Debt Rattle, March 31 2008

Ilargi: If you don’t mind, I’ll shift the inane “Paulson Plan” left of center stage for now. As soon as I saw the Wall Street Journal write that the US has a “lame duck President”, the last few doubts about the plan vanished: it’s just a balding man trying to strike a convincing pose.

Still, don’t forget that Paulson headed Goldman Sachs for a long time: if and when the Fed takes over the US, Goldman will be sitting pretty. The bald man has laid an egg. And when the crisis truly explodes later this year, the blueprint is ready when the nation starts begging for a strongman to stand up. We are about where Berlin was 80 years ago.

For now, I have a sliver of hope left that someone will wake up to the fact that it’s insanity in its purest incarnation to give the reigns over your economy to an organization that everybody takes great pains to paint as independent from the democratically elected government. There should be alarm bells ringing somewhere, I’d say, but perhaps that’s just the romantic part of me that can’t stop hoping either that Snow White never knew the dwarfs in a biblical sense.

First though, we’ll see rallies in the market, simply because there’s still suckers out there that can and need be cleaned out. Not that I see a significant rally this year, not even a bear one, the model is already too broken.

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Updated 12.45 pm EDT

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Ilargi: The Fed has “shouldered most of the burden of saving the global economy”? The ECB has loaned out at least as much as the Fed, so I would doubt that. Plus, the Fed is not trying to save the global economy, just the US. And the ECB does so for Europe. Presumably.

"The ECB and Bank of England have so far failed to restore order to money markets.". Well, so has the Fed, right? Am I missing something?

Here's a crucial detail that few recognize: “Bernanke has committed as much as 60 percent of the $700 billion in Treasury securities on his balance sheet..” Hey, 40% to go, let’s party. When that is gone, the Fed will get dictatorial powers over Wall Street anyway, so why worry?


Trichet, King May Support Fed as Ammunition Runs Low

Federal Reserve Chairman Ben S. Bernanke has so far shouldered most of the burden of saving the global economy and financial markets. He may be about to get more help. With the credit crisis entering its ninth month, Bank of England Governor Mervyn King and European Central Bank President Jean-Claude Trichet are on the verge of new steps to spur lending and increase liquidity, say economists at Lloyds TSB Group Plc and Royal Bank of Scotland Group Plc. Interest-rate cuts may be next if the crisis persists.

"We're inching closer to the great global monetary easing," says Joachim Fels, co-chief economist at Morgan Stanley in London. Lloyds predicts King's next step will be to accept more types of collateral for loans. Trichet will pump more money into banks, RBS forecasts. Such measures would take Europe's two biggest central banks further down the path laid out by Bernanke this month.

The Fed chairman needs all the help he can get. In addition to lowering interest rates at the fastest pace in two decades, Bernanke has committed as much as 60 percent of the $700 billion in Treasury securities on his balance sheet to expand lending. The Fed has also offered a $29 billion loan against illiquid securities to assist the buyout of failing securities firm Bear Stearns Cos.

"There is a barrier in terms of the size of the Fed's balance sheet as to how much it can do" short of printing more dollars, says Neil Mackinnon, chief economist at London-based hedge-fund ECU Group Plc, which manages about $1.5 billion. "If the European central banks were to adopt more Fed-style measures, it would go a long way to helping the Fed tackle the crisis. This is not only a problem for the U.S. to resolve."

The ECB and Bank of England have so far failed to restore order to money markets. The cost of borrowing in euros and pounds last week rose to highs for the year. The three-month London interbank offered rate for euros climbed 5 basis points to 4.73 percent, the highest level since Dec. 27. It fell today for the first time since March 3, according to the European Banking Federation.

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Bear market rallies only delay day of reckoning

Every slump is punctuated by exuberant bursts of optimism, known to traders as "bear market rallies". Japan had four false dawns during its long slide into the abyss. Each lifted Tokyo's Nikkei index by an average of 53pc. Such bounces can be intoxicating.

Teun Draaisma, Morgan Stanley's stock guru, expects the current rally to boost Europe's MSCI 600 index by 21pc from its trough in late January, with similar moves on the S&P 500. The battered shares do best: builders and banks this time. There have been nine bear rallies since 1970. The average length is four months. The surge misleads investors into believing that sunlit uplands lie ahead. Then the sucker punch hits.

"The Federal Reserve's actions have averted financial Armageddon, but they cannot avert an earnings recession. We don't expect a new bull market until early 2009," he said. Morgan Stanley says earnings will fall 16pc this year as debt leverage kicks into reverse. Investor psychology is "asymmetric". The market discounts trouble in advance. Share prices start falling a year before earnings peak. In a downturn investors keep selling until earnings hit bottom.

"Bear markets are terrible for the human psyche. You get one profit warning after another. People see their hopes dashed so many times that they stop believing," said Mr Draaisma. "You have got to be very disciplined and not buy shares too early just because they look cheap. Things can go down further than you ever dare believe," he said. He is not predicting a bloodbath along the lines of 1929-1933 (-88pc) or 2001-2003 (-49pc): just a long slog, with failed rallies.

For now, the markets are flashing a tactical buy signal. Mr Draaisma's "capitulation indicator" has crashed to the lowest level since the 1998 LTCM crisis: the share "valuation indicator" is near an all-time low. UBS is also gearing for a big rebound, convinced that the Fed's move to shoulder $30bn of Bear Stearns liabilities has changed the game. In its latest report -"Ready for a Rally" - it said financial shares rose 448pc in the 12 months after the Swedish rescue in 1992, 88pc after Japan's Revitalisation Law in 1998; and 82pc after Roosevelt's Emergency Banking Act in 1933.

The pessimists at Société Générale remain sceptical, even though the Fed has gone nuclear. "We expect global equity prices to fall by up to 75pc from their peaks as a deep global economic downturn unfolds over the next few years," said Albert Edwards, their global strategist. He fears a 50pc collapse in earnings, compounded by an "Ice Age derating of equities".

Whatever happens, there will always be tactical rallies. Mr Edwards cites four Wall Street bounces above 25pc in the 2001-2003 bust. The buying cue is when investor gloom nears black despair. The put/call ratio on options is now at a bearish extreme of 0.90. "That would historically suggest that a joyous 25pc spring rally is close at hand," he said. Yet Mr Edwards remains wary as long as analysts cling to their belief that earnings will rise 11pc in 2008. This is not the sort of "washout" level of gloom required to clear the air.

Still, the oldest adage on Wall Street is "never fight the Fed". In short order, Ben Bernanke has slashed interest rates by 300 basis points to 2.25pc, and invoked the emergency clauses of Article 13 (3) of the Federal Reserve Act for the first time since the Great Depression to take on direct credit risk.

The Bush administration has told the housing agencies Fannie Mae and Freddie Mac to absorb $200bn of extra mortgage debt. It has implicitly nationalised them in the process. The network of Federal Home Loan Banks has mopped up $900bn of mortgage securities. Congress has rushed through a $170bn fiscal blitz.

This is not to be sniffed at. It is worth a good spring rally, until the inexorable logic of a 25pc house price crash prevails once again. Bernard Connolly at Banque AIG, who foresaw this crisis with uncanny accuracy, believes central banks will resort to full-throttle reflation, setting off a fresh boom in shares and gold. But this will occur only after the economic slump has spread to Europe and beyond.

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Brace for $1 Trillion Writedown of 'Yertle the Turtle' Debt

Be it ever so devalued, $1 trillion is a lot of dough. That's roughly on a par with the Russian economy. More than double the market value of Exxon Mobil Corp. About nine times the combined wealth of Warren Buffett and Bill Gates.

Yet $1 trillion is the amount of defaults and writedowns Americans will likely witness before they emerge at the far side of the bursting credit bubble, estimates Charles R. Morris in his shrewd primer, "The Trillion Dollar Meltdown." That calculation assumes an orderly unwinding, which he doesn't expect.

"The sad truth," he writes, "is that subprime is just the first big boulder in an avalanche of asset writedowns that will rattle on through much of 2008." Expect the landslide to cascade through high-yield bonds, commercial mortgages, leveraged loans, credit cards and -- the big unknown -- credit-default swaps, Morris says. The notional value for those swaps, which are meant to insure bondholders against default, covered about $45 trillion in portfolios as of mid-2007, up from some $1 trillion in 2001, he writes.

Morris can't be dismissed as a crank. A lawyer, former banker and author of 10 other books, he knows a thing or two about the complex instruments that have spread toxic debt throughout the credit system. He once ran a company that made software for creating and analyzing securitized asset pools. Yet he writes with tight clarity and blistering pace. The financial innovations of the past 25 years have done some good, Morris notes. Collateralized mortgage obligations, invented in 1983, saved homeowners $17 billion a year by the mid-1990s, according to one study.

CMOs transformed the business by slicing pools of mortgages into different bonds for different risk appetites. Top-tier bonds had the first claim on all cash flows and paid commensurately low yields. The bottom tier was the first to absorb all the losses; it paid yields resembling those on junk bonds. What began as a good thing, though, soon spawned a bewildering array of new asset classes that spread throughout the financial system, marbling balance sheets with what Morris calls inflated valuations, hidden debt and "phony triple-A ratings."

The more the quants fine-tuned the upper tranches of CMOs and other collateralized debt obligations, the more dangerous the bottom slices grew. Bankers began calling it "toxic waste." Guess where the toxins wound up? That's right: Credit hedge funds are now the weakest link in the chain, Morris says. Their equity stands at some $750 billion and is so massively leveraged that "most funds could not survive even a 1 percent to 2 percent payoff demand on their default swap guarantees," he writes.

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Global Assets Deflating

About $2.4 trillion has been lost in US housing values and stocks are down too

Few things in life are more satisfying than shooting teenagers…watching them yelp in pain and fall down in a heap…defeating youthful energy with age and treachery. More about that below…but first, the financial situation: The weekend gave people time to think. Too bad. Thoughts lead to action which leads to trouble. What the commentators, pundits, and policymakers are thinking about is how to ‘fix’ problems in the capital markets. Most of them couldn’t fix a flat tyre, of course. But that doesn’t stop them. They imagine that they can find the hole in the world’s money system…and patch it. .

“US readies overhaul of financial regulation,” is today’s big headline in European version of the Wall Street Journal. The article goes on to tell us that a whole group of changes are coming our way. As near as we can tell, these changes mean nothing – they are simply rearranging the bureaucrats’ desks. This is the plan put forward by Hank Paulson, former Goldman chief executive and now head man at the Treasury.

Critics charge that it doesn’t go far enough…that it is really an extension of the deregulation trend that got us into trouble in the first place. A whole chorus of whiners is now calling for re-regulation of the financial institutions – with heavy emphasis on mortgage lending. The real problem in today’s capital markets is not that the machinery of capitalism is broken, but that it’s working. And that is what the reformers aim to stop. They want to ‘fix’ the markets… like you would ‘fix’ a stray cat – so it couldn’t have kittens. What they really want is to neuter the market…spay it, so it is a cuddly pet, but one that doesn’t give you any trouble.

So far, US homeowners have lost probably about 12% of the wealth they thought they had in their houses. The total capital value of the residential housing market is about $20 trillion. So, a 12% loss is equal to about $2.4 trillion. A few foreign housing markets have been hit harder – Ireland, Spain and Iceland, for example. The equity markets have been hit by similar losses. Equity funds alone have seen $100 billion of cash pulled out by nervous investors. But here – something curious – “In an ugly global crisis, US markets not so bad,” another WSJ headline.

In 2008, the Dow is down 7.9%. But foreign markets are down more. France has lost twice that amount. Germany has dropped even more – 18.7%. But the biggest losses are in the go-go markets of the East. Indian stocks have lost nearly 20% of their value. The Shanghai stock market has fallen 32%. Overall, non-US and Canadian markets are down about 15% - meaning, that the world’s equities have taken a loss of about $4.5 trillion in local currency terms…or about $3 trillion when measured in dollars. (The dollar has gone down so that dollar-based investors have lost less on foreign markets than local investors.)

We have been pointing out that these huge reductions in the implied wealth of the world’s investors weigh heavily on the deflation side of the scales. The money people thought they had is disappearing. To a hedge fund investor, the vanished money may mean nothing more than a missing digit on his portfolio report. But to a marginal homeowner, the losses force him to change his standard of living – cutting back on expenses so as to balance his family budget. For not only does he have less money, his costs keep going up. Every three months the American Farm Bureau buys a typical bag of groceries. This quarter, the price was up 8.9% over a year ago. And gasoline? It’s up 64 cents a gallon over the last 12 months.

A good part of the world economy seems to be drifting into a slump – despite the efforts of the feds to keep the money flowing.
“Capital shortage lingers despite Fed’s latest steps,” reports the WSJ. The banks are rebuilding their balance sheets; they’re not taking on more risky credits. Analysts will take aid and comfort from the performance of the US market so far this year; they will see it as a sign of strength that American equities have sunk less than others. But it is really a sign of weakness.

While foreign markets soared over the last 10 years, US stocks went nowhere. Having not gone up, now they’re not going down. And while they are not going anywhere the value of the dollar continues to fall – wiping out stockholders’ real wealth. In terms of what they can buy on world markets, US stock market investors have lost 25% to 30% of their purchasing power over the last decade. They’ll probably lose another 30% over the decade ahead.

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Proposed Rules Bring Cheers, Fears

With a trader's eye toward risk and reward, Wall Street saw upside in the possibility of lighter, more streamlined regulation, but worried that rules designed to make the financial system safer could cut into profits.
Treasury Secretary Henry Paulson is proposing a sweeping overhaul of the system that regulates banks, brokerages, exchanges and insurance companies that is designed to streamline the structure.

The proposal also would shift power from states to the federal government and eliminate some regulatory agencies, giving more power to the Federal Reserve. The plan is unlikely to gain approval soon, with a lame-duck president and an increasingly partisan Congress unlikely to make major moves in an election year.

Wall Street gained some comfort that the plan, spearheaded by Mr. Paulson -- former chief executive of Goldman Sachs Group Inc. -- began as an effort to simplify financial regulation. Many were worried, however, that because the rules are coming just two weeks after the Fed helped avert the collapse of Bear Stearns Cos., political finger-pointing will create a more-onerous regulatory system.

The Fed's decision to lend money to Wall Street firms on the same terms it does to Main Street banks opened the door for regulators to demand more information from them. It also could require investment banks like Lehman Brothers Holdings Inc. and Goldman Sachs to keep more capital on hand than currently required. "I think that is a realistic quid pro quo for access to the Fed's borrowing facilities," said Thomas Russo, chief legal officer and vice chairman at Lehman.

That would be offset by a more efficient regulatory system. "This is a major step forward in the modernization of the U.S. financial services markets," Mr. Russo said. Last year, the number of U.S. regulators overseeing and inspecting securities firms fell to just two from three with the merger of the National Association of Securities Dealers and the enforcement arm of the New York Stock Exchange, which resulted in the creation of the Financial Industry Regulatory Authority, or Finra. The proposed plan could dilute the oversight of the other regulator, the Securities and Exchange Commission, while the Fed would take on a bigger role.

Critics argue that the goal should be far tougher regulation on Wall Street, in particular to protect small investors from being duped into buying risky securities they don't understand. They point to the current mess involving so-called auction-rate securities, which were pitched to investors as the equivalent of cash, but now can't be sold and are losing value.

The auction-rate securities situation follows problems in the municipal-bond market, the structured-finance business, derivatives including collateralized debt obligations, and only just a few years ago, the technology-stock bubble, where Wall Street firms happily peddled profitless dot-com companies that ultimately went bust.

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Paulson Plan Endorses Fed's Enhanced Market Authority

Treasury Secretary Henry Paulson's plan to overhaul U.S. market regulation would officially endow the Federal Reserve with the broader authority that it has already accrued in the past two weeks. The Fed, which engineered JPMorgan Chase & Co.'s purchase of Bear Stearns Cos. and became lender of last resort to the biggest bond dealers, will oversee "market stability," under proposals that Paulson will unveil today.

The Securities and Exchange Commission, traditionally the main regulator of Wall Street firms, will be merged with the Commodity Futures Trading Commission, according to a draft of the report. "It would be Congress and the president essentially giving a blank check to a regulator over which they have very little power," said Michael Greenberger, a professor at the University of Maryland in Baltimore and a former CFTC official. Paulson's proposal will "allow Wall Street to do whatever they want until a crisis occurs, at which point the Fed would intervene."

The central bank's response to the credit freeze and the near bankruptcy of Bear Stearns shows how the role of regulators is being redefined by events, regardless of Paulson's review, which began nine months ago. SEC Chairman Christopher Cox isn't protesting the proposed merger of his agency -- formed during the Great Depression -- with the CFTC, saying that regulation would be better served by fewer organizations.

"Just as systemic risk cannot be neatly parceled along outdated regulatory lines, the overarching objective of investor protection can't be fully achieved if it fails to encompass derivatives, insurance, and new instruments that straddle today's regulatory divides," Cox said in a statement on March 29.

The Treasury will recommend that the Fed share authority over banks, securities firms and insurers in monitoring corporate disclosures, writing rules and stepping in to prevent economic crisis, according to the draft, which was distributed to officials last week and obtained by Bloomberg News.

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Why the Paulson Plan is DOA

Let’s see. In the middle of perhaps the greatest financial upheaval since the Great Depression, Treasury Secretary Hank Paulson is proposing a change in financial regulations which basically amounts to a big wink to Wall Street.

His plan will go nowhere, both for political and practical reasons. In fact, it does not even meet the minimum standard of improving transparency, which would reduce the possibility of a similar crisis in the future.
The main point of the Paulson plan is to make regulation more efficient. It notes that changes in the capital markets are

…pressuring the U.S. regulatory structure, exposing regulatory gaps as well as redundancies, and compelling market participants to do business in other jurisdictions with more efficient regulation.

So what does the plan actually propose? The one clear improvement is more regulatory oversight for mortgage lenders. Otherwise everything else in the plan consists of rearrangements and clarifications of current regulatory responsibilities, at least in the short and medium run.

For example, responsibility for regulating insurance companies would gradually be shifted from the state to the federal level. And the SEC and the Commodity Futures Trading Commission (CFTC) should be merged. The Paulson plan makes sure to note that the new combined agency should engage in faster approvals of new financial products. As the executive summary says:

The SEC should also consider streamlining the approval for any securities products common to the marketplace as the agency did in a 1998 rulemaking vis-à-vis certain derivatives securities products. An updated, streamlined, and expedited approval process will allow U.S. securities firms to remain competitive with the over-the-counter markets and international institutions and increase product innovation and investor choice.

I have nothing against regulatory efficiency, and I applaud financial innovation. But the Paulson plan belongs in a fictional world where financial institutions do a good job in regulating and monitoring themselves. Unfortunately, that’s not the world we live in.

The most striking thing about the current problems is just how much money the banks and the investment banks have lost. They apparently had no idea of how risky their own exposure was. The supposedly smart guys were simply stupid.

For me, the main lesson from this debacle is that both banks and investment banks must be required to fully report what securities they are holding, both directly and indirectly. No more off-the-book special purpose vehicles, no more hiding derivatives under the table. If a bank or an investment bank is holding a security, they have to publish the amount and the basic characteristics.

This requirement may seem onerous to Wall Street, and it is. But it’s for the benefit not just of the financial system, but for the banks themselves, who appear not to be able to keep track of their own risks without assistance. Everything should be fully reported. Without this simple step towards transparency, nothing else matters. With transparency, other market participants have the chance to make their own judgement.

For political reasons, nothing is going to happen until after the presidential election. The Democrats in Congress have no reason to sign onto the Paulson plan. But the next president—whoever it may be—should put financial transparency at the top of the regulatory agenda.

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Fed eyes Nordic-style nationalisation of US banks

The US Federal Reserve is examining the Nordic bank nationalisations of the 1990s as a possible interim solution to the US financial crisis. The Fed has been criticised for its rescue of Bear Stearns, which critics say has degenerated into a taxpayer gift to rich bankers.

A senior official at one of the Scandinavian central banks told The Daily Telegraph that Fed strategists had stepped up contacts to learn how Norway, Sweden and Finland managed their traumatic crisis from 1991 to 1993, which brought the region's economy to its knees. It is understood that Fed vice-chairman Don Kohn remains very concerned by the depth of the US crisis and is eyeing the Nordic approach for contingency options.

Scandinavia's bank rescue proved successful and is now a model for central bankers, unlike Japan's drawn-out response, where ailing banks were propped up in a half-public limbo for years. While the responses varied in each Nordic country, there a was major effort to avoid the sort of "moral hazard" that has bedevilled efforts by the Fed and the Bank of England in trying to stabilise their banking systems.

Norway ensured that shareholders of insolvent lenders received nothing and the senior management was entirely purged. Two of the country's top four banks - Christiania Bank and Fokus - were seized by force majeure. "We were determined not to get caught in the game we've seen with Bear Stearns where shareholders make money out of the rescue," said one Norwegian adviser.

"The law was amended so that we could take 100pc control of any bank where its equity had fallen below zero. Shareholders were left with nothing. It was very controversial," he said. Stefan Ingves, governor of Sweden's Riksbank, said his country passed an act so it could seize banks where the capital adequacy ratio had fallen below 2pc. Efforts were also made to protect against "blackmail" by shareholders.

Mr Ingves said there were parallels with the US crisis, citing the use of off-balance sheet vehicles to speculate on property. All the Nordic banks were nursed back to health and refloated or merged. The tough policies contrast with the Fed's bail-out of Bear Stearns, where shareholders forced JP Morgan to increase its Fed-led rescue offer from $2 to $10 a share. Christopher Wood, chief strategist at brokers CLSA, says the Fed's piecemeal approach has led to "appalling moral hazard".

"Shareholders have been able to lobby for a higher share price only because the Fed took over the credit risk on $30bn of the investment bank's dubious paper. The whole affair also amounts to a colossal subsidy for JP Morgan," he said.

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M&A Bankers Suffer 35% Drop in Fees as Deals Dry Up From Record

Mergers and acquisitions bankers suffered a 35 percent drop in fees during the first quarter, just weeks after cashing bonuses from a record year. Advisory fees fell to about $8.7 billion from $13.4 billion in the first three months of 2007, data compiled by analysts at New York-based Freeman & Co. show. Executives at Lehman Brothers Holdings Inc. and Bank of America Corp. predicted in December that takeovers would decline about 20 percent this year.

"As recently as three months ago, we thought we had seen the worst and it was going to begin to get slowly better," said Eduardo Mestre, 59, the former head of Citigroup Inc.'s investment banking unit and now vice chairman of New York-based advisory firm Evercore Partners Inc. "It only got worse."

The collapse of the U.S. subprime mortgage market threatens to stifle economic growth and further curb corporate purchases. New York-based Goldman Sachs Group Inc., the world's leading M&A adviser, reported a 47 percent decline in revenue from providing takeover advice in the first quarter from the fourth. The value of announced mergers and acquisitions fell to $656.2 billion this quarter from $971 billion a year earlier, according to data compiled by Bloomberg.

January and March were the slowest months for takeovers since November 2004. Rising financing costs have hampered leveraged buyouts, which dropped to $60 billion in the first quarter from $201 billion a year ago, the data show. A record $4 trillion of takeovers was announced in 2007, including the $50.6 billion buyout of Montreal-based BCE Inc., Canada's largest phone company, by a group including the Ontario Teachers' Pension Plan, Providence, Rhode Island-based Providence Equity Partners Inc. and Madison Dearborn Partners LLC of Chicago.

LBO firms announced an unprecedented $748 billion of acquisitions last year, Bloomberg data show. "The first half of 2007 was very, very unusual," said Frank Aquila, 51, a partner at Sullivan & Cromwell LLP in New York, the top legal adviser on mergers last year. "The private equity guys are smart. There was plentiful cheap credit so they took that horse and rode with it."

Now even some announced deals are in doubt. Clear Channel Communications Inc., the biggest U.S. radio broadcaster, said on March 28 its sale to private-equity firms may collapse after banks backed out of financing the $19.5 billion transaction.
Clear Channel can't estimate a closing date for the sale, the San Antonio-based company said in a filing with the Securities and Exchange Commission. Bank representatives didn't attend a March 27 meeting scheduled to complete the deal.

Banks are reeling after $208 billion in credit losses and writedowns linked to rising mortgage defaults in the U.S. They're also stuck with $200 billion in loans and bonds from leveraged buyouts after failing to find buyers.

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Piercing This Bubble For Good

In the past two weeks, the Federal Reserve has lent or guaranteed at least $57 billion to investment banks. This sudden infusion, the first to Wall Street firms since the 1930s, underscores the financial emergency facing the nation. Yet just last June, the markets were euphoric. How, within nine months, could a lending bubble inflate to gargantuan proportions and then burst into this credit market disaster?

Two points are fundamental as we piece together what happened. First, this is only the latest in a series of modern financial bubbles that have collapsed. Second, while we cannot prevent bubbles, we can prevent a recurrence of this one. Financial bubbles occur regularly on both the debt and equity sides of investing. Recent ones include the conglomerate stock craze in the 1960s, the junk bond and Japanese excesses of the 1980s, and the dot-com speculation of the late 1990s.

The interaction of crowd psychology and the betting nature of markets cause these episodes: After a certain upward point, market momentum can become self-perpetuating -- until it reaches such a peak as to collapse onto itself. Much like putting too much air into a balloon.

Over 2004-05, there developed an unusual combination of low interest rates and low inflation, reasonable growth, and a surplus of global savings recycling into the United States. This meant that all types of lenders were highly liquid but faced low yields from traditional lending practices. Seeking better returns, they lowered credit standards and lent to weaker parties, i.e., subprime mortgage borrowers and over-leveraged firms.

The headlines have been reporting what happened next, but the amount of credit that was extended to these weaker borrowers is amazing. Historically, C-rated borrowers have been unable to borrow much from public-debt markets because over decades more than 30 percent of such low-rated debt has defaulted before maturity. In 2006, more than $25 billion of these securities were sold; the previous 10 years, the average was $2 billion.

The music stopped when home prices, which had soared for five years, finally plateaued and then began to fall last year. This reversal spread nationwide and weakened the entire economy. Unable to refinance, countless overstretched homeowners could not make their mortgage payments. Suddenly, defaults loomed, and every lender changed his stance overnight. Deleveraging became the goal, and the credit spigot was shut.

It was, as always, too late. The Fed has poured emergency liquidity into the financial system to avert a collapse, but foreclosures have already skyrocketed, and hundreds of billions in credit losses have been realized. Our country is headed into a recession.

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Capital flight puts Russia on the ropes

Capital flight from Russia over the first two of months this year reached $20bn (£10bn), exceeding the outflows seen at the height of the 1998 default crisis. Analysts said foreign funds had begun to unwind large positions in Russia, fearing the country is overheating and has become increasingly vulnerable to a fall in oil and commodity prices.

Alexei Kudrin, the finance minister, said there was no cause for alarm, citing Russia's huge cushion of foreign reserves: "This would have been a significant event in the past, but this time $20bn left the country in two months and the country did not even feel it.

"The crisis being experienced by global financial markets is unprecedented in scale and depth. It will create some additional challenges and risks for the Russian financial system this year, but we are not expecting a crisis to develop in Russia, " he told the Duma. Oil and gas exports have lifted Russia's foreign reserves to $502bn, the world's third largest. The central bank said that a surprisingly high 9pc of this huge stash is held in sterling.

The government expects foreign funds to return this year to finance energy companies and infrastructure projects, but many experts fear that the country's roaring boom may be starting to falter. Yakov Mirkin, head of the Institute of Financial Markets, said foreigners accounted for 70pc of Russia's debt market and are becoming wary of excess credit growth and other signs of stress in the economy. Russia's private sector has built up $378bn in foreign debts.

"When many non-residents leave the market, selling stocks and bonds as we're seeing now, it's called capital flight. It eventually leads to serious financial problems," he told Izvestia newspaper. About 80pc of Russia's exports come from energy and metals, distorting the economy through what is known as the "resources curse".

Moscow has become the most expensive city in the world for many goods. The manufacturing sector is also facing a serious cost squeeze, shifting plant out of the country. Even though oil has been trading at record prices, Russia's current account surplus has fallen rapidly from a peak of 9.6pc of GDP in 2006. Danske bank says it may turn negative within two years if imports of luxury goods continue to soar.

Car sales rose 67pc last year to $53bn, led by German models. Critics say the oil bonanza is draining into shopping malls. If oil drops below $60 a barrel for any length of time, the hard landing could prove painful.
"Debt payments are becoming a larger and larger negative on the current account," said Jonathan Schiffer, of rating agency Moody's.

Russia's inflation has hit 12.7pc. President-elect Dmitry Medvedev called it a necessary evil. "This is the price we are paying for our presence in the club of world economic powers," he said.

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Careers vanish after subprime 'free fall'

Kent and Mysti Cope met and fell in love working for one of the nation's top subprime lenders. Now, their life has been turned upside down after the sudden implosion of the subprime mortgage industry. Mysti was one of the last people out the door at New Century Financial, once the nation's No. 2 subprime lender. She had been in charge of e-commerce customer service with dozens of employees reporting to her. It was at New Century where the Copes met in 2000.

Kent worked for several of the firms that helped give birth to the industry, which specializes in making loans to people with less-than-perfect credit, in the 1990s. He has been out of work since August when he was laid off by Friedman, Billings, Ramsey Group (FBR) unit First NLC Financial Services. "We're still both in shock that it could go from something so good to so bad so quick," said Kent, 59. "New Century in 60 days went from top of the heap to out of business."

The two didn't say exactly how much money they made at their last jobs but Kent admitted they each had six-figure incomes. Today, they're trying to get by on his unemployment benefits of about $450 a week, which covers only about an eighth of the basic payments they owe every month. Their home equity line, mortgage, health and life insurance premiums alone cost about $10,000 a month. Still, they are trying to hang onto what they call their dream home with a view of the Pacific Ocean where they live with Mysti's 11-year old son.

Kent estimates the mountainside home in San Clemente, Calif., which they bought in 2005, is worth 20% less than it was a year ago. And in the current market, he said he's not sure he could sell it for even that amount. "We've used up most of our reserves, cashed in her 401K," said Kent. "We're going Mach 1 into a wall. When we run into it, then we've got to decide what to do next."

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CBI warns 11,000 City jobs axed by June

Up to 11,000 jobs could be cut from the UK's financial services industry over the three months, according to forecasts by the CBI. The employers' group said that based on analysis of its latest Financial Services Survey, there will be finance sector job losses of between 10,000 and 11,000 between from early March and the beginning of June.

The survey, conducted in conjunction with PricewaterhouseCoopers, reported that the sector endured a painful first quarter of 2008, with higher operating costs and a sharp fall in profitability, and gave a gloomy outlook of rising borrowing costs for the coming six months. Ian McCafferty, the CBI's chief economist, commented: "This is a very serious crisis."

"Some have suggested it's the worst financial crisis since the Second World War," Mr McCafferty said. "I think one of the key characteristics is that it will go on for quite some time to come." Almost 50 per cent of the companies questioned for the CBI’s survey reported a fall in business volumes that was worse than expected. Close to 20 per cent said that profitability was down, while 25 per cent had cut jobs during the quarter. Employment expectations for the coming three months were the bleakest since December 2002.

The Bank of England has been providing an extra £5 billion each week at its cash auctions for Britain’s banks, but Mr. McCafferty said that this would not solve the fundamental problem of the lack of trust in the financial markets that was plaguing companies. As a result, banks had refused to lend to each other and lending to other businesses has slowed dramatically.

“It’s clear that the credit crunch has worsened over the first three months of this year,” he said. “The interbank markets have become more gummed up, with banks even more unwilling to lend, and credit spreads have widened.” Companies said that their plans for spending on IT were flat and expenditure on land, buildings, vehicles, plant and machinery were the lowest since June 1992. Almost 10 per cent of respondents predicted that lending to industrial and commercial companies would decline in the next quarter.

Credit spreads were reported to have widened strongly by 35 per cent of the companies surveyed – the biggest gap since March 1993. Continued funding difficulties meant that respondents were more pessimistic about the credit crunch than they had been in the final quarter of 2007.

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Europe Inflation Accelerates to 3.5%, Sentiment Drops

European inflation accelerated to the fastest in almost 16 years in March, heightening the European Central Bank's quandary at a time when the economy is cooling and confidence is falling. Consumer-price inflation in the euro area accelerated to 3.5 percent this month, the highest rate since June 1992, the European Union's statistics office in Luxembourg said today.

That is faster than the 3.3 percent median forecast of 36 economists in a Bloomberg News survey. A separate report showed consumer and business confidence fell more than economists expected. Rising food and energy prices are stoking inflation in the euro area, eroding consumers' purchasing power and pushing up costs at companies. ECB council member Erkki Liikanen said today that inflation expectations have "hardened" and the growth outlook has "become more subdued," summing up the dilemma for the central bank, which is resisting cutting interest rates as inflation accelerates.

"The ECB's hawkish stance will be reinforced, but hoping that the economic slowdown will be moderate and short-lived seems too optimistic to us," said Aurelio Maccario, an economist at Unicredit MIB in Milan, said before the report. Europe's economic growth "has settled below trend."

Consumer and business confidence fell to 99.6 this month from 100.2 in February, led by the construction industry, the European Commission said in a report today. Economists had forecast a decline to 100 from an initially reported 100.1 in February. The construction confidence measures in Germany, Europe's largest economy, Spain, Ireland and Italy, all fell.

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Pound drops as expectations build for UK rate cut next week

The pound fell sharply against major currencies as expectations mount that the Bank of England will cut interest rates next week. A series of bad news for the United Kingdom economy out this morning has added to the bearish sentiment surrounding the pound at the end of last week and sent the euro to a fresh all-time record high of 0.7959 pounds.

The latest house price survey from Hometrack reported that United Kingdom house prices fell in March for the sixth consecutive month while a report from the Confederation of British Industry said profits in the UK's financial services sector are falling at their fastest rate since the start of the war in Iraq five years ago.

Last week Bank of England governor Mervyn King conceded that current conditions in the credit markets mean the Monetary Policy Committee is more pre-disposed to cut interest rates. Markets interpreted this as a sign that the next interest cut could come next week rather than in May which many economists had been expecting previously.

On Friday a key consumer sentiment survey reported that confidence was at a 15-year low and today's housing market figures have added to expectations that consumer spending is set to slow sharply. Hans Redeker, head of currency strategy at, said this means the pound is set to fall even further in the coming months.

'We continue to believe that sterling will be one of the most significant under performers of 2008 and the most recent data releases, which add to the evidence that the slowing housing market (and tightening credit conditions) is having a negative impact on the consumer, add to the case for a rate cut in the next couple of months, maybe even as early as April's meeting,' he said.

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UBS Hit By New Write-Down Fears

UBS, the European bank worst hit by the credit crunch, could be preparing for a $16.1 billion capital injection to maintain its capital position, and prevent ratings downgrades. Shares in UBS tumbled 3.9%, or 1.14 Swiss francs ($1.15), to 27.84 Swiss francs ($28.03), on Monday morning in Zurich, after a Swiss newspaper said the bank may ask shareholders to approve a capital hike of 16 billion Swiss francs ($16.1 billion).

”If UBS wants to keep its capital ratio at 12.0%, the group needs 16 billion Swiss francs ($16.1 billion),” Switzerland's Sonntag newspaper said Monday, quoting anonymous sources. ”Sixteen billion dollars is certainly not an unreasonable figure, and is within the realm of possibility,” Helvea analyst Peter Thorne told Forbes.com.

International banking covenants require banks to have a capital ratio of at least 4.0%, though Switzerland’s Federal Banking Commission prefers them to have a Tier 1 ratio of at least 10.0%. If UBS's capital position falls below this level, it could lead to further ratings downgrades that could increase the bank’s funding costs.

There has been much speculation over whether UBS will be forced to seek another capital increase at its annual general meeting on April 23. It has already received a capital injection of $18.2 billion, after writing down $19 billion during 2007. The bank’s continued high exposure to risky subprime related assets, including residential mortgage-backed securities, collateralized debt obligations and leveraged loans, has left analysts expecting massive write-downs of between $10 billion and $20 billion, largely expected in the first quarter of this year.

The massive losses have shaken confidence in the Swiss bank, and has left its wealth management business vulnerable, as worried clients have moved their funds into other banks, including rivals like Credit Suisse. According to the Sonntag newspaper, UBS is suffering from a cash drain, and customers in the Zurich area alone have withdrawn 700 million Swiss francs ($704.8 million) since the start of the year.

The bank’s credibility suffered another blow on Friday after it decided to write down the value of its $5.9 billion portfolio of auction-rate securities by an average of 5.0%. Investors had been left with the high yielding, high-risk bonds, after being unable to sell them at regular auctions, and UBS, fearful of taking on more illiquid assets onto its balance sheet, declined to buy them back.

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Spanish Property Market in Freefall

Spain's once-booming property market is in freefall, official statistics have revealed for the first time.
The announcement that house sales had plunged has dashed government hopes for a "soft landing" in the sector that has driven the Spanish economy for more than a decade.

The buying and selling of homes fell by 27 per cent in January compared with the same period last year, Spain's National Statistical Institute (INE) announced yesterday. The collapse coincided with a 25 per cent fall in the granting of mortgages, the biggest drop since 2004. The size of individual mortgages has also fallen, by nearly 4 per cent, as providers fear for the security of their loans.

The indicators published by the state organisation for the first time confirm the widespread fear that Spain's property sector is not just cooling off, but falling sharply. "We have to accept this is not a gentle correction, but a full-blown crisis. We can only hope it will be sharp and short," says Fernando Encinar, a director of Spain's leading online estate agent, idealista.com.

The news will scare millions of Spaniards -- and hundreds of thousands of Britons and other northern Europeans -- who stretched themselves to get mortgages on homes they believed were a cast-iron investment. Miguel Blesa, president of the Caja Madrid savings bank, Spain's second leading mortgage provider, warned that things would get worse. "There will be more problems in the property sector in coming months, since the market in new homes is paralysed," Mr Blesa predicted.

"Many people thought that buying property, especially a second or third home, was an investment to make a profit. Now we'll see cascades of these homes up for sale." Mr Blesa was speaking in Vienna, where his savings bank yesterday inaugurated a new headquarters to handle credit lines for big construction companies operating in central and eastern Europe. The message seemed clear: leading financiers are forsaking domestic homeowners and shunning Spain's burst bubble to boost property development in livelier markets abroad.

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Ilargi: I don’t quote Jim Kunstler much here, since he doesn’t know much about finance, as he’s acknowledged to me, and he never sent me the promised press-copy of his new book. Easier to say nothing than to say no?!

I’ll make an exception today, because Jim points to something, and he’s done this a hundred times, that nobody has the guts to address. That is, the rage of the crowds when they find out there’s nothing left for them. I’d go one step further than he does here: the entire Hamptons may well be driven into the ocean before they know what hit them. They are the quintessential “Let Them Eat Cake Crowd”. Who never realize that they better serve that cake.

Upscale

  Things continue to slip, slide, and shift strangely Out There. Last Wednesday, a bunch of peeved mortgagees protesting government favoritism in the Bear Stearns case entered the lobby of the company's (soon-to-be-former) headquarters building in midtown Manhattan.

While it might not seem like much, I view the symbolic "penetration" of this corporate stronghold as the very first sign of a much broader citizen revolt against the extraordinary protections being shown to crapped-out investment banker boyz -- at the expense of millions of equally crapped-out poor shlubs facing the default and re-po of their McDwelling places.

Occupying an office building lobby peacefully in broad daylight is one thing. Wait until summer gets underway and The New York Post gossip page resumes its coverage of hijinks in the Hamptons. The executives of Goldman Sachs, J.P. Morgan / Chase, and other dealers in fraudulent securities, plus the art world and show biz glitteratti who party together out there, might all find themselves the object of considerable grievance and resentment as the beaching season ramps up, and the limos roll around the charity lobster roasts, and the guests stray down the lawns, chardonays in hand, to plot divorce from their over-leveraged husbands.... God knows what seekers-of-vengence will be creepy-crawling the privet plantings along Gin Lane in the crepuscular gloom, searching for trophy wives to garrote.

Perhaps a bankrupt landscaping contractor from Lake Ronkonkoma, recently stiffed by a hedge fund manager over the installation of a half acre of pachysandra, will be arrested on the Wantagh Highway with blood on his sleeves and a high-C piano wire in his pocket. The non-Hampton precincts of Long Island, which make up more than 90 percent of the fish-shaped appendage to New York State, will be full of angry re-po victims, and the Hamptons lie at the very dead-end tail of the geographical fish. Will the banker boyz attempt to flee by yacht? And where might they escape to? Newport, Rhode Island? Labrador. . . ?

I maintain, of course, that the media (and the public itself) has no idea how quickly things might get weird in this country -- or how weird they might get.

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Citigroup to Separate Card Unit in Banking Overhaul

Citigroup Inc., battling to restore profit after a record loss, will set up an independent credit-card unit and overhaul consumer banking along geographical lines, two people with direct knowledge of the plan said. Steven Freiberg, the current co-head of consumer banking, will run the card unit, the people said, asking not to be identified before an announcement that may come as early as today. The rest of the consumer group, mainly bank branches and non-bank lending, will be led by five regional heads, the people said.

Vikram Pandit, who succeeded Charles O. "Chuck" Prince as Citigroup Chief Executive Officer in December, is reshuffling management at the New York-based bank after it lost more than half its market value in five months. The consumer chiefs will all report to Pandit as he bids to halt a profit decline for a unit that contributes 70 percent of revenue and was previously run by just two people, Freiberg and Ajay Banga.

"One should be supportive of major changes when past performance has been disappointing," said Guy De Blonay, a director at New Star Asset Management Group Plc in London who helps manage $1.2 billion in financial stocks. "In being quite aggressive in removing people and getting in fresh blood, hopefully they can turn around the story."

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Lessons From Japan's Malaise

A little knowledge can be not just dangerous but grossly misleading. That is the right conclusion to draw from the latest, surprisingly reassuring data about the U.S. economy and from the interview in yesterday's Wall Street Journal in which Sen. Hillary Clinton warned that America must avoid a "Japanese-like situation."

Clinton should have researched what actually happened in Japan after its financial crash before using the bogeyman of a Japan-style malaise to support her proposal that taxpayers' money be used to bail out holders of troubled mortgages. She thinks that Japan's mistake was to rely excessively on monetary policy to rescue its economy, rather than on fiscal and other measures. The truth is the exact opposite.

Japan's stock market collapse began in January 1990 and continued throughout that year. The property market followed, with a lag. Yet the Bank of Japan did not try to prevent this financial crash from damaging the real economy by cutting interest rates, as the U.S. Federal Reserve has done spectacularly during the past three months.

To the contrary, Japan's central bank used its monetary policy as if to make sure that the country's asset-price bubble had truly burst: It carried on raising interest rates until September 1990 and did not make its first cut until July 1991, 17 months after the financial crisis began.

In fact, the Bank of Japan did not begin using monetary policy as an aggressive tool to arrest the slump until deflation had set in toward the end of the 1990s. Japan did do two things: It used a massive increase in public spending, particularly on construction projects, to try to rescue indebted firms and to inject public money into the economy; and it helped banks conceal the true extent of their losses and their bad-debt burdens, in order to prevent markets from clearing at painfully low prices.

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McCain, the mortgage crisis, and voters with economic concerns

This week Sen. John McCain drew a sharp distinction between himself and the two remaining Democratic presidential candidates. He warned of the federal government doing too much in America’s mortgage crisis and said a McCain administration would adopt a more hands-off approach.

“[I]t is not the duty of government to bail out and reward those who act irresponsibly, whether they are big banks or small borrowers,” Senator McCain told a group of Hispanic businessmen in Santa Ana, Calif., Tuesday. It’s not exactly breaking news when a Republican opposes government involvement, of course. But considering the amount of economic pain some voters are feeling, the Arizona senator’s comments do represent something of a line in the sand in the campaign.

McCain is distinguishing himself on what is now the No. 1 issue to voters: the economy. In contrast, both Sens. Barack Obama and Hillary Rodham Clinton have proposed big plans for handling the mortgage crunch. People in two Patchwork community types, “Service Worker Centers” and “Emptying Nests,” are likely to pay special attention to the candidates’ economic proposals because in these areas many live on below-average or fixed incomes.

On the whole, those we contacted in Lincoln City, Ore., (Service Worker Centers) and Clermont, Fla., (Emptying Nests) agreed with McCain’s diagnosis of the problem, but did not agree as much with his prescription. “[I] agree with him that banks, lenders and mortgage holders were to blame for much of the problem,” Lincoln City Mayor Lori Hollingsworth wrote in an e-mail. “I don’t agree that real people need to suffer because of the mistakes and greed of those intuitions.”

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Soybean Acres to Rise After Year of Soaring Prices, USDA Says

U.S. farmers will plant 18 percent more acres with soybeans this year, more than expected, after price gains made the oilseed more profitable than corn, the Department of Agriculture said. Growers will seed 74.793 million acres with soybeans, up from 63.631 million last year, after prices rose 67 percent in the past year, partly because of increased demand and reduced supplies, the USDA said today in a report.

Acreage may also increase because soybeans are less expensive to grow than corn since they produce their own nitrogen fertilizer. "Corn is a crop that has much higher input costs, especially with regard to nitrogen that is now over $900 per ton," said Joel Karlin, a product manager at Western Milling in Goshen, California. "Soybeans are a good option for those that want to replenish the nitrogen in their soil."

Soybean futures on the Chicago Board of Trade surged to a record $15.8625 a bushel on March 3 because of increased demand and because farmers last year planted the fewest acres in 12 years. The May contract fell 4.5 percent, or 60 cents, on March 28, closing at $12.6725 a bushel.

If realized, the soybean acreage would be the second- largest ever, behind 1996, the USDA said. Analysts and traders surveyed by Bloomberg News forecast growers would plant 71.7 million acres of soybeans. Corn acres will fall 8.1 percent, more than expected, to 86.014 million, as growers make room for soybeans, the USDA said. Most-active corn futures rose 44 percent in the past year before today, trailing soybeans.

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Buyers' Revenge: Trash the House After Foreclosure

Eddy Buompensiero noticed eight pairs of shoes outside the door of the modest house on Mother of Pearl Street, evidence that the former owners were still living there even though the bank had foreclosed. Mr. Buompensiero, a gray-bearded inspector for REO Asset Services-1st Realty Group, rang the bell.

When no one answered, he taped a letter to the door offering the occupants $1,000 to move out. The catch: They won't get a cent if they trash the house before they leave. "If it was me, I'd take the money," Mr. Buompensiero said as he drove away. Either way, they're "going to get thrown out in a couple of weeks."

The stucco subdivisions of Las Vegas are caught up in the nation's foreclosure crisis. These days, bankers and mortgage companies often find that by the time they get the keys back, embittered homeowners have stripped out appliances, punched holes in walls, dumped paint on carpets and, as a parting gift, locked their pets inside to wreak further havoc.

Real-estate agents estimate that about half of foreclosed properties to be sold by mortgage companies nationwide have "substantial" damage, according to a new survey by Campbell Communications, a marketing and research firm based in Washington, D.C.

The most practical way to ensure the houses are returned in decent shape, lenders and their agents say, is to pay homeowners hundreds or even thousands of dollars to put their anger in escrow and leave quietly. A ransom? A bribe? "Yeah, somewhat," says John Carver, an agent specializing in foreclosed homes for Prudential Americana Group in Las Vegas. But "you lose a house, and then you get some financial help -- it's a good thing...It's a win-win for both parties."

No one tracks how frequently such payoffs are made. In Las Vegas, agents hired by the banks to handle foreclosed properties say the "cash for keys" approach, as it's known in the industry, is a regular part of the job. After all, formal eviction proceedings can take months and cost potentially much more than a payoff.

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