Debt Rattle, April 15 2008: The Albania Model

Nebraska 1940: No child left behind

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See also today's Siegfried & Roy, Greenspan & Bernanke
and The Fury of the Poor

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Ilargi: Looking outside, where spring is kicking in for real, I’d almost get all happy and positive. Looking at the news, though, I get the opposite effect. The reality of what is going on at Fannie and Freddie (we can include Ginnie Mae, FHA and FHLB) is hitting home in the main media. Of course this comes long after you have been able to read it here, nothing new there.

I must admit, some of the numbers surprise even me. F&F’s share of the US new mortgage market has increased to over 80%. That is totally insane. How bad do you imagine home sales would be without all that public money? It’s Nationalization 101.

Those of you who are regulars at The Automatic Earth know that I’ve been talking about nationalization for a long time. Well, it’s starting to get worse. If home prices dive another 15%, says economist Kenneth Rogoff, F&F will not ”be able to withstand it”. Does anyone still doubt they will lose that added 15%? I think they’ll go down over 50% more.

Then we get into Nationalization 102. Now, understand this: the US will never use the actual term “nationalization”. But there is no longer any chance that F&F will not be incorporated in the government. If it would not be done, their multi-trillion dollar portfolio’s would fail, dragging the entire financial system with them. This option was discarded long ago; therefore, the GSE’s could easily be encouraged to grow at breakneck speed, since all losses will be absorbed by taxpayers anyway. It was decided long ago.

Since last Wednesday, when the Fed announced the intention to become a giant debtor to the American people, instead of the creditor it is by law required to be, the whole discussion about nationalization has become sort of obsolete. Or, to put it in the symbolic terms, or metaphors, I have been using here, we are on the doorstep of the cross-over between The Bulgaria Model and the next phase, The Albania Model. The difference is of course that in Albania, secrecy and oppression were -perhaps still are- an order of magnitude more severe. Think of it as meaning that you yourself are being nationalized, not just the housing and finance sector.

And you’re just letting it happen, and listen to nonsense about markets picking up later in the year, and good deals on homes and loans. It’s over, people, it really is, the model is broken, and will never be repaired. This is the end of an era, and teh end of a lot of freedoms you have enjoyed and taken for granted.

In other fine news: see what happens to banks trying to sell bad debt, and be ready to look for failures in major US and European financial institutions, before summer. That's my prediction.


Fannie, Freddie Threaten US Government Credit Rating

A deep recession could force mortgage-finance titans Fannie Mae and Freddie Mac to require a federal bailout large enough to hurt the U.S. government's top-grade credit rating, Standard & Poor's warned Monday. A lower credit rating would mean higher borrowing costs for the U.S. government and could lead to a flight from Treasury securities, which investors — including foreign governments — consider to be virtually risk-free.

The financial stress Fannie and Freddie may face poses a far larger risk to the government than the $29 billion in mortgage assets taken on by the Federal Reserve to avoid the bankruptcy of investment bank Bear Stearns Cos, the credit rating agency said. Still, S&P analysts see a bailout of Fannie and Freddie as unlikely and point out that U.S. officials "are focused on avoiding a deep and prolonged recession."

While the government isn't obligated to assist Fannie or Freddie in a financial emergency, many on Wall Street believe it would bail them out if there is a collapse. The idea that they are "too big to fail" enables the two companies to borrow relatively cheaply by issuing top-rated securities backed by mortgages.

Washington-based Fannie and McLean, Va.-based Freddie face intense pressure to do more to help out a hobbled housing market. Over the past year, their share of new mortgages has soared, as Wall Street investors have backed away from all but the safest mortgage investments. The two companies' share of new mortgages rose from 46 percent in the second quarter of 2007 to 82 percent in January, S&P said.

Encouraged by regulators and politicians intent on keeping more homeowners from defaulting, Fannie Mae and its smaller government-sponsored sibling Freddie Mac have expanded their roles in the stricken housing market. The companies together must provide as much as $200 billion in new funding for home loans in exchange for getting their risk cash cushions reduced. The government requires them to keep a certain amount on reserve to guard against risk.

The Bush administration has long been concerned about the risks posed by Fannie and Freddie, but given a housing market on the skids, has no choice but to let the two play a bigger role, said David Jones, president of Denver-based consulting firm DMJ Advisors. "It's a risk the government has to take," he said, adding that the country's $14 trillion economy is strong enough to insulate the government's credit rating from a downgrade.

Many analysts, however, believe the government's actions expose Fannie and Freddie to more risk. "If housing prices go down another 15 percent, they're not going to be able to withstand it," said Harvard University economist Kenneth Rogoff.

But it's not just economists and policymakers who are closely monitoring the growing dependence on Fannie and Freddie. Their shareholders, too, should see the reliance as a "growing concern," Piper Jaffray analyst Robert Napoli wrote in a research report Monday. "The U.S. government will go to great lengths to lessen the pain of this housing market downturn," Napoli wrote, adding that shareholders' stake in the company could wind up being diluted as the companies may be pressured to raise more capital than investors desire.

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Goldman Sachs and Wells Fargo warn 'delusional' investors on stocks

Wall Street faces the growing risk of an equities bloodbath in coming months as the credit crunch spreads to the wider economy and earnings crumble, according to a pair of grim reports issued by Goldman Sachs and Wells Fargo. David Kostin, the chief US investment guru for Goldman Sachs, expects the S&P 500 index of Wall Street equities to plummet a further 15pc over the "near term" as companies scramble to lower their outlook for this year.

"Although only a few firms have reported first quarter results, early signs are awful. We expect a swath of lowered profit guidance," he said in a research note published today, entitled 'Fasten Seatbelts'. Mr Kostin, who replaced the ever-bullish Abby Cohen as chief strategist in December, expects the S&P index to reach 1,160, which would amount to a fall of 27pc from the bull market peak of 1,576 in September and enter the annals as a relatively severe bear market.

Goldman Sachs was the only major investment bank on Wall Street to turn a profit from the credit crunch, taking out huge "short" positions on sub-prime mortgage bonds before they went into a tailspin. The firm's daily trading notes are one of the most closely watched sources in global finance.

Scott Anderson, chief economist at Wells Fargo, is equally pessimistic, describing the bullish views of some market players as "bordering on delusional". "The equity markets have not yet priced in a prolonged downturn in economic growth in my opinion. We are still in the early stages of the credit crunch. Earnings estimates for the second half of the year are likely still far too high," he said.

Mr Anderson said investors should pay attention when the International Monetary Fund cuts its global growth forecast for 2008 three times in less than five months. The Fund has put the odds of a world recession at 25pc and predicted $945bn in losses from the credit debacle spread across banks, hedge funds, pension funds, and insurers.

"Even more alarming, the IMF estimates that only a quarter of these potential losses have been recognized," he said. "Rarely do we ever see such uncertainty surrounding the economic and financial outlook. The forecasts for GDP growth in the second quarter of 2008 are currently all over the map. If you feel you must wade into equities at the present time, I would suggest spreading your bets widely," he said.

Goldman Sachs said the key for equities will be the full-year guidance offered by companies rather than first quarter profits. It cited the example of Bed Bath & Beyond, where the stock fell sharply last week after the firm said the earnings prospects for 2008 would be around 16pc below consensus estimates.

Mr Kostin said investors often "look through" downturns, preparing for the sunny uplands that lie on the other side as the cycle recovers. But the pattern in this bear market has been a series of earnings shocks precipitating sudden share price falls. The implication is that investment funds have been caught badly off guard by the severity of the economic slump and are scrambling to catch up with reality.

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Wall Street braced for further $11bn writedown at Citigroup

One of Wall Street's most influential analysts has predicted a further $11 billion (£5.6 billion) of writedowns at Citigroup when the banking giant reports its first-quarter figures on Friday. Meredith Whitney, the first analyst to forecast correctly that Citigroup would need to cut its dividend to prop up its finances, said that she expected a writedown, which would be on top of $18 billion of writedowns in the third and fourth quarters. It would mean that Citigroup would record an overall group loss of nearly $7 billion in the first quarter.

Merrill Lynch, the biggest American banking casualty of the credit crunch, with $24 billion of writedowns so far, will report its latest losses on Thursday, the day before Citigroup. Brad Hintz, an analyst at Sanford Bernstein, expects the group to take a $4.5 billion writedown for the first quarter. Ms Whitney believes that the figure will be $6 billion, giving the group an overall loss of $3 a share. Mr Hintz is forecasting a group loss of $1.60 a share, compared with a profit of $2.26 a share the previous year.

Mr Hintz said: “With $30 billion of collatoralised debt obligations [high-risk and complex securities] still on Merrill's balance sheet at the end of 2007, we believe the ‘CDO overhang' will be an ongoing concern for the firm over the next 24 months.” JPMorgan Chase has faired much better than most of its rivals in the sub-prime crisis, yet still the bank is expected to take a $2.8 billion writedown when it announces its first-quarter results on Wednesday. Analysts forecast that this will push the bank's profit for the period down to seven cents a share, from $1.34 a share a year ago.

Washington Mutual (WaMu), which agreed a $7 billion cash injection last week, is among the other American banks still thought to have more big writedowns to come. The savings and loans institution will take a $14 billion writedown on its remaining sub-prime mortgage portfolio for the year, James Fotherington, a Goldman Sachs analyst said. WaMu announced an overall group loss of $1.1 billion, or $1.40 a share, for the first quarter last week as it nearly doubled its forecast writedowns on credit securities to $3.5 billion.

UBS, the European bank most damaged by the credit crunch, said at the weekend that it had weathered the worst of its problems. Marcel Rohner, chief executive of Switzerland's largest bank, said that it was “no longer at the lowest point.
“There are certain factors that we cannot influence, however, such as the US real estate market. There, there is volatility,” he told SonntagsZeitung. “But we are strong enough to manage our risks and our positions. Now it is about winning back the destroyed trust on the customer side.”

Mr Rohner said that trading had picked up in areas where there had been no markets for months. “This is generally a sign that an end [of the financial crisis] is foreseeable,” he said. The UBS chief said that he would reveal next month how many jobs would go at the bank, but he insisted that estimates of 3,000 to 4,000 redundancies in its investment banking business were too high.

Peter Kurer, who has been proposed by the UBS board as a replacement for outgoing chairman Marcel Ospel, told Neue Zuercher Zeitung that UBS's writedowns could not get any worse because they had already been so aggressive. The bank has taken a $37 billion hit on credit-related assets and has asked investors for SwFr28 billion (£14.2 billion) worth of emergency cash.

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The Inflation Solution to the Housing Mess

The policy alternatives in the post-housing-bubble world are painfully unpleasant. In my view, the least bad option is for the Federal Reserve to print money to help stabilize housing prices and financial markets. Yes, use reflation to soften the pain for Main Street and Wall Street. If instead we let housing prices fall another 25%-30% – as predicted by the Case-Shiller Home Price Index – it's almost certain that Washington will end up nationalizing the mortgage business.

So far, the Fed's lending programs have not provided adequate liquidity to financial markets: Reserves supplied to the banking system have grown at a tiny 0.6% annual rate since December. That's because the reserves the Fed is injecting by lending are effectively pulled out or "sterilized" by its sales of Treasury securities. The Fed has been selling these securities to keep the fed funds rate at the level targeted by its Federal Open Market Committee directives.

Congress and the Treasury have proposed voluntary measures to help mortgage borrowers, but the impact on mortgage availability has been nil. As average house prices plummet – declining at a 23% annual rate over the three months ending in January – lenders are sharply curtailing access to mortgage-based, home-equity loans. The 15% of U.S. mortgage holders with negative equity in their homes have no access to credit, and 20% with marginal equity have limited access at best. Overall access to credit is contracting: Ask Americans trying to utilize home-equity lines or arrange student loans.

Meanwhile, the collapse of house prices and the attendant damage to credit markets have become so severe that the Fed has been forced to create new policy measures at a fast clip, including the radical decision to take $30 billion worth of Bear Stearns' risky mortgages onto its own balance sheet, and to open the discount window to investment banks.

The bottom line is this: The Fed could have watched a run on investment banks quickly turn into a run on commercial banks, or protected the creditors of investment banks (like the depositors of commercial banks) at the expense of Bear Stearns' shareholders. The Fed wisely chose the second alternative.

Still, the Fed's intervention has done no more than buy a respite from the crisis in the financial markets. The monetary easing I'm recommending can occur by having the Fed print money to purchase mortgages directly, or purchase Treasury securities directly. The latter is probably more desirable because it adds higher-quality assets to the Fed's balance sheet. The Bank of Japan was also forced to reflate by printing money in 2001, after two years of a zero interest-rate policy failed to lift the economy out of a prolonged recession that had moved Japan to the brink of a deflationary crisis.

Fed reflation – to slow the fall in home prices and alleviate the distress for households and lenders – carries many risks. But the alternative is to struggle with a patchwork of inadequate efforts to shore up mortgage markets, while the Fed sticks to its current tactic of pegging the fed funds rate without increasing the money supply. This, I would submit, is even more risky. It risks a severe recession that will only intensify the drive for reregulation of financial and mortgage markets after the election.

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Ilargi: We have predicted it often: there is a flood of questionable debt sitting on banks’ balance sheets, and they all try to sell it at the same time. Of course that means prices plunge. As a result, new standards for offloading bad debt are “silently’ set these days. Citi was supposed to get 90 cents on the dollar because it gave the purchase money away to the buyers. Not even that works, though. The buyers insist on being able to pick only the best debt, even with these conditions.

Goldman has chosen to sell outright; the result is 65 cents on the dollar. Chrysler’s value: 63 cents.

The reason they are so eager to get the debt off their sheets is, apart from dismal overall numbers, the hunger for new deals. These banks have relied, in the past few years, to a large extent on fees from deals such as these to generate profits. And they truly are like sharks: they can’t stop swimming, or they will face the big banker in the sky.

How Bad Is It: The Going Price for Buyout Debt

Citigroup and Deutsche Bank aren’t the only investment banks trying to shuffle off billions of dollars of debt related to leveraged buyouts. Goldman Sachs Group and other banks also are trying to sell some of what they have on their books. Take Goldman, which along with Dresdner Kleinwort, backed the financing for Bain Capital’s €1.4 billion acquisition ($2.2 billion) of German yacht maker Bavaria Yachtbau. Goldman sold €100 million of the debt related to the deal at 65 cents on the euro and is holding on to another €300 million.

On this side of the Atlantic, Wachovia is getting slightly better prices. The firm accounted for $6.5 billion of unfunded commitments in the first quarter at prices “in the low to mid-80s in terms of a price that we’ve applied for these securities,” said Wachovia Chief Financial Officer Tom Wurtz on today’s conference call. Wurtz called that estimate “conservative.” It actually might be right in line with other offerings. According to Standard & Poor’s Leveraged Commentary & Data, Citigroup is trying to sell a $500 million block of covenant-lite debt from auto-parts supplier Federal Mogul, which emerged from bankruptcy last year. Another $500 million of the company’s debt is being sold in Citigroup’s $12 billion sale.

These prices are indicators of the market right now as Citigroup prepares to sell off $12 billion of leveraged loans and Deutsche Bank prepares for its sale. These banks are heavily exposed to leveraged loans and need to clear their backlogs, but that isn’t stopping them and their rivals from picking up new deals. For instance, J.P. Morgan Chase, Deutsche Bank, Morgan Stanley Senior Funding and BNP Paribas will provide financing to back Manitowoc Co.’s $2.1 billion acquisition of Enodis.

According to Standard & Poors Leveraged Commentary & Data, “The credit agreement provides for committed funds of $2.4 billion, which will be used to finance the offer, refinance existing debt, cover expenses of the merger and provide ongoing working capital for the enlarged Manitowoc Group.” And RBC Capital Markets has underwritten the debt involved in Apax Partners’ $1.4 billion buyout of medical software concern TriZetto Group.

The Goldman involvement in Yachtbau, however, has to be a reminder of the “good cop, bad cop” situation in the credit markets. Where Goldman is willing to take a haircut on the financing Bain’s deal, there are six other banks digging in their heels on the much larger financing for another Bain deal: the pending $19.4 billion buyout of Clear Channel Communications.

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Goldman Sachs' huge discount offloads debt

Goldman Sachs has been forced to give investors the largest discount yet offered by an investment bank in the credit crunch in an attempt to offload loans linked to a highly leveraged buyout, The Times has learnt. Goldman Sachs and Dresdner Kleinwort agreed to back Bain Capital’s €1.4 billion (£1.1 billion) buyout of Bavaria Yachtbau GmbH, one of Europe’s largest yachtmakers, last June.

A month after the deal closed, the credit crunch took hold and the banks were forced to sit on €900 million worth of Bain’s debt as investor appetite for leveraged deals dried up. Now Goldman Sachs has agreed to sell €100 million of the senior debt at 65 cents in the euro. The bank, which declined to comment, has been marketing the deal and took investors, mainly hedge funds, to meet the group’s management in a bid to persuade them to buy the debt.

Sources said that there were doubts about the health of the yacht manufacturer as some of its customers - bankers and hedge fund managers - have been hit by the credit crunch. It is understood that Goldman Sachs will sit on its €350 million share of the remaining debt. Dresdner Kleinwort is believed to have decided to sit on its share of the debt for longer. The discount is an example of what banks are prepared to do to shift high-risk leveraged loans off their balance sheets.

“They’re prepared to crystallise losses just to get this stuff off their books,” one banker with knowledge of the deal said. This week, Citigroup agreed to sell a heavily discounted $12 billion (£6 billion) package of leveraged loans to a group of private equity buyers. To persuade them to buy the loans at 90 cents in the dollar, Citigroup lent the buyers about two thirds of the price in new loans. Goldman Sachs has been one of the few banks that has managed to steer clear of the full onslaught of the credit crisis. One trader said: “This is clearly the deal that Goldman is most worried about.”

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Buyout Debt Butout: Let Me Help You to Help Me

Lawsuit, schmawsuit. A Bain Capital affiliate, Sankaty Advisors, is considering buying some of the $20 billion in debt Deutsche Bank is selling off. The move is interesting in part because Bain and Deutsche Bank are two of the parties locked in lawsuits surrounding the $19.4 billion buyout of Clear Channel Communications.

Are the talks an olive branch between Bain and one of its recalcitrant lenders? Probably not entirely. The early talks more likely are an act of enlightened self-interest by Bain and Sankaty. For one thing, debt right now is cheap, and quite a few firms are snapping up loans at 80 cents or less on the dollar in the hopes of a profitable turnaround in the debt markets. More importantly, if Bain helps Deutsche Bank clear its books, there probably is a better chance of getting the Clear Channel deal done.

That deal is hung up on arguments over financing; Deutsche Bank, along with Citigroup, Morgan Stanley and three other banks, stand to post a loss of roughly $3 billion on the debt securities that will be sold to finance the Clear Channel buyout, based on current market prices. The banks have dug in their heels in negotiations because they can’t think of distributing any new debt until they clear their warehouses of the immense backlog. At the end of 2007, for instance, Deutsche Bank had $55 billion of leveraged loans held on its balance sheet, while Citigroup had $43 billion.

That is why Sankaty’s emergence as a potential buyer shows how smart it is for private-equity firms to have access to a fund that buys up debt, particularly in times of crisis. Sankaty shares Bain’s Boston headquarters and many of Sankaty’s leaders, including Chief Investment Officer Jonathan Lavine, are former Bain Capital staffers. Sankaty–named after that Nantucket lighthouse above left–was set up in October 1997 by former Bain Capital partner Marc Wolpow, who left Bain in 1999–after the departure of former chief Mitt Romney–to start another private-equity fund.[..]

It is unclear how far talks between Sankaty and Deutsche Bank have progressed, and the Bain affiliate may end up not buying anything from Deutsche at all. Still, the fact that it is showing interest is a sign that the ties between private-equity firms and investment banks may be too tight to cut.

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Citi allows loan ‘cherry picking’

Citigroup is allowing private equity groups bidding for up to $12bn of its leveraged loans to cherry-pick from a wide range of assets with different prices and credit ratings – a move that could complicate Citi’s efforts to clean up its balance sheet. People close to the situation said that, rather than selling the loans as a block, Citi was asking buy-out firms including Apollo, TPG and Blackstone to choose from a menu of leveraged loans used to fund at least seven major buy-out deals.

The assets range from loans used to fund Cerberus Capital Management’s deal to buy a stake in Chrysler, which now trades as low as 63 cents on the dollar, to better-performing credits, such as those financing the $45bn buyout of utility TXU. People familiar with the sale said private equity groups were likely to focus on loans linked to deals they knew well, while steering clear of those that were perceived as troubled or unlikely to recover. As a result, Citi might end up selling less than the $12bn it had originally targeted, they added.

News of Citi’s piecemeal approach comes as it emerged that Deutsche Bank has been trying to sell parts of its €36bn ($56bn) portfolio in leveraged loans to private equity groups since August. Last year, the US unit of Credit Suisse sold off $20bn of its buyout financing. Goldman Sachs also has sold off large chunks of its portfolio of leveraged loans. People close to the situation said that Deutsche was in discussions to sell €5-6bn of loans to Apollo Management, one of the most aggressive buyers of distressed debt, and Blackstone Group in a deal that involves the use of borrowed money from Deutsche Bank.

People familiar with the Citi sale said the bank and the potential buyers were still negotiating the terms and scope of the sale. People who have seen a recent list of loans on offer said it contained up to $2.6bn in loans pegged to the $27.5bn buy-out of Alltel, along with another $1.2bn in debt used to finance the TXU deal. Citigroup is also working to sell off $1.2bn of exposure to the $17.3bn buy-out of gaming company Harrah’s, and $1.3bn of loans tied to the takeover of telecoms equipment company Avaya.

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Bankruptcies Rise for Firms 'That Should Have Failed'

U.S. corporate bankruptcies are accelerating as the economic slowdown compounds the end of easy credit.
The filing by Frontier Airlines Holdings Inc. April 11 followed those of three other airlines and companies in restaurants and retailing this year. Increased levels of distressed corporate debt signal that failures will accelerate, says Lynn LoPucki, a professor at the University of California, Los Angeles law school who studies bankruptcies.

The amount of distressed corporate bonds jumped to $206 billion April 11 from $4.4 billion in March 2007, according to a Merrill Lynch & Co. index of bonds yielding at least 10 percentage points more than Treasuries. The share of leveraged loans considered distressed was 16 percent at the end of March, the highest since 1997, says Standard & Poor's, based on loans trading below 80 percent of their face value.

"Money was so easy, companies that should have failed were kept alive," said Rick Cieri, a bankruptcy lawyer at Kirkland & Ellis in New York. He said bankruptcies will include businesses "with severe operational problems" and too much debt. "Companies may well be sicker when they enter Chapter 11." A company bankruptcy isn't just a sign of a weakening economy, LoPucki says. There is an economic effect.

"It is a disruption of the use of resources, and the costs of redeploying them are huge," said LoPucki, who keeps a Web site and wrote the 2005 book, "Courting Failure: How Competition for Big Cases is Corrupting the Bankruptcy Courts." "People need to look for new jobs. Someone needs to take physical assets and recycle them. All the organizational work that went into the construction of the enterprise is lost."

Bankruptcy filings have just begun to increase. According to court records compiled by Jupiter eSources LLC, Chapter 11 business bankruptcies, including small, nonpublic companies, increased 16 percent in the first quarter of 2008. Under Chapter 11 of U.S. bankruptcy law, a company seeks court protection from creditor lawsuits while working out a reorganization. "I think this is the beginning," said Brett Barragate, a bankruptcy lawyer at Jones Day in New York. "You have rising defaults into a market where it's virtually impossible to get refinanced."

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Swaps Tied to Losses Became 'Frankenstein's Monster'

The credit-default swap market has become a lesson in being careful what you wish for now that Wall Street has taken $245 billion of losses partly tied to such exotica. Rather than dispersing risk and lowering borrowing costs as former Federal Reserve Chairman Alan Greenspan predicted, the contracts have exacerbated the debt crisis. What was intended as a way for lenders to protect against defaults spawned a market covering $45 trillion of bonds and loans where no one knows how much is traded and speculators who bet on deteriorating credit quality end up forcing that reality.

Some credit-default indexes have morphed into what Wachovia Corp. analysts led by Glenn Schultz call "Frankenstein's monster" because they now often drive prices in the so-called cash bond market, rather than the other way around. Fearing a repeat of losses, banks are refusing to support new indexes that would allow investors to wager on everything from auto loans to European mortgages, reining in a market that's about doubled in size every year for the past decade.

"The indices are just trading on their own account with no relationship whatsoever to an underlying cash market that's ceased to exist," Jacques Aigrain, chief executive officer of Zurich-based Swiss Reinsurance Co., said at a March 18 insurance conference in Dubai.

Markit Group Ltd., the London-based index provider, said banks last month shelved plans for indexes intended to allow investors to speculate on the $200 billion market for bonds backed by U.S. auto loans because of a lack of dealer support. Indexes on European mortgages and U.S. Alt-A loans, or mortgages made to borrowers a step above subprime, were also postponed. "The last thing the securitization market needs is another no-cash-upfront instrument that people can use to knock the markets about with," said Andrew Dennis, the London-based head of the asset-backed debt syndication group for UBS AG of Zurich.

Wachovia, based in Charlotte, North Carolina, wrote down $600 million of commercial mortgages in January because of declines in prices indicated by CMBX indexes, which measure the derivatives tied to bonds backed by loans on everything from offices to shopping malls. New York-based Citigroup Inc., the largest U.S. bank by assets, wrote down its subprime holdings by $18.1 billion after using ABX credit-default swap indexes that track securities derived from the loans to help value the assets.

Accounting rules require companies to estimate a value for some assets that are seldom traded and to record any change as an unrealized gain or loss. Where quoted prices aren't available, companies are required to use other measures, such as indexes of credit-default swaps. "The dealers got caught in a vicious cycle," said Schultz, head of asset-backed bond research at Wachovia. "They did a great job of selling the indexes. At the end of the day, they had to mark their own books to the prices on the indexes. They fell victim to their own sales job."

Investors, traders and bankers start gathering today in Vienna for the International Swaps and Derivatives Association conference's annual meeting. The damage on Wall Street has been exacerbated by the ABX indexes, which are based on a sample of 20 bonds from the thousands backed by home loans to Americans with poor credit. The ABX is the main benchmark that prompted banks and securities firms to write down the value of collateral provided by mortgage companies in exchange for financing.

The latest version for AAA rated subprime mortgage bonds slumped by 43 percent since it began trading in August, according to Markit, as rising U.S. home loan delinquencies triggered a surge in the cost of credit-default swaps. That implies a 53 percent loss on the underlying mortgages, according to Schultz, almost four times the 13.75 percent rate predicted by Wachovia.

The cost to protect $10 million of AAA commercial mortgage securities jumped 10-fold during one six-month period to $100,000 a year, based on the first CMBX index from Markit. That implies about 13 percent losses on the underlying loans, more than four times the 2.8 percent forecast in the event of a recession by JPMorgan Chase & Co. analyst Alan Todd in New York. "ABX, CMBX, any kind of X you like, are totally uncorrelated to any kind of underlying market," Swiss Re's Aigrain said at the Dubai conference.

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Wachovia’s pain felt on Wall Street, Fremont trading suspended, delisted

California's mortgage woes keep landing on Wall Street's doorstep. Wachovia Corp. surprised investors Monday by saying it had raised $7 billion in new capital and slashed its dividend. The nation's fourth-largest bank is shackled with billions of dollars in troubled adjustable-rate mortgages from its 2006 acquisition of a California savings and loan.
 
Also Monday, struggling lender Fremont General Corp. in Brea said it would sell its retail operations, including 22 bank branch offices in California and $5.6 billion in deposits, to CapitalSource Inc. of Chevy Chase, Md. The New York Stock Exchange suspended trading of Fremont shares and moved to delist the company, once the nation's fifth-largest provider of home loans to those with poor or little credit. The NYSE noted that Fremont had fallen below Big Board listing standards into penny-stock territory, with its stock trading at less than $1 for more than 30 consecutive days.

Wachovia's actions came as it reported a first-quarter loss of $393 million, a major disappointment to industry analysts who had expected a profit of about $900 million. The Charlotte, N.C., bank also set aside $2.8 billion for anticipated loan losses, a move that some experts said would probably be repeated in coming quarters. "You're still left wondering how much more there is to come," said analyst Donn Vickrey of Gradient Analytics Inc. in Scottsdale, Ariz. He said the rate of nonperforming loansat Wachovia was "still accelerating."

Wachovia's dismal earnings report weighed on other banking shares Monday and helped drag the stock market's major indexes slightly into negative territory. The Dow Jones industrial average fell 23.36 points to 12,302.06. Wachovia shares sank $2.26, or 8%, to $25.55, their lowest closing price since 2000.

Much of Wachovia's trouble stems from so-called option ARMs acquired in the bank's purchase of Oakland-based Golden West Financial Corp. When Wachovia acquired Golden West, nearly all of the savings and loan's mortgages were option ARMs. The loans now account for $121 billion of Wachovia's $170 billion of mortgages, the company said. s.

Wachovia's headaches didn't surprise everybody on Wall Street. Despite repeated denials by executives, Oppenheimer & Co. analyst Meredith Whitney predicted last week that the bank would cut its dividend. She was vindicated Monday when Wachovia said it would cut the quarterly dividend 41% to 37.5 cents a share.

She said the denials and the company's slowness to recognize publicly the extent of its mortgage-related problems -- well after such rivals as Bank of America Corp. took major write-offs -- raised "an issue of management credibility." Whitney said $18 billion worth of Wachovia's mortgages now exceeded the value of the underlying homes. She predicted that the bank would have to continue adding to its loan-loss reserves for at least the next two quarters.

Vickrey estimated that Wachovia also has $8 billion to $10 billion of additional mortgage-related exposure that doesn't show up on its balance sheet.

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U.S. Foreclosures Jump 57% as Homeowners Walk Away

U.S. foreclosure filings jumped 57 percent and bank repossessions more than doubled in March from a year earlier as adjustable mortgages increased and more owners gave up their homes to lenders. More than 234,000 properties were in some stage of foreclosure, or one in every 538 U.S. households, Irvine, California-based RealtyTrac Inc., a seller of default data, said today in a statement. Nevada, California and Florida had the highest foreclosure rates. Filings rose 5 percent from February.

About $460 billion of adjustable-rate loans are scheduled to reset this year, according to New York-based analysts at Citigroup Inc. Auction notices rose 32 percent from a year ago, a sign that more defaulting homeowners are "simply walking away and deeding their properties back to the foreclosing lender" rather than letting the home be auctioned, RealtyTrac Chief Executive Officer James Saccacio said in the statement.

"We're not near the bottom of this at all," said Kenneth Rosen, chairman of Rosen Real Estate Securities LLC, a hedge fund in Berkeley, California and chairman of the Fisher Center for Real Estate at the University of California at Berkeley. "The foreclosure process will accelerate throughout the year." Rising foreclosures will add more inventory to an already glutted market, keep home prices down through at least next year and thwart efforts by Congress and President George W. Bush to help homeowners avoid default, Rosen said in an interview.

About 2.5 million foreclosed properties will be on the market this year and in 2009, Lehman Brothers Holdings Inc. analysts led by Michelle Meyer said in an April 10 report. U.S. home price declines will probably double to a national average of 20 percent by next year, with lower values most likely in metropolitan areas in California, Florida, Arizona and Nevada, mortgage insurer PMI Group Inc. said last week in a report.

Borrowers who owe more on their mortgages than their homes are worth may be buffeted by increasing job losses in a "very substantial recession," Rosen said. About 8.8 million borrowers had home mortgages that exceeded the value of their property, Moody's Economy.com said last week. "At least 2 million jobs will be lost because of this recession, so we'll get a cumulative negative spiral," Rosen said. "A normal recession is 10 months. We think this one may be twice as long."

Bank seizures climbed 129 percent from a year earlier, according to RealtyTrac, which has a database of more than 1 million properties and monitors foreclosure filings including defaults notices, auction sale notices and bank repossessions. March was the 27th consecutive month of year-on-year monthly foreclosure increases. In February, foreclosure filings rose 60 percent.

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Mayday From FGIC

FGIC staked up a "For Sale" sign Monday afternoon, saying it's in talks for "strategic alternatives"--amusing words for a company that insisted only two weeks ago that everything was under control. The bond insurer, whose full name is Financial Guaranty Insurance Co., has been hit by numerous downgrades following the blowup of the mortgage securitization market. The Bermuda-based company lost $1.8 billion last year, making it difficult to sell contracts to repay bondholders if bond issuers default.

In a statement, FGIC said one of the options being considered would be to effectively split itself in two, raising capital to establish a new triple-A guarantor dedicated exclusively to municipal and government bonds. This company would also assume FGIC ’s existing public finance and international infrastructure business, it said. It also said it would consider a sale of all or part of the company. Any drop below a triple-A financial strength rating is a big hit to bond insurers and their customers, because they effectively transfer their ratings to bond issuers.

FGIC lost its triple-A rating in January. The ratings agencies have worried in recent months that there could be a surge in bond insurance claims because of rising delinquencies and defaults on mortgages. The phrase "beleaguered bond insurer" has entered the collective consciousness of investors, with a lack capital, drastic cuts in share prices and their business lines, and subsequent government hearings and interest from mega-investors. More than 70% of the $314 billion FGIC insures is local government debt--bonds floated to fix roads or build schools, for example.

The agencies that sell these bonds are able to raise money through taxes so their debt is generally considered safe. What has stung FGIC-- and its rivals in the bond insurance industry--is its expansion into "structured" bonds. FGIC insures more than $70 billion in mortgage debt, asset-backed bonds and other investments that have become a focal point of the credit crisis. The company, which is owned by the private-equity firms Blackstone and PMI, is also considering "reinsuring" all or parts of its book.

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London could lose 40,000 financial jobs: JPMorgan

Total job losses in London's City financial district are likely to hit 40,000 due to fallout from the U.S. subprime crisis and global credit crunch, analysts at JPMorgan said on Tuesday, doubling their previous estimates. The shakeout equates to 5 per cent of jobs compared with losses of 7 per cent after the dotcom bubble burst in 2000-01.
But the number of jobs in the City has grown dramatically since then on the back of a strong international economy and booming markets.

JPMorgan estimated last December that 20,000 City jobs would be lost in the current financial crisis. In a note published jointly last week by JPMorgan banking and property analysts, the U.S. bank warned of severe job cuts in 2008 and 2009 after an initial 10 per cent cull of staff in debt securitization, private equity, and other investment banking departments hammered by the turmoil in financial markets. Analyst Harm Meijer told Reuters on Tuesday that a widely reported forecast of 19,200 cumulative City job losses by the Centre for Economics and Business Research, an economics think-tank, was too optimistic.

That was despite the fact it was based on a wider definition of the “City” financial district, which included Canary Wharf and parts of the West End, but excluded non-financial employment. Meijer said on a like-for-like basis, JPMorgan expected up to 28,000 City job losses. Based on a rough space requirement of 150 square feet per office worker, 40,000 jobs equates to about 12 of London's landmark “Gherkin” buildings, adding to the potential overhang of supply just as completed developments begin to peak.

As a result, City vacancy rates were likely to peak at 12.2 per cent in 2009 while City office rents were set to fall by 16 per cent in 2008-2010, JPMorgan said. The hedge fund haunt of London's West End would also not be immune, with rents seen dropping by almost 9 per cent in the period, it said. Only Madrid of the key European office markets featured in JPMorgan's report was seen as more vulnerable, with a flat jobs market and a likely 22 per cent drop in rental growth in the next three years.

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UK house prices decline at record levels

House prices are experiencing their most widespread decline since records began because of the fallout from the credit crisis, a report released today shows. Almost four out of five chartered surveyors saw a fall in values in March, research by the Royal Institution of Chartered Surveyors has found.

RICS disclosed that they were the worst figures since it started compiling such data 30 years ago. The widespread nature of the decline has eclipsed the house price crash of the early 1990s, when two thirds of surveyors registered drops, it said. The RICS report blames the falls on the tightened lending conditions, a view echoed by economic commentators.

"Sentiment is at a very low ebb and will continue to remain depressed while the economy suffers from this unique blight," said Jeremy Leaf, a spokesman. "The slowdown in prices is directly attributable to a lack of available finance which has hit demand."

Ed Stansfield, of Capital Economics, warned that significant house-price falls appeared more likely than ever. He said: "It is grim. This is evidence of a lack of confidence among buyers and that the terms of lending are less generous than before. Lenders are offering them lower multiples of income, so they can't raise the necessary finance." With buyers unable to meet prices, values had to fall, he said.

Last week, the International Monetary Fund warned that house prices in Britain could fall by as much as 10 per cent in the next year. The monthly RICS report comes as further evidence emerged of the impact the financial crisis is having on households. Yesterday, the Office of National Statistics released inflation figures showing wholesale food prices have risen by 8.5 per cent over the past year. Independent research showed the average family's annual grocery bill had increased by almost £600.

The RICS report shows that more surveyors than ever - 73 per cent - believe that prices will fall over the next three months. The average number of unsold properties on their books has also risen from 66 last October to 90 last month. In the East Midlands, almost nine out of 10 surveyors reported falling prices, while 86 per cent said prices were dropping in East Anglia. Scotland is the only area in Britain where a majority of surveyors are not reporting falls, the report said.

Last Saturday, The Daily Telegraph disclosed that house prices have declined over the past year in 45 per cent of all England and Wales's 2,300 postcode districts, according to research by the analyst Hometrack.
Last week, Halifax statistics showed house prices tumbled by 2.5 per cent from February to March, the biggest such fall since 1992. Mr Stansfield said there was little that anyone could do to stop significant house price falls.

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Philips hit as Europe’s building boom deflates

The Dutch industrial giant Philips Electronics posted a 75pc drop in profits in the first quarter and warned of a squeeze in lighting sales as Europe’s construction boom deflates. The earnings slide came days after General Electric shocked Wall Street with grim results, raising fears that the global market for electronic and consumer goods is succumbing to the effects of the credit crunch.

Philips’ share price dropped 2.77pc to €23.20 in Amsterdam and set off a fresh round of jitters on Europe’s bourses. Technical analysts say European stocks are showing ominous signs of breaking down through key support levels. Pierre-Jean Sivignon, the group’s chief financial officer, said there were signs of weakening demand in the Europe, Japan, and across the mature economies.

"It is a situation we are watching: if there are things to be done, we would do them without wasting time," he said, alluding obliquely to retrenchment plans. "We’re seeing softness in professional lighting, especially in Spain. This is highly correlated to new building activity," he told the Daily Telegraph. Europe’s industrial output grew 0.3pc in February, but there were sharp variations between countries with falls of 0.2pc in Italy, 0.3 in Ireland, and 4.7pc in Greece.

Howard Archer, Europe economist at Global Insight, said the fall in Europe’s purchasing managers index in March from 52.4 to 48.2 points to a clear slowdown. "We suspect that Eurozone manufacturers will find life increasingly difficult over the coming months as they are buffeted by the very strong euro, elevated oil and commodity prices, and tighter lending conditions," he said.

Philips suffered losses of €95m on television sales, up from €51m a year ago as cut-throat competition from Asian producers eats into margins. It announced plans to pull out of the TV business altogether in the United States, reducing its operations to a branding deal with Japan’s Funai Electric. "Our results are clouded, more than we would like, by the adverse situation in our TV business," said the company.

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Rice hits a record high

U.S. rice futures rose to an all-time high on Tuesday, extending this year's gains to more than 60 per cent and prompting further concerns over global supplies, while corn kept within sight of recent records. Chicago Board of Trade rough rice futures for July delivery rose over 2 per cent, peaking at $22.22 (U.S.) a hundredweight.

CBOT rice prices have doubled since last September while Asian prices have soared even more sharply since January, as big importers have rushed to build stocks on fears that supplies will become scarce as exporters clamp down on shipments.
While wheat and soybean prices have fallen back from record highs earlier this year amid signs of improving supply, rice and corn have taken the lead in the grains complex, unnerving policy makers worried about inflation and, increasingly, unrest.

European grains futures opened mixed on Tuesday in very thin trade. Wheat was stable to lower with May off 1.00 euro at 233.75 euros a tonne by 0930 GMT and June maize up 0.25 euro at 200.25 euros a tonne. U.S. President George W. Bush on Monday announced $200-million in emergency food aid, a day after top finance and development officials from around the world called for urgent steps to stem rising food prices, warning social unrest would spread unless the cost of basic staples was contained.

A global decline in rice stocks in recent years coupled with export restrictions from big suppliers including Vietnam and India has fuelled rice's gains this year, said Kenji Kobayashi, a grains analyst at Kanetsu Asset Management in Tokyo. It has also encouraged hoarding. “There is almost daily news about rice now in the regular media, and there is a growing interest in it,” he said. Other grains have also risen due to active investment by money managers eager for a hedge against inflation, traders say.

Corn has staged a renewed rally on concern about slow progress in U.S. plantings because of wet weather, said Pat Cogswell of commodities broker MF Global. Oilseeds were buoyed on Monday by talk that China was seeking vegoils and on worries about supplies from Argentina, where talks continue between the government and farm workers after industrial action restricted supplies.

European rapeseed opened on a firm note, with May gaining 4.00 euros a tonne at 452.00 euros. Sources familiar with Chinese government trading said Beijing had bought 150,000 tonnes of soy oil and 300,000 tonnes of soybeans for state reserves last week to help minimize the impact on inflation of record high cooking oil prices.

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Canada: Credit crisis spurs foreign bank exodus

The credit crunch is realigning the top ranks of corporate lending, as beaten-up heavyweights such as Citigroup Inc. retreat and smaller domestic rivals such as Toronto-Dominion Bank and Royal Bank of Canada use their balance sheets to cement relationships. Recent loans to energy giants Petro-Canada and Suncor Energy Inc. show foreign banks are scaling back lending, while locals step up their commitment.

The shift began in August, when the collapse of the U.S. subprime mortgage market ended an era of easy credit, and shows no sign of stopping. “With the notable exception of JPMorgan, the American and European banks are pulling away from Canadian corporate lending,” said the Canadian head of one foreign-owned bank. The players are changing in part because banks with weakened balance sheets are unable or unwilling to lend. Citigroup, for example, is retrenching in the wake of an $18.1-billion (U.S.) writedown in the last quarter, while Bank of America recently cut its Canadian corporate lending team.

Corporations are also shifting the business to banks seen as more reliable or better capitalized. “Banks that have taken the biggest writedown on exposures to troubled credit products have suffered the biggest hits to their reputations,” concluded a study last week by U.S. consulting firm Greenwich Associates. The firm found that up to 25 per cent of corporate clients intend to cut ties with banks that have taken a pounding since August. The new order is showing up first in the oil patch, where massive borrowing is needed to fund oil sands development and other projects.

Petrocan leads the pack, with plans to spend $5.3-billion (Canadian) this year on a variety of projects and up to $7-billion of capital spending in each coming year. The last Petrocan loan, struck in 2006, featured 11 lenders. Five were domestic banks, with TD playing a relatively small role. The six foreign banks were JPMorgan, Citigroup, BNP Paribas, ABN Amro, HSBC Bank and Deutsche Bank. Petrocan secured its new $3.57-billion credit facility in recent weeks. TD doubled the size of its commitment, the largest increase in exposure among lenders.

Another bellwether market is leveraged buyout lending, where credit was easily obtained prior to August, but now strictly rationed. Where many banks are exiting, RBC head of global investment banking Doug McGregor makes a point by stating his teams are still in this business, citing recent loans to clients such as Onex. “Long-time relationships are being broken as banks walk away from lending to private equity clients,” said the head of one investment bank, who added that it typically takes a bank seven to 10 years to rebuild ties that break down over pulled credit.

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Canada ABCP: Firms balk at banks' immunity

A group of major Montreal companies stranded with troubled asset-backed commercial paper (ABCP) plans to challenge a blanket immunity proposal that would release bankers and other parties from any potential legal claims related to the investment crisis. Lawyers representing half-a-dozen Montreal companies, including Jean Coutu Group (PJC) Inc., Transat A.T. Inc. and Aéroports de Montréal, filed a motion in Superior Court of Ontario seeking to amend a court proposal to restructure $32-billion of ABCP frozen by last summer's credit market meltdown.

The restructuring is under bankruptcy court protection. Lawyers and spokesmen for the Montreal companies declined to comment. But people familiar with the motion said the group intends to challenge a proposed legal release that would make it impossible to sue any person or company involved in the creation, sale or financing of ABCP. The release was demanded by Canadian and foreign banks in exchange for their commitment to lend billions of dollars to support a workout plan that calls for investors to wait up to nine years for the troubled notes to be repaid.

It is understood that the Montreal companies are in discussions with other corporations to form a coalition to increase their leverage in court. One Montreal businessman, Hy Bloom of Ace Mortgage Corp., separately filed an affidavit in court stating it is “wrong and unfair” for him to be blocked from suing National Bank of Canada which he alleged improperly sold his companies the notes as a safe savings alternative. The bank “will be permitted to walk away unscathed” if lawsuits are denied, he said.

The corporate investors' strategy follows a successful campaign by an estimated 2,000 individual investors to demand repayment from the brokers and other financial institutions who sold them the flawed notes. Vancouver brokerage Canaccord Capital Inc. agreed last week buy back $138-million of ABCP held by 1,430 of its clients. Credential Securities, an investment dealer associated with credit unions, is also expected to unveil a plan to buy the notes back from about 300 clients this week.

Although the ABCP holdings of individual investors are only a fraction of the estimated $4- to $6-billion of ABCP owned by companies, the smaller investors as a group have more clout because collectively they account for the vast majority of votes required to win majority support for the restructuring proposal. To overcome their limited voting power, sources said, some corporations intend to ask the court to separate them into a separate class of investors. Such a move would mean that the restructuring could not succeed without the support of majority of corporate investors.

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Ilargi: Jeff Rubin is either delusional or an ordinary liar, and most likely he’s all of the above. So let me repeat my prediction from last year: CIBC -the bank- won’t see Christmas in one piece.

Canadian economy will avoid recession, CIBC forecasts

The Canadian economy will avoid being dragged into a recession by the U.S. downturn thanks to healthy domestic activity and strong commodity prices, a major Canadian financial institution forecast Monday. However, CIBC World Markets warned that Canada may slowly bleed factory jobs for years, and long after what it sees as a relatively short U.S. recession ends.

"The energy-and resource-rich Canadian economy will manage to sit out this U.S. recession ...," said Jeff Rubin, CIBC economist and one of the authors of the forecast. "Nevertheless manufacturing - and in particular, autos and parts - remains vulnerable, both to a U.S. recession and a parity exchange rate."
CIBC is forecasting that high commodity prices, which are cushioning Canada's resource sector, will push the loonie to US$1.05 by year end. The currency closed at US98.08 cents Monday, up from US97.71 cents Friday.

Oil, which CIBC sees reaching US$150 a barrel over the next several years, rose more than a dollar to a record high close of more than US$111 a barrel Monday. TD Bank, meanwhile, reported that its commodity price index, led by surging oil prices, "rallied strongly last week" to a "whopping" 29% more than a year earlier. CIBC forecast that continuing high commodity prices and the strong dollar will hurt central Canada's manufacturing-based economy.

"Weakness in the Ontario economy, which will likely come the closest to outright recession of any of the provinces, will likely spur further Bank of Canada rate cuts," Mr. Rubin said. CIBC expects another three-quarters of a percentage point reduction in interest rates here, somewhat less than in the U.S., which will also help lift the loonie.

Canadian economic growth will slow to 1.6% this year from 2.7% last year, it forecast but would rebound to a healthy 3% next year. While the U.S. slipped into recession in the first quarter of this year and will remain in a recession this quarter, it will start to recover in the summer, leading to 0.9% growth for the year, accelerating to 2.3% in 2009.

While the U.S. rebound will help Canada's struggling manufacturers, the strong dollar and a relatively heavy reliance on labour will continue to weigh heavily on the sector, it warned. "Relative to the U.S. Canadian manufacturing was loading up on workers during the cheap Canadian dollar era ...," Mr. Rubin noted, warning, "we could see years of slow bleeding in factory jobs and activity ... ."

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Ilargi: And while we’re on the topic of delusion, look at this. Where is that money going to come from, bozo?

Infrastructure spending expected to rise to US$2-trillion annually

Infrastructure has become a major theme in the global investment community with spending expected to average US$2-trillion annually through 2015. More than half of that is forecast to come from emerging economies. At the same time, the developed world is being forced to rebuild ageing infrastructure like airports, expand inadequate assets and respond to new demands like climate change.

In emerging markets, the public sector can tap large current account surpluses. But developed countries are seeing more private investment from sources like private equity, pension funds and sovereign wealth funds, which means reduced vulnerability to slowing spending in the public sector, Edward Kerschner, managing director of U.S. equity research at Citigroup said in a report.

All of this spending means opportunity for “builders” like engineers and construction firms. But “owners,” particularly private ones, that many cash-strapped governments in developed economies have turned to, can leverage both their experience and infrastructure assets to cash in on what Mr. Kerschner calls “economies of skill.” Meanwhile, since private ownership in some developing economies is not possible, the best opportunity is often for “operators” to pursue public-private partnerships, he noted.

Figures show that US$120-billion was raised by private infrastructure investors in the fifteen months through June 2007, while established infrastructure operators only have US$40-billion in capital available to invest. Mr. Kerschner puts these two numbers together (US$160-billion) and levers it up with 80% debt to produce US$800-billion in potential funding for new projects. But even if all of that were to be spent on new building and upgrading of existing assets, it would still be well short of the US$2-trillion in forecasted annual global infrastructure expenditures.

While pension funds have for the most part been slow to allocate funds to infrastructure, Mr. Kerschner notes that Australia and Canada have been quicker and therefore have higher levels of investment. Institutional investors also have the choice of whether they want to invest in an infrastructure fund or a project directly. Even the U.S. Senate Banking Committee is taking a look at establishing a new national bank specifically focused on investments in infrastructure priorities.

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Ilargi: Our friend Stranded Wind deservedly makes it into Kos promised land talking about the Iceland and Austria article I posted yesterday, Small change with global consequences. I changed your title, Iowa.

The Butterfly Effect of Finance

 Iceland has 315,000 people and their GDP is about $15 billion - about $47,000 per resident. Their banks were sensible in 2001, with just 4% of their loans being foreign debt. Fast forward to today and what do we find? Kaupthing had assets worth $63.6 billion, Glitnir $47.4 bilion and Landsbanski $49.1 billion.

Add those all up. $160 billion. Almost eleven times their GDP and the smallest is still triple their GDP. If even one of these goes under they can't bail them out. If even one of them goes under it will take down the other two due to the coupling between the banks as they share such a small economy. So ... Iceland alone has as much trouble as is chronicled on The Bank Implode-o-meter and they're just one tiny country. We've already seen what Bear Stearns running right up to the edge got us - a de facto nationalization of any bad bank debt.

 The world's financial system is under strain. Let me convert that into naval terms for you. The world's financial system is in the same position as a world war II era submarine with dead batteries stuck 400' below the surface. It's cold. It's dark. There is no power left to blow the ballast and thusly no way to climb back up to the sunlit surface. All of the vessel creaks and groans under strains it was never built to withstand; prayers of those aboard provide 22% of its structural material.

The Bear Stearns hedge fund collapse last August was the first stream of high pressure water penetrating the hull. The collapse of the entire Bear Stearns operation a few weeks ago was a loud *BANG* from the rear of the boat followed by the popping of everyone's eardrums as the pressure began to increase rapidly.
 
If this were a World War II submarine movie we'd switch to a view of the sonarman on a nearby destroyer listening to the crunching of collapsing bulkheads as the boat goes down with all hands. There won't be anyone in this role this time; the massive systemic fraud perpetrated with the shadow banking system of derivative issuers and holders is everywhere. We just don't have anywhere to bail this mess to even if we had the political will to do so.

So ... food riots are already happening in Haiti, Egypt, Kuwait, India (nuclear), Pakistan (nuclear), and twenty eight other countries named by the World Bank's president are considered in danger, including places like Indonesia, Yemen, Ghana, Uzbekistan and the Philippines. This is happening before the above described bulkhead collapsing really gets rolling.  The last depression got us the Sino-Japanese war, the Spanish civil war, the Italian adventure in Ethiopia, and it all rolled up into World War II. This will be worse, with nuclear weapons propagating and the major oil producing region of the world just inches away from boiling over like the Balkans did at the start of World War I.

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Lands of Waste and Debt
Many States Face Huge Budget Shortfalls

We cannot say what gift of prophecy or data tipped Bernanke to perceive a contraction, slight or otherwise. For us, it was the news that many states are reporting their largest budget shortfalls since the onsets of the most recent recessions, in 2001 and 1991.

The Center for Budget and Policy Priorities, which spends its days looking for ways to spend your money on bigger budgets and social-policy priorities, reports that at least 25 states face an imbalance between programs and revenues to support them. It dismisses the others as fortunate to have oil revenues or farm exports to tax. Last year at this time, the states were luxuriating in revenues. Nearly all found it easy to raise spending. The total spending of the states increased 9.3% in 2007, according to the National Association of State Budget Officers. This year, the growth in spending is slowing to a mere 4.7%.

Around the country, governors and their allies in their legislatures are talking out of both sides of their mouths. They are raising spending and they say that to sustain vital programs, they must raise taxes. This year, 42 governors have given state of the state addresses in which they proposed over 1,000 new initiatives, according to Input, a consultancy on prospects for doing business with governments.

Some of the states in the biggest trouble are the states with long attachment to inflated spending and higher taxes. Massachusetts has a budget gap of $1.3 billion. The legislature seems intent on a $1-a-pack increase in the cigarette tax, a corporate income-tax increase and a dip into the rainy day fund. But don't look for austerity -- three large bond issues to finance state "investments" in transportation, housing and higher education are on the agenda.

In imperial New York, the new governor and the legislative leaders face a $5 billion budget gap, largely because they have agreed on a 4.4% spending increase, to $124 billion. It includes a record 9% increase in state aid to local schools. Recently, Gov. David Patterson suggested reducing the spending increase by $800 million; the legislature whittled the "cut" to $300 million. The current plan includes a $1.50 increase in the cigarette tax, and they intend to try to levy sales taxes on goods sold on the Internet.

New Jersey Gov. Jon S. Corzine submitted a $33 billion budget claiming $2.7 billion in spending cuts, but they include unlikely reductions in sacrosanct state aid to communities. Corzine spoke the truth in February, when he said, "Frankly, New Jersey has a government its people cannot afford." Among those paying extra for it are the state's public employees: New Jersey has skipped $5.6 billion in pension contributions since 2003, bringing its pension deficit to $19.6 billion.

Arizona has a $1.8 billion budget gap, a wide chasm in a state budget attempting to spend little more than $11 billion. The legislature wants to keep the financing of public-school construction on a pay-as-you-go basis, but won't say how it can; the governor wants to borrow this year's payment. Maryland's legislature took the easy way out, raising the sales tax a penny to 6%, increasing the corporate income tax from 7% to 8.25% and doubling the cigarette tax to $2 a pack.

Then there's California, which takes the fiscal cake as usual. Gov. Arnold Schwarzenegger earlier this year declared that the "budget wolf" was at the door. The state intended to spend $116 billion and had only $101 billion of projected revenue. Presumably, this wolf is a refugee from the Disney version of "The Three Little Pigs." He's the wolf who huffed and puffed and blew down the pig houses made of straw and hay. In California, rest assured, the budget house is not made of brick.

Some $42 billion in new borrowing was approved by California voters in 2006. The legislature has approved another $7.7 billion in lease-appropriation debt, largely for prisons, and the governor's budget proposes $48.1 billion in additional bonding for votes in 2008 and 2010. Investors may be comforted to know that states enjoy an average Double-A bond rating on their general obligations. History suggests that the worst-rated states are far less likely to default on their bonds than the average Triple-A corporate issuers. But the news from the state capitals still indicates that business is not good.
The corpses planted in the good years have begun to sprout.

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