Wednesday, September 3, 2008

Debt Rattle, September 3 2008: Unproven Reserves

Detroit Publishing Co. Old Man River 1900
Mississippi River Landing.
Sternwheeler "Belle of Calhoun" and sidewheeler "Belle of the Bends" taking on cargo.

Ilargi: Wall Street stock exchange regulator SEC has been under pressure for years to allow oil companies to put unproven reserves in their books as proven. To make its case, the energy sector points to historical "recovery" levels, where a percentage of unproven reserves actually turned out to exist.

Now the SEC is about to give in to the demands, and the timing is suspicious. Big oil has seen its reserves shrink hugely; first, because countries where the reserves are, increasingly exploit them themselves; second, because reserves overall are 'drying up'.

In spite of record profits, it should be clear that this is a severe threat to the companies. Their reserves determine share prices, as well as access to capital markets (borrowing power). So it comes at a mighty convenient time for the SEC to loosen the regulations.

Still, if the reserves we are talking about would have been of the same sort and quality as the historical ones, a certain increase in regulatory flexibility would hardly have posed much of a problem. But they are largely not the same.

We are looking at oil sands, oil shale, coal-bed methane, deep sea wells, and perhaps even hydrates/clathrates. These are all reserves -providing they deserve the label- that share a number of familiar differences with conventional oil and gas reserves.

They are technically more daunting, they take more energy to exploit, they swallow up a lot more capital to exploit, all of which poses the question whether they are even economically and energetically viable at all.

The viability of course is related to the profits that can be hauled in from marketing the resources. And profit depends on prices. If oil prices would be $150 or more through the near and midterm future, exploring some of these unconventinal reserves might be profitable. But even at that price level, by no means all of them would.

And that is where we run into the world economy’s credit mayhem, which is about to wipe out an enormous part of the purchasing power that now exists in our societies. In fact, it already has; people are just slow to realize it.

The US Center for Economic and Policy Research reports that the housing crisis has so far cost Americans $4 trillion, and that does not yet include losses outside of the domestic real estate sector. A large chunk of the richest part of the population is set to lose at the very least a third of its personal net worth.

And there is no end anywhere in sight to the depletion of capital. Neither is it a US phenomenon: this crisis, like the markets, is global. With England as a frightening worst case example, Europe is sliding fast and furious.

Asian central banks are intervening in battered domestic markets. Korea sees a shattering capital outflow, Thailand is on the verge of civil war, Chinese stock markets are a dark pit, and Japan’s prime minister has been driven out.

In the face of all these events, oil prices have so far dropped 25%. If investors keep buying US dollars into 2009, in a world economy bleeding ever more profusively, oil will undoubtedly slip back at least another 25%, and move back to $70-80 per barrel, or below.

Which is a pricing level that makes a huge chunk of the unconventional reserves unprofitable for oil companies. But they will now still be able to put them in their books as proven reserves, with all the perks that provides.

I guess this falls under the "leveling the playing field" moniker. If banks can continue to pretend the paper in their vaults has value (as long as it stays in that vault), the financial version of unproven reserves, then energy companies should be allowed to count "probable" and "possible" sources as real assets.

But make no mistake about it: oil shale and coal-bed methane have no more real economic value than CDO’s, securities, derivatives and all the rest of the toxic paper. The SEC regulatory change will simply inject more virtual and funny money into the financial system.

And the problem with that is that funny money is the cause of the collapse of the global finance system, as well as the ensuing poverty that will dominate the 2010’s and beyond. The more you add, the worse it gets.

SEC rule change could fuel energy sector takeovers
A U.S. Securities and Exchange Commission plan to overhaul oil and gas reporting rules will boost oil companies’ proven reserves, lift their shares and may even lead to takeovers. The SEC said in June it wanted to revise the rules, devised in the 1970s, saying they were based on “outdated” thinking.

The stockmarket regulator plans to allow companies to book reserves from “unconventional” oil and gas sources such as oil sands and coal-bed methane—currently two of the hottest areas of investment. Companies would also be able to book reserves at some deep-water projects that cannot currently be described as “proven”, and firms could also publish data on “probable” and “possible” reserves, recovery of which is much less certain.

“The companies will actually be able to book more reserves,” said Frederic van Parijs, Senior investment manager with ING Investment Management in the Hague. The planned reporting changes will not only apply to U.S. oil companies like Exxon Mobil but also European majors, as most report under SEC rules.

“For some companies, it would have a significant impact, particularly if they have a heavy exposure to non-traditional sources of future production,” said Peter Newman, who heads the oil and gas practice at Deloitte & Touche in London. Individual companies declined to comment on the impact of the changes but support the SEC’s move strongly through industry bodies.

The world’s second-largest non-government-controlled oil company by market value, Royal Dutch Shell is likely to benefit most among the oil majors, analysts said. The company invested heavily in squeezing crude from bitumen-soaked soil in Canada, and in extracting gas locked in coal beds in Australia and China, as it sought to rebuild its asset base after a reserves overbooking scandal in 2004.

But rivals including ConocoPhillips, Exxon and more recently BP have also bet big on non-conventionals as oil-producing countries, flush with cash from crude prices above $100/barrel, increasingly keep their richest fields for their state oil companies to develop.

Reserves bookings are an estimate of how much oil and gas a company will extract from its fields, which allows investors to calculate future cash flows and so is probably the key industry measurement investors use for evaluation purposes. The industry’s failure to grow its proven reserves in recent years has prompted investor fears for its long-term future, despite the industry’s claim that the current, restrictive classification for reserves painted too bleak a picture.

Even though a reclassification of fields doesn’t increase the amount of oil that will be recovered, it is likely to boost sentiment toward companies’ shares, Mr. van Parijs said, as it supports the companies’ argument that their performance has not been as bad as the headline numbers suggest. The overhaul could also lead to more mergers.

“We believe that these rule changes could be the catalyst for a wave of acquisitions, with those companies with the largest unproved resource bases making juicy takeover targets for some of the larger cash-rich majors,” Neil McMahon, oil analyst at Bernstein said in a research note.

Mr. McMahon cited British gas producer BG and Marathon Oil as potential targets. BG has stakes in deep-water Brazilian fields that are estimated to contain billions of barrels of recoverable oil but which may not be booked for many years under existing SEC rules. Marathon has investments in oil sands and shale, another hot unconventional source where companies crack open the shale rock with water jets to release natural gas locked inside.

On Tuesday, BP said it would pay $1.9 billion for a 25% stake in Chesapeake Energy’s Fayetteville shale assets. Mr. McMahon predicted the rule changes could apply to 2008 year-end reporting, though Mr. Newman said 2009 was more likely. The SEC opened a consultation period that ends later this month but has not committed to a timeline for implementation.

The proposed amendments will bring the SEC rules closer to European reporting standards, under which companies already publish figures for “proved” plus “probable” or “2P” reserves. Tony Durrant, CFO at UK oil explorer Premier Oil, said the SEC’s plans could encourage U.S. investors to buy into the many UK-listed oil firms.

“It should make North American investors more comfortable with our reporting because they’ll get used to seeing it in domestic companies,” he said.

Ilargi: As the country’s Arctic ice melts 10 times faster than expected, Canada’s own leading theo-conservative, prime minister Stephen Harper, is set to grab majority powers through a snap election. Since Canada’s economy will fall into a black hole next year, his timing is accurate.

For nature, though, it’s not such a good idea. Harper, as it behooves a Rapture-seeker, doesn’t recognize global warming as a reality, other than in the form of a profit opportunity.

Massive Arctic ice shelf breaks away
A huge 19 square mile (55 square km) ice shelf in Canada's northern Arctic broke away last month and the remaining shelves have shrunk at a "massive and disturbing" rate, the latest sign of accelerating climate change in the remote region, scientists said on Tuesday.

They said the Markham Ice Shelf, one of just five remaining ice shelves in the Canadian Arctic, split away from Ellesmere Island in early August. They also said two large chunks totaling 47 square miles had broken off the nearby Serson Ice Shelf, reducing it in size by 60 percent.

"The changes ... were massive and disturbing," said Warwick Vincent, director of the Centre for Northern Studies at Laval University in Quebec. Temperatures in large parts of the Arctic have risen far faster than the global average in recent decades, a development that experts say is linked to global warming.

"These substantial calving events underscore the rapidity of changes taking place in the Arctic," said Derek Mueller, an Arctic ice shelf specialist at Trent University in Ontario.

"These changes are irreversible under the present climate and indicate that the environmental conditions that have kept these ice shelves in balance for thousands of years are no longer present," he said in an e-mailed statement from the research team sent late on Tuesday.

Mueller said the total amount of ice lost from the shelves along Ellesmere Island this summer totaled 83 square miles -- more than three times the area of Manhattan island. The figure is more than 10 times the amount of ice shelf cover that scientists estimated on July 30 would vanish from around the island this summer.

"Reduced sea ice conditions and unusually high air temperatures have facilitated the ice shelf losses," said Luke Copland of the University of Ottawa. "Extensive new cracks across remaining parts of the largest remaining ice shelf, the Ward Hunt, mean that it will continue to disintegrate in the coming years," he said.

The first sign of serious recent erosion in the five shelves came in late July, when sheets of ice totaling almost eight square miles broke off the Ward Hunt shelf. Since then that shelf has lost another 8.5 square miles.

Ellesmere Island was once home to a single enormous ice shelf totaling around 3,500 square miles. All that is left of that shelf today are the four much smaller shelves that together cover little more than 300 square miles. Scientists say the ice shelves, which contain unique ecosystems that had yet to be studied, will not be replaced because they took so long to form.

The rapid melting of ice in the Canadian Arctic archipelago worries Ottawa, which fears foreign ships might try to sail through the waters without seeking permission first. Last week Prime Minister Stephen Harper said Canada would toughen reporting requirements for ships entering its waters in the Far North, where some of those territorial claims are disputed by the United States and other countries.

European GDP deepens gloom, eyes on US data
Europe showed just how exposed its economy is to a broader downturn in the industrialised world on Wednesday with news that weak investment, household spending and exports all hurt in the second quarter, when the economy shrank.

EU statistics' office Eurostat's first breakdown of the reasons for a drop in gross domestic product in the second quarter showed the chief culprits were a more than one percent slide in investment as well as a fall in household spending.

Declines in growth of 0.2 and 0.1 percent quarter-on-quarter in the euro zone and wider 27-country European Union respectively have fuelled fears the bloc will slide into full-blown recession. Business surveys for August also showed activity in the services sector, as in manufacturing, dipped yet again in August, if not quite as much as in July, suggesting the third-quarter would be little better.

In the United States, where the current economic downturn began, markets were eyeing a raft of data including durable goods, the Redbook readout on chain-store sales, as well as August car sales figures. Britain's dominant services sector shrank in August for the fourth straight month, a survey on Wednesday showed, although signs of weakness were much less pronounced than expected.

In Asia, where Japan's economy contracted too in the second quarter, the focus on Wednesday was more on South Korea, where the government is struggling to stem a slide in the won, which has fallen some 10 percent since early July.

Amid further suspected intervention to support the currency, government officials acknowledged the economy was in difficulty but dismissed the idea of deeper trouble in a country hard hit by the Asian financial crisis of the late 1990s.

The euro zone numbers showed a drop in investment of 1.2 percent knocked 0.3 percentage points off GDP and a 0.2 percent dip in household consumption took GDP down by another 0.1 percentage point. Exports dropped 0.4 percent but the net effect on GDP was offset by less imports.

The picture was broadly the same for the EU as a whole, which includes countries such as Britain, Sweden and many from the formerly Communist bloc on Europe's eastern flank.

Germany added to the confusion and recession speculation. Finance Minister Peer Steinbrueck told Reuters on Tuesday that his country, with a target of 1.7 percent growth for 2008, was not facing recession, but a more junior minister said close to the opposite on Wednesday.

"If we end up with zero in the third quarter we can consider ourselves lucky. The trend is more that we'll see a negative number," Deputy Economy Minister Walther Otremba said in an interview with Reuters. German GDP dropped 0.5 percent in the second quarter versus the preceding one. Two consecutive quarters of contraction is generally called a recession by economists.

As for early signs for the third quarter,monthly surveys of business showed further contraction in service sector activity in August in both the euro zone and Britain, just as similar surveys have shown for manufacturing in both cases.

The Markit Eurozone Services Purchasing Managers Index (PMI) rose marginally in the euro zone from July's five-year low, to 48.5 from 48.3, but continued to contract, for a third straight month. Britain too stayed in contraction.

New forecasts published on Tuesday by the Organisation for Economic Co-operation and Development showed Britain in the clutches of recession and the euro zone on the brink. The OECD forecasts showed Japan recovering from the GDP dip of the second quarter and the U.S. economy faring marginally better than Europe but remaining feeble.

While the large industrialised economies of the G7 club are all suffering a downturn that started with a US housing slump and the financial market turmoil triggered by a defaults crisis in the U.S. sub-prime lending market, China and many other emerging market nations are still growing strongly.

South Korea, though, has been snared by a resurgence of concern among foreign investors, primarily about debt levels. Suspected dollar-selling intervention by the South Korean authorities lifted the won from a four-year low on Wednesday, but failed to stop the currency from deepening its losses this year to more than 18 percent.

Deputy Finance Minister Shin Je-yoon told local online media outlet EDaily that the economy was in difficulty but dismissed suggestions of a financial crisis. An International Monetary Fund official also played down worries that South Korea's $243 billion in foreign reserves -- the world's sixth largest -- were shrinking too fast because of interventions.

Meral Karasulu, the IMF's resident representative in Seoul, told Reuters the reserves were adequate to cover the country's short-term international obligations. She also said foreign debt was not unusually large.

British banks tapped soon-to-be-defunct Bank of England emergency scheme for $400 billion
Troubled lenders in the UK may have tapped the Bank of England's emergency funding scheme for as much as £200bn, according to investment bank UBS - double the most aggressive estimates.
Alastair Ryan, UBS banks analyst, has calculated that "the take-up could be £200bn or more".

When Bank Governor Mervyn King first unveiled the Special Liquidity Scheme in April he indicated that it might be used for £50bn, while debt specialists forecast a total take-up of £90bn-£100bn by the time the scheme closed on October 20.

A Bank spokesman said yesterday: "As has always been the case, there is no cap on the scheme. Its size will reflect its use." The scheme, which allows banks to swap untradeable mortgage securities for liquid Treasury bills for up to three years, has filled the funding hole left by the closure of the wholesale markets since the credit crisis. The last major syndication of mortgage securities was in June last year.

Mr Ryan believes banks are using the scheme to replace maturing funding lines, as well as to fund future lending and past lending that would normally have already been syndicated.

Such action would tally with assertions by Sir James Crosby in his recent mortgage report for the Treasury that "the shortage of mortgage finance will persist throughout 2008, 2009 and 2010" and that banks must find £40bn a year to meet their existing obligations before making any new loans.

HBOS alone, Britain's biggest mortgage lender, has £156bn of wholesale funding that comes up for renewal before June. The Bank for International Settlements on Monday revealed that UK lenders issued a record £45bn of mortgage-backed bonds in the three months to June in order to use the scheme.

Mr Ryan described it as "a qualified success" because inter-bank lending rates are still well above base rate at about 5.75pc. Bankers and economists were surprised by the forecast, calling it "unlikely but plausible".

One, Simon Ward, economist at New Star, said: "If it is right, then the British banking system is relying much more heavily on state support than either Europe or the US, which would suggest the banking system here is in greater trouble

Americans’ net worth falling fast
You already know that the housing crisis has wreaked havoc with the economy and financial markets, not to mention the lives of millions who've lost or could lose their homes. But there may be a less obvious casualty too: your retirement prosperity.

According to a recent report from the Center for Economic and Policy Research, a Washington, D.C. think tank, the collapse of house prices that started in 2006 has wiped out more than $4 trillion in home equity, putting a sizable dent in the net worth of millions of baby boomers.

Among its more ominous findings: By next year, the average net worth of households headed by homeowners age 45 to 54 will be almost 25% less than it was in 2004. Of course, chances are your situation is not anywhere near as gloomy. Unlike most Americans, you probably don't have all your net worth tied up in your house.

If you've been saving diligently, you can rely primarily on your 401(k), IRAs and other investments in retirement. A hit to your home's value, while hardly welcome, is something you can likely take in stride. Still, I believe the bursting of the housing bubble provides three valuable lessons for retirement planning.

In the '90s it was tech stocks. Then real estate became the sure thing, which led to a spree of trading up, flipping fixer-uppers, collecting second homes and even buying condos with IRA cash. This year the "can't lose" investments are natural-resources stocks (up 29% for the 12 months to June 30), precious metals (up 29%) and energy (up 26%).

I'm not predicting that Armageddon lies just around the corner for today's winners. But gains of this magnitude aren't sustainable. They're likely to be followed by stagnant returns or outright losses, as was the case with housing. So while it's natural to want to plow money into hot sectors, remember: Big bets on the investment du jour are more often a recipe for downsizing your wealth than growing it.

The housing bubble had another perverse effect on our planning: It led us to save less. "Many people thought, 'I'm wealthier, I already have a big chunk of my nest egg thanks to my house, so I don't have to save as much,' " says Moody's chief economist Mark Zandi.

Using asset gains as an excuse to cut back on saving can be dangerous, especially when those gains come during a period of unprecedented returns. Bloated asset values can be illusory - and temporary. So even if your retirement accounts balloon during your career, keep making contributions. If nothing else, you'll give yourself a wider safety margin to deal with setbacks.

Many homeowners exacerbated the damage done by falling prices by borrowing heavily from their homes. Federal Reserve economist James Kennedy estimates that from 2002 through 2007 owners pulled $2.5 trillion in equity out of their homes via cash-out refinancings and home-equity loans.

That's nearly a third of the increase in home values over that period. While there are many valid reasons to borrow against your home, it can also be comforting to know that your home equity will be there later in life for emergencies.
Today's housing collapse will likely rank among the biggest debacles in modern American economic history. You can't escape it. But it will be an even bigger shame if you don't learn from it.

House price crash goes global
The property crash that began in the US is spreading across the globe, according to international estate agents Knight Frank, which said today that steep declines are now taking place across Europe and into Asia.

The country recording the sharpest fall is Latvia, where house prices have plummeted 24.1% over the past year. New Zealand, Denmark and Lithuania have all seen falling prices, along with Malta, Germany, Ireland, Estonia, Britain and the US. Even countries where prices have not fallen are witnessing a rapid deceleration in price growth.

In South Africa the rate of house price inflation has collapsed from 15.5% this time last year to 3.8%, and is expected to be negative soon. In France, Spain and Greece price growth has halved and is running below 3.2%. The only countries to have bucked the trend are Bulgaria, Slovakia, Cyprus and the Czech Republic, where house price growth has accelerated.

Last year's fastest growing market, Russia, which was seeing house price growth at an astonishing 53.7% in the second quarter of 2007, has dropped back to 26.5%.

Nick Barnes, head of international research at Knight Frank, said: "The index shows that global house price inflation is continuing to fall back, with much of continental Europe now seeing low or negative growth. "Housing markets in countries such as Spain, Denmark, the UK and Ireland are all being severely challenged by the global credit squeeze."

Globally, the rate of house price growth fell to 4.8% in the second quarter of 2008, down from 6.1% in the first quarter of the year. Several countries are now entering their second year of house price declines. Among the worst hit is Germany, where prices were falling at a rate of 4.4% last year and 2.5% this year.

"There is less demand for owner-occupied property in Germany than in many other European countries and there is no shortage of supply," said Barnes. In Spain, the Knight Frank index recorded a price rise of 2.4% annually, but it warned that falls are now almost inevitable.

"The well-publicised problems in Spain have not yet fed into house price statistics. So far, price falls have been concentrated in the coastal resorts and among new developments in the large cities," said Barnes. "Spain looks likely to fall into recession later this year, and house sales fell steeply during June. The number of sales dropped by 34.2% in May and 29.6% in June, suggesting that wider price falls could be imminent."

But investors who bought second homes in Bulgaria have reason to feel bullish. Knight Frank said current annual price growth is 32.2%, only slightly lower than the 33.7% rate recorded in the first quarter.

Biggest fallers: Year-on-year house price change to Q2 2008
Latvia -24.1%
United States -16.8%
Estonia -16%
Lithuania -9.9%
Denmark -9.6%
Ireland -8.1%
UK -3.9%
Malta -2.7%
Germany -2.5%
New Zealand -2.2%

UK unemployment to soar
Britain's jobs market is suffering from the slowdown in the economy as a new report out today shows the number of permanent jobs available has plunged to its lowest level since 2001.

Unemployment had been falling for 15 years to its lowest level for three decades, but has risen by about 70,000 this year. Economists say tumbling house prices and stagnant economic growth are likely to push unemployment up sharply over the next year or more.

The Recruitment & Employment Confederation's latest survey today says permanent placements contracted for the fifth consecutive month in August while temporary jobs fell for the first time since May 2003.

"The slide in the UK economy continues to hit the jobs market hard - with yet another sharp drop in recruitment," said Alan Nolan, director at KPMG, which sponsors the report. "UK employers are continuing to control payroll costs through redundancies - and by refusing to take advantage of a growing (but increasingly unused) pool of skilled labour."

He warned that skilled workers are starting to move abroad in search of employment, which could result in a labour shortage when the market picks up again. Thousands of jobs have been shed in the construction sector as the housing and commercial property markets have collapsed. Figures out yesterday showed that Britain's construction sector shrank for a sixth consecutive month in August.

The Chartered Institute of Purchasing and Supply/Market construction index picked up slightly to 40.5 last month from a low of 36.7 in July, but remains in difficulties. A figure below 50 signifies contraction. David Blanchflower, a member of the Bank of England's monetary policy committee, said last week that there was a risk of unemployment rising by 60,000 a month and hitting 2 million by the turn of the year.

"We are going to see much more dramatic drops in output," said Blanchflower, who has been a lone voice on the nine-member MPC in calling for lower interest rates in recent months.

In an interview with Reuters, he said: "The fears that I have expressed over the past six months have started to come to fruition. I've obviously voted on quite a number of occasions now for small [quarter-point] cuts but we need to act and we probably need to act in larger amounts than that. We need to get ahead of the game and it appears that we are now behind."

The Bank begins its two-day meeting today to deliberate on the level of interest rates. Borrowing costs have been unchanged at 5% since April as the MPC remains concerned about rising inflation. But many analysts believe that the Bank must cut rates this week to prevent a recession.

The Organisation for Economic Cooperation and Development said yesterday that Britain will enter recession this year with contractions of economic output in the third and fourth quarters. The OECD predicted that the British economy will shrink by 0.3% this quarter and by 0.4% in the October to December period as the credit crunch and the housing market downturn worsen.

Therefore, this would be two consecutive quarters of negative growth, which is commonly used as the definition of recession. The OECD said Britain would fare worst among the group of seven leading economies.

Shadow chancellor George Osborne said: "Not only is the British economy predicted to shrink in the next two quarters, but it is also the only economy not predicted by the OECD to see a recovery this year. All of our major competitors are predicted to see at least some growth by the end of the year."

The Liberal Democrat Treasury spokesman, Lord Oakeshott, said: "Other big economies are forecast to recover but the OECD says Britain is worst placed of all because of falling house prices. "British families are now paying through the nose for Gordon Brown's complacency, which has allowed house prices and debt to get out of hand."

US companies hack away at jobs
The number of summer job cut anouncements reached its highest level since 2002, according to a report released Wednesday.

From May through August, employers said they would cut 377,325 jobs, according to employment consultancy Challenger, Gray & Christmas, Inc. That's nearly 30% more than during the first four months of the year. The number of job cut announcements usually dips during those particular months as business slows down over the summer, Jim Pedderson, a Challenger spokesman, said.

During the summer of 2002, in the wake of the 2001 recession, companies said they would cut 378,777 positions, according to the report. Businesses tried to cut jobs this summer as they were hit by "the double whammy of limited access to credit and the high price of oil," said chief executive John Challenger.

Despite the summer climb, plans to reduce labor forces tapered off last month from July as oil prices fell from their highs. The number of announced job cuts fell to 88,736 in August compared with 103,312 in July, but remained more than 12% higher than the same period last year, the report said.

Planned job cuts in the financial sector, which has been suffering from mortgage and credit market losses, also declined. The number of announced layoffs in the financial sector fell to their lowest level since July 2007, totaling 2,182, down from 14,396 job cuts averaged over the previous seven months, according to the report.

"It might suggest that [credit] conditions are beginning to relent," John Challenger noted. But don't look for significant relief anytime soon, he said. "It is too early to say that the decline in financial job cuts last month marks the start of a turnaround for the industry," he remarked in a press release. "Many firms are still experiencing major losses in earnings and could make more workforce reductions as 2008 comes to a close." 

Ilargi: Yo, psst... I got a full dozen bridges for sale in Brooklyn. Nice discount if you take three....

Fannie, Freddie may avoid U.S. bailout
Fears a government takeover would wipe out shareholders at U.S. mortgage finance companies Fannie Mae and Freddie Mac battered the price of their stock last month, but a rescue may yet be avoided.

Fannie Mae and Freddie Mac are the nation's two largest sources of housing finance and the pass-through point for 70 percent of new mortgage-backed securities. Washington policy-makers have increasingly relied on the two government-sponsored enterprises, or GSEs, to support the housing market after Wall Street banks, hit by rising loan default rates, lost its appetite for mortgage debt.

The failure of the two mortgage giants would further darken the already heavy clouds hanging over the economy. As foreclosures have mounted, both companies have seen their capital eroded and analysts have fretted they could fail without government aid.

However, a new perspective is taking hold among many observers, who now believe Fannie Mae and Freddie Mac can pull through the crisis under their own power using the billions of dollars they have socked away to cover mounting losses. While they have suffered a combined $14 billion in losses over the past four quarters, they still have more than $80 billion in capital on hand.

A bailout plan hatched in July, and approved by Congress, gave the U.S. Treasury authority to take a large stake in either company if needed to avoid a collapse. The Treasury could also lend them an indeterminate amount of cash.

In the weeks since that emergency plan was conceived, some media reports and analysts have suggested an effective nationalization of the companies was all but certain. Barron's magazine helped push the share prices of the two companies to 20-year lows with a report in its August 18 edition that said government officials believed the companies would be unable to raise needed capital.

It cited a Bush administration insider as saying that if that proved to be the case, the Treasury was likely to go ahead with its refinancing plan. Fannie Mae's and Freddie Mac's preferred shares, generally considered safe and widely held by banks, have been hit by a series of credit ratings downgrades in the past several weeks.

On Monday, Fitch Ratings cut them to BBB-, the lowest investment grade. They are trading at just a fraction of face value. Investor sentiment improved last week, however, as some Wall Street analysts concluded the housing slump would not break the companies and that Treasury had no desire to orchestrate a bailout.

In a report on Thursday last week, Lehman Brothers said Fannie Mae does not need to tap investors for more capital despite the billions in losses it has taken. Separately, Merrill Lynch concluded that out-sized fears of government action had driven shares of Fannie Mae and Freddie Mac to bargain levels. "Shares are overly discounting a possible catastrophic event," it said in a research note.

Still, most analysts agree Fannie Mae and Freddie Mac face an uncertain fate and say investors should tread with caution. Data from the Federal Reserve on Thursday suggested foreign central banks were cutting back on their holdings of GSE debt, and concern that the appetite for their debt was waning broke a rally in their shares on Friday.

The size of the companies' capital cushion is the source of investors' anxiety and analysts' relief. Those cash-like reserves have fallen as losses have climbed. After accounting scandals earlier this decade, their regulator forced them to buttress their capital. Freddie Mac must hold 20 percent more capital than the minimum required by law while Fannie Mae must hold 15 percent more than the least capital required.

All told, Fannie Mae has $47 billion on hand and Freddie Mac holds $37 billion. While the size of any future losses are uncertain, many analysts think they have sufficient reserves. "Our analysis suggests they have breathing room, and where they probably need to raise additional capital at some point, there is no urgency to do so," said Citigroup analyst Bradley Ball.

Two weeks ago, a source familiar with the U.S. Treasury's position told Reuters the administration would like to see Fannie Mae and Freddie Mac remain in private hands. Beyond that, little is known of Treasury Secretary Henry Paulson's thinking. Officials have been unusually tight-lipped, concerned investors would make bets based on any comments.

Last week, the Wall Street Journal editorial page chastised Paulson for giving "the impression of wanting desperately to pass these problems along to someone else." With the November presidential election just two months away, the Bush administration is hoping it won't be forced into undertaking a dramatic bailout.

Fitch Warns on Option ARMs: "High Defaults Await"
Fitch Ratings on Tuesday released a wide-ranging look at option ARMs that paints a decidedly negative picture for the mortgage markets over the next 36 months. In fact, the picture is a downright scary one: the bottom line is that most outstanding neg-am mortgages won’t get out of 2011 alive, thanks to forced recasts.

Fitch analysts said they now expect roughly $29 billion in option ARMs to recast to higher monthly payments by the end of 2009, and an additional $67 billion to recast in 2010; of this, approximately $53 billion is attributed to early recasts.

“Though recent declines in the 12-month Treasury average rates have mitigated some risks, the majority of option ARM borrowers have elected to make the monthly minimum payment over the past 24 months,” Fitch said in the report. “As a result, a large number of these loans, especially those with 40-year amortization and 110% principal caps are expected to reach their recasts before the end of the five-year mark.”

The result? Fitch said it expects 90-day plus delinquencies — already ranging from 10 percent to 24 percent, depending on vintage — to more than double after recast for 2004-2007 vintage loans. It gets worse: Fitch also estimated the potential average payment increase on the re-casting loans to be 63 percent, representing on average an additional $1,053 due each month.

“The combined impact of payment shock, negative amortization, declining home prices and restricted availability of mortgage credit may leave many option ARMs’ borrowers unwilling to continue paying their mortgage,” said group managing director Huxley Somerville.

“Also, because of their use as an affordability product, option ARM defaults will likely spread into higher priced neighborhoods, as many borrowers leveraged the very low minimum monthly payment to buy more expensive homes.”

Barclays Faces $13 Billion Capital Shortfall
Barclays Plc, the U.K.'s third- biggest bank, may need to raise as much as 7.5 billion pounds ($13.3 billion) to bring its capital ratio in line with investment banking peers, Royal Bank of Scotland Group Plc said.

While the London-based bank's so-called tangible common equity is in line with the industry, it's low compared with securities firms, analysts led by Ian Smillie wrote in a research note to clients today. Analysts at Citigroup Inc. in July estimated Barclays may need about 9 billion pounds of capital.

"A deeply ingrained performance-led culture facilitated the generation of 8.3 billion pounds of economic profit over the last four years," Smillie said. "It has, however, also led Barclays to a higher level of balance-sheet gearing than peers, an uncomfortable position in the current environment of financial system de-leveraging and heightened external scrutiny of banks' balance sheets."

Barclays raised 4.5 billion pounds in a share sale in July to help shore up capital depleted by credit writedowns and to fund consumer-banking growth overseas. The bank's fund raising lifted its so-called Tier 1 capital ratio, which measures a bank's ability to absorb losses, to about 6.3 percent. The bank's "large and growing equity shortfall" may mean it has to sell more shares, Smillie said.

Barclays fell 4.3 percent to 348 pence as of 12:39 p.m. in London trading, valuing the bank at 28.4 billion pounds. The stock has fallen 29 percent this year amid concern about capital adequacy and writedowns at U.K. banks.

Barclays may post this year a tangible equity ratio, which ignores hybrid bonds, of about 4.8 percent compared to the average of 6.8 percent of its peers, Smillie said. The bank's capital ratio may be eroded by a further 4.7 billion pounds of writedowns and increasing customer bad debts, the analysts said.

Analysts at Goldman Sachs Group Inc. last month estimated Barclays has further potential credit market-related losses of 4.6 billion pounds. U.K. banks may have tapped the Bank of England's special funding plan for about 200 billion pounds amid the seizure in credit markets, analysts at UBS AG wrote Sept. 1. The central bank introduced its so-called special liquidity scheme in April, enabling British lenders to swap mortgage-backed securities for government bonds.

Tangible equity ratio, a measure of capital widely followed in the U.S., excludes bonds that combine elements of debt and equity. Investors are looking for new ways to judge the strength of banks after financial services companies worldwide wrote down since the beginning of last year almost $510 billion on subprime-related investments.

South Korea heads for black September with won problems
The deepening woes at Fannie Mae and Freddie Mac, badly stretched central bank reserves and a losing battle to support the won are pushing South Korea towards a full-blown currency crisis this month, analysts have said.

Heavy investment by the Korean Government in Fannie, Freddie and other US-related agency bonds has left a potentially huge liquidity problem - perhaps $50 billion (£27.4 billion) - in the foreign reserve portfolio. Some believe that Seoul might have no ammunition left to prevent a significant flight from the won. Fruitless currency intervention by South Korea - increasingly desperate-looking verbal and financial measures to fight the market trend - cost about $20 billion in July alone.

Attempts to prop up the won come as South Korea’s household and corporate sectors are wincing from the pain of high energy prices and inflation. A summer of strikes by lorry drivers and mass street demonstrations calling for President Lee to resign reflect rising public concern that the economy is in trouble.

The intervention efforts have failed to prevent the currency sliding more than 7 per cent against the dollar in the past month. The won is teetering at a 44-month low against the greenback and, with the central bank’s foreign exchange reserves still dwindling, economists at CLSA, the brokerage, say that it is “a game that Korea can literally no longer afford to play”.

Moreoever, the situation could worsen dramatically: $6.7 billion of Korean bonds mature this month, potentially creating vast downward pressure on the won if a large part of that sum immediately flees abroad. Korea’s foreign exchange reserves stand at $247 billion. The International Monetary Fund recommends that emerging market economies should hold nine months’ worth of import cover, which would be about $320 billion.

More worrying, according to economists at HSBC, is the level of Korea’s foreign exchange reserves relative to its short-term debt ratio. Korea’s debt maturing within a year has shot up to $215.6 billion because of hedging against the oil price. While that is nominally within the 100 per cent coverage by forex reserves deemed necessary, the Fannie and Freddie crisis in the United States raises the question of whether any sense of security is illusory.

A large part of Korea’s foreign reserves are not government bonds but the kind of US-based mortgage-related bonds that once looked so solid. Depending on how the Fannie and Freddie situation develops, a significant portion of Korea’s forex reserves could turn out to be extremely illiquid, leaving the country ever more vulnerable to external shock.

“The coverage ratio may in reality be not as comfortable as the authorities would like, meaning they have less with which to defend the currency,” said one senior Asia-based economist. Although few are predicting a financial meltdown such as the one that hit the region in 1997, recent weeks have exposed some unique vulnerabilities in Asia’s third-largest economy.

The danger, Sharmila Whelan, CLSA’s senior economist, said, is that South Korea has not recognised the perils of intervention, given the country’s hefty current account deficit. “The risk is that once investors realise how tenuous Korea’s reserve position actually is, they will start abandoning Korea in droves and send the currency tumbling,” Ms Whelan wrote in a recent note to clients.

Soaring inflation and a legacy of massive borrowings by households add an additional, potent layer of instability. Government insiders in Seoul have told The Times that there is a “credible risk” that the Korean banking system could be ravaged by a self-generated version of the credit crunch that has hit Wall Street and the City. Analysts predict a rising tide of nonperforming loans, delinquency ratios and bankruptcies and some of the country’s large mutual savings banks are expected to go bust.

Won slide could make Korea's bond fears come true
All the fretting in South Korea about a foreign exodus from maturing bonds may have become a distraction from the real danger facing the country's markets -- won selling could turn a feared capital flight into a reality.

The latest selloff has been driven by fear that investors would pull cash out of the $7 billion in bonds maturing this month. The actual impact on the bond market and the currency from such a relatively small withdrawal could be anybody's guess.

What is certain is that the rapidly sinking currency is hurting sentiment. And panic selling of the currency could become a self-fulfilling prophecy, accelerating the exodus by eating into returns of foreign investors holding won assets. That apart, it is almost impossible to foretell the impact on markets.

Even if foreigners do decide to withdraw all $7 billion from the bond market, most of those investments could be hedged. Analysts estimate more than 80 percent of all foreign bond investments in Korea are hedged -- meaning there will be no selling pressure on the won. And, yields on Korean bonds are still attractive enough to tempt the bond holders to re-invest their funds. "If it is fully hedged, the impact has already occurred," said ING economist Tim Condon.

But he reckons the past week's events -- the slide in the won to four-year lows on worries the Korean authorities would not defend the currency -- would however persuade more investors to repatriate rather than renew their Korean assets. "The bigger worry is that over the last week foreigners' desire to hold Korean assets has diminished because of the fear that they are not being compensated for risk," he said.

Peter Redward, head of strategy at Barclays Capital, suggests that about half the $7 billion of foreign holdings would be taken out of Korea. That demand for foreign currency could have some impact on the won markets, where daily trading volumes in the spot and forward markets average between $6 billion and $7 billion. But just how much depends on whether overseas buyers of Korean bonds did the "arbitrage trade" using swaps to hedge the currency risk, or simply converted their dollars into won.

The maturing debt has hogged headlines in Korea. The amount overseas buyers hold of this debt is relatively modest compared with Korea's $243 billion currency reserves and the $23 billion foreigners have withdrawn from Korean equities this year. Yet the issue has morphed into a test of the Bank of Korea's ability and willingness to defend the won. Fears that the Korean authorities lack the resources to defend the won have already pushed it down 8 percent against the dollar in just two weeks.

Some banks expect the won to spiral down to 1,200 per dollar soon. But the maturing debt may in reality have no bearing on this trend. Traditionally, foreign investors have bought Korean debt on an asset-swapped basis. That means, they swap dollars or any foreign currency into won using cross-currency swaps which protect them against any adverse moves in the exchange rate.

That won is then ploughed into Korean bonds or stocks, with the swap ensuring the investor gets his dollars back on maturity. Would these investors want to remain invested in Korean bonds? Foreign ownership of Korean bonds is negligible, less than 6 percent of the total outstanding 874 trillion won. The yields are extremely attractive. Besides, this is a good time to be buying them if, as economists expect, the authorities make growth a priority and start cutting rates.

Because Korean shipbuilders and other exporters keep the forward market skewed with their dollar sales, a foreigner can get one-year won funds at rates as low as 3.4 percent. Bonds yield almost 5.5 percent for that tenor, and 6 percent for longer maturities. "The trade still makes sense," said Redward. "But it has very substantial mark-to-market volatility. From a Sharpe ratio, risk management perspective for an investor there may be better places to invest money right now."

The Sharpe ratio measures the return investors get for every unit of risk taken. The won's 19 percent decline against the dollar so far this year is just one of the risks, diminishing returns to a degree that investors may not have anticipated. Credit risk is rising as investors worry about Korea's short-term debt and deteriorating policy credibility.

That in turn is making funding scarce, with 3-month certificate of deposit rates at a 8-month high. Eventually, the cost of won funds through the cross-currency swaps could rise. As of now, none of this risk is discernible in any part of Korean financial markets, barring the spot won and stocks.

Bonds have barely blipped, with 3-year yields up just 8 basis points in a week. The offshore forward market where most speculative interest manifests, is also unruffled, pricing in a mere 0.2 percent depreciation in the won within 12 months.

Flock of banks—including HSBC—seen flying lazy circles over Lehman
State-controlled Korea Development Bank (KDB) proposed buying 25% of Lehman Brothers for up to $5.3 billion, a newspaper reported, but other Korean banks rumored to be joining a KDB bid consortium denied they were involved. Daily Chosun Ilbo also reported on Wednesday that top European bank HSBC Holdings, several U.S. hedge funds and an unidentified Chinese bank were among other potential buyers of Lehman, the fourth-ranked U.S. investment bank.

KDB had confirmed on Tuesday it was in talks with Lehman over a possible joint investment with other Korean banks, but declined to give details of its negotiations. On Wednesday, it said it was still unsure whether there would be a deal. “Korea Development Bank has considered M&A deals in foreign investment banks including Lehman Brothers, and asset management companies, as part of its privatization and competitiveness efforts, but nothing has been decided yet,” it said in a statement.

The Chosun report quoted an unnamed financial industry source as saying KDB had sent the proposal to Lehman—which has over $60 billion of mortgage and mortgage security exposure—and that leading local banking groups Woori Finance Holdings and Shinhan Financial Group were seriously considering joining.

Shinhan and Woori, whose shares were hit hard on Tuesday on concerns about the extent of Lehman’s problems and their potential exposure, were quick to deny the newspaper’s report. “We have not seriously considered the idea and have no plans to do so in the future,” said a spokesman at Shinhan, South Korea’s second-biggest financial services firm.

Third-ranked Woori Finance also said in a statement: “We have not received any offer about the Lehman deal nor have we considered it internally.” The smaller Hana Financial Group reiterated a previous denial. Lehman prefers KDB, whose CEO used to head the U.S. bank’s South Korean operations, over other contenders as KDB plans to keep its current management after an acquisition. But the deal may fall through as KDB’s bid price is considered very low, the paper said.

According to the report, KDB was offering 5-6 trillion won ($4.4-$5.3 billion) for 25% of Lehman and also wants a guarantee it can later increase its stake to 40-50%. South Korean authorities have publicly said they are against KDB playing more than the role of a catalyst in any purchase of Lehman, preferring private banks to take the lead.

Separately, the chairman of South Korea’s military savings fund told Reuters it would consider joining KDB in any bid for Lehman, as now appeared a good time for U.S. investments. Lehman is under pressure to raise capital as Wall Street firms reel from the fallout of the subprime mortgage crisis. The fourth-largest U.S. investment bank is looking for buyers for some $40 billion of commercial mortgages and property on its balance sheet.

Korea military fund may back Lehman bid
South Korea’s Military Mutual Aid Association, a military pension fund, said on Wednesday it might consider making a joint investment in Lehman Brothers with state-run Korea Development Bank. “We will consider investing in Lehman if KDB makes an offer for a joint bid,’’ said spokesman Yang Sung-Kee. But he added that the military fund has yet to receive a proposal from KDB.

KDB confirmed on Tuesday that it was in talks about a possible investment in the beleaguered US investment bank. Lehman’s chief executive, Dick Fuld, is considering a variety of ways to raise capital ahead of his company’s earnings report, which is expected later this month. Analysts say Lehman could take $4bn of more writedowns, but people familar with the bank’s situation believe the writedowns could be higher.

KDB is seeking local partners to make a joint bid for a stake in the US bank. MMAA is one of the largest pension funds in the country and has emerged as a strong force in South Korea’s mergers and acquisitions market as it looks for higher growth.

With more than Won5,400bn (€4.6bn) in assets as of 2006, the association has in recent years lent support to local strategic investors in the country’s active buy-out market, and often seen as a “protector” of South Korean companies against ”foreign predators”.

A local newspaper, Chosun Ilbo, on Wednesday said HSBC was also interested in buying a stake in Lehman but an HSBC executive in Seoul has told the Financial Times that HSBC is not interested in investing in Lehman.

Tokyo Mitsubishi 'interested in buying' Lehman Brothers
Japan’s biggest megabank, Tokyo Mitsubishi UFJ is poised to enter the bidding for a substantial stake in Lehman Brothers, and may even seek control of the ailing Wall Street titan, according to banking industry sources in Tokyo. Senior sources close to the Japanese group say that the possible acquisition is being treated as a “once in a lifetime” opportunity but that the notoriously conservative bank will proceed with extreme caution.

Tokyo Mitsubishi, which has ample sources of funding for a multi-billion dollar acquisition, is expected to keep its powder dry until after Lehman announces its third quarter results next week — an event that traders around the world believe could see yet another bout of “kitchen sinking” and another potential dip in Lehman’s share price.

Traders believe that, in addition to its ongoing woes, Lehman’s results could result in the bank being probed by analysts and investors over activities related to R3 Capital Partners, a hedge fund. The fund, which was established this spring by a former senior executive at Lehman and which has the bank as a “passive, minority investor”, has become the focus of rising market concern that it may provide yet more bad news for Lehman.

Lehman has consistently said that all its transactions with R3, as an investor and a seller of assets, are at arm’s length. The bank is understood to have sold perhaps as much as $4.5 billion (£2.5 billion) of assets to R3 since May. Traders in Tokyo and Hong Kong said that the next few weeks would show whether R3 represents an Achilles heel for Lehman in the way that hedge funds related to Bear Stearns contributed to that firm’s downfall.

The head of one Hong Kong-based dealing room told The Times that the results announcement was expected to be the turning point for Lehman. From the point of view of Tokyo Mitsubishi — or any other potential bidders — the period immediately after the results could present the same opportunity that is currently on the table but at a much cheaper price.

If Lehman surprises the market with more bad news or fails to convince that it has a decent capital injection on its way, its shares will fall again and that is when the big Japanese bid will come in, said a source at a large Tokyo brokerage. The possible emergence of a Japanese-backed capital injection into Lehman comes as the troubled US firm remains locked in negotiations with the state-backed Korea Development Bank over the sale of a possible 25 per cent stake.

Chosun Ilbo, South Korea’s largest daily, today reported that HSBC, a trio of US hedge funds and an unnamed Chinese bank may also be eyeing big stakes in Lehman. But a spokesman for HSBC told The Times: "We're not interested in acquiring an investment bank. We're focused on growing in emerging markets, not developing markets." HSBC is not thought to be interested in acquiring any parts of Lehman.

HSBC, China bank, hedge funds also interested in Lehman
Europe's biggest bank HSBC Holdings and an unidentified Chinese bank are among potential buyers of Lehman Brothers, South Korea's Chosun Ilbo newspaper reported on Wednesday, citing a financial industry source.

HSBC and the Chinese bank, along with top U.S. hedge funds, are competing with Korea Development Bank (KDB), which has proposed to buy 25 percent stake in Lehman for 5 trillion-6 trillion won ($4.4-5.3 billion), the newspaper said. State-owned KDB confirmed on Tuesday it was in talks with Lehman over a possible joint investment in the U.S. bank with other Korean banks, but declined to give details of its negotiations.

Lehman, which has more than $60 billion of mortgage and mortgage security exposure, is under pressure to raise capital as Wall Street firms continue to reel from the fallout of the subprime mortgage crisis. The fourth-largest U.S. investment bank is looking for buyers for some $40 billion of commercial mortgages and property on its balance sheet.

KDB's proposal also includes a clause which allows the South Korean bank to increase its ownership to 40-50 percent at a later stage, according to Chosun. Lehman prefers KDB over other contenders as KDB plans to keep its current management after an acquisition, but the bid price is considered low, the South Korean daily said.

Lehman in Talks With Korea Development Bank
Korea Development Bank is in talks to buy a stake in Lehman Brothers Holdings Inc., the fourth-biggest U.S. securities firm, as Asian investors shore up Wall Street firms beaten down by the global credit squeeze.

Lehman climbed as much as 5 percent in Frankfurt trading after Korea Development Chief Executive Officer Min Euoo Sung confirmed the discussions in an interview in Seoul today. "I cannot comment further," said Min, who headed Lehman's Seoul branch before joining the Korean bank in June.

An investment from Korea Development would help Lehman Chief Executive Officer Richard Fuld bolster the company's finances after $8.2 billion of writedowns on mortgage-related assets and a 75 percent share-price plunge this year. Government-backed firms in Korea, China and Singapore have bought into stricken Wall Street banks during the past year, betting their investments will yield windfalls when financial markets stabilize.

"It's an opportune time for KDB to buy into a global company, and it's in line with KDB's long-term goal of becoming a global investment bank," said Mo Jae Sung, who helps manage the equivalent of $1 billion at Hanwha Investment Trust Management Co. in Seoul. "Such an acquisition won't pose much of a capital strain on KDB."

Korea Development is seeking to team up with local banks to buy a stake in Lehman, Min told Yonhap news agency in comments that were confirmed by a spokesman, who declined to be identified citing company policy. Negotiations have been "difficult because of differences over price," he said.

Lehman is trying to shed mortgage assets, raise capital and is poised to eliminate as many as 1,000 jobs, or about 4 percent of its workforce, in the fourth round of cuts at the firm this year, people familiar with the matter said last week. The headcount reductions may be announced when Lehman reports third- quarter results this month, according to the people.

Goldman Sachs analyst William Tanona is forecasting $10 billion of writedowns for Lehman, Morgan Stanley, JPMorgan Chase & Co. and Citigroup in the third quarter. The year-old global credit crunch has so far produced more than $500 billion of losses at the world's biggest banks and securities firms. Fuld, 62, may set up a company funded by outside investors to purchase some of Lehman's mortgage assets, people familiar with the plan said last month.

Lehman has renewed talks with Korea Development about a capital injection of as much as $6 billion, the Sunday Telegraph reported Aug. 31, without saying where it got the information. Korea Development may team with a domestic lender, probably Woori Finance Holdings Co. or Hana Financial Group Inc., to buy a stake, Dong-a Ilbo reported today, citing financial officials that it didn't identify.

Lee Jung Dae, a spokesman for Seoul-based Hana, said the company has no plans to join a bid for a stake in Lehman. Woori spokesman Lee Won Chuel said his firm hasn't received any offer from Korea Development or any other party to join a transaction.

"I don't think KDB will secure enough local partners when there are other M&A targets in the home banking sector," said Shim Jae Duk, who oversees the equivalent of $800 million as head of equities at Hyundai Wise Asset Management Co. in Seoul.

Korea Development hired bankers from Perella Weinberg Partners to advise on the talks, which might be concluded this week, according to the Telegraph report. Lehman executives, including Fuld, discussed structures through which the Korean bank may buy as much as 25 percent of Lehman, the Telegraph said.

A government official, speaking on condition of anonymity because he isn't allowed to publicly discuss the matter, said yesterday the financial regulator has yet to receive an application from the bank for permission to invest in Lehman.

Min, the same age as the 54-year-old Korea Development, is accelerating the Seoul-based bank's transformation into an international investment bank and corporate lender. The global credit market turmoil provides "a good opportunity for investments," Min said in July. State-run Korea Development, set up to fund reconstruction and industrial development after the 1950-53 Korean War, is scheduled to become privatized by 2012.

At the end of 2007, KDB had 146.9 trillion won ($138 billion) of assets and 21.7 trillion won of shareholder equity, according to the company's Web site. KDB's 2007 net income of 2.52 trillion won, or $2.37 billion, is just over half of Lehman's $4.2 billion of full-year profit.

The global banking crisis triggered by the U.S. subprime mortgage collapse has led sovereign funds in Asia to buy U.S. assets. Temasek Holdings Pte, Singapore's $130 billion sovereign wealth fund, plans to boost its investment in Merrill Lynch & Co. to between 13 percent and 14 percent from 9.4 percent. Government of Singapore Investments Corp. or GIC, the bigger of the city state's two sovereign funds, invested about $18 billion in UBS AG and Citigroup Inc. in the past year.

China Investment Corp., the nation's $200 billion wealth fund started last year, has invested $8 billion in Blackstone Group LP and Morgan Stanley. South Korea's Korea Investment Corp. put $2 billion into Merrill Lynch this year. Not all deals have been successful. China's government in January rejected a plan to allow state-owned China Development Bank to invest in Citigroup because of concerns about more financial-industry losses, a person with knowledge of the decision said at the time.

Chinese Banks Cut Fannie, Freddie Debt
China's big banks, having trimmed their holdings of U.S. mortgage-related debt, are facing increasingly difficult decisions about how to invest their sizable foreign-currency holdings.

Amid jitters about the future of Fannie Mae and Freddie Mac, China's four biggest listed banks have pared back their holdings in debt related to the two U.S. mortgage giants. At the end of June, the four banks held a combined $23.28 billion of debt issued or guaranteed by Fannie and Freddie. That's a small fraction of the trillions of dollars outstanding, but the reductions attracted interest as a possible gauge of broader sentiment toward such securities.

In earnings conferences in recent days, several Chinese banks said they had trimmed their Fannie and Freddie portfolios since June. Bank of China Ltd., by far the largest holder of Fannie and Freddie securities among the four big banks, said it had sold or allowed to mature $4.6 billion of the $17.3 billion it held as of June 30 -- which was down from more than $20 billion at the end of last year.

China Construction Bank Corp. said it had cut its Fannie and Freddie holdings to just above $2 billion by the end of July, down from $3.2 billion a month earlier. Bank of Communications Co. sold all of its $27 million in holdings in early July. Industrial & Commercial Bank of China Ltd., the country's biggest lender, said it held $2.7 billion worth of Fannie- and Freddie-related debt at the end of June, but didn't provide a comparison with previous months.

Analysts said the banks were likely erring on the side of caution, paring their holdings to please investors and ease concerns about their earnings outlook. While Fannie's and Freddie's shares have been battered this year, their debt generally is still considered relatively low-risk.

Zhang Jianguo, Construction Bank's president, told reporters last week that bonds issued by Fannie and Freddie are still "relatively safe." The U.S. government "has already made clear its guarantee" of the two companies' debt, Bank of China President Li Lihui said. Zhu Min, a Bank of China vice president, said the company "will adopt a cautious stance" in managing its foreign-exchange assets amid global economic weakness.

The shift away from Fannie and Freddie debt further reduces an already dwindling array of attractive foreign-currency investment options, with meager returns on low-risk instruments like U.S. Treasuries and continued instability in major stock markets. Because most developed economies are expected to slow further this year, the global investment climate is unlikely to improve soon, analysts said.

China's banks have significant overseas funds to deploy. Bank of China had $240 billion of overseas assets at the end of June, while the other three big lenders had a combined total of $219 billion. Some analysts said they see merit in Chinese banks expanding their foreign-currency loan businesses. They have lots of liquidity as many Western institutions are squeezed by the credit crisis, so the Chinese banks may be able to pick up market share in lending to attractive companies.

"They have to deploy their liquidity in some way and at the moment Treasurys don't look very lucrative," said Warren Blight, a banking analyst at Fox-Pitt, Kelton (Asia) Ltd. "But with credit so scarce, they can do a bit more syndicated lending or even direct corporate lending as yields and spreads are getting more attractive on that front."

Syndicated lending is one of the few bright spots in the banking business, analysts said, in part because borrowers have shied away from issuing debt in the face of higher yields. Using more of their overseas funds for corporate lending would help build Chinese banks' international experience.

"Given the fact that a lot of Chinese companies are seeking overseas expansion, it's a good opportunity for cash-rich big Chinese banks to develop a syndicated-loan business," said She Minhua, a banking analyst at China Securities Co.
Bank of China set up three centers earlier this year to manage its syndicated-loan business around the world.

It has been involved in a handful of small but noteworthy syndicated-loan deals, including a $592 million deal in Indonesia in which it led a group of 17 other banks to finance a power project. Its BOC Hong Kong (Holdings) Ltd. unit participated in a planned $3 billion refinancing facility for telecom operator PCCW Ltd.

Asian central banks step in as turbulence buffets region
Asian central banks embarked on a day of intervention in foreign exchange markets yesterday as inflation, social unrest and plunging stock markets weighed heavily on currencies.

Dealing floors in Tokyo, Hong Kong and London said that there had been noticeable intervention efforts by authorities in Malaysia, Indonesia, the Philippines and India - each selling dollars in favour of local currencies. Although the moves were near-simultaneous, analysts said that they were unlikely to have been part of a concerted scheme.

Derek Halpenny, senior currency economist for the Bank of Tokyo Mitsubishi UFJ, said that it was “hardly surprising, given what has happened in the last 48 hours” that so many central banks in the region might have decided to intervene now. He added that several central banks in the region - notably in Indonesia and Malaysia - had made little secret of plans to control their currencies more tightly as oil and food-related price rises raised the burden of imported inflation and as currency weakness aggravated the situation.

The moves across Asia coincided with the declaration of a state of emergency in Bangkok after violent anti-government protests overnight led to public order being handed to the Thai military. Emerging market analysts in Singapore gave warning of a possible flight of foreign capital from a basket of Thai baht-based assets if violence worsened and the political crisis deepened.

The turmoil in Thailand is another big blow to emerging-market investors. Merrill Lynch's monthly Fund Managers Survey in August showed that Thailand was institutional investors' second-favourite emerging market, after Russia, where sentiment has wilted since its invasion of Georgia.

As the political violence in Thailand plays itself out, the baht could remain under heavy pressure. The Thai central bank acknowledged that it had sold dollars to draw a line under the baht, which nevertheless dived to a year low. Foreign investors have become cautious in assessing risk in other South-East Asian markets.

In Malaysia, opposition parties rallied behind Anwar Ibrahim, the politician who has boasted that he will, within the next two weeks, overturn the Barisan Nasional coalition that has ruled the country for 50 years. In South Korea, where shares have taken a heavy beating and the won has fallen to a four-year low, the central bank engaged in “verbal intervention” yesterday in an effort to persuade investors to lighten the selling pressure on the beleaguered currency.

South Korea's new light touch in actual currency interventions has triggered speculation that the authorities are prepared to let the won slide so that the attractiveness of Korea's exports - critical to the economy - is enhanced.

Bank of Japan chief says global slowdown a needed adjustment
A slowdown in the world economy is a part of necessary adjustment to achieve sustainable growth and stability in resource prices in the future, Bank of Japan Governor Masaaki Shirakawa said on Tuesday.

Once the world's economy has gone through such a process, the Japanese economy will return to a moderate growth path from the current stagnation, Shirakawa said. "The world's economy is in a transitional phase to more sustainable growth. Although it's painful to every country ... a certain pace of adjustment in the world economy seems necessary," he told business leaders in Nagoya, central Japan.

Financial markets showed a muted response to his remarks as they did little to alter dominant market views that the BOJ will neither raise nor cut interest rates from the current 0.5 percent for the rest of this year or even longer.

Shirakawa also said the central bank will watch for fallout on financial markets from Japanese Prime Minister Yasuo Fukuda's sudden resignation announcement late on Monday. Japan began searching for a new prime minister after Fukuda became the second leader to abruptly resign in less than a year, threatening a further policy vacuum.

Japanese share prices fell to a five-month low, mainly on weakness in Asian shares, but some said the political mess did not help market sentiment. "Given today's falls in share prices, Shirakawa may be worried that Fukuda's resignation, coupled with weak economic fundamentals, could weigh on share prices," said Seiji Shiraishi, chief economist at HSBC Securities.

Japan's economy shrank in the second quarter as weaker U.S. and European export markets hit factories, and consumer sentiment wilted on rising food and fuel costs. Last month the BOJ delivered a bleak assessment of Japan's economy, calling it "sluggish" -- a word it has not used since the Asian financial crisis of 1997-1998.

Most economy watchers, including government officials, see Japan as either heading into a recession or already in one, although they do not expect a sharp downturn as seen in 1998 or 2001. Despite that, a BOJ rate cut is seen as very unlikely as prices are rising, unlike a decade ago when Japan was entering deflation.

Core consumer inflation accelerated to a decade-high of 2.4 percent in July, nearly five times the BOJ's policy target rate of 0.50 percent. Shirakawa said core consumer price inflation was likely to remain high, departing from his earlier assessment that price rises will accelerate further, possibly suggesting he sees inflation peaking in the near term.

The BOJ chief also said hefty rises in commodities and energy prices have not led to broad-based price increases. Yet he also said a prolonged period of easy monetary policy can lead to excessive economic activities, citing Japan's asset bubble from the late 1980s to the early 1990s.

"We should keep in mind that an excessively accommodative monetary policy often causes large swings in the economy after a certain time lag," Shirakawa said. "The subprime problems and the rise in oil prices have complex origins but neither could have occurred without the continuation of high growth in the world's economy and a long period of easy monetary policy."

Kyohei Morita, chief economist at Barclays Capital Japan, said Shirakawa will continue to face a balancing act between the need to deal with both downside and upside risks in the near term and to watch long-term side effects of keeping interest rates low for too long. "Unless he decides to put more emphasis on one of those risks, his comments won't send any new message to markets," Morita said.

Shirakawa said history showed that a deterioration in the fiscal balance could cause problems. "We are very interested in long-term interest rates. Japan's long-term interest rate is around 1.5 percent now. That's because market players do not expect inflation.

If they think only inflation can solve Japan's debt problems, rates will rise," Shirakawa said said in a question and answer session after a speech to academics. His comments came as speculation rises that Taro Aso, a leading candidate to succeed Fukuda, might increase fiscal spending sharply to bolster the economy.

If a picture is worth a thousand words then...
I have been a stock market observer and participant for almost 13 years now. However, in all those years I have never seen what I saw in yesterday's (Thursday August 28, 2008) market.

Thursday's regular market trading session and after-market action was unprecedented in it's scope and range. What happened is that most large cap stocks that had a higher closing price at the end of the day closed down by exactly the same dollar amount in after-hours trading.

At first I thought it was some sort of quirk or error by the website or quote provider. However, when I typed in random large-cap stock symbols, the answer turned out the same most of the time. Here are the examples that I found on the internet from Google Finance, Yahoo!Finance and CNNMoney.

In all of the visual examples that I have provided, you should be able to find the source, date, closing price, and the after-hours price. Air Products (APD) was the company in the first three examples and General Dynamics (GD) was in the last two. I cross referenced the data with the New York Stock Exchange after hour system (Arca) and the NASDAQ after hour system and arrived at the same prices.

What I have just shown in the above examples could be found in so many stocks that I got tired of chronicling them all. The anomaly can be found in the following (although incomplete) list of stocks:


Never before have I seen such broad based market activity that glaringly highlights "management" of the stock market. The scale of such an endeavor, if proven to be "managed," would point to an organization(s) with unlimited resources at its disposal. My only conclusion is that something is brewing and it is beyond the scope of most "average" market participants.

Ilargi: Sort of related to the article above, this video poses a question: how free are the markets?

The Playbook

Weak economy set to hit credit card companies hard: defaults, loss rates to soar
U.S. credit card delinquencies are rising and the credit card issuers could be in for a lot of agony. Expectations that cash-strapped consumers and businesses will default on their credit card balances in greater numbers are forcing lenders to reduce consumer credit lines, cut back on signing up new customers and raise fees.

But even these, in some cases drastic moves, are likely to be too late to save the credit card issuers from substantial credit losses. “The bottom line is consumers have too much debt, they’re going to have to scale it back and that’s a painful process that will take time,” said Walter Todd, portfolio manager at Greenwood Capital Associates.

Hardest hit are likely to be Discover Financial Services and American Express, given their greater reliance on the credit card industry and limited access to funds, in comparison with big banks such as Citigroup or Bank of America Corp., said James Ellman, president at hedge fund Seacliff Capital.

Less affected will be Visa Inc. and MasterCard Inc. because they only process transactions and do not lend money. Furthermore, the world’s two biggest credit card issuers have continued benefiting from the growth of payments transactions, particularly outside the United States. What is certain is that any pullback in the availability of credit will only further strain an economy already hurt by the slide in home prices and wider credit crisis.

“If consumers aren’t spending as much, it’s hard to have economic growth. Credit is like oxygen for the economy,” said Sung Won Sohn, professor of economics at California State University-Channel Islands. Just how painful this deleveraging of the consumer will be is difficult to forecast, in part because this economic slowdown does not fit the standard mold.

Usually, consumers first default on their credit card and then stop paying their mortgages only after the economy has slowed for some time, because giving up a home is such a wrenching experience. But in this recession, many homeowners refinanced their mortgages to pay down their credit card debt, ran their credit card debt back up over time, and then defaulted on their mortgages.

There is early evidence that credit card defaults are rising. Banks wrote off their credit card loans in July at a rate that would amount to about 6.6% of their total loans if annualized, according to Fitch Ratings. The levels of unemployment and write-offs tend to move together and, if joblessness doubles, write-off rates will also roughly double, Fitch said in a recent report. The U.S. jobless rate has increased to a four-year high of 5.7% in July from 5.5% in June.

Bank of America, the largest U.S. retail bank, said its managed credit card loan losses rate jumped to 5.96% in the second quarter from 4.75% in the same period of 2007. J.P. Morgan Chase, the third largest U.S. bank by assets, reported its net credit cards charge-off rate jumped to 4.98% in the second quarter from 3.62% in the same period last year.

American Express shocked investors last month after giving up its earnings per share growth forecast amid a significant worsening of the economic environment since January, particularly during the month of June. “If we in fact do have a tough recession ... credit cards loss rates will move from 6% or 7% to 10%, 11% in 2009, meaning a 50% increase in loss rates," said Mr. Ellman.

Seacliff Capital’s president called those estimates “conservative.” He said loss estimates rates were low at the beginning of the subprime crisis, but now banks have recorded close to $500 billion of write-downs and credit losses.

The U.S. economy grew faster than expected in the second quarter, boosted by strong exports and consumer spending. But many analysts fear these factors will taper off in the second half of the year as the impact of a tax rebate program dries up and as weakening global growth and a stronger U.S. dollar crimps demand for U.S. exports.

Regulatory and legal pressures could hurt too. A bill pending in Congress seeks to protect credit card users from sudden rate increases and changes on fees and could put bank revenues under further pressure.

Given this kind of constraint, banks are making credit harder to get. About 65% of domestic banks said they had tightened lending standards on credit card loans over the past three months, according to the July Federal Reserve survey released earlier this month. Certainly, some consumers may even begin to wistfully look back on the times when their mail included several credit card offers a day.

Ospraie to Close Lehman-Affiliated Flagship Hedge Fund After 38% Loss
Ospraie Management LLC, the investment firm run by Dwight Anderson, will close its biggest hedge fund after slumping 38.6 percent this year because of bad bets on commodity stocks. The New York-based Ospraie Fund fell 26.7 percent in August after a "substantial sell-off" in energy, mining and resource equity investments, Anderson said in a letter to investors yesterday.

Ospraie's losses, once the largest commodity hedge fund firm, underscore how the sudden swing in commodities caught even experienced managers off-guard. The Morgan Stanley Commodity Related Index of 20 mining, energy and agricultural companies declined 13 percent in July and August as the slowing global economy cut demand for raw materials.

"Commodities have been the story du jour, what with China's 1.2 billion population industrializing," said Peter Rup, chief investment officer at New York-based Orion Capital Management LLC, which invests in hedge funds. "It's easy to find a trend and ride the train. The problem is, managers don't know when to get off it."

The shuttering of the Ospraie Fund, which opened in 1999 and managed $2.8 billion at the start of August, leaves Anderson's firm with three funds overseeing more than $4 billion of assets, down from $9 billion in March. "I am extremely disappointed with this result and the fund's sudden reversal in performance," Anderson, 41, said in the letter. "After nine years of striving to be a good steward of your capital, I am very sorry for this outcome."

Lehman Brothers Holdings Inc., based in New York, bought a 20 percent stake in Ospraie Management in 2005 and Zurich-based Credit Suisse Group AG invested an undisclosed amount the following year. Ospraie this year bought ConAgra Foods Inc.'s commodity-trading unit for $2.8 billion.

The Ospraie Fund had returned an average of 15 percent annually through the end of last year. Anderson generally invested about half of the fund in shares of natural-resource companies and the rest in commodity futures such as oil and zinc. Investments are usually held for two years. Futures are contracts for delivery of a security at a specified time in the future at an agreed price.

Ospraie plans to return 40 percent of the fund's assets to investors by the end of September and another 40 percent by year- end, Anderson said in the letter. The remainder, mostly held in so-called illiquid investments, may take as long as three years to distribute, he said.

Clients were locked into the fund for two or three years, depending on the fees they paid. The fund's loss of more than 30 percent triggered a clause that would have allowed investors to withdraw money at the end of September. Ospraie's remaining funds include the $1.2 billion Special Opportunities Fund, which makes private-equity-type investments in companies such as miners and barge operators; the $200 million Real Return fund, a so-called long-only fund that bets on rising commodity prices; and Wingspan, which invests in other hedge funds that together manage $2.5 billion.

The Standard & Poor's GSCI index of 24 commodity futures declined 18 percent during July and August, led by losses in oil and oil products, soybeans, aluminum and copper. Ospraie's largest shareholdings included oil and gas producer XTO Energy Inc., International Paper Co. and chemicals company Cytec Industries Inc., fillings with the U.S. Securities and Exchange Commission show.

Anderson has faced losses before. The Ospraie Fund fell 19 percent in the first five months of 2006 on losing bets in the metals market. That year the firm also closed its Point Fund, which had slumped 29 percent. "The fact that I had a horrible quarter is a statistical probability, and we had always told people there is that possibility," Anderson said in an interview last year. "We do everything that we can to manage the risk, and I think we're better at it today than we were a year ago."

Anderson graduated from Princeton University with a degree in history and earned a master's in business administration at the University of North Carolina at Chapel Hill. He joined Julian Robertson's Tiger Management LLC in 1994 and was soon put in charge of the New York-based hedge fund's basic-industries group.

Five years later he moved to Tudor Investment Corp., the Greenwich, Connecticut-based hedge-fund firm run by Paul Tudor Jones. Anderson started the Ospraie Fund at Tudor, named after the marine bird of prey. He spun off from Tudor in 2003.

Hedge funds are private, largely unregulated pools of capital whose managers can buy or sell any assets, bet on falling as well as rising asset prices and participate substantially in profits from money invested. This year they've lost 5.09 percent through Aug. 28, according to data compiled by Chicago-based Hedge Fund Research Inc.'s HFRX Global Hedge Fund Index.

Melt-down of Ospraie fund singes raw material producers
Hedge fund manager Ospraie Management will close its flagship fund after it plunged 27% in August on losses in energy, mining and natural resources equity holdings. The shut-down marks one of the biggest ever closures of a commodities-focused hedge fund.

The closure of the fund, announced by the firm’s founder Dwight Anderson in a letter to investors on Tuesday, could be more bad news for Lehman Brothers, which took a 20% stake in the hedge fund manager in 2005. One expert said the closure of the fund, which at the time of the letter’s writing had lost 38.59% this year, may also have played a role in bringing down U.S. stocks on Tuesday, which fell after initially climbing more than 1%.

“This is just adding to the fire for commodity-related names,” said Peter Holst, managing director at Delta Global Advisors in Southern California. “Even this morning when the market opened, some of the names that Ospraie has positions in were getting hammered.” As of the beginning of August, the flagship fund, Ospraie Fund Ltd, had $2.8 billion invested, a person familiar with the situation said.

Ospraie Management still manages $4 billion in other investment funds, including a special opportunities fund, the source said. That fund bought the commodity trading and merchandising operations of ConAgra Foods earlier this year. In the letter, Ospraie Management said it planned to distribute 40% of Ospraie Fund’s assets to investors by September 30 and an additional 40% by the year-end. The remaining 20% of the fund’s assets are mostly illiquid and could take up to three years to give back to investors, it said.

Based on a Securities and Exchange Commission filing, Ospraie Management held shares in companies including Alcoa and Arch Coal. It was not immediately clear which fund held what stocks. Ospraie owns major stakes in several Australian resources companies, mostly held through Ospraie Portfolio Ltd, in which Ospraie Fund is a main shareholder. Ospraie Portfolio owns about 16% of Australian plantations group Great Southern and 19.5% of Consolidated Rutile.

“At this stage we have no reason to think the announcement will have any impact on Great Southern,” Great Southern spokesman David Ikin said in an e-mail. Ospraie Fund had an 11.8% stake in Iluka Resources but that was sold to below 5% last week, according to a substantial shareholder notice to the Australian securities exchange. “They’ve reduced, if not exited, their holdings,” said Iluka spokesman Robert Porter.

Ospraie also owns at least 5% in Australian resources and mining services companies Emeco Holdings and Mineral Deposits. Executives at Consolidated Rutile, Emeco and Mineral Deposits were not immediately available to comment. A UBS dealer in Australia said he could not comment on Ospraie’s sell-off due to client confidentiality. Mr. Anderson said in the letter he was extremely disappointed with the outcome.

“Not only as a portfolio manager, but as one of the largest investors in the Ospraie Fund L.P., I have shared in the losses with you,” he wrote. “After nine years of striving to be a good steward of your capital, I am very sorry for this outcome.” He said the decision to close the fund was reached after it breached a threshold which would have allowed investors to redeem their money irrespective of the fund’s lock-up provisions.

This marks the second time in two years that Ospraie Management, which has been a major player in commodities markets, has run into problems. In early 2006 soured bets on copper left the fund down roughly 20% before it pared most of those losses by year’s end. Also in 2006, Mr. Anderson, who made his name in hedge funds at Tudor Investment and Tiger Management, closed down his $250 million Ospraie Point fund.

Ospraie Management is the latest in a number of hedge funds to have run into trouble in the $2 trillion hedge fund industry this year. Last month, Dan Benton said he will shut down his $2 billion Andor Capital. “I think it’s probably the first of more hedge fund closings to come, given that a significant majority of hedge funds have had negative performance this year,” said Chris Orndorff, head of equity strategy at Payden & Rygel in Los Angeles.

“I think it’s another piece of bad news for Lehman which is unfortunate and it probably raises the stakes on their conversations with the Korean Development Bank,” he said.

The Next Bailout
The Federal Deposit Insurance Corporation is on the brink of bankruptcy and taxpayers may be forced to pony up hundreds of billions to bail it out—for the second time in a generation.

All the while banks like Washington Mutual are deliberately putting taxpayers at greater risk.   But more on WaMu later.
Created during The Depression, the FDIC protects depositors from bank failures by insuring deposits up to $100,000.  To fund itself, the FDIC charges insurance premiums to member banks.

It ran out of cash once, in the early 90s, due to the savings and loan crisis.  Back then S&Ls advertised high interest rates to attract deposits, which they used to fund everything from speculative land deals to risky derivative trades.  Their marketing pitch to depositors was compelling: high interest rates on deposits backed by federal insurance, for which the banks themselves paid little. 

When their risky investments lost money, they’d simply offer higher interest rates to bring in more deposits.  Like any Ponzi scheme, eventually the S&Ls went bust.  And taxpayers were left holding the bag. Regulators, and Congress, still haven’t learned their lesson…..

FDIC reported last week that its assets stand at $45.2 billion, a puny 1.01% of the nation’s insured deposits, the lowest level since its bankruptcy twenty years ago. This is not an opportune moment for FDIC to be short of cash:  the bigger news from its report is that the list of “problem” banks has jumped to 117 from 90.

Sure enough, the next day Chairwoman Sheila Bair said FDIC may have to borrow money from taxpayers.\ Ultimately, the bill may be quite steep.  Ten banks have failed this year, costing FDIC over $10 billion.  But there are dozens of bank failures yet to come. One possibility looks particularly frightening: Washington Mutual.

WaMu has over a hundred billion dollars in the most toxic types of home loans—subprime, Alt A “liar loans,” home equity loans, pay option ARMs—the kind worth 30-60 cents on the dollar.  It’s stock is down over 90%, losses are piling up and the bank is short of cash.

In a move reminiscent of the S&L scandal, WaMu recently began offering the highest deposit rates in the nation: 5% on one-year CDs.  That’s 1.4% above the national average. Normally, big banks don’t have to offer the highest interest rates to attract deposits. But in the wake of the subprime crisis, some of the largest banks are also some of the most desperate.

Before it went bust, California’s IndyMac offered interest rates well above average.  Countrywide, recently rescued by Bank of America, is still in the top ten. Banks desperate for capital today are willing to sacrifice profits tomorrow.   So they market high interest-rate  savings products to attract the capital they need to keep funding loans.   With federal insurance protecting them, why wouldn’t depositors take advantage of high rates?

According to the FDIC website, WaMu had over $140 billion of insured deposits at the end of June.  To put that in perspective consider IndyMac, which went bust in July.  IndyMac had $16 billion of insured deposits and will cost $9 billion to bail out. If WaMu fails, it could wipe out FDIC’s remaining $45 billion.

Bair knows the FDIC doesn’t have enough cash to survive this banking crisis.  Besides asking the U.S. Treasury for funds, she wants to raise deposit insurance premiums.  But banks are perilously short of cash themselves. So where will FDIC find the billions it will need to finance its way out of this crisis? Taxpayers, most likely. And the more deposits that troubled banks attract by offering high interest-rates, the higher the price of the inevitable taxpayer-funded bailout.

One wonders: how may bailouts will taxpayers have to fund?  There was $29 billion for Bear Stearns, $150 billion for low-income Americans (the “stimulus plan”), $300 billion for homeowners and lenders in the latest housing bill, soon perhaps a couple hundred billion for Fannie Mae and Freddie Mac, potentially $50 billion in loans for Detroit carmakers and possibly hundreds of billions more for the nation’s bank depositors.  The bill may ultimately top $1 trillion.

Loss of customer data at Bank of New York Mellon much bigger than first thought
A security breach that occurred at the Bank of New York Mellon earlier this year turned out to be three times as large as it initially reported, the bank revealed last Thursday.

The breach involved the loss of unencrypted computer back-up tapes that contained confidential information about 12 million customers of the bank’s shareholder services unit, rather than the 4 million it originally announced. That could triple the company’s cost of dealing with the problem and potentially expand its liability.

In a statement, Bank of New York Mellon said it was in the process of notifying all the customers affected by the breach, as required by the Personal Data Privacy and Security Act of 2007. It is also paying for credit monitoring services and identity theft insurance for affected customers.

“We are actively engaged in a top-to-bottom review of our security policies and procedures,” Brian Rogan, the bank’s chief risk officer, said in a statement. “We are taking the steps necessary to ensure we have industry-leading security measures in place across all of our businesses.”

The security breach occurred when the unencrypted back-up tapes were being transported to a storage facility operated by third-party vendor Archive Systems. The tapes, which included Social Security numbers, names, addresses and dates of birth, went missing on Feb. 27. The bank maintains that there is no evidence that information on the tape has been accessed or misused in any way.

Robert Scott, managing partner of Scott & Scott, a law and technology services firm, said that because Bank of New York Mellon is a financial services firm that is regulated by federal agencies, there may be more potential problems that arise from this breach.

“There is a different legal landscape when you deal with a federal regulated entity as opposed to a retail business,” Mr. Scott said, noting that banks must meet standards set by the Office of the Comptroller of the Currency, while investment advisory firms must meet standards set by the Securities and Exchange Commission when it comes to security breaches.

He said in this case, if it is found that there was a failure to comply with the rules pertaining to data breach, federal agencies could bring legal actions or fines against the Bank of New York Mellon, in addition to any lawsuits filed by state attorney generals and customers who are harmed.

Since there are no set penalties for failing to safeguard customer data, the amount of liability for the company is very open-ended. “The legal landscape involving data breaches is very much in flux,” said Mr. Scott.

Corporations in the financial services and health-care industries are particularly vulnerable to data breaches involving back-up tapes, he said. Mr. Scott advises companies to purchase network security and privacy insurance to cover the cost of any actions taken by state and federal agencies and the cost of notifying customers, as well as customer losses.


Greg said...

I wonder if one can map the money flows (or evaporation of money) over time of the economy to see how bad it will get?...Seems like a downward spiral with no end in sight.

Anonymous said...

Harper (Canada's neo-con PM) is no where near majority position. The one poll that came out this week saying so was contradicted by other recent polls, and those which have been shown to be historically accurate. Or so I tell myself so I can sleep at night.

Of course, the Liberals (that's big-L Liberals to you non-Canucks) haven't done a hell of a lot to stop them recently, even though they could have. The arctic meltoff is close to the 2007 recent levels in terms of total ice area, and unlike last year, seems to be still melting this time of year (it leveled off last year in late August). Wonderful. Let's put people and resources thousands of kms from the nearest food and equipment supply. Brilliant!

Anonymous said...

The prices of homes increased 1/4 in the last year. It seems that Czech Republic will join to the club of fallen economics in a year or two :-(

I expected that the CO2 level will rise faster than before as the polar ice will melt. Because there is huge amount of CO2 in air bubbles inside the ice. It was captured in the ancient ages, when the CO2 levels were much higher than today (there was much higher volcanic activity on those days). When the ice melts, the gas releases to the free air and it causes global warming which causes more ice to be melted and more CO2 to be released.

It will not stop by its own, it must be stopped by putting more green plants and trees around the cities. I have read few weeks ago that Japan scientist made the artificial photosyntesis as the plants do it. It produced pure hydrogen and sugar just from CO2, water and the light. Maybe this is the way how to make the clean energy and keep the CO2 level on stable value.

Greetings from Czechia

el_pollo said...

I watched xenix2012's The Playbook a few days ago. Seems plausible to me. I am sure that I & S would be simply shocked if it were true :-)

My one question is - how does the PPT drive the market up on the pump without losing a boatload of money on the dump?

I also renew my question from yesterday - what kind of cash are the big boyz seeking shelter in?

Ilargi said...

"... how does the PPT drive the market up on the pump without losing a boatload of money on the dump?"

The answer is too simple maybe: by selling at the top and moving into shorts.

Anonymous said...

I & S

My understanding is that the PPT also derives a lot of power from the shady sales/Loaning of gold bullion. i.e the stated numbers of gold bullion being held by central banks is bunk.

Anonymous said...

I believe that I & S have mentioned a book that discusses th herd behavior dynamic in relation to markets. Can anyone tell me what the book is? thanks you.

Anonymous said...

Ilargi, maybe they'll return back to the gold (silver) standard, after this financial system will fail.

CrystalRadio said...


The answer is too simple maybe: by selling at the top and moving into shorts.

Wouldn't that be pretty traceable even if many were involved and playing some sort of ring around the Rosie?

Anonymous said...

theModernMystic's Doom Watch: Deflation is the word.

Anonymous said...

How reliable is theModernMystic's Doom Watch? Can we trust him as much as ilargi and stoneleigh?
Anonymous Reader

scandia said...

Anon, about the Harper conservatives...A poll on my federal by election shows what was a four way race 2 weeks ago is now a two way race between the Liberals( leading) and the Greens. The Greens have twice as much of the vote as the Conservatives who are a dismal 12% to the Greens 24%. the NDP are in fourth position. So no, third place does not portend a majority.No wonder Harper wants to cancel these 4 byelections!

Durandal said...

There is a lot of speculation that the KDB buyout negotiations of Lehmans are because of a political agreement between SK's president and Bush, who wants that time bomb out of American hands.

Sounds stupid, but the SK president is the type to bend over if Bush asked for it.

CrystalRadio said...

How reliable is theModernMystic's "Doom Watch? Can we trust him as much as ilargi and stoneleigh?"
Anonymous Reader

I hope ilargi and Stoneleigh find that a pretty odd statement! I just finished taking a look at those Doom Watch videos and can't see much they would violently object to. I would commend your faithfulness but it smacks too much of blind followership.

As far as trust goes, if you want to trust someone trust yourself, when you put blind trust in someone else all you do is either put a load on them or risk feeding a despot.

Stoneleigh said...


We promise not to become despots ;)

By the way, if anyone is interested, Ilargi and I were discussing finance and energy, as well as inflation and deflation, at Garth Turner's site yesterday. Any of our Canadian readers who don't already read his blog on the Canadian real estate situation should consider doing so.

Anonymous said...


good point regarding to trust.

the interesting thing one can get from watching theModernMystic on youtube is to see how his thought process has evolved. in a January video he talked about the debate of inflation/deflation and he thought deflation is more likely. after the northern rock nationalization, he talked about "inflation 2009" and just a week or two ago, he was still thinking current deflation should soon lead to hyperinflation in order to make "historical sense." now he thinks, though still somewhat confusing, the consensus is that there is no way to get out this deflationary death spiral.

have you listened to the interview with Bob Hoye and Marc Faber on Commodity Watch Radio? Hoye presented some arguments about the inevitability of the deflation from a historical perspective. Faber has changed his view from inflation towards a hybrid of deflation and inflation.


CrystalRadio said...

Blogger Stoneleigh said...


We promise not to become despots ;)


Uh huh, ;)

Caught both your an ilargis comments on the Garth site you mentioned, good stuff; also I will have to pass that site on to my brother who is still not listening to me about the housing situation ... one can take that not blindly following business a bit too far at times, especially when I am the elder brother, damnit! :(

red-dog99 said...

I checked the proposed SEC oil and gas reserves reporting criteria for public companies, and speaking as someone who used to work in the industry, the proposals are a vast improvement over the existing rules.

The SEC has by and large adopted the Canadian securities regulation 51-101, which has been in place for over 4 years.

If adopted, the new rules will ensure that no company will be forced to write down their entire bitumen reserves from an existing producing project, as happened a few years ago when the price for bitumen on the last day of December was below the cost of production. Now the price used to determine the economic value of reserves will be based upon the previous 12 months average price.

Also, oil companies will now be permitted to disclose the extent of their unproved reserves and resources, which are strong indicators of future proved reserves.

It should be pointed out here that reserves of oil and gas are not measured physical quantities, they are merely estimates, with associated risks and levels of uncertainty. Reserves always change over time as projects are developed, reserves are produced, and prices and costs change, as infrastructure and technology change, and as more information is obtained about the resource.

Proved reserves are required to meet the test of "reasonable certainty", which is considered to be equivalent to 90% certainty. This means that 9 times out of 10, proved reserves are understated.

On average, proved reserves from an oil well, a project or a company will be adjusted upward over the years because of this statistical bias.

Adjustments will also be made over the years because the uncertainty level of the revised estimates will also reduce over time.

The end result will be more and better public disclosure of information, leading to higher efficiency in accessing capital markets.