Debt Rattle, July 18 2008: Blow me over

Dorothea Lange Multimillionaire November 1936
"Cotton picker. Southern San Joaquin Valley, California"

Ilargi: The overall level of disconnect in US (and abroad) financial reporting never ceases to amaze. If the expert writers miss the story by miles, and years, as they routinely do, there can, according to them, of course only be one reason: it was impossible to foresee.

Never mind that others, like for instance The Automatic Earth, started warning about all of it long ago. Roubini first predicted today’s events years ago, Michael Panzner wrote Financial Armageddon long ago, and there are many more. Just look at the blogroll on this page.

Perhaps the most important reason why the prima donna’s are such failures is not that hard to see: they live in the same world, and walk the same streets, as the people and firms they write about. These reporters work hard to keep myths alive. If they write positive stories, they can count on getting the best quotes, which are then used in subsequent positive stories; never rock your own cradle or bite your own hand: it’s all just as incestuous as Washington "journalism". Truth be damned. We make reality.

The most obvious sign that US journalism has failed utterly in its coverage of the financial crisis is easy: you’re looking at it. If the writers did their truth-finding jobs, there would be no need for The Automatic Earth. Instead, there are thousands of people every single day who come here to find out what "professional" publications keep silent about.

What the "professional" media are doing is not trying to make sure that the truth comes out, but that they will continue to have a well-greased meal ticket.


Wall Street meltdown tough on journalists

Aside from Iraq and Afghanistan, the most demanding assignment in journalism this year has been covering the meltdown of the U.S. financial system. Talk about a depressing, fast-moving beat. Let's recap with some headlines from Wall Street:

Financial firms have taken about $380 billion in write-downs worldwide. Subprime problems evolve into a full-fledged fiasco. Proud, old Bear Stearns has to beg for a buyer, while Lehman Brothers teeters. Bear Stearns, Merrill Lynch and Wachovia all fire their top executives. This week, regulators are talking about limiting naked shorting of shares in Fannie Mae and Freddie Mac. By the time you read this, something else entirely may be in the spotlight.

"I've been doing this for almost 40 years," said Allan Sloan, a top writer for Time Warner's Fortune magazine. "What's been going on is the most dangerous -- and weird -- [financial] market. And the stock market is the least of it." The flow of scary news "just doesn't go away," Sloan marveled. "It sends a shiver down your spine. People are losing faith in deposit insurance." The seemingly endless stream of gloomy financial news has posed special challenges to journalists.

I interviewed two of the best: Sloan and Daniel Gross, who succeeded Sloan at Washington Post's Newsweek and also writes for online magazine Slate. What has made an impression on Gross is how quickly everything is changing. For instance, the collapse of Bear Stearns, one of Wall Street's proudest investment banks, was a major news story for weeks. "Now," Gross mused, "I walk past the Bear Stearns building and don't give it a second thought."

That's because so many fresh headlines have been written since then. Some Wall Street pundits have speculated that Lehman could suffer a similar fate. Gross sees bloggers playing a bigger role in reporting on the latest financial woes than in previous Wall Street fiascos.

"This is a story made for bloggers because there are so many manifestations of credit problems popping up: car sales, student loans, foreclosures in California, layoffs at Merrill Lynch," he said. "The best blogs scour the Internet for bits and pieces that might seem random and then, by aggregating them, seem coherent." In addition to newspapers and some magazines, Gross regularly reads such blogs as Irvine Housing and Calculated Risk.

Gross praised Grant's Interest Rate Observer, long a financial-news bible, by saying that "James Grant was one of the only people who nailed this story in all its complexity, ahead of the curve." Gross also complimented The Wall Street Journal's comprehensive coverage of the Bear Stearns and Lehman stories. For financial journalists, the biggest challenge may be trying to accumulate instant expertise in so many areas.

"You have to get a primer on Fannie and Freddie," lamented Gross. "Next week, it's going to be the FDIC. Before, it was the Fed and the discount window. It has been a rolling problem." "I try to write big-picture things and find the truffle on the forest floor," Sloan told me. Sloan is not only one of the senior observers on the Wall Street scene, but also one of the most forward-thinking of the lot.

"It's different for me [because] I have to be three weeks ahead," he said, referring to Fortune magazine's demands. "It's hard to get three minutes ahead of anything because of all competition." Sloan, who also writes for Fortune's Web operations, has the luxury of being able to sit back and do the rarest thing a journalist can do during a crisis: think!

"I try to be dispassionate," he said, preferring to act "when I see that people have missed something obvious. There is much more pack coverage than ever before. People have the excitement of the moment. People are so hot to be first." He does, however, believe the media have done a good job of covering the financial crisis.

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Concern grows over US fiscal crisis

As the Bush administration proposes backstopping mortgage giants Fannie Mae and Freddie Mac with a $300 billion line of credit and Congress contemplates another economic stimulus, the question is who will bail out the government?

"People seem to think the government has money," said former U.S. Comptroller General David Walker. "The government doesn't have any money." A rare consensus has developed across the political spectrum that the government's own fiscal affairs are precarious, with an astonishing $53 trillion in long-term liabilities, according to the Government Accountability Office.

To put that number in human terms, the debt has reached $455,000 per U.S. household. As that debt grows, the United States increasingly relies on foreigners, including China and Middle East oil producers, for financing.

"The factors that contributed to our mortgage-based subprime crisis exist with regard to our federal government's finances," said Walker, now head of the Peter G. Peterson Foundation, a group established to raise alarms about the nation's budget. "The difference is that the magnitude of the federal government's financial situation is at least 25 times greater."

This year's presidential election coincides with the first retirements of the 78 million people born between 1946 and 1964. The first of this Baby Boom generation may now collect Social Security. In three years, they will join Medicare, the giant health care program whose finances are commonly described as out of control. Medicare accounts for the bulk of the nation's long-term liabilities.

"Health care costs are just amazing," said John Shoven, director of Stanford University's Institute for Economic Policy Research. Total health care costs now consume 16 percent of the economy and are headed quickly toward 30 percent, Shoven said. "Social Security is a big problem, but it's dwarfed by health care. Even the housing problem is dwarfed by health care."

Just the built-in rise in spending on programs for the elderly will cost about 25 percent of workers' payrolls over the next generation, said Richard Jackson, director of the Global Aging Initiative at the Center for Strategic and International Studies.

Robert Greenstein, director of the liberal Center on Budget and Policy Priorities, agreed that "the nation faces large, persistent, long-term deficits that ultimately risk damage to the economy. We agree that policymakers have to make tough choices soon."

There is consensus, too, on what needs to be done: Cut spending and raise taxes. A bigger problem is how to contain health care costs, but some form of rationing is necessary, experts said. The only real disagreement is whether the government's fiscal condition will lead to a financial meltdown, or whether the U.S. economy is strong enough to right itself without a sudden loss of confidence and a flight of foreign capital.

"People on Wall Street think I'm Dr. Doom & Gloom," said Kent Smetters, an economist at the Wharton School of Business at the University of Pennsylvania and a former Bush Treasury official. "I believe we could have a financial crisis like we've seen in South America or Asia.

It could easily happen, and under current policy will happen in the United States. People say, 'Gee, give me a date.' Obviously, that's impossible, but the longer we wait, the higher the probability. Could it happen in the next decade? Absolutely."

Alice Rivlin, budget chief in the Clinton administration, discounts the possibility. "We're a much stronger economy than Argentina," Rivlin said. The government "can handle borrowing in the range that would be necessary in a recession," she said. "What we can't handle is the cumulative long-run obligation."

Financial markets are often fixated on the short-run, and the government's finances are far from transparent. Unlike corporations, the government is not required to state its long-term obligations. Crises of confidence, like today's banking problems, strike suddenly when a tipping point is reached and investors decide to flee. The government's fiscal problems are "like termites in the house," said Jackson. "You don't notice it until foundations are eroded."

"I had such a frustrating meeting the other day on the Hill, where one staffer said, 'We don't have a problem until Wall Street tells us we have a problem,' " said Maya MacGuineas, head of fiscal policy at the nonpartisan New America Foundation. "By the time the financial markets tell us we've gone too far, it will be too late to fix this in any rational way. We are the toad in boiling water, where it's getting hotter and hotter and nobody's really noticing."

The key is whether foreigners will continue to buy U.S. debt. They now hold 45 percent of U.S. Treasury securities, and in all about $11.5 trillion of U.S. public and private debt, say UC Berkeley economists Ashok Bardhan and Dwight Jaffee. Chinese entities, including sovereign wealth funds that invest government savings overseas, own about 10 percent of U.S. Treasury securities.

Even a minor change in China's investment policy could have a major effect on the dollar's value and cause "a sizable increase in interest rates," the economists said. Still, because of a shortage of creditworthy debt instruments worldwide, and the large role of U.S. institutions in global credit markets, foreigners have little choice but to invest in the United States, they said, predicting "slim chances of abrupt change."

Whoever's right, all agree that the sooner the problem is tackled, the better. "Like almost any financial problem, if you don't work on it, what happens is it compounds with interest," Shoven said. "There are lots of ways to fix it, and what we pick is none of the above."

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Merrill Shares Drop on $4.7 Billion Loss as $9.7 Billion in Writedowns Dwarf Estimates

Merrill Lynch & Co. declined in German trading after the third-biggest U.S. securities firm posted a wider-than-estimated second-quarter loss yesterday on $9.7 billion of credit-market writedowns.

Moody's Investors Service cut Merrill's credit rating and the firm's shares fell as much as 7 percent in Germany. The net loss of $4.65 billion, or $4.97 a share, exceeded the firm's $1.96 billion first-quarter loss, while rivals Goldman Sachs Group Inc. and Morgan Stanley stayed profitable. Merrill earned $2.14 billion in the second quarter of 2007, before the credit contraction led to losses that now stretch over 12 months.

Chief Executive Officer John Thain cut about 4,200 jobs in the first half of the year and is selling assets to replenish the firm's capital. Merrill completed the $4.43 billion sale of its stake in Bloomberg LP and said it signed a letter of intent to sell a controlling interest in Financial Data Services Inc., a mutual-fund administrator valued at $3.5 billion, to an undisclosed buyer.

Thain "has to do a lot to reassure investor confidence," Ryan Lentell, an analyst at Morningstar Inc. in Chicago said in a Bloomberg Television interview. Analysts' estimates ranged from a loss of 93 cents a share to a loss of $4.21 a share, according to a survey by Bloomberg. Merrill's charges from the credit crisis now exceed $46 billion.

The firm's shares changed hands at $28.43 in German trading, down from $52.97 at the end of 2007. Analysts at Citigroup Inc., Oppenheimer & Co. and Wachovia Corp. had predicted the company would book at least $5 billion of writedowns in the quarter.

"Clearly the size of the loss was a surprise," Jeff Harte, an analyst at Sandler O'Neill & Partners in Chicago, said in a Bloomberg Television interview. "It still leaves people with the question of when are these marks going to stop and does Merrill Lynch have enough capital to weather the storm." Harte has a "hold" rating on Merrill shares.

Goldman Sachs, the biggest U.S. securities firm by market value, reported earnings of almost $2.1 billion for the three months ended May 30. Morgan Stanley, the industry's second- largest company, posted $1 billion of net income. Both are based in New York.

Merrill yesterday confirmed the sale of its 20 percent stake in Bloomberg LP, the parent of Bloomberg News. Merrill said it's financing the sale to Bloomberg Inc., the parent of Bloomberg LP. The deal, when combined with gains from the Financial Data Services transaction, may boost Merrill's capital and stave off further rating downgrades.

At the end of June, the firm's ratio of Tier 1 capital to risk-weighted assets -- a measure scrutinized by regulators -- stood at 7.5 percent, Thain said yesterday on a conference call with investors. With the transactions, that figure climbs to 9.5 percent, he said.

Thain, 53, abandoned an effort to sell Merrill's 49.8 percent share of fund manager BlackRock Inc. In a statement yesterday, BlackRock said the two firms "agreed to extend and strengthen our global distribution agreement." "We have consistently for the last couple of quarters replaced any losses with new capital," Thain said on the conference call.

"We will look at all our different options," he said when asked whether he'd consider additional asset sales. "You know we have a $1 trillion balance sheet. There are in fact other options."

Money-losing collateralized debt obligations -- securities packaged from other bonds, many linked to subprime mortgages -- continue to cause Merrill's biggest writedowns. The firm was one of the largest underwriters of CDOs before the credit crisis hit last year, and Merrill was stuck with more than $46 billion of them on its books when buyers fled the market.

The firm's remaining CDO holdings fell to $19.9 billion at the end of June from $26.3 billion at the end of March, according to the firm's statement yesterday. The majority of the reduction resulted from $3.5 billion in writedowns. "They had really big marks against things that we hoped had been marked down enough," Harte said.

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Ilargi: OK, in the last article we saw this: "[Merrill lost] $4.97 a share.. " and "Analysts' estimates ranged from a loss of 93 cents a share to a loss of $4.21 a share"

So all analysts were way off, the "best" still by almost 20%, the worst by some 400%. How useless are these folks? Well, curiously enough, it doesn’t matter in the universe they reside in. To wit: the next article is about predictions by the same well-paid blunderers. Really, I don’t get it. It looks like it doesn’t matter what they say, just as long as they say SOMEthing.

Analysts see much higher 2008 loss for Merrill

At least seven analysts significantly widened their 2008 loss estimates for Merrill Lynch & Co on Friday, a day after the investment bank posted a quarterly loss way above market expectations and unveiled plans to sell billions of dollars of assets to shore up capital.

"That management has to hold a yard sale to keep Merrill afloat is troubling enough, and now the margin for error for equity holders is getting precariously thin," Fox-Pitt Kelton analyst David Trone said. Wall Street's third-largest investment bank said it has completed and is helping finance the long-expected sale of its 20 percent stake in Bloomberg LP, the news and financial data company, to Bloomberg Inc for $4.43 billion.

Merrill also said it intends to sell Financial Data Services Inc unit, which provides mutual fund administrative services and retail banking products, to an undisclosed party in a transaction valuing the unit at more than $3.5 billion. "The Bloomberg sale is unfortunate," Bernstein Research analyst Brad Hintz. "Nevertheless, Bloomberg was not strategically important. We think the potential Financial Data Services Inc sale is fortuitous."

Merrill, which last November appointed John Thain as its chief executive officer, posted its fourth straight loss as it grapples with huge write-downs of complex debt securities. Analyst Richard Bove of Ladenburg Thalmann believes that the company's earnings power had been severely compromised. He said even though Merrill now has exemplary management it could take years for the firm to recover.

In the meantime, Banc of America's Michael Hecht does not expect Merrill to return to profitability in 2008. "Exposure to risky assets remains Merrill's largest challenge," Goldman Sachs analyst William Tanona said. He expects this to remain a problem for the next few quarters, barring a substantial improvement in the operating environment.

Merrill recorded $9.4 billion of write-downs from exposure to CDOs, residential mortgages, bond insurers and other investments for the quarter. It has written down about $40 billion since the credit crisis began a year ago, leading to net losses exceeding $19.2 billion.

"We would prefer to see Merrill rid itself of these assets and clean up the balance sheet; however, this could bring about simultaneous capital needs that could be very costly for Merrill," Tanona added. Shares of Merrill, which have lost 43 percent of their value this year, were down 21 cents at $31.04 in early morning trade on the New York Stock Exchange.

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Ilargi: Today, investors and media pundits alike are celebrating Citi’s $7.2 billion writedowns and $2.5 billion losses. Apart from the evident absurdity in the simple fact, they all find it convenient to disregard the report a few days ago that Citi is sitting on dozens of billions in shaky Level 3 holdings as well as $1.1 trillion in off-balance sheet assets.

Citi Posts Smaller-Than-Estimated Loss on $7.2 Billion Writedowns

Citigroup Inc., the biggest U.S. bank by assets, reported a smaller loss than analysts estimated after about $7.2 billion of credit-market writedowns.

Citigroup rose in New York trading after the bank said its second-quarter net loss was $2.5 billion, or 54 cents a share, compared with earnings of $6.23 billion, or $1.24, a year earlier. Analysts estimated the loss would be $3.67 billion, according to a Bloomberg survey.

Citigroup's report follows surprisingly strong profits from JPMorgan Chase & Co. and Wells Fargo & Co., and disappointing results from Merrill Lynch & Co. Citigroup Chief Executive Officer Vikram Pandit, who took over in December, has raised $44 billion of capital and outlined plans to reduce assets by $400 billion over the next two to three years.

"The worst news is out," said Malcolm Polley, chief investment officer of Milwaukee-based Stewart Capital Advisors LLC, which manages more than a $1 billion, including Citigroup shares. "I don't think it's going to get worse. It may not get better for a while."

Credit Suisse Group analyst Susan Roth Katzke had predicted the company would have as much as $10 billion of writedowns in a June 24 note. Shares of the company rose to $18.56 in New York trading, from $17.97 at the close on the New York Stock Exchange yesterday. Second-quarter revenue dropped 29 percent to $18.7 billion, compared with the average estimate of $17.3 billion among analysts surveyed by Bloomberg.

The U.S. consumer unit, which includes retail banking and loans to individuals and small businesses, had revenue of $7.89 billion, virtually unchanged from a year earlier. The global cards business rose 3 percent to $5.47 billion. Revenue at Citigroup's corporate and investment bank plunged 71 percent to $2.94 billion.

Pandit, 51, put former Morgan Stanley colleague John Havens in charge of trading and investment banking, moved U.S. consumer head Steve Freiberg to head a new credit-card division and recruited former Wells Fargo executive Terri Dial to oversee consumer banking in the U.S.

He also is taking steps to free up capital by selling assets. Under Prince, Citigroup's balance sheet swelled by $689 billion, an amount larger than the entire balance sheet of Wells Fargo, the fifth-biggest U.S. bank. Total assets stood at $2.2 trillion at the end of last year.

Citigroup slumped 39 percent this year through yesterday, reaching the lowest point since the bank was created a decade ago from the merger of Citicorp and Travelers Group Inc. The decline led to the ouster of former CEO Charles O. Prince as credit- market losses piled up and Citigroup's market value fell below those of Bank of America Corp. and JPMorgan.

New York-based JPMorgan reported second-quarter earnings yesterday of $2 billion. Wells Fargo's profit was $1.75 billion. "We will continue to have substantial additional marks on our subprime exposure this quarter," Chief Financial Officer Gary Crittenden said on a conference call last month.

Citigroup also wrote down the value of so-called monoline insurance companies including Ambac Financial Group Inc. after they were stripped of their AAA credit ratings. "All of the over $300 billion in capital raises worldwide have plugged holes," Oppenheimer & Co. analyst Meredith Whitney said in a Bloomberg Television interview earlier this week.

"They haven't funded new equity growth. You plug these holes and you are still in the same situation where you started off."

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Freddie Gets Asia, Europe Buyers for $3 Billion Bonds

Investors in Asia and Europe snapped up a $3 billion sale of Freddie Mac bonds at near record yields, a sign that the beleaguered mortgage finance company has the support of foreign central banks.

Investors outside North America including central banks bought 61 percent of the two-year notes yesterday, McLean, Virginia-based Freddie Mac said. That compares with 55 percent in its last sale of securities with the same maturity in May.

Freddie Mac fell 64 percent in New York Stock Exchange trading during the past month and Fannie Mae lost 56 percent of its market value on concern they may not have enough capital to survive the housing slump.

Treasury Secretary Henry Paulson announced a rescue plan for the nation's biggest mortgage companies on July 13 and the Wall Street Journal reported today that Freddie Mac may sell $10 billion of new shares, citing people it didn't identify.

"We're operating as business as usual this week," Treasurer Timothy Bitsberger, who was assistant secretary for financial markets at the Treasury before joining the government- chartered company in 2006, said in a telephone interview. "The dramatic change is that we're just under a very large, powerful microscope."

Freddie Mac and Fannie Mae rely on foreign institutions to finance their business. The Federal Reserve held $983.9 billion of so-called agency debt on behalf of international investors as of July 16, up from $950.9 billion on June 4 and $1.83 billion in 2003.

While some investors may have lost confidence in the companies, "all I know is that we've been able to sell paper this week," Bitsberger said. Freddie Mac fell 64 cents, or 7.7 percent, to $7.69 at 11 a.m. in Frankfurt, where 38,000 shares traded. Shares in Fannie Mae dropped 47 cents, or 4 percent, to $10.45 with about 16,000 shares changing hands.

Yields on the companies' debt rose relative to Treasuries this week as Paulson's plan to seek authority from Congress to pump equity into Fannie Mae and Freddie Mac and to increase their lines of credit met resistance from lawmakers. Freddie Mac and Fannie Mae weren't the only ones facing wider spreads, Bitsberger said. Corporate and mortgage debt spreads also increased.

The gap, or spread, on Freddie Mac's benchmark debt widened to 83 basis points, from 50 basis points on Dec. 31, according to Merrill Lynch & Co.'s U.S. Agencies, Freddie Mac Reference Notes Index. The premium rose as high as 101 basis points in March, compared with 34 basis points a year ago. A basis point is 0.01 percentage point. Freddie Mac's reference notes yesterday sold at the widest spread to Treasuries in at least five years.

The debt was priced to yield 3.358 percent, or 88 basis points more than U.S. government debt of similar maturity. "You have better liquidity in Treasuries, but 88 basis points is a fairly decent incentive," said Daniel Fuss, vice chairman of Loomis Sayles & Co. in Boston and co-manager of the $18 billion Loomis Sayles Bond Fund. The companies' notes are "selling where they ought to sell," he said.

Freddie Mac received higher-than-average demand earlier this week for $3 billion of three- and six-month bills. The bid-to- cover ratio, which compares total bids with the amount sold, was more than 50 percent above the average of the past three months, according to Stone & McCarthy Research Associates. The ratio for the three-month auction was 4.16, compared with an average of 2.83.

Asian investors bought at least 34 percent of the Freddie Mac debt sold yesterday, while European buyers purchased 27 percent, the most for two-year notes in more than a year, according to Nancy Vanden Houten, an analyst at Stone & McCarthy in Skillman, New Jersey.

Net foreign purchases of Fannie Mae, Freddie Mac, and other so-called agency debt and agency mortgage-backed securities, rose to $24.2 billion in May from $15.3 billion in April, Treasury said this week. The senior debt of Fannie Mae and Freddie Mac is rated AAA because of its implied guarantee by the U.S. government, making it attractive to central banks, pension funds and insurance companies seeking low-risk investments.

Asian banks and insurance companies own about $800 billion of the companies' debt, including $200 billion held by Japan and $376 billion by China, Moody's Investors Service said in a report yesterday, citing the U.S. Treasury.

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Mortgage Giant Freddie Mac Considers Major Stock Sale

Mortgage giant Freddie Mac -- emboldened by emergency regulatory actions that have triggered a two-day rebound in its battered stock -- is considering raising capital by selling as much as $10 billion in new shares to investors, according to people familiar with the matter.

The high-stakes maneuver would have the potential to avoid a full-blown government rescue for Freddie Mac and Fannie Mae, twin keystones of the U.S. housing market. The publicly traded, government-sponsored companies own or guarantee about $5.2 trillion of home mortgages, or nearly half the total outstanding, and are at the center of government efforts to prop up the sagging housing market.

Both companies' stock fell about 45% last week amid worry about whether they have enough capital to cover mortgage losses. The depth of their troubles spurred the Treasury Department on Sunday to unveil an unusual plan to temporarily extend an unspecified credit line to both companies -- as well as buy stock in them if necessary.

That plan quickly came under fire on Capitol Hill. Critics argue it could cost American taxpayers billions of dollars. For its part, Freddie would like to avoid the stricter government oversight that could accompany any rescue. Its moves come as new details emerge about its recent stumbles. The past two days have raised hopes at Freddie for a sale of shares to investors other than the Treasury.

Freddie and Fannie shares both surged more than 29% on Wednesday, a day after the Securities and Exchange Commission set emergency rules limiting the ability of bearish investors to place aggressive bets that their stocks would keep falling. On Thursday, Freddie shares were up another 22%, though they remain down 76% for the year.

A sale by Freddie of common and preferred stock could be tough to pull off. For starters, the preferred shares would require Freddie to offer a very high rate of return to attract buyers. The yield on one existing issue of Freddie's preferred stock, for example, is about 13.8%.

At that rate, even a $5 billion preferred-stock offering would entail a $690 million annual payout, on top of the $272 million Freddie paid out on its existing preferred shares in the first quarter. That would reduce the money available to common-stock shareholders, cutting the value of those holdings and potentially sending the stock price lower.

The main buyers for any new-stock issues are likely to be existing shareholders world-wide, according to one person involved in the discussion, adding that a definitive plan hasn't yet been determined. In the short term, a sale of new shares might eliminate the need for the Treasury's help, but a government bailout might still be required later. "At the heart of this crisis of confidence is uncertainty about the true financial condition of the companies," says Armando Falcon Jr., their former regulator.

Analysts expect that Freddie and Fannie both will face significant losses in the months ahead as the housing crisis shows no signs of slowing. Both companies, which were originally chartered by acts of Congress, buy mortgages from lenders. They package those loans into securities for their own investment portfolios and for sale to investors world-wide.

The two companies -- which are rivals in the same business -- have reported a combined $11 billion of losses over the past three quarters, largely because of increasing defaults by homeowners on mortgages. When homeowners don't make mortgage payments, Fannie and Freddie must reimburse the holders of securities backed by those defaulting mortgages. At the same time, falling home prices cut the value of the collateral backing the loans, increasing losses for Fannie and Freddie.

Investors and analysts can only guess how bad the losses might be as several million American homes go through foreclosure. Analysts at Goldman Sachs Group Inc. this week estimated that Fannie faces default-related losses of $32 billion and Freddie $21 billion. Those losses, expected to be mostly realized over the next few years, will be offset to some extent by growing revenues and higher fees the companies can now charge.

Freddie's board met Thursday to review options for selling new shares. Freddie Mac Chief Executive Officer Richard Syron has huddled frequently with investment bankers from Morgan Stanley and Goldman Sachs Group Inc. and has held two board meetings this week at Freddie's New York office. The proceeds of a sale are expected to be in the range of $5 billion to $10 billion, according to people close to the discussions.

One idea that has been raised is a "rights offering" of shares, in which existing shareholders get first dibs on the new stock. Freddie, for its part, says it has plenty of cash for now and has hinted that it could resort to eliminating its dividend, for savings of $650 million a year. The seeds of the companies' capital questions were sown in 1992. Lobbyists from Fannie and Freddie persuaded Congress they didn't need to hold much capital as a cushion against homeowner defaults, which were expected to be small.

Fannie and Freddie grew at a dizzying pace, raising their combined holdings of mortgages to $1.58 trillion in 2003 from $136 billion in 1990. They dominated their industry, providing funding or guarantees for 57% of all U.S. home mortgages in 2003, according to Inside Mortgage Finance, a trade publication.

That control weakened a few years back amid accounting irregularities at Fannie and Freddie and aggressive lending by other financial firms, particularly in "subprime" and other risky mortgages to low-end borrowers. Eager to regain market share, Fannie and Freddie started buying riskier mortgages themselves.

Still, when the credit crunch hit last year, Fannie and Freddie appeared to be in relatively good shape. They had avoided some of the worst lending practices, and their Wall Street rivals were on the ropes. The companies' market share shot up to 68% in this year's first quarter from 45% a year earlier. As of March 31, Freddie had "core capital" -- a measure of financial strength consisting of retained earnings and other items -- totaling $38.3 billion. That works out to 1.8% of the $2.15 trillion of mortgages Freddie owned or guaranteed as of that date.

That's low compared with the requirements placed on other financial institutions, such as banks. Indeed, if Freddie were a bank, it would need about $91 billion to be considered well-capitalized, says Karen Petrou, managing partner at research firm Federal Financial Analytics in Washington. Her firm does consulting work for trade associations that are sometimes publicly critical of Fannie and Freddie.

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Ilargi: As we saw just above, if Freddie Mac were subject to "normal" banks’ accounting rules and requirements, it would need to raise over $ 50 billion in one big swoop. But no, Freddie has capital enough, it says. Suppose that were true: Do you ever wonder why those requirements are in place for banks in the first place?

Freddie Says It Has Enough Capital, Files With SEC

Freddie Mac, the second-largest U.S. mortgage-finance company, said early indications of its second- quarter results show it probably has enough capital to remain above the 20 percent mandatory surplus demanded by its regulator.

The company isn't under any mandate to raise more than the $5.5 billion in capital it agreed to earlier this year with its regulator, Freddie Mac said in a filing with the U.S. Securities and Exchange Commission today that was a step toward becoming fully registered, removing a hurdle to selling stock and fulfilling an agreement made six years ago with lawmakers.

The SEC is likely to approve the registration today, according to people with knowledge of the plans. The quarter will reflect "the challenges that face the industry," Freddie Mac said in the filing. "We expect to take actions to maintain our capital position above the 20 percent mandatory target surplus."

Freddie Mac may raise as much as $10 billion selling new shares to investors, the Wall Street Journal reported. McLean, Virginia-based Freddie Mac lost 64 percent during the past month and the larger Fannie Mae declined 56 percent on concern they may not have enough capital to survive the housing slump.

Freddie Mac's plan to raise cash might avoid an immediate government rescue and stricter oversight that would come with such a bailout, the Wall Street Journal said, citing people it didn't identify. The companies' stock slump prompted U.S. Treasury Secretary Henry Paulson to announce a rescue plan on July 13, seeking authority to buy equity in Freddie Mac and Fannie Mae and increase a credit line to the companies should they request it. The Federal Reserve agreed to lend directly to the companies.

Freddie Mac since 1970 has been exempt from registering its common stock and debt securities with the SEC because of its government-chartered status. The company, under pressure from lawmakers, agreed in 2002 to register its stock, a plan that stalled when Freddie Mac's auditor uncovered $5 billion in accounting errors and forced an overhaul of internal controls. Fannie Mae registered in March 2003.

The filing will also allow Freddie Mac to move ahead with plans to raise additional capital, which the company put off until it completed the registration process. The SEC still needs to approve the filing. The companies have already raised $20 billion in the past year to cover losses.

Freddie Mac had planned to sell $5.5 billion of stock next month. Because of "unfriendly" market conditions, Ofheo isn't pushing Freddie Mac to raise the capital, the UBS analysts said. Friedman Billings Ramsey & Co. analyst Paul Miller in Arlington, Virginia, estimates Fannie Mae and Freddie Mac will each need to raise $15 billion.

The companies would be "very prudent" to raise $10 billion to $15 billion, Barclays Capital analysts including Ajay Rajadhyaksha and Rajiv Setia in New York said in March. The companies don't need to raise capital immediately, Rajadhyaksha, head of U.S. fixed-income at Barclays, said in a telephone interview last week.

Moshe Orenbuch, an analyst at Credit Suisse in New York, estimates Freddie Mac may need $3 billion more after raising $5.5 billion. Freddie Mac will probably report a bigger surplus above the statutory minimum required for second quarter, according to the filing.

The Office of Federal Housing Enterprise Oversight, Freddie Mac's regulator, agreed this year to lower the companies' surplus capital requirement from 20 percent to 10 percent after it registers with the SEC and raises new capital.

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Auction Implosion Reaps Fees, Not Scorn, for Dealers

The surprising thing about the collapse of the auction-rate securities market is how well states and municipalities are taking it.

Since dealers stopped supporting the $330 billion market back in February, issuers of auction-rate securities have spent more than $1 billion on fees and higher interest rates, and they haven't made a peep about the guys responsible for this misery.
No, I don't mean the maniacs who concocted all the subprime securities that are threatening the entire financial system, or the rating companies that so compliantly slapped their AAA on the things, or even the bond insurers who binged on them.

I refer to the dealers and underwriters. If anything, they are being rewarded for wrecking the market. Issuers paid them to set up the auctions and sell their bonds, gave them money to run the auctions, and compensated them for the interest-rate swaps that became the must-have accessory to auction securities.

They paid them to keep running auctions that failed, and now, more often than not, they are paying the same firms to sell new bonds to refinance their now-dead auction- rate debt and to undo the swaps. Perhaps some cross words have passed between issuer and underwriter, but I doubt it.

It's still pretty early in the process, of course -- it looks like issuers have refinanced their way out of about $90 billion of the once $166 billion municipal piece of the auction- rate market, or they intend to do so. And a bunch of states made inquiries into why their pals at the securities firms decided to blow up the market. But that's as far as it has gone.

The state of Massachusetts filed a complaint against UBS AG on June 26 for the Zurich-based bank's role in the debacle, but that lawsuit is all about investors, not the taxpayers who are footing the bill. Can it be that public officials everywhere appreciated exactly what they were getting into when they first sold auction- rate debt? You mean, they all realized that dealers could bid on their securities, but had no obligation to bid? Really?

Sweet reason doesn't usually enter into the relations that states and municipalities enjoy with the securities industry. Remember how angry Orange County, California, was after it declared bankruptcy back in 1994? The county sued the dealers that enabled treasurer and tax collector Robert Citron to perpetuate his fantasy of financial mastery.

Merrill Lynch & Co., Citron's top broker, wound up paying $400 million to Orange County, which sued it for providing bad financial advice. So far, the hundreds of municipalities that made up the auction-rate securities market have been silent. Perhaps we live in a more gracious and understanding age. On July 8, an issuer that was forced to pay one of those well-documented 20 percent penalty interest rates after its failed auctions filed a lawsuit -- against an insurer.

The lawsuit filed by a New England Patriots football team affiliate is against Ambac Assurance Corp. Ambac insured the auction-rate debt sold in 2006 by the Patriots for their new stadium. After the auction market froze in February and the penalty rate kicked in, the team refinanced. Ambac then presented it with a bill for $2,765,073, representing a portion of the annual premiums the insurer would have collected through 2017.

Where's the Outrage? The lawsuit basically says "What? Are you kidding me?" about the insurer's claim for future premiums, and explains: "Due to Ambac's weakening credit position and market uncertainty as to how much subprime exposure it had in its portfolio, on February 20, 2008, the risk associated with the 2006 Bonds was so high, that there were no buyers for the bonds, and the auction failed."

What the complaint doesn't mention is that most dealers stopped supporting auctions a week earlier, and that their presence in this market was crucial. Just how crucial was spelled out in the June 26 complaint against UBS filed by Massachusetts Secretary of State William Galvin.

Between 2006 and Feb. 28, 2008, UBS submitted support bids in 30,367 auctions for municipal and student-loan securities, the complaint said, and the bids were drawn upon 86 percent of the time. The "market" was a fiction. The only reason it failed so catastrophically was because dealers got tired of buying more and more auction-rate paper. Most taxpayers haven't seen the bill being exacted by this auction-rate mess yet. When they do, we might see more outrage.

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Investors sue Bank of America over auction rate securities

Investors filed a class-action lawsuit Thursday against Bank of America Investment Services Inc. and Bank of America Securities, alleging that brokers deceived them about their risk.

Bank of America offered and sold auction rate securities to the public as highly liquid cash-management instruments and as suitable alternatives to money market mutual funds, the suit alleges. On Feb. 13, all of the major broker-dealers, including Bank of America, withdrew their support for the auctions, leaving the market to crumble and investors unable to access their money.

The investors involved in the suit bought the securities between June 11, 2003 and Feb. 13, 2008. The lawsuit, filed the same day state regulators investigated Wachovia Securities in downtown St. Louis for its handling of auction rate securities, is pending in the U.S. District Court for the Southern District of Illinois. The lawsuit alleges that Bank of America failed to disclose the following facts to investors:

• The auction rate securities were not cash alternatives like money market funds but were instead complex long-term financial instruments with 30-year maturity dates.
  
• The auction rate securities were only liquid at the time of the sale because Bank of America and other broker-dealers were artificially supporting and manipulating the market to maintain the appearance of liquidity and stability.
  
• Bank of America and other broker-dealers routinely intervened in the auctions for their own benefit to set rates and to prevent all-hold auctions and failed auctions.
  
• ank of America continued to market auction rate securities as liquid investments even after Bank of America and other broker-dealers determined that they would likely be withdrawing support for the periodic auctions and that a freeze of the auction rate securities market would result.

Auction rate securities are municipal or corporate debt securities or preferred stocks that pay interest at rates set through periodic auctions. The instruments typically have long-term maturity dates or no maturity date.

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Citi Bottoms (Or Has It?); Merrill Flunks Test; The Return of Freddie

Investors have been making some whopping big bets that the worst is over in the crisis in financial services. (Of course, those same investors did the same thing in April, and look how that turned out.) And they’re doubling down - in some cases - in Friday’s action. With Citigroup.

With Citi shares up 19% from the 12-year low notched on Tuesday, the stock is poised to mount another double-digit advance in Friday’s trading - shares rising 10% in pre-market action - leveraged off the better-than-expected second-quarter results. Check that - ”better than expected”? This is ”dog with fewer fleas” stuff going on here. Citi lost $2.5 billion in the quarter.

But the bottom line to this bottom line is that Citi only lost half as much money in the period as analysts had forecast. (You can add your own air-quotes around the word ”only” in that sentence.) There’s enough fleas on that quarterly statement to start a fairly prosperous circus. A company that has written down $40 billion in assets in four quarters wrote down more in the second quarter.

Credit losses rose 20% to $4.5 billion. Write-downs in its securities and banking businesses increased 42% year-over-year. Profits at its Smith Barney and private banking buisness climbed 21%. A company that has raised $39 billion in new capital since the fall might need more. And a dividend cut can’t be ruled out.

Still, there’s some encouraging signs that new management’s re-engineering plans have gained some traction. Losses amounted to 49 cents a share - downright gaudy, compared with forecasts of 66 cents in losses. And so the big bet that the elusive bottom was reached sometime in the quarter has been laid.

It’s gotten personal - and not real pretty - at Merrill Lynch (MER). When John Thain, the former Goldman executive fresh off his success at the top of the New York Stock Exchange, got installed in the top job late last year, Wall Street widely applauded the much-needed change in command. Certainly, his ascension garnered more accolades from the analyst community than did Citi’s nomination of Vikram Pandit to the top post at the bank.

Thain has had a couple quarters to demonstrate that his vision for the investment bank would lead to salvation. And so far, the results have left investors wanting. (Pandit, on the other hand, would seem to be winning over the nay-sayers.)

Meredith Whitney at Oppenheimer, assaying the second-quarter results that showed losses doubling Wall Street’s estimates - and accompanied by announcements of considerable asset sales - described Thain’s initiatives as the kin of ‘’selling the sofa to pay the rent,” and hinted that the dining table could go next.

The firm took nearly $10 billion in write-downs in the quarter. And prompted fresh questions as to whether another round of capital-raising initiatives could be in the offing. Still, Merrill shares - by dint of participating in the broader financial services recovery - aren’t expected to pay much of a price in Friday’s trading, tacking on about 2% in the pre-market action.

Freddie Mac clearly believes that striking while the iron is hot is the best strategy for its long-term recovery. Emboldened by the two-day recovery - engineered, in large measure, by the government’s attempts to fashion a restructuring while simultaneously keeping the wolves away from the mortgage door - Freddie has tip-toed up to the SEC’s registration window with a plan to raise fresh capital. Sum total: maybe $5 billion, perhaps $10.

The filing removes one obstacle to its efforts to raise capital, and could allow the mortgage finance concern to avoid the full force of a government rescue, which would likely be accompanied by the yoke of fresh limits on its activities. Activities that have, of course, resulted in its share of the $11 billion in losses that it and its compadre and rival Fannie Mae have notched.

If it succeeds in successfully raising new moolah, government regulators have promised to reduce the capital targets imposed on the operation. (Taking the proverbial foot off the functional brake.) Raising fresh capital is no slam-dunk, however.

Freddie is going to have to offer prospective investors some pretty attractive terms to lure them in, given that its preferred shares are currently yielding about 14%. However, the implicit suggestion that a capital-raise would alleviate the need to cut the dividend has sent shares rocking 10% higher Friday.

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Wall Street's Great Deflation

Phil Gramm, the senator-banker who until recently advised John McCain's campaign, did get it right about a "nation of whiners," but he misidentified the faint-hearted. It's not the people or even the politicians.

It is Wall Street--the financial titans and big-money bankers, the most important investors and worldwide creditors who are scared witless by events. These folks are in full-flight panic and screaming for mercy from Washington, Their cries were answered by the massive federal bailout of Fannie Mae and Freddy Mac, the endangered mortgage companies.

When the monied interests whined, they made themselves heard by dumping the stocks of these two quasi-public private corporations, threatening to collapse the two financial firms like the investor "run" that wiped out Bear Stearns in March. The real distress of the banks and brokerages and major investors is that they cannot unload the rotten mortgage securities packaged by Fannie Mae and banks sold worldwide.

Wall Street's preferred solution: dump the bad paper on the rest of us, the unwitting American taxpayers. The Bush crowd, always so reluctant to support federal aid for mere people, stepped up to the challenge and did as it was told. Treasury Secretary Paulson (ex-Goldman Sachs) and his sidekick, Federal Reserve Chairman Ben Bernanke, announced their bailout plan on Sunday to prevent another disastrous selloff on Monday when markets opened.

Like the first-stage rescue of Wall Street's largest investment firms in March, this bold stroke was said to benefit all of us. The whole kingdom of American high finance would tumble down if government failed to act or made the financial guys pay for their own reckless delusions. Instead, dump the losses on the people.

Democrats who imagine they may find some partisan advantage in these events are deeply mistaken. The Democratic party was co-author of the disaster we are experiencing and its leaders fell in line swiftly. House banking chair, Rep. Barney Frank, announced he could have the bailout bill on President Bush's desk next week. No need to confuse citizens by dwelling on the details. Save Wall Street first. Maybe lowbrow citizens won't notice it's their money.

We are witnessing a momentous event--the great deflation of Wall Street--and it is far from over. The crash of IndyMac is just the beginning. More banks will fail, so will many more debtors. The crisis has the potential to transform American politics because, first it destroys a generation of ideological bromides about free markets, and, second, because it makes visible the ugly power realities of our deformed democracy.

Democrats and Republicans are bipartisan in this crisis because they have colluded all along over thirty years in creating the unregulated financial system and mammoth mega-banks that produced the phony valuations and deceitful assurances. The federal government protects the most powerful interests from the consequences of their plundering. It prescribes "market justice" for everyone else.

Of course, the federal government has to step up to the crisis, but the crucial question is how government can respond in the broad public interest. Bernanke knows the history of the last great deflation in the 1930s--better known as the Great Depression--and so he is determined to intervene swiftly, as the Federal Reserve failed to do in that earlier crisis.

By pumping generous loans and liquidity into the system, the Fed chairman hopes to calm the market fears and reverse the panic. So far, he has failed. I think he will continue to fail because he has not gone far enough. If Washington wants real results, it has to abandon the wishful posture that is simply helping the private firms get over their fright. The government must instead act decisively to take charge in more convincing ways.

That means acknowledging to the general public the depth of the national crisis and the need for more dramatic interventions. Instead of propping up Fannie Mae or others, the threatened firm should be formally nationalized as a nonprofit federal agency performing valuable services for the housing market. That is the real consequence anyway if the taxpayers have to buy up $300 billion in stock.

The private shareholders "are walking dead men, muerto," Institutional Risk Analytics, a private banking monitor, observed. Make them eat their losses, the sooner the better. The real national concern should be focused on the major creditors who lend to Fannie Mae and other US agencies as well as private financial firms. They include China, Japan and other foreign central banks.

Foreign investors hold about 21 percent of the long-term debt paper issued by US government agencies--$376 billion in China, $229 billion in Japan. It is not in our national interest to burn these nations with heavy losses. On the contrary, we need to sustain their good regard because they can help us recover by bailing out the US economy with more lending. If these foreign creditors turn away and stop their lending now, the US economy is toast and won't soon recover.

Americans should forget about whining; it's too late for that. People need to get angry--really, really angry--and take it out on both parties. What the country needs right now is a few more politicians in Washington with the guts to stand up and tell us the hard truth about out situation. It will be painful to hear. They will be denounced as "whiners." But truth might be our only way out.

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Mystery Surrounds Wells Fargo’s Earnings

Wells Fargo was one of the first to use heavy Level-3 placement of toxic paper early in 2007. Last quarter there was a debate on how they valued their mortgage servicing rights - if you remember Wells beat last quarter from “mortgage banking.” Yeah, right. It seems like every quarter, questions arise on the quality of their earnings. Yesterday was no different.

This story concerns their massive $84 BILLION Home Equity Line/Loan portfolio, of which much is now underwater due to massive house price depreciation.  Technically (and realistically) these have become unsecured. This is a real problem for banks.  By my estimates, Wells Fargo wildly under-reserved on their home equity exposure.

Not only did Wells change the time line for placing a loan into technical “default” by extending the term out 60-days, essentially hiding 60-days of defaults, but they are also using AVMs to determine value from March of 2008, though the median home price has fallen 5.4% since then.

A 5.4% fall could have thrown double-digit percentages of home equity loans into an even more serious negative equity position, which would have required additional loss reserves.   Wells does not seem to care.  Maybe Buffett should urge them to come clean?  Or does the sage of Omaha think (real) home prices will come back to the frothy peak of the bubble, even in California?

As a note, about $12 bb of Wells home equity exposure is in first lien home equity loans, which do have a much lower default risk. However, such a massive amount is over 90% that even if you deleted all the other exposure, the $35.6 bb in high risk is enough to do serious damage to shareholder equity. From Housing Wire:

In the second lien portfolio set up for liquidation, the percent of loans that saw borrowers miss two or more payments rose during Q2 to 3.6 percent, up from 2.79 percent one quarter earlier. The $73 billion “core” home equity portfolio saw a similar rise to 1.88 percent in 60 day delinquencies, compared with 1.71 percent in Q1.

So delinquencies continued to rise during Q2; net credit losses, however, did not. Charge-offs on second liens were actually down $104 million compared with first quarter 2008 — but don’t let that fool you.

The improvement was primarily due to a change in how the bank handles its home equity portfolio charge-offs; earlier in Q2, the bank extended its charge-off policy from 120 days to 180 days, in an effort to give troubled borrowers more time to reach a loan workout (or to protect earnings, take your pick.

Wells Fargo changed its policy to hide defaults: “In the second quarter, Wells Fargo changed its policy toward charged-off home equity loans to 180 days delinquent from 120 days “to provide more time to work with customers to solve their credit problems and keep them in their homes,” the company said on Wednesday.

The change deferred roughly $265 million of charge-offs in the second quarter. Approximately 900 customers with $90 million of home equity loans have been modified due to the change, Wells Fargo said.”

Finally, Wells Fargo used old valuations from March. Since then the median home price in CA — where they are home equity-heavy — have fallen 5.4%, this could have thrown double digit percentages of home equity loans into an even more serious negative equity position which would have required additional loss reserves.

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US Mortgage Insurers’ Troubles To Worsen

The US mortgage insurance industry’s troubles are not over and may get worse before they improve, according to Fitch Research. In a special on mortgage insurer delinquencies, Fitch makes the following key observations:

• The 2007 vintage insurance in force (IIF) displays significantly higher levels of first- year delinquencies than the 2006 and 2005 vintages, each of which displayed successively higher first-year delinquencies than the prior vintage.
  
• The composition of 2007 vintage origination contained a significantly greater proportion of loans with initial loan-to-value (LTV) ratios in the 95%?100% range than prior years’ originations. This was largely attributed to the decline in originations of simultaneous-second, or “piggyback”, mortgages in 2007. This category of loans from the 2007 vintage has performed poorly and has contributed to increased delinquency levels in the 2007 book.
  
• The second-year delinquency rate of the 2006 vintage was significantly higher than that of the 2005 vintage at the corresponding point in time, and on average exceeded the 2005 vintage third-year delinquency rate.

While steps have been taken by the industry to improve the prospects of future business, Ftch says its analysis indicates that “the mortgage insurance industry’s troubles are not over and may, in fact, get worse before they improve.”

In Fitch’s view, 2007 will likely prove to be one of the worst underwriting years in the modern history of the U.S. mortgage industry.

Fitch puts the industry’s “risk in force”-to-capital ratio at 13.3%, ranging from 11.7% for PMI to 20.5% for Triad Guaranty, which has fallen out of compliance with Fannie Mae and Freddie Mac requirements. Fitch’s findings echo those of CreditSights, which recently called the outlook for the mortgage insurance industry “extremely negative.”

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Frank Backs Linking Rescue Plan to U.S. Debt Limit

U.S. Representative Barney Frank, the Democrat who heads the House panel overseeing housing, aims to tie the Treasury's plan to aid Fannie Mae and Freddie Mac to the federal debt limit, placing a potential constraint on the help.

It's "very clear," lawmakers won't support exempting the rescue from the debt limit, said Frank, the chairman of the House Financial Services Committee. "The fact that any expenditure under this bill would be subject to the debt limit is a cap in effect on the amount," he said. Such a cap will limit taxpayer liability, he said.

The debt limit is $9.815 trillion and the current outstanding public debt subject to that limit is about $9.4 trillion, according to the Treasury Department. Treasury Secretary Henry Paulson met with lawmakers at the U.S. Capitol for the second consecutive day today in a bid to secure support in Congress for the rescue plan, which may be voted on next week.

Paulson said he expects to reach "a very acceptable result" next week in negotiations with lawmakers on his plan to aid mortgage buyers Fannie Mae and Freddie Mac. "I feel even better than I did yesterday in my confidence level that we will come to a very acceptable result, and come to it next week," Paulson told reporters today in Washington after meeting with Frank.

Paulson has said that an "unspecified" amount of aid would best help restore confidence in them. Paulson is seeking authority to make unlimited equity purchases in Fannie Mae and Freddie Mac and the right to make "unspecified" increases in their lines of credit. Frank said he doesn't expect the plan to incur significant costs for taxpayers because it will spur investor confidence in the lenders, limiting the need for public money.

Louis Crandall, chief economist at Wrightson ICAP LLC, a Jersey City, New Jersey-based research firm, said Paulson has "been very focused on making sure that there are no unintended constraints that might raise unwanted questions about the adequacy of the Treasury backstop."

House Minority Leader John Boehner, an Ohio Republican who proposed delaying consideration of the plan so that lawmakers could have more time to study it, said yesterday there's no question "that this will become law and become law very soon."

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Gordon Brown has 'lost his grip on the economy' as government borrowing soars

Government borrowing has soared to its highest level since records began more than 60 years ago, it was announced yesterday as Gordon Brown was accused of losing his grip on the economy.
 
Official figures showed that the budget deficit soared to £24.4 billion in the three months to June - the biggest shortfall since comparable records began in 1946. The Office for National Statistics said the deficit climbed to £9.2 billion.

It came after it emerged that the Prime Minister was considering abandoning the two fiscal rules which have controlled public spending, borrowing and taxing for the past decade. The news led to speculation that the Government is considering borrowing billions more in the coming years as the economy faces a housing slump and a possible recession.

The Government's accounts are likely to worsen even more in the coming months as the amount it raises in taxes from businesses and individuals slumps along with the UK economy, experts warned. News of the record borrowing is highly embarrassing for Mr Brown, who staked his reputation as both Prime Minister and Chancellor on his economic proficiency.

Instead, experts said, the economy was in danger of falling victim to the problems faced by successive Labour governments: record public debt, a slumping pound, soaring inflation and a sinking economy.
Shadow Chancellor George Osborne said: "The Brown era of economics is over.

He staked his credibility on the fiscal rules. They were part of the arrangement he announced a decade ago to constrain government and make sure that money was put aside in the good years to prepare for the bad years.

"Now we've reached those bad years, the public finances are in a mess, and the rules are being ditched. It's like giving the prisoner the keys to their own prison cell. The Treasury can't stick with a tax policy for more than about three weeks and Britain lacks economic leadership at the very moment it needs it most."

Mr Brown set himself two borrowing rules in 1997 as a guarantee to the City that he would not fall prey to the temptation of overspending and overborrowing. The golden rule was designed to prevent the Treasury borrowing to fund current spending, such as civil servants' wages, rather than investment, such as the construction of new schools, over the course of an economic cycle.

The sustainable investment rule prevented the Treasury from letting its total debt mountain climb above 40 per cent of Britain's gross domestic product. However, both rules have been undermined in recent years, as Mr Brown changed the dating of the economic cycle, allegedly to help him meet the golden rule, and was forced to nationalise Northern Rock, effectively breaking the sustainable investment rule.

With the economy now facing a possible recession, Treasury policymakers are believed to have concluded that keeping the rules at all is unrealistic over the coming years. A spokesman admitted that the rules will be reconsidered later this year, but dismissed as speculation the idea that the existing rules will be thrown out.

Philip Shaw, chief economist at City institution Investec said the major slump in the state of the public finances reported by the ONS meant the Government was now already far from meeting the existing rules. "June's public finances made for some grim reading. In short the figures were absolutely horrific.

Faced with a choice of tightening fiscal policy [namely, raising taxes or cutting spending], breaking both the rules or changing them, the Government seems to be opting for the third choice. "Altering the rules just before they are about to be broken does not show a great sense of timing, but on the upside the UK might emerge with a more credible and robust fiscal framework."

In the latest sign of the housing market's woes intensifying, the Council of Mortgage Lenders reported that the amount lent out in home loans dropped to a new record low of £23.8 billion in June. It follows news last week that house prices are falling at the fastest rate since the Great Depression in the 1930s

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UK mortgage drought deepens on 32% lending fall

UK mortgage lending fell by 32 per cent in the year to June and is will worsen further if the Bank of England raises interest rates in a bid to combat inflation, mortgage lenders warned today.

Figures from Council of Mortgage Lenders (CML) show that during June - traditionally one of the busiest periods in the housing market - gross mortgage lending fell 3 per cent to an estimated £23.8 billion as buyers struggled to secure new home loan deals.
The CML said today the pace of decline in the mortgage market was accelerating, with lending in the first three months of this year down 11 per cent and by 21 per cent in the second quarter.

But there was a glimmer of hope for homeowners as Halifax, the UK's biggest mortgage lender, announced it was cutting some mortgage rates by up to 0.15 per cent. This comes after Nationwide Building Society cut some of its rates earlier this week, although it increased rates for borrowers who have less than a 10 per cent deposit.

However, Michael Coogan, director general at the CML, said that lenders' funding shortages was hampering the mortgage market and indicated that the Government needed to step up support. He said: “Government efforts to help housing associations purchase new-build properties and borrowers to save for a deposit are welcome, but are likely to have only a marginal impact on the housing market. "

Earlier this week, the CML published its proposals to help kick-start the mortgage market. It suggested that the Bank of England offer further loans in exchange for new mortgage-backed securities which have been sold in the credit markets. In a stark warning, Mr Coogan said that the situation in the mortgage market was unlikely to improve soon. “While by historic comparisons we still have had a good level of gross lending, new net lending has been constrained in 2008 and this picture will continue for the rest of this year," he said.

Earlier this month, the Bank of England's Monetary Policy Committee voted to keep the UK interest rate at 5 per cent. However, there are fears the Bank could decide to raise borrowing costs following another increase in inflation which is now at 3.8 per cent - nearly double the Government's 2 per cent target.

Howard Archer, chief UK and European economist at Global Insight, said: "It is very possible that the Bank of England's next move could be to raise interest rates, which would clearly be very bad news for the housing market. "Very negative housing market sentiment also heightens the risk that house prices will fall sharply over the next couple of years."

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Barclays investors snub £4.5bn fundraising

The bulk of Barclays shareholders have snubbed the bank's £4.5bn share issue, leaving a group of sovereign wealth funds and key institutional investors to shoulder the programme.

Barclays today revealed that shareholders bought just 19pc of new shares issued by the bank, ensuring the Qatar Investment Authority becomes its principal investor with about 6pc of total equity. Barclays pre-placed the 1.576m new shares with a series of funds and institutional investors then offered "claw-back" rights to existing shareholders at 282p.

Though it represented a discount of about 9pc on the market price when the capital raising was announced, Barclays shares, like others in the sector, have fluctuated erratically since, deterring many investors from taking part. The shares, which closed on Tuesday at 260.5p - a low not seen in almost a decade - have surged more than 6pc today to trade above 310p early this afternoon.

Qatari investment vehicle Challenger is among the funds to take part in the placing, along with China Development Bank and Singapore's Temasek, which already had Barclays stakes. Japan's third largest bank, Sumitomo Mitsui Financial Group, has also invested £500m, while hedge fund GLG Partners is among other investors. The new shares will start trading from Tuesday.

Analysts have broadly welcomed the Barclays placing and open offer as a means to raise capital without resorting to a rights issue while enabling shareholders to protect the size of their stake. MF Global analyst Mamoun Tazi said today that the placing was "a very well structured and intelligent way of raising capital". "It avoided the pitfalls that have been associated with rights issues," Mr Tazi said.

Meanwhile the £4bn HBOS rights issue has closed today, with shares in the major mortgage lender trading below the 275p price this morning but climbing to about 280p at the noon deadline. HBOS shares were trading at 280p mid this afternoon.

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Millions of decent taxpayers will foot the bill for institutional idiocy

So now we know: the Government gave the public a "wholly misleading picture" of the safety of their savings. That is the assessment of the Parliamentary Ombudsman after an exhaustive inquiry into Equitable Life's collapse.

Well, blow me down. Who would have believed it? Ministers, best known for squandering public resources, have discovered a commodity with which they prefer to be economical - the truth. Shocking! How long before an official investigation concludes something very similar about Northern Rock, for which Alistair Darling approved a £25 billion state loan and other guarantees worth at least as much again?

When the Newcastle-based bank, crippled by a flawed strategy, began sucking in public money last autumn, the Chancellor's message was unambiguous: taxpayers' money is safe. In November, he insisted that the Rock's debt was underpinned by "quality assets", including mortgages.

Given that the cash was being absorbed by a dysfunctional business, his confidence about the likelihood of full repayment seemed strangely at odds with reality. What's more, the housing market had already cracked and the value of the Rock's collateral was starting to slip away.

Not surprisingly, Mr Darling's reassurances and those of his puppet master next door have since morphed, in the style of Animal Farm, into something less certain (some subsidies, it seems, are more equal than others). Even so, as recently as February, when the Government decided to nationalise the Rock, the Chancellor was still looking on the bright side.

"When market conditions improve, the value of Northern Rock will grow and therefore the taxpayer will gain," he said. Gain? Wow, there was I thinking that Mr Darling had been driven by political expediency - a desperation to shore up votes in Labour's north-east heartland - but all along he had a cunning plan to outwit professionals and make a profit.

Ah, if only the Grey Fox had been running the Treasury when Equitable Life went under. Who knows, instead of having had their pensions slashed, the members might now be lighting cigars with £10 notes. Or maybe not.

An important difference between Equitable and the Rock is that, whereas the mutual insurer's customers were invited to contribute, taxpayers were compelled to hand over a sum not far short of Britain's annual defence budget to an ex-building society that had become too big for its boots.

As Westminster's resident comedian, Vince Cable, pointed out: "This Prime Minister and his Chancellor have invested the equivalent of 30 Millennium Domes in this bank and we don't even have a pop concert to show for it." The Chancellor's case was that he had acted to protect taxpayers' money and save the banking system from ruin. It sounded noble enough, but didn't bear scrutiny.

First, when has taxpayers' money ever been safe with Government? Second, the world would not have ended had the Rock tumbled into administration like any other poorly managed company. Willem Buiter, a professor at the LSE and a former member of the Bank of England's Monetary Policy Committee, said Northern Rock had no systemic significance:

"Its insolvency would not threaten financial stability… Indeed in the longer run, the insolvency of Northern Rock would no doubt enhance the financial stability of the UK banking sector, because it would represent a stark warning against reckless funding."

On the day Gordon Brown moved into Number 10, he promised us a new style of government. And, to be fair, he has delivered something different: an origami administration. Everything it touches folds like rice paper.

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Ilargi: Stock markets in Pakistan differ very little from those in England and the US at this moment in time: they are vehicles to rob unsuspecting, gullible, small people of their savings. In our part of the world that happens in several ways at the same time; pension funds and mutual funds lose your money as fast as your own investments hit the gutter. Pakistani’s lose it all at once.

Investors riot in Pakistan as market tumbles

Popular anger over tumbling equity prices erupted in Pakistan on Thursday, underscoring the difficulties regulators face in attempting to prop up falling markets as turbulence in many of the world's financial markets continues unabated.

The turmoil in Pakistan comes at a time when several emerging markets are considering market stabilization measures, while regulators in the United States are moving to limit short selling and speculation in the oil market. Regulators in China have signaled their intention to stabilize the local market, which became the worst performer among global markets this week. India has suspended futures trading in several commodities.

In Pakistan on Thursday, more than 200 protestors attacked the Karachi Stock Exchange, the country's main equity market, and demanded a temporary closure of the market to curb further drops in share prices, the BBC reported. Smaller protests took place in Islamabad and Lahore.

The Karachi's KSE-100 benchmark stock index fell 2.6% to end at 10,212 points, declining for a 15th session in a row. It is down 27.5% year-to-date. "You've seen this before and you'll see it again when a hot stock market has sucked in all the unsophisticated retail money," said Reiner Triltsch, head of the international equity team at Federated Investors.

"People who don't understand markets can go down, they get furious," he said, adding that any government measures to prop up the market usually don't work. "In the long run, if the fundamentals are not positive, if liquidity is going away, if growth is slowing, and then you introduce the specter of increasing interest rates, [government intervention] will not affect the eventual valuation of the market unless they just shut it down," Triltsch said.

Local investors, who dominate Pakistan's equity market, have learned the hard way how quickly fortunes can change in the stock market. Pakistani shares, despite the country's precarious political situation, had a great ride until late April this year. In 2007, for example, the KSE-100 index soared 41%. In the first few months of 2008, the KSE-100 was the best performer among major emerging markets indexes.

However, since April 18, when the index soared to a record high of 15,676 points, the KSE-100 has tumbled 35%. "Any excessive speculation is not conducive to the normal functioning of the market," said Jack Dzierwa, global strategist and co-manager of the Global MegaTrends Fund at U.S. Global Investors.

"You don't want to be over-regulating, but where do you draw the line? No one wants to have the market completely collapse," Dzierwa said. The Pakistani market's precipitous decline prompted regulators to put in place market stabilization measures in late June, which included trading curbs, banning short selling and setting up a market stabilization fund.

The Karachi exchange, for example, reduced the lower trading curb to 1% from 5% previously and increased the upper trading curb to 10% from 5% previously. The day the measures were introduced, shares rallied nearly 9%. The new rules, however, also led to a steep decline in trading volume on the Karachi exchange.

Last Friday, regulators reversed the upper and lower circuit breaker to 5% effective July 14. They also allowed short selling and reiterated their intention to launch an Equity Market Opportunity Fund. This latest decision eroded investor sentiment. The KSE-100 was down 17% year-to-date on Friday, meaning that it has fallen 10% since Monday.

"Government measures to control stock price volatility and the slump proved counterproductive in this case," said Arpitha Bykere, an analyst at RGE Monitor. "The relaxation of the trading limit has created great uncertainty among investors," she said, explaining that while the initial rules were positive, the reversal of most of those rules was a big negative.

The risk is that if governments create this kind of policy uncertainty, foreign investors will withdraw money from the country, which would make it very hard to finance the country's soaring deficits, Bykere said. Pakistan is also struggling with inflation, which accelerated to a three-decade high of more than 21% in June.

"Looking at recent trend of stock markets around the world, we've seen extreme stock market volatility," Bykere said. "Governments are bound to undertake such measures and it's highly understandable in this kind of market turmoil."

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