Tuesday, September 16, 2008

Debt Rattle, September 16 2008: Feeding the Fear

W.L. Drummond Germany Surrenders 1918
Celebration on Wall Street upon the news of Germany's surrender in World War I.

Update 8.30 PM EDT Ilargi: The situation gets truly serious now. Every main politician in Washington is involved, many of whom have no idea what they're talking about. The reason they're there, to put it bluntly, is that legal lines are being re-drawn, and Bernanke, Paulson and Wall Street need permission to break -additional- laws.

The federal government has no authority to put AIG into conservatorship. Therefore, other ways and means have to be found.

The US government is as of this evening in official panic mode. Not that they will admit to it, just watch for their statements later tonight. The gravity of the issue is perhaps best illustrated by the fact that the politicians' staff members were ordered out of the meeting. That staff, of course, ironically (or should we say cynically) form the one and only barrier between their leaders and utter ignorance on what is happening.

I understand the deal's been done. Here's the Fed statement.

What this means is the start of what you might call finance anarchy. The US government has lost control, that much is clear to everyone now, or at least those who've been paying attention. As I've said, the companies will now be picked off one by one through shorting and swapping. The free market reaches its self-chosen and inevitable climax.

AIG has liabilities that run into the hundreds of billions of dollars, if not thousands. The vultures know this, make no mistake about it. So an $85 billion rescue is but a joke. It won't lift nothing for more than a few hours, probably not even long enough to last till the Dow opens tomorrow.

There is blood in the water, and it's feeding time.

Fed Readies A.I.G. Loan of $85 Billion for an 80% Stake
In an extraordinary turn, the Federal Reserve was close to a deal Tuesday night to take a nearly 80 percent stake in the troubled giant insurance company, the American International Group, in exchange for an $85 billion loan, according to people briefed on the negotiations.

All of A.I.G.’s assets would be pledged to secure the loan, these people said, and in return, the Fed would receive warrants that could be exchanged for an ownership stake. Stock of existing shareholders would be diluted, but not wiped out. A person briefed on the matter said the agreement does not require shareholder approval.

If the Fed takes a controlling stake, it is likely that it would want to replace A.I.G.’s board as well as its chief executive and chairman, Robert B. Willumstad. The Fed’s action came after Treasury Secretary Henry M. Paulson and Ben S. Bernanke, president of the Federal Reserve, went to Capitol Hill on Tuesday night to meet with House and Senate leaders.

Mr. Paulson called the Senate majority leader, Harry Reid, Democrat of Nevada, about 5 p.m. and asked for a meeting in the Senate leader’s office, which began about 6:30 p.m. The Federal Reserve and Goldman Sachs and JPMorgan Chase had been trying to arrange a $75 billion loan for A.I.G. to stave off the financial crisis caused by complex debt securities and credit default swaps.

The Federal Reserve stepped in after it became clear Tuesday afternoon that the banking consortium could not complete the deal in time. Without the help, A.I.G. was expected to be forced to file for bankruptcy protection.

The need for the loans became necessary after the major credit ratings agencies downgraded A.I.G. late Monday, a move that likely to have forced the company to turn over billions of dollars in collateral to its derivatives trading partners worsening its financial health.

Until this week, it would have been unthinkable for the Federal Reserve to bail out an insurance company, and A.I.G.’s request for help from the Fed of just a few days ago was rebuffed. But with the prospect of a giant bankruptcy looming — one with unpredictable consequences for the world financial system — the Fed abandoned precedent and agreed to let the money flow.

Attending the meeting on the Capitol Hill were Democratic Senate leaders that included Charles E. Schumer of New York, Richard J. Durbin of Illinois, Christopher J. Dodd of Connecticut and Kent Conrad of North Dakota A contingent of Republicans was led by Mitch McConnell of Kentucky, the minority leader, and included Richard C. Shelby of Alabama, Jon Kyl of Arizona and Judd Gregg of New Hampshire.

House leaders included John Boehner of Ohio, the Republican leader; Spencer Bachus, Republican of Alabama; and Barney Frank, Democrat of Massachusetts. Members of the leaders’ staffs were asked to leave the meeting shortly after it began.

Ilargi: At the Automatic Earth, two principles have always been unshakable and unmoveable.

The first is that all the virtual money, the casino toilet paper, created in the past two decades through the introduction of the "innovative and creative" financial -debt- instruments so lauded by the capo di tutti capi, Alan Greenspan, will have to disappear, never to be seen again.

The second is that this will lead to the mother-fcuker of all deflations. The only possible outcome left in its wake will be individual and societal debt burdens so high that the Great Depression and the wars it engendered will seem and feel like a sun-drenched dreamy all-the-icecream-you-can-eat kindergarten birthday bash in Disneyland.

That is what we have been talking about all this time and that is what we are looking at now.

In the wake of the most recent corporate failures, central banks pump $100’s of billions "into the markets", but, as before, they never reach those markets. They instead get sucked up by doomed financial institutions, who sit their black hole-shaped debt-ridden fat asses right down on top of them. Yesterday it was yours, today it no longer is. And you are none the wiser.

Overnight, money market rates doubled, which is a loaded gun because credit derivatives are directly impacted. The only response central banks have is to pump yet more liquidity into those same fat asses. Yesterday it was yours etc etc. All the pumping has one effect only: it prolongs the suffering, without solving a thing. And you get to pay the tab.

In my list of institutions at risk, I have over the past two weeks left out Citigroup. Not because think they’re doing so well, but at a certain point you need to focus on the most immediate threats, or else the list gets endless. As I said yesterday, there are no safe banks left in the world.

Now Meredith Whitney starts warning on Citi (again). Whitney is the expert on Citi, with a whole slew of correct -dire- predictions to her name, she’s sort of Citi’s best enemy. She doesn’t give a timeline for Citi’s problems, but in the present climate if we've learned one thing, of course, it’s that things can happen very fast.

And that makes me think that my prediction last week -even though it proved to be bang-on- that Wall Street would never look the same after the past weekend, may need some tweaking, or rather: expansion.

If Citi now joins the list of Lehman, Merrill Lynch, WaMu and AIG, it won’t just be Wall Street that has forever changed. If Citi falls as well as the others, Main Street will never look the same again.

The expectation is that the Fed will cut interest rates this afternoon, to 1.75%. That’s why stocks are doing so nicely right now. While it will lift markets somewhat, it’s an insane policy. It will de facto mean that banks get paid -even more- for borrowing money.

With overall price increases (often erroneously called inflation) well over 2%, it’s cheaper to borrow than not to do it. And it’s all the same story all the time: wealth gets taken from you and your children and parked underneath a bunch of fat asses.

Whitney has a few other notions that warrant attention. First, she expresses surprise at what she calls "very high" equity prices; she thinks stocks need to fall much further and harder than they have done so far. If they look kind of good this afternoon after the Fed's rate cut, you might want to remember that.

Second, Meredith revises and sharpens her prediction for US housing prices. Earlier this summer, she stated that a 33% peak to trough drop was so low as to be "mathematically impossible". Now, her prediction is for domestic real estate to fall at rates "well north of 40-45%". While nicely phrased, it means at least another 30% will have to come off. And so Meredith Whitney is inching ever closer to my prediction of a price decrease of 80% or more. It just takes her a bit longer, but she'll get there.

The fears over the horror scenario of potential losses in -credit- derivatives are becoming palpable. Look for a lot more on the topic in the days and weeks to come. Nobody really knows who is exposed to what, and to what extent, but that very uncertainty now starts feeding the fear. For good reasons.

PS: it looks like Morgan Stanley may be under siege.

Meredith Whitney
Meredith Whitney now predicts housing prices will plunge "well north of 40-45%". $3 trillion in credit has been taken out of the markets in the past year. She is surprised stock (equity) markets haven’t fallen much more than they have.

Industry Efforts to Rescue A.I.G. Said to Falter
The prospects of a private market solution to the deterioration of the American International Group appeared to be faltering on Tuesday, as talks involving the Federal Reserve and several banks turned to the possibility of using government money to shore up the ailing insurance giant, people briefed on the negotiations said Tuesday morning.

Fed officials were still meeting with A.I.G., JPMorgan Chase, Goldman Sachs, Morgan Stanley and others at the Federal Reserve Bank of New York Tuesday morning to discuss possible options. It isn’t clear that any solution, including one involving government money, will emerge, this person said. If a financing solution is not reached, A.I.G. may file for bankruptcy as soon as Wednesday, a person briefed on the matter said Monday night.

Gov. David A. Paterson of New York, who recently allowed A.I.G. to borrow $20 billion from its subsidiaries, told CNBC Tuesday morning that the company could survive only one day without the financing. It is possible that the banks are maintaining this argument to prod the Fed into adding money, perhaps in a 50-50 joint effort.

A collapse of A.I.G. might surpass Lehman Brothers’s bankruptcy in terms of its damage to the financial system. In recent years, the company became one of the largest insurers of mortgage-backed securities, intertwining it with major banks around the world. Kenneth Lewis, the chief executive of Bank of America, told CNBC on Monday that virtually every Wall Street giant would be touched by an A.I.G. failure.

Treasury Secretary Henry M. Paulson Jr. has argued that no taxpayer money be used to prop up the insurance giant, a stance he reiterated on Monday. But especially after major ratings agencies downgraded A.I.G.’s debt Monday night, the possibility of a $75 billion credit line financed by the nation’s largest banks appeared dimmer than ever.

Shares in A.I.G. were down 42 percent at $2.79 as of early Tuesday afternoon, and fell more than 60 percent earlier in the day. Most of A.I.G.’s businesses, including a dizzying array of insurance companies, an aircraft leasing business and an automotive unit, are healthy. But its financial products unit in London, which underwrote derivatives insuring mortgage-linked securities, threatens to drain cash faster than temporary financing can be arranged.

The ratings cuts by Standard & Poor’s and Moody’s now allow counterparties in those derivatives contracts to require A.I.G. to post more collateral. According to a regulatory filing made by the company last month, it may need to post at least $10.5 billion in fresh collateral very soon.

The Crime In Buying AIG Time
Let's tie it all together.

New York Gov. David A. Paterson (D) is going to violate regulations and allow AIG to borrow up to $20 billion from its subsidiaries. Timothy Geithner, president of the Federal Reserve Bank of New York approves this transaction. New York state insurance superintendent Eric R. Dinallo claims "At this point the insurance companies are financially strong and solvent and fully able to meet any claims." In the proposed swap-o-rama the spokesman for the superintendent claims "We're not going to allow them to put junk in the place of good stuff." (as if he has any clue).

Here's the Deal If the "insurance companies are financially strong and solvent" why the hell do they need to raise $75 billion in another all night poker game with every rule in the book being broken to do so?

What's At Risk? Life insurance policies, retirement annuities, and those with policy coverage against all manner of calamities, from financial to natural disasters are put at risk just so AIG can make good on a bunch of derivative bets gone bad.

Who Does AIG Owe? This one should be easy to figure out: any bank or brokerage house scrambling like mad trying to "help" AIG raise cash so that it can pay off on its derivatives bets. The state insurance regulator is stupid enough to go along with this arrangement.

Here's a comment from the Kitco Voy Forum made by "MOA". I received this via email while writing this post.
Right now, illegally and with the regulators watching and nodding in agreement as it happens, lot's of bank deposits, life insurance savings and any unencumbered cash held in the system .... i.e. real life savings and earnings .... has suddenly been made available by the weekend rule changes by the Fed and US treasury. They are now being swept into accounts that hold the other side of the derivative trades.

The firewalls against fraud have been torn in expedience "to save the system from itself". The fraud and incompetence is running rife and has just been taken up another notch. There will be nothing left but the empty husk when the locusts and other assorted parasites have finished.

AIG is blowing all the policyholders protections with the assistance of New York insurance superintendent Eric R. Dinallo, Timothy Geithner, president of the Federal Reserve Bank of New York, and David A. Paterson, Governor of New York

Fed Adds $50 Billion to the Banking System; Funds Rate Declines
The Federal Reserve added $50 billion in temporary reserves to the banking system when it arranged overnight repurchase agreements, or repos.

The rate for overnight loans between banks had opened at 3.75 percent, above the Federal Reserve's targetrate, as American International Group Inc.'s credit rating cut increased banks' reluctance to lend. The rate dropped to the central bank's target of 2 percent after the cash injection.

The Fed added $70 billion in reserves to the banking system yesterday, the most since the September 2001 terrorist attacks, to bring borrowing costs down after the bankruptcy of Lehman Brothers Holdings Inc. triggered a hoarding of cash. Funds opened at 3.5 percent yesterday.

"From a pure reserve perspective, the desk might not need to arrange any repos at all today," Wrightson ICAP analysts wrote in a note. "From a dealer-funding perspective, another round of large morning repos may have a calming effect."
Funds traded to as high as 6 percent yesterday, or 4 percentage points above the central bank's target rate for overnight loans between banks, according to ICAP Plc, the world's largest inter-dealer broker. That margin was the greatest at least since Bloomberg began tracking the data in 1998. The rate closed at 0.25 percent yesterday, and reached as low as 0.01 percent.

The Fed will lower its target rate by a quarter percentage point to 1.75 percent, futures trading showed. Contracts on the Chicago Board of Trade put the odds on a cut at 96 percent, compared with 2 percent a week ago. Of the 105 economists surveyed by Bloomberg News, 100 expect the Fed to leave rates unchanged today.

Central banks from Tokyo to Frankfurt injected cash into their financial systems in a bid to calm markets. The European Central Bank awarded 70 billion euros ($99.8 billion) in a one-day money-market auction today. The Bank of Japan added a total of 2.5 trillion yen ($24 billion) and the Bank of England pumped in 20 billion pounds ($36 billion). Counterparts in Australia and Switzerland took similar steps.

Banks' demand for the security of cash rose again after AIG had its credit ratings cut by Standard & Poor's and Moody's Investors Service yesterday, threatening efforts to raise funds to keep the company afloat and roiling global financial markets.

The so-called effective funds rate was 2.93 percent yesterday, according to ICAP. The rate was from 2.1 percent on Sept. 12, according to The Federal Reserve Bank of New York reports daily the official effective funds rate, for the previous trading session. It is a weighted average rate of unsecured overnight lending transactions. A basis point is 0.01 percentage point.

The Fed will also auction $20 billion in 28-day repos for mortgage-backed securities for one-day forward delivery that it has been arranging on Tuesdays. The forward transaction is part of the Fed's so-called Single-Tranche OMO Program. Under the program announced March 7, the Fed agreed to make up to $100 billion available through weekly 28-day repurchase agreements. The Fed has $78 billion in repos maturing today.

In repos, the Fed buys U.S. Treasury, mortgage-backed and so-called agency debt from its 19 primary dealers for a set period, temporarily raising the amount of money available in the banking system. At maturity, the securities are returned to the dealers, and the cash to the Fed. Repos help maintain enough money in the system to keep overnight interest rates close to the central bank's target. They don't signal a policy shift.

Overnight Interest Rate Doubles as Banks Hoard Cash on Failure Speculation
The cost of borrowing in dollars overnight more than doubled to the highest since 2001 as the collapse of Lehman Brothers Holdings Inc. and credit downgrades of American International Group Inc. led banks to hoard cash. The overnight dollar rate soared 3.33 percentage points to 6.44 percent today, its biggest jump in at least seven years, according to the British Bankers' Association. The rate was as low as 2.07 percent in June.

Banks are driving up short-term lending rates on concern that AIG will follow Lehman into bankruptcy and leave financial institutions with losses on $441 billion of credit derivatives issued by the biggest U.S. insurer. Central banks around the world pumped more than $210 billion into the financial system as they sought to alleviate the credit-market seizure.

"It's fear, you don't know who has exposure and who might not be getting their money anymore," said Imke Jersch, a senior money-market trader in Hanover at Norddeutsche Landesbank Girozentrale AG, Germany's fourth-biggest state-owned bank. "It's a domino effect. You never know who might fall next."

The increase underscores how the credit seizure that started in August 2007 with the collapse of the U.S. subprime- mortgage market is worsening, causing more than a dozen U.S. banks to fail. Money-market costs are used to calculate rates on $360 trillion of financial products worldwide from home loans to credit derivatives.

Treasuries, StocksU.S. Treasuries soared, stocks dropped and the cost of default protection on Wall Street banks rose to a record as investors sought the safety of government assets. The yield on the 10-year note dropped to the lowest in five years and the Standard & Poor's 500 Index lost as much as 1.6 percent. Credit- default swaps on Morgan Stanley, Goldman Sachs Group Inc. and Citigroup Inc. all traded at record highs.

The difference between the London interbank offered rate for three-month dollar loans and the overnight indexed swap rate, the Libor-OIS spread that measures the availability of funds in the market, widened 12 basis points to 117 basis points, the most since at least December 2001. That compares with an average of 8 basis points in the 12 months to July 31, 2007, before the credit squeeze started.

The cost of borrowing euros for one week jumped 7 basis points to 4.49 percent today, the highest level since Dec. 24, according to the European Banking Federation. It was the biggest increase since July 3.

The Fed added $50 billion in temporary reserves to the banking system today through overnight repurchase agreements, or repos. The European Central Bank offered 70 billion euros ($100 billion) in a one-day refinancing operation and the Bank of England injected 20 billion pounds ($36 billion). The Bank of Japan added 2.5 trillion yen ($24 billion) and the Reserve Bank of Australia injected A$1.85 billion ($1.5 billion).

Traders raised bets the Fed will cut interest rates at a meeting today. Futures on the Chicago Board of Trade showed a 90 percent chance the central bank will lower its 2 percent target rate by a quarter-percentage point, compared with 68 percent yesterday and no chance a week ago. Policy makers are scheduled to announce their decision at 2:15 p.m. in Washington.

"It's all a mess out there, it's unbelievable, it's very tough," said Padhraic Garvey, head of investment-grade strategy in Amsterdam at ING Bank NV. "There really is no sign of this going away. If the Fed were to cut rates, it's not necessarily going to solve anything."

Financial institutions have posted more than $514 billion in losses and writedowns since the beginning of last year as the U.S. mortgage crisis deepened. Bank of America Corp., the biggest U.S. consumer bank, agreed to acquire Merrill Lynch & Co. yesterday for about $50 billion.

The seizure in the credit markets and increase in short- term borrowing costs this year triggered doubts over the validity of Libor, which is administered by the London-based British Bankers' Association.

Global equity selloff wreaks havoc on money markets
Investors dumped equities, oil and emerging market assets on Tuesday, unleashing a panic rush to secure short-term cash as the financial turmoil escalated a day after Lehman Brothers collapsed.

A global exodus from risky assets extended into a second day after Lehman filed for bankruptcy protection and Bank of America agreed to buy Merrill Lynch on Monday. The low-yielding yen rallied and safe-haven government bonds surged, sending the 30-year U.S. Treasury yield below 4 percent for the first time since the early 1960s.

Acute stress was building up in the interbank money markets, where the cost of borrowing dollars overnight shot up to more than three times the benchmark U.S. interest rate of 2 percent. Liquidity injections from Asian and European central banks, to the tune of billions of dollars, did little to calm investors' nerves in a market where world stocks hit their lowest level since December 2005.

An interest rate decision by the U.S. Federal Reserve tops the day's agenda after investment bank Goldman Sachs reported a 70 percent decline in third quarter profits and concerns grew about the state of American International Group. Interest rate futures fully priced in a chance that the Fed would cut rates to 1.75 percent later, with some analysts talking about a bigger half percentage point reduction.

"The market seems to be fairly convinced ... that the Fed will offer some form of monetary stimulus," said Andre de Silva, global deputy head of bond strategy at HSBC. "The minimum the market is looking for is some sort of response to see whether that helps but the biggest risk now is not only financial market conditions -- we've had this market stress for over a year now -- but (also it) is more about what this translates into in terms of economic risk."

The MSCI main world equity index fell 1.7 percent, its lowest since December 2005, after a 3.6 percent tumble on Monday. In September alone the index has so far lost more than 10 percent of its value and is on track for the worst monthly performance since September 2002. The FTSEurofirst 300 index fell 3.3 percent while Asian stocks fell more than 4 percent.

AIG, thrown a $20 billion lifeline by New York state, came under renewed pressure as ratings agencies downgraded the insurer's debt. U.S. stock futures were down as much as 1.7 percent after Wall Street suffered on Monday its worst performance since markets reopened after the September 11 attacks.

There were signs that the financial crisis is freezing activity in the interbank money market. At one stage overnight dollar deposit rates rose to 11.6 percent, according to Reuters data. In the London interbank market, overnight dollar rates were fixed at 6.4375 percent.

"The banking crisis is not over and we have potentially a difficult few months to get through right to the end of this year," said Padhraic Garvey, head of investment grade strategy at ING. "The issue is that providing liquidity is one obvious solution but the reality is that the banking sector is not going to be happy till they have really sorted out the problem areas out there."

The low-yielding yen extended its steep rise, with the currency hitting a four-month high of 103.62 per dollar. On Monday, the dollar suffered its biggest one-day drop against the yen in nine years. The yen hit a two-year high of 147.19 per euro while the dollar fell against a basket of major currencies. Safe-haven government bonds surged around the world. U.S. 30-year Treasury yields hit 3.9547 percent as prices soared and the December bund future gained 105 ticks.

The broad sell-off in risky emerging assets, already under pressure from slowing global growth, gained new momentum. Emerging sovereign spreads blew out to 410 basis points over U.S. Treasuries, their widest level since October 2004. Emerging stocks fell 4 percent to their lowest since October 2006.

U.S. light crude extended losses, falling 4 percent to $91.81 a barrel as investors extended across-the-board deleveraging, taking oil more than $50 off its record high set in July. Gold fell to $781.00 an ounce.

Bond Risk at Record on AIG's $441 Billion Counterparty Concern
American International Group Inc.'s ratings cut drove the cost of default protection on Wall Street banks to a record on concern that the insurer needs more cash to back $441 billion of credit derivatives.

Credit-default swaps on Morgan Stanley, Goldman Sachs Group Inc., Wachovia Corp. and Citigroup Inc. all traded at record highs as investors sought to hedge against losses on financial companies and to replace hedges they had with Lehman Brothers Holdings Inc., which filed for bankruptcy early yesterday. Contracts on AIG, the biggest U.S. insurer, and Washington Mutual Inc., the biggest U.S. savings and loan, rose further into distressed levels on concern ratings downgrades will cripple the companies.

AIG may have to post as much as $17 billion in collateral after the company was downgraded yesterday, UBS AG analysts said. The biggest U.S. insurer by assets is seeking as much as $75 billion in loans arranged by Goldman Sachs Group Inc. and JPMorgan Chase & Co., after posting $18 billion in losses over the past three quarters, according to two people familiar with the situation.

"If AIG goes under, there could be a domino effect," said Andrea Cicione, a credit strategist at BNP Paribas SA in London. "AIG is very connected to the financial system and it is very connected to the real economy."

Credit-default swaps on the Markit CDX North America Investment Grade Index jumped as much as 25 basis points to a record 220, and was quoted at a mid-price of 216.5 as of 8:41 a.m. in New York, according to broker Phoenix Partners Group.

Buyers of protection on AIG paid a record 49 percent upfront and 5 percent a year, according to Phoenix. It was last quoted at a mid-price of 52 percentage points. The 49 percent trade was up from 33 percent yesterday and means it cost $4.9 million in advance and $500,000 a year to protect $10 million in bonds for five years.

Credit-default swaps, contracts conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements. A rise indicates a deterioration in the perception of credit quality; a decline signals the opposite.

AIG insured $441 billion of fixed-income assets, including $57.8 billion in securities tied to subprime mortgages in the credit-default swaps market. Losses and writedowns triggered by the U.S. housing crisis caused the company's market value to shrink 93 percent since 2006, when it ranked among the world's five biggest financial companies.

Standard & Poor's lowered AIG's long-term counterparty rating three grades to A- from AA-, citing a "combination of reduced flexibility in meeting additional collateral needs and concerns over increasing residential mortgage-related losses." Moody's Investors Service and Fitch Ratings also cut their ratings.

The downgrades will likely result in "more than $17 billion" in collateral calls, UBS analysts led by Andrew Kligerman in New York said in a note to investors today. Credit-default swaps on Morgan Stanley jumped 375 basis points to 850 basis points, according to Phoenix. Contracts on Wachovia, the fourth-biggest U.S. bank, rose 135 basis points to 753, CMA Datavision prices show. Goldman Sachs surged 163 to 513. Citigroup jumped 78 basis points to 358 and JPMorgan Chase & Co. climbed 51 to 246.

Bank of America Corp., which agreed to buy Merrill, the world's biggest brokerage firm, for about $50 billion, increased 47 basis points to 252 basis points. JPMorgan rose 40 basis points to 235 basis points. Citigroup climbed 76 basis points to 356 basis points.

"If AIG spirals in the same way as Lehman, the ramifications will be much more substantial," said Jim Reid, head of fundamental credit strategy at Deutsche Bank AG in London. "The rating downgrades have accelerated the need for an imminent response."

Toss AIG from the Dow! And GM Too!
Lehman Brothers has filed for bankruptcy. And Wall Street is wondering if battered savings and loan Washington Mutual has enough capital to survive the credit crunch. But there's yet another troubled financial that dwarfs Lehman and WaMu that also is in serious danger.

American International Group, the insurance giant, is expected to announce Monday that it will sell its aircraft-leasing arm, International Lease Finance Corp, and possibly its annuities business and auto insurance unit to raise cash. AIG has lost nearly $18.5 billion in the past three quarters - primarily due to a plunge in the value of credit default swaps tied to subprime mortgages. Credit default swaps are contracts designed to protect bondholders from default.

The company's shares have plummeted nearly 93% this year, including a 64% slide Monday. AIG's stock fell more than 30% Friday due to fears about further losses tied to its real estate exposure. Late Friday, ratings agency Standard & Poor's said it may downgrade the company's debt. So even if the only thing you know about AIG is that they advertise a lot of on TV, you should be concerned.

A blowup at AIG could have an even bigger impact on the stock market than Lehman, WaMu and even Fannie Mae and Freddie Mac have already had. That's because AIG is a component of the venerable Dow Jones industrial average.

A further plunge in the value of AIG would threaten to drag the Dow deeper into bear market territory since there is still a long way to go down. AIG, with a current market value of $32.6 billion, is worth nearly five times more than Lehman and WaMu combined. The firm had $110 billion in annual sales last year and employs 116,000 people, 44,000 more than the combined workforces of Lehman and WaMu.

In addition, AIG is a company that more average consumers deal with than Lehman, since the firm has a massive life insurance business and retirement planning unit. With this in mind, it might be time for the editors of The Wall Street Journal, who manage the Dow Jones indexes, to start thinking about replacing AIG in the Dow.

Simply put, the collapse in AIG's stock price is forcing the company to consider downsizing. And the argument for adding AIG to the Dow back in 2004 - along with Verizon and Pfizer - was that it was a diversified insurance and asset management company. If AIG winds up unloading divisions in order to raise cash and avoid a credit ratings downgrade, it will become a much smaller company than it already is.

Now, the editors at the Journal typically do not make rash decisions about removing and adding companies to the industrial average. In addition, it's rare for them to just remove one company at a time. But as I've argued in several previous columns, I also think that it may be time for General Motors.

Analysts expect GM to lose $10.2 billion this year and another $5.1 billion in 2009, and now has a market value of only $7.4 billion, making it by far the smallest Dow component based on this measure. Yes, removing GM would be problematic because it is still the largest auto manufacturer in the country, with sales of $182 billion last year. And there's no likely replacement for GM, since the only relatively healthy car companies are foreign-based firms.

Even though Toyota and Honda, for example, have U.S.-listed stocks, the editors at the Journal have steadfastly maintained that the Dow is an index for U.S.-headquartered companies only. Still, with GM and its fellow Big Three automakers currently begging Congress for $25 billion in loans to help them retool their plants to produce more of the fuel-efficient cars that are now in demand in the wake of high gas prices, does the Dow really need an American car maker anymore?

It's painful and unfortunate to admit this but for the time being, the U.S. auto industry has lost the leadership role in the global market. So it may be time for GM to go and the possible breakup of AIG could be just the catalyst to do it.

Lehman Brothers fall gives money markets a heart attack
Any bank harbouring hopes of an end to the credit crisis had a rude awakening yesterday. Lehman Brothers' bankruptcy was another heart attack for the money markets, incapacitating them for who knows how long this time.

Since the crisis struck last year, the markets have suffered regular seizures but - with careful nursing by governments and central banks - they appeared to be on the slow road to recovery. No longer. Fears about other banks' exposures to Lehman and renewed uncertainty as to where the crisis may strike next will freeze up the wholesale markets yet again. The crisis is back with a vengeance.

It's not hard to see why. Lehman's collapse into bankruptcy protection is the biggest corporate debt default in history; in the complex interwoven world of modern banking, no one properly understands where the risks lie. Wall Street's titans gathered on Sunday afternoon to begin the process of tracking the paths of these impenetrable credit structures. It will take months at the very least for each bank to establish its exact - or "naked", in banking parlance - exposure.

Establishing those positions is vital. Last week, David Wright, deputy head of the European Commission internal market unit, noted that regulators still did not know the full size of global securitised product issuance one year on from the crisis. "We have to believe the numbers," he said. "If we can't, we can't restore confidence."

Without confidence, the wholesale markets will effectively remain closed for funding. As one of the UK money market's largest users with £150bn of obligations due for renewal by June, HBOS's 17?pc share price fall on the London Stock Exchange yesterday appeared to reflect those concerns.

What little confidence the markets had recovered in recent months, Lehman has knocked for six. According to experts, Lehman has $150bn (£84bn) of debt outstanding. By comparison, US telecoms group WorldCom - the largest debt default until today - had $23bn to $30bn (depending on whose calculations you use) when it went bust in 2002.

Lehman bonds and loans that were trading at 80 cents to 90 cents in the dollar last week are now worth little more than 40 cents, according to Deutsche Bank's credit market experts. In other words, about $70bn of Lehman debt held by other institutions has been wiped out. The holders of that debt are facing huge potential losses with untold ramifications of their own.

The scale of the potential crisis has been exacerbated by the credit default swap (CDS) market. CDSs are insurance contracts for holders of corporate debt that guarantee to repay the loan in the event of the company's bankruptcy. Most of these products are offered by investment banks to low-risk institutions such as pension funds. Sandy Chen, banks analyst at Panmure Gordon, reckons this is "where the real stress will come from".

He estimates that the "CDS market as a whole had notional contracts roughly four times greater than the underlying debts issued". By his calculations, which differ slightly to the credit analyst's above, that would make "$350bn in CDSs written on Lehman debts". Even using a more optimistic valuation of 60 cents in the dollar for the value of the debt, he says this could cost the banks providing the insurance $140bn.

By comparison, when the sub-prime crisis struck last year - tipping the markets into seizure - the initial cost was estimated at $200bn, though it has turned out to be multiples more. Furthermore, Lehman's collapse will flood the market with assets for which there are very few buyers - such as the residential and commercial mortgages that triggered the crisis last year.

The banks are already having to write down their positions on a quarterly basis, largely because the value of these assets is declining. With the market now expected to be deluged with such securities, prices will tumble further - necessitating more writedowns.

Central banks know it will be touch and go. Hence the $70bn liquidity pool provided by 10 of the biggest investment banks yesterday for any one of them that needs to tap it. Hence the decision by the US Federal Reserve to widen the set of assets eligible as collateral for Treasury loans to include all investment grade paper, and to almost double the size of these loans to $200bn. Likewise the extra €30bn (£24bn) of liquidity provided by the European Central Bank and £5bn by the Bank of England yesterday.

As CDS contracts are called in and financial counter-parties pull back from the money markets, the same funding crisis that did for Northern Rock and Bear Stearns will rear its head. Analysts at Bernstein Research warned of a "major reduction" in credit-market liquidity, adding: "We would expect commercial bank lenders to pull back from lending to other institutions."

As to the size of the counter-party risk - other banks with complex financial instruments held through Lehman - no analyst or credit market expert could hazard a guess as to the likely cost. Mr Chen said Lehman had $729bn of "notional derivatives contracts" that Lehman believed in May were worth $16.6bn. Again, should that turn into a loss, those will have to be punched into the complex, interlaced banking system to work out where the liabilities ultimately may lie.

The collapse of Lehman may potentially be as costly as the $200bn initial estimate of the US sub-prime mortgage fall-out. Given where that has left the world's banks - in terms of losses, writedowns, capital raisings and share price falls - there's every reason to be worried.

In the worst case scenario, as Alan Greenspan, the former chairman of the Federal Reserve, said over the weekend: "We will see other major firms fail." If they do, the vicious circle will continue. A "second order implication" will hit the banks, as those badly damaged by Lehman themselves start to reel.

Among the gloom, though, there are glimmers of hope. Bank of America's decision to buy Merrill Lynch for $50bn, a 70pc premium to the share price last week, just as Lehman was collapsing shows that the market is willing to manufacture a solution for the right bank.

Moreover, the scale of the losses from Lehman may not be as bad as feared. According to New York investment bank Keefe, Bruyette & Woods: "Lehman's demise has been some time coming, hence counter-parties are likely to have been closely monitoring their net and gross exposures in recent weeks, reducing the risk of disorderly settlement or large counter-party losses at individual banks.

"In essence, while Lehman's bankruptcy has the potential to throw up some nasty surprises, we do not believe the Fed would have let it proceed if it presented a systemic threat." The banks will certainly hope so.

Bank of America to Acquire Merrill as Crisis Deepens
Bank of America Corp., the biggest U.S. consumer bank, agreed to acquire Merrill Lynch & Co. for about $50 billion as the credit crisis claimed another of America's oldest financial companies.

Bank of America will pay $29 a share for New York-based Merrill in stock, 70 percent more than the Sept. 12 closing price, the company said in a statement today. Merrill, battered by $52.2 billion in losses and writedowns from subprime- mortgage-contaminated securities, has plunged more than 80 percent from its peak of $97.53 at the start of last year.

The takeover ends 94 years of independence for Merrill and gives Charlotte, North Carolina-based Bank of America a sales force with 16,690 brokers who manage $1.6 trillion for customers. Merrill, led by Chief Executive Officer John Thain, was in danger of becoming the next subprime casualty after Lehman Brothers Holdings Inc. filed for bankruptcy court protection earlier today.

"If Bank of America can put a fence around the bad assets, that retail distribution is a powerhouse," said Peter Sorrentino, senior portfolio manager at Huntington Asset Advisors in Cincinnati, which oversees $16.5 billion in assets. "The Merrill Lynch combination makes more sense than a Lehman deal."

Merrill is the second bargain picked up this year by Bank of America Chief Executive Officer Kenneth Lewis tied to the collapse of the mortgage markets. The bank bought Countrywide Financial Corp. for $2.5 billion in stock last July to become the nation's biggest home lender. As recently as Sept. 12, Bank of America was considering making a bid for New York-based Lehman.

Bank of America and Merrill said they both have "nominal" exposure to Lehman. Lewis and Thain made the comments on a conference call with analysts and investors. Each Merrill share will be exchanged for 0.8595 shares of Bank of America stock, according to Bank of America's statement. That works out to $29 a share, based on Bank of America's closing price of $33.74 on Sept. 12. Because the payment is in stock, Merrill shareholders would get less if Bank of America's share price falls. The deal is scheduled to close in the first quarter of next year.

Standard & Poor's cut its long-term counterparty credit rating on Bank of America Corp. to AA- from AA and the credit ratings on the holding company were put on CreditWatch with "negative implications." Moody's Investors Service also said it's considering cutting Bank of America's rating. "Acquiring one of the premier wealth management, capital markets, and advisory companies is a great opportunity for our shareholders," Lewis, 61, said in the statement.

"My bet is that Ken Lewis has made a very wise investment," Saturnino Fanlo, CEO of KKR Financial Holdings, said in an interview. "I believe over time it will prove to be a great decision." The Merrill takeover would be the largest in the financial- services industry this year, data compiled by Bloomberg show. It's the fifth-largest transaction since Bank of America bought FleetBoston Financial Corp. in 2003 for about $48 billion in 2003.

The deal would mark the end of Merrill's almost century- long history as an independent company. According to Merrill's Web site, founder Charles Merrill solidified his reputation by advising clients to sell stocks prior to the crash of 1929. The firm went public in 1971 and in 1974 introduced its corporate logo -- a bull that Merrill executives say embodies one of the most recognizable brands in the world.

Merrill's stock returned more than 13 percent a year from 2000 through 2006. Then last year, the housing market began to falter, and investments linked to the subprime mortgage market made under then-CEO Stan O'Neal tumbled in value. The firm posted a loss of more than $2 billion in last year's second quarter, and O'Neal was dismissed in October 2007.

The board replaced him with Thain, 53, a former Goldman Sachs Group Inc. executive who earned the moniker "Mr. Fixit" for his stewardship of the New York Stock Exchange for four years beginning in January 2004. Thain took over Dec. 1.
Lewis has made more than $100 billion of acquisitions since becoming CEO seven years ago, including the purchases of FleetBoston and credit-card issuer MBNA Corp.

"This creates the company that instantly would have taken a decade to build," Lewis said on the conference call.
Wealth Management In Merrill's case, he's buying assets worth more than $40 a share, according to a Sept. 12 Citigroup Inc. analysis. The wealth management unit alone is worth $16 a share, said the report by Prashant Bhatia.

Merrill also owns about half of BlackRock Inc., the New York-based money-management company that had a market value of $24 billion as of Sept. 12. Bank of America employed about 207,000 people at midyear, compared with Merrill Lynch's 61,900. Bank of America will take a restructuring charge of $2 billion for the purchase, executives said on a conference call.

"The fact that the biggest brokerage would be bought by the biggest retail bank is certainly historic," said John Medlin Jr., 74, retired chief executive officer at Wachovia Corp. "Bank of America decided they weren't going to take on the Lehman risk, but they concluded the risk wasn't as severe at Merrill Lynch."

Bank of America paid $3.3 billion in July 2007 for U.S. Trust Corp. to expand its wealth management business. The company had $589 billion in assets under management as of June 30 and its full-service brokerage, Banc of America Investments, employs about 5,600 financial advisers. The wealth management business contributed 14 percent of Bank of America's profit last year.

The bank said today it expects to cut $7 billion of costs by 2012. "B of A is known for making big cuts," said John Challenger at Challenger, Gray & Christmas Inc., the Chicago- based placement firm. "They go in and thin it out," moving some functions to the bank's headquarters, he said. Fusing the two companies' investment banks transforms Bank of America into a bigger player in several of Wall Street's most lucrative businesses, CreditSights Inc. analyst David Hendler said yesterday in a report.

Merrill is the world's sixth-biggest adviser on corporate mergers this year and Bank of America ranks 18th, Bloomberg data show. Together, Bank of America would climb to ninth, according to the statement. Bank of America is the biggest arranger of U.S. loans to companies with junk credit ratings, or those below investment grade. Merrill is the third-biggest stock underwriter.

The Merrill purchase comes less than a year after Lewis, frustrated by proprietary trading losses at his company, said on a conference call, "I've had all the fun I can stand in investment banking" and vowed to scale back the unit.
Lewis said today his opinion has changed. "I like it again," Lewis said on the conference call.

Lewis previously replaced the head of investment banking and eliminated staff, citing slower demand for many capital markets businesses. He promoted former wealth management division leader Brian Moynihan as president of the corporate and investment bank.

Lehman, AIG Trigger Calls for Credit-Derivatives Clearinghouse Amid Chaos
Banks may accelerate efforts to move trading in the $62 trillion credit-default swaps market through a central clearinghouse or to an exchange after the bankruptcy of Lehman Brothers Holdings Inc. and the credit downgrade of American International Group Inc.

Lehman, the first major market-maker to go bankrupt in the decade-long history of the privately negotiated, unregulated business, may leave behind billions of dollars in potential losses for trading partners, according to Barclays Plc of London. No one knows exactly how much because there's no central exchange or system for recording trades.

"The fact that I can't tell you the notional value of derivatives contracts Lehman has written the day after a bankruptcy is a scary thing," Brian Yelvington, a strategist at New York-based bond research firm CreditSights Inc., said yesterday.

A clearinghouse capitalized by owners could have reduced the risks because it becomes the so-called counterparty, for a fee, to each side of the trade. Now, banks are sifting through trading positions to "net" trades that offset each other and reduce potential losses. Untangling that web may last into 2009, said John Jay, a senior analyst at Boston-based Aite Group, a financial services consulting firm.

"Just figuring out what they have could take a week, but the thornier issue is to figure out valuations," said Jay. "It's a Gordian knot because you have different ratings, different counterparties, different end-dates and you have to somehow attach a value to these contracts. It's an operational nightmare and a legal nightmare of interpreting what each contract says."

The Markit CDX North America Investment Grade Index, which rises as confidence in companies deteriorates, climbed 25 basis points to a record 220 at 7:50 a.m. in New York, according to broker Phoenix Partners Group. AIG led a jump in the cost of default protection on U.S. banks after the biggest U.S. insurer by assets had its credit ratings cut by Standard & Poor's and Moody's Investors Service. Sellers of protection demanded a record 49 percent upfront and 5 percent a year, Phoenix Partners prices show.

Contracts on Goldman Sachs Group Inc. surged 120 to 470, while credit-default swaps on Bank of America Corp., which agreed to buy Merrill Lynch & Co., the world's biggest brokerage firm, increased 97 to 445 basis points, CMA Datavision prices show.

The cost of protecting bank debt against default also rose as the overnight London interbank offered rate for dollars, or Libor, more than doubled to 6.44 percent amid a tightening in lending. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. Each contract is a separate agreement between two so-called counterparties and trades in over-the-counter transactions, leaving parties exposed to the risk that their partner will default.

Barclays analysts estimated in February that if a financial institution that had $2 trillion in credit-default swap trades outstanding were to fail, it might trigger between $36 billion and $47 billion in losses for those that traded with the firm. That doesn't include the market-value losses investors face as the cost to protect companies against a default widens.

"There should be some central agency which prevents risk in the future of a large counterparty failing and causing losses," said Puneet Sharma, the head of investment-grade credit strategy at Barclays Capital, the U.K.'s third-biggest bank. "This was not necessary."

Wall Street created credit-default swaps more than a decade ago to help banks hedge against loan losses. Dealers later came up with contracts and indexes that allowed investors to speculate on a borrower's creditworthiness without owning any bonds.

The market grew 100-fold in the past seven years leaving dealers, who until a few years ago recorded trades on scraps of paper, struggling to keep up. New York Fed President Timothy Geithner assembled dealers in September 2005 to develop a plan to reduce the backlog of paperwork and unconfirmed trades.

In July the 17 dealers agreed to form a clearinghouse, create a system to better manage the collateral that protects trading partners from losses and tear up offsetting contracts to reduce the number of positions that banks have to oversee.

The clearinghouse may fall behind schedule, delaying completion until next year, said a person familiar with the process who asked not to be identified last week because the discussions weren't made public. The development was postponed after the Fed pushed Chicago-based Clearing Corp. to obtain a banking license, which would place it under the central bank's watch, the person said.

A spokesman for the Federal Reserve Bank of New York, Andrew Williams, declined to comment. Clearing Corp. spokesman Andy Merrill declined to comment, pointing to a statement last week that the company "and its clearing participants have been moving aggressively to prepare the CDS platform for launch as soon as the appropriate regulatory approvals are achieved."

"The industry's progress in building a strong foundation for our business will enable it to successfully address current issues," said Eraj Shirvani, chairman of the International Swaps and Derivatives Association and head of European credit at Credit Suisse Group in London, said yesterday in a statement. Clearing Corp. said it will guarantee trades between dealers, at least at first, and only contracts on benchmark indexes rather than on individual companies.

"We've got to come up with a different architecture," said Carlos Mendez, senior managing director at Institutional Credit Partners, a New York-based hedge fund with $13 billion in assets. "Right now, we're just doing what we can, but we're in essence concentrating risk when we should be spreading risk. And I think that's what the government is not quite grasping right now."

The Lehman failure may also increase efforts to move trading to an exchange. Chicago-based CME Group Inc. and Chicago Board Options Exchange both have offered contracts that mimic credit- default swaps. "If we were going to see a catalyst to bring over-the- counter trading on to an exchange, this is the time when we will see it," said Bill Cline, a former Accenture Ltd. partner. "When investors don't feel they have a transparent view as to the risk they're are taking, then that really undermines investors confidence."

Washington Mutual cut to junk by S&P
Washington Mutual Inc, was downgraded to "junk" status on Monday by Standard & Poor's amid concern about mortgage losses, causing shares of the largest U.S. savings and loan to slide after-hours following a 27 percent plunge in regular trading.

The credit rating agency lowered the Seattle-based thrift's credit rating to "BB-minus," three notches below investment grade, from "BBB-minus." It cut its rating on Washington Mutual's banking unit one notch to "BBB-minus" from "BBB." S&P's outlook is "negative," indicating another cut is possible within two years.

Washington Mutual responded that none of its unsecured debt is subject to ratings-based financial covenants and that it does not expect the downgrade to have a material impact on its borrowings, collateral or margin requirements.

The company sees its capital levels at the end of the quarter significantly above the levels required of "well capitalized" institutions and that it has not changed its outlook for expected credit losses. The announcement followed downgrades last week by Moody's Investors Service and Fitch Ratings. Moody's also cut the thrift to junk, while Fitch still rates it investment grade.

Washington Mutual on September 11 said it expects to set aside $4.5 billion in the third quarter for loan losses, down from $5.9 billion in the previous quarter. The thrift has reported $6.3 billion of net losses in the last three quarters. "Increasing market turmoil and the related impact from managing its concentrated mortgage franchise in this troubled housing and credit cycle led to the downgrade," S&P said.

S&P also expressed concern about the thrift's share price, which has fallen 94 percent in the last year, and said "it increasingly appears that market conditions could overtake credit fundamentals and leave the company with greatly diminished financial flexibility."

Washington Mutual nevertheless has "adequate capital positions from a regulatory perspective," with a stable deposit base, S&P said. Last week, the thrift said retail deposits as of August 31 were "essentially unchanged" from $143.6 billion at the start of the year.

In its statement the bank also said it has "de minimis" trading exposure to Lehman Brothers Holdings and no trading exposure to AIG. It has a maximum exposure to any one institution of $40 million. Shares of Washington Mutual closed Monday down 73 cents at $2 on the New York Stock Exchange, following the bankruptcy of Lehman Brothers Holdings Inc, which also had heavy mortgage and real estate exposure. The shares fell another 20 cents, or 9.5 percent to $1.80 after-hours.

AIG Down Again Amid Cash Crisis
American International Group Inc. was facing a severe cash crunch as ratings agencies cut the firm's credit ratings, forcing the giant insurer to raise $14.5 billion to cover its obligations.

With AIG now tottering, a crisis that began with falling home prices and went on to engulf Wall Street has reached one of the world's largest insurance companies, threatening to intensify the financial storm and greatly complicate the government's efforts to contain it. The company is such a big player in insuring risk for institutions around the world that its failure could shake the global financial system.

Shares of AIG fell 42% to $2.70 in recent premarket activity Tuesday after earlier in the premarket session rising 5% to $5. The stock tumbled 61% on Monday amid the U.S. stock market's worst daily point plunge since the first day of trading after the Sept. 11, 2001, terrorist attacks. In addition to AIG's woes, the financial markets were rattled by the rushed sale Sunday of Merrill Lynch & Co. to Bank of America Corp. and the bankruptcy-court filing of Lehman Brothers Holdings Inc.

AIG has been scrambling to raise as much as $75 billion to weather the crisis, and people close to the situation said that if the insurer doesn't secure fresh funding by Wednesday, it may have no choice but to opt for a bankruptcy-court filing. "The situation is dire," a person close to AIG said. Many market participants have been anticipating a government-led rescue. So far, however, the U.S. has been reluctant to step in, preferring instead to broker a private-sector solution.

The Federal Reserve hosted a meeting to discuss AIG's prospects at the central bank's offices in New York on Monday with company executives, bankers as well as state and federal officials. With strong encouragement from the Fed, Goldman Sachs Group Inc. and J.P. Morgan Chase & Co. are seeking to raise $70 billion to $75 billion in loans to help prop up AIG, according to people familiar with the situation. Word of AIG's efforts to borrow that much sent the stock market tumbling in the last hour of trading.

The company turned to the government in earnest after a weekend where intense efforts failed to produce a plan to raise roughly $40 billion in capital. The worsening crisis has now forced the firm to seek considerably more, underscoring its precarious position. AIG needs the money to sidestep a potentially fatal downgrade by credit-rating firms.

The downgrades by Moody's Investors Service and Standard & Poor's mean that AIG's counterparties, or trading partners, can demand that it post an additional $14.5 billion in collateral, according to a filing AIG made with the Securities and Exchange Commission in August. It is not clear how quickly AIG would have to produce those funds. In addition, AIG or its counterparties could demand early termination based on the downgrades, resulting in payments of up to about $5.4 billion, the filing said.

One sliver of optimism for AIG last night was that much of its exposure is related to credit default swaps, insurancelike contracts tied to corporate defaults. AIG's counterparties on these instruments include Wall Street firms, which may have an incentive not to immediately demand more collateral so as not to trigger a wider panic. Such collateral could come in the form of cash or liquid assets such as government or municipal bonds.

But many of AIG's counterparties are based in Europe and Asia and may have less interest in helping to prop up the firm. The market for credit default swaps is immense, trading against about $62 trillion of debt. Some participants in the largely unregulated market worry that the default of a major player such as AIG could trigger chaos.

Analysts believe that AIG's insurance businesses remain healthy. But losses elsewhere, linked to subprime mortgages, have helped make the major credit-rating agencies skeptical of its ability to raise enough capital to offset the losses. In New York, where AIG is based, Gov. David Paterson announced Monday that state officials are working with the insurer on a plan that would allow the firm to, in effect, loan itself $20 billion, by borrowing against its assets.

The state would allow the company to shift assets that are subject to tight regulation in order to give the company better liquidity in the short term. The private loans facilitated by banks, should they become available, would provide a huge measure of relief to AIG. The insurer had sought a bridge loan from the Fed to tide it over until it was able to sell some assets, but Fed officials are not inclined to provide one, especially right after spurning Lehman Brothers.

The Fed's failure to come to Lehman's aid forced the firm to file for Chapter 11 bankruptcy protection Monday. At a midday news conference, U.S. Treasury Secretary Henry Paulson said AIG's meetings with federal officials had "nothing to do with any bridge loan from the government" and rather represented a private-sector effort that was important to the "financial system."

Indeed, the company's woes could pose problems in many corners -- a concern that has the federal government on watch. AIG's massive assets mean that its millions of traditional insurance customers will likely get claims paid, no matter what happens next.

But AIG's shares and debt are widely held, and the firm is used by many companies world-wide to manage a range of risks, including exposure to investments in subprime mortgages. Its demise would potentially make it harder or more expensive for businesses to control their risks.

AIG had hoped to have a comprehensive plan in place before the start of trading on Monday. It was unable to broker a deal in time and made no public pronouncements about its plans. Each day lost can make it harder to craft a solution. AIG's businesses include selling life and property-casualty insurance policies. It operates in more than 100 countries around the world. With more than 100,000 employees world-wide, AIG has a sprawling portfolio of companies that also includes units that make consumer loans and lease aircraft.

AIG's business selling credit protection against the possibility of default in a variety of assets, including subprime mortgages, set it apart from most other insurers and tied it more closely to the fate of the housing and credit markets. When the housing market began to spiral downwards, the value of those contracts plunged. That issue is at the heart of AIG's massive losses, which have totaled $18 billion over the past three quarters.

The losses have put the company over a barrel. To raise money, AIG in recent days has explored selling off valuable units. The company, for instance, is looking into selling AIG Variable Annuity Life Insurance Co., which provides retirement services, according to a person familiar with the matter. An AIG spokesman declined to comment.

AIG has also held discussions in recent days with private-equity firms about providing an infusion of cash. But some firms balked at putting in money absent a Fed bridge loan, and at this point, private-equity firms such as TPG and Kohlberg Kravis Roberts & Co. are more interested in buying specific AIG assets rather than contributing money to a capital infusion, according to people familiar with these firms' thinking.

The company also talked with Warren Buffett, chairman of Berkshire Hathaway Inc., which has a number of insurance businesses. The talks didn't result in specific plans, and it wasn't clear if they were ongoing. The problems confronting AIG are especially striking because the company is so large. At the end of the second quarter, its assets exceeded its liabilities by $78 billion. But most of those assets are held by its insurance subsidiaries, as guarantees that they will be able to pay claims.

As a result, those assets can't be liquidated to meet the company's other obligations, such as those associated with the recent losses. AIG raised $20 billion earlier this year, but it's not clear how much of that it still has on hand. And if ratings agencies downgrade it, the company could have to come up with at least $10 billion, and perhaps as much as $18 billion.

That is one way loans from banks or New York state's moves could aid the company -- by giving it short-term cash while it works on longer-term efforts to raise money, such as by selling assets. In New York, Insurance Superintendent Eric Dinallo is working with AIG on efforts to shift around assets that it could use to help raise cash. Insurance companies operate under strict regulations about moving assets among subsidiaries, in order to guarantee that they can meet their obligations to policyholders.

New York, though, may allow AIG to move certain assets that are harder to liquidate quickly into its insurance subsidiaries, where they would back up possible future claims, and then shift more easily tradable assets, such as municipal bonds, to the parent company. The parent company could then borrow against those more liquid assets, which could in turn help ease its needs for cash in the short term.

AIG's Ratings Cut by S&P, Moody's, Threatening Fund Raising
American International Group Inc.'s credit ratings were downgraded by Standard & Poor's and Moody's Investors Service, threatening efforts to raise emergency funds to keep the company afloat.

The ratings downgrades occurred after two people familiar with the situation said that the biggest U.S. insurer by assets is seeking $70 billion to $75 billion in loans arranged by Goldman Sachs Group Inc. and JPMorgan Chase & Co. to replenish capital.

AIG Chief Executive Officer Robert Willumstad has tried to raise cash to forestall debt-rating downgrades that could hobble the insurer. A ratings cut may have "a material adverse effect on AIG's liquidity" and trigger more than $13 billion in collateral calls from debt investors who bought swaps, the insurer said in an Aug. 6 filing.

Wall Street's biggest firms convened at the New York Fed for a fourth consecutive day, this time to discuss AIG, which sold the banks and other investors protection on $441 billion of fixed-income assets, including $57.8 billion in securities tied to subprime mortgages. AIG's shares plunged 61 percent today in New York trading.

"I don't know of a major bank that doesn't have some significant exposure to AIG," said Kenneth Lewis, chief executive officer of Bank of America Corp., in a CNBC interview. An AIG collapse would "be a much bigger problem than most that we've looked at." AIG fell $7.38 to $4.76 at 4:15 p.m. in New York Stock Exchange composite trading. The company has declined 92 percent this year in New York trading, making it the worst performer in the Dow Jones Industrial Average.

S&P lowered AIG's long-term counterparty rating three grades to A- from AA-, citing a "combination of reduced flexibility in meeting additional collateral needs and concerns over increasing residential mortgage-related losses." The ratings assessor also lowered AIG's short-term counterparty credit rating by two levels to A-2 from the top A- 1+ rating, and cut its counterparty credit and financial strength ratings on most of AIG's insurance operating subsidiaries by three notches to A+ from AA+. The ratings remain on watch for a possible further downgrade, S&P said.

AIG's senior unsecured debt rating was downgraded by Moody's to A2 from Aa3. Moody's said in a statement that its decision was made "in light of the continuing deterioration in the U.S. housing market and the consequent impact on the group's liquidity and capital position due to its related investment and derivative exposures." Moody's placed AIG's long-term and Prime-1 short-term ratings on review for possible downgrades.

A downgrade of AIG's long-term senior debt ratings to A1 by Moody's and A+ by S&P would permit counterparties to make additional calls for up to approximately $13.3 billion of collateral, while a downgrade to A2 by Moody's, and to A by S&P would permit counterparties to call for approximately $1.2 billion of additional collateral, AIG said in the Aug. 6 filing.

"If either of Moody's or S&P downgraded AIG's ratings to A1 or A+, respectively, the estimated collateral call would be for up to approximately $10.5 billion, while a downgrade to A2 or A, respectively, by either of the two rating agencies would permit counterparties to call for up to approximately $1.1 billion of additional collateral," the filing said.

AIG has already posted $16.5 billion in collateral through July 31. A downgrade could also set off early termination of swaps with $4.6 billion in payments, AIG had said.

The Federal Reserve urged AIG to seek private capital and discouraged the insurer from expecting a loan from the central bank, according to two people with knowledge of the discussions. Goldman and JPMorgan are working with AIG to determine how much the New York-based insurer needs, said two more people, all of whom declined to be identified because negotiations are private.

The loan would involve temporary financing, a so-called bridge loan, through a syndicate of banks, and there's no assurance an agreement will be worked out, one of the people said. "We're still working on a number of alternatives," said Nicholas Ashooh, spokesman for AIG. JPMorgan's Brian Marchiony and Goldman's Lucas van Praag declined to comment.

AIG was given special permission to access $20 billion of capital in its subsidiaries to free liquidity, New York Governor David Paterson said today. The move gives the insurer time to work on securing more capital, he said.

The insurer "needs immediate access to capital" and will be able to swap illiquid assets to free up holdings at its subsidiaries, Paterson said. Each time AIG uses assets as collateral for cash loans, the insurance department will examine the transaction to protect policyholders. "We have seen some of the companies that serve as the bedrock of our financial system unraveling before our eyes," Paterson said.

The Fed has hired Morgan Stanley to examine alternatives for AIG, a person familiar with the situation said. Morgan Stanley will review what role, if any, the government should play in helping the insurer, said the person, who declined to be identified because the talks are confidential.

AIG may report writedowns of $30 billion resulting in its "worst quarter yet" for the period ending Sept. 30 if Lehman's bankruptcy leads to distressed sales of mortgage assets, providing lower market values for AIG's holdings, Citigroup Inc. analyst Joshua Shanker said today in a note. He downgraded AIG to "hold" from "buy."

The company may consider selling units including American General Finance, AIG's consumer lender, which could fetch more than $6 billion if the unit sold for twice its book value. AIG Investments could sell for more than $3 billion if it sold for 2.5 percent of clients' assets under management. The company's stake in reinsurer Transatlantic Holdings Inc. is worth about $2.25 billion, based on today's share price.

Bank of America analyst Alain Karaoglan said Willumstad, 63, should reconsider the decision to keep its aircraft-leasing unit, International Lease Finance Corp., which could sell for $7 billion to $14 billion. AIG rejected investments from buyout firms KKR & Co., TPG Inc. and J.C. Flowers & Co., people familiar with the talks said.

Billionaire Warren Buffett's Berkshire Hathaway Inc., is no longer talking with AIG about an investment in the insurer, CNBC reported today, citing people familiar with the situation it didn't identify.

The insurer raised $20.3 billion in May by selling debt and equity, diluting the holdings of long-time investors. It's "very hard to predict" if AIG will need more capital, Willumstad said on Aug. 7. Last week, the U.S. Treasury seized Fannie Mae and Freddie Mac, the two biggest sources of funding for U.S. mortgages, wiping out most of the value of their shares. AIG had $550 million to $600 million of preferred shares in the companies, said a person who declined to be identified because the insurer hadn't made a formal announcement.

Hurricane Ike, which struck Texas Sept. 13, may also pressure AIG, costing insurers $6 billion to $18 billion, the most since the record storm season of 2005, according to firms that specialize in gauging the effects of disasters. AIG's former CEO and Chairman Maurice "Hank" Greenberg, who controls the largest stake in the insurer, wasn't involved in the company's planning Sept. 13 and yesterday and has "repeatedly offered" to assist the firm, his spokesman Glen Rochkind said yesterday.

Greenberg, 83, saw his holdings decline by $3.1 billion last week. He controls 11 percent of AIG shares through two investment firms and personal holdings.

Lehman Dumps Real Estate: Commercial Mortgage Bond Yields Over Benchmarks Soar to Record
Yields on commercial mortgage bonds relative to benchmark rates rose to record highs on concern that Lehman Brothers Holdings Inc. may dump its real estate on the market after filing for bankruptcy.

Spreads on AAA rated commercial mortgage-backed debt rose 41.25 basis points to 318.81 basis points more than benchmark swap rates as of yesterday's close, Bank of America Corp. data show. The previous record of 312.35 basis points was set March 10, the week before the Federal Reserve arranged JPMorgan Chase & Co.'s purchase of Bear Stearns Cos. A basis point is 0.01 percentage point.

"A bankruptcy is not a positive for any credit products," said Lisa Pendergast, an analyst at RBS Greenwich Capital in Greenwich, Connecticut. "There is a concern that as Lehman moves into bankruptcy, the liquidation will put pressure on the prices of all commercial mortgage securities."

The $776 billion market for commercial-mortgage debt may plummet further if more financial institutions fail and have to sell assets. Since the start of last year, banks worldwide have taken more than $514 billion in writedowns and credit losses amid the worst housing slump since the Great Depression.

Lehman held $8.5 billion in commercial-mortgage backed securities as of last month, the company said last week. Lehman held an additional $15.5 billion in commercial mortgage loans that had not been sliced up and sold as bonds. The cost to protect commercial-mortgage bonds against default soared yesterday, credit-default swaps show. Spreads on AAA contracts on Markit's CMBX index rose 43 basis points to 191 basis points, according to New York-based Markit Group.

The cost to insure against default on BBB- commercial mortgage-backed securities, the lowest investment-grade rating, soared 131 basis points to 2,437 basis points. That means it costs about $2.44 million to insure $10 million of the underlying securities.

Credit-default swaps are used to speculate on a borrower's ability to repay debt. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. Rising spreads on the CMBX index mean investors are more concerned that commercial mortgage loans may be in jeopardy.

New York-based Lehman was forced into bankruptcy after Bank of America and Barclays Plc backed away from bidding for the investment bank when the U.S. Treasury wouldn't provide a backstop on losses. Bank of America agreed to acquire Merrill Lynch & Co. for $50 billion yesterday.

National City wins OK for $7 billion
National City Corp, a U.S. Midwest regional bank battered by mortgage losses, has won stockholder approval to authorize new shares to allow for a $7 billion capital infusion, the bank said on Monday.

The Cleveland-based bank said shareholders authorized an increase in the maximum shares outstanding to 5 billion from 1.4 billion. Shareholders also approved the conversion of some convertible debt into common stock, and the exercise of some warrants. These actions were related to a capital raising plan announced in April, in which National City raised dilutive capital from Corsair Capital LLC and other investors.

The new capital gives National City "the necessary flexibility to address current market challenges," Chief Executive Peter Raskind said. He added that the bank has no exposure to Lehman Brothers Holdings Inc, the Wall Street bank that filed for bankruptcy protection, and has routine derivatives contacts with Lehman's broker-dealer unit.

Separately, National City named Thomas Richlovsky interim chief financial officer, effective Sept 30. He succeeds Jeffrey Kelly, whose departure had previously been announced. Richlovsky is the bank's principal accounting officer. National City is looking externally for a permanent CFO.

Goodbye Lehman, Hello Deflation
A few short weeks, a few banking failures, a massive fall in oil and commodity prices and deflation is back on the agenda.

The events of the weekend -- the failure of Lehman Brothers, the takeover of Merrill Lynch and insurance giant AIG's reported emergency appeal for Federal Reserve aid -- have given another kick to the vicious cycle of debts going bad and asset prices falling. More markers will be called, more assets marked down, more capital destroyed, less credit offered.

As for recapitalizing the banking system, sovereign wealth funds and anyone else with eyes and ears will be waiting on the sidelines for things to look slightly less grim. Meanwhile, back in the real economy large swathes of the developed world from Tokyo to Berlin to Los Angeles have been hurt badly by the credit crunch and are very likely already in recession.

Oil and commodities prices are falling rapidly in response. Oil at about $95 a barrel is 35 percent below its summer peaks and the benchmark commodities index .CRB is down by more than 25 percent since July.
So even with inflation still at heady levels, the chances that we slip close enough towards deflation that it becomes a concern have increased markedly in recent days and weeks.

"Deflation looms, it certainly does loom," said George Magnus, senior economic advisor at UBS and a man who has predicted both the credit bust and many of its implications. "The cycle in which debt destruction and asset price destruction reinforce each other clearly has a very, very strong negative effect on the economy. This effect is both direct and on banks, who are supposed to try and create the credit that makes economic growth possible."

Government bonds are certainly not showing a lot of worry about inflation, though this in part reflects a flight to safety as investors seek to hold the most secure instruments. Treasury futures had their biggest gain in 20 years on Monday and two-year yields dropped 40 basis points. A look at inflation protected bonds shows that market pricing in the least amount of inflation since 2003, when the Federal Reserve was last actively fretting about deflation.

A real estate bust and systemic banking crisis in Japan helped usher in a period of recession and deflation -- falling prices -- starting in the early 1990s. As production and consumption are delayed to take advantage of future lower prices, deflation can feed upon itself and be difficult to stop.

Japan resorted to extraordinary measures to halt the price drop, slashing interest rates to near zero and force feeding liquidity into the banking system. Inflation finally revived only with the help of the global commodity price boom.

It certainly looks as if the threat of inflation being exported from emerging markets has now diminished. China's central bank cut interest rates on Monday by 27 basis points and eased reserve requirements it places on banks, moves taken out of concern for deteriorating growth. Inflation in China has eased markedly in recent months; consumer prices actually contracted slightly during August.

To be clear, inflation in the United States still has a way to fall; consumer price inflation was 4.5 percent in July, the highest since 1991, and food prices may stay stubbornly high for some time to come. So why will the demise of Lehman make price contraction more likely?

An enormous amount of leverage is being taken out of the system suddenly, prompting new sales of assets into a market already suffering indigestion. This will drive prices for many assets lower, which will in turn force other firms holding those assets on their own balance sheets to mark the value down. This creates even more need for new capital, and makes further failures of banks and insurers more likely.

Companies will find it tougher to get loans and will be more prone to throw people out of work. The authorities have powerful weapons with which to fight deflation. They are already using one, having effectively nationalized the U.S. mortgage sector. And there are also interest rate cuts. At this writing, the market was actually betting the Federal Reserve would cut rates when it decides on Tuesday.

Then there is the currency printing press. We are of course nowhere near that, and in some ways if inflation ebbs away the Federal Reserve will have a less complicated job than if they were trying to aid the recapitalization of a banking system with one hand and fight inflation with another.

Russell Jones, global head of fixed income research at Royal Bank of Canada in London, points out that CPI in the United States tends to fall by half or two-thirds following a recession and that its successive troughs have been lower and lower. "At the very least the inflationary risk has diminished very sharply, at the most we could be moving to a problem of the opposite kind," he said.

Japan, China Join Central Bank Efforts to Calm Market
The Bank of Japan added a total of 2.5 trillion yen ($24 billion) to the financial system and China cut interest rates as Asian central banks attempted to calm markets after Lehman Brothers Holdings Inc. filed for bankruptcy.

The Federal Reserve yesterday added $70 billion in reserves to the banking system, the most since the September 2001 terrorist attacks, and may cut its benchmark lending rate today. China lowered its benchmark rate for the first time in six years late yesterday and may act again.

Japanese bonds jumped, sending the yield on the benchmark 10-year bond to its biggest drop in five years on concern the credit crisis will worsen. Financial institutions worldwide have reported more than $510 billion in losses and writedowns and the credit-market collapse has erased $11 trillion from global stocks in the past year.

"Central banks have to show they are ready to take action to ensure stability," said Thomas Lam, an economist at United Overseas Bank Ltd. in Singapore. "Precautionary steps are high on their list to prevent any significant impact and support their markets." The Bank of Japan added 2.5 trillion yen in two operations today. Today's increase in funds was the first since June 30 and the biggest since March 31, when the central bank added 3 trillion yen.

Australian one-month money market rates dropped 3 basis points to 7.21 percent today, the first decline in five days, after the Reserve Bank of Australia injected A$1.848 billion ($1.5 billion) to the financial system, adding to yesterday's $2.1 billion.

The European Central Bank, the Bank of England and the Swiss central bank also added liquidity yesterday. Three-month money market rates in Europe dropped 4 basis points to 4.25 percent yesterday, the lowest level since Aug. 27. Yesterday, the federal funds rate soared as high as 6 percent, triple the Fed's target, as banks hoarded cash. That spurred the Fed to pump $70 billion into money markets through repurchase operations, the most since September 2001.

"The Bank of Japan will carefully monitor the recent developments among U.S. financial institutions and continue to try to secure smooth fund settlements and financial-market stability by implementing appropriate money-market operations," Governor Masaaki Shirakawa said. The central bank starts a two- day policy meeting in Tokyo today.

South Korea will provide liquidity "through open-market operations," Vice Finance Minister Kim Dong Soo said before an emergency meeting today with his counterparts from the central bank and the financial regulator in Seoul. The Bank of Korea said in a separate statement today it will provide foreign currency liquidity through the swap market when necessary to "help calm market players."

The People's Bank of China reduced the one-year lending rate to 7.20 percent from 7.47 percent, effective today. It lowered the reserve-requirement ratio for smaller banks to 16.5 percent from 17.5 percent. "The authorities are afraid of a chain reaction and a further tightening of financial conditions, which would ultimately have a negative impact on the economy," said Tomoko Fujii, head of economics and strategy at Bank of America N.A. in Tokyo. "They have no choice but to try to calm the markets."

Taiwan's government instructed its four major funds and state-owned banks to buy shares to help reverse the stock market's slump. The index, which fell as much as 5.4 percent today, was 4.5 percent lower at 1:05 p.m. in Taipei.
Fed policy makers will meet today to decide on its key interest rate. The central bank hasn't reduced rates since April 30, when it made the seventh cut since September 2007, bringing the target rate for overnight loans between banks to 2 percent.

Futures show traders boosted odds to 68 percent that the Fed will cut rates at the meeting. "Cutting interest rates may not be the most appropriate way to solve the crisis," said Lam. "It's better for them to continue or enlarge their liquidity and collateral program."

Goldman Loses $845 Million, Profit Drops 70%, Says It's `Well-Positioned'
Goldman Sachs Group Inc., the largest of the two remaining independent U.S. securities firms, said third-quarter profit fell 70 percent, the sharpest decline in its nine years as a public company, and said it remains "well positioned."

Goldman fell 7 percent in New York trading after the New York-based firm said in a statement that net income dropped to $845 million, or $1.81 a share in the three months ended Aug. 29, from $2.85 billion, or $6.13, a year earlier. The earnings compare with the average estimate of $1.71 a share of 19 analysts surveyed by Bloomberg. Goldman has beaten estimates for 13 straight quarters.

After setting Wall Street profit records in 2006 and 2007, Chief Executive Officer Lloyd Blankfein is grappling with market convulsions that have driven Merrill Lynch & Co. and Bear Stearns Cos. into emergency sales and Lehman Brothers Holdings Inc. into bankruptcy. Goldman shares slumped 12 percent and its senior notes dropped to a record low in New York trading yesterday on concern no investment bank, even the most profitable, was safe.

"We own Goldman because they're best in class, they're taking share from those that are having trouble, but you can't expect them to turn water into wine," said Ralph Cole, a vice president in research at Ferguson Wellman Capital Management Inc. in Portland, Oregon, which oversees $2.7 billion, before the earnings report. "It's a tough environment out there and you can only do so much." The shares declined $9.54 to $124.96 in trading before the official open on the New York Stock Exchange.

While Goldman has suffered a fraction of the writedowns on fixed-income assets that New York-based competitors Citigroup Inc. and Merrill have taken, its shares have dropped 37 percent this year as markets tumbled and fees from securities underwriting and providing merger advice dried up. The drop in third-quarter profit is the biggest since a 60 percent decline in 1999, which was caused by one-time costs tied to the firm's initial public offering.

"We remain well-positioned to meet the needs of our clients and identify and act on the right market opportunities," Blankfein said in the statement. Return on equity, a measure of how effectively the firm reinvests earnings, fell to 7.7 percent. Revenue dropped 51 percent from a year ago to $6.04 billion.

Fixed-income, currencies and commodities, the company's biggest source of revenue, generated $1.6 billion, down 67 percent. The firm took $275 million in writedowns on leveraged loans and related hedges, $500 million on residential mortgage loans and securities and $325 million on commercial mortgage loans and securities.

Equities trading revenue fell 50 percent to $1.56 billion and revenue from investment banking, which includes providing merger advice and underwriting stock and bond sales, dropped 40 percent to $1.29 billion. The principal investments group, which includes the company's stake in Industrial & Commercial Bank of China Ltd., produced a $453 million loss, compared with a gain of $211 million a year earlier.

ICBC dropped 17 percent in Hong Kong trading during Goldman's fiscal third quarter. Goldman owns about 5 percent of the company, although about two-thirds of its holding is on behalf of clients. Lehman reported the biggest loss last week in its 158-year history, and its share price plunged 74 percent as management led by CEO Richard Fuld raced to find a buyer. Negotiations over the weekend at the New York Federal Reserve's downtown Manhattan headquarters failed to assuage the concerns of potential buyers and the company filed for bankruptcy protection yesterday.

Lehman's predicament made it clear to Merrill CEO John Thain that his firm's survival could be in jeopardy if he didn't find a buyer soon. Merrill, expected to post its fifth-straight quarterly deficit next month, agreed to be acquired by Charlotte, North Carolina-based Bank of America Corp. in an all- stock deal valued at about $50 billion. Merrill considered selling a minority stake to Goldman before agreeing to the Bank of America deal, the Wall Street Journal reported today, citing people familiar with the matter.

Morgan Stanley, the second-biggest U.S. securities firm after Goldman, is scheduled to report third-quarter earnings tomorrow. The firm may post a 44 percent drop in net income to $866 million, according to the average estimate of 10 analysts surveyed by Bloomberg. Goldman and Morgan Stanley need to show investors that they've learned from the errors made by Merrill, Lehman and Bear Stearns by selling off some of their holdings of complex, hard- to-trade assets.

"I would hope they have taken the last few months as an adequate caution to clarify their positions and reduce some of their exposures," said John Gutfreund, president of Gutfreund & Co. and the former CEO of Salomon Brothers, in a Bloomberg Television interview yesterday.

What does the Lehman collapse mean for you?
Chancellor Alistair Darling might permit himself a rueful little chuckle this morning. A mere couple of weeks after the pundits lined up to shoot him down over his claim that Britain was facing the worst economic conditions in 60 years, the papers are now full of comparisons to 1929.

Of course, he won’t be laughing for long. After all, the collapse of Lehman will just leave him with yet more headaches, and doubtless there’s still plenty of drama to come on both sides of the Atlantic. But forget him – how does all of this affect you?

Stock markets around the world took a hammering yesterday, unsurprisingly. The Dow Jones ended below 10,000, slumping 504 points. The FTSE 100 was off 212 points at 5,204. This isn’t over. Lehman Brothers is gone, Merrill Lynch has been sold off, but the impact will be felt throughout the markets for a long time. No one is entirely sure what will happen as Lehman’s liabilities are unwound.

That means a whole new round of disruption to interbank lending as banks become more afraid to lend to each other again. So forget about mortgages getting any cheaper any time soon. There’s the debt that Lehman actually has outstanding (around $150bn, about five times that of telecoms group WorldCom, which was until now the biggest debt default in history).

The debt is still worth something – Lehman itself clearly has some valuable assets – so we’re not talking about a loss of that entire $150bn. But whatever it’s worth, it’ll be a lot less than its face value. Then there’s the credit default swaps (CDS) issue to worry about. CDSs are basically a type of insurance written on corporate debt, guaranteeing payment of the debt in the event of a company going bankrupt.

Sandy Chen at Panmure Gordon reckons there was about $350bn in CDSs written on Lehman debt. Again, because the debt is worth something, we’re not looking at an entire $350bn – but using an “optimistic” 60 cents in the dollar, that’s still $140bn the banks writing the insurance will have to pay out.

Then of course, as Lehman sells off its dodgy assets, the market price of these will fall further, which will also mean that other banks have to take further writedowns on their own dodgy portfolios. All in all, it looks a bit like the subprime meltdown all over again.

Then there’s the small matter of insurance giant AIG, which is struggling to raise emergency funds as I write this. As Kenneth Lewis, chief executive of Bank of America told CNBC, “I don’t know of a major bank that doesn’t have some significant exposure to AIG.” A collapse would “be a much bigger problem than most that we’ve looked at.” We’ll have more on this story on the website later today.

Unsurprisingly, the main losers in the UK amid the sea of red – the only risers were utility stocks – were the banks. HBOS was the top faller, down 17.5%, with Royal Bank of Scotland and Barclays close behind. As the three British banks most exposed to ‘toxic’ assets, they’ve been hit hardest.

Now we’ve been warning readers away from investing in banks for a long time, so hopefully most MoneyWeek readers will have avoided taking a hit from their share prices collapsing. As for concerns about another Northern Rock - on this point, we’ve already suggested, along with every other newspaper, that it’s a good idea to make sure you only have a maximum of £35,000 saved with each individual bank. That’s the limit covered by the Financial Services Compensation Scheme.

That’s not to say that anything is going to happen to any of the high street banks that would imperil people’s savings. If Northern Rock was deemed too big to fail, the government can hardly pull a Lehman Brothers on a genuinely important bank like HBOS, for example. But it’s always better to be safe than sorry.

As for the rest of your portfolio - something interesting happened yesterday amid all the carnage. The oil price took a dive. This could be put down to Hurricane Ike being less disruptive than feared, or to increased fears about the state of global growth.

But I’d argue that it’s yet more proof that much of the recent surge above $100 a barrel was due to a flood of speculative money, which is now being yanked out of the markets. We suggested selling out of oil at the start of August and I wouldn’t be looking to buy back in again yet.

At the same time, the gold price moved higher. Gold – as my colleague Dominic Frisby has pointed out – has had an awful time recently, partly down to the dollar rally and some thoroughly misplaced optimism about the US economy. But events like yesterday’s demonstrate the key reason for holding gold – as insurance against financial disaster.

In a recent edition of his Gloom, Boom and Doom newsletter, Marc Faber argued: “I am not a great believer in insurance policies, but since I think that sooner or later the entire financial system will blow up I want to make sure that… I shall still be left with some assets that are mine (physical gold in a safe deposit box – not in the US).”

Now that’s a very downbeat way to look at things. But the point is that the more that things like the Lehman collapse happen, the more people start to wonder if Mr Faber is right. That’ll drive demand for gold higher, regardless of whether a total financial collapse happens or not. And if it does, well, there are worse things to be holding than gold

Indian Rupee Falls Most in Decade as Capital Outflows May Rise
India's rupee fell the most in a decade on speculation turmoil on Wall Street will heighten risk aversion among global investors, boosting sales of emerging- market assets.

The currency dropped to the lowest in more than two years after mounting credit losses led to the collapse of Lehman Brothers Holdings Inc., the sale of Merrill Lynch & Co. and a debt-rating downgrade of American International Group Inc. The rupee also slumped as India's benchmark share index fell for a sixth day, sliding in tandem with equity markets worldwide.

"Capital outflows may increase as the global investment climate has deteriorated and stock markets are down across Asia and elsewhere," said Vikas Agarwal, a strategist in Mumbai at JPMorgan Chase & Co., the third-biggest U.S. bank. "The rupee may come under more pressure as foreign investors remain net sellers of local equities."

The rupee fell 1.9 percent to 46.925 per dollar as of the 5 p.m. close in Mumbai, according to data compiled by Bloomberg. It slid as low as 46.975 earlier. JPMorgan forecasts the rupee to drop to 47 by the end of the year. The rupee was the second-biggest loser among the 10 most- active currencies in Asia outside Japan today. The South Korean won slid 4.4 percent, the most since 1998 as well.

Credit losses forced Lehman to file for the biggest bankruptcy in history. Merrill, the world's biggest brokerage firm, yesterday agreed to be sold at about $50 billion to Bank of America Corp. Debt ratings of AIG, the biggest U.S. insurer, were downgraded yesterday by Standard & Poor's and Moody's Investors Service, threatening efforts to raise emergency funds to keep the company afloat.

Indian stocks fell. The Bombay Stock Exchange's Sensitive Index, or Sensex, declined for a sixth day, heading for its first annual loss since 2001. The rupee also weakened on speculation the nation's companies increased purchases of dollars to pay for shipments from abroad and to repay overseas loans. A weaker rupee makes overseas purchases costlier.

"Expectations are increasingly shifting toward greater medium-term rupee weakness," JPMorgan's Agarwal said. "Importers and those with outstanding overseas loans are increasingly likely to secure their foreign-currency needs." India's imports have grown faster than exports this year, causing the nation's trade deficit to widen. Shipments from abroad increased at an average 38 percent per month, beating a 26 percent average growth in overseas sales. The shortfall averaged $9 billion a month this year, compared with $5.8 billion in 2007, central bank data show.

Bill Gross's PIMCO Guaranteed $760 Million of AIG Debt
Bill Gross, manager of the world's largest bond fund, guaranteed $760 million of debt issued by American International Group Inc. as of June 30, obligations that may prove costly if the insurer fails to stay afloat.

Pimco Total Return Fund, which oversees $132 billion in assets, backed the bonds by selling credit default swaps to investors that pay off if AIG defaults, according to a filing with the U.S. Securities and Exchange Commission last month. The fund had sold insurance on $7.7 billion of bonds, including $4.8 billion issued by financial-services companies, as of the end of June.

The swaps are part of a larger bet by Gross that some beaten-down corporate bonds will recover because they are too important for the U.S. government to let fail, analysts said. That theory was tested yesterday as Lehman Brothers Holdings Inc. filed for bankruptcy protection and AIG's request for $40 billion in loans was rebuffed by the Federal Reserve.

"It's conceivable that Lehman being allowed to fail will have Pimco rethinking which firms meet their standards and which firms don't," said Lawrence Jones, associate director of fund analysis at Morningstar Inc., a Chicago-based stock and mutual- fund research firm. "The financials they are looking for generally are ones they feel are going to be backstopped by the government if anything were to really go wrong."

Standard & Poor's lowered AIG's long-term counterparty rating three grades to A- yesterday, citing the company's "reduced flexibility in meeting additional collateral needs" as well as "concerns over increasing residential mortgage-related losses." The annual cost of insuring $10 million of AIG debt for five years rose to $1.9 million yesterday, equaling 19 percent of face value, according to CMA Datavision prices.

Pimco Total Return agreed to provide credit default protection on the AIG bonds at rates ranging from 0.2 percent to 2.27 percent, according to the Aug. 29 filing by Pacific Investment Management Co., where Gross is co-chief investment officer. The bulk of the contracts run until 2013.

Mark Porterfield, a spokesman for Newport Beach, California- based Pimco, declined to comment on the credit default swaps. The SEC filing is the most recent available for the fund, so Pimco may have since sold some or all of the AIG swaps.
Following the Fed's refusal to provide financing, New York- based AIG is seeking a loan for as much as $75 billion through Goldman Sachs Group Inc. and JPMorgan Chase & Co..

AIG, the largest U.S. insurer by assets, has been hammered by three quarterly losses totaling $18.5 billion, primarily from investments in mortgage-backed securities and credit default swaps that it has written. "AIG contains some very quality subsidiaries, not that they don't have their problems," Gross, 64, said in a Sept. 14 interview with Bloomberg News. "I wouldn't put them in the failing category at the moment."

As credit default prices rise, Pimco Total Return must write down the value of the swaps to reflect the increased risk it may have to make a payout. The fund had net markdowns of $299 million on its credit default swaps at June 30, the SEC filing shows. While the writedowns reduce the fund's net asset value, it doesn't have to pay out cash unless AIG defaults.

"The key issue with the Pimco position is if AIG goes into technical default," said Gary Kelly, head of research at Tradition Asiel Securities Inc., a broker in New York that trades credit default swaps.

In addition to AIG, Pimco Total Return had sold credit protection on almost $435 million of bonds issued by Citigroup Inc., $298.4 million of debt issued by Fannie Mae and $924 million of bonds issued by General Electric Capital Corp. The fund has also backstopped about $867 million of bonds issued by Ford Motor Credit Co. and General Motors Acceptance Corp., which provide financing for auto sales, and $493 million of debt at SLM Corp., which makes student loans.

At the major brokerages, the fund had sold credit protection on bonds with the following face values: $112 million at Morgan Stanley; $20 million at Merrill Lynch & Co.; $72 million at Goldman Sachs; and $105.4 million at Lehman.

Credit default swaps can boost Pimco Total Return's performance because the contracts generate annual income without requiring any cash upfront. The fund can take advantage of exaggerated fears in the marketplace that companies will default to boost returns.

"Essentially what you are doing is taking a much more levered bet on whether the company will go into default," said Kelly at Tradition Asiel Securities. "If they are fairly comfortable those companies aren't going to go into bankruptcy, it seems a pretty shrewd strategy."

Gross invested 61 percent of Pimco Total Return's assets in securities backed by mortgage providers Fannie Mae and Freddie Mac this year after subprime losses led the yields on their bonds to widen in relation to U.S. Treasuries. On Sept. 7, the U.S. government announced it would take control of the two companies, essentially backstopping their debt.

The following day, Pimco Total Return gained 1.31 percent. That was 0.51 percentage point higher than the Lehman Brothers Aggregate Bond index, its best performance against the benchmark, Jones at Morningstar said. "A lot of financial bonds have really traded down," said Jones, adding that yields on bonds issued by companies such as Citigroup, at 8 percent, "are pretty dramatic. Citigroup has its troubles, but I don't think its going away anytime soon."

It Was Fun While It Lasted
We were strolling along the beach about halfway to the first jetty when I realized something was slightly off, like the jangling of nerves only moments before a horrible accident... when the danger is felt not seen. It was approaching low tide and the waves were coming in rough and lumpy, breaking with a weird, deadened flop. No, this is wrong, I thought. This is not happening. Not in front of my son. He's only twelve!

Each time a wave rolled in, it carried with it dozens of hideous gelatinous blobs, spitting them up onto the beach as if the ocean itself was choking on its own vomit. Tristan suddenly bolted ahead and picked up one of the jiggling, spherical blobs, examining it with wide-eyed wonderment and awe the way only a twelve-year-old can. "Creeping Jesus!" I yelled. "Put that filthy thing down, you don't know where it's been."

It must be the storm, I thought. Yes, the storm. Clearly, a cruise ship of strippers must have capsized in the storm, and after the shark attacks all that was left were these silicone breast implants washing up everywhere. There were thousands of them. It was a tragedy beyond comprehension and explanation, especially to a twelve-year-old boy. He'd have to come to understand it on his own terms.
"Here, dad" he said, casually tossing the breast implant, which I made out to be about a size C, at me. "It's a dead jellyfish," he said with a shrug. And so it was. Quod erat demonstrandum.

You may be wondering what this has to do with Lehman Brothers, or Merrill Lynch, or American International Group. At first, I was too. But the sea is a magnet for portentous signs, and thousands of dead jellyfish washed up on the shore of a beach in New Jersey is perhaps the perfect symbol of where we are in this credit cycle.

Jellyfish are simple and dumb. They lack basic sensory organs and instead rely on a primitive nervous system structure to perceive stimuli. They are carnivores, but they are also passive by design, and so ultimately they are no match for the strong ocean currents that can define their lifespan.

In other words, the meaning of thousands of dead jellyfish washing up on a beach is simply this: sometimes the dumb get caught in a storm, and when they do, punishing them is nature's way. There's nothing remarkable about that insight, except that punishing the dumb is sometimes a deeply disturbing and unpleasant spectacle. This is true whether we're watching dead jellyfish wash ashore in New Jersey or dead investment banks soil the streets of Manhattan.

There's nothing fun about watching ham-eyed television broadcasters and reporters try and make sense of financial disasters. Sunday night when the special programming began I knew there was very little time to compose my thoughts before they became polluted with nonsense and gibberish. There is only one thing you need keep in mind when breaking financial disasters take place, and that is you can pretty much do the opposite of everything you see and hear on television and come out ahead within three months.

It's not a matter of intelligence. Hell, look at me. I'm a product of a Kentucky public school system that during my day consistently battled with Mississippi for title of Worst School System in the Northern Hemisphere. No, television broadcasters aren't any dumber than the rest of us. It's just the fact they have the unenviable task of being forced to formulate a thought about something before it's even finished happening. It must be like waking up every day and going to a job where you're supposed to appear in front of a large crowd and guess the age and weight of a number between A and G. It's a cruel game. Nothing but the act of guessing itself makes any sense.

But enough of that. The reason we are here is to judge the awful train wreck unfolding in the economy, of which the failure of a big Wall Street bank is just one bent rail in the whole twisted mess. Just when we thought it was over, it's really only beginning. The most important thing for stock market investors and traders to keep in mind today is that this debt destruction will be an ongoing process. It is tempting to see the Lehman bankruptcy, the Bank of America and Merrill deal, as signposts marking the culmination of a financial stress event. They are not. They are merely symptoms of an ongoing debt crisis.

By allowing Lehman to fail, the Federal Reserve has, perhaps inadvertently, embraced debt deflation. Now they are contributing to it. The net result of the failure of Lehman will be still more credit contraction and debt destruction.

Some will argue that by adding $25 billion to the now $200 billion Treasury lending facility, accepting equities as collateral and by cutting short term interest rates, which the FOMC will almost certainly do September 16, the Fed is making more credit available, but that credit is being absorbed by the financial system so quickly that the net result is a still ongoing credit contraction. But that's only half the story. The other half is about the debt destruction responsible for making both dollars and treasuries dear.

Indeed. The Financial Times ran an op-ed this morning discussing this "dwindling threat," and noting, correctly, that "unless core inflation rates start to jump or the falls in commodity prices to reverse, central bankers can shift attention from inflation." The reality is that this debt destruction and revulsion, which began more than a year ago in a small corner of Wall Street responsible for packaging and trading obscure products built around subprime mortgages, has transmogrified into a full scale debt deflation.

The jellyfish on Wall Street are washing ashore. The stinging tentacles of credit have now dissolved. All that's left are gelatinous globs that resemble artificial breast implants in both shape and symmetry. And if you think about it, that's how it should be; the striking resemblance between a dead jellyfish and a silicone breast implant. An empire built on inflated credit. Yes, I like that. It perfectly captures the artifice of synthetic growth...  an empire built for nothing but the sake of appearance and purposeless pleasure. But hot damn, it was fun while it lasted.

The Ultimate Wall Street Nightmare
In the wake of Lehman's demise, Fed Chairman Bernanke and Treasury Secretary Paulson will try to put out the word that it's no great trauma.

But it's a lie and they know it. If they openly admitted that the Lehman collapse will paralyze Wall Street, torpedo the stock market and sink the economy, they'd have to pony up $100 billion or more to support it. Instead, their agenda was to push big banks to put up the money. And they failed to do so.

No matter what, there's no denying that the Lehman debacle is a massive and immediate threat to U.S. and global markets. At the latest reckoning, Lehman had $691 billion in assets. That makes it bigger than Wachovia, twice as big as Washington Mutual, and over sixteen times larger than Schwab.

Lehman's debts — at $668.6 billion — are also enormous. Even if you added together all the debts of TD Ameritrade, E-Trade and Schwab, you'd still have only $108.5 billion, or less than one-sixth the total debts which Lehman reports.

In fact, among brokers, there are only two other U.S. firms that beat Lehman in the debt category: Morgan Stanley, with $1 trillion, and Merrill Lynch, with $988 billion.

Can you imagine anyone in his right mind making the argument that a Merrill Lynch downfall would be "no great trauma to investors and financial markets"? Of course not.

The reality: The collapse of America's third-largest brokerage operation is very serious business with equally serious consequences. The primary concern ...

Defaults on Derivatives

We've lost count of how many times the authorities have virtually sworn on a stack of Bibles that "our financial system is fundamentally sound."

But no one could possibly lose count of their recent desperate efforts to prevent the system's collapse — actions which directly belie their words:

One — the coordinated efforts by central banks to flood the global economy with liquidity in the summer of 2007.

Two — the hasty bailout of Bear Stearns in March of this year.

Three — the giant Fannie and Freddie rescue announced just eight days ago.

Each time they intervene, they say "we must not reward CEOs who deceive the public and walk off with multibillion dollar bonus checks." And each time they say it's the "last time we'll make an exception to that rule."

But then they go ahead and do it anyhow, not only breaking their own word ... but also trashing the long tradition of restraint established by their predecessors since the Great Depression.

Why? Because they had neither the courage nor the audacity to confront Wall Street's ultimate nightmare: A collapse in the giant mountain of derivatives.

Derivatives are essentially bets on interest rates, foreign currencies, stocks or specific events like the bankruptcy of a particular company. The interest rate-related bets are by far the biggest. But the bets on bankruptcies — called credit default swaps — are the fastest growing and the most volatile.

These derivatives were originally designed to help hedge investments reduce risk — like insurance policies. But in practice, they've been increasingly used to leverage investments, increasing the risks of participants.

Here are some essential facts that illustrate the enormity of the problem ...

* The amounts are absurdly large. The total "notional," or face value, of derivatives held by U.S. banks is $180 trillion, and it's three times that much globally. This figure is said to overstate the actual market risk. But it does not overstate the risk of defaults such as those that could be triggered by the failure of a company the size of Lehman Brothers.

* Over 90% of all derivatives are traded outside of regulated exchanges. Consequently, other than very general information, the authorities have no mechanism for keeping track — let alone efficiently cleaning up the mess in the wake of a giant failure.

* Off the balance sheets. Some companies report nothing more than the total value of their derivatives in footnotes to their financial statements. Others don't report at all. Consequently, the actual risk, amounts and even the very existence of derivatives is often poorly disclosed to investors.

* Disclosure in the brokerage industry is especially bad. Many brokerages are private and do not disclose more than their rank and serial number. The SEC collects sparse data and does not publish it. So if you want to figure out how much derivates risk your broker is exposed to, good luck! Getting the information can be like pulling teeth.

Big Banks Risk All with Danger of Defaults on Derivatives

* Concentrated in the hands of five major players. Nearly 97% of all U.S. bank-held derivatives are concentrated in the hands of just five major U.S. banks — JPMorgan Chase, Citibank, Bank of America, Wachovia and HSBC.

* Far larger than assets. As you can see in the chart to the left, the pile-up of derivatives greatly exceeds the total assets of the firms. At the same time, in most cases, the default risk related to these holdings greatly exceed the banks' capital.

* Big brokers are also loaded with derivatives. Merrill Lynch has $4.2 trillion. Morgan Stanley has $7.1 trillion. As best we can determine, Lehman Brothers has significantly less — $729 billion. But in proportion to its dwindling capital, its exposure seems to be among the worst.

* The capital of major firms has been further weakened by recent losses and the failure to raise enough capital to cover them. The chart below tells the story in a nutshell:

Recent mortgage and credit losses greatly exceed new capital raised

Consistently, in bank after bank, the losses suffered from the mortgage and credit crisis have exceeded the amount of new capital they could raise. This was true when investors still had confidence in their ability to overcome the difficulties. It's even more true today.

Here's the great dilemma: The tangled web of bets and debts linking each of these giant players to the other is so complex and so difficult to unravel, it may be impossible for the Fed to protect the financial system from paralysis if just one major player defaults. And if Lehman is not that player, the next one will be.

To understand why, put yourself in the shoes of a senior derivatives trader at a big firm like Morgan Stanley (which has $7.1 trillion in derivatives on its books and about $10 billion in capital).

Let's say you're personally responsible for $500 billion in derivatives contracts with Bank A, essentially betting that interest rates will decline.

By itself, that would be a huge risk. But you're not worried because you have a similar bet with Bank B that interest rates will go up.

It's like playing roulette, betting on both black and red at the same time. One bet cancels the other, and you figure you can't lose.

Here's what happens next ...

  • Interest rates go up, reflecting a 2% decline in bond prices.

  • You lose your bet with Bank A.

  • But, simultaneously, you win your bet with Bank B.

  • So, in normal circumstances, you'd just take the winnings from one to pay off the losses with the other — a non-event.

But here's where the whole scheme blows up and the drama begins: Bank B suffers large mortgage-related losses. It runs out of capital. It can't raise additional capital from investors. So it can't pay off its bet. Suddenly and unexpectedly ...

You're on the hook for your losing bet.
But you can't collect on your winning bet.

You grab a calculator to estimate the damage. But you don't need one — 2% of $500 billion is $10 billion. Simple.

Bottom line: In what appeared to be an everyday, supposedly "normal" set of transactions ... in a market that has moved by a meager 2% ... you've just suffered a loss of ten billion dollars, wiping out all of your firm's capital.

Now, you can't pay off your bet with Bank A — or any other losing bet, for that matter.

Bank A, thrown into a similar predicament, defaults on its bets with Bank C, which, in turn, defaults on bets with Bank D. Bank D has bets with you as well ... it defaults on every single one ... and it throws your firm even deeper into the hole.

So now do you understand why bookies belong to the Mafia and why gamblers who welsh on their debts wind up at the bottom of the East River? It's because defaulting gamblers are a grave threat to the entire system, just like Lehman Brothers is today.

Now do you see why the $180 trillion in U.S. derivatives, supposedly overstating the true risk, is actually a lot riskier than almost everyone cares to admit? It's because defaulting banks or brokerage firms are also a grave threat to the entire system.

And now do you understand why Mr. Bernanke and Mr. Paulson are probably bluffing?

Don't let them fool you. The Lehman Brothers debacle is a far greater threat than anyone has dared tell you. And if you haven't done so already, you must take the urgent defensive action we've been recommending day after day, week after week.

Is this the death knell for derivatives?
If this is the death of Wall Street as we know it, the tombstone will read: killed by complexity. Derivatives in their baffling modern forms – collateralised debt obligations, credit default swaps and so on – lie at the heart of the failure of Lehman, Bear Stearns, Fannie and Freddie, and even our own Northern Rock.

The philosophy that underpins the growth of derivatives is the idea that risk can be transferred to institutions more able to take the strain. In theory, it's a terrific scheme – the weak can get rid of risks they can't handle, and the financial system should be stronger as a result.

The practice is very different, as Warren Buffett worked out years ago. His 2002 letter to his Berkshire Hathaway shareholders made headlines by condemning derivatives as "financial weapons of mass destruction". The passage comprised only a couple of pages of the lengthy letter but read it again today - it is the best guide to understanding how Wall Street has arrived at today's mess.

Here is Buffett on General Re Securities, a derivatives dealer that Berkshire inherited with its purchase of insurer General Re. "At year-end (after ten months of winding down its operation) it had 14,384 contracts outstanding, involving 672 counterparties around the world. Each contract has a plus or minus value derived from one or more reference items, including some of mind-boggling complexity. Valuing a portfolio like that, expert auditors could easily and honestly have widely varying opinions."

Now consider Lehman Brothers balance sheet. On page 62 of last year's accounts, under the heading "off balance sheet arrangements" you will find a staggering figure. Lehman had derivative contracts with a face value of $738bn.
The notes, fairly, make the point that the fair value is smaller than the notional amount – Lehman believed the figure was $36.8bn. Even so, "mind-boggling complexity" perfectly describes Lehman's business

How can you hope to sell such a business over a weekend? You can't, unless the state is willing to underwrite the risk. This time, the US Treasury, said "no". Quite right, too: the US taxpayers are on the hook for too much already.
Complexity breeds other faults, as Buffett described. Derivatives, because they are so hard to value, make it easier for traders and chief executives to inflate earnings.

They exacerbate problems if a company, for unrelated reasons, suffers a credit downgrade that requires it to post collateral with counterparties – "a spiral that can lead to a corporate meltdown," he wrote. They create a "daisy chain" of risk as the troubles of one company infect another.

Buffett made a gloomy prediction half a decade ago. "The derivatives genie is now well out of the bottle, and these instruments will almost certainly multiply in variety and number until some event makes their toxicity clear," he said. "Central banks and governments have so far found no effective way to control, or even monitor, the risks posed by these contracts."

That event has duly arrived. Lehman Brothers has declared bankruptcy. Merrill Lynch has rushed into the arms of Bank of America. AIG, once the US's largest insurer, is pleading with the Fed for funds. Unwinding a big derivatives book is no easy task - like Hell, derivatives are easy to enter and impossible to exit, said Buffett.

That's why the failure of a firm the size of Lehman presents such a risk to the financial system – we don't know how many other firms will be brought down as the body is extracted from the financial web. In the long run, though, financial regulators must now know what must happen: it's time for them to bring down the curtain on the era of opaque financial derivatives.


goritsas said...

One interesting point about the financials here is the second beating HBOS is taking. The last time it lead to a probe by the FSA. But, here we are again. There must be a whole lot more than meets the eye on this one. I wonder if we’ll see the end of HBOS as we knew it. There’s no way Brown or Darling would allow it to belly-flop.

Anon of Florida said...

CNN Ticker saying that "The Federal Reserve keeps key short-term interest rate unchanged at 2% despite investor hopes for a cut."

FB said...


Westexas (welcome) yesterday mentioned the "Generally Assume the Opposite Theory".

That is certainly true in Germany where Steinbrück (finance minister) today heaped scorn on those who fear a simple recession.

I expected better of him. Oh well.


Jenks said...

Re the AIG situation.


AIG are suffering a 'run on the Bank' - even though they aren't a Bank..
"In Singapore, hundreds of anxious investors thronged the office of an AIG unit to redeem their policies."

Anonymous said...

"It's better to be a dog in a peaceful time than be a man in a chaotic period."

Anonymous said...

This is an amazing site! I've never seen anything quite like it.

Let me ask a few simple questions:

How do these impending world-spanning financial disasters directly impact the day-to-day lives of Americans?

What do we have to look forward to?

Just how bad is it going to get for Joe Everyman?

Are we looking at a New Great Depression?

Anonymous said...

Anon of Florida: I think they simply can't go much lower.

Anonymous said...

it surprised me that DJIA ends in green after that all

rumor said...

Stoneleigh, speaking as a Canadian, it's nice to see you weighing in on Canadian sites as well. Spotted you over at greaterfool.ca.

You and Ilargi keep up the good work. I'll be dropping you a donation next month when I have some spare cash. In the meantime, accept my ongoing thanks for all the clarity you both provide.

Stoneleigh said...


How do these impending world-spanning financial disasters directly impact the day-to-day lives of Americans?

They mostly haven't yet, but they will. Credit contraction and losses in the financial world lead to economic contraction in the real world, and then later to unpleasant political consequences (a xenophobic blame-game and repressive central control).

What do we have to look forward to? Just how bad is it going to get for Joe Everyman?

It's going to be a very rough ride, to put it mildly. People are so far in debt, and the value of their assets is about to plummet at the same time as they lose the jobs they need to keep making debt payments. They're going to lose access to credit as well and benefits and entitlements, just when they need them most. They may well also lose their savings (if they have any) to bank failures and their investments to a market crash.

Here's the advice I give to people who want to know how to avoid losing their shirts over the next couple of years:

* Hold no debt (for most people this means renting)
* Hold cash and cash equivalents (short term treasuries) under your own control
* Sell equities, real estate, most bonds, commodities, collectibles (or short if you can afford to gamble)
* Don't trust the banking system, FDIC or no FDIC
* Gain some control over the necessities of your own existence if you can afford it
* Be prepared to work with others as that will give you far greater scope for resilience and security
* If you have done all that and still have spare resources, consider precious metals as an insurance policy.

See the comment thread on yesterday's Debt Rattle for far more detail (it was a long post and I don't want to copy the whole thing over to today's thread).

Are we looking at a New Great Depression?

We are looking at a Greater Depression. The global integration of financial markets will propagate risk and contagion. Money will be extremely scarce once credit is no longer available, meaning that purchasing power will be very limited. The few people who still have money will be able to buy things for pennies on the dollar, as there will be so many desperate sellers and very few buyers.

Stoneleigh said...

Thanks Rumor :)

Garth Turner's site is a must-read for Canadians. If I lived in his constituency, I'd vote for him. It's really rare to find a politician with a lively and independent mind, and the courage to speak it.

Anonymous said...

I just heard that AIG may be taken under government control like Fannie and Freddie. Can anyone say what the result of that would be?


Anonymous said...

Stoneleigh, I understand and agree with most of your advices, but one:

Hold cash or cash equivalents: which currency?

With current crisis on Wall St., in particular AIG is underwriter of a big part of "muni" debt, so that means that these cities / hospitals / electricity coops, etc. are going to come down, and THAT is a real physical world crisis!! And if the FDIC fails after the failure of WM / Wachovia / whoever else is on the list, I would say that chaos will follow.

So I am not sure that holding US Dollars or US treasuries is a safe bet, the currency as such is also going to deflate, compared to other currencies.

Can you comment on this?

scandia said...

igz, I recall a comment on TAE( Ilargi's I believe) that events will overtake whatever Paulson and Bernacke do. I have noticed the word " fear" is now being used by MSM. We are long past concern,worry,anxiety...Raw fear it is.
Read just to-day that the Russian market experienced a fear driven collapse then closed.
What will to-morrow bring....

/thehangedman/ said...

"I just heard that AIG may be taken under government control like Fannie and Freddie. Can anyone say what the result of that would be?"

Maybe America's realization that the natural state of affairs is a mixed economy, like every other society composed of Homo Sapiens?

Just a thought.

Stoneleigh said...


Hold cash or cash equivalents: which currency?

For most people, the answer is to hold your own country's currency. Otherwise you are taking on currency risk and incurring transaction costs. High-flyers with lots of money to deal with may well choose specific non-domestic currencies (perhaps yen or Swiss francs), but for most it wouldn't be worth it.

For the time being the US dollar should hold up against other currencies anyway, although the same may well not be true in the longer term. The dollar has been rallying since March, and although a counter-trend pullback seems likely, the larger rally should last for months at least.

The dollar benefits internationally from a flight to safety, as improbable as that may sound. As the long-standing reserve currency, it becomes a knee-jerk safe haven in times of uncertainty and upheaval.

The main point, however, is that domestically the dollar will increase enormously in value in comparison with available goods and services. In other words, if you still have money, you will have much greater purchasing power than you have now.

Stoneleigh said...


Fear is indeed building up, but in comparison with what's coming, we haven't seen anything yet. We're very close to a market cascade and that will involve panic selling.

A huge amount of assets are going to end up in a firesale as a result of the Lehman's bankruptcy and the approaching failure of AIG, among others. That kind of mark-to-market event will devalue whole asset classes at a stroke, forcing another round of writedowns and sending more companies to the wall.

Losses on that scale will ricochet through the financial system like an out-of-control nuclear chain reaction. Like a reactor, the result will be a meltdown.

Anonymous said...

AP Sources: $85B gov't bailout of AIG likely

Anonymous said...

Bailout of the huge insurer AIG, people with knowledge of the situation said Tuesday, in a bid to avoid further market upheaval.

The people said an announcement from the government about the plan was expected by 9:30 p.m. EDT.


Anonymous said...

Market Ticker

Karl Denninger at 18:46


Anonymous said...


Bailout out by the Treasury 9:45 EST


Anonymous said...

Heaven help us all.

Anonymous said...


Shameless predatory capitalism ...


Anon of Florida said...

Wow, bailouts, mid week? This is bad. May I add an Orlovism? Orlov writes on how for a soviet apparatchik, bread riots were absolute calamities that were to be avoided at all costs, for both their pragmatic threat to the local Party, and the symbolic threat to the legitimacy of the Communist party. I think that for the Capitalist party (whether republican or democrat, different flavors of the same shit), the equivalent would be either bank runs or their equivalents. These are absolute calamities to these American apparatchiks, for their practical consequences(tax base evaporating into ether), and for their symbolic threat to the capitalist order.

Ilargi said...

Tonight, and I'm sure this is worse than blasphemy, while looking at the Fed deal for AIG, with all the politicians that matter gathered in one room, arriving at a $85 billion bail-out for a firm that carries trillions in liabilities, I am wondering about the legal status, the legitimacy if you will, of the US government.

Not the Bush White House, no, the entire structure, Congress, Senate, the works. That gathering tonight, with everyone who counts in Washington, resulted in an outcome that won't be able to hold off a category 0.0001 storm in the market. But the magnitude of the setting makes it very clear that this is all they have.

So we have a government that has for all intents and purposes lost control of its economy. And that's what I'm thinking about: what exactly is the legal power of a government that has no control left over its economic system?

I don't pretend to know, but I do know it's a legitimate question. The political consequences of events unfurling the way I now think they must can't be anything short of shattering. Pretending to be in control can last for a long time, but there is an end. And what do you have when you reach that end?

marianne said...

I am not sure how to go about transferring my bonds, equity, registered mutual funds into ST treasures. I also have proceeds from the sale of my house in a MM fund - all held at a very well respected investment house.
Do I go to my bank to have stuff transferred? And where do I go to get precious metals - a discount broker?
This may sound naive, but I've always (well, since I've saved some money) dealt with an independent financial planner. I have no knowledge - like all of you re: investing - and it gets very complex.
It is sort of like any of us trying to perform cardiac surgery on someone - we wouldn't know what we were doing, so we'd leave that to the heart surgeon.
I want to get busy and do this asap.
Thank you.

dlowe said...

I am with ilargi with regard to the immediate effect of the AIG announcement on what passes for government. It appears from the news reports so far that the executive and legislative branches are no longer able to function with regard to the Fed (not a government agency) ...Rather it seems to me that that banking cartel *might* have effectively completed a sort of coup of these two branches of government ... Essentially, the bankers are now firmly in control of the public purse, and have rapidly morphed private capital and the public sector into some sort of Franken$tein monster.

So ... a crisis of legitimacy cannot be far behind for the national government in the US. How *that* will play out is anybody's guess.

Frankly, I am still trying to get a decent theory as to what the consequences of these actions by Da Boyz will be ... I think I have the deflation bit ... but how this will all warp the national government and the services it provides, I haven't a clue -- although I wonder if this makes it more difficult for USG to sell bonds and access more credit on the international markets?

Although, I guess this means that they don't have to. The Fed may now print money with wild(er) abandon, and no worries about oversight by USG. Sticking it into every bleeding, pestilent orifice these companies have or will develop. In the end though, I am not sure that will put any additional cash in consumer wallets ... some of these companies may survive as a result, but surely the consumer economy is going to take a pretty hard hit (no access to $$ to buy stuff)

Anonymous said...

marianne, What are the capabilities of that financial planner of yours?

The ones I have dealt with would be able to do all you ask.

If yours is unable to do the things you wish, such as buy treasuries for you, I would look for another one that offers full services. You could try a larger credit union if you do not wish to deal with a bank.

rachel said...

Ilargi: thank you for your blog.
Goodnight and Goodluck

dlowe said...

Here's the NY Times reporting on the state of our government in this crisis:

"Representative Barney Frank, Democrat of Massachusetts and chairman of the House Financial Services Committee, said Mr. Paulson and Mr. Bernanke had not requested any new legislative authority for the bailout at Tuesday night’s meeting. “The secretary and the chairman of the Fed, two Bush appointees, came down here and said, ‘We’re from the government, we’re here to help them,’ ” Mr. Frank said. “I mean this is one more affirmation that the lack of regulation has caused serious problems. That the private market screwed itself up and they need the government to come help them unscrew it.”"

Anonymous said...

That the meeting was w/o any of the staffers worries me alot....they want to keep a lid on this shit-storm until all the right people get out.Its what other topics they talked about that got me a bit spooked..some plans that we,as citizen might not care for.

I don't think they will keep the lid on 'till the election.I think in the next few weeks bad,bad things will start to move faster than the clowns can...

[I remember the clowns who would keep china plates spinning on top of sticks...the trick was to see how many he could keep up,as they would each need attention...the most I ever saw was like 18-20...and at the point when he could keep no more up...they all came down into 10,000 bits and pieces.The plates are all coming down now.....]

Your thought about the 'legitimacy' of our government gave me pause.Many have said that our leader has been 'selected', not elected and thus has from the day of his swearing in,not acted "legally".

Mr.Bush may well go down in whatever history is recorded,be it electronic[I hope]or by the chants of "Those who Remember"[if it goes badly]as the singularly worst leader our country has ever had.

I have to admit to a certain amount of fear in my own soul ,mostly put there today by a small quirk in the system.

I purchase PM from a little coin shop that has been at the same place for 30 years,with the same small,wizened man.I had a few hundred that I decided would be going into long term savings,so I called to find the price of 10z slugs,and pick up a few on the way home.Wrong.He has 6 back orders and has not a clue when he will see more.No physical.[He had a few gold 1/10th.liberties but the premium sucks on those.]He said this was the first time he had ever seen this happen...ever

That spooked me.Just a bit.This is not news on the net,or rumors ect...this was NO physical.

Now explain to me where it says that the treasury of the usa can bail out insurance companies,stock brokerages...pretty much anyone who is on Paulsons 'goodguy' list.The last time I looked,the power of the purse was held by congress...

This is all so twisted and sick.When I think of all the greedy bastards that have spouted the "wisdom of the market"B.S. for years...and Greenspans aggressive inflation of all the bubbles...and his evil actions to insure the working folks of this country didn't get "too comfortable"...

Now the greed and corruption are now coming out in a huge blast,and it looks like its going to take a lot of the whole system with it.
Well,It looks like that one conservative commentator/activist who wanted to get the government down to the size it could be "drowned in a bath tub" is going to get his wish.I think a lot of this whole worlds financial system is getting the same type of treatment Galveston Texas just got.

What I dont think he understood was that the process that wiped out a whole lot of the .gov[deregulation],also took out
a very big chunk of the world incestuous cannibalistic capital financial systems,['cause they were all in each others pants]

There is usually good reasons for most laws,rules,and regulations,as any average person can tell you...sometimes bad things happen when they are repealed

60-or 70 years from now,when were dead,and they are getting ready to "do away with" what ever laws they enact to deal with this current financial crisis,I hope the trail is clear enough to see the stupidity of allowing banks and brokerages to mix business.....this would be the 3rd time that mistake has been made


scandia said...

Stoneleigh, the reactor metaphor is apocalyptic! I have been seeing that the natural outcome of prolonged opague conditions is fear. As a species we do not well tolerate extended uncertainty.
This fear I feel is in my gut. It is not a thing of a reasonable mind. Kind of " primal".

goritsas said...

Regarding HBOS mentioned above, now we know why!

HBOS in merger talks with Lloyds

HBOS and the BoE and the Brown government are such piss ant liars.

The whole lot deserve to have the granite counter top experience so eloquently described by Kuntsler.

goritsas said...

This whole HBOS LloydsTSB thing really smells. There’s the £4Bn rights issue. Then there’s the short beating HBOS took a few weeks back. Then the PR campaign chief executive Andy Hornby has been busy on, telling all and sundry everything is just peachy, we’ve learned many valuable lessons, this won’t happen again, blah, blah, blah.

There’s also the reports of HBOS and the BoE’s King supposedly having meetings about the future of HBOS borrowing requirements, these were roundly denied. Then the second big short beating comes along and, boom, next day, not only are there discussions about a merger, but the discussions are well advanced. This wasn’t something they just came up with out of the blue.

Then we’re told the announcement could come as early as tomorrow.

If these two shit holes couldn’t survive alone, how’ll they survive together? Now, instead of needing £4Bn in new capital, they’ll need £10Bn. Not to mention the inevitable “streamlining,” meaning job losses. How many? Who knows. But one thing is for sure, every HBOS location also has a branch of LloydsTSB. Do they need two branches? Likely not.

What the hell is going on? Why aren’t we all out with pitchforks breaking into home counties estate houses and slamming these arseholes down on their granite counter tops and giving them a reaming they’ll remember long after they stop breathing?

Folks, this is bad, real bad. No matter what the financial elite do, no matter what they say, this is spreading and it’s spreading fast indeed. What’s even weirder, the financial economy is feeding upon itself. These people are insane. That’s the only way to describe them. Sure, a few of them will get out. Sure they’ll be well rewarded. But, there’s going to nothing left of global finance. They’ll have consumed themselves and all that will be left are the bones the rest of us will be expected to knar upon.

What’s even more weird than even weirder, we have only ourselves to blame. We did this. We did nothing to stop Reagan and Thatcher selling off everything to their criminal friends in The City and on Wall Street. We did nothing to halt the ever widening corporate influence infecting and corrupting our governments and our supposed representatives. Say goodbye to your pensions. Say goodbye to your savings. Say goodbye to heat and light and 3 thousand mile Caesar salads. Our world is being transformed before our very eyes and collectively we see nothing. Not a damned thing.

Bigelow said...

Russian bourses halt trading for second day

marianne said...

I am not sure what this financial planner can do. He is independent of the company he works with - an independent investment house that only sells mutual funds (their own - similar to PH & N, but not them).
I work in health care, am doing 12 hour shifts and up at the crack of dawn to do another day shift. (doing lots right now as we don't get holidays, so have to trade shifts then work a gruelling number in a row to get time off). Ilargi's current news has me freaked more than anything else I've read.
I have Monday off, so need to know if this FP won't do anything, I march to my own tune, but where do I go?
This sounds sad, but I do need some advice. Will the banks go bust, or is it okay to go to BMO or should I go to Wood Gundy or similar places?
Any suggestions would be appreciated.
Thanks very much.

Anonymous said...

“The financial press this morning reports that Daniel Mudd, the retiring CEO of Fannie Mae, is leaving with a severance package of approximately $9.2 million. Richard Syron, the retiring CEO of Freddie Mac, is leaving with a severance package of approximately $14.9 million.

I remember sitting in a meeting at HUD when the coinsurance program was being canceled. One senior official expressed concern when the general counsel suggested that we abrogate our contracts to companies that were preforming well. His point was that the agency had legally valid and binding contracts with these companies. The general counsel said something like, “F*ck ‘em. Let ‘em sue us. By the time they win in court, we will be gone.”
So if Mudd and Syron are being allowed to keep their severance packages while thousands, if not millions, of Americans are losing their jobs and their homes, there is a reason. Given that Fannie Mae and Freddie Mac have now cost shareholders $100 billion, bankrupted households and communities through the country, terrorized investors globally and stuck the U.S. government with responsibility for $5.4 trillion in debt, you would think there would be a basis for a few offsets against severance agreement payouts.
Or…perhaps Mudd and Syron are being paid for a job well done, which would include remaining silent about what exactly that job really was.”
Fannie and Freddie Become Penny Stocks - Part V, C.A. Fitts

/thehangedman/ said...

AIG was "too big to fail", but Lehman's wasn't. So we know the brackets on that parameter. :)

Was AIG a major player in the financing of energy projects? Maybe "no AIG" = "no drill, drill, drill".

Anonymous said...

I saw Orlov mentioned above and have been thinking for the past few days - could the events unfolding before us and those predicted here be later described as the "Collapse of Capitalism"?

Much like the fall of the USSR is described as the Fall of Communism.

Many say that the communist system employed by the USSR was perverted and not a true example of how a communist system should function.

Is it possible to say the same thing now about our Capitalist system?


OuttaControl said...


Maybe it's a good time to take a mental health day ;)

If you don't have a few months supply of cash on hand, now would be the time to do that. Call your bank first and let them know. They don't keep much on hand.

Keep the rest in plain old cash. On October 6, buy Canada savings bonds and keep the certificates at home. For your RRSP, if you have one, you can't do much unless you want to take the penalty. But have everything in your RRSP in cash. We are almost getting to the stage where I'm considering doing just that; losing 50% off the top just to rescue it.

You may have seen a comment I wrote about my DB pension plan last week. I figure it's down about 8% last week. The pension is bigger than the company I work for. It was already actuarially insolvent before the market went down. If you're under 50 and your pension is like mine, you have options. This is a good time to find out all about commuted values,locked-in RRSPs and new rules in Jan that allow you to rescue those funds, albeit slowly.

If you want to know more about what I've done - and plan to do - email me at outtacontrol at ymail dot com.

OuttaControl said...

Wow, no naked shorts on anything.


goritsas said...


I'm not sure why you're gulping. Naked shorting has always been against the (unenforced) rules. You've always been required borrow the shares before you short.

OuttaControl said...

The enforcement is the gulp.

No, it won't do anything. It's pathetic, really. It just shows how desperate things have become. Even if they forbid shorting altogether, the options market can be used to bring things down, like Denninger said last night. And if they shut down the CME? Plain old selling will probably do it.

goritsas said...


Even if you exercise your put option, you're still supposed to have the shares before you sell. At least the way I remember this all works. If you don't have the shares and you exercise your option, you're still naked shorting.

When you say CME, are you talking about index options?

OuttaControl said...

Er, make that the CBOE. I'll admit I was talking out my a$$ there a little.

I guess what I'm saying is that this smells of desperation. They can shut down the stock markets entirely like the Russians but, unless they never want to re-open them, that too will fail. I think the options to instill confidence are running a little thin.

Do you think the prohibition on naked shorts will help? Or anything?

CrystalRadio said...

Forest said:

Many say that the communist system employed by the USSR was perverted and not a true example of how a communist system should function.
Is it possible to say the same thing now about our Capitalist system?

Forest, you big silly, of course not, our Capitalist system always was perverted and as well a true example of greed rampant and very successful at that.
Hey OC, I wouldn't worry about that, we all talk out of that end at times and a good thing too or we wouldn't learn anything, and anyway
Maybe it's a good time to take a mental health day ;)


CrystalRadio said...

Just on CNN Treasury to shore up Fed balance sheet.

n said...

outtacontrol said:

On October 6, buy Canada savings bonds

Why buy these specifically? They're more likely than other investments to be worth more than the paper they're printed on? Because of the rate?

OuttaControl said...


No, not because of the rate. The rate will be low. It's because gov't debt won't fail before its banks. Will some Cdn banks fail? Possibly, perhaps probably. I don't know which one(s). But, if my bank fails, I don't want to line up to get my money. If I have a piece of paper guaranteed by the gov't, I can go to any bank that's open, and get cash.

It's the return of principle rather than the return on prnciple.

By the way, I've been asking others what they thought of this strategy for a while on this forum and no one has offered any significant criticism yet. But I'd still like to hear any thoughts, particularly if they're negative.

CrystalRadio said...

Marrian said:

independent investment house that only sells mutual funds (their own - similar to PH & N, but not them).

I take it from the PH % N you are Canadian likely in Vancouver? , If your financial planner can't handle all you feel you need to do I would go to the nearest credit union and ask their financial advisor to handle your things (quite an easy process to move your accounts). Wood Gundy or Odlum Brown if you prefer but you must be firm in what you want,
all these guys want you in the market not on the sidelines but will do your bidding if you are firm. If by any chance you are living in Vancouver Van City might be good to give a phone call to.

You will likely have redemption fees but a lot of what you have might be taken out on a no tax basis, get that figured out first and see what's left and decide on risk verses taking a hit.

rumor said...

I'm in favour of shunting investments into Canada Savings Bonds, as well. For myself, I'm shifting my RRSPs (currently in GICs at a big bank) over to them next month. Short of taking the money out and burying it in a hole, this is the safest option for reasons OC already went into.

rumor said...

I should add that savings bonds can be registered, so you pay no withdrawal tax on moving RRSPs from a bank into the bonds (depending on your bank/investment institution, though, they may charge you an unrelated private removal fee).

n said...

outtacontrol said:

I can go into any bank that's open, and get cash

Any bank? Or any Canadian bank?

Forgive my ignorance on the subject, but I'm unclear as to whether the generic US bank down on Main St will redeem it.

OuttaControl said...


I assumed you were Canadian asking about CSBs. If you're American, I'm not sure whether you can buy CSBs or whether you'd be able to do much with them in the US if you could but them.

BTW, everything I say is for entertainment value only and not to be taken as financial advice. I'm a bit of a retard, actually. Having said that, Americans might want to consider treasurydirect.

n said...


I think I can buy them online. Redeeming them might be an issue - not sure.

No way I'm buying US Treasuries. Confidence Meter pegged at ZERO.

CrystalRadio said...


Just a note on how I am positioned at this moment.
All stocks gone, 10% money market ( holding for a soon happening anniversary date) 15% Treasuries, 10% GIC's and the remainder in several bank accounts,

Will be looking at Canadian Savings bonds in October, not sure how I will structure them as there are several options that look good for different reasons.

This has been a bit of a slow waltz for us as a year ago we were fully invested in Mutuals and stocks and have had time to move a little slower than you will need to. The Polka can be fun though.

Get those professionals working for you as you sound like you have a plate full as it is. Good luck

Anonymous said...



How long before the Bond Market says, "go to Hell"?

How long before our Treasuries are worthless?

At the current rate of change, it may only be a matter of months...

Anonymous said...

S&P’s Chambers: says pressure is building on the AAA US sovereign rating
- says the AIG bailout weakens the US fiscal profile
- says the ratings remain stable
- says the AAA rating is not a “god-given gift”, the AAA rating must be earned, it is not guaranteed


OuttaControl said...


Just a words of advice on professionals. A professional would make little commission on a cash account or CSBs or anything like that. Ergo, if your professional is like the one my in-laws used, he/she will sit you down and say "give your head a shake. Trust me. Markets go up and down. This is a long term thing and, long term, things always go up".

After the stock market high in 1929, its subsequent crash was not recovered until 1954. I'm told this crash will be worse than 1929. So unless you have at least 25 years to ride this out, I'd just sit in cash. And you don't need a professional to try to convince you otherwise. Your professional is likely fighting for his/her financial life right now or maybe his/her company is. No-one on this board has anything to gain or lose from anything you do and yet we're all pretty much saying the same thing.


robert said...

if you think treasuries will become worthless, what's the point of sitting on a bushel of green paper?

goritsas said...

I think many of us are forgetting all this is happening in other countries as well. The dollar isn’t ready to die yet, at least in the medium term. If you’re looking for a “safe” currency, what are your options? The Euro? The Yuan? The Rouble? A Middle East currency? The dollar may only be backed by the full faith of the U.S. government, the financial system may be in the pan and ready to go down, but as currencies go, there aren’t a lot of options.

The U.S. is still a very rich nation. It has immense arable land acreage. It has vast timber forests. It still produces 7 million barrels of oil a day. It has large navigable rivers and an extraordinary coastline. In the Great Lakes it has a vast fresh water resource. While much of its infrastructure may be in various states of decay, it still has a fully functioning road network, the possibility of a resurrected rail network, and ports all along the ocean coastline, as well as the inland navigable waterways. It also has a capacity to defend itself unequalled by any other country in the world. This is not a nation that needs to fail, it’s a nation that will choose to fail.

Compared to the EU, for example, the U.S. is a sovereign nation. The U.S. dollar is a sovereign currency back by a sovereign nation. The EU is already showing cracks. The Euro is only a decade old and has never been tested. The manifold crises in the PIGS (Portugal, Italy, Greece, and Spain) may very well bring the downfall of the Euro. China (and India) has far to many people and will be unable to feed and power their population. Sure, they’ve had a good run, but I doubt it’ll last. Beyond a generation. Russia is slowly returning to its cultural roots and will become some ugly hybrid of Czarist Russia and the FSU. While Putin may have succeeded in reigning in the Oligarchs, the Russian Federation never replaced its failed infrastructure and is living on the power it exerts through its large fossil fuel reserves. Domestically it’s controlled by some bizarre combination of the Mafia and Putin. How long can that last? How stable can that be?

The U.S., as every other western nation, is going to undergo a radical transformation in its financial structure. This will very likely produce some radical changes in its political structure. But of all the nations out there, the U.S. has not only a vast reserve of natural capital, it has an unparalleled reserve of human capital. I’d be rather circumspect before I write them out of the book.

Anonymous said...

This is too sweet ... an oxymoronic entry for today's Debt Rattle?


Ishmael said...

How's this for bad news:

The Federal Reserve has gone broke and is out of money. The Treasury is creating an emergency loan for the Fed.

Pretty sweet, huh?

CrystalRadio said...

Right you are OC, One must state clearly to one's financial advisor (in writing if necessary) that ones risk tolerance is zero. They will move one to cash as quickly as one likes or risk the loss of a client and all those future good returns that will happen when the sun shines and the birdies sing again. I suggest Credit Union Financial people as they are not by a long shot as dependant on commissions as the usual full service broker so much easier to talk about such things with.

Stoneleigh said...


Large-scale socioeconomic structures never work in practice as they should in theory, as the abstract models neglect the human element. Moreover, any system that has lasted a long time eventually becomes rigid and sclerotic due to the power of vested interests. Capitalism and communism are not so different in any case - both are ultimately utopian projects destined to fail.

The fall of the Soviet Union has many lessons for us, as Orlov has ably explained. However, I don't think Orlov really understands the monetary system, which hampers his ability to draw economic distinctions.

The Soviet Union was not a credit-based society - in fact most people had no access to credit whatsoever (no mortgages, credit cards etc). They also had a fundamental distrust of banks and tended to keep their money in their mattresses. As their system was collapsing, people kept their jobs, although they were payed months late if at all. Their purchasing power didn't generally disappear quickly - it petered out as their savings were depleted. Then the government reissued the currency, deliberately crashing the money supply by making it very difficult for ordinary people to convert to the new notes (ie smoking out the money under the bed). The small 'middle class' was mostly ruined.

In the North America and Europe we're facing a credit crash and a systemic banking crisis, where people's purchasing power is likely to disappear much more quickly. Very few have savings (since they've relied on the perennial availability of credit), and even fewer have them outside of financial institutions, so there would be no need to 'smoke out' hidden reserves as there mostly aren't any.

Actual money will be worth a lot when assets are selling for pennies on the dollar.

n said...

Robert said:

if you think treasuries will become worthless, what's the point of sitting on a bushel of green paper?

I don't know that they will, but I'm not willing to bet on it for a very small return.

Seems to me, the guy down the street selling apples is more likely to take a green piece of paper that says 10 than a white piece of paper that say 1000.

robert said...

N, more likely he'll take a wheelbarrel full of tens for a perfectly good apple. The government can and will print unlimited amounts of cash before they'll default on treasuries.

n said...


What is the point of a treasury note? It's a very safe investment that earns next to nothing, no? If it ceases to be very safe, then I say why bother.

robert said...

not giving out investment advice. It just strikes me as silly to sell your T-bills in order to sit on wads of cash. Now if you want to buy gold (which went up $90 today) or collectables at least there's a rationale.

If you pull a dollar bill out of your wallet you will see it says it is a federal reserve note. Which is to say an IOU from the federal reserve.

robert said...

What I'm trying to say is that the T-bill and the dollar bill are both debts of the central government. Just because you handle one every day, and the other is kind of mysterious, doesn't make one safer than the other. I'm not trying to talk anybody into or out of any particular investment.

n said...

I understand, and agree.

I'm saying that I have cash, and trading it in for US treasuries seems like a bad idea to me.