Tuesday, August 12, 2008

Debt Rattle, August 12 2008: A bursting leveraged speculating community bubble

National Photo Company Old Dutch Market 1920.
The chain ("The Market of Cleanliness"), whose main store was at 622-24 Pennsylvania Avenue, had about a dozen branches in the Washington area.

Ilargi: So far in August, while one half of the population is in a state of euphoria induced by lower commodities prices and a higher dollar, the other half keeps its eyes on the ball, the chain and the money.

Yes, the US trade deficit went down a bit in June, but you want to know why? Because the dollar was so low until August started that US products were cheap and exports went up.

The higher buck will take care of that one. Oil prices went down, partly, because Americans can’t afford to drive at higher prices. Not really a sign that justifies euphoria either.

But what is more important is that the developments that have led the way down until now, keep getting worse. In housing, we see British real estate agents down to one sale per week.

In the US, Alt-A, Option-ARM and prime mortgages are starting to default in frighteningly large numbers. In both countries, the tendency and direction in the financial world is one of an increasing tightening of credit.

No matter what is offered to Fannie and Freddie, they are both so deep in the doghouse that they must cut their purchases of mortgage loans. They cannot take on more risk.

Their shares have entered single-digit numbers, and there is no respite; they lose more every single day, and the point will come when they're worth less than a dollar per share. That is simply too low to be considered going concerns.

That means no-one is left to purchase loans, in no shape or form. Banks and lenders can’t keep them on their books, because they in turn also cannot take on more risk. And investors today feel about mortgage backed securities the way they do about their mothers-in-law.

This will mean that banks have no more credit to lend out, not for individuals looking for a home mortgage, a student loan or a car loan, nor for companies seeking to finance their operations.

Our societies will cease to function the way they always have during our lifetimes, and that will force us to adopt an entirely new (for us) way of living and working.

The only correct way to summarize the state of the real estate industry, in the US, and the UK and soon in many more countries, is "collapse". 90%+ of builders and lenders will go the way of the dodo.

A vast majority of the companies in the field are bleeding money left right and center. They have survived this far because they had some reserves, and their accounting methods are allowed to be borderline criminally creative.

However, the main, and often only, reason they hold on is their hope and faith that things will soon turn around and happy la-la land days will be back.

But finance is not a religion, and faith can’t print money. There will be no magical comeback of anything even resembling the industry as it was until recently, not for many years. We have literally spent our future.

There remain trillions of dollars in unaddressed gambling debt problems in vaults around the world. Some of them are housing related, but many more are not.

The giant Threadneedle and Wall Street casino's have bet on everything that moves, and for good measure also on everything that doesn't. Until we have seen the bets, and they have been properly processed and paid off, nothing will be solved.

And as we saw yesterday, an estimated $1.2 trillion and $6 trillion have vanished from Britain's and America's respective total wealth. In one year.

That is about $20.000 for every citizen of these countries, and $80.000 for a nuclear family. And the losses don't just continue unabated, they get worse. This cannot go on much longer; something's got to give.

The present euphoria is not a sign of a return to stable and well-funded conditions. It's the expected and inevitable sign of dangerous volatility, the kind that can blow up at any given moment.

Update 4.30 pm EDT Ilargi: Here's today's financials closing numbers, blood red all around again. Funny that carmakers are the lone risers, on the same day that a report states US oil consumption is down 800.000 barrels per day.

In this first piece, Doug Noland offers a strikingly accurate view of what is happening.

Riddle of the burst bubble
Here's how I see it. Many are celebrating the bursting of the energy/commodities bubble. Rapidly declining oil and resource prices are now expected to alleviate inflationary pressures while bolstering household purchasing power. There'll be no pressure on the US Federal Reserve to raise rates, while their global central bank compatriots can soon begin cutting.

The consensus view is that this is bullish for the US economy and stock market and, if nothing else, market action did take attention away from troubling financial and economic news. I am not one to easily dismiss notions of bursting bubbles, and perhaps there is something to the energy-bust thesis. I'm just skeptical of the idea that a slumping global economy is behind recent stunning price declines.

Examining the global market backdrop, I sense different dynamics at play - important dynamics. And I tend to believe rapidly retreating commodities markets should be viewed in the context of a bursting leveraged speculating community bubble. The leveraged speculators have struggled since this year's initial trading sessions.

"Quant" and "market neutral" strategies in particular have foundered, although wild market volatility, illiquidity, and weak global securities markets have been an impediment for virtually all strategies. The hedge-fund industry has been trying to adapt to tighter credit conditions from the Wall Street firms and generally less-liquid markets. Overall, leveraged strategies have been problematic, whether the underlying positions were in residential mortgages, commercial mortgages or corporate loans.

The easy days of leveraged spread trades ("borrow cheap and lend dear") quickly became quite difficult. And the easy returns in emerging markets turned abruptly into painful losses. Overall, global equities have performed quite poorly and global bonds somewhat poorly. Not many things have performed well and, worse yet, various trades that were supposed to offer diversification all became too tightly correlated.

Crude ended the first half at US$140. Major commodities indices concluded June at record highs - sporting spectacular year-to-date gains. There's no doubt that the speculator community had all crowded into the energy/commodities trade, one of a rapidly narrowing menu of speculations offering juicy (and desperately needed) returns. At the same time, the long energy/short financials "pairs trade" was also put on in great excess.

The speculator community likely crowded as well further into dollar short positions, for years now an almost surefire winner. The more the crowded industry struggled for performance, the more they were forced to crowd into the same crowded trades. I would argue that the bubble in the leveraged speculating community played a significant role in fueling energy/commodities prices inflation beyond what was justified by exceptionally bullish fundamentals.

I wouldn't, however, write off energy and commodities as burst bubbles. A lot of things had to go right for the vulnerable leveraged speculator community not to be pushed over the edge. Of course, markets tend not to accommodate the impaired - and the current market is particularly ruthless in this regard. The energy trade has unraveled badly. Commodities markets have been in near freefall. The dollar has mustered its most ferocious rally in quite some time.

At the same time, spreads on agency debt and mortgage-backed securities (MBS) have widened, while global bond prices have offered little performance help. Corporate debt prices have performed poorly, while "private-label" MBS and various mortgage-related derivatives have traded dismally.

Meanwhile, the financial stocks and other heavily shorted equities have rallied significantly. In short, a whole host of popular trades have gone wrong at the same time - a huge problem for the fragile industry. We're now in the midst of another one of these precarious periods. I believe global markets - equities, debt, currencies, and commodities - are all in some stage of dislocation (perhaps not emerging debt, at least yet).

Trading conditions across the spectrum of markets are as chaotic as I've ever witnessed, a dislocation chiefly related to the now forced unwinds of speculative positions. Recent extreme global market volatility is part and parcel to the heightened monetary disorder I have been addressing for months now. The massive global pool of speculative finance has run amuck. The bulls will celebrate the rally, yet markets this unstable are prone to "melt-ups" that lead to breakdowns.

Earnings reports last week from Freddie Mac, Fannie Mae and AIG - three of our largest financial institutions - were horrendous. Financial sector hemorrhaging has actually accelerated, and definitely do not underestimate the impact of tightened credit in the pipeline from Fannie, Freddie and others. With limited "capital" quickly evaporating, Freddie stated that its aggressive retained portfolio growth has come to a conclusion.

Fannie intimated about the same. Fannie will curtail purchases of alt-A loans, and it is clear that both companies have lost the capacity to provide the speculators a "backstop bid" in the MBS marketplace. This major additional tightening of mortgage credit availability and marketplace liquidity will further depress housing markets and bolster the headwinds buffeting our vulnerable economy.

Yet it is not the nature of dislocated markets to let fundamentals get in the way of price movement. Markets, after all, live on fear and greed. Sinking energy prices and a short squeeze ignited US stocks this week. And surging stock prices always entice the optimistic viewpoint, with many viewing runs in stocks and the dollar as confirmation that the worst of the financial and economic crisis is behind us. The bursting of the so-called energy/commodities bubble is also viewed in positive light.

Yet if the key dynamic is instead a bursting leveraged speculating community bubble, entirely different dynamics are now in play. Enormous short positions have built up, the vast majority as part of "market neutral," "quant" and myriad risk hedging strategies.

If today's dislocation develops into a significant unwind of these positions, the market immediately then becomes vulnerable to a disorderly "melt-up" followed almost inevitably by a sharp reversal and disorderly decline. The unwind of bearish speculations and hedges would be a most problematic market development, unleashing a final bout of speculative excess and disorder that would set the stage for a major market crisis.

It is not difficult to envision the backdrop for problematic market liquidation and deepening financial crisis. The hedge-fund community is now susceptible to huge year-end redemptions, generally poor performance, shrinking assets and tighter credit - all taking place in a climate of inhospitable market conditions that dictate ongoing credit system de-leveraging.

The pool of players willing and able to acquire US risk assets is being depleted by the week. To be sure, the unfolding change of fortunes for the leveraged speculating community is one more key facet of tighter system credit and faltering marketplace liquidity - extremely problematic financial conditions for the finance-driven US bubble economy. And this makes the current market dislocations in the face of rapidly deteriorating fundamentals such a dangerous development

The next wave of mortgage defaults
Prime mortgages are starting to default at disturbingly high rates - a development that threatens to slow any potential housing recovery.

The delinquency rate for prime mortgages worth less than $417,000 was 2.44% in May, compared with 1.38% a year earlier, according to LoanPerformance, a unit of First American CoreLogic that compiles and analyzes residential mortgage statistics.

Delinquencies jumped even more for prime loans of more than $417,000, so-called jumbo loans. They rose to 4.03% of outstanding loans in May, compared with 1.11% a year earlier. And prime loans issued in 2007 are performing the worst of all, failing at a rate nearly triple that of prime loans issued in 2006, according to LoanPerformance.

"The extent of how bad these loans are doing is very troubling," said Pat Newport, real estate economist with Global Insight, a forecasting firm. Washington Mutual CEO Kerry Killinger said last month that the bank's prime loan delinquencies are on the rise. As of June 30, 2.19% of the prime loans issued by WaMu in 2007 were already delinquent, compared with 1.40% of prime loans issued in 2005.

Also last month, JP Morgan Chase CEO Jaime Dimon called prime mortgage performance "terrible" and suggested that losses connected to prime may triple. For the second quarter, the bank reported net charges of $104 million for prime rate delinquencies, more than double the $50 million recorded three months earlier.

Prime loans are just the latest class of mortgages to suffer a spike in failure rates. The first lot to go bad was, of course, subprime mortgages, whose problems set the housing meltdown in motion. Next were the Alt-A loans, a class between prime and subprime loans that doesn't require strict documentation of a borrower's assets or income.

Now, as prime loans are added to the mix, the resulting foreclosures could haunt the housing market for a long time, according to Global Insight's Patrick Newport. "Home prices will drop for quite a while - maybe several years," he said.

Prices are already off nearly 20% from their 2006 highs, according to the S&P/Case-Shiller Home Price index.
And there's a strong inverse correlation between home prices and defaults, according to Lawrence Yun, chief economist for the National Association of Realtors.

"It's a feedback loop," he said. "Price declines lead to more defaults, which leads to more price declines."
More foreclosures will add to an already massive oversupply of homes on the market. Inventories are up to about 11 month's worth of sales at the current rate.

Indeed, about 2.8% of all homes for sale were vacant as of June 30, according to Census Bureau statistics. That's up about 50% from three years ago, and near historic highs. The failure of prime mortgages will also make it more difficult for new borrowers to find affordable loans - and that will slow sales even more.

Lending standards have been tightening for months, but if prime loans start to look risky, lenders will be even more conservative about who gets a mortgage. About 60% of the loan officers surveyed reported that they tightened lending standards for prime mortgages during the first three months of 2008, according to the April 2008 Senior Loan Officer Opinion Survey on Bank Lending Practices from the Federal Reserve, which is released quarterly.

That number will likely be even higher for the second quarter, according to Mike Larson, a real estate analyst for Weiss Research. "It's already harder and more expensive to get loans," he said. "Lenders pull in their horns when things go south."

While easy credit fueled the housing boom, restricted credit is certainly contributing to the bust. "Eventually," said Newport, "time will break the cycle. Pricing will drop enough to attract more buyers, and inventories will decline."
But there will probably more hard times ahead before markets come back into balance and recovery begins. 

Credit squeeze getting worse, US banks say
The credit squeeze worsened in the past three months, the Federal Reserve reported Monday, and most banks expect to keep a lid on credit for the next year at least.

Despite all the aggressive moves by the Fed in the past year to ease the flow of credit to the economy, a record percentage of banks were making it more difficult for borrowers in the three months ending in July, the Fed said in its quarterly senior loan officer survey of 52 major banks.

A majority of banks tightened their rules for granting loans to businesses and consumers. The survey shows little appetite at banks to lend for home mortgages, credit cards, home equity loans, commercial real estate loans, or commercial and industrial loans. No bank in the survey eased credit terms for any type of loan in the past three months, and only one bank said it anticipated easing standards for consumers in the next 12 months.

Tighter credit could slow economic growth, especially consumer spending, economists say. Lack of credit could sink the commercial real estate market, and curb capital investments by businesses. The survey is considered a leading indicator of credit creation in the United States.

"This is consistent with our view that consumer spending will slow markedly over the next several quarters," wrote economists for Lehman Bros. "The impending tightening may ultimately curb consumer credit noticeably," wrote Harm Bandholz, an economist for UniCredit Markets. "This in turn would be another nail in the coffin of the U.S. consumer, who is already suffering from the weak labor market, high inflation and falling house prices."

Despite the tighter credit standards, however, other data from the Fed show consumers increased their borrowing on credit cards and auto loans through the end of the second quarter, perhaps because other sources of borrowing, such as home-equity loans and auto leases, are less available.

Banks told the Fed they were restricting credit because of worries about the economy, worries about risk or illiquid markets, and worries about their own fragile capital position. Ninety-eight percent of the banks cited the uncertain economy, 92% cited illiquid secondary credit markets, and 75% cited reduced appetite for risk.

Banks were lowering credit lines, increasing interest-rate spreads, requiring more documentation, demanding more collateral, or requiring co-signers and or covenants before granting credit.

Consumers continued to be hit hard by tighter credit standards. A record 74% of banks said they had tightened standards for prime mortgages, usually given only to those with the best credit. A record 84% of banks said they tightened standards on nontraditional mortgages (also known as Alt-A), and a record 86% of banks that still make subprime mortgages said they had tightened those standards.

Businesses were also being squeezed. A record 65% of banks tightened standards for commercial and industrial loans to small customers. For commercial real estate loans, a record 81% tightened standards.

Goldman Estimates Cut by Oppenheimer, Deutsche Bank
Goldman Sachs Group Inc. had its third-quarter profit estimates lowered by Oppenheimer & Co. analyst Meredith Whitney and Deutsche Bank AG's Mike Mayo, who cited weaker revenue from underwriting and advising on deals at the biggest U.S. securities firm.

Goldman fell as much as 4 percent in New York trading after Whitney said in a note the firm will probably earn $2.15 per share in the period, compared with her previous estimate of $3.54. Mayo late yesterday lowered his earnings-per-share estimate for the New York-based firm to $2.40 from $3.25.

The world's largest finance companies have taken more than $493 billion of writedowns and credit losses since the beginning of last year as mortgage-backed securities, leveraged loans and other fixed-income assets lost value. Goldman's $3.8 billion in losses are the smallest of the four largest U.S. securities firms, though earnings have dropped for two straight quarters.

"Goldman is not immune to capital-market pressures, especially given perhaps weaker European growth," Mayo wrote in a research note. "Goldman has among the highest exposures to equities," an estimated 35 percent, "during a period of more significant equity-market declines," he wrote.

Whitney cited lower "customer volumes, overall weak equity markets, and weak advisory and underwriting revenues." The U.S. Securities and Exchange Commission's emergency ban on so-called naked short sales in shares of 19 finance companies expires today. In traditional short selling, traders borrow shares and sell them. If the price drops, they profit by buying back the stock, repaying the loan and pocketing the difference. Naked short sellers trade without borrowing shares.

Deutsche Bank lowered its share-price estimate to $192 from $209. The firm also cut its profit projections for this year to $14.60 from $16.25 and for 2009 to $15.55 from $16.20. Mayo changed his rating on the shares to "hold" from "buy."

Ladenburg Thalmann analyst Richard Bove yesterday cut his 2008 estimate for Goldman by 8.3 percent, saying Wall Street's earnings expectations are "much too high." Bove, who recommends selling Goldman stock, lowered his estimate for fiscal 2008 to $14.16 per share from a previous estimate of $15.45.

Last week, Merrill Lynch & Co. analyst Guy Moszkowski cut his third-quarter earnings estimate for Goldman by 35 percent, saying the company may be hurt by results from its commodities and hedge-fund business. He reduced his estimate to $2.80 from $4.28 and his full-year profit prediction to $15.27 from $17.71.

Bond Vigilantes Who Gave Bush a Pass May Ambush Obama or McCain
The bond vigilantes who've been missing in action under George W. Bush may be preparing for a return engagement once Barack Obama or John McCain takes office next year.

Investors and former policy makers predict that the same market forces that torpedoed President Bill Clinton's "putting people first" spending initiatives at the start of his presidency are gathering again at the prospect of McCain's tax cuts and Obama's health-care and education programs.

"Though times are different and a lot of the government spending is necessary, we're going to see rates rise in a saw- tooth pattern over the next few years," says E. Craig Coats Jr., the head of Salomon Brothers' government securities desk when it was the world's biggest bond trader. Coats considers himself one of the original vigilantes, the bearish traders who drove up long-term interest rates, persuading Clinton to place deficit-reduction above fulfilling his spending promises.

That course-reversal prompted Clinton political adviser James Carville to observe at the time: "I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody."

Economists and traders say the prospects for increased government borrowing needed for either McCain or Obama to enact their proposals will again lead investors to shun Treasuries and push up interest rates. Ten-year yields are forecast to reach 4.63 percent by the end of 2009, according to a Bloomberg survey of 68 economists.

"The demand from the Treasury is just going to be huge," says Coats, 62, who is now the co-head of fixed income at Keefe, Bruyette & Woods Inc. in New York. The bond bears have largely been invisible during Bush's presidency, even as tax cuts, expanded government spending, wars in Iraq and Afghanistan and two economic downturns drove the federal budget deficit to a record $412 billion in 2004 and to the forecast of another record -- $482 billion -- in fiscal 2009.

Today's 10-year Treasury yield, about 3.93 percent, is actually negative in real terms, with consumer prices up 5 percent in June from a year earlier, the biggest jump since 1991. Economists and bond managers say Bush's free ride has basically been the result of two forces: contained inflation through most of his presidency, and the nearly insatiable demand by foreign investors and central banks for U.S. debt.

"China and other governments have not been demanding higher interest rates as the deficit increased because their main motive has been to prevent their currencies from appreciating," says Brad Setser, an economist at the Council on Foreign Relations and former U.S. Treasury official.

Now, at least part of the equation that favored Bush is changing, says Ajay Rajadhyaksha, head of U.S. fixed-income strategy at Barclays Capital Inc., one of 19 primary dealers that trade government securities with the Federal Reserve.

"The one thing we had going for us at that time was inflation credibility," says Rajadhyaksha. Now, he says, "that credibility is starting to erode for the first time in two decades. So it becomes far less certain that foreign investors will continue to bail us out."

To be sure, some major bond rallies have occurred when the federal deficit was widening, says Edward Yardeni, who coined the term "bond vigilantes" as chief economist at EF Hutton in 1983. That's because government debt tends to balloon in recessions, which also prompt a flight to the quality of Treasuries.

Still, says Yardeni, now head of Yardeni Research Inc. in Great Neck, New York, deepening deficits, "rotten" financial systems and government intervention in the economy mean "there could be a renewed flight from the dollar and from our bonds."

Leon Panetta, Clinton's first budget director, says that "if we continue to run these large deficits, not only bond traders but the securities markets are suddenly going to awaken with concern about whether or not the administration is doing anything to discipline the budget."

If that happens, Panetta says, "it's just a matter of time before they start to put pressure on a new administration."
Clinton's experience shows what such pressure can do to a president's agenda. Promises of spending on education, public works and a middle-class tax cut fell by the wayside as advisers led by Robert Rubin, who later became Treasury secretary, convinced the new president the best thing he could do for the economy was to show investors his resolve on fiscal discipline.

"You mean to tell me that the success of the economic program and my re-election hinges on the Federal Reserve and a bunch of fucking bond traders?" Clinton raged at aides, according to journalist Bob Woodward's book, "The Agenda." Clinton's deficit-reduction policies resulted in a sustained economic boom that generated budget surpluses from his last four budgets and helped pull 10-year yields, which topped 8 percent in 1994, below 5 percent by the late 1990s.

Just as Bush benefited from the achievements of the Clinton years, gaining room to pursue his initial tax-cut agenda, either McCain or Obama will likely be under immediate pressure to fix the problems left over from Bush. "Government borrowing is annoyingly high," says Jeffrey Gundlach, chief investment officer at Los Angeles-based TCW Group, Inc., which has $145 billion under management. "In the long term, we're looking at rising yields," says Gundlach, 48, who has managed bond funds for more than 20 years.

McCain's tax-cut proposals would add more than $400 billion to annual deficits by the end of a first term, while Obama's would widen the budget gap by almost $300 billion, according to the Tax Policy Center, a nonpartisan research group in Washington. Obama also proposes at least $130 billion a year in new spending by 2012 on health care, energy, education and infrastructure, among other programs.

Either outcome is unwelcome for bond investors, says Bill Gross, manager of the world's largest bond fund at Pacific Investment Management Co. "To the extent that either one of them believe or pretend the budget deficit is going to be balanced in their term, they are talking fiction," Gross said in a Bloomberg Television interview last week.

In an open letter to Obama in July, Gross said the Democratic candidate's spending plans would fuel inflation. "Intermediate and long-term yields on government bonds have already bottomed and will gradually rise throughout your first, and perhaps second administration," Gross wrote.

Gross didn't send a similar letter to McCain. Organizations advocating balanced budgets, such as the Washington-based Concord Coalition, say the Republican candidate's plans would create bigger deficits. For either a President Obama or a President McCain, the best hope may be the possibility that markets have changed so much that vigilantes won't be able to wield the clout they did in years past.

"Markets are much bigger and much more closely linked to different options and derivatives" than they were in the 1980s and early 1990s, says former vigilante Bjoern Wolrath, making it far harder for investors to influence events. In 1994, Wolrath, then general director of insurer Skandia Group, declared that Skandia was "not going to buy a single Swedish bond" until the government adopted a credible policy to rein in deficit spending that had swollen to 13 percent of the nation's economy. Sweden this year is running its fourth consecutive annual budget surplus.

Those days are past, says Wolrath, who now serves on the boards of corporations that include one specializing in clearing land mines. Referring to billionaire George Soros's legendary 1992 assault on the British pound, he says, "Not even Mr. Soros would have a chance of having an effect on the big capital markets any longer."

Countrywide faces FTC probe over loan servicing
Countrywide Financial Corp, which was the largest U.S. mortgage lender before being acquired by Bank of America Corp, faces a Federal Trade Commission probe into whether its loan-servicing activities violated federal law.

Countrywide in its quarterly report filed on Monday with the U.S. Securities and Exchange Commission said the FTC has issued civil investigative demands requiring it to provide documents. It said the agency is assessing whether activities related to Countrywide's $1.49 trillion servicing portfolio, covering roughly 9 million borrowers, violated laws the agency administers.

FTC spokeswoman Claudia Bourne-Farrell confirmed that the agency had begun a probe but she did not elaborate. Servicers handle billing and payment collections. The FTC probe adds to legal headaches for Bank of America, which last month paid about $2.5 billion to buy Countrywide.

California, Connecticut, Florida and Illinois have all sued Countrywide over its lending practices. Countrywide also faces U.S. Department of Justice lawsuits accusing it of abusing or mismanaging the bankruptcy and foreclosure processes.

Charlotte, North Carolina-based Bank of America last week said Countrywide also faces a formal SEC probe. This concerns whether former Countrywide Chief Executive Angelo Mozilo violated insider trading laws and whether Countrywide's financial disclosures misled investors, the Los Angeles Times said.

Separately, Countrywide is under investigation by the FBI, authorities have said. That agency last month said it had 21 corporate targets in its probe of potential corporate fraud in the mortgage industry.

Moody's cuts ratings on 36 Countrywide alt-A deals
Moody's Investors Service cut ratings on 529 tranches from Alt-A transactions issued by Countrywide Financial Corp., citing higher-than-anticipated rates of delinquency, foreclosure and properties returned to lenders. Moody's did not give the value of the transactions.

The rating agency lowered ratings of tranches from 36 Alt-A transactions issued by Countrywide, which was acquired by Bank of America Corp. in June. Of those tranches, 22 face further possible downgrades. Separately, 33 senior tranches kept AAA ratings.

Alt-A loans, which fall between subprime and prime, were extended to buyers with poor or spotty credit. As home prices continue to decline, more Alt-A and prime borrowers have defaulted on their mortgages. Most of the tranches cut were AAA-rated, with some being slashed all the way to junk status.

Credit raters have been criticized for initially giving mortgage-backed securities overly optimistic ratings. Countrywide, which was the nation's biggest mortgage lender at the time of its acquisition, has had its feet held to the fire as well, getting lambasted for allegedly conducting unsufficient due diligence and giving people loans with which they had little chance of keeping current.

S&P Lowers Some Fannie, Freddie Securities Ratings
Standard & Poor's Ratings Services lowered ratings on certain securities of Fannie Mae and Freddie Mac, a move that may further complicate their efforts to raise capital. The ratings agency cut ratings on preferred stock and subordinated debt for both companies to A minus from AA minus. It left their senior debt ratings at AAA.

The AAA rating reflects the belief that the U.S. government would have to back the senior debt of the two mortgage companies in a crisis. But there is less assurance that the government would protect holders of preferred stock and subordinated debt.

The companies' new regulator "has receivership powers that would place the non-senior creditors … at a greater risk of nonpayment," S&P said, adding that this applies especially to dividend payments on preferred stock. Fannie and Freddie were chartered by Congress to assure a steady flow of money for home mortgages. As defaults on home mortgages soar, they have recorded combined losses of about $14 billion over the past four quarters.

The downgrades will put "negative pressure" on any new issues of preferred by the companies, Federal Financial Analytics Inc., a Washington research firm, said in a report. The firm said that banks outside the U.S. that already hold the affected securities will have to adjust their risk-based capital holdings as a result of the downgrades.

Freddie has said it plans to raise at least $5.5 billion of capital, likely through offerings of common and preferred stock, but is waiting for market conditions to improve. Fannie raised $7.4 billion through common and preferred offerings in May but said last week that it may need to raise more capital eventually. S&P cited an "uncertain appetite" for Freddie's preferred stock as a concern.

Moody's Cuts Morgan Stanley's Credit Rating on Mortgage-Loss Concerns
Morgan Stanley had its long-term credit rating lowered by Moody's Investors Service, which cited the second-biggest U.S. securities firm's failed risk-management practices. Morgan Stanley's debt was downgraded one level to A1 from Aa3, Moody's said in a statement today.

Both firms are based in New York. A1 is the fifth-highest investment-grade rating. "Performance of the company over the past year has shown that the risk controls haven't worked," said Peter Nerby, an analyst at Moody's. "The firm has said it's making changes to the risk management systems."

Morgan Stanley lost its AA rating from Standard & Poor's on June 2, when the credit rating was reduced by one level to A+. Morgan Stanley is still ranked one grade above Merrill Lynch & Co. and Lehman Brothers Holdings Inc., which had their ratings cut in recent months due to mortgage-market writedowns.

Morgan Stanley has recorded $14.4 billion of writedowns on its mortgage-related portfolio since the third quarter of last year. Merrill's writedowns have exceeded $46 billion. Moody's said Morgan Stanley's rating would be cut further if the firm lost an additional $7 billion on its mortgage assets.

Following the downgrade today, credit-default swaps tied to Morgan Stanley climbed 7 basis points to 210 basis points as of 4:26 p.m. in New York, according to broker Phoenix Partners Group. The company's shares fell as much as 2.4 percent to $44.32 in after-hours trading.

Cuomo Seeks Auction-Rate Securities Settlements With 3 More Banks
Andrew Cuomo isn’t done investigating the auction-rate securities market just yet. Mr. Cuomo, the New York state attorney general, said on Monday that he is expanding his investigation into the collapse of those securities to three more banks.

He said in a statement that he has sent letters to JPMorgan Chase, Wachovia and Morgan Stanley, essentially asking them to craft similar settlement terms. Citigroup and UBS struck settlements with Mr. Cuomo’s office last week, agreeing to buy back more than $25 billion worth of auction-rate securities to head off potential litigation.

Merrill Lynch separately said it would buy back up to $10 billion of these securities, without having entered a settlement. “Today we’re expanding our investigation into the auction rate securities scandal to insure investors across New York State and the nation get their money back,” Mr. Cuomo said in a statement.

“We believe that when you protect the investor you also increase investor confidence, which helps the entire market.” Invented in the 1980s, auction-rate securities are preferred shares or debt instruments whose rates reset regularly, usually weekly, in auctions hosted by the originating brokers.

But the credit troubles that began last summer brought those auctions to a crashing halt, leaving investors — many of whom had been told that the securities had as much safety and liquidity as cash — holding onto instruments they couldn’t sell.

Banks’ costs of settling investigations by Mr. Cuomo and his confreres in other states could prove expensive. Last week, a Bank of America analyst estimated that total settlement costs could reach $8 billion. That figure excludes fines.

A JPMorgan spokesman said that the firm is “cooperating with all regulatory inquiries we have received regarding auction-rate securities.” A Wachovia spokeswoman said the company was meeting with regulators on Monday in Jefferson City, Mo. and “looks forward to the discussions.” A spokesman for Morgan Stanley could not be reached.

JPMorgan, Wachovia Face Auction-Rate Accord Demand
JPMorgan Chase & Co., Morgan Stanley and Wachovia Corp. were asked by New York Attorney General Andrew Cuomo to begin "immediate" settlement talks to resolve probes of their sales of auction-rate securities.

Cuomo's office sent letters to the banks today. Last week, Citigroup Inc. and UBS AG agreed to settlements in a nationwide inquiry into whether banks stuck clients with the hard-to-sell bonds before the $330 billion market collapsed in February. Cuomo's probe involves at least 18 different banks.

"Our investigation's focus is shifting to the next group of market participants," wrote David Markowitz, chief of the attorney general's investor protection bureau, in his letters to the three banks. "Any resolution would need to address the same concerns addressed in the" previous settlements.

Auction-rate securities are typically bonds whose interest rates are reset by periodic bidding. Investors were left unable to redeem securities that were billed as equivalent to cash after the dealers that ran the bidding in February suddenly stopped supporting the market as they had for years.

The market's seizure left Citigroup holding at least $6.5 billion of the securities on its trading desk at the end of March, after booking $1.5 billion of writedowns during the first quarter, according to a May regulatory filing from the bank. Cuomo is demanding that banks create auction-rate securities buyback programs for retail customers, reimburse consumers forced to sell off their securities at "below par" prices and institute a claims-resolution mechanism.

UBS is to pay $150 million in fines and begin buying back $18.6 billion in failed auction-rate securities, the largest settlement in the investigation. The bank will buy $8.3 billion of the securities from its clients beginning on Oct. 31 under a settlement with the U.S. Securities and Exchange Commission and a group of state regulators including New York, according to terms of the accord announced Aug. 8.

Zurich-based UBS must also help its institutional clients sell an additional $10.3 billion in securities and may have to buy back the bonds if they fail to find a market, Cuomo has said. New York-based Citigroup settled state and federal claims, agreeing to buy back $7.3 billion in securities from individual customers, charities and small businesses, pay $100 million in fines and help 2,600 institutional customers unload $12 billion of securities.

Morgan Stanley spokesman Mark Lake said his firm has been cooperating with the probe and working with clients "to provide liquidity on a case-by-case basis." Wachovia spokeswoman Christy Phillips Brown said her bank is meeting with regulators today. Brian Marchiony, a JPMorgan spokesman, said his bank also is cooperating.

Cuomo's office said it would help coordinate bank settlements with the SEC and other regulators probing the matter. Merrill Lynch & Co. separately announced last week it would offer to buy back about $10 billion in auction-rate securities from retail clients. Cuomo said the plan by New York-based Merrill failed to contain certain "investor protection safeguards" and is under further review by his office.

Missouri Secretary of State Robin Carnahan said in a statement today that she met with Wachovia executives Aug. 8 and "progress was made" towards an agreement to address the $9.5 billion of auction rate securities held by their customers. She said negotiations will continue this week. Carnahan said that Missouri is leading the auction-rate investigation of Charlotte, North Carolina-based Wachovia on behalf of a national task force of states.

Morgan Stanley Offers to Buy Back Auction-Rate Debt
Morgan Stanley, the second-biggest U.S. securities firm by market value, offered to buy back about $4.5 billion in auction-rate securities from retail clients, following a similar offer last week by Merrill Lynch & Co.

Morgan Stanley will begin to repurchase notes at par value no later than Sept. 30, the New York-based firm said today in a statement. New York Attorney General Andrew Cuomo earlier today sent letters to Morgan Stanley, JPMorgan Chase & Co. and Wachovia Corp. calling on the banks to begin "immediate" settlement talks to resolve probes into sales of the notes. Cuomo's office said Morgan Stanley's offer was insufficient.

"This is too little, too late, and our investigation into Morgan Stanley continues," Alex Detrick, a spokesman for Cuomo, said in an e-mail. Regulators have been investigating how banks and Wall Street firms sold auction-rate securities before the $330 billion market collapsed in February. Morgan Stanley said it informed state and federal regulators about its plan to buy back the securities sold by the firm before Feb. 13.

The investments have been frozen in customer accounts since Wall Street firms backed away from the market in February, leading to claims by customers and investigations by the U.S. Securities and Exchange Commission and regulators in New York and Massachusetts.

Morgan Stanley's offer follows one by Merrill Lynch, which last week volunteered to buy back about $10 billion in auction- rate securities. Citigroup Inc. has agreed to a $100 million fine and will repurchase about $7.3 billion of the debt under a settlement with U.S. and state regulators. UBS AG is paying a $150 million fine and will buy back $18.6 billion.

Morgan Stanley said today it told Cuomo's office, as well as the Securities and Exchange Commission and the state regulator in Illinois, about its plan. Last week, Morgan Stanley agreed to buy back $1.5 million in auction-rate securities from two municipalities in Massachusetts to settle claims there of improper sales.

Wachovia, the fourth-largest U.S. bank, said today that its second-quarter loss was bigger than reported in July because of costs to settle a probe of auction-rate securities sales. The Charlotte, North Carolina-based bank revised the loss to $9.11 billion, or $4.31 a share, from $8.86 billion, or $4.20, according to a regulatory filing.

UBS carves up bank structure as rich clients flee
UBS will split off its investment banking unit that made it Europe's top casualty of the credit crunch -- and scared off wealthy clients -- a move that analysts said signals the sale of the beleaguered business.

The world's biggest banker to the rich gave in to shareholder pressure to restructure on Tuesday, admitting there were problems with its one-bank model as it reported fresh writedowns and clients withdrawals in the second quarter. The Swiss bank also ushered in a new financial chief and members of the board in an attempt to rebuild confidence in Switzerland's once-solid banking system.

Investors welcomed the reorganisation, saying it could ultimately lead to a break up of the bank, and its shares rose 2.4 percent to 23.74 francs by 0955 GMT, compared to a 0.3 percent weaker DJ Stoxx European banking sector. "We believe UBS investment bank will be not fully owned and even potentially disposed of by UBS over the next two years," said JP Morgan analyst Kian Abouhossein.

UBS Chairman Peter Kurer told a news conference that competitors were on the prowl for assets they could pick up cheaply in the global market slump, but he said the group was not for sale and had not received any formal offers. "It might be that we keep or divest or enter into joint ventures or collaboration," Kurer told journalists. "For the time being, there are no plans to divest."

His remarks signify a major change for the bank, which has long stood by its strategy of running asset management, banking for the rich and investment banking together. Helmut Hipper, a fund manager at shareholder Union Investment, said wealth management had fared worse than expected. "A big part of the money outflows were international," he said. "The reputational problems are hitting home internationally."

UBS said there had been net new money outflows of almost 44 billion Swiss francs ($41 billion) in the second quarter -- compared with inflows of 34 billion francs a year earlier -- and it racked up a further $5 billion in writedowns on investments. This took its total bill from the markets crisis to $42 billion.

UBS joins U.S. peers Citigroup and Merrill Lynch in taking more big hits in the quarter from exposure to risky mortage assets. They remain the three hardest hit banks and investors are still worried about yet more subprime costs. UBS's admission that the one-bank model is broken comes just a week after rivals Societe Generale, HSBC and Barclays all defended the model, which has been badly bruised during the credit crunch.

UBS has come under continued pressure from activist investor Olivant -- headed by former UBS Chief Executive Luqman Arnold -- to hive off investment banking, which has dented its wealthy customers' trust in the private bank. The bank made a bigger-than-expected loss of 358 million francs in the second quarter and said finance chief, Marco Suter -- an ally of former chairman Marcel Ospel who was toppled in the crisis -- would go.

Last week it agreed to buy back almost $19 billion of bonds after U.S. authorities sued it for steering clients towards auction-rate securities -- debt which became impossible to sell after the market froze. UBS said this would cost it $900 million. UBS is also under fire from U.S. congressional investigators who say it helped U.S. clients dodge taxes, striking at the heart of Switzerland's prized banking secrecy rules.

But UBS's difficulties do not end there. It faces tough new rules later this year from the Swiss banking watchdog that will force it to hoard considerably more capital, putting a brake on capital-intensive investment banking. The avalanche of problems has crippled the Swiss bank's stock. UBS's share price has tumbled by almost two thirds since the start of the year -- twice that of European peers.

SEC considers action in Wachovia derivatives probe
Wachovia Corp. said Monday that the Securities and Exchange Commission is considering instituting civil or administrative proceedings against the bank in connection with an ongoing investigation into possible misconduct in the company's municipal derivatives group.

In its quarterly filing with the SEC, the Charlotte, N.C.-based bank said it has also received subpoenas from various states' attorneys general regarding these matters. Wachovia said it is cooperating with the investigations. The Department of Justice and the SEC began requesting information regarding competitive bids from several financial institutions, including Wachovia, in November 2006.

Wachovia previously said that it had received subpoenas from both the DOJ and the SEC for documents and information from its municipal derivatives group. In February, Wachovia said the DOJ was investigating two unidentified company employees for possible misconduct in connection with certain competitively bid transactions.

Wachovia's Second-Quarter Loss Widens on Legal Costs
Wachovia Corp., the fourth-largest U.S. bank, said its second-quarter loss was bigger than reported in July because of costs to settle a probe of auction-rate securities sales. It also increased planned job cuts.

The bank revised the loss to $9.11 billion, or $4.31 a share, from $8.86 billion, or $4.20 a share, according to a regulatory filing today. The Charlotte, North Carolina-based bank now plans to dismiss 6,950 employees later this year, 600 more than previously disclosed. The new job cuts will come from Wachovia's mortgage operations, spokeswoman Christy Phillips Brown said.

Chief Executive Officer Robert Steel, a former Treasury official, last month replaced Kennedy Thompson, whose $24 billion purchase of Golden West Financial Corp. in 2006 saddled Wachovia with adjustable-rate home loans as the housing market peaked. Steel is hiring new chief finance and risk officers and cutting back the company's main mortgage operations to states where it operates deposit-taking offices.

"At this point Bob Steel wasn't part of the problem so he has nothing to hide," said Nancy Bush, an independent bank analyst in Aiken, South Carolina. "He has everything to gain by putting it all out on the table and saying this is how bad it is and it might get worse."

The revision marks the second straight quarter that Wachovia updated its results to show a bigger loss. This time, the wider gap resulted from a $500 million addition to legal reserves made after the July 22 report. Missouri state officials said today they're making progress in talks with Wachovia on how to resolve the investigation.

Auction-rate securities are typically bonds whose interest rates are reset by periodic bidding. Investors were left unable to redeem securities that were billed as equivalent to cash after the dealers that ran the bidding in February suddenly stopped supporting the market as they had for years. Wachovia Securities is based in the Missouri city of St. Louis.

Wachovia retail brokerage clients held $8.7 billion in auction-rate securities as of August 1, down from $13 billion on March 31, the company said in today's filing. The bank said the job eliminations are part of an expense- cutting effort aimed at preserving $1 billion in capital.

The bank isn't filling another 4,400 open positions and cutting $350 million in previously planned capital spending. The company's investment banking unit shrank in the past year by 478 jobs, or 7 percent, to 6,394 employees in the second quarter.

Wachovia said Aug. 8 it plans to cut 125 jobs as it ends direct mortgage lending in 19 states, mostly in the central and northwest regions of the U.S. Wachovia bank employees will still make home-equity and 30-year fixed-rate loans in three of those states, while its mortgage unit will offer a variety of loans in 15 other states where it has bank branches.
Wachovia listed more than 120,000 employees at the end of the first quarter.

Mortgage-Market Trouble Reaches Big Credit Unions
Five of the nation's largest credit unions are reporting big paper losses on mortgage-related securities, a sign that housing-market distress is spreading even to the most risk-averse financial sectors.

The federal regulator overseeing credit unions says the losses are likely to be reversed when mortgage markets stabilize, and that the institutions are sound and adequately capitalized. But some outside observers are concerned that the credit unions are underestimating the depth of their mortgage-market problems.

"This is a serious situation," says Gerald Hanweck, a finance professor at George Mason University, who studies the banking industry and is a visiting scholar at the Federal Deposit Insurance Corp. Mr. Hanweck believes the five firms have sufficient access to funding to handle a deeper downturn, but he worries that perceptions of added risk could lead to a run on one or more of them.

Credit unions are not-for-profit, member-owned cooperatives that take deposits and lend money like banks. The mortgage problems are focused on so-called corporate credit unions, which are key players in the industry. They don't deal directly with consumers, but provide investment services and financing to regular credit unions, which do.

The five corporates showing big mortgage-related losses, according to federal regulatory filings, are U.S. Central Federal Credit Union; Western Corporate Federal Credit Union; Members United Corporate Federal Credit Union; Southwest Corporate Federal Credit Union; and Constitution Corporate Federal Credit Union.

Together, they reported about $5.7 billion in "unrealized" losses as of the end of May, the filings indicate. Unrealized losses happen when the market value of a security falls, even if it hasn't been sold.

Credit unions in general are among the most conservatively run financial institutions in the U.S. That some are showing strains indicates that almost no financial sector is immune from the mortgage meltdown that has caused widespread carnage among commercial banks and on Wall Street. Financial-services firms have already taken write-downs of more than $300 billion in connection with the mortgage mess.

"We're not much different from any financial institution," says Michael Kinne, chief financial officer of Constitution Corporate in Wallingford, Conn. "Nobody is insulated from this. It seems like every time you turn around, somebody else is taking a billion-dollar write-down."

Kent Buckham, director of the office of corporate credit unions for the National Credit Union Administration, the federal regulator, says the mortgage investments held by corporate credit unions are safer than many that are causing havoc on Wall Street, and are very likely to rebound in value.

In his view, the paper losses reported by the corporate credit unions reflect unrealistically low market values for mortgage investments, in part due to investor nervousness about the sector. He says he doesn't expect the firms will have to sell those assets at "fire-sale prices."

There have been predictions for months that the mortgage-market turmoil was coming to an end, and that mortgage-related assets would bounce back in value. So far, that hasn't happened.

The paper losses of the five big corporate credit unions are large enough to wipe out the net worth of each of them. Added together, their negative equity totals $2.9 billion -- meaning, in theory, that their debts exceed the current market value of their assets by that amount.

The shorts are back
Should the financial sector endure yet another harrowing period of wild market swings and rumors later this week, expect regulators to round up the usual suspects - namely, the short sellers.

Effective Wednesday, the Securities and Exchange Commission lifts its moratorium on the practice of "naked" short selling some 17 domestic and international securities firms, along with the twin mortgage buyers Freddie Mac and Fannie Mae.

Last month, regulators announced the plan as part of an effort to soothe the panic surrounding financials. At the time, many in the market were blaming short sellers, or those investors who profit when a stock goes down. Traditional short sellers borrow stock with the aim of selling it, then buying it back at a lower price, hoping to pocket the difference.

Naked short selling, however, goes a bit further. Instead, investors short the stock without actually borrowing it, making it much easier to drive down the share price. The consensus, however, among market experts is that the financials are unlikely to make a return to that painful period of mid-July after the ban on naked short selling is lifted.

"It has been volatile even after this went into effect," said Gerard Cassidy, managing director of bank equity research at RBC Capital Markets. "I'm not sure it will get back to where it was a month ago."

While some better-than-expected second quarter results helped temper some of the fears about the sector, the ban appeared to provide a bit of relief to financial firms that found themselves at the mercy of market chatter. The volume of short selling in the 17 primary dealers plunged by 70% in the first day after the ban was announced, according to the market data firm S3 Matching Technologies.

Some members of the group even watched their beaten down stocks stage a recovery. Lehman Brothers, for example, which was besieged by rumors about its liquidity position prior to the announcement of the ban, has seen the value of its stock climb 50% since then. Citigroup, which was also included in the group, has seen its stock price climb 27% as Friday's close.

At times, naked short selling has been linked with market manipulation, but not always. When combined with a nasty market rumor, naked short sellers can collect a handsome profit when a company's stock falls. In effect, it is the opposite of "pump and dump" scams in which investors talk up a stock price before selling it at a handsome profit.

Some market observers have suspected that short sellers helped push Bear Stearns toward its ultimate demise in mid-March. But they have also served as a much-needed voice of reason at times, including the dot-com era when tech stocks soared to ridiculous valuations.

Short sellers, or so-called "shorts", argue that this period is such an instance. William Fleckenstein, a well-known "short" who serves as the president of the Seattle-based money management firm Fleckenstein Capital, argues that financials have no one to blame but themselves.

"Short sellers didn't make the stock go down, they didn't lever up the company," he said. "And they didn't lower the fed funds rate or tell people to take out ARMs [adjustable-rate mortgages] when they shouldn't have."

What's more, notes Fleckenstein, savvy investors who wanted to place a bet that a stock would fall, don't necessarily have to rely on naked short selling. Instead, they can buy "puts" on a stock, which gives the owner the right to sell shares for a certain price in the future. Or there's always the traditional short sale. "[Borrowing stock] is just an extra step," he said.

FDIC Fund Strained by Bank Failures To Lift Premiums
The failure of IndyMac Bancorp Inc. and seven other banks this year may erase as much as 17 percent of a government insurance fund and raise premiums for all banks, from Franklin National of Minneapolis to Bank of America Corp.

The closing of IndyMac in July, the third-biggest U.S. bank failure, may cost the Federal Deposit Insurance Corp.'s fund $4 billion to $8 billion, in addition to an estimated $1.16 billion for seven closures through Aug. 1. Premiums for insuring deposits will likely rise, FDIC Chairman Sheila Bair said in a July 30 interview. A decision is due by the fourth quarter.

"It's going to be a bloody, expensive mess for the banking industry," said Bert Ely, president of Ely & Co. Inc., a bank consulting firm based in Alexandria, Virginia. "Healthy banks are paying for the mistakes made by failed banks." The pace of bank closings is accelerating as financial firms have reported almost $495 billion in writedowns and credit losses since 2007.

The FDIC's "problem" bank list grew by 18 percent in the first quarter from the fourth, to 90 banks with combined assets of $26.3 billion. A revised list is due this month. The insurance fund had $52.8 billion as of March 31. The FDIC estimated its shutdown of California-based mortgage lender IndyMac, which filed to liquidate its assets last month, might drain as much as 15 percent from the fund. Seven other banks will take $1.16 billion, or about 2 percent.

The potential $9.16 billion in withdrawals would be the highest since the insurance account was created in 1933, Diane Ellis, the FDIC's associate director of financial-risk management, said in a telephone interview. Bank failures pulled a record $6.9 billion from the fund in 1988 during the savings- and-loan collapse, Ellis said.

The FDIC is required to shore up the fund when the reserve ratio, or the balance divided by the insured deposits, slips below 1.15 percent or is forecast to fall below that level within six months. A 2006 law directs the agency to take steps to reach the 1.15 percent ratio within five years.

"Raising rates is our first and best option if we need to get more revenue to increase the fund and the reserve ratio," Ellis said. The ratio fell to 1.19 percent in the first quarter from 1.22 percent the previous quarter, the agency reported in March. IndyMac's collapse may push it down at least 9 basis points, to below the 1.15 percent threshold, Ellis said. A basis point is 0.01 percentage point.

Premiums charged banks in 2007, which averaged 5.4 cents per $100 of insured deposits, were based on risk levels and capital determined by the FDIC. Troubled banks pay higher rates, the agency said. A new rate hasn't been determined, Ellis said.

Bank of America is the biggest U.S. bank by deposits, with almost $800 billion as of March 31, followed by JPMorgan Chase & Co., Wachovia Corp., Wells Fargo & Co. and Citigroup Inc., the FDIC said. Franklin National had $100 million in deposits. The FDIC insured $4.43 trillion in deposits as of March 31.

The fund will collect about $5 billion this year as insured banks pay an estimated $2.5 billion and the fund balance generates about $2.5 billion in interest, said James Chessen, chief economist at the American Bankers Association, a Washington-based industry group.

"Certainly, the industry is ready to step up to the plate and make sure the FDIC is financially secure," Chessen said. "That has to be balanced against the fact that money coming back to Washington is money that banks can't use" to lend in local communities.

The 90 banks the FDIC reported on its "problem" list as of March, up from 76 in the fourth quarter, had a combined $26.3 billion in assets, or about 0.2 percent of total assets in FDIC- insured banks. "It's still very small historically and unlikely to cause significant problems to the FDIC fund," Chessen said.

Bank regulators, including Bair, said last month more banks will fail as the pace of shutdowns returns to normal levels. She said historically 13 percent of banks on the list fail. Gerard Cassidy, an analyst at RBC Capital Markets in Portland, Maine, said he expects 300 U.S. banks to fail in the next few years, mainly because of mounting losses from real estate-related loans.

Besides increasing premiums, the FDIC has options if failures escalate and further drain the fund. The agency can tap a $30 billion line of credit at the Treasury Department and borrow up to $40 billion from the Federal Financing Bank to cover assets at failed banks.

As a last resort, the U.S. Congress can step in to protect depositors with legislation and appropriations as it did during the savings-and-loan crisis by creating the Resolution Trust Corp. in 1989 to manage the closings of 747 failed thrifts.

"So if Armageddon scenarios did play out, the people's deposits would be backed by the full faith and credit of the United States government," Bair, 54, said on July 30. The banking industry would ultimately be responsible for any government spending, Bair added.

"Even if we did have to call upon our taxpayers' backstop, our statute requires us to pay back those funds over time through industry assessment," she said. "So, ultimately, the taxpayer would not pay." The FDIC insures deposits of up to $100,000 per depositor per bank and up to $250,000 for some retirement accounts at 8,494 lenders with $13.4 trillion in assets.

UK estate agents are selling just one property a week
Estate agents are selling just one property a week, as figures show the worse drop in sales for 30 years. The Royal Institution of Chartered Surveyors (RICS) said the number of properties sold had dropped to its lowest level since records began in 1978.

It blamed the lack of affordable mortgages available to home owners for the collapse in transactions. While mortgage rates on some lenders' most popular deals have been cut in recent days, lending criteria remains tight with the best rates only available to those with a significant deposit.

At the beginning of the year, RICS said estate agents were selling 23.9 properties every three months compared with 32 properties per three months at the beginning of 2004. Today, the figure has dropped to 14.4 over the last three months or 1.1 properties a week.

Nigel Naish, a member of RICS based in Yorkshire, said: "Lack of demand, due to market funds non-availability for the bottom end of the market, has caused the market to slow, almost to a stop."

The RICS housing market survey also indicated that house prices are likely to continue to fall. It said almost 84 per cent more chartered surveyors reported a fall than a rise in house prices, a decrease from 86.9 per cent in June. New buyer enquiries are still at a low ebb and sellers are dropping their asking prices to more realistic levels, the survey said.

Last week Halifax, Britain's largest mortgage lender, said that house prices had fallen by nearly £20,000 in the last six months. Peter Hayward, a member of RICs based in Carlisle, Cumbria, said: "Sales are still very scarce. Buyers are confused, but some are having to move forward to take account of life changes.

"Realism is the key," he added. "Prices are under pressure where deals can progress."

Britain’s property market grinds to a halt amid mortgage drought
The housing market ground to a virtual standstill last month as the drought in the mortgage market helped to drive down the number of homes changing hands to levels not seen for four decades, a key survey shows today.

In the latest symptom of dire housing market conditions, the average number of property sales handled by surveyors across the country over the past three months tumbled to only 14.4, or fewer than five a month, according to the Royal Institution of Chartered Surveyors.

RICS blames the near-freeze in housing transactions last month on the scarcity of home loans, with would-be buyers struggling to secure mortgages, and forced to pay significantly more for the loans that can be had. The institution also sounds a warning that the market is being further undercut as confused signals from the Government over the possibility of future stamp duty concessions from the Chancellor deter potential buyers.

Today's RICS findings underline the scale of the national housing slump, after Halifax figures last week showed house prices falling at an 11 per cent annual rate, marking the first double-digit decline since the end of the last recession in 1992.

However, there are some glimmers of hope for anxious homeowners, as well as potential buyers, with the RICS pointing to tentative signs that activity in the market may be close to hitting a floor, while the scale of price falls appeared to have eased a little. Bank of England figures also revealed a modest fall in some key mortgage rates during the past month.

In a rare dose of more positive news, the RICS survey shows that the proportion of surveyors reporting falling house prices was lower last month, for a third month in a row. Some 83.9 per cent more surveyors still said that prices had fallen in July than said they had increased, but this compared with a low point reached in April of 94.7 per cent more talking of declining prices.

At the same time, the survey also finds that numbers of new buyer inquiries rose last month, while expectations of future numbers of sales among surveyors also climbed amid signs of sellers cutting asking prices.

There was also some relief for those struggling to secure a competitively priced mortgage as the Bank's figures showed that the average interest rate on a two-year fixed-rate home loan, based on borrowing 75 per cent of a property's value, dropped to 6.36 per cent last month, from 6.6 per cent in June.

Meanwhile, the average interest rate last month on a five-year fixed-rate loan, for 95 per cent of a property's value, edged upwards, rising to 7.14 per cent to reach its highest since early 2000, the Bank's figures showed.

UK economy 'worse than thought'
The CBI, the UK's largest employers' organisation, has warned that the UK economy is deteriorating faster than it previously thought. There was "no doubt that the mood has darkened in the last two or three months," its director general Richard Lambert warned members in a letter.

Forecasters, including the CBI, had been "over-optimistic" about the economic outlook, he added. High inflation and slowing growth have prompted fears of a possible recession. The level of inflation - which most analysts expect to surpass 4% when the July figures are released this week - had taken people "by surprise", Mr Lambert said in the letter, seen by the BBC.

And he added that the credit crunch had been "bigger and broader" than first expected. "A year ago it seemed reasonable to hope that the worst would be over by now. That has not turned out to be the case." Economic activity is slowing in all key sectors of the economy, business confidence is waning and falling house prices and tight credit conditions have dented consumer spending.

"This is why most analysts are now suggesting that the economy will at best only manage to stagnate in the coming few quarters, and that the growth prospects through 2009 and into 2010 look no better than anaemic," Mr Lambert said. The CBI earlier cut its forecast for growth in 2009 from 1% to 0.4%.

And last week the International Monetary Fund again revised down its forecast for UK economic growth this year and next year. It now expects growth of 1.4% this year and 1.1% in 2009, although the government still expects the figures for both years to be 2% or above.

"The CBI, along with most other forecasters, has been consistently over-optimistic about the economic outlook over the last 12 months," Mr Lambert added. He added that there were still many companies who were doing well - especially in the manufacturing of high value items.

But he conceded that it was going to be an "uncomfortable time" for many. "A sharp economic slowdown is a new experience for many people in government and in business," he said.

UK pension funds fall into £24.1 billion deficit
The finances of nearly 7,800 schemes had an overall deficit of £24.1bn at the end of July, according to the PPI. Britain's final salary pension schemes slid from an £8.3 billion surplus at the end of June to a deficit of £24.1 billion by the close of last month.

Following a year of stockmarket turbulence, the retirement funds are in a far worse state than they were a year ago, when they had a £88.3 billion surplus. The figures were released today by the Pension Protection Fund, which releases monthly updates on Britain's 7,800 largest defined benefit schemes.

The value of the schemes are worked out in the same way that an insurance company would, if the fund's supporting employer were to sell the pension scheme. If the funds in surplus were not there to offset them, the funds in deficit would have a shortfall of £80.1 billion at the end of July, compared to £34 billion at the same time last year.

The funds in surplus, without those in deficit to drag them down, would have a surplus of £56 billion, down from £117.3 billion last year.

Dollar Gain Signals More Pain as Rally Prompts Calls to Exit Bullish Trade
Just because the dollar posted its biggest gain against the euro in almost eight years doesn't mean the U.S. currency won't continue to be plagued by the nation's slowing economy, widening budget and trade deficits and negative inflation-adjusted interest rates.

The 4 percent surge against the single European currency this month was enough to prompt Bank of America Corp. to tell its customers to exit trades betting on more gains. Morgan Stanley still forecasts the greenback will approach a record low by October as the U.S. housing slump and credit-market losses keep the Federal Reserve from raising interest rates this year.

Barclays Plc in London and New York-based Merrill Lynch & Co. said trading patterns suggest the dollar's 5.1 percent gain in the past three weeks measured by an index of six major trading partners can't be sustained. That's mostly because there's no indication the U.S. will return to the late 1990s annualized gross domestic product growth of 4.23 percent with inflation running at no more than 3.3 percent.

Since September, 2000, the dollar has declined more than 44 percent as inflation accelerated to an annual 5 percent today, growth slowed to 1.9 percent and U.S. interest rates provide no cushion for holding U.S. assets.

"I would not chase the dollar's strength versus the euro as the pair has moved beyond interest-rate support," said Sophia Drossos, a strategist in New York at Morgan Stanley, who also recommended closing out bets on the dollar versus the currencies of Malaysia and Singapore. "The dollar is not out of the woods. It will take the market a while to come around to our point of view."

The dollar strengthened to $1.5005 to the euro last week from $1.5564 on Aug. 1, the biggest weekly increase on a percentage basis since January 2005. It surged 2.08 percent on Aug. 8, touching $1.4998, the most since Sept. 6, 2000, and the second largest rally since the euro was introduced in 1999.

Those gains sent the dollar above the $1.51 per euro yearend mean target of 39 analysts in a survey by Bloomberg. By the end of 2009, the dollar will likely strengthen to $1.40 per euro, based on the estimates. It gained 6.4 percent since hitting a record low of $1.6038 on July 15.

In addition to the gains against the euro, the dollar also appreciated 2.3 percent versus the yen to 110.18, the most in eight weeks. The euro lost 1.29 percent against the Japanese currency to 165.38, the biggest drop in 13 weeks. U.S. economic data suggest that a sustained recovery isn't imminent, said Robert Sinche, head of global currency strategy at Bank of America in New York.

Interest-rate swaps indicate the currency should trade at about $1.54 per euro, said Sinche, who still forecasts that the dollar will strengthen to $1.45 per euro by the second half of next year.

The number of U.S. home foreclosure filings more than doubled in the second quarter from a year earlier, according to RealtyTrac Inc., a seller of default data. Government reports this week may show retail sales fell 0.1 percent in July, the first decrease since February, and the U.S. trade deficit widened in June to $62 billion from $59.8 billion.

The U.S. budget deficit, which totaled $163 billion for 2007, is forecast by the administration of President George W. Bush to widen to a record $482 billion for 2009. Morgan Stanley predicts the dollar will weaken to $1.60 by October, because the faltering U.S. economy means the Fed is unlikely to raise rates anytime soon, Drossos said.

That means investors will continue to suffer inflation-adjusted returns that are negative based on the current annual consumer price index of 5 percent and Treasury securities yielding between 1.695 percent for three-month bills and 4.53 percent for 30-year bonds.

Asian markets fall amid worries over China economy
Stock markets fell across Asia on Tuesday amid profit-taking, inflation fears and stubborn worries about the Chinese economy. Chinese stocks dropped to their lowest close in 19 months as a sharp improvement in consumer price data failed to ease pessimism over the country's economic outlook.

The benchmark Shanghai Composite Index fell 0.5 percent to 2,457.20 — its lowest close since Christmas Day 2006. The index lost 5.2 percent Monday. The drop helped to pull benchmarks lower across the region. Japan's Nikkei 225 shed 0.95 percent to 13,303.60, reversing half its 1.99 percent gain from Monday.

Hong Kong's Hang Seng fell 1.0 percent to 21,640.89. Stock benchmarks also fell in India, Indonesia, the Philippines, Singapore, South Korea and Taiwan. Australia's main stock index rose 0.6 percent, meanwhile, and the Thai stock exchange was closed for a public holiday.

In the Chinese and Japanese markets, shares defied economic news that tends to buoy markets. In China, a decline in July's consumer price index to 6.3 percent from the previous month's 7.1 percent failed to relieve worries over inflation and the broader economy. The report on the CPI followed reports Monday that wholesale price inflation — an indicator of future price trends — rose 10 percent in July.

"The market is dropping heavily these days because of deeper worries about an economic slowdown," said Feng Yuming, an analyst at Oriental Securities in Shanghai. The CPI data, coming amid a slew of reports on troubles in the real estate sector and other industries, "couldn't disperse that pessimism," Feng said.

Airlines continued to lose ground, with Air China falling 8.2 percent and China Eastern Airlines losing 6.2 percent. Major refiner China Petroleum & Chemical Corp., or Sinopec, dropped 1.9 percent. However, heavyweight property firms, steel makers and financials rebounded, helping to offset other losses.

The drop in Tokyo came despite a strengthening dollar and falling crude oil prices, which both tend to be a plus for Tokyo shares. The dollar, which had fallen to levels below 100 earlier in the year, was trading at about 110 yen, holding on to recent gains.

Also, oil prices have fallen to a 3-month low as the stronger dollar and weakening crude demand from China weigh on investor sentiment. By late afternoon in Singapore, light, sweet crude for September delivery was changing hands just above US$113 a barrel in electronic trading on the New York Mercantile Exchange.

Hideyuki Ishiguro, supervisor at Okasan Securities Co. in Tokyo, said that the Nikkei was likely to stay boxed in around 13,000 points for some time because of worries about the global economy. "Corporate performance is lagging, and even with oil prices stabilizing, increasing material costs are likely to weigh on companies," he said.

Of particular concern was a Bank of Japan report released Tuesday that found the nation's corporate goods prices rose at their fastest pace in more than 27 years amid surging oil and commodities prices, said Ishiguro. Japan's index for domestic corporate goods prices in July climbed 7.1 percent on year to 112.0, marking the fastest pace since an 8.1 percent gain in January 1981.

Among the biggest losers were steel companies, including JFE Holdings, which dropped 6 percent. Nippon Steel Corp. lost nearly 5 percent. Toyota Motor Corp., which has been gaining on the back of a stronger dollar, held relatively steady, dropping 0.2 percent.

Hong Kong shares skidded, hurt by the drop in mainland China markets and heavy selling in wireless carrier China Mobile.
Hang Seng index component China Mobile lost ground after Citigroup cut its target for the company's stock price on concerns over reduced consumer spending. Shares in the cell phone carrier, Asia's biggest, plunged 4.6 percent to HK$94.5 — their lowest close in nearly a year.

Many traders were still waiting to see whether the Chinese government would move to support stock prices, analysts said. "There's a lack of direction right now, it really depends on the performance of A-shares," said Peter Lai, investment manager at DBS Vickers, referring to mainland China stocks. "If the Chinese authority (takes) measures, that will help. If they don't, we could see more selling."

Chinese airlines listed in Hong Kong continued their slide, with China Eastern falling more than 9 percent and China Southern off 6.7 percent. Major refiner China Petroleum & Chemical Corp., or Sinopec, retreated 3.8 percent despite easing oil prices. Banks lost ground as well, with China's leading lender ICBC down 2.8 percent.

Dollar Bottom Against Yuan Gets Louder as Traders Discount China's Economy
Just as the Bush administration prepares to take a bow for persuading China to let the yuan strengthen 18 percent against the dollar over the past three years, the gains are grinding to a halt.

The yuan retreated in the last two weeks after government officials said supporting growth is as important as fighting inflation. That raised speculation that currency policy will be adjusted to bolster exports as the trade surplus shrinks. Legg Mason Inc.'s Western Asset Management Co. is trimming bets on the yuan after it rose in July by the smallest amount in a year.

"Exporters are crying," said Rajeev De Mello, head of Asian bonds in the Singapore office of Western Asset, which manages $600 billion. "There's a slowing in the economy. There will be less and less appreciation in the currency."
The yuan fell 0.24 percent to 6.8588 per dollar in the five days ended Aug. 8, near a six-week low.

It dropped 0.34 percent the week before, the most since China scrapped the currency's peg to the dollar in July 2005. The People's Bank of China has kept the yuan little changed since June, after gains of 4.1 percent in the first quarter and 2.3 percent in the second.

U.S. Treasury Secretary Henry Paulson, writing this month on the Web site of Foreign Affairs magazine, said yuan strengthening still has "much further to go." Of the advance since the peg ended, Paulson said 70 percent has come about since he initiated semiannual economic talks with China in 2006.

China is reining in yuan appreciation to help exporters weather a global slowdown and deter so-called hot money, speculative funds attracted by anticipated gains in the currency. The yuan recovered from earlier losses today after a government report showed export growth unexpectedly gathered pace in July and the trade surplus widened for the first time in four months.

Overseas sales rose 26.9 percent from a year earlier, after climbing 17.2 percent in June, and the surplus totaled $25.3 billion. Economists forecast a 16.8 percent gain and a gap of $20.25 billion, Bloomberg surveys showed. China's currency ended up 0.02 percent at 6.8577 per dollar as of 5:30 p.m. in Shanghai, having earlier fallen as much as 0.11 percent.

"For the next three to six months we could see a weaker yuan," said Phillip Blackwood, head of the emerging-markets division of Sydbank A/S, Denmark's third-largest bank by market value. "The slowdown is spreading to China."

The currency may fall as much as 2 percent, Blackwood said. He oversees $5 billion of emerging-market bonds for the bank in Aabenraa, 25 kilometers (15.5 miles) north of the Danish-German border. Blackwood would consider buying if the currency falls "a couple" of percentage points, he said.

It's too soon to start betting on the dollar rising against the yuan, Goldman, Sachs & Co. told clients last week. "It would be the wrong decision to close long yuan exposure at these levels," Thomas Stolper, a London-based strategist at the world's biggest securities firm by market value, wrote in an Aug. 5 research note.

China's yuan is likely to appreciate versus the dollar "almost three times as fast" as traders predict because money flowing into the country is still increasing, Stolper said. China's economy, the world's fourth largest, expanded 10.1 percent in the second quarter from a year earlier.

While that is the slowest pace since 2005, it's still the fastest among the world's 20 biggest economies. The yuan is likely to strengthen 3.4 percent to 6.63 in the second half of the year, according to the median estimate of 25 analysts surveyed by Bloomberg.

So-called non-deliverable forward contracts indicate investors have been scaling back bets on currency gains. They suggest the yuan will reach 6.6060 per dollar in the next 12 months, an advance of 3.8 percent from the current exchange rate.
Two weeks ago the contracts, which allow traders to bet on the future value of China's currency, predicted an advance of 5.3 percent. At the start of last month, they priced in a 6 percent rise.

Forwards are agreements to buy and sell assets at current prices for delivery at a specified time and date. Non- deliverable contracts are used for currencies that can't be freely converted and are settled in dollars. China let the yuan strengthen against the dollar for the first time in a decade after mounting criticism from the U.S. and Europe that the nation had an unfair trade advantage.

The U.S. trade deficit with China ballooned to a record $256 billion last year, equivalent to about a 10th of the Asian nation's gross domestic product. The central bank manages the yuan against a basket of currencies by setting a daily reference rate versus the dollar. China's currency can fluctuate 0.5 percent on either side. The bank today lowered the rate for the ninth time in a row, the longest run of reductions since the peg ended.

Chinese President Hu Jintao cautioned this month against overestimating the benefits to the economy of the Beijing Olympic Games. He also said maintaining steady and fast expansion, while controlling inflation, is a priority. New York-based JPMorgan Chase & Co., the world's sixth- biggest currency trader, on Aug. 1 advised investors to close bets that the yuan will be higher in three months.

It cited "increasing growth headwinds" for the economy. Singapore-based currency strategists Claudio Piron and Yen Ping Ho had recommended the position just 12 weeks earlier. "There's no opportunity to make money on the yuan revaluation," said V. Anantha-Nageswaran, head of investment research for Asia and the Middle East at Bank Julius Baer (Singapore) Ltd., part of Switzerland's biggest independent money manager.

A retreat in the Chinese currency may take the shine off Paulson's successes in the run-up to the November election, after which President George W. Bush and his cabinet will step down. The Treasury chief, who says he has visited China more than 70 times, will leave behind the worst housing slump since the Great Depression and an economy that may be shrinking.

Yuan gains won't help the U.S., said Zuo Xiaolei, chief economist in Beijing at China Galaxy Securities Co., the nation's biggest brokerage. "The U.S. has no reason or justification to push for further appreciation," he said. "The U.S. needs money to clean up the collapse of its housing market and that will require a stronger dollar to lure back investors."

Ilargi: Japan’s game is starting to look positively weird; central bank interest rates are still at 0.5-1%, while prices rise 5 to 10 times as fast.

Japan's Wholesale Inflation Rate Reaches 27-Year High
Japan's wholesale inflation rate accelerated to a 27-year high in July as companies raised prices to offset oil and commodity costs. Producer prices climbed 7.1 percent from a year earlier, after a revised 5.7 percent increase in June, the Bank of Japan said in Tokyo today. The median estimate of 31 economists surveyed by Bloomberg News was for 5.7 percent.

The central bank last month raised its inflation forecast and cut its economic growth estimate, saying higher costs are squeezing companies and households. Corporate bankruptcies caused by rising raw-material costs in the first half of 2008 already outnumbered those for all of last year, according to Teikoku Databank Ltd.

"Even though oil prices have been coming down in recent weeks, companies will keep trying to raise prices because they've made up for only a fraction of the cost increases they've suffered," said Azusa Kato, an economist at BNP Paribas in Tokyo.
The yen traded at 110.09 per dollar at 8:58 a.m. in Tokyo from 110.14 before the report was published.

The government is considering raising prices of wheat it sells to millers as much as 20 percent in October, the second increase this year, Kyodo News reported yesterday, citing farm ministry officials. It raised wheat prices 30 percent in April, prompting bread, pasta and noodle makers to follow suit.

Nippon Paper Group Inc., Japan's second-largest paper maker, said last month it will raise prices by 10 percent in September, the second increase this year. Fuel and raw materials are "rising so rapidly that it's too difficult to recover profits with cost-cutting efforts alone," the company said on July 30.

The increase in producer prices was the steepest since January 1981. From a month earlier, prices climbed 2 percent, the fastest pace since April 1980, when oil prices surged in the wake of the 1979 Iranian Revolution. Higher commodity costs are also feeding into retail inflation. Consumer prices excluding fresh food, fish and vegetables climbed 1.9 percent in June from a year earlier, the fastest pace in a decade.

Some 235 companies went bust in the six months ended June because of rising costs, exceeding the 229 bankruptcies recorded for the same reason in all of 2007, Teikoku Databank reported. Transport, food and metal companies led the failures.

Producer price gains will probably ease in coming months as oil falls and a global slowdown reduces demand for raw materials. Crude oil has dropped 21 percent since reaching a record $147.27 a barrel on July 11. Retail gasoline prices climbed to a record 185.1 yen a liter ($6.39 a gallon) this month.

Wholesale inflation "will probably stay around 5 percent through the end of this year and then gradually head in the opposite direction next year," said Mari Iwashita, chief market economist at Daiwa Securities SMBC Co. in Tokyo.

Even so, producer costs will keep fueling consumer prices for a while, economists said. Ajinomoto Co., the country's biggest foodmaker, last week announced plans to raise prices, and McDonald's Holdings Co. Japan said a Big Mac may soon cost Japanese consumers 30 yen more.

"We expect core prices will rise 2.2 percent in July and 2.3 percent in September," said Hiroaki Muto, a senior economist at Sumitomo Mitsui Asset Management Co. in Tokyo. "Even though crude oil prices are being adjusted now, the ongoing cost-push inflation won't weaken easily."

Canadian Dollar's Losing Streak Longest in 3 Years
The Canadian dollar declined for an eighth day, its longest losing streak in more than three years, as commodities fell and a report showed housing starts slowed, raising speculation the Bank of Canada may cut borrowing costs.

The currency touched the lowest in almost a year as crude oil reached a 14-week low. Commodities account for about half of Canada's exports. The U.S. is Canada's biggest trading partner. "There's a realization now that the Canadian economy is weak, even flirting with recession," said Carlos Leitao, chief economist at Laurentian Bank Securities Inc. in Montreal.

"The recent declines in commodity prices have had an impact, but more fundamental is the weakness in the Canadian economy." The currency decreased 0.3 percent to C$1.0699 per U.S. dollar at 2:21 p.m. in Toronto, from C$1.0667 on Aug. 8. Earlier it touched C$1.0716, the lowest since Aug. 17, 2007. One Canadian dollar buys 93.47 U.S. cents.

The Canadian dollar depreciated for nine days during the period ended April 18, 2005, on concern opposition parties would call for a no-confidence vote to oust the governing Liberal Party over a kickback scandal. Canadian new-home starts plunged in July to their lowest level this year. The July total of 186,500 units on an annualized basis compares with a revised 215,900 in June, Canada Mortgage and Housing Corp. said today in Ottawa.

Economists predicted starts would drop to 210,000 from an initially reported 217,800 units in June, according to the median of 18 responses in a Bloomberg survey. "We've seen signs of weak data, particularly on the housing side, an area which had been a bastion of strength," said Michael Gregory, a senior economist in Toronto at the Bank of Montreal.

"The Canadian economy is quite sluggish, giving some weight to the view that the Bank of Canada might cut rates sooner than expected." The Bank of Canada kept its overnight lending rate at 3 percent on July 15 after lowering borrowing costs four times since December. The central bank's next meeting is Sept. 3.

Consumer prices rose 3.1 percent in June from a year earlier, as gasoline increased 27 percent, Statistics Canada said July 23. The inflation rate was the highest since September 2005. The Canadian dollar will weaken to C$1.08 by the end of 2009, according to the median estimate of 31 economists surveyed by Bloomberg News.

The yield on the two-year government bond rose 6 basis points, or 0.06 percentage point, to 2.77 percent. The price of the 3.75 percent security due in June 2010 fell 11 cents to C$101.71. The 10-year bond's yield increased 3 basis points to 3.64 percent. The 10-year bond yielded 87 basis points more than the two- year security, down from 90 basis points on Aug. 8.

Canada's two-year bond yield will touch 3.28 percent by the end of this year, with the 10-year yield reaching 3.90 percent, according to the median forecast in a Bloomberg survey. Canadian government bonds have returned 4.3 percent in 2008, according to Merrill Lynch & Co. index statistics. U.S. Treasuries returned 3 percent so far this year.

Bringing Down Bear Began With $1.7 Million of Put Options On March 11, the day the Federal Reserve attempted to shore up confidence in the credit markets with a $200 billion lending program that for the first time monetized Wall Street's devalued collateral, somebody else decided Bear Stearns Cos. was going to collapse.

In a gambit with such low odds of success that traders question its legitimacy, someone wagered $1.7 million that Bear Stearns shares would suffer an unprecedented decline within days. Options specialists are convinced that the buyer, or buyers, made a concerted effort to drive the fifth-biggest U.S. securities firm out of business and, in the process, reap a profit of more than $270 million.

Whoever placed the bet used so-called put options that gave purchasers the right to sell 5.7 million Bear Stearns shares for $30 each and 165,000 shares for $25 apiece just nine days later, data compiled by Bloomberg show. That was less than half the $62.97 closing price in New York Stock Exchange composite trading on March 11. The buyers were confident the stock would crash.

"Even if I were the most bearish man on Earth, I can't imagine buying puts 50 percent below the price with just over a week to expiration," said Thomas Haugh, general partner of Chicago-based options trading firm PTI Securities & Futures LP. "It's not even on the page of rational behavior, unless you know something."

The 57,000 puts that traded March 11 at the $30 strike price and the 1,649 that traded at $25 were collectively worth about $1.7 million, Bloomberg data show. Each put is equal to 100 shares of stock.

"That trade amounted to buying a lottery ticket," said Michael McCarty, chief options and equity strategist at New York-based brokerage Meridian Equity Partners Inc. "Would you buy $1.7 million worth of lottery tickets just because you could? No. Neither would a hedge fund manager."

During the next four days, New York-based Bear Stearns unraveled in the swiftest investment-banking failure in Wall Street history. Speculation about a cash shortage proved self- fulfilling, causing customers and lenders to demand their money back. Bear Stearns's stock sank 47 percent to $30 on Friday, March 14.

That's when the Fed moved to stave off a panic by helping the U.S. Treasury arrange JPMorgan Chase & Co.'s purchase of the company for $2 a share, a price unimaginable to the firm's 14,000 employees. In the aftermath, Bear Stearns Chief Executive Officer Alan Schwartz told Congress that the firm was toppled by rumor- mongering and abusive trading.

Regulators have begun peeling back trading records, hunting for suspects. The fire sale of Bear Stearns was the climax of a nine- month credit seizure that started with the failure of two Bear Stearns hedge funds, caused more than $490 billion of losses and writedowns in the banking and securities industry and ousted the CEOs of Citigroup Inc., Merrill Lynch & Co., and UBS AG. Never in its 95-year history had the Fed done so much to rescue Wall Street during its worst financial crisis in at least two decades.

Evidence of any scheme to bring down Bear Stearns is most likely buried in options data, according to former government investigators. Options, contracts to buy or sell shares by a certain date at a specific price, can offer forensic evidence of market manipulation and insider trading, said Brent Baker, a former U.S. Securities and Exchange Commission Enforcement Division lawyer who helped prosecute Anthony Elgindy, the stock- picker convicted in 2005 on 11 counts of securities fraud, wire fraud, extortion and racketeering.

"On CSI Wall Street, the options are the DNA," he said, referring to the television series, "Crime Scene Investigation." While Bear Stearns executives tried to quash rumors about the firm's insolvency with press releases and television appearances by its CEO Schwartz, the number of $30 Bear Stearns put options held by speculators soared 10,768 percent from Monday March 10 to Tuesday March 11, Bloomberg data show.

On March 11, when the Fed said it planned to make up to $200 billion available through weekly auctions and for the first time lend cash in exchange for debt that included the devalued mortgage-backed securities that contributed to the credit seizure, one or more unidentified traders requested the Chicago Board Options Exchange list the even deeper out-of-the-money strike at $25.

Bear Stearns also was rocked that week by failed trades, a problem associated with naked short selling. Failed trades in Bear Stearns soared more than 10,800 percent during the week of March 10, according to data released by the SEC. Bear Stearns fell 11 percent to $62.30 in the first trading day of the week on speculation that the firm had insufficient liquidity, or enough funds to cover any sudden withdrawals.

The 58-year-old Schwartz, who was in Palm Beach, Florida, at an industry conference, was puzzled by the rumors, according to people who talked to him. He was told by associates that the firm had no shortage of cash. Clients weren't pulling their money, trading counterparties weren't refusing to do business with Bear Stearns, and short-term credit lines weren't being cut.

To quell the speculation, the company issued a two- paragraph statement at the end of the day, saying its financial position was "strong." Hedge funds, concerned about losing their money, weren't convinced. Eagle Asset Management Inc. moved to other prime brokers, according to Managing Director Todd McCallister.

Investors who had credit default swap contracts with Bear Stearns turned to Goldman Sachs Group Inc. and other Wall Street firms, asking them to buy the contracts. On Wednesday, March 12, Schwartz appeared on CNBC, live from Florida, saying the company had ample resources to weather the credit crunch.

While for the moment, at least, that assuaged concerns in the market, the capital flight began again the next day. Many of Bear Stearns's traditional creditors reduced or halted their lending to the 85-year-old company founded by Joseph Bear and Robert Stearns.

By the end of the day, Bear Stearns's cash was almost depleted and its stock closed at $57. As Schwartz realized the company couldn't function on Friday without access to overnight borrowing, he called government officials, regulators and JPMorgan CEO Jamie Dimon.

After discussions late into Thursday night, the Fed agreed to provide cash through JPMorgan, the second-biggest U.S. bank by market value, because Bear Stearns didn't have direct access to the Fed as a lender of last resort.

Then, on March 14, the CBOE listed a series of put options with less than five days to expiration. The lowest strike price, $5, was more than 90 percent out-of-the-money in what options traders refer to as a "bankruptcy put." Bear Stearns slumped 47 percent that day to $30 in NYSE trading.

The out-of-the-money Bear Stearns puts point to a raid, said Baker, who's now a securities lawyer whose clients include companies that have filed complaints over naked short selling. The $25 Bear Stearns puts, and others obtained March 14 involving the right to sell 630,000 shares at a strike price of $5 by March 22, were "bizarre," according to Haugh, the PTI partner who spent 18 years as a CBOE options-market maker.

"An incredible amount of bearish activity could have been generated by just 10 to 15 people," Haugh said. "Other people then pile in, because they think somebody knows something."

John Olagues, who started trading options 30 years ago, said he has never experienced anything like it. Olagues, who runs a New Orleans consulting company called Truth in Options, also manages more than $1 million for a client who had a stake in Bear Stearns, which plummeted 94 percent in value on March 17. The drop prompted Olagues to start poring over options trading records and call officials at the CBOE.

"In just one tick, the company's share price lost nearly all its value, a steeper drop than Enron's right before its de- listing in 2001," said 63-year-old Olagues, referring to the bankruptcy of Houston-based energy trading company Enron Corp. "I've never seen a stock perform like that in my life."

Olagues, who was an options market maker at the Pacific Exchange and then the CBOE from 1976 to 1984, said he knows all about so-called time decay, implied volatility, arbitrage and the complexities of options trading. The former all-conference pitcher at Tulane University, who started Truth in Options in 2003, said he has found options transactions that convince him Bear Stearns was the victim of insider trading.

"I would stake my reputation on that," he said.

Olagues said he was able to avoid losses for his client on Friday, March 14. His hedged position -- a so-called vertical put spread designed to absorb losses as great as 50 percent -- made money by the closing bell that day. The hedging failed the next trading day, March 17, when the stock opened at $3.17. "Nobody prepares for the stock going from $57 to $3 in just two days," he said.

Schwartz told the U.S. Senate Banking Committee on April 3 that there are "lots of reasons why people could have a financial motivation to induce panic" and "a lot of trading would point to that." Bear Stearns has forwarded options data to the Senate Banking Committee and the SEC, said a person close to the firm, who declined to be identified.

SEC Chairman Christopher Cox told Congress last month that the agency is probing whether illegal trading spurred the collapse of Bear Stearns and the 72 percent drop this year in Lehman Brothers Holdings Inc.'s market value. The inquiry focuses on investors suspected of seeking to profit by intentionally spreading false information about the companies.

The SEC subpoenaed Wall Street's largest firms and hedge funds for trading records and communications, including e-mails. The agency also enacted an emergency limit on so-called naked short sales in Freddie Mac, Fannie Mae and 17 brokerages as it prepares broader rules to thwart stock manipulation. That limit expires at midnight tomorrow.

Naked shorting, which can be illegal, occurs when short sellers who intend to profit from a decline in securities prices fail to borrow stock by the settlement date. Traders can use that method to drive down prices by flooding the market with sell orders.

The strategy can "turbocharge" the effect of false rumors on a stock price, Cox said on a July 16 conference call with reporters. The SEC will consider new rules to prevent improper short selling, Cox told Congress on July 24. It also may force investors to disclose "substantial" bets on falling stocks, he said.

On Tuesday, March 11, when Federal Reserve Bank Chairman Ben Bernanke attended a luncheon with Wall Street executives at the New York Fed and the CBOE listed its $25 Bear Stearns put option, McCarty of Meridian red-flagged Bear Stearns in his "MEP Noteworthy Option Activity" memo.

What got McCarty's attention that day was the volume of put trading in strike prices of $35 and below. Investors traded 84,109 puts at strike prices that would require a calamitous drop to make money, he said. "Somebody placed some big bets that day that paid off," McCarty said. "The question is, did they make it pay off?"

On March 14, when Schwartz sought emergency funding, Bear Stearns opened at $54.24 in NYSE trading. That day, the CBOE listed eight new put options that expired in five days with strike prices that ranged from $22.50 to $5. The lowest was 90.7 percent below the opening stock price.

Gail Osten, a spokeswoman for the CBOE, declined to say who placed the order for the options. "Nobody in their right mind would buy that put unless you knew what was going down," said Ray Wollney, Olagues's partner at Truth in Options. On Friday, March 14, a total of 6,303 of the March $5 Bear Stearns puts traded.

That night, Schwartz got a call from Treasury Secretary Henry Paulson making it clear that Bear Stearns had until Sunday evening to find a buyer because the Fed planned to withdraw its financial backing. Paulson, who didn't want the government to appear to be bailing out a Wall Street firm, then brokered the sale to JPMorgan.

Schwartz and Bear Stearns Chairman James "Jimmy" Cayne convinced fellow board members by explaining that their only alternative was to accept the deal or face bankruptcy. The agreement was announced Sunday night. Options bets that looked irrational on Friday proved brilliant on Monday, when the shares traded between $3 and $5.

By Wollney's calculations, the traders who spent $35.8 million on the deep out-of-the-money puts reaped an estimated $274 million windfall from the plunge in Bear Stearns. Peter Chepucavage, a former general counsel for compliance at Nomura Securities and onetime SEC lawyer, said the Bear Stearns bets were neither smart nor lucky.

"When you buy $5 strikes when the stock is trading over $50, you either have to be manipulating, or you have to have insider information," said Chepucavage, who's now with Washington-based Plexus Consulting.

John Welborn, a London School of Economics-educated economist who works at Haverford Group investment firm in Salt Lake City, has been analyzing data released by the SEC on Bear Stearns shares sold but not delivered to buyers within the required three-day limit.

From March 10 to March 14, SEC data show that the failed Bear Stearns trades jumped to 2.1 million from 19,424, Welborn said. The failed trades correlate with increases in the firm's put volume. The volume of Bear Stearns puts soared to 237,770 on March 11 from 32,081 on March 7. Put contracts doubled again to 445,635 on March 14.

"It looks to me like Bear Stearns got riddled with bullets," Welborn said. The question is whether the trading was premeditated and designed to ruin Bear Stearns, Chepucavage said. If there is a link between these separate activities, only subpoena power will be able to establish it, he said. "Track the rumors," Chepucavage said. "Follow the puts."

The Trouble with Georgia
The Abkhaz and the South Ossetians have made their preference very clear by applying for and being issued with a Russian passport.

That's right, the majority of the present native population of these two "separatist enclaves" are bona fide citizens of the Russian Federation with all the privileges appertaining thereto. Lacking any other options, they are happy to accept protection from Russia, use Russian as their lingua franca, and fight for their right to be rid of Georgians once and for all.

One of the privileges of being a Russian citizen at this stage, when Russia has recovered from its political and economic woes following the Soviet collapse, is that if some foreign entity comes and shells a settlement full of Russian citizens, you can be sure that Russia will open one amazingly huge can of whoop-ass on whoever it feels is responsible.

Add to that the atrocities allegedly perpetrated by the Georgian forces, such as finishing off wounded Russian peacekeepers, and you can see why the normally shy and reticent Russian army might get behind the idea of making sure Georgia no longer poses a military threat to anyone.

The Georgians have really done it to themselves this time, and we should all feel very sorry for them. They are not evil people, just incredibly misguided by their horrible national politicians. The West, and the US in particular, bear responsibility for enabling this bloodbath by providing them with arms, training, and encouraging them to fight for their "territorial integrity."

This, it will no doubt turn out, was the wrong thing to do.


cj said...

For some reason I continue to have difficulty in posting a comment. Your system will not recognize my password. I have to sign up for an account each time I want to post.

In the past you stated that you thought that US Treasuries was the best way to go in protecting real savings. Is that still your stance?
I must say that I have a very hard time handing my real savings over to the same folks that brought us this financial nightmare! Nor do I feel comfortable leaving it in the hands of the Banksters. I wish that I could put it all in real cash and hold it myself.

Anonymous said...

Same dilemma here. My understanding is that in my "flight to safety", that is purchase of treasuries, I am investing in the most toxic sludge of the credit bailout, the exact thing that I was trying to avoid. Or should I say investing in a bankrupt nation instead of a bankrupt bank. It's a catch 22. It was quite brilliant on Hank's part--getting conservative investors with the real money to purchase the riskiest of the insolvent "assets" from the big boys. But, in the end, I guess people still assume that UST's will be the last asset to be declared worthless.

Bigelow said...

Short term (3 month) Treasuries should be no problem because the government day to day money is right there; default on those and the government is (use your imagination) immediately.

el pollo said...

What exactly makes a mattress full of $100's safer than 3 month's treasuries (other than the question of whether your greater risk is with the banksters or the gangsters)? This is a serious question.

Anonymous said...

Ilargi, I assume that the "bursting" of the commodities bubble has come because of massive selling on the part of speculators that drove prices up in the first place.

That must be the case with oil, for instance: Russia is invading Goergia (a BIG hub for caspian oil) and the price still goes down??!!

Unfortunately, I have found no news about it in the media.

I think that maybe the banks and funds are raising cash undoing their positions in commodities mkts to prop up their balance sheets, now that they are bleeding with sub prime, alt A, and prime b mortgage related instruments...

cowpoke said...

^ Anonymous ^

I think the first article Ilargi asked us to read in full helps explain why the oil price is having trouble gaining traction again.

"The pool of players willing and able to acquire US risk assets is being depleted by the week. To be sure, the unfolding change of fortunes for the leveraged speculating community is one more key facet of tighter system credit and faltering marketplace liquidity - extremely problematic financial conditions for the finance-driven US bubble economy. And this makes the current market dislocations in the face of rapidly deteriorating fundamentals such a dangerous development"

Here is an interesting thread from LATOC finance forums relating to oil speculation you guys might find interesting.

Could this be the cause of spike/drop?

Anonymous said...

For the kind souls here who are concerned about holding their wealth in the form of electronic digits called U.S. Treasury bills... consider silver and gold bullion coins... both are currently on sale... but I think the sale ends at the end of the month. Just some food for thought. GSJ

Bigelow said...

El pollo,

Years ago Doug Noland coined the word “moneyness”. As part of blowing the credit bubble people were encouraged to believe many financial concoctions had qualities of moneyness that really didn’t. Cash and 3 month Treasuries are considered low risk and equivalent for collateral purposes. To put a fine point on it one is still an electronic bookkeeping entry which pays interest, while the other pays nothing but you can carry it on your person.

See Nope, That’s Not Money

Bigelow said...

Nice link Cowpoke. There is also a complement for theautomaticearth too. Jeromie says:

“The automatic earth covers it in one sentence. Markets are deleveraging. Absolutely! Leveraged positions are having their loans phased out. They must sell out and make good the losses or take out the residual profits. Big commodity players leverage no different than Yen Trade players or asset backed mortgage hedge funds. The collapse of Sem Fuel is no different than the five day collapse of Carlyle Capital Corporation who leveraged AAA government implied guarantee mortgages.
Speculation is reversing what speculation drove up. Trading is speculation or manipulation in my book if you are not a producer or consumer in the case of goods.”

Anonymous said...

Yesterday from Jenna Orkin:
“According to a Russian friend, Russian news is reporting that the conflict in the Caucasus was instigated by Georgia with material support, in the form of weapons, from the U.S. The motive was to benefit McCain by highlighting the need for foreign policy experience. The fact that the attack took place while Obama was on vacation, resulting in footage of him elegantly relaxing while bombs exploded in an allied country, lends some credence to this theory. The friend also commented on the fact that the American-educated President Sakashvili conducts his press conferences in English.”

Durandal said...

You know, all of the financial meltdown stuff I believe has partly contributed to me getting an ulcer! I'd stop reading TAE, but it's like watching a train wreck in that you just can't turn away!