investor business to draw upon. Almost daily, Bear Stearns has to renew a large percentage of its $102 billion worth of open repurchase agreements - or short term loans from Wall Street dealers - or make up the difference out of its cash position.

It's unclear what exactly started Bear Stearns' nightmare this week. Veteran repurchase agreement traders told Fortune.com that a major European bank last week refused to accept Bear Stearns as a counterparty to a large swap trade. By late Monday and early Tuesday, traders at hedge funds told Fortune that they were being charged a premium by the swaps desks at Deutsche Bank, UBS and Citigroup to execute trades with Bear Stearns as the counterparty or which involved its credit. The bottom fell out on Thursday, Bear Stearns CFO Molinaro told investors. The demands for cash came from counterparties as well as hedge fund clients who wanted to close out their prime brokerage accounts. The market voted with its feet and wallets.

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UBS says U.S. brokerage unit is "not for sale"

Swiss banking giant UBS AG, struggling with heavy mortgage losses, on Friday denied market speculation that it was seeking a buyer for its U.S. wealth management unit. Analysts and investors have called on UBS, whose shares have struggled amid a series of trading and investment missteps, to shed volatile capital markets businesses and focus on its most profitable assets: private banking and asset management.

One unit that has been the subject of recurring speculation about the U.S. brokerage, a division built around its purchase of New York's PaineWebber Group in 2000. "This business is not for sale. Wealth Management U.S. continues to be part of our leading global wealth management franchise," said Rohini Pragasam, a spokeswoman for the bank.

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UBS bows to pressure over disclosure of losses

UBS suffered a potentially embarrassing blow Friday after bowing to pressure from an activist investor and agreeing to publish details of an inquiry into how it became Europe's biggest casual?ty of the US subprime mortgage crisis. UBS said Friday it had reached agreement with Ethos, an activist investor representing Swiss pension funds, to publish a summary of the investigation by the Swiss Federal Banking Commission (EBK) into how the bank suffered large subprime losses, which are by far the biggest disclosed by any European bank.

The EBK is investigating the circumstances in which UBS made writedowns of $18.4bn last year on its massive portfolio of securities related to US residential mortgages. Many analysts believe Switzerland's biggest bank will be forced to take further significant writedowns this year, with some estimating UBS could disclose a further $15bn in losses. The EBK inquiry will also look into the circumstances regarding the opening, then closure of Dillon Read Capital Management, the ill-fated in-house hedge fund that was among the contributors to UBS's difficulties.

The inquiry will also examine potential weaknesses in the bank's risk assessment and management procedures. The results of such an investigation would normally be kept secret. However, Ethos said Friday the bank had agreed to publish the material to head off a separate threat of an independent inquiry. At UBS's emergency shareholders' meeting last month, which was called to approve a massive SFr21bn ($21bn) recapitalisation, Ethos demanded such an independent inquiry and had warned it would use provisions in Swiss company law to force the bank to comply, even if its motion was overturned.

In the event, the bank was able to fend off the demand, but Ethos claimed moral victory in securing support from 45 per cent of the votes for its motion, and threatened to turn to the courts. The two sides have now reached a settlement, with UBS confirming in writing that it would engage in more transparent communication on the inquiries concerning the impact of US subprime crisis.

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Election drapes ‘bail-out’ in a politically incorrect shade

When is a bail-out not quite a bail-out? When it occurs in a US election year, it might seem. Or that, at least, is the cynical thinking floating around some well-informed market minds. For as the credit crunch grinds on, pressures in the financial system are rising by the day. Never mind the fact that hedge funds are now imploding; in a sense that is only to be expected (and arguably overdue).

Instead, what is really worrying investors, ahead of the release of broker results next week, is the risk that serious capital pressures will emerge at some banks if they are forced to mark their books to (ever falling) market prices. There is also growing concern about the capital position of housing behemoths, such as Fannie Mae and Freddie Mac, as mortgage defaults rise. Thus the trillion-dollar question haunting the markets is where on earth will the capital to plug these potential gaps come from? Will private sector investors (such as sovereign wealth funds) step to the plate again? Or will the next chapter in this saga entail the US taxpayers footing the bill, through covert or overt means?

Unsurprisingly, this latter scenario is not something that anybody in Washington is keen to debate in public right now. And the Federal Reserve, for its part, is working overtime to avoid this worst-case scenario by devising ever-more creative measures to tackle pockets of market illiquidity. But while this week’s $200bn Fed package should earn points for lateral thinking, the Fed now seems to be running to keep still: as soon as it announces one set of confidence-boosting measures, a fresh set of market brushfires break out.

Even if the Fed’s measures ease liquidity pressures, they cannot by themselves solve the most fundamental source of capital pressures on banks. After all, the banks’ woes do not entirely stem from mark-to-market accounting practices; behind the drama of tumbling securities prices there are tangible credit losses. And whether you think these credit losses will eventually total $300bn or four times that level (which is roughly the range of current forecasts), what is clear is that losses will exceed the $60bn to $100bn of capital injections so far garnered from sovereign wealth funds.

It is also clear that these funds have growing qualms about writing new blank cheques. Hence the rising question about how to plug the capital gap. So will the US government step in instead? Not in a classic sense anytime soon, I suspect. After all, no politician in his (or her) right mind wants to be seen rescuing greedy Wall Street bankers right now – or not unless it is presented as a collective action plan in which plenty of bankers go to jail.

But producing a coordinated deal between multiple stake holders looks hard right now, particularly given the US election. Thus the US faces the reverse of Japan’s problem a decade ago: where Japan was hobbled by an excess of collectivism, the US is now hobbled by extreme individualism. Forging proactive plans requiring shared pain and sacrifice is not something that comes easily in America now.

Of course, this situation might change if a full-blown financial fiasco erupts. Further ahead, the next administration may find it easier to take radical steps by blaming the problems on the past. But in the meantime, I expect to see the intensified use of more subtle forms of public support, via ill-understood institutions such as the Federal Home Loan banking system or Fannie Mae and Freddie Mac.

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Fed Interventions Spur Worries Of Sowing Seeds For Next Crisis

In deploying its most powerful weapon on Friday, the Federal Reserve made clear that some banks are simply too big to fail. While Bear Stearns' near-death experience is sending shudders through the financial world, it also provided a reminder that banking giants have the ultimate insurance policy -- a government rescue. Previous bailouts, notably the 1998 effort to smoothly wind down hedge fund Long-Term Capital Management, have generated cries that the government, by creating moral hazard, is sowing the seeds of the next financial collapse.

Such criticism may be more muted now because market turmoil has already exacted a high toll -- with hedge funds collapsing and all of Wall Street recoiling. Last August, when the Fed came to the rescue by lowering the discount rate after the failure of two Bear Stearns hedge funds, former Labor Secretary Robert Reich bemoaned the moral hazard in the Wall Street safety net. The Fed's promise to "promote the orderly financing of markets," Reich wrote, "means that lenders, credit-rating agencies, financial intermediaries and hedge funds will be bailed out."

But after the Fed's rescue of Bear Stearns Friday, Reich compared it with "someone with an helium tank blowing more air into a leaky balloon." "It only postpones the inevitable, which is that the balloon will lose its air and float back to Earth," Reich wrote. In other words, he's not too concerned about financiers getting carried away with risk.

"This whole situation has been rife with moral hazard, but that doesn't mean people haven't learned lessons," said Don Luskin, chief investment officer at Trend Macrolytics. Luskin, though, doesn't see a moral hazard in the New York Fed's move to provide emergency financing to Bear Stearns. The Fed was created precisely for that purpose -- "to step in and prevent a run on a bank." Rather, the moral hazard came from the Fed lowering its key borrowing rate to 1% in 2003 and keeping it there for too long. By making money available at a negative real interest rate, it encouraged mortgage providers to "lend money to people who don't have jobs," Luskin said.

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Fed Efforts Foiled By Banks as Residential Mortgage Rates Rise

Ben S. Bernanke can't revive the housing market and the banks are no help. The U.S. Federal Reserve cut interest rates five times, pumped $200 billion into the financial system, and yesterday its New York branch provided funds to help rescue Bear Stearns Cos.

None of that has brought down mortgage rates for residential borrowers, whose success in refinancing or buying would help bolster the U.S. economy. The interest rate on a 30- year fixed-rate mortgage has climbed to 6.37 percent from 5.5 percent since Jan. 24, according to the Mortgage Bankers Association, as financial institutions try to cover $195 billion in mortgage-related losses and save capital for future losses.

"The mortgage rate isn't down as much as it should be because the banks are in desperate straits and they need to maintain a larger spread than they normally would," said Alan Nevin, chief economist with the California Building Industry Association in Sacramento. "The banks need to generate income and the easiest way to do that is to broaden the spread. If they pay 3.5 percent and charge 6 percent, that's a lot of money."

Over the past 10 years, the average spread between 10-year U.S. Treasuries and 30-year fixed-rate mortgages has been 1.75 percent. Last week, the spread was 2.83 percent. That means a homeowner's mortgage costs are more expensive now than they have been.

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American inflation dwindles to zero

Consumer inflation in the United States reversed course in February to post the mildest reading in six months as energy and food costs moderated. The relief was expected to be short-lived, however.The U.S. labour department reported yesterday that consumer prices were unchanged last month, although a 0.3 per cent gain had been expected.

Core inflation, which excludes energy and food, was also unchanged on the heels of a worrisome 0.3 per cent jump in January. The February inflation reading, however, is likely be reversed before long, considering the big surge in energy prices in recent weeks. Light, sweet crude for April delivery touched as much as $111 (U.S.) a barrel during trading Thursday, although the contract slipped 12 cents on the day yesterday to settle at $110.21. In February, however, energy prices declined 0.5 per cent.

Food costs, which have been surging of late, also moderated a bit in February, rising by 0.4 per cent after a huge 0.7 per cent jump in January. The flat reading for core inflation in February left underlying inflation rising 2.3 per cent over the 12 months, above the Federal Reserve's comfort range of 1 to 2 per cent. The unchanged reading for overall prices followed sizable gains of 0.4 per cent in January and December.

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Sagging Spain holds lessons for Britain

Between 1995 and 2007 Spanish house prices doubled in real terms, but there is now a glut of unsold homes. The economic impact of a property downturn will hit Spain hard because construction investment constitutes a “staggering” 18% of Spanish GDP (in France and Germany the proportion is about 10%).

If the construction sector’s share of GDP were to shrink to 10% over four years, growth would fall by around 2% a year. Add in the consumption effect (people being unable to extract further equity from their homes to spend) and you “easily get a half-decade of zero growth – perhaps longer, perhaps worse or both”.

Fortunately, the Spanish economy has some “notable strengths”. Spain has been running budget surpluses and has a manageable debt-to-GDP ratio that makes it better equipped to deal with a short cyclical shock than countries such as the UK. It also has a “robust” banking sector that has “avoided some of the pitfalls of modern credit markets”. Finance minister Pedro Solbes told the FT that he would step up public works to absorb construction workers who are being laid off (unemployment has risen rapidly, to more than 8.6% of the workforce). He has also pledged to maintain a fiscal surplus, currently 2% of GDP, throughout the economic downturn.

In spite of this, investors aren’t confident. The spreads on Spanish bonds have “ballooned” to reflect an “abrupt change in perceptions”. It’s not just Spain. The yields on bonds issued by different governments in the eurozone are diverging more widely than at any time since the creation of the euro in 1999, as the global credit crisis gathers intensity and investors become more selective.

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Canada ABCP committee to file for bankruptcy Monday

The players negotiating the restructuring of the non-bank asset-backed commercial paper market said they expect to file what would amount to the biggest insolvency filing in Canadian history on Monday. The Pan-Canadian Investors Committee to restructure the non-bank asset-back commercial paper (ABCP) market said it expects to file and application under the Companies' Creditors Arrangement Act (CCAA) that would call a meeting of noteholders of the $32-billion dollar market to vote on the restructuring.

"Doing so will also continue the protections to date kept in place under consensual standstill arrangements and provide noteholders an opportunity to consider fully the Committee's proposal in an informed way," said Committee Chairman Purdy Crawford in a press release. The move would essentially use Canada's bankruptcy laws to restructure the 20 trusts and then force a vote on the plan. The committee had planned to make the court filing by Friday afternoon to facilitate the implementation of the framework it announced last December.

However, a source close the to talks said "there's a whole bunch of parties" who have to be comfortable with the language. As such, lawyers were still negotiating the wording of the thousands of pages of documents that have been drafted. The parties agreed to effectively put it into "escrow" so they could continue their work through the weekend. "The banks putting up the liquidity have to be comfortable that everything is being done properly. We're almost there," the source said.

Meanwhile, small retail investors who have consistently complained that their situation has been ignored by the Pan-Canadian Committee may get a chance to have their say in Ottawa. Investors are concerned that they will not get all their money back. Under the restructuring framework, their short-term notes will be turned into long-term investments and those who hold them for five to eight years will get their money back.

However, it's likely a secondary market will arise and the investors say they have been told by the man heading the restructuring committee, Purdy Crawford, that the notes will trade initially at a significant discount to par.

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