Debt Rattle, May 23 2008: Free market, without the market

Dorothea Lange: Six bits a day, June 1938
In Memphis, hundreds of colored laborers congregate near the bridge every morning at daylight in hopes of work chopping cotton on a plantation, where they are taken by truck. Reduced acreage has made employment scarce for this class of seasonal labor in all towns.
"You can't live the commonest way on six bits a day. Not alone nor no way.
A man like me can't get no foothold. It's a mighty tough old go.
The people here in the morning are hungry, raggedy, but they don't make no hungry march."

Ilargi: If there’s one single reason for the financial quicksand malaise we find ourselves sinking away in, more and deeper every day, it would be that the money brokers have, and have been allowed to, and have been encouraged to, value a broad spectrum of paper at prices that have nothing to do with real worth.

Much of it has been marked-to-model, where prices are decided solely by a software application, which does what it is programmed to do. Obviously, it’s easy to pick a model that does what you like it to do: get a good programmer, with few scruples, and anything goes. The more cynical and realistic observers call it mark-to-fantasy.

It must seem silly if you put it like this; you think: "this can’t be true". But make no mistake: that is how Wall Street, and the entire global mortgage and derivatives industries, and even the government, have been functioning since at least the early 1990’s. It took ten years for the truly perverse consequences to work their way through the markets, but they predictably took over everything. It’s simply too tempting and convenient to be able to give a piece of paper any value that suits you.

That way you can have a burger-flipper sign a $500.000 mortgage, and you can rack up $750 trillion in derivatives. If you can get away with that, you’re the king of the world; you’re printing your own money.

The banks now clamor for the mark-to-model model to persist, claiming that the markets are distorted, which they allege has a negative influence on values. But that’s the world upside down: the distortion came from the models in the first place, the distortion is not taking place now, when they are forced to sell paper. What’s happening now is reality is kicking in. Like all addicts, banks resist reality and daylight.

It seems an insane fantasy, as anyone who’s ever known an alcoholic or heroin junkie will recognize. So why are they very close to getting away with it? Because the very people you elected to Congress are in on it, and are just as addicted to spending YOUR money as Wall Street is. They want a free market, without the market.


Top banks call for relaxed writedown rules

The world’s leading banks have stepped up pressure to relax controversial accounting rules with a new plan aimed at breaking the “downward spiral” of huge writedowns, emergency fundraisings and fire-sales of assets.

The proposals on “fair value” accounting by the Institute of International Finance, an alliance of 300-plus companies chaired by Josef Ackermann, Deutsche Bank’s chairman, would enable financial companies to cushion the blow of financial crises by valuing illiquid assets using historical, rather than market, prices.

Under the plan, which has been obtained by the Financial Times, banks that decided to keep assets on their balance sheet would also be freed from the requirement to hold them to maturity and would be able to sell them after two years. The IIF’s proposals, which were sent to US and European central banks, governments and accounting watchdogs, underline financial groups’ view that the credit crunch will inflict long-lasting damage on their business.

The IIF’s paper says: “The writedowns required under current interpretations may be substantially in excess of any actual or reasonably probable loss on many instruments”. Financial companies around the world have been hit by more than $300bn in writedowns and been forced to raise more than $260bn from outside investors since last year, according to Bank of America analysts.

Senior bankers have long sought a change to the accounting rules, arguing that the requirement to mark the value of assets to the market price even when markets are illiquid or frozen creates a vicious circle of excessive losses, capital depletion and forced asset sales.

“Often dramatic writedowns of sound investments required under the current implementation of fair-value accounting adversely affect market sentiment, in turn leading to further writedowns...in a downward spiral that may lead to large-scale fire sales of assets,” the IIF’s paper argues.

However, accounting standard-setters in the US and Europe so far resisted pressure to relax fair value rules. Other regulators have also criticised financial companies for proposing rule changes that would reduce the impact of a crisis triggered in large part by their aggressive lending and underwriting practices. The IIF declined to comment.

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Banks kick out at marking to market

It is unwise to put the boot in when you do not have a leg to stand on. Yet that is what a tarnished banking industry risks with its critique of fair value accounting. The Institute of International Finance, an industry body, notes marking-to-market has “generally proven highly valuable”, but wants to amend rules in the medium term.

The IIF argues that marking-to-market can create a downward spiral in asset prices. It proposes that, in “disrupted markets”, banks?be?allowed to value instruments using their own models or book value. It also wants lenders to have the flexibility to move assets from trading books onto banking books, where mark-to-market rarely applies.

However diplomatically couched, the proposals are unedifying. After precipitating a crisis and then borrowing large amounts of public money, it takes an audacious industry to cast accounting as a villain. Banks did not complain when dodgy assets were going up. The 20 western institutions on the IIF board include most of the biggest losers from the crisis. Five have been forced into emergency equity raising, sometimes after being in deep denial.

Yet the proposal’s real weakness is in its logic, not its tone-deafness. The IIF wants “stable valuations” that “increase market confidence”. This is not the purpose of accounting standards. Even if market prices have overshot (the Bank of England reckons aggregate subprime securities are worth about 80 per cent of par, versus a market value of about 60 per cent), relying on banks’ interpretations is worse.

A generous view of the credit crisis is that banks lacked the competence to value assets accurately. A critical view is they chose not to. If anything, banks’ influence over their own disclosures, in particular Basel II risk weightings, should probably be lowered further.

There is a strong case that the crisis has been a triumph for fair value accounting. Within a year, the detritus created by systematic bad lending is being addressed, faulty managers are being removed and banks are beginning to restore their capital. Mark-to-market is part of the cure, not the disease.

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Ilargi: Today's NAR numbers are uglier than ugly. Bob Shiller says prices will come down 30%, I say 80%. Think of the $5000 homes sold in Detroit, and take your pick.

U.S. Economy: Home Resales Decline, Inventories Jump

Sales of previously owned homes in the U.S. fell in April and the supply of unsold properties reached a record, signaling no let-up in the 27-month housing slump. Purchases declined 1 percent to an annual rate of 4.89 million, higher than forecast, the National Association of Realtors said today in Washington. The median price fell 8 percent from April last year, the second-biggest drop.

"There is no indication that things are improving," said Christopher Low, chief economist at FTN Financial in New York, who forecast sales would drop to a 4.9 million pace. "Inventories will stay out of balance at least until the end of 2009 and prices will keep falling."

Defaults on subprime mortgages have prompted lenders to restrict credit, while falling property values have given buyers who are still able to get financing reason to delay purchases. The slide in home values may hurt consumer spending, which accounts for more than two-thirds of the economy.

Treasury securities, which had risen before the report, stayed higher. Benchmark 10-year note yields fell to 3.84 percent at 11:54 a.m. in New York, from 3.92 percent late yesterday. The Standard & Poor's 500 stock index dropped 1.2 percent to 1,377.5. Resales were forecast to fall 1.6 percent to a 4.85 million annual rate, according to the median forecast of 67 economists in a Bloomberg News survey. Sales were down 18 percent compared with April 2007.

The number of previously owned unsold homes on the market at the end of April jumped to 4.55 million from 4.12 million in March. The total represented 11.2 months' supply at the current sales pace, the highest on record and up from 10 months at the end of the prior month. The median price of an existing home fell to $202,300 from $219,900 in April 2007.

"We had an unrealistic run-up of prices and the faster they come back down to the real world the better," William Cheney, chief economist at John Hancock Financial Services in Boston, said in an interview with Bloomberg Television. "The faster prices come down, the quicker we can get back to an equilibrium where we actually have transactions."

Property values may drop more than 30 percent from their peak in 2006, Robert Shiller, an economics professor at Yale University and co-creator of a housing-price index, said in an interview with the London-based Times last month.

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Merrill Carves Out Distressed Asset Task Force

Mirroring a similar move this week by UBS AG, Wall Street firm Merrill Lynch & Co. is carving out a team of top sales executives to purge distressed mortgage-related assets from the company’s books. The new division, called FICC Asset Management, includes some of the company’s top fixed-income sales leaders and will be headed up by Doug Mallach, the company’s top fixed income sales exec, according to a report Thursday by Bloomberg News.

The new team will look to unload collateralized debt obligations backed by subprime mortgage bonds, as well as ostensibly subprime RMBS and other assets that are now trading for pennies on the dollar thanks to continued mortgage and credit woes in the primary housing market. Via Bloomberg (which gets Merrill stories early and often, given that the i-banking giant owns a 20 percent stake in the news platform):

Mallach’s appointment is “part of our ongoing effort to optimize our asset and risk profile,” David Sobotka, who oversees Merrill’s Fixed Income, Currencies and Commodities division, wrote in a May 21 memo that was confirmed by spokeswoman Danielle Robinson.
Merrill, the third-largest U.S. securities firm, had about $26 billion of senior collateralized debt obligations — securities formed by pooling mortgage bonds and other forms of debt — as of March 28. Investors are wary of assets linked to mortgages because of the U.S. housing market’s decline, and Merrill has had to write down its CDOs to about 32 percent of their original value, based on an April 17 estimate by Oppenheimer & Co. analyst Meredith Whitney.

CEO John Thain has been on a mission to eradicate bad MBS bets from the Wall Street giant’s balance sheet since taking the helm from ousted CEO Stan O’Neal. While the move isn’t as radical as UBS’ strategy of selling the assets off of its balance sheet to a third party and then looking for market vultures to buy, it’s a clear signal that many of Wall Street’s larger players are now looking to trade some of the more illiquid bonds on their books in an effort to clear the playing field.

Thain had originally begun talking up CDOs as a “good value” during January’s earning call in the hopes hedge funds and other investors might bite, but few funds had jumped into the mortgage-ridden junk bond market until recently. Even those that are now looking to buy, are doing so “very selectively,” one fund manager told Housing Wire on Thursday.

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JPMorgan Swap Deals Spur Probe as Default Stalks Alabama County

As nighttime temperatures plunged in Birmingham, Alabama, last October, Dora Bonner had a choice: either pay the gas bill so she could heat the home she shares with four grandchildren, or send the Birmingham Water Works a $250 check for her water and sewer bill.

Bonner, who is 73 and lives on Social Security, decided to keep the house from freezing. "I couldn't afford the water, so they shut it off,'' she says. Bonner's sewer bills have risen more than fourfold in the past decade. So have those of others in Jefferson County, which has 659,000 residents and includes Birmingham, the state's largest city.

What's threatening to increase them even more isn't the high cost of treating waste; it's the way county officials chose to finance the $3.2 billion in debt they took on to build a new sewer system. The county relied on advice from a bank, JPMorgan Chase & Co., to arrange its funding, rather than use competitive bidding. Like homeowners who took out mortgages they couldn't afford and didn't understand, Jefferson County officials rejected fixed- rate debt and borrowed instead at rates that varied with the market.

The county paid banks $120 million in fees -- six times the prevailing rate -- for $5.8 billion in interest-rate swaps. That was supposed to protect the county from rising rates for their bonds. Lending rates went the wrong way, putting the county $277 million deeper into debt.

In February, the county's interest rate soared to as much as 10 percent, up from 3 percent just weeks earlier. The swaps have now compounded the risk that Jefferson County will file for bankruptcy as it faces its worst financial crisis since it was founded in 1819.

The same subprime chaos that has felled chief executive officers on Wall Street and forced banks to write off $322 billion has plowed into Jefferson County and other municipalities. That means local officials now have to pay to banks money that otherwise might have been used to build schools, hospitals or public housing. Meanwhile, the U.S. Securities and Exchange Commission and the Justice Department are now investigating bankers and officials involved in Jefferson County's swap agreements.

Bankers who worked for New York-based Bear Stearns Cos. and JPMorgan when Jefferson County bought its swaps have been told they might face criminal charges under an antitrust investigation of the municipal derivatives industry, according to records filed with the Financial Industry Regulatory Authority Inc.

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Citigroup's ''Last Roman' CDO Shows Enron Accounting

Citigroup Inc. created a $2.5 billion mortgage-backed security called Bonifacius Ltd. in August as capital markets seized up and panic swept Wall Street. The issue took the name of a general, called by historian Edward Gibbon the "last of the Romans," who fought and died for a fading empire.

The bonds were created from subprime home loans as demand evaporated. Within six months, Bonifacius collapsed as homeowners fell behind on their payments in record numbers. Citigroup, Merrill Lynch & Co., UBS AG and other banks created more than $1.5 trillion of collateralized debt obligations like Bonifacius, keeping an undisclosed amount in off-balance-sheet funds called variable interest entities.

Bonifacius and $190 billion of similar securities have gone bust since October, spotlighting loopholes the Financial Accounting Standards Board failed to close when Enron Corp. went bankrupt in 2001 after disclosing investments that weren't on its books.

"They never got the real problem fixed after Enron," said Lynn Turner, the chief accountant for the Securities and Exchange Commission when the Enron scandal was exposed. "When people find out how little FASB did, they're going to be shocked. FASB needs to be taken out behind the woodshed and given a good whoopin'."

Variable interest entities, or VIEs, are a post-Enron version of special-purpose vehicles, the term for the investments Citigroup created that led to the demise of the energy-trading company. The lack of disclosure about VIEs is adding to concern among investors after financial institutions reported $382.6 billion of writedowns and losses from subprime-contaminated debt since the start of 2007.

A bank can set up a VIE as long as its partners stand to gain or lose the most from projected changes in the value of the underlying securities. Banks aren't required to disclose the assets they sell to their own VIEs, what price was paid, or whether they have lost value, making it harder for investors to determine when the subprime crisis will end.

Citigroup spokeswoman Danielle Romero-Apsilos declined to say whether Bonifacius was put in a VIE. The New York-based bank also didn't say if any losses from the security were included in the $7.4 billion it wrote down from the ventures since September. "We have provided extensive disclosures on our VIE and subprime CDO exposures and suggestions to the contrary are false," Romero-Apsilos said in an e-mailed statement today.

Citigroup shares, rising 66 cents, or 3.1 percent, to $21.72 in composite trading on the New York Stock Exchange, had fallen 61 percent from last year's high. The drop eliminated about $154 billion of market value as investors struggled to figure out the amount of the company's losses from subprime-linked securities. The company's losses and writedowns total $42.9 billion, more than any other bank, according to data compiled by Bloomberg.

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Home Purchase Prices Fall At Record Pace; Refis Tell Another Story

U.S. home prices fell in the first quarter of 2008 — and at a record pace, too, if you look only at purchases and exclude refinancing activity. The Office of Federal Housing Enterprise and Oversight said Thursday morning that its seasonally-adjusted first quarter index for purchases dropped 1.7 percent from the fourth quarter of 2007, the steepest quarterly decline in the purchase-only index’s 17-year history.

Annually, purchase prices have fallen 3.1 percent between Q1 2007 and Q1 2008, OFHEO said — also the largest annual price decline on record. Those sharp price decline numbers contrast with an all-transactions index, however, which adds in refinancing activity. OFHEO reported that its all-transactions house price index fell just 0.2 percent on a quarterly basis, and was actually flat on an annual comparison basis.

It’s not immediately clear why refinancing transactions would so strongly moderate price declines in the purchase only index. Sources that spoke with Housing Wire Thursday said that one reason may be that borrowers in neighborhoods less affected by the housing slump would be likely more able to refinance; others suggested that the pressure to hit target values could lead to inflated home prices in refinancing transactions.

OFHEO researchers [noted] that refinancing activity has been a “important factor that has affected” the overall HPI in recent quarters. Approximately 82.3 percent of all transactions in the first quarter all-transactions HPI were refinancings, OFHEO said, the highest such share of activity since the third quarter of 2003.

Click to enlarge

A look at the effect of appraisal data from refinance loans on the OFHEO HPI shows that refinancings led the OFHEO HPI to significantly overshoot the purchase-only HPI during the housing boom, and that now refinancing activity is leading the HPI to undershoot purchase-only transactions during the bust.

“I’d call that [graph] a smoking gun,” said one MBS analyst, who asked that his name not be used. “Appraisers were inflating home values on refis during the boom, enabling the home ATM, and now they’re faced with trying to keep homeowners in their home in many cases.”

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Ilargi: I haven’t mentioned the "Bulgaria Model" for a while, which I coined a few months ago.. Not to worry, we’re still perfectly on track. The state will own the houses and collect the rents. Maybe through the FHA, but that is all the same rancid soup.

PS: This is the third time this week I see braindead words coming from Dean Baker. Here’s from yesterday, in a piece on Americans’ multi-trillion dollar liabilities:
”Economist Dean Baker says the huge liabilities are potentially misleading because future generations will have greater income.”
That’s some weird utter nonsense from the co-director of the Center for Economic and Policy Research. Maybe we should look into Mr. Baker.

Democrat’s Proposal Would Turn Foreclosed Homeowners into Tenants

We’ve all heard of rent-to-own, but a new idea from House Rep. Raúl M. Grijalva (D-AZ) would turn troubled former homeowners into renters, sort of an own-to-rent housing proposal. On Thursday, Grijalva unveiled the proposal — H.R. 6116, the Saving Family Homes Act of 2008 — ahead of a House Committee on Oversight and Government Reform subcommitee meeting.

The Subcommittee on Domestic Policy, headed up by Dennis Kucinich (D-OH), had scheduled a hearing for Thursday afternoon to discuss how to target federal funds towards managing vacant and abandoned properties. Grijalva’s proposal would grant homeowners whose mortgages have been foreclosed the right to petition a judge to allow them to remain in the home as renters, and pay a fair market rent.

The rent would be set by a court-appointed appraiser and adjusted annually for inflation, the Congressman’s office said in a press statement. The proposal would limit eligibility to mortgages on single-family, principal residences, occupied for at least 2 years, which sold for less than the median home value in the metropolitan statistical area in which the home resides, or the median value in the state, if MSA-level pricing information is not available.

“This bill is urgently needed for the millions of American families facing risk of foreclosure, and I am glad to have had the opportunity to make this statement that the sanctity of the American home and family should take precedence in this time of crisis,” said Grijalva. The bill incorporates many of the ideas put forth by housing policy wonk Dean Baker, co-director of the Center for Economic and Policy Research, an economic think-tank.

Of course, more than a few in the industry see the bill as a form of rent control; which is a pretty bad word for anyone that has spent time in the mortgage servicing industry, to say the least. “Sure, let’s just let the government manage rents and set allowable charges,” said one servicing manager sarcastically, who asked not to be named. “That’s worked out really well for places like Oakland [California].”

Nonetheless, the idea of “own-to-rent” is one that enjoys some support from from conservative economists, including American Enterprise Institute (AEI) Fellow Desmond Lachman and former economic advisor to President Bush, Andrew Samwick.

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Ilargi: Let’s take another look at UBS. Their troubles look gravely serious:

• World’s 2nd largest subprime writedown total, $38 billion.

• Sold $22 billion in risk paper to BlackRock, for which it will receive only $15 billion. That is another $7 billion lost. But according to some, the paper’s real “sales value” is just 44 cents on the dollar, which suggests perhaps $4-5 billion more gone. And that’s not yet the whole story: BlackRock will pay for over $11 billion of the purchase with money borrowed from...UBS..., undoubtedly at very favorable terms. Plus, if the paper sinks even more, arguably below those 44 cents, a clause is triggered, and UBS will have to take it back on its balance sheet.

• The very day after this deal is completed, their balance sheet still looks so bad, they need to raise $16 billion more, or they risk falling below reserve requirements. "UBS is hoping that the rights issue will help it return to financial strength". Yeah, right, but what if US housing keeps tanking, and/or Europe real estate goes down etc. what if there are more losses?

All in all, especially when looking at the BlackRock deal, I get the impression UBS is not merely bending over backwards. They are performing a full-fledged contortionist act, and there’s substantial risk it will break their backs.

UBS seeks to raise $16 billion to repair balance sheet

UBS, Switzerland's biggest banking group, unveiled a near SwFr16billion (£8 billion) rights issue yesterday, one of the biggest in European corporate history, as it moved to repair its ravaged balance sheet. The rights, which are fully underwritten, will be offered to existing shareholders at a discount of more than 30 per cent.

If successful, UBS will have raised almost $1 billion (£504 million) more than had been expected. The move by the bank, which has written down $37 billion of its exposure to risky American sub-prime home loans, comes just a day after it offloaded $22 billion of its investment risk to BlackRock, the American money manager.

That sale prompted speculation, reported in The Times yesterday, that UBS was poised to launch its rights issue. Shareholders gave the bank approval to increase its share capital last month. UBS will be offering 760 million shares at SwFr21 each, a discount of 31.46 per cent on last night's closing price. UBS shares have fallen more than 35 per cent this year.

The shares fell a further 1.4 per cent to SwFr31.06 yesterday. They have dropped more than 6 per cent this week on speculation over the capital raising. The bank is going to its existing owners for fresh equity as a string of its European rivals seek capital to shore up their financial position. Royal Bank of Scotland is asking for £12 billion, HBOS is seeking £4 billion and Bradford & Bingley wants £300 million from its shareholders.

When completed, UBS's rights issue will be the fourth-largest in European corporate history, according to Thomson Reuters, the data provider. It will rank behind the RBS deal, a €15 billion cash call by France Télécom, the telecommunications giant, in 2003, and a €13.1 billion capital-raising by Fortis, the Belgo-Dutch financial services group, completed last year. France Télécom launched its rights issue as part of a €45 billion rescue plan five years ago.

The telecommunications giant employed a syndicate of 21 banks to work on its deal, while UBS has hired JPMorgan, Morgan Stanley, BNP Paribas and Goldman Sachs for its transaction. It is understood that the underwriters will be offloading their risk to an additional group of 18 financial institutions. UBS hopes to complete the issue over the next three weeks.

However, later in the year, UBS's equity issue will be relegated to fifth position in the league of super-deals, if Carlsberg, the Danish brewer, is successful in its attempts to raise almost €20.7 billion (£16.4 billion) from investors. Carlsberg's cash call is expected in the third quarter. UBS is hoping that the rights issue will help it return to financial strength. The bank has been battered over the past 12 months by its exposure to American sub-prime mortgages.

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UBS/BlackRock: Adieu or au revoir?

UBS has said au revoir to $15bn of noxious US mortgage-backed assets by selling them to BlackRock, the asset manager. But it may not have bid adieu. BlackRock is footing most of the bill for the securities, mainly backed by subprime and Alt-A loans, with a UBS loan. That gives them a route back on to UBS’s balance sheet.

It would take quite some storm to reunite UBS and these problem assets. The bank has already taken a $7bn hit on them, implying writedowns to an average of 68 cents in the dollar. It would require a writedown to an average of 51 cents in the dollar to wipe out the $3.8bn equity BlackRock is putting in and put UBS back on the hook.

But that’s not inconceivable. Royal Bank of Scotland, the UK bank, is braced for worse. Apply the markdowns which it took last month on its mortgage-backed assets to the portfolio BlackRock has bought, and it is worth roughly 44 cents in the dollar. This read across implies a potential further $1.6bn writedowns at UBS, on top of BlackRock’s equity.

Mind you, if BlackRock, a pretty smart operator, considered this likely, it wouldn’t be risking $3.8bn on the deal. Besides, as things stand, the deal is a big fillip to UBS’s plans for detox after bingeing on US mortgage-backed securities. The sale portfolio represents about half the toxic assets scheduled for ring-fencing in a so-called “bad bank”.

What’s more, UBS has taken its capital ratio up a notch. Because the Basel II regime applies a far lower risk weighting to assets used as collateral for loans than those taken neat on balance sheets, the deal will improve the bank’s Tier 1 capital ratio by roughly 0.2 percentage points to more than 12%.

Still, it does illustrate investment banks’ difficulty in extricating themselves completely from subprime holes. UBS has not had to copy Deutsche Bank, which offered buyers of some of its stuck loans cut-price finance. But it has had to offer its buyer plenty of potential upside. Sure, UBS has negotiated an undisclosed cut of BlackRock’s gains, but only after the portfolio has recovered above what is understood to be a high hurdle. The upshot is that BlackRock looks on course to double its money if the securities recover even to 85 cents in the dollar.

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Ilargi: Earlier in this Debt Rattle, there's a list of the biggest subprime writedown "victims”’. AIG, at no.4, is the only non-bank. Now Moody’s predicts a lot more in losses for the world’s largest insurer. I always find it comical to see how firms that try to project an image of conservative, safe, realiable, have become completely swamped in derivatives, swaps, toxic securities and any and all other bad gambling behavior.

I predict that AIG will make the headlines a lot in the near future, for all the wrong reasons, and I wouldn’t be surprised if it doesn’t last in its present form till Christmas. Note that they get downgraded AFTER raising $20 billion in the past three weeks, a signal that even Moody’s -and its computer models- don’t believe that amount is nearly enough.

Moody's Cuts AIG Rating

Moody's Investors Service lowered the senior unsecured debt rating of American International Group Inc. and several subsidiaries "whose ratings have relied on material support from" AIG and those "with significant exposure to the U.S. residential-mortgage market." The move follows the insurance giant's first-quarter report issued two weeks ago, in which AIG disclosed a net loss of $7.8 million and said it plans to raise billions more in capital.

Moody's said Thursday night the possibility for further downgrade at AIG remains, "reflecting the company's exposure to further volatility in the U.S. mortgage market as well as uncertainty surrounding the strategic direction for AIG Financial Products Corp." That unit houses AIG's derivatives operations, source of much of the company's woes.

It sold guarantees on collateralized debt obligations using credit-default swaps, a type of derivative-based insurance that pays out in the event of a default. Moody's noted that in the past two quarters, AIG has recorded more than $13 billion in losses on mortgage-exposed swaps held by AIG Financial Products and more than $5 billion in other losses, largely from residential mortgage-backed securities held by AIG's domestic life insurance and retirement services operations.

The latter's insurance financial strength ratings were cut one notch to Aa2, while the IFS rating at AIG's commercial-insurance business and AIG's senior unsecured and long-term issuer ratings were all lowered a tick to Aa3. To overcome the investment battering, AIG raised $20 billion in fresh capital this month. Bruce Ballentine, Moody's lead AIG analyst, said the new money "will help AIG to absorb economic losses that may develop over time."

Earlier Thursday, Fitch Ratings affirmed its ratings on AIG, noting the capital raising, while Standard & Poor's Rating Service did so Wednesday. Both announced one-notch downgrades within two hours of AIG releasing its first-quarter results on May 8, while Moody's said the following day it would undertake a ratings review.

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UK bank shares: Rights turn wrong

When Royal Bank of Scotland unveiled its £12bn rights issue last month, it traded at 372.5p. A month on, the bank is scraping 250p, not far off the 200p price of the new shares to be issued on June 6 and well below its initial theoretical ex-rights price of 307p.

RBS’s "nil paid" shares lost over a quarter of their value in their first two days of trading. Bradford & Bingley shares are also trading well below the initial theoretical ex-rights price implied by the terms of its £300m rights issue. Shares in both banks have fallen over 30% in a month. What’s going on?

Part of the explanation is technical. Some shareholders may want to take up their rights but lack the cash and so must sell part of their entitlements to raise capital. That pushes down the value of the nil-paid options. The RBS share price has also been hit by the sale of American Depository Receipts - whose holders aren't eligible for the rights issue - and the adjustment of certain options.

Other shareholders may simply have concluded they don’t want to plough more cash into the UK banking sector. Bradford & Bingley’s mishandled rights issue has particularly knocked investor confidence in management and share price alike.

But the main reason seems to be fears over the health of the UK economy. The Bank of England revealed last week that inflation could rise as high as 4% over the next two years, raising the spectre of interest rate hikes, dwindling margins and heavy losses in the UK housing market. That’s hit sentiment towards the whole UK bank sector.

HBOS, the other UK bank undertaking a rights issue, is down 16%, albeit still trading above its initial theoretical ex-rights price. Meanwhile, the grim economic news seems to have attracted a new wave of short-selling. Some 20% of all B&B stock is currently on loan, according to reports.

RBS and B&B shares have not yet fallen to the point where the underwriters of their rights issues need to be losing sleep. Instead, those suffering restless nights are more likely to be other UK banks such as Alliance & Leicester and Barclays. They have thus far ruled out raising fresh capital but may yet find that the deteriorating economic climate forces a rethink.

If so, they may discover that wary underwriters will demand even steeper discounts and higher fees to compensate – making raising equity not only highly embarrassing but very costly, too. With Barclays down 17% last month as well, perhaps shareholders see the danger already.

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Subprime, Alt-A mortgage delinquencies rising

Delinquencies in U.S. subprime debt and higher-quality mortgages known as Alt-A securities are continuing to increase, Standard & Poor's said on Thursday. Delinquencies for Alt-A mortgages rated between 2005 and 2007 are climbing, with total delinquencies rising as high as 17 percent in some cases, more than 6 percentage points higher than previous estimates, the ratings agency said in a report.

Lower-quality subprime mortgage delinquencies soared as high as 37 percent for mortgages originated in 2006, 4 percentage points higher than previous estimates, S&P said.

Subprime mortgages originated in 2007 saw delinquencies climb to almost 26 percent, 6 percentage points higher.
"The 2007 issuance year continues to be the worst-performing vintage in terms of cumulative losses," S&P said, regarding subprime mortgages. "Serious delinquencies" of payments 90 days late or more and foreclosures also are rising, S&P said.

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A run on central banks?

When I see what commodity prices are doing, I don't think "low interest rates" or "skyrocketing demand". I think about a loss of confidence. There is that old saw about gold, that it is the only money that is no one's liability. Wheat is no one's liability, and neither is corn. Oil is no one's liability.

It is common to invest in commodities as an "inflation hedge". If the central bank prints too much money, you need wheelbarrows to buy bread. If you have a sack of wheat, you will have your bread whatever the central bank does. But if everyone buys wheat, the price of grains will rise, even if the central bank does nothing at all.

Just as the fear of a bank's insolvency can precipitate a run that drives a bank to ruin, loss of confidence in a central bank can provoke a great inflation. The Federal Reserve, much I might criticize it, has not gone on a printing spree. It has lowered interest rates, and altered the composition of bank assets by replacing less liquid with more liquid securities.

But the most these measures should do is bring us back, monetarily speaking, to the status quo ante, back to a year ago when asset-backed securities were liquid. The Fed's actions are best described as antideflationary, not inflationary.
But confidence is a funny thing. Central bankers are supposed to be dour and dependable. The current crop is not.

Rather than "taking away the punchbowl", central bankers have become the life of the party. Japan's central bankers hand out Yen like free acid. China's guy will give you a microwave oven and a DVD player if you draw him a picture (and sign Henry Paulson's name to it).

Our man Ben is an Amadeus-cum-Macguyver, he's brilliant, unpredictable, he'll improvise a Delaware company from paper clips and vacuum up your derivative book with a toenail clipper. Even the ECB's Trichet, who at first comes off like a sourpuss, turns out to be alright, when you've got some Spanish mortgages to pawn.

Some of us think that something's wrong, and these guys we're drinking with aren't serious enough to fix it. We know that trillions of dollars in presumed housing wealth have disappeared, but we don't know who's ultimately going to bear the loss. Americans know that as a nation, we cannot afford our clothes, furniture, or gas, unless the people who are selling it to us lend us our money back. Economists fret about "imbalance" and "adjustment", but we've yet to see a serious plan, other than let's-keep-this-party-going.

So, we lose faith. When we lost faith in Northern Rock, Bear Stearns, Citigroup, or Lehman, the central bankers stepped into the fray, and stood behind them. So, we ask, who stands behind the central bankers? We take a peek, and all we see is our own money. Which we quickly start exchanging for something else.

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Commodities Spike: Vote of No Confidence in Central Bankers?

This commodities run-up (at least as of 2008) has had the quality of not adding up. The fundamentals are not a sufficient explanation for the velocity of the move. The hype, the desperation, the conviction seem out of proportion to the underlying facts (save in some agricultural commodities).

But is lack of faith in central bankers, as much as it makes for great phrase-making, the best way to frame this? What we are seeing is a large-scale repudiation of financial assets. US stocks have been less badly hit; indeed, the real train wrecks have been in OTC markets.

In a weird way, belief in an inflationary scenario (which is the assumption underlying a commodities run-up, that is, if you accept the speculative hypothesis) reveals a limited degree of trust in central bankers. Investors believe Bernanke will ward off deflation; they see the overhang of debt to GDP and assume inflation is the only way out. Either Bernanke will inflate to diminish the real value of the liabilities, or many of these will effectively be moved over to the Federal government's balance sheet, and the resulting fiscal deficits will be inflationary.

But consider: narrow money supply growth has been negative, despite the Fed's aggressive cuts. M3 growth has been very high, due to movement of funds into deposits (that is consistent with general risk aversion and perhaps also deflationary fears). The Fed's monetary options are severely constrained at this juncture. Even if you use a magic wand and wave away inflation worries, the Fed can cut at most another 1%.

It isn't willing to go into zero nominal interest rate territory. There have been some weak Treasury auctions on the longer end of the yield curve. Even if the Fed were to cut interest rates down the road, any rise in long rates would neutralize its effect via their effects on mortgage markets. Thus the Fed may not be able to provide enough easing to ward off deflation. A re-run of Japan's experience (with complications due to our lack of savings) is not out of the question.

So many investors are looking into a chasm. It's not the mind-focusing abyss of mid-March, of possible major meltdown of the financial system (although that danger is still lurking in the background with the credit default swaps market). It's that they are unmoored. What they know how to do, what they trust, no longer seems to work.

Run to commodities? If you think we are going to have stagflation, that's a simple move in this unsettled environment that makes sense. Run to cash until the smoke clears? That sounds like a good precaution. Buy stocks on dips? Sure, Greenspan provided deep conditioning for that reflex (and hey, even in bad markets, there are always good stocks, right?)

But most investors are in denial about unpleasant truths:
1. Financial assets are far riskier than the press, the textbooks, and conventional methodologies indicate. The models that the pros use are based on assumptions that are fundamentally flawed. The dangers of the erroneous belief that financial assets are safe is now being revealed.
2. The people who control the markets (the intermediaries) have their own, and not the publics', best interest at heart. Due to the proliferation of OTC markets and the value of assets involved, they cannot be dispensed with. And the regulators lack the skill and will to ride herd on them. As Keynes remarked, "When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done."

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Ilargi: Talking about free markets: I have said many times before that if you leave the provision of basic human needs in the hands of companies set up for profit, you inevitably end up in a situation where human lives are discounted and people become dispensable.

We see this these days in other parts of the world when it comes to the basic need 'food', for which the world’s poor are prized out of the market. In the US, the reality of the food situation can still be disguised through cheap fat burgers and pop, though that’s only a thin veil, about to be lifted.

Health care is the basic human need that has already blown up in the face of about 50 million US citizens. In other rich countries, the EU and Canada, that would be unimaginable.

The New Big Dig

Mitt Romney's presidential run is history, but it looks as if the taxpayers of Massachusetts will be paying for it for years to come. The former Governor had hoped to ride his grand state "universal" health-care reform of 2006 to the White House, but his state's residents are now having to live with what he and the state's Democratic Legislature passed. As the Boston press likes to say, it's "the new Big Dig."

The showpiece of RomneyCare was its individual mandate, a requirement that all Massachusetts residents obtain health insurance by July of last year or else pay penalties. The idea was that getting everyone into the insurance system would eliminate the "free-rider" problem of those who refuse to buy insurance but then go to emergency rooms when they're sick; thus costs would fall. "Will it work? I'm optimistic, but time will tell," Mr. Romney wrote in these pages in 2006.

Well, the returns are rolling in, and the critics look prescient. First, the plan isn't "universal" at all: About 350,000 more people are now insured in Massachusetts since the reform passed. Federal estimates put the prior number of uninsured at more than 657,000, so there was a reduction. But it was not secured through the market reforms that Governor Romney promised.

Instead, Massachusetts also created a new state entitlement that is already trembling on the verge of bankruptcy inside of a year. Some two-thirds of the growth in coverage owes to a low- or no-cost public insurance option. Called Commonwealth Care, it uses a sliding income scale to subsidize coverage for everyone under 300% of the federal poverty level, or about $63,000 for a family of four. Commonwealth Care also accounts for 60% of statewide growth in individual insurance over the last year, and the trend is expected to accelerate, perhaps double.

One lesson here is that while pledging "universal" coverage is easy, the harder problem is paying for it. This year's appropriation for Commonwealth Care was $472 million, but officials have asked for an add-on that will bring it to $625 million. For 2009, Governor Deval Patrick requested $869 million but has already conceded that even that huge figure is too low. Over the coming decade, the expected overruns float in as much as $4 billion over budget.

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Foreclosure tale shows that nobody is immune from crisis

As the real estate market softened in 2007, the new owner of a three-bedroom, 1,600-square-foot house in Sacramento's Curtis Park neighborhood ran into trouble. The house that was purchased for $535,000 in January had lost equity. The owner fell behind in her payments, and eventually, the bank seized the home.

What makes this story different from the thousands like it is that the owner of this house was a member of Congress. The story of the foreclosure of Long Beach Democrat Laura Richardson's Sacramento home is a tale of a real estate market gone sour. It is also an illustration of how far many candidates will go to seek elected office, even if it means quite literally mortgaging their own financial future.

While being elevated to Congress in a 2007 special election, Richardson apparently stopped making payments on her new Sacramento home, and eventually walked away from it, leaving nearly $600,000 in unpaid loans and fees.

Richardson's decision to let the house slip into foreclosure was set in motion by an unlikely chain of events, only some of which had to do with Sacramento's crumbling real estate market. Richardson was elected to the Assembly in November 2006, and purchased her new capital home two months later. But in April 2007, Rep. Juanita Millender-McDonald succumbed to cancer, creating a Congressional vacancy in Richardson's district.

Richardson declared her candidacy for the seat, and soon found herself locked in a hotly contested, and very expensive race for Congress against state Sen. Jenny Oropeza, D-Long Beach.

While her campaign heated up, Richardson's house slipped into default. Richardson fell behind on her mortgage payments as she loaned her Congressional campaign $60,000 – money that has begun to be paid back to Richardson personally from her campaign account, according to records from the Center for Responsive Politics.

Richardson's opponent, Oropeza, loaned herself $115,000 for her run against Richardson. Oropeza's Congressional committee still shows nearly $200,000 in debt.

Tax records at the Sacramento County assessor's office show that in January 2007, Richardson took out a mortgage for the entire sale price of the house -- $535,000. The mortgage amount was equal to the sale price of the home, meaning she was able to buy the house without a down payment, even though the housing market was beginning to turn.

A March 19, 2008 notice of trustee's sale indicates that the unpaid balance of Richardson's loan, which is held by Washington Mutual, is more than $578,000 –$40,000 more than the original mortgage.

The Curtis Park house is not Richardson's primary residence. She also owns a four-bedroom house in Long Beach, in her Congressional district. Real estate records show she purchased that house in 1999 for $135,000. An estimate from Zillow.com puts the current value of that house at $474,000

Like many homes that have gone through foreclosure, Richardson's new residence quickly became an eyesore. With Richardson gone, upkeep on the home lapsed, and neighbors began to get angry.

"The neighbors are extremely unhappy with her," said Sharon Helmar, who sold the home to Richardson. "She didn't mow the lawn or take out the garbage while she was there. We lived there for a long time, 30 years, and we had to hide our heads whenever we came back to the neighborhood."

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Canadians are not prepared for economic downturn

Canadians are not prepared -- and not preparing -- for a rainy day, like an economic downturn, a major bank is warning. The vast majority of Canadians admit they're poor savers, with barely one-half having a rainy-day account. And of those, only half have enough to cover a month's expenses, RBC said Wednesday in releasing results of a spring survey of the saving and spending habits of Canadians.

Despite the current uncertain economic situation, less than a quarter are saving more than before and nearly two thirds are spending as much or more than before, it said. "One need only look at the newspapers or television to see that North America is in an economic downturn," said Ashif Ratanshi, senior vice-president, RBC Branch Investments and Banking.

"This is the time for Canadians to re-assess their own finances and ensure they are effectively managing their money so that they can withstand any sudden pitfalls or changes in their lives." But the survey found they aren't, he said in an interview.

"Generally, Canadians are saving a lot less money than they were saving in prior years, he said, noting that is apparent not just from surveys that RBC has conducted but from household income data as well. "We're saving less and less money, and we're relying more on our credit cards, and loans and mortgages."

Only 22% are saving more than they did before, while 43% haven't changed their spending habits, and 20% actually are spending more, it said. "The message we'd like to really emphasize is that it's important to . . . put away money first because you never know when an economy turns and . . . we would hope we've got some emergency funds put away to get us through those times," Mr. Ratanshi said.

"The reasons why people are saving less vary from person to person, but there are a lot of individuals who may have the income don't have good savings habits." A key finding was that most Canadians do not believe they are good savers, RBC said, noting that 83% worry they don't have enough money saved, and 86% that they can't save as much as they would like.

"Many Canadians are also not prepared to cope with an unexpected long-term emergency or sudden life-changing event," it said. Only 49% have a rainy-day account set up, and of those that do 55% have only enough saved to cover one-month's worth of expenses, while just 24% have three-month's worth of expenses covered.

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BCE ruling could hit other Canada takeovers

A Canadian court ruling that could block the world's largest leveraged buyout, the C$34.8 billion ($35.2 billion) acquisition of BCE Inc., could deter other takeovers in Canada if it is allowed to stand. The surprise ruling by the Quebec Court of Appeal would require that companies consider the interests of all stakeholders, including bondholders, rather than simply trying to obtain the highest value for their shareholders.

"Certainly the decision was an unexpected result," said Aaron Dhir, who teaches corporate law at Osgoode Hall Law School in Toronto. The Quebec court ruled in favor of BCE debtholders who had complained that the takeover by a group of investors led by Ontario Teachers' Pension Plan was unfair to them.

It said BCE had failed to prove that a buyout could not have been structured to provide a satisfactory share price while avoiding an adverse effect on the debenture holders. The decision chopped more than 10 percent off BCE shares on Thursday as speculation mounted that the deal could fail.

"This ruling could have profound effects on future merger and acquisition activity in Canada. Boards no longer have a duty to just maximize shareholder value," RBC Capital Markets analyst Jonathan Allen said in a note to clients, noting it gave bondholders extra protection in takeover scenarios. He said the ruling could require suitors to offer debtholders better terms to win their approval, making deals more costly. And it could add uncertainty to any proposal.

BCE hopes to appeal to the Supreme Court of Canada, which has two free weeks in June when it could handle the case on an expedited basis if it considers it to be of national interest. "I would think the Supreme Court might find it hard to refuse leave (to appeal) in these circumstances," said McGill University emeritus law professor Stephen Scott. He said courts have generally been unfriendly to bondholder suits, particularly in the United States.

"It's true that the Supreme Court of Canada has taken somewhat aggressive views suggesting that corporations have fiduciary duties not only to their common shareholders but it seems to other shareholders and it seems to bondholders as well," Scott said.

In its ruling, the Quebec appeals court relied partly on the 2004 Peoples case in the Supreme Court, where the Canadian court said directors had to act in good faith "with a view to the best interests of the corporation" in resolving the competing interests of shareholders and creditors. The court also said the directors must not favor one group of stakeholders.

"Peoples definitely opens the door to this," Dhir said. Dhir said many had interpreted Peoples to mean that directors were allowed to take others' interests into account. But the BCE decision meant they now were required to do so.
Scott said it was impossible for companies to consistently have "a fiduciary duty to everybody at the same time."

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Toronto-Dominion May Benefit as BCE Buyout Threatened

Toronto-Dominion Bank rose after a court ruling threatened the proposed C$52 billion ($52.7 billion) sale of BCE Inc., which may help the Canadian bank avoid losses from financing the world's largest leveraged buyout.
"This is good news for TD," Desjardins Securities analyst Michael Goldberg wrote in a note to investors today. "A new deal or no deal would mean that TD would not experience losses on the syndication of its financing."

BCE, Canada's biggest phone company, lost a court ruling yesterday when a Quebec judge said bondholders can challenge the sale because they weren't treated fairly. The ruling threatens the takeover, and may force the buyers to renegotiate the terms of the purchase.

Toronto-Dominion, Canada's third-biggest bank, was among the bondholders challenging the sale, along with Canadian Imperial Bank of Commerce and money manager Phillips Hager & North Investment Management Ltd. The Toronto-based bank also acted as an adviser on the buyout, and is helping finance the bid by a group led by the Ontario Teachers' Pension Plan.

The bank has probably marked down its BCE financing commitment by about C$150 million, mostly in the last two quarters, Goldberg said. The bank has said it agreed to finance about 10 percent of the equity portion of the BCE purchase, or about C$3.3 billion.

Lenders including Citigroup Inc., Deutsche Bank AG and Royal Bank of Scotland Group Plc, which have committed C$34.3 billion in BCE funding, asked buyers to renegotiate financing terms for the deal, a person familiar with the transaction said May 19. The banks say the terms were negotiated before the credit crisis accelerated last year, causing LBO borrowing costs to more than triple.

"For TD, it's probably positive if this deal gets renegotiated," said Craig MacAdam, who helps manage about $3 billion as a portfolio manager at Aurion Capital in Toronto. "All the stakeholders will have to get back to the table and renegotiate." The lenders are committed to the deal until November, according to Jeffrey Fan, an analyst at UBS Securities Canada Inc.

Toronto-Dominion Chief Executive Officer Edmund Clark said as recently as last month that his bank plans to take part in the BCE transaction. BCE and the buyers' group plan to appeal the ruling to the Supreme Court of Canada, and indicted they may delay the closing beyond the scheduled date of June 30.

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New famine for Horn of Africa

Hundreds have died already, but relief officials are predicting a new famine in the Horn of Africa that could rival the catastrophe that killed millions in the late 1980s and early 1990s. Drought, food shortages, civil war, increasing numbers of refugees and imperiled foreign aid operations are combining to create a "perfect storm" of human suffering and despair in Africa's northeastern corner.

Humanitarian aid agencies are pleading for help in the face of food shortages in Ethiopia, Eritrea, Djibouti, Somalia and parts of Kenya. On Wednesday, UNICEF said six million children under the age of five in Ethiopia alone are at risk of acute malnutrition after the spring rains failed. Aid officials say there has been a rapid increase in cases of severe acute malnutrition and kwashiorkor, the nutritional disease in which listless children with distended stomachs provide the tell-tale signs of outright famine.

Two days earlier, the World Food Program (WFP) said up to 3.4 million people in the Horn of Africa were in urgent need of life-saving humanitarian aid. This is in addition to the eight million already depending on international food handouts to survive. The WFP also estimates it is 183,000 tonnes short of food to meet current needs in the area and predicts conditions could worsen quickly if the rains fail to come by the end of the month. It requires US$147-million immediately to make up the shortfall.

"We will need a rapid scaling-up of resources, especially food and nutritional supplies to make increased life-saving aid a reality," said John Holmes, head of the UN's office for humanitarian affairs and emergency relief. The situation is expected to worsen as the drought triggers yet another crop failure. Thousands died from starvation and thirst in the same area two years ago during another severe drought.

A month ago, CARE International warned about 14 million people would be in dire need of emergency food aid if the dry weather continued. "Without significant rain, millions of people, already left devastated and vulnerable by the 2006 emergency, risk further loss of their livelihoods and possible starvation as water and pasture rapidly diminish," it said. Those rains never came.

Now aid workers say residents are caught in a series of colliding crises created by skimpy rainfall, disastrous harvests, soaring food prices, dying livestock, escalating violence and shrinking food aid. The full impact is expected to hit home in July or August, when farmers should be harvesting summer crops. Instability has already forced aid groups to scale down their operations in the region.

On Wednesday, two Italians and one Somali aid worker were kidnapped while working 45 kilometres south of the Somali capital Mogadishu. Islamist insurgents have been waging a guerrilla war since early 2007 against an internationally backed Somali-Ethiopian force. More than one million people have been displaced by the fighting and 11 aid workers have been killed in Somalia this year. Last weekend, Somali pirates hijacked a Jordanian ship carrying humanitarian aid to Mogadishu.

Aid officials fear international concern for cyclone-hit Burma and earthquake-shattered China could make it more difficult to attract the aid needed for Africa's emerging crisis. In addition, startling increases in global food prices have already put many staples beyond the reach of the poor, while escalations of fighting in Somalia, the Ogaden region of Ethiopia and in Kenya have deepened the crisis and complicated distributions of aid.

In Kenya, 113,000 internally displaced refugees are living in hastily created camps, after weeks of post-election political violence.
Last month the government of Djibouti declared a state of emergency because high rates of malnutrition, which exceeded a national threshold of 15% of the population. War-torn Somalia already has a malnutrition rate of about 24%, say UN officials, and could rapidly soar past emergency thresholds to become a full-blown famine.

Nearly a third of Somalis already depend on international food handouts. "If things do not improve within the coming weeks, we will be confronted with the images of 1991-1992, when drought and civil strife claimed the lives of hundreds of thousands of Somalis," said Elisabeth Byrs, a spokeswoman for the UN humanitarian affairs agency.

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Surging inflation will stoke riots and conflict between nations

Riots, protests and political unrest could multiply in the developing world as soaring inflation widens the gap between the "haves" and the "have nots", an investment bank predicted yesterday.Economists at Merrill Lynch view inflation as an "accident waiting to happen". As prices for food and commodities surge, the bank expects global inflation to rise from 3.5% to 4.9% this year. In emerging markets, the average rate is to be 7.3%.

The cost of food and fuel has already been cited as a factor leading to violence in Haiti, protests by Argentinian farmers and riots in sub-Saharan Africa, including attacks on immigrants in South African townships. Merrill's chief international economist, Alex Patelis, said this could be the tip of the iceberg, warning of more trouble "between nations and within nations" as people struggle to pay for everyday goods.

"Inflation has distributional effects. If everyone's income moved by the same rate, you wouldn't care - but it doesn't," said Patelis. "You have pensioners on fixed pensions. Some people produce rice that triples in price, while others consume it." A report by Merrill urges governments to crack down on inflation, describing the phenomenon as the primary driver of macroeconomic trends. The problem has emerged from poor food harvests, sluggish supplies of energy and soaring demand in rapidly industrialising countries such as China, where wage inflation has reached 18%.

Unless policymakers take action to dampen prices and wages, Merrill says sudden shortages could become more frequent. The bank cited power cuts in South Africa and a run on rice in Californian supermarkets as recent examples. "You're going to see tension between nations and within nations," said Patelis. The UN recently set up a taskforce to examine food shortages and price rises. It has expressed alarm that its world food programme is struggling to pay for food for those most at need.

Last month, the World Bank's president, Robert Zoellick, suggested that 33 countries could erupt in social unrest following a rise of as much as 80% in food prices over three years. Merrill's report said the credit crunch has contributed to a global re-balancing, drawing to a close an era in which American consumers have been the primary drivers of the world's economy.

In a gloomy set of forecasts, Merrill said it believes the US is in a recession - and that American house prices, which are among the root causes of the downturn, could fall by 15% over the next 18 months.

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