Debt Rattle, August 30 2008: Broke Back Banking

Jack Delano Home Depot December 1940
Secondhand plumbing store, Brockton, Mass.
Saba Mechanical Plumbing & Heating is still in business in Brockton

Ilargi: The 10th bank to fail in the US this year, announced during the traditional Friday Happy Hour, was a faith-based institution by the name of Integrity. How is that not funny?

We all intuitively understand that there is no safer place to park our money than directly in the sacred hands of Jerry Falwell and Ted Haggard (whose life story was so vividly portrayed in 'Brokeback Mountain'), the unblemished selfless messengers tirelessly relating the latest news, as it comes in, from the direct link to their Master.

At first, you might think that it’s a pretty crazy way to approach banking, and wonder exactly where Hail Mary's enter the credit scheme. But then of course you realize that the entire US financial system is faith-based.

And as the Vatican can testify (but won’t), Jesus for 2000 years has proven to be a solid and reliable accomplice when it comes to relieving people of their excess wealth.

The handling of the $1.1 billion in Integrity assets will cost the FDIC some $300 million. Now that is not funny.

Then again, once you learn to appreciate bankruptcy as a metaphor for the Rapture, being milked out of your last penny will turn out to be a blessing in disguise.


Economy at 60-year low, says Darling. And it will get worse

Britain is facing "arguably the worst" economic downturn in 60 years which will be "more profound and long-lasting" than people had expected, Alistair Darling, the chancellor, tells the Guardian today.

In the government's gravest assessment of the economy, which follows a warning from a Bank of England policymaker that 2 million people could be out of work by Christmas, Darling admits he had no idea how serious the credit crunch would become.

His blunt remarks lay bare the unease in the highest ranks of the cabinet that the downturn is making it all but impossible for Gordon Brown to recover momentum after a series of setbacks. His language is much starker than the tone adopted by the prime minister, who aims to revive his premiership this autumn by explaining how he will help struggling families through the downturn.

The chancellor, who says that Labour faces its toughest challenge in a generation, admits that Brown and the cabinet are partly to blame for Labour's woes because they have "patently" failed to explain the party's central mission to the country, leaving voters "pissed off".

In a candid interview in today's Guardian Weekend magazine, Darling warns that the economic times faced by Britain and the rest of the world "are arguably the worst they've been in 60 years". To deepen the sense of gloom, he adds: "And I think it's going to be more profound and long-lasting than people thought."

The economic backdrop presents Labour with its toughest challenge since the 1980s. "We've got our work cut out. This coming 12 months will be the most difficult 12 months the Labour party has had in a generation," he says. But Labour has been lacklustre. "We've got to rediscover that zeal which won three elections, and that is a huge problem for us at the moment. People are pissed off with us.

"We really have to make our minds up; are we ready to try and persuade this country to support us for another term? Because the next 12 months are critical. It's still there to play for." Darling was given a personal taste of the austere climate when ticked off by a waiter for ordering a second bottle of wine during a meal with his wife, Maggie, and another couple. "The waiter came over and said 'too much wine' in a loud voice. So we stuck to one bottle for the entire meal."

Darling admits that he was recently challenged at a petrol station by a motorist struggling with the rising cost of petrol. "I was at a filling station recently and a chap said: 'I know it's to do with oil prices - but what are you going to do about it?' People think, well surely you can do something, you are responsible - so of course it reflects on me."

But he has some words of comfort for Brown when he predicts there will be no leadership challenge against the prime minister. He also reveals that Brown has no plans to carry out an imminent cabinet reshuffle as he delivers a defiant put-down to critics who have said that he could be replaced as chancellor.

"You can't be chopping and changing people that often," he says. "I mean, undoubtedly before the end of the parliament he will want to do a reshuffle, but I'm not expecting one imminently. I do not think there will be a reshuffle."

Darling does not name names, but says some people want his job and have been trying to undermine him. Many in the Treasury believe that Ed Balls, the schools secretary, has been less than supportive. "There's lots of people who'd like to do my job. And no doubt," he adds, half under his breath, "actively trying to do it."

The chancellor's remarks about the economy - in an interview conducted over two days at his family croft on the Isle of Lewis - highlight the nerves at the top of the government after the loss of Labour's 25th safest seat in Britain in the Glasgow East byelection in July. The Tories are comfortably ahead in polls as leaders return on Monday after the holiday.

Darling, who speaks about how the prime minister is one of his oldest friends in politics, admits Brown has struggled to connect with voters. Asked whether Brown can communicate Labour's mission, he says: "Yes, I do think he can." Asked why Brown has not done so, Darling falters as he says: "Er, well. Well, it's always difficult, you know ... But Gordon in September, up to party conference, has got the opportunity to do that. And he will do that. It's absolutely imperative."

Darling even describes himself as "not a great politician". Saying how he usually avoids personal interviews and photographs, he says maybe "that's why I'm not a great politician. You know, I'm not very good at looking at pictures and subjecting them to the equivalent of textual analysis".

Today's interview was designed to show the chancellor in a more personal light after a year in which he faced criticism over Northern Rock and the loss of discs with details of half the population. He says nothing of tensions with No 10 after he was reportedly rebuffed by Brown when he pointed out the dangers of abolishing the 10p tax rate.

His press adviser tells Darling, whose relations with Downing Street have been tense over the past year, to speak his mind in the interview. "Now Alistair," the adviser tells the chancellor as Decca Aitkenhead begins the interview. "Tell her everything. Make sure you tell her everything."

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Millions more Britons face big energy price increases

This summer's misery for energy consumers reached a climax yesterday when the last two of the big six suppliers raised prices for millions of household customers.

ScottishPower, which has just over 5 million customers, said gas bills would rise by 34% from the beginning of next month, and electricity by 9%. Npower said it was putting up gas prices by 26% and electricity by 14% for its 6.6 million customers with immediate effect.

The latest increases come amid growing calls for a windfall tax on energy companies to help the increasing numbers of households struggling to cope with rising energy bills at a time when food and fuel costs are also increasing. Yesterday a coalition of Age Concern, Child Poverty Action Group and National Energy Action increased the pressure for government action by demanding measures to make social tariffs for energy fairer and more effective.

The coalition said that 5.5 million households were likely to face fuel poverty - defined as spending more than 10% of income on heating and lighting - this winter. Age Concern's director general, Gordon Lishman, said: "Many pensioners already worrying about whether they can afford to heat their homes this winter will be outraged by news of yet more colossal price hikes.

"It is a huge worry that one in three pensioner households are likely to be living in fuel poverty by the end of 2008 and many are already feeling forced to cut back on essential food or fuel." Tim Wolfenden, head of home services at uSwitch.com, a price comparison and switching service, said: "All the major suppliers have increased prices for a second time this year. This is a heavy blow and few households will emerge unscathed or unconcerned about the future affordability of their energy."

The government is expected to respond to the calls for help for people struggling with rising fuel bills within the next few days, though it remains unclear how any further help will be funded. An extra £225m from companies for social programmes for poorer customers over the next three years was announced earlier this year but the companies face demands to go further.

The government is said to be wary of a windfall tax on the sector when the industry is facing the challenge of finding more than £100bn to invest in renewable generation and the replacement of ageing nuclear power plants, and coal-fired stations that will have to close under European legislation.

Earlier this summer EDF Energy, British Gas and more recently E.ON and Scottish and Southern Energy all raised prices. The second round of increases by the big six takes the average household bill on standard plans for gas and electricity combined into a range of £1,200 to more than £1,300, depending on the supplier, according to uSwitch.com. At the beginning of the year average dual fuel bills for all six were well below £1,000.

The companies blame the rising cost of wholesale gas and power prices for the increases for residential customers. Gas prices are linked to oil prices because of the UK's increasing dependence on imports from continental Europe where gas contracts are often indexed to the price of oil. International coal prices have also risen sharply.

Yesterday ScottishPower, which is owned by Iberdrola of Spain, said coal prices had risen by 45% since February, while wholesale gas prices had climbed 65% and electricity by 55% over the same period. By contrast, it said, its own prices for dual fuel users would rise an average of 25%.

Willie MacDiarmid, ScottishPower's director of energy retail, said: "These are difficult times and we understand the financial impact this announcement will have on our customers. Although we're one of the last companies to announce increases we're sorry we couldn't hold on any longer. However we have worked very hard to protect people for as long as possible from these considerable increases in the wholesale market."

Giuseppe Di Vita, managing director of npower, part of German utility RWE, said the decision had been taken "extremely reluctantly, especially as household budgets are being squeezed so much".

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UK home sales boosted by desperate vendors

The London property market, once one of the most buoyant in the world, is now so stagnant that desperate vendors are spending hundreds of thousands of pounds buying houses they don’t want in order to sell their homes.

The extreme measure arises from the growth of the so-called property chains that often frustrate home sales in the UK, where houses are normally sold by one party to another, rather than by auction. The chains occur when a line of buyers and sellers all rely on each other’s transaction to go through. If one deal falls through, because someone pulls out or cannot get a mortgage, for instance, the rest are delayed or fail.

In the increasingly difficult London market, where estate agents say prices have been falling or weak for most of the year, there are fewer cash buyers so vendors are facing longer chains that break down more often as buyers fail to obtain mortgages or try to negotiate discounts.

Rather than waiting for chains to clear, agents say vendors have begun to buy the properties of people further down the chain to clear the way for their own home to be sold. One homeowner engaged in such a process told the Financial Times she had only been able to sell her house for £450,000 – in order to upgrade to a £700,000 home – by buying an apartment at the bottom of her chain for £200,000.

“I know several people doing this,” she said. “It allows you to retain some exposure to the property market and gets everything moving so you can sell.” Hamptons International, one of London’s biggest agents, says it has a number of clients who have sold properties worth between £2m and £3m after buying homes in the region of £300,000 further down the chain. These properties are then being rented out or given to children.

“Every sale is a bit more precarious in the current market and if the chain breaks down, the buyer at the top wants to make sure their sale goes through,” said Mark Anderson, managing director of Hamptons. “If they are prepared to be a bit more creative they can get the sale they want.”

Other agents said buyers at the top of chains were also more willing to pass price discounts down to ease the process for those at the bottom.

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Integrity Bank Becomes 10th U.S. Failure This Year

Integrity Bank of Alpharetta, Georgia, was closed by U.S. regulators today, the 10th bank to collapse this year amid a surge in soured real-estate loans stemming from the worst housing slump since the Great Depression.

Integrity Bank, with $1.1 billion in assets and $974 million in deposits, was shuttered by the Georgia Department of Banking and Finance and the Federal Deposit Insurance Corp. Regions Financial Corp., Alabama's biggest bank, will assume all deposits from Integrity, which was run by Integrity Bancshares Inc. The failed bank's five offices will open on Sept. 2 as branches of Regions, the FDIC said.

"Depositors will continue to be insured with Regions Bank so there is no need for customers to change their banking relationship to retain their deposit insurance," the FDIC said. Banks are being closed at the fastest pace in 14 years as financial companies report more than $505 billion in writedowns and credit losses since 2007.

California lender IndyMac Bancorp Inc., which had $32 billion in assets, was closed July 11 in the third-largest bank seizure, contributing to a 14 percent drop in the U.S. deposit insurance fund that had $45.2 billion at the end of the in the second quarter.

Regions will buy about $34.4 million in assets and will pay the FDIC a premium of 1.01 percent to assume the failed bank's deposits, the FDIC said. The FDIC estimates the cost of the Integrity failure to its deposit-insurance fund will be $250 million to $300 million.

Integrity was ordered by federal and state regulators in May to present a capital-raising plan within 60 days. At the time, the company had been trying without success for at least eight months to raise $40 million after loans to residential and commercial developers were hurt by the collapse of the real estate market.

"Banks must meet certain regulatory minimums to ensure safety and soundness," Georgia bank commissioner Rob Braswell said in a telephone interview. "When those minimums are not able to be met and solvency is in jeopardy, we have no choice but to close the institution and to place it into receivership."

Integrity Bancshares, which sold for more than $14 a share in January 2007, closed today at 4 cents in over-the-counter trading. The FDIC insures deposits of up to $100,000 per depositor per bank, and up to $250,000 for some retirement accounts at 8,451 institutions with $13.3 trillion in assets.

The FDIC this week said 117 banks are classified as "problem" in the second quarter, a 30 percent jump from the first quarter. The agency doesn't identify "problem" lenders. "More banks will come on the list as credit problems worsen," FDIC Chairman Sheila Bair said at an Aug. 26 Washington news conference.

The credit market turmoil may topple some of the nation's biggest banks, Kenneth Rogoff, former chief economist at the International Monetary Fund, said in Singapore Aug. 19. "Like any shrinking industries, we are going to see the exit of some major players," Rogoff told Bloomberg, declining to name the banks he expects to fail. "We're really going to see a consolidation even among the major investment banks."

Before today's action, the FDIC had closed 36 banks since October 2000, according to a list at fdic.gov. The U.S. shut 11 banks in 2002, the highest in the period. In 1994 the government had closed a dozen institutions by the end of August.
U.S. regulators this year also closed Columbian Bank and Trust of Topeka, Kansas, on Aug. 22; First Priority Bank of Bradenton, Florida, on Aug. 1; Reno-based First National Bank of Nevada and Newport Beach, California-based First Heritage Bank in July; Staples, Minnesota-based First Integrity Bank and ANB Financial in Bentonville, Arkansas, in May; Hume Bank in Hume, Missouri, in March; and Douglass National Bank in Kansas City, Missouri, in January.

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Real Estate Lender Is 10th Bank to Fail This Year

Integrity Bank of Alpharetta, Ga., on Friday became the 10th United States bank to fail so far this year, hurt by the very business it was built on — real estate lending.

Regions Bank of Birmingham, Ala., is assuming all of Integrity Bank’s $974 million in insured and uninsured deposits in 23,000 accounts, and about $34.4 million of the bank’s $1.1 billion in assets. The remainder of Integrity’s assets are being retained by the Federal Deposit Insurance Corporation. The agency said it estimated that Integrity’s failure would cost its deposit insurance fund $250 million to $350 million.

Integrity Bank, which opened for business in November 2000, specialized in real estate lending in the Atlanta area with a self-described “faith-based culture.” Throughout the early part of the decade when the housing market was booming, Integrity Bank grew into a billion-dollar publicly traded company — but when the real estate market started faltering, the bank struggled.

A F.D.I.C. spokesman, Rickey McCullough, said late Friday that the bank had failed because of its aggressive pursuit of construction loans, coupled with falling real estate values and “inadequate risk management.” Construction loans were 76 percent of the bank’s total loan portfolio. During the quarter ended June 30, the bank posted a net loss of $33.6 million.

Integrity’s five branches in Atlanta, which were closed Friday, will open Tuesday as Regions Bank branches. Regions has about $144 billion in total assets. Integrity Bank is the first Georgia bank to fail since late September of last year, when NetBank — also based in Alpharetta — was closed.

“Despite today’s announcement, it is important to emphasize that the overwhelming majority of banks operating in Georgia, 96 percent, are well capitalized and have adequate reserves,” the chief executive of the Georgia Bankers Association, Joe Brannen, said. The number of bank failures has shot up this year amid continuing mortgage defaults.

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This Week's Bank Failure Surprisingly Costly

Some of the usual suspects have dutifully noted the closure of $1.1 billion in assets at Integrity Bank of Alpharetta, Georgia The plot is already familiar: the Friday night, FDIC prepack, in this case, with Birmingham, Alabama-based Regions bank assuming all $974 million of deposits and $34 million of assets. The New York Times reported that the bank focused on real estate lending and had a "faith based culture". The results suggest that they might have relied overmuch on divine intervention at the expense of due diligence.

Now let's get to the juicy bit. As Bloomberg noted:

Banks are being closed at the fastest pace in 14 years as financial companies report more than $505 billion in writedowns and credit losses since 2007.....

Regions will buy about $34.4 million in assets and will pay the FDIC a premium of 1.01 percent to assume the failed bank's deposits, the FDIC said. The FDIC estimates the cost of the Integrity failure to its deposit-insurance fund will be $250 million to $300 million.

$250 to $300 million of losses for a mere $1.1 billion in assets bank? As reader Steve A noted:

Today's failure of the amusingly named Integrity Bank of Alpharetta, GA, confirms two very ugly trends: once again, FDIC was only able to pass cash and cash-equivalents to the assuming bank, and the FDIC's loss estimate is extremely high ($250M - $350M on $1.1B of assets). I don't have hard numbers handy but I seem to recall that receivership losses in the range of 25% - 35% were unusual in the commercial bank failures of the late 80's. I could be wrong, but the numbers this year are extremely high. FDIC's expected losses certainly make me wonder what on earth the bank examiners were doing for the last year besides critiquing the bank's coffee and color scheme.

Now given that the bank was only eight years old and may have have used its religious positioning to hide some less-than-upstanding practices, the magnitude of the bust may reflect fraud, and well executed fraud harder to detect than good old fashioned recklessness or shoddy controls.

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The four horsemen of the market

As investors, they fly solo. As market observers, they don't lead or follow as much as go their own way. It's tempting to dismiss their Cassandra-like warnings as overly pessimistic and hopelessly out of step, but their track records show that can be a costly mistake.

Jeremy Grantham, Bob Rodriguez, John Hussman and Steve Leuthold are contrarian-minded investors and opinionated commentators who share one thing in common: Those who buy into their funds never know exactly where their money will be parked. It could be emerging markets or alternative energy, high-yield debt or Treasurys. And if these risk-conscious money managers don't see compelling values, they might hedge their portfolios against unruly markets or even stash a good chunk of shareholders' assets in cash until better bargains appear.
  
You might call them the Four Horsemen of the Market, riding ahead of the predictable approaches and traditional thinking that defines most of the mutual-fund business. While these strategists display individualistic tailoring and design, what they have to say about stock and bond markets and economic conditions should get investors' collective attention.

Jeremy Grantham: 'Officially scared' Jeremy Grantham is not given to false alarms. The chief investment strategist at GMO, the highly regarded Boston-based manager of institutional and high-net-worth accounts, makes buy and sell decisions with a combination of computerized technical analysis and old-fashioned spadework. But nowadays, his digging for attractively valued stocks is mostly hitting rocks, and that has Grantham deeply concerned.

"The fundamentals have turned out to be worse than I had thought," Grantham said. "My advice would be, don't take any risk."
What he means is that in this market, don't be a hero; live to fight another day. Here's why: Global economic growth is slowing under the weight of increasingly illiquid credit markets and inflationary pressures. Weaker growth slashes corporate earnings, and since stock prices are tied to earnings, the outlook for equities worldwide, as Grantham sees it, is poor to middling.

"I don't consider myself a 'perma-bear,'" Grantham said. "Merely a realist." It's a grim reality, to be sure. In Grantham's world view, stocks in both developed and emerging markets are "substantially overpriced," with the possible exception of high-quality blue-chip companies that have strong, defensible global franchises.

"I underestimated in almost every way how badly economic and financial fundamentals would turn out," Grantham wrote shareholders in a July letter. "Events must now be disturbing to everyone, and I for one am officially scared!" One of his biggest fears, he added in an interview, is that "the whole global economy will be weaker than the market expects for quite a considerable time." How long? "I would guess at least two years of sustained disappointment."

Notably, just a few weeks ago Grantham turned negative on his "beloved" emerging markets, which had been a spot-on bullish call. "If the global economy is going to disappoint, the cost of holding them just seemed too high," he said. Grantham is particularly uneasy about China, a leading engine of world growth that seems to be sputtering. "I worry on behalf of the global economy at the consequences of China stumbling," he said.

Without China's robust demand, he added, "the whole level of global imports and exports would start to drop." Don't hide under the mattress just yet. Grantham points out that many of the world's strongest companies are based in the U.S., which could help the U.S. market's relative performance. Moreover, he said, the weaker global picture will benefit the U.S. dollar, so the American market could turn out to be "a safe haven."

Bob Rodriguez: 'Buyer's strike' Bob Rodriguez wants to be left alone. The manager of FPA Capital Fund and bond-focused sibling FPA New Income Fund has since June 2003 been on a self-proclaimed "buyer's strike" regarding high-quality bonds with maturities greater than two years.

Rodriguez believed then -- and is even more convinced now -- that longer-term Treasury yields aren't substantial enough to compensate investors for inflation's eroding impact on purchasing power. He wants to get 5% on 10-year Treasurys, which recently yielded 3.8%, before venturing back.

Consequently, Rodriguez continues to focus on "caution and capital preservation," as he explained to fund shareholders in a June letter. More than 40% of Capital Fund, for example, is given to short-term government agency and Treasury notes and cash.

"We will not provide long-term capital to borrowers with unsound and unwise business management practices at unattractive real yields," Rodriguez wrote. That includes the U.S. government, he noted. "We require a higher level of compensation -- i.e. more yield, for these potential risks."

The line in the sand hasn't hurt performance, however. Capital Fund, which is closed to new investors, has gained about 9% over the five years through Aug. 27, matching its midcap-value peers but with much less risk. New Income, meanwhile, is open to new money; it's 4% annualized five-year gain also was achieved with below-average risk.

"He's not naturally the most optimistic person you'll ever chat with," said Christopher Davis, a fund analyst at investment researcher Morningstar Inc. "Even in the best times he's looking for the gray lining in a silver cloud. That's one of the reasons you invest with him."

As for stocks, the value-oriented fund manager was early to embrace the energy sector several years ago and has hung on for the ride. And not surprisingly, Rodriguez steered clear of banks and other financial-services firms even as many of his value-driven counterparts saw bargains.

"By my calculation he adds about two percentage points a year through market timing or varying his exposure" to stocks, said Robin Carpenter, principal of CarpenterAnalytix.com, which develops investment tools for money managers. "That's a big number when it's added on top of the other returns you're getting. Some managers would kill for two extra percent."
Rodriguez declined requests to be interviewed.

John Hussman: 'Stay defensive' It's tough to put John Hussman in a box. Not that you'd want to. Hussman runs two portfolios: stock-focused Hussman Strategic Growth Fund and bond-centric Hussman Strategic Total Return Fund. Both are run with a careful eye to valuations and broad economic conditions that dictate the degree of market risk that Hussman is willing to accept.

For Hussman nowadays, risk-taking doesn't offer much reward. "We're fully hedged," the fund manager said, meaning that a portfolio won't be affected, positively or negatively, by market gyrations. The reason? Hussman said he's looking for another shoe to drop once investors recognize that the U.S. has not avoided recession.

"The stock, bond and foreign-exchange markets continue to trade essentially on the theme that the global economy is weakening, but that the U.S. has dodged a recession," Hussman wrote in his weekly market commentary in late August.
Investors' consensus is mistaken, Hussman contends. He said the U.S. is mired in recession, and once investors realize that earnings expectations are overblown, stocks will take another major hit.

"The potential downside could be abrupt, leaving little opportunity to make defensive changes after the fact," Hussman wrote.
While Strategic Growth's hedges insulate it from the market's volatility, Hussman is anything but neutral. The portfolio is fully invested in stocks, and how these selections fare determines the fund's return. "What drives our fund is the difference in performance between the stocks we own and the indices we use to hedge," Hussman said.

That said, Hussman doesn't expect much from stocks. He predicted that U.S. market returns will average 4%-6% annualized over the next decade, primarily due to weaker corporate earnings. Given that slower-growth view, Hussman dumped most of his exposure to the commodity, industrials and precious-metals sectors, which thrive in expansionist periods, and he's spotted bargains in consumer-related industries such as health-care products and medical devices; one of Strategic Growth's top holdings is Johnson & Johnson.

"A lot of those [consumer] names in my view got too far depressed," Hussman said. He also sees value in technology stocks, and at the end of June Strategic Growth had meaningful stakes in Amazon.com and Research in Motion Ltd.

Steve Leuthold: 'Pretty positive' Steve Leuthold has been called a "superbear" for his extreme pessimism about stocks during the bull run of 1998, and more recently a year ago when stock exposure in flagship funds such as Leuthold Core Investment Fund and sibling Asset Allocation Fund barely scraped 30%.

Leuthold is a colorful figure, offering targeted portfolios with catchy names like the bear-market Grizzly Short Fund and the bottom-fishing Undervalued and Unloved Fund. But Leuthold is straightforward about stock research, and he goes where it tells him. So he didn't balk a couple of weeks ago when the signs all said "buy."

Now Leuthold's allocation-driven portfolios are covering short positions and other hedges and moving from a neutral, 50-50 equity/bond allocation toward 60% stocks -- nearing their 70% maximum threshold. "Our whole office is surprised," Leuthold said in an interview "This is quite a departure for us. I don't believe I've ever seen such a dynamic change, going from mildly negative through neutral to pretty positive."

Like Hussman, Leuthold is convinced that the U.S. economy is in recession. But he points out that the stock market typically bottoms around the midpoint of the downturn. By his reckoning, the economy entered recession toward the end of 2007, and the extensive valuation criteria he uses tell him there's now light at the end of the tunnel.

"The bottom has been made," Leuthold said. "The economy is going to start showing some positive signs sometime in the first half of 2009." So he's getting in early, loading up on shares of biotechnology and alternative-energy companies in particular, and keeping a modest amount in oil drillers and natural gas producers.

Enthusiastic stock buying sets Leuthold apart, but it's in keeping with his iconoclastic ways. "I guess I still am a contrarian," he said. "He's definitely not your standard money-management personality," added Greg Carlson, a Morningstar fund analyst. "His approach is quite different from the norm. It's his willingness to be bearish that sets him apart."

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Banks seek preferential treatment for their Fannie, Freddie preferred

Bankers have started to lobby the Treasury Department to go easy on their Fannie Mae and Freddie Mac preferred stock. But do they have a prayer?

Both the Financial Services Roundtable and the American Bankers Association today confirmed that they have asked the Treasury to consider the damage to banks’ preferred shares in the government-sponsored enterprises if Fannie and Freddie are nationalized. By some estimates, banking companies own up to half of the roughly $36 billion in Fannie and Freddie preferred equity outstanding.

Christopher Whalen, co-founder of Institutional Risk Analytics, a unit of Lord Whalen, said on Friday that it’s unlikely the government will take pity on banks. He added that officials at Treasury should just get it over with. “I don’t know how we can play favorites,” Mr. Whalen said. “If you wipe out the common, I just don’t know even legally how a conservator would be able to spare the preferred.”

And given the capital squeeze, “you could make the argument that the corporate debt ought to take a haircut as well,” he said. But one value investor, who holds Fannie and Freddie shares, believes Mr. Whalen is being premature, even alarmist.

“This is all conjecture,” said David Dreman, chairman of Dreman Value Management. “It’s almost like Alice in Wonderland. There’s been no discussion of a bailout at this point that we know of.” Mr. Whalen is hoping such a discussion will take place—and soon. In fact, he was disappointed Treasury officials didn’t hold a press conference today to announce nationalization of Fannie and Freddie.

“If we don’t take this off the table, and let spreads on these agencies fall back to where they belong, then the whole Treasury market is going to be disrupted,” he said. “We’ve got plenty of other things to do. We have to be able to fund the FDIC".

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Fannie and Freddie doubts grow

Shares in Fannie Mae and Freddie Mac fell on Friday amid concerns foreign investors were reassessing their exposure to the troubled US mortgage financiers’ bonds and guaranteed securities.

Bank of China this week revealed it had cut its portfolio of securities issued or guaranteed by the two government-sponsored enterprises by a quarter, or $4.6bn, since the end of June. The sale underscored signs of nervousness among foreign buyers of Fannie and Freddie’s debt.

Shares in Freddie Mac were 12.9 per cent lower in morning trade on Friday while Fannie Mae fell 11.9 per cent, halting a strong recovery for the companies’ stocks. Federal Reserve custody data on Thursday showed foreign official and private investors reduced their holdings of agency debt for the sixth consecutive week.

Bill O’Donnell, analyst at UBS said: “If this recent theme of cooling passions for GSE’s debt becomes a longer-term trend, then it could be problematic for the GSEs given that the central banks have taken . . . roughly 30 to 60 per cent of new GSE issuance in recent months and years.”

Foreign investors have been a mainstay of the market for agency debt in recent years but uncertainty over the mortgage financiers’ capital potisions and the timing and structure of a potential government rescue has made some investors re-evaluate their positions. Asian investors in particular have become net sellers of agency debt in recent weeks, said analysts.

The US Treasury was granted powers last month to extend its credit lines to Fannie and Freddie and to invest in their debt and equity.

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Hedgies pulling the plug on their funds

Running a hedge fund was long considered the crown jewel in finance. But this summer, a growing number of managers have called it quits, unable or unwilling to keep going during one of the industry’s worst-ever years.

Last week Dan Benton, whose savvy technology bets at Pequot Capital Management and Andor Capital Management catapulted him into an industry star, told investors he plans to shut down his fund in October. Earlier this month, business journalist Ron Insana, who promised clients access to some of world’s most famous hedge funds through his extensive Rolodex, told investors that it was “imprudent” to continue business operations.

And before that, Jeff Dobbs announced plans to shut down Turnberry Capital Management after many of his investors had already asked for their money back. “There certainly seems to be a bigger number of hedge fund managers going out of business right now than ever before,” said Brad Alford, founder of Alpha Capital Management, an advisory firm that invests in hedge funds.

While the three men gave different explanations for getting out now, a common theme seems to be that running a hedge fund may not be worth the headache. Tumbling stock prices, the deepening foreclosure crisis, and rising unemployment rates have made for volatile trading conditions that translated into losses at many hedge funds.

The average hedge fund, after posting the industry’s worst-ever first-quarter returns, is off 3.54% this year through July, according to Hedge Fund Research data. While that is less than the average stock mutual fund’s roughly 11% loss during the same time, it is enough to unnerve wealthy investors, who once poured so much money into hedge funds that industry assets doubled in three years.

Hedge fund managers often promised to make money in all markets but several said that shorting stocks, the way to make money in down markets, is becoming more difficult as more investors are trying that strategy. It’s also making it tougher—and costlier—to locate the stocks to short. In turn, funds’ potential for profits are reduced as their bets are no longer a sure thing.

This means the prospect of earning a 20% performance fee on top of a 2% management fee, numbers that lured thousands of traders and portfolio managers into the industry, is in jeopardy. Performance fees are paid for gains, not losses, and this year some individual hedge funds have lost as much as 20%, some investors who saw the data said.

“By my math, some people are taking a pretty big pay cut to be running a hedge fund and who needs that?” said one manager who asked to remain anonymous in order to speak candidly.

Already more global hedge funds have closed their doors in the first quarter of 2008—170 at last count—than during the same time a year earlier, according to data from Hedge Fund Research. And that number is expected to rise for the second quarter when HFR releases the data next month.

“Hedge fund managers are smart people but they need a trend and there just isn’t one right now. That sets the stage for a shakeout in the industry where we will soon see the haves and the have-nots,” Alpha Capital’s Alford said. Making hedge fund managers’ lives even tougher is the fact that raising and keeping capital is becoming harder.

“The fact that investors are quick on the draw to pull capital out makes the management even more difficult in already trying circumstances,” said Ken Miller, who tracks hedge funds as head of due diligence at Greenwich Alternative Investment. Given all of this, it is no wonder that many managers are ready to retire in middle age from managing others’ money.

“People are realizing that life is short and it makes perfect sense for some managers to quit now,” said Mike Hennessy, managing director of investments at Morgan Creek Capital Management, adding “No matter how much energy hedge fund managers have, they are only human.”

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Lehman Has Plan for Real-Estate Loans

Lehman Brothers Holdings Inc., trying to shore up its balance sheet, has settled on a structure that will allow it to offload billions of dollars in real-estate loans from its books.

The Wall Street firm run by Chief Executive Officer Richard Fuld is still hammering out the final details and it isn't clear when a plan will be unveiled. One sticking point: finding financing in this cash-strapped environment for a spinoff or sale of these assets.

In addition to offloading the real-estate assets, Lehman is trying to sell its Neuberger Berman investment-management unit. Ideally, Lehman management would like to announce both transactions at the same time so it can assure investors that it has a bold plan to navigate its way out of the current credit crisis.

For the real-estate assets, Lehman has set up a so-called good bank/bad bank structure. Such a deal is likely to involve a spinoff of the holdings to shareholders as well as an investment by outside investors. Details of the plan weren't clear. One option may be a "sponsored spin."

That would involve bundling some of the troubled assets into a new entity, which would then be spun off to Lehman holders on a tax-free basis. Also, a new investor or group of investors could take a big minority stake in the new company, thus "sponsoring" it.

Lehman, according to one person close to the deal, is expected to provide at least some financing. Lehman was sitting on $40 billion in commercial real estate at the end of the last fiscal quarter and another $24.9 billion in residential assets.

If Lehman goes with this plan, it will differ from the one Merrill Lynch & Co. opted for in August when it sold more than $30 billion in toxic mortgage-related assets at just 22 cents a dollar. That deal was done with just one buyer: private-equity firm Lone Star Funds but Merrill provided financing.

A Lehman announcement will no doubt be a relief to investors who have watched the stock bounce up and down in recent weeks as details of the firm's negotiations for a cash fix have leaked out. Lehman's stock closed at $16.09, up 22 cents, as of 4 p.m. New York Stock Exchange composite trading on Friday.

Lehman stock has fallen 75% this year, and its market value has slipped to $11 billion. Lehman had a second-period loss of $2.8 billion, its first loss since going public in 1994, and analysts predict it will lose more than $2 billion this quarter.

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Why a drop in demand could end Lehman

As my colleague Doug McIntyre posted this morning, the New York Times reports that Lehman Brothers Holdings Inc. plans to cut 1,500 jobs -- that's 6% of its workforce and Lehman has already terminated 6,000 staffers since June 2007.

While Lehman has been a big player in mortgage origination and securitization, there is also the potential for cuts in other lines -- such as investment banking and trading, according to the Times. Since the credit crunch is so enormous in scale and scope, there may simply not be enough demand for Lehman to survive in its current form.

Lehman is expected to have a rough quarter. The Times reports that it could take a "$4 billion loss for the quarter of $3.30 a share." Much of the loss is due to its mortgage- and asset-backed securities -- of which it owns "about $61 billion."

And since there is no market for them, Lehman must write down their value and take a charge against earnings and capital. Meanwhile after dropping 71% in the last year, Lehman's stock market value is roughly a sixth of the size of that portfolio of dodgy securities.

Lehman has evidently leaked several options for raising capital -- to add to the $6 billion it got earlier this year. The Times reports that these include "the sale of Lehman's investment management division, which includes Neuberger Berman and could fetch $7 billion to $10 billion.

Other options include the sale of about $40 billion of troubled commercial real estate, and the creation of a separate unit that would be owned by Lehman shareholders and house a substantial portion of Lehman's commercial and residential mortgage assets, freeing the investment bank to try to move forward."

Beyond the race between its efforts to raise capital and write-off its bad investments, there is the more common problem during economic downturns of a loss in demand for investment banking and trading services. When the demand drops, the company needs to adjust its workforce to the level of demand it anticipates in the medium-term.

Although Wall Street has ended the jobs of 101,000 workers so far, it is likely that the rolls of the unemployed will slowly rise as it dawns on banks that their services are no longer needed. And this lack of demand is the ultimate factor likely to end Lehman as we know it.

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Big jump in gold sale spurs manipulation talk

Recent heat from Congress and regulators, along with public speculation, over whether commodity prices are being manipulated has also reached gold pits, where the debate was stirred by a surge in bets last month that gold prices would fall.

"Congress is already investigating allegations of manipulation in the oil market, and it seems likely that it is only a matter of time before a similar investigation will be required in the precious metal markets," said Mark O'Byrne, executive director at Gold and Silver Investment.

Three unidentified U.S. banks held 86,398 short positions, or bets that gold prices will fall, in the COMEX gold market as of Aug. 5 -- 10 times more short positions than a month earlier, a government report showed. The report by the Commodity Futures Trading Commission, which regulates U.S. futures markets, also showed short positions held by three U.S. banks in silver futures had increased more than four times during the same period.

"The data in the bank participation report is so clear and compelling that it is hard to conclude anything but manipulation," said Theodore Butler, a precious metals analyst, in a note. The sudden jump in short positions coincided with a slide in silver and gold prices, which fell $12.30 an ounce in July and another $89.20 in August, their biggest monthly loss since at least 1984, according to Factset.

Taking a short position, even large amounts, however, doesn't equate to manipulation, which would imply collusion between several big players to influence prices one way or the other. But the fact that three big banks were singled out in the CFTC report is nothing new. The regulator's reports always show the largest three players in futures markets in any given month. "One can take any data and make it suit their argument," said Jon Nadler, senior analyst at Kitco Bullion Dealers.

"The theory that the market is somehow sinisterly manipulated, especially as it comes at a time when U.S. regulators are keeping a keen eye on the goings-on in the commodities and financial markets for just such type of evidence, is simply ludicrous and totally out of touch with market reality."

The talk of manipulation in metals markets follows similar allegations that crude oil and agricultural commodities prices were bid up by speculators, and were not the result of fundamental demand and supply situations. As oil surged this year and almost reached $150 a barrel in early July, while food prices also kept on rising, cries grew louder in Congress that something had to be done.

The CFTC took steps to stamp out "excessive speculation" in the oil markets, while Congress also held numerous hearings and investigations into other futures market. In July, the CFTC charged Dutch company Optiver Holding BV with manipulation of crude oil and of other energy futures. In at least five out of 19 attempts, the defendants successfully manipulated certain energy futures contracts, causing artificial prices, the CFTC alleged.

Some analysts say the surge in oil and gasoline prices earlier this year caused many worries in Washington, where all eyes were already turned toward the presidential elections in November. "My gut feeling is that the Republicans wouldn't mind taking oil back down under $100 before the elections," said Paul Mendelsohn, chief investment strategist at Windham Financial Services.

Mendelsohn said he believes the government has tried to make the U.S. economy, oil, and markets appear in better shape and also to temporarily curb the immediate effects of the slumping housing market, of bad home loans and of the credit crisis. In July, the Securities and Exchange Commission, the stock market regulator, limited so-called "naked" short selling of shares in Fannie Mae, Freddie Mac and 17 other financial firms.

The measure temporarily halted some financial stocks from falling further. But when the rule expired earlier this month, most stocks covered by the moratorium started dropping again. Jeffrey Saut, market strategist at Raymond James, also believes that the commodities bull run may have run out of steam, even if only temporarily, because of the upcoming elections.

"There is a lot of nervousness, especially in energy pits, about the efforts underway to propose wrong-footed legislation from politicians who want to bring down the price of gasoline," said Jeffrey Saut, market strategist at Raymond James. "I don't believe we have a speculative bubble, but these moves are going to drive a lot of hot money out of commodities pits between now and the elections," he told MarketWatch back in July.

Many analysts also point to fundamental factors that helped bring down prices in commodities over the past month and a half.
"There is indeed a rational explanation for the decline in the price of gold and silver: the dollar has staged one huge rally, and fundamentals suggested the dollar should rally," wrote Mike Shedlock, an investment advisor at Sitka Pacific Capital Management, in an online blog post on Wednesday.

Dollar-denominated commodities, such as gold and crude oil, tend to fall when the dollar rises, as the commodities become more expensive to purchase for holders of other currencies. The dollar has rallied against the euro and the British pound as European economies showing increasing signs of slowing down. A slump in the dollar in the first half of this year, as the credit crisis flared up and the U.S. economy slumped, had helped push gold and silver prices to historic highs.

As for the banks involved in the recent short selling of gold, they are only market makers, taking orders from large money players, such as hedge funds, said Jeffery Christian, founder of commodities research firm CPM Group. Banks "stand to buy or sell the commodities, taking the other side from other people or institutions entering a market," said Christian. Gold and silver prices slumped recently "because investors, particularly short-term, technically-oriented funds, were selling."

Short-term funds tend to use over-the-counter channels to trade gold and silver and their positions were therefore not recorded by the CFTC. "What you have here is the footprints of hedge funds exiting the commodities markets en masse," said Kitco's Nadler.

Banks, playing as a market maker to buy contracts from funds, hedge their risks by doing opposite trading in the futures market: They sell, or short, gold and silver contracts in the futures markets. That explains the recent jump in banks' short positions, said Christian. "Banks are the passive agents usually in markets," Christian added. "They make the markets, and take what is coming at them."

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Get Real about Real Estate

Once again, real estate market watchers have pounced on a shred of seemingly positive news to proclaim that the long sought “bottom” is in sight.

The routine is becoming extremely stale, but somehow the media never seems to tire of it. This time the “good” news was that the percentage declines in national home prices (according to Case Shiller) in July where not as large as they were in June. Although the report contained many other negative data points, including increased inventories and a spike in foreclosure sales, it was the slowing declines that got spotlight.

Talk about grasping at straws. The truth is that real estate has been grossly overvalued for years, and the adjustment process back to realistic pricing has only just begun. The problem is few among us seem to appreciate the magnitude of this adjustment and its implication for an economy dependant on inflated assets values.

By most accounts, the decade long housing boom began in 1996 and finally went poof in mid-2006. In January 1996, the Case Shiller 10 city composite home price index stood at 76. By June 2006 it had tripled to 226, by far the largest increase in U.S. history. Since then, the index has pulled back by 20% to 180.

For those who believed that home prices could never retreat nationally, this 20% correction is more than enough. In reality, it’s just the down payment.

When real estate prices were expected to rise in perpetuity, the price of a house had two components, one representing shelter and the other investment. The shelter component was the actual utility and desirability of the house and the investment component was the expected future appreciation.

My guess is that at the peak of the real estate mania, a $500,000 house might have been comprised of $250,000 for the shelter component and $250,000 for the investment component. In effect, the appreciation potential, and the ability of the homeowner to tap into it though refinancing and home equity loans, offset the real costs of home ownership, such as mortgage payments, taxes, insurance, and maintenance.

So the main reason a buyer would commit to a mortgage that would soak up 50% of his disposable income was that he expected to recover most of that outlay through future appreciation. Absent the expectation of that windfall, buyers would not have been willing to pay such staggering prices for houses or commit to burdensome mortgage payments.

Lenders were caught in the same delusion. Since they too believed prices could only rise, lending standards were thrown out the window. If the collateral (the house) were to always rise in value, what difference would it make if the buyer made the payments? In effect, instead of relying on the borrower’s ability to pay to mitigate its risk, lenders merely relied on the house’s ability to appreciate.

However, now that real estate prices are falling, lenders are beginning to rely solely on the borrower’s ability to pay. As this trend continues, lending standards will tighten and mortgages will be brought back into line with the incomes of borrowers. In addition, down payments will be larger to reflect the greater likelihood of losses should loans end up in foreclosure. When prices were rising the foreclosure risk was negligible.

However, now that foreclosures are soaring and recovery rates are less than 50 cents on the dollar, those risks are enormous.

So with falling real estate prices, mortgages are much less appealing to both borrowers and lenders. The only solution is for home prices to fall to where they are cheap enough for buyers to afford the mortgage payments (both interest and principal) without relying on appreciation, teaser rates, or negative amortization, and save enough for a down payment that would protect a lender in the event of default.

In addition, the collapse of the mortgage securitization market means houses must be cheap enough for our limited pool of domestic savings to supply the funding, as we will likely lose access to much of the foreign funding that fueled the bubble.

Of course we need to be honest about the winners and losers of this credit crunch. Just because mortgage money becomes scarce and lending standards tighten does not mean people will not be able to buy houses --it simply means they will pay a lot less for them and that fewer new houses will be built. Therefore it is sellers, builders and those holding or insuring existing mortgages who lose, while buyers win big.

That is because despite higher interest rates and larger down payments, they end up borrowing a lot less money. In the end they will become true homeowners rather than indentured servants. If home ownership is truly is the American dream that so many realtors profess, then the ongoing collapse in home prices will be a dream come true.

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Ilargi: For fear of fast escalating repitition, once the first one has been done, there must be a lot pressure to avoid Jefferson County’s bankruptcy.

Reprieve for a County Near Bankruptcy

Jefferson County in Alabama and its lenders pulled back from the brink of a threatened bankruptcy filing on Friday after the county proposed restructuring $3.2 billion of sewer debt.

Gov. Bob Riley of Alabama, who this week entered the months of talks, said in a statement that the county, which is home to the state’s largest city, Birmingham, would be presented with a standstill agreement against default through Sept. 30 and that negotiations with lenders would restart next week.

A current standstill, or forbearance, agreement had been scheduled to expire on Friday and would have initiated a bankruptcy filing. “The county presented a proposal that provides for a restructure of the existing bond debt at lower, fixed interest rates over a longer term,” Mr. Riley said. “Creditors received the proposal and agreed to respond next week.”

The immediate issue among bond holders, insurers and the county turns on about $850 million of notes with interest rates that reset periodically and that defaulted earlier this year. The notes are held by banks, including the Bank of America and JPMorgan Chase.

There is also about $2 billion of Jefferson County auction-rate sewer debt outstanding, with the rest of the $3.2 billion comprised of fixed-rate debt, according to Standard & Poor’s.

Jefferson County originally sold the debt to pay for upgrades to its sewer system, and its debt crisis began in early 2008 with ratings downgrades of municipal bonds insurers. Those ratings cuts throttled auction-rate markets and drastically increased the interest costs for Jefferson County and many other issuers of auction-rate securities.

The interest on auction-rate debt resets through periodic auctions, typically held every seven, 28 or 35 days. That market seized up in February after Wall Street brokerage firms stopped supporting the debt, and investors demanded much higher interest rates from debt issuers.

A bankruptcy filing by Jefferson County over its sewer debt would be the biggest by a local government since Orange County, California, filed for protection in December 1994. Such a filing, a rarity by a local government, would also make Jefferson County the latest casualty of the global credit crisis, hit by its exposure to the auction-rate securities market.

Mr. Riley said in his terse written statement that, “The tone of the meeting was positive and constructive, and I remain willing to facilitate further progress towards a solution.”

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Agency Mortgage-Bond Yield Spreads Reach Lowest in a Month

Yields on agency mortgage securities touched the lowest in a month relative to U.S. Treasuries after buyers took advantage of some of the widest spreads since 1986.

The difference between yields on Fannie Mae's current-coupon 30-year fixed-rate bonds and 10-year government notes narrowed 6 basis points this week to 200 basis points, data compiled by Bloomberg show, reducing the cost of new home loans. The spread fell from 215 basis points on Aug. 18, the widest since a 22-year high of 238 in March.

Spreads widened in July and early August amid concern that financial companies led by Fannie and smaller competitor Freddie Mac may cut holdings as capital-depleting losses continue. Asian investors reduced purchases as Fannie and Freddie's slumping shares sparked concern that the U.S. government will need to step in to ensure the quality of the securities.

"Mortgages had gotten extremely cheap, so even if Fannie and Freddie are capital-constrained and might not be as aggressive, other leveraged accounts can put on the same trade that they might have," said Gary Cloud, who oversees $500 million in fixed-income securities at Financial Counselors Inc. in Kansas City, Missouri.

Spreads on agency mortgage bonds, a $4.5 trillion market guaranteed by federal agency Ginnie Mae or Fannie and Freddie, set their lowest close since July 31 yesterday, and fell lower earlier today before widening. Last month, U.S. Treasury Secretary Henry Paulson forged a rescue package for the government-chartered companies, which reported $14.9 billion in net losses in the past four quarters as loan delinquencies rose. Narrowing mortgage-bond spreads suggest that Paulson may see less of a need to intervene.

"If I'm Paulson, I'm looking at spreads," Gary Gordon, an analyst at New York-based Portales Partners LLC, said in an interview. The Treasury may decide to buy the securities itself or take other actions to lower mortgage rates rather than make capital injections to Fannie and Freddie if officials believed spreads were too wide, he said.

Fannie fell $1.11, or 14 percent, to $6.84 in New York Stock Exchange composite trading today, after rising six straight days. Freddie fell 73 cents to $4.55, following a four- day increase. The rallies had reduced concern that Washington- based Fannie and McLean, Virginia-based Freddie need a bailout. The difference between yields on Ginnie and Fannie securities fell to 24 basis points from 30 basis points on Aug. 20.

Returns on fixed-rate agency mortgage bonds compared with those of Treasuries with maturities similar to their expected lives turned positive yesterday for August, at 14 basis points, Lehman Brothers Holdings Inc. index data show. The debt underperformed government notes by 111 basis points in June and July. A basis point is 0.01 percentage point.

Spreads may also be rallying as slowing growth in outstanding securities helps offset any drop in demand, said Cloud, who helps manage the AFBA 5 Star Balanced Fund. The Federal Reserve's holdings for foreign official and international accounts of agency mortgage bonds and agency debt, such as Fannie and Freddie's corporate bonds, fell to $970.5 billion in the week ended Aug. 27, down 1.4 percent from a record high on July 16.

Bank of China Ltd., the nation's third-largest bank, said in an earnings report that it pared its holdings of mortgage bonds guaranteed by Fannie and Freddie by 22 percent to $5.17 billion between June 30 and Aug. 25.

Bloomberg current-coupon indexes represent the average of yields for the two groups of mortgage bonds with prices just above and below face value, the ones lenders typically package new loans into. The spread helps determine the rates offered to homeowners on new prime mortgages of $417,000 or less in most areas, and up to $729,500 in high-cost counties.

On an option-adjusted spread basis against interest-rate swaps, another common benchmark, with maturities similar to their expected lives, Fannie's securities have fallen 21 basis points from an Aug. 15 level near the highest on record to 62 basis points, according to data complied by Bloomberg. The spread against Treasuries yesterday was near the lowest since July 30 at 145 basis points, according to Lehman data.

An option-adjusted spread takes into account the inability to predict when the underlying mortgages will be refinanced or otherwise paid off. Simple yield spreads against benchmarks of a single maturity also fail to reflect that borrowers' principal is paid down both sooner and later than the average lives of the debt. A swap rate is the fixed yield paid in return for floating payments linked to short-term bank borrowing costs.

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Ilargi: Any day now, the Wall Street Journal will announce the Hank Paulson fanclub.

The Fannie & Freddie Question

In Henry M. Paulson's first month as Treasury secretary, two deputies flagged Fannie Mae and Freddie Mac as significant risks to the economy. He didn't share their level of concern.

When he was at Goldman Sachs, he told the aides, the mortgage giants weren't on the list of things that kept him up at night. Two years later, they're at the top of his list. Mr. Paulson is embroiled in emergency planning on ways to shore up the companies to avert a destabilizing jolt to the U.S. economy and the world's financial system.

Central bankers, Wall Streeters and members of Congress are waiting for what Mr. Paulson might do. He initially said he had no plans to use his authority -- won from Congress in July -- to inject funds into Fannie and Freddie. But he is meeting daily with his domestic finance staff as they hash out how to intervene if necessary. Scenarios range from buying preferred shares in the companies to various structures for lending.

Mr. Paulson is weighing whether to treat both mortgage companies equally, whether to leave management in place, and the effect on common and preferred shareholders, which include many pension funds. Among the concerns he's wrestling with: A large capital injection would essentially amount to a federal takeover of the companies, including responsibility for guaranteeing trillions of dollars worth of home mortgages.

Mr. Paulson didn't come to the Treasury to be an interventionist. He is a Wall Street pragmatist, a former deal maker whose focus isn't on ideology but on practical fixes and getting things done. It's a measure of the depth of the credit crisis that after joining a laissez-faire Republican administration, Mr. Paulson has helped engineer a transformation of the relationship between the federal government and financial markets.

In March, he joined Federal Reserve Chairman Ben Bernanke in forcing Bear Stearns Cos. into the hands of J.P. Morgan Chase & Co. Earlier, Mr. Paulson jawboned lenders into freezing interest rates for some stressed home buyers. His Treasury also took greater responsibility for financing student loans, and he has called for sweeping regulatory changes to give the Fed more power to police banks and Wall Street.

Fannie and Freddie are his biggest test. The companies are crucial to the housing market, owning or guaranteeing nearly half of U.S. mortgages outstanding -- some $5.2 trillion -- and buying most of the new ones being made. A federal intervention in these giants would be one of the largest and most complex in history.

Fannie and Freddie have said they exceed their regulatory capital requirements and don't need help from Treasury. While Mr. Paulson has authority to invest or take an equity stake in the firms, the companies would have to agree to either move.

Mr. Paulson's request for this authority in mid-July was meant to calm the financial markets. But some suggest it further exacerbated problems at Fannie and Freddie, by making investors unsure what the Treasury might do and how this would affect their investments.

Some say the uncertainty is complicating the companies' already-difficult task of raising capital by selling common or preferred shares, though they continue to be able to fund themselves through the debt markets.

Mr. Paulson's efforts have drawn the ire of some fellow Republicans, including some in the White House. They say federal backstops only encourage the private sector to repeat its mistakes, and they lament the potential cost of bailouts to taxpayers.

"Wall Street has always had a tendency to seek government help when it benefited them," says Rep. Spencer Bachus, an Alabama Republican. "The whole philosophy of 'the government doesn't need to be in the markets' seems to change when companies start losing money."

Mr. Paulson says he sought authority to aid Fannie and Freddie to stabilize markets, "not because of wanting any favors for anyone on Wall Street." He adds: "This was not an easy thing to do emotionally. It's not something I came to Washington wanting to do."

Mr. Paulson, 62, arrived in July 2006 eager to tackle issues like Social Security, finishing global trade talks and pressing China to modify certain economic policies. He had spent 32 years on Wall Street, most recently as chief executive of Goldman Sachs Group Inc., where he was known as an aggressive deal maker. With a fortune estimated at $500 million, Mr. Paulson isn't ostentatious or even especially polished. He can stammer at times, or absent-mindedly rub his belly or head while talking.

His style is to dive into data and details. Just hours after issuing marching orders, he may phone to check on progress. In the Bush administration, his aggressive approach quickly earned him a reputation and a nickname, "Hurricane Hank."

But he wanted no part of a long-running argument over Fannie and Freddie. Critics said they were too big, posing a risk to the economy if they failed, and unfairly got to raise money cheaply because of an implied federal guarantee. Administration hard-liners wanted to shrink the pair and toughen regulation, such as by making them raise their relatively low ratios of capital to liabilities. But many in Congress, beneficiaries of the companies' lavish campaign giving, favored a softer approach.

Mr. Paulson wasn't happy to be dragged into what he called this "holy war." In September 2006, an assistant Treasury secretary told reporters the department was considering ways to rein in Fannie and Freddie if Congress didn't. Massachusetts Rep. Barney Frank called to blast Mr. Paulson, saying the statement jeopardized progress Congress had made on the issue.

Mr. Paulson ordered his deputies into his office and began furiously stamping on a marble coffee table, according to several people who were in the room. He yelled that he needed to establish a good relationship with Mr. Frank, then ranking Democrat (and now chairman) at the House Financial Services Committee.

In subsequent months, Mr. Paulson got the White House to drop its demands for shrinking the companies and focus on toughening oversight, a step he agreed was needed. In mid-2007, with defaults up and the market for mortgage securities faltering, Mr. Paulson's concerns about housing grew.

He asked Robert Steel, then a Treasury undersecretary (and now Wachovia Corp.'s CEO), to canvass experts. Among those called was Lewis Ranieri, who years ago helped pioneer the repackaging of home loans into securities. Treasury officials gathered around a speakerphone as Mr. Ranieri told them the mortgage situation was "a bit more troubling" than most people realized, says a person familiar with the call.

Mr. Paulson began convening Sunday sessions at his home to focus on housing. As he sat on a couch, often nursing a Diet Coke, staff members arrayed in a semicircle on high-back chairs pitched ideas. They told him there were no easy public-policy options -- that the private sector needed to help financially stressed home buyers.

After Labor Day 2007, Mr. Paulson had his staff get officials of the biggest mortgage players in for meetings. At sessions with lenders, mortgage servicers and nonprofits that counsel troubled borrowers, Mr. Paulson said that foreclosure was in nobody's interest, and industry coordination was vital.

Within weeks, he had his senior adviser, Neel Kashkari, now an assistant secretary, inform companies in the mortgage industry he wanted them to form an alliance to work case-by-case with stressed homeowners. On Oct. 10, the Treasury unveiled the alliance, called Hope Now.

In November, with the number of borrowers behind on their payments rising, Mr. Paulson shifted gears. At the Treasury's urging, companies in the alliance agreed to freeze interest rates temporarily on certain troubled loans. Mr. Paulson demanded monthly updates on foreclosures prevented and loans modified. Some of what he wanted wasn't available, irritating him. He wanted company-specific data, but companies demanded the data be lumped together because they were rivals.

At times, told that a company was rumored to be shirking, Mr. Paulson demanded that an assistant get its CEO on the phone. Staff members persuaded him not to make such calls, arguing that doing so could fracture Hope Now.
Mr. Paulson attended housing town-hall meetings around the country, where he often heard from people fearing for their homes.

"Hank came back from that tour and said things are worse than I thought they were," says Rep. Frank. Prices of homes kept sliding, and inventories rising. Investors were shunning securities based on mortgages, having seen some collapse despite top safety ratings.

That made Fannie and Freddie even more important, as places where lenders could still sell loans. Without the two government-sponsored enterprises, lending would dry up. But now, they, like banks that invested in mortgage securities, had started reporting sizable losses. Mr. Paulson began suggesting that Fannie and Freddie raise additional capital.

Any illusions the government wouldn't have to get deeply involved in the credit crisis ended in March when Messrs. Paulson and Bernanke arranged for the takeover of Bear Stearns, fearing the uncertain ways a collapse might ripple through markets. But Mr. Paulson, worried the sale to J.P. Morgan Chase would look like a bailout, insisted on a low sale price so Bear Stearns shareholders wouldn't benefit.

Then in June, as home prices showed new declines, investors whipsawed the stocks of Fannie and Freddie. Mr. Paulson heard from his counterparts abroad and from central banks, big holders of Fannie and Freddie debt, wondering what was going on.

He urged his staff to think through what Treasury could do. While some contingency planning existed, staffers began compiling a firmer list of options, from lending the companies money to nationalizing and then reselling them in pieces. Mr. Paulson rejected the nationalization idea, partly because it would make the U.S. responsible for the companies' $1.6 trillion of debt as well as for all the mortgages they guarantee. It became clear the favored route was lending to them or buying equity in them.

Pressure rose on July 7, when a Lehman Brothers analyst speculated an accounting change could force the mortgage giants to raise tens of billions of dollars of new capital. The stocks went into a freefall. Mr. Paulson believed an accounting change wouldn't change the companies' capital situation, but he saw that confidence in them was waning.

On July 10, he decided to call Alan Greenspan for his view. At first, the Treasury couldn't find the former Fed chief's home number. Once Mr. Paulson got through, he and several of staff members hunched over a speakerphone, struggling to hear Mr. Greenspan's soft voice. They discussed the housing slump's impact on financial firms and whether they had the capital to weather it. (Mr. Greenspan has since said the administration should have recommended the mortgage giants be nationalized, recapitalized, split up and eventually sold to private investors.)

By Friday, July 11, Fannie's and Freddie's stocks were down so much Mr. Paulson decided he must act. "Friday morning it was just clear to me that we didn't want to stress the system, as fragile as it was," he says. At 7:15 a.m. he briefed President George W. Bush. He began calling members of Congress, asking them to approve a request he would soon make to let the government either invest in Fannie and Freddie or greatly expand their line of credit with the Treasury.

That weekend, as staffers worked out details of the proposal, they camped at the Treasury building, eating sandwiches from the Corner Bakery, the only nearby place open. An agitated Mr. Paulson began circling his staff's offices with questions. Would the markets be reassured? Would the proposal be done in time for the opening of Asian financial markets?

He queried staff members so frequently that before long they had nothing new to tell him. Finally, his chief of staff suggested Mr. Paulson return to his office, telling him that "you need to leave us alone so we can do our jobs," according to people familiar with the discussion.

At one point, Mr. Paulson went for a short bike ride to let off steam. As the deadline neared to get the plan in place before Asian markets opened, Mr. Paulson, at his staff's urging, went home to shave and change out of his jeans. At 6 p.m. he appeared on the Treasury's steps, calling for authority that would involve the federal government more deeply than ever before in the nation's financial markets

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Ancient Amazon Actually Highly Urbanized

In 1925 British adventurer Colonel Percy Fawcett disappeared into the wilds of the Amazon, never to be heard from again after going there in search of a lost city he called Z. But decades later, a city of sorts—actually a series of settlements connected by roads—has been found at the headwaters of the Xingu River where Fawcett went missing in an area previously buried beneath the dense foliage in what is now Xingu National Park.

Anthropologist Michael Heckenberger of the University of Florida teamed with the local Kuikuro people in the Brazilian state of Mato Grosso to uncover 28 towns, villages and hamlets that may have supported as many as 50,000 people within roughly 7,700 square miles (20,000 square kilometers) of forest—an area slightly smaller than New Jersey. The larger towns boasted defensive ditches 10 feet (three meters) deep and 33 feet (10 meters) wide backed by a wooden palisade as well as large plazas, some reaching 490 feet (150 meters) across.

The remains of houses and ceramic cooking utensils show that humans occupied these cities for around 1,000 years, from roughly 1,500 years to as recently as 400 years ago. Satellite pictures reveal that during that time, the inhabitants carved roads through the jungle; all plaza villages had a major road that ran northeast to southwest along the summer solstice axis and linked to other settlements as much as three miles (five kilometers) away. There were bridges on some of the roads and others had canoe canals running alongside them.

The remains of the settlements also hint at surrounding large fields of manioc, or cassava (a starchy root that is still a staple part of the Brazilian diet) as well as the earthen dams and artificial ponds of fish farming, still practiced by people who may be the present-day descendants of the Kuikuro. Although such "garden cities," as Heckenberger describes them in Science, do not match the dense urbanism of contemporary Brazilian metropolises such as Rio de Janeiro or São Paulo, they do blend seamlessly into the jungle and maximize use of limited natural resources. They also suggest that the rainforest bears the marks of intense human habitation, rather than being pristine.

But, ultimately, these cities died; most likely a victim of the diseases brought by European explorers in the early 16th century, according to Heckenberger. Two thirds or more of the original human inhabitants of Brazil are believed to have been killed by such disease, and the forest quickly swallowed the cities they left behind.

As a result, later European explorers had no idea that a civilization had once flourished in the Amazon, despite clues in kilometer-long earthworks and unusually fertile so-called terra preta (dark) soil. The 500 or so Kuikuro may have known of their ancestors' exploits—and they may have drawn the attention of Fawcett and other explorers—but only now can the "lost cities" of the Amazon claim to have been found.

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