Debt Rattle, October 12 2008: Money is no object

G. G. Bain Fifth Avenue Stroll 1913

Ilargi: New round, new rules, new prizes. Every new day brings a whole new game. What was presented as smart and necessary yesterday, today is revealed as dumb and useless. The White House rethinks the $700 billion, McCain does Letterman, and Obama says this is not the time to panic. Nobody who says that ever volunteers what the right time is.

All countries around the globe may guarantee all deposits. Even if they can’t afford to, they can no longer afford not to. Likewise, they’ll buy big stakes in banks, so you can all kind of pay interest to yourselves and pay through the nose for the privilege. And why not guarantee all interbank lending in the process. Or all mortgages. Money is no object.

Tomorrow is a holiday in North America, and Europe, especially England, may suspend trading. Yeah, that’s a great way to boost confidence.

Meanwhile, all these banks have untold billions in useless pieces of paper marked down as valuable "assets" on their sheets. And no goverment on the planet can make that stuff do a Lazarus. So all those trillions in public money will evaporate as soon as they touch the ground running. There’s no escaping it.

Moreover, since the $2 trillion already lost in the US alone means that some $20 trillion will be gone in credit available to the market, there’s only one direction to go from here. Down down deeper and down.

I'm still waiting for the first country to do the only right thing: force open the vaults, put the day’s market values on the paper, swallow hard, and get it over with. Show some class. Show some sympathy. Show some taste.

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More Fed graphs, courtesy of François. He wanted to make clearer when the big changes started.

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IMF: Global financial system on the brink of systemic meltdown

The International Monetary Fund has warned that the world financial system stands on the "brink of systemic meltdown", despite international efforts to bring the crisis to an end. Dominique Strauss-Kahn, the IMF's managing director, made the comments after talks with US President George W Bush and other leading finance minister in Washington as they tried to find a solution to the global financial turmoil, which has seen stock markets around the world plunge on fears of recession.

He said: "Intensifying solvency concerns about a number of the largest US-based and European financial institutions have pushed the global financial system to the brink of systemic meltdown." The IMF also warned global equities could plunge by a further 20 per cent in the coming days unless governments deliver concrete action to address the crisis. At the meeting of finance ministers from the Group of Seven leading world economies, including the UK and US, world leaders pledged to part-nationalise swathes of the global banking system as part of a drastic international plan to halt the panic gripping financial markets and prevent the crisis from descending into a global depression.

Finance ministers from the Group of Seven leading world economies, including the UK and US, said they stood ready to pump public money into banks in order to prevent them from collapse. The agreement came as Chancellor Alistair Darling admitted that the UK was facing "turbulence the like of which we have never seen" after markets ended their worst week in history, with shares having fallen by more than a fifth on all leading stock exchanges.

The G7 presented a five-point "Plan of Action" to arrest the turmoil, including, most significantly a promise to "ensure that our banks…can raise capital from public and well as private sources, in sufficient amounts to re-establish confidence and permit them to continue lending to households and businesses." It leaves the G7 – which also includes Japan, France, Italy and Canada – open to start buying bank shares with taxpayers’ cash.

US Treasury Sectretary Hank Paulson said he was preparing to use the American $700bn bail-out scheme to fund buying troubled banks’ shares. It mirrors Gordon Brown’s £50 billion bail-out of Britain’s struggling institutions unveiled earlier this week. With investors gripped by panic, the FTSE 100 has fallen by 21 per cent this week, and yesterday alone suffered a drop of 8.9 per cent – the third biggest in history. Despite assurances from President George W Bush, shares in Wall Street fell for an eighth successive day on Friday, while the pound and the euro slumped against other currencies.

The agreement produced last night by finance ministers in Washington is thought to represent a last-ditch attempt for governments to prevent the financial crisis from worsening yet further next week. Some experts fear that unless it succeeds in boosting confidence the financial system may collapse entirely, threatening a worse economic slump than was experienced in the 1930s.

The G7 statement, which was among the most eagerly awaited in recent history, said: "[We agree] today that the current situation calls for urgent and exceptional action." Mr Paulson described the G7 statement as "an aggressive action plan to address the turmoil in global financial markets and the stresses on our financial institutions." Among the five pledges was a promise to protect savers’ deposits when banks collapse.

It came after Mr Darling and Bank of England Governor Mervyn King pledged to do everything in their power to prevent economic catastrophe. On a frenzied day in financial centres across the world, Mr Darling urged his fellow ministers to "step up to the mark and do something" Fears will remain about whether the plan is enough to arrest the decline in shares, since the UK plan did not prevent further falls in equities. However, the plan is as far-ranging and dramatic as many, including Mr Darling, had hoped.

Around $4,600 billion has been wiped off the value of shares worldwide this week – more than one and a half times the total amount of cash generated by the UK economy last year. Experts said yesterday that confidence was unlikely to return to markets until they were convinced that all major economies would take similar forthright steps to rescue the global banking systems.

On a frenzied day in financial exchanges throughout the world:
- The FTSE 100 dropped beneath the talismanic 4,000 mark for the first time since 2003, dropping 381.74 points to 3932.06. Money markets remained frozen.
- The pound dropped to its weakest level in five years, slumping below $1.70 against the dollar. By last night it was down almost a cent and a half to $1.69485.
- Oil prices dropped beneath the $80 a barrel mark for the first time in a year.
- President George W Bush pledged to end the vicious cycle of "uncertainty and fear" but offered no new remedies for the problem. Presidential candidate Barack Obama urged G7 ministers to do something to end the turmoil.
- The Icelandic Prime Minister admitted domestic customers will get priority over British savers as the country’s banks are wound up. It also emerged that the International Monetary Fund has sent emissaries to Iceland, and may arrange a bail- out package within days – the first IMF rescue of a major economy since Britain in the 1970s.

As he went into the G7 meeting, held alongside the annual IMF meetings in the US capital this weekend, Mr Darling said the world stood on a dangerous tipping point. "We like everybody else have been affected by turbulence the like of which we have never seen," he said. "We need to strengthen the financial system," he said. "If international co-operation is to mean anything it means governments need to move on from talking about a general approach and actually doing something to resolve the problems that we face."

With the financial turmoil worsening by the day, fears are growing for the health of the wider economy. Most economists now believe the UK is already in recession, and the International Monetary Fund this week slashed its forecasts for British economic growth by more than any other advanced economy. With businesses unable to get finance, there are now fears the UK could suffer a depression that lasts not for months but for years, with rising unemployment and falling profits.

Mr King said: "Central banks will work together as we demonstrated this week, to ensure sufficient short term liquidity is provided to stabilise banking systems. But it is also vital that governments work together to ensure their banking systems are recapitalised to enable them to lend to finance spending in the real economy."

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European summit works on "ambitious" crisis plan

European leaders raced against the clock on Sunday to clinch a rescue strategy for banks battered by the worst financial crisis since the 1930s, under intense pressure to throw them a lifeline before world markets reopen. At a summit in Paris, the focus fixed firmly on how much state money governments could mobilise to buy into banks if needed, and if they would also underwrite lending between banks, paralysed for now by fear and distrust.

French President Nicolas Sarkozy told reporters the meeting would come up with an "ambitious and coordinated plan" to tackle the crisis, which spread from the United States more than a year ago but hit fever pitch in recent weeks. Officials suggested action rather than rhetoric could emerge from a gathering that involved the leaders of Britain and the 15 countries of the euro currency zone as well as European Central Bank President Jean-Claude Trichet.

"If market confidence is not restored this weekend, it's game over," said Marco Annunziata, chief economist for UniCredit, an Italian bank which is among many whose shares have been hurt in panic-stricken stock markets. The American Standard & Poor's 500 index tumbled more than 18 percent last week, its worst weekly fall on record. European stocks plunged 22 percent and Tokyo's Nikkei crashed 24 percent.

Money markets, less visible to the public, are essentially on life support and dependent on regular, massive injections of emergency liquidity from central banks across the globe because banks themselves will not lend to each other as they used to.
The Paris meeting was hastily arranged by Sarkozy on the heels of a G7 summit of rich nations in Washington that offered no concrete, collective action but promised to do whatever was needed to unfreeze credit markets.

British Prime Minister Gordon Brown, whose country has not adopted the euro currency, was invited to Paris because the euro zone wanted possibly to replicate something like the rescue plan announced in London last week. Sarkozy and German leader Angela Merkel, who met in France on Saturday, said they had prepared a number of solutions to try to restore normal flows in credit markets.

At a Paris summit a week earlier, Merkel rejected the idea of a collective European rescue fund for banks and Sarkozy said he had not proposed one. That would not preclude governments on Sunday saying they were ready to pay up even if they do not put all the money in one pot or surrender control of what they offer.

Before the full summit, Sarkozy held a preliminary session with Brown, the ECB's Trichet, European Commission President Jose Manuel Barroso and Jean-Claude Juncker, Luxembourg prime minister and chief spokesman for euro zone finance ministers. Britain's rescue plan makes available 50 billion pounds ($86 billion) of taxpayers' money for injection into its banks and, crucially, calls for underwriting interbank lending.

In an interview with the Observer newspaper on Sunday, Brown said he would try to broker a Europe-wide bail-out of banks modelled on his plan, warning that the 'stakes could not be higher' for jobs, mortgages and the future of the economy." In London, big British banks were in talks with government officials and regulators and were likely to announce plans to recapitalise early on Monday, according to a person familiar with the matter. The talks there were to determine how much capital each bank needs from the 50 billion pounds ($86 billion) offered by Britain on Wednesday, said the source, who declined to be identified.

Sarkozy said he would announce some specific French measures for the domestic banking sector on Monday. On Saturday, media reports said Germany was readying a rescue package that could be worth up to 400 billion euros, including the injection of equity capital worth "double digit" billions into its banks and guarantees for interbank lending.

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Dutch Finance Minister criticizes US attitude

The Dutch Finance Minister Wouter Bos has criticised the US government's attitude to the financial crisis at the International Monetary Fund meeting in Washington. He says the Americans see the problems on the financial markets as a business hazard and not as an important economic problem that has to be resolved.

Mr Bos was surprised that top officials, not ministers, represented the government at important moments during the conference. He says the British do realise there is a need to monitor the financial sector more closely, but the Americans do not.

He was pleased with the appeal by the IMF members to play a more important role in shaping a new financial structure. He says, "If there has ever been an opportunity for the IMF to play a leading role it is now".

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US Treasury waits in wings to save Morgan Stanley

Morgan Stanley and Goldman Sachs, the last remaining independent investment banks, may receive cash injections from the American government as part of Treasury Secretary Henry Paulson’s plan to buy stakes in financial institutions.

Shares in the Wall Street titans were last week hammered in the stock market rout, raising fresh concerns about their financial stability from credit rating agencies and regulators. On Friday, Morgan Stanley’s shares plummeted 25 per cent, taking the total drop to 60 per cent on the week, despite claims by its chief executive, John Mack, that the bank was not in trouble. Moody’s, the ratings agency, had earlier said that it might cut Morgan Stanley’s credit rating on concerns over future earnings.

The threat of a downgrade raised concerns that Mitsubishi UFJ Group might pull out of buying 20 per cent of the US bank. The agreed $9bn stake now almost equals Morgan Stanley’s total market capitalisation. The cost of protecting against a Morgan Stanley default has soared since the middle of last month, indicating some investors think it will struggle to pay back creditors.

Moody’s said Morgan Stanley’s deal with Mitsubishi is “critical to maintaining current rating levels in light of the more challenging business conditions for wholesale investment banks”. This weekend both sides insisted the deal would go ahead, although insiders said the terms would be altered. “I’d like to reinforce the fact that the deal will go through on Tuesday,” a source close to the Wall Street bank said. One source claimed the Japanese group was considering buying the whole bank, including the Chinese-owned stake of 10 per cent. If a deal does not go through, it is likely the US government will buy a stake.

On Friday, Paulson said the US will purchase equity in a large number of banks and other financial firms to restore market stability and ensure economic growth. Goldman Sachs shares closed down just over 12 per cent, a total of 29 per cent on the week. On Friday, Moody’s lowered its outlook for Goldman Sachs’s Aa3 long-term rating to negative.

Morgan Stanley and Goldman were among the most profitable firms in Wall Street history and paid out $36.7bn in compensation and benefits to employees for 2007. Both stayed profitable through the first three-quarters of this year. The bankruptcy of Lehman Brothers on September 15 ignited investor fears about Goldman and Morgan Stanley.

Investors feared that stand-alone investment banks might no longer be viable as credit markets continue to deteriorate. There have been concerns that Morgan Stanley’s counterparties and trading partners could lose confidence in the investment bank, and walk away from transactions. To try to win back confidence, the firms obtained Federal Reserve approval to become bank holding companies and raised new capital from private investors.

At the end of last week, Egan-Jones Ratings, an independent rating agency in New York, said Morgan Stanley needs to raise $60bn in new equity to reassure customers and investors, according to Bloomberg News.

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German Bailout Likely to Be Over $500 Billion

German Chancellor Angela Merkel heads to Paris to present Sunday to her colleagues from the euro zone a financial sector bailout plan for Germany that's expected to be more than half the size of what has been enacted in the U.S.

A person familiar with the situation told Dow Jones Newswires that the government is considering a total bailout plan of €300 billion to €400 billion ($402 billion to $536 billion), which includes state guarantees and the option to get a direct stake in banks. As part of this, the government is mulling recapitalizing financial institutions by injecting €50 billion to €100 billion in capital, the person who declined to be named said.

"These figures are currently being discussed but there is no final decision yet and everything is still in flow," the person said. The Cabinet is expected to debate the rescue plan on Monday. The comments come after German Finance Minister Peer Steinbrueck and Bundesbank President Axel Weber told reporters following the group of seven leading nations' meeting in Washington that Germany will present a "far-reaching" rescue package before markets open Monday.

Speaking in France Saturday after a bilateral meeting with French President Nicolas Sarkozy, Chancellor Merkel said she wouldn't rule out support for banks who seek it, but that conditions would be attached. "One cannot talk of nationalization," Ms. Merkel said at a press conference in Colombey-les-Deux-Eglises according to the Associated Press.

Germany, Europe's largest economy, will outline the plans to the leaders of the other 14 euro-zone countries, who will meet for an emergency summit in Paris Sunday to ensure a coherent approach in dealing with the current crisis that has led to massive sell-offs in stocks and has frozen credit markets. Mr. Steinbrueck has been tight-lipped about details of the plan, which he said he already outlined to the G-7 officials in Washington.

With European officials heading back across the Atlantic Saturday, market attention will be shifting to the euro zone as it has so far failed to come up with a common approach. The U.S. Congress has enacted a $700 billion rescue package to bail out the ailing financial sector, the biggest government intervention in financial markets since the 1930s. The U.K. government Wednesday said it will invest in a number of U.K. banks in an effort to recapitalize the industry, end concerns about the viability of individual institutions and encourage banks to resume lending to consumers and businesses.

As part of the £400 billion ($682 billion) package, the U.K. government will boost banks' capital by buying preference shares of up to £50 billion, provide a £250 billion guarantee for short- and medium-term bonds issued by the banks, and provide additional liquidity of around £100 billion through the Bank of England's Special Liquidity Scheme. The U.K's move to guarantee bonds has put pressure on other countries to act because it will put their banks at a disadvantage to U.K. banks. Several European countries, including Spain and Italy, have also provided cash to bail out the ailing banking sector over the past days.

The German government has also been under pressure after it opposed an Europe-wide rescue fund for the banking sector proposed by the French, saying the banking market is too fragmented to respond to with a one-size-fits-all approach. While Germany so far has focused on case-by-case bailouts for institutions hit hard by the credit squeeze and subprime crisis, such as IKB Deutsche Industriebank AG and mortgage financier Hypo Real Estate Holding AG, it's now changing gear and will present a master plan for its national sector.

Some German banks have called for a countrywide umbrella solution for German banks instead of rescuing individual banks. "We will present to the partners of the euro zone what's crossing our mind in order to generate a coordinated behavior and prevent disparate developments in Europe," Mr. Steinbrueck told reporters Friday after the G7 meeting. "Under the headline of a cooperative procedure, each country will have search for and find problem-adequate responses." Germany's largest banks are Deutsche Bank AG, Commerzbank AG and the banking unit of Allianz SE Dresdner Bank AG, which is in the process of being taken over by Commerzbank, and the German unit of Italy's UniCredit SpA's, HVB Group.

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The Party is Over

More than just a mere liquidity or credit crisis, the current financial storm represents the death throes of the old global economic order, and perhaps the birth pains of a new one. The sun is setting on the borrow and spend culture that has defined us for a generation. Our long ride on the global gravy train is finally coming to an end, and once it does nothing will be the same. The sooner we come to grips with this the better.

Despite the myriad of proposals that are coming from Washington and other world capitals, we must understand that this crisis cannot be cured by governments. In the United States, credit is gone because savings are gone. Our shallow pool of savings has been depleted through bad loans, and we can no longer entice foreigners to lend us their available savings. Given that we are already too loaded up on existing debt they we cannot realistically repay, who can blame them for not wanting to lend us more?

As a result, the free market is trying to put an end to our spending spree. Without savings or home equity to fall back on, Americans struggling with rising prices are finally being forced to cut back. This has terrified our leaders and is causing them to dismantle the remaining structure of our free enterprise-based economic system.

The intention of all these daily federal interventions is to keep the credit spigots open so Americans can go even deeper into debt to buy more stuff they can't actually afford. This should be clear enough to anyone who listens to what our leaders are actually saying. When speaking about the need for an even larger fiscal stimulus package, Barney Frank, chairman of the House Financial Services Committee, said, "We have to prop up consumption." He has it backwards.

The government has been propping up consumption for far too long, and the best thing they can do now is remove the props so spending can be replaced by savings. The sad reality is that we borrowed and spent our way into this crisis, and we are not going to borrow and spend our way out of it. Legitimate credit can only be supplied if there are genuine savings to finance it.

Savings can't be magically concocted into existence by a printing press, but can only be created by consumers who spend less than they earn. Efforts to fool the market will not work and will ultimately lead to a monetary disaster and runaway inflation. Were the government to allow market forces to work, Americans would now have to pay cash for their consumption.

That would mean no instant credit for new cars, plasma TVs, appliances, consumer electronics, clothing, furniture, etc. Unless buyers actually had the cash in their checking accounts these purchases would have to be deferred. From an economic perspective this is precisely what the doctor ordered. But for an economy based 72 percent on consumer spending, the medicine will go down hard.

Ultimately, a serious reduction in consumer and mortgage credit, combined with an increase in personal savings, would again provide a pool of needed capital for businesses to produce products and provide employment opportunities. However, the danger is that this potential credit could be completely crowded out by massive borrowing by the Federal Government. In addition, prices for such things as houses and college tuition will fall sharply, as the credit artificially propping them up disappears.

People would still be able to buy houses and send their kids to college only they would pay much lower prices when they do. However, if the government keeps creating inflation to artificially sustain consumer borrowing and spending, there will be no savings left to fund anything and prices will be so high that despite massive consumer spending there will be few goods that Americans could actually afford to buy.

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Europe's Leaders Race to Find Financial Solution

European leaders meet today to forge a new set of measures to combat the credit freeze after their failure to act a week ago contributed to the worst sell-off in the region's stocks in two decades.

French Finance Minister Christine Lagarde said leaders will aim to put ``meat and muscles'' on a commitment to safeguard key banks. German Chancellor Angela Merkel, whose government earlier this month rejected French suggestions to form a joint bank- rescue fund, said yesterday the euro region will implement ``the same toolbox of instruments.''

Merkel, French President Nicolas Sarkozy and their counterparts in the 15-nation euro region are being forced to shift stance as a deepening slide in financial markets has threatened to tip Europe into a prolonged recession. ``Measures by euro-area governments to end the financial crisis have been uncoordinated and insufficient,'' said Juergen Michels, a Citigroup Inc. economist in London. ``Increasing risks of an economic disaster might force governments to set up more coordinated and more comprehensive measures.''

The euro-area leaders, along with U.K. Prime Minister Gordon Brown and European Central Bank President Jean-Claude Trichet, will meet today in Paris from 5 p.m. local time. They gather after finance chiefs from the Group of Seven nations established guidelines on Oct. 10 for combating the credit crunch, while falling short of adopting new initiatives.

Luxembourg's Jean-Claude Juncker, who heads the Eurogroup of euro-region finance ministers, said in a statement today that ``no financial institution of systemic importance'' can be allowed to fail. Juncker, who will take part in today's meeting in Paris, said that access to liquidity will be assured, efforts to unblock financial markets will be intensified and individuals' savings accounts will be protected.

``Some of us hoped it had had more teeth or more muscles to it, but at least it was endorsed,'' Lagarde told reporters in Washington yesterday, referring to the G-7 statement. Sarkozy has convened ``a meeting of all heads of states of the euro-group. Not to talk about it, but to actually put meat and muscles on the bones of that skeleton.'' ``I can assure you, you will not be disappointed, and it will be quite specific,'' she said. Merkel said yesterday during a visit to eastern France that Germany backs ``coherent reaction in the euro-zone to the international financial crisis.''

European benchmark stock indexes slid 22 percent last week amid an investor panic about the freeze in credit markets. The cost to protect corporate debt from default set new highs around the world and the rate banks charge each other for three-month loans climbed to record premiums over central bank benchmark rates. Contracts on Europe's benchmark Markit iTraxx Crossover index, a measure of the cost to insure corporate bonds, soared more than 2 percentage points in the past month to 756.60 two days ago, according to JPMorgan Chase & Co.

Anglo-Irish Bank Corp. Plc, Ireland's third-biggest lender, and ING Groep NV, the largest Dutch financial-services institution, plunged more than 42 percent, leading declines in banks and insurers last week. U.K. policy makers took the lead in planning to purchase stakes in banks hammered by losses on assets tied to mortgages. Brown set up a 50 billion-pound ($85 billion) program to invest in at least eight British lenders. U.S. Treasury Secretary Henry Paulson will tap some of the $700 billion financial-rescue package approved by Congress this month to buy equity in financial companies.

It ``made sense to implement measures in Germany and other European states like the ones in the U.S. and U.K.'' Commerzbank AG Chairman Klaus-Peter Mueller said in a Bloomberg Television interview. A German program may allot up to 100 billion euros ($134 billion) to recapitalize private banks, state banks and insurance companies, Handelsblatt reported, citing unidentified officials. Merkel said the plan would involve ``providing banks with sufficient capital so that they are able to operate on their own -- and I don't rule out that there could be capital support.''

European officials last month rejected taking more concerted action. Lagarde said then she had ``decided to take no other measures'' than banning short-selling and German Finance Minister Peer Steinbrueck dismissed the need to ``adopt a comparable program'' to the U.S. program to buy distressed assets from banks. At an Oct. 4 summit, leaders of France, Germany, Britain, Italy, Luxembourg, the ECB and European Commission stopped short of a regional rescue effort. They agreed to ease accounting rules, seek tougher financial regulations and weaken enforcement of competition and budget laws.

Today's Paris crisis talks, the second in as many weekends, reflects the speed at which the U.S.-led credit crunch has infected Europe's banking system, financial markets and economy. Governments this month have bailed out financial companies including Fortis and Dexia SA. The ECB cut interest rates this past week for the first time since 2003 and offered banks unlimited funding every week at the main refinancing rate.

Even so, Europe's credit markets remain frozen, like those elsewhere. The cost of borrowing euros for three months remains close to a record high, choking off access to cash for companies and consumers. That is pushing the 15-nation euro area toward its first recession since the single currency began trading in 1999. ``We have to reduce the cost of borrowing in Europe and there is room for that,'' Corrado Passera, chief executive officer at Intesa Sanpaolo SpA, Italy's second-biggest bank, said yesterday.

Brown's government has also proposed guaranteeing loans between banks to thaw money markets. The G-7 refrained from endorsing the approach two days ago. The U.K. leader may renew his push today. The U.K. plans to recapitalize its biggest banks including Royal Bank of Scotland Group Plc and provide 250 billion pounds of bank loan guarantees.

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Iceland ready to turn to the IMF

Iceland signalled on Sunday it was growing increasingly open to the idea of seeking International Monetary Fund help to pull the country through its worst economic crisis. As Icelandic officials prepared to depart for Moscow this week to begin negotiations for an emergency loan from Russia of potentially billions of euros, a top minister gave Iceland's strongest signal yet that it was ready to turn to the IMF.

"My conclusion is that if we appeal to the IMF, other central banks and other nations would follow that track," Industry Minister Ossur Skarphedinsson told the Morgunbladid newspaper in a report published on its Web site on Sunday. Skarphedinsson said that would give Iceland a chance to rebuild its foreign currency market swiftly and would "strengthen our own currency and ensure a considerable cut in interest rates."

When the financial crisis took hold this past week, Iceland at first downplayed the idea of seeking help from the Washington-based lender. Countries typically avoid going to the Fund for money, both as a point of national pride and to avoid the conditions the organisation may impose on them in return for much-needed cash.

As Iceland was forced over the past week to take over one major bank after another, to shut down its stock market and to abandon attempts to defend its free-falling currency, Prime Minister Geir Haarde showed more willingness about going to the IMF, calling it a definite possibility. On Friday, Haarde said Iceland would not take a decision while the finance minister was in Washington for the annual IMF meetings taking place at the weekend.

Many in financial markets believe that ultimately the crisis-stricken country will have little choice but to borrow from the Fund. On Thursday, the IMF said it had activated emergency plans to provide lending to countries in crisis.

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UK government to take majority stake in RBS

Banking shares across the G7 nations could be suspended tomorrow as Government prepares to take a £35bn equity stake in four of the UK’s high street banks. Treasury sources confirmed that the Government had drawn up plans to take on a majority stake in Royal Bank of Scotland and big holdings in Lloyds TSB, HBOS and Barclays under its £500bn plan to bail out the banking industry.

Talks were continuing this weekend, added the source, warning that it was a fast-moving environment. The Government is expected to invest £12bn in RBS, £10bn in HBOS, £7bn in Lloyds TSB and £3bn in Barclays, following request for the emergency funding from the banks. Analysts believe a further 20 per cent fall in bank shares this week would leave the Government with little option but to nationalise virtually the entire sector.

With markets in the US and Japan closed on Monday, Britain and the other G7 nations are determined to avoid further slumps in banking stocks that could compound the global contagion. The developments emerged as the International Monetary Fund warned global equities could plunge by a further 20 per cent in the coming days unless governments deliver concrete action to address the crisis.

The world financial system was standing on the “brink of systemic meltdown”, Dominique Strauss-Kahn, the IMF managing director, said. “Intensifying solvency concerns about a number of the largest US-based and European financial institutions have pushed the global financial system to the brink of systemic meltdown.” The warning came as Chancellor Alistair Darling told his fellow finance ministers that they “must get on with” dramatic plans to recapitalise their banking systems.

The German government is today expected to unveil plans to pump billions of euros into banking shares. The country is likely to announce a plan to spend around €50bn to €100bn on bank equity. Speaking about the recapitalisation plans, Mr Darling said: “This is not an optional extra. It is imperative [other countries] get on with it. There is a very clear sense that governments need to act now. The reality is staring us starkly in the face. This is a necessary step towards stabilisation. The threat is blindingly obvious. You can’t stabilise economies unless you have a stable banking system.”

He spoke as the IMF pledged to support a radical international plan to halt the financial crisis. The French government is also expected to unveil a rescue plan at a summit in Paris today. The US confirmed on Friday that it will use its $700bn bail-out fund to buy shares in troubled banks and financial institutions. “We’re going to do it as we can do it in a proper way that will be effective. Trust me, we’re not wasting time, we’re working around the clock,” said Henry Paulson, the US Treasury Secretary. In Britain, insurers and pension funds have been approached by banks in an attempt to use surplus cash on their books to improve liquidity in the banking system.

Institutions have been approached to gauge their interest in further capital-raisings at the banks. Richard Buxton, head of UK equities at Schroders, said: “The likelihood is we will support a number of banks to varying degrees. But there is no way the markets will be able to provide the full £25bn required.” Although the bail-out announced last Wednesday focused attention on recapitalisation through preference shares rather than straight equity, the banks are now looking increasingly in need of core equity injections.

All four major lenders have been in discussions with the Financial Services Authority over the additional writedowns they must take on their “toxic” assets. Large provisions will erode their equity base, which cannot be replaced with preference shares. Banking sources said the Government wants to “err on the side of caution” and recapitalise the four stricken lenders with a massive cash injection. One bank director said: “If you are going to do this, you have got to do it right. The Government can’t come back a second time.”

Bank bosses were yesterday locked in negotiations with the Government that are scheduled to continue today in an attempt to hammer out a deal before the markets open on Monday. Banks that cannot secure institutional support will see the taxpayer step in with the money through the underwriting process. Buxton said investors may be deterred from supporting lenders they fear will end up with large government stakes.

After their equity raisings, the banks will top up with preference shares. The coupon, or interest rate, on the shares is expected to be set at between 9 and 12 per cent, depending on the bank, and cannot be retired for five years. The coupon will provide an attractive income for the taxpayer and encourage the banks to refinance the preference share debt as soon as the five years are up. If the banks recover and the markets reopen beforehand, other institutions may buy the preference shares off the Government for the high coupon.

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U.K. banks set to unveil bailout plans

Major British banks are likely to announce their plans to recapitalize early on Monday, a person familiar with the matter said, a move which could see the government take multi-billion pound stakes in several lenders. Banks were in crisis talks with the government and regulators on Sunday to determine how much capital each needs from the 50 billion pounds ($86 billion) offered by Britain last week.

An announcement is expected before the market opens on Monday but details are still being fine-tuned, said the source, who declined to be identified. The Sunday Times said Royal Bank of Scotland, HBOS, Lloyds TSB and Barclays could ask for a combined 35 billion-pound lifeline. RBS may need at least 10 billion pounds, HBOS over 5 billion pounds and Lloyds and Barclays more than 3 billion apiece, according to industry sources and analysts' estimates.

That could result in the government becoming the biggest shareholder -- and even a majority investor -- in RBS and HBOS. Earlier this year RBS shareholders had said Chief Executive Fred Goodwin he would need to step down if the bank sought to raise more cash. The government could take seats on the boards of banks, a government source said on Saturday.

British Finance Minister Alistair Darling, attending a G7 finance ministers' meeting in Washington, said on Saturday the government was to give more details early this week about its already announced 400 billion pound banking rescue plan. The Sunday Times said the scale of the fund-raising could lead to trading at the London Stock Exchange being suspended to give the market time to digest the impact.

The LSE downplayed that prospect, however. "My information is that the market will open on Monday," a spokesman said. RBS, which has seen its market value fall to below 12 billion pounds, is to ask ministers to underwrite a 15 billion pound cash call, the Sunday Times said. HBOS, Britain's biggest provider of mortgages, was seeking up to 10 billion pounds, Lloyds wanted 7 billion pounds and Barclays needed 3 billion pounds, the newspaper said.

Barclays, Britain's second biggest bank, has said it is considering raising capital privately and is expected to try and raise funds from existing shareholders to limit any funds provided by the government. Lloyds is in the process of buying HBOS and the fundraising could see Lloyds renegotiate the terms of the deal, although both sides were still keen for the merger to go ahead, the Sunday Times said.

Banks were in talks over the weekend with the Treasury, the Financial Services Authority and the Bank of England. The scale of the cash required by each will depend on estimates of more losses from their exposure to subprime mortgages and other financial instruments, the source said. Capital is the cushion a bank keeps to protect its depositors against losses. Many banks ran down their capital in recent years amid a benign economic backdrop, but have been hit by big losses in the last year and now need to recapitalize in the face of an economic recession.

Last week's multi-billion pound package was aimed at stabilizing banks and getting them lending again, but it failed to halt a collapse in share prices. The package included a 50 billion pound cash injection, guaranteeing interbank lending by 250 billion sterling to help unfreeze wholesale markets, and extending a Bank of England scheme that swaps banks' risky assets for government debt to provide 200 billion pound of cash to the system.

RBS could need to raise 10 billion pounds to rebuild its capital, analysts at Credit Suisse said on Friday. Dresdner analysts also estimated RBS needs about 10 billion pounds and other analysts have predicted it could need more. Barclays and HBOS will each raise about 5 billion pounds and Lloyds needs about 4 billion, Credit Suisse said.

RBS shares fell over 60 percent last week and it and HBOS have lost more than three-quarters of their value this year. The broader European bank index has halved this year as fears that more banks will fail have been stoked by the deepening financial crisis and prospect of recession.

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Fed's Fisher Says All Options Weighed to End Crisis

The Federal Reserve will consider all policy options necessary to stabilize financial markets and limit damage to the economy, said Richard W. Fisher, president of the Dallas Fed bank. ``We can and we will restore order to the credit markets,'' Fisher said during a panel discussion sponsored by the Institute of International Finance in Washington. He said the U.S. faces a period of ``negative growth'' and pledged that the Fed would do ``whatever'' is necessary to ease strains on markets and the economy.

Fisher didn't offer details on what options may be under consideration. He said he was breaking from Fed officials' public-speaking tradition of not talking on behalf of the entire policy-making Federal Open Market Committee. ``This morning I am casting that convention aside,'' he said. ``I speak for all of us when I say that the Federal Reserve will continue to explore every avenue and consider every option to see the credit markets through the credit crisis.''

The Fed, the European Central Bank and other central banks lowered interest rates last week in an unprecedented coordinated effort to ease the economic effects of the freeze in credit markets. Fisher voted for the policy change after dissenting as recently as Aug. 5 against holding the benchmark rate unchanged in favor of an increase because of inflation concerns. The Fed reduced its benchmark rate to 1.5 percent. Traders anticipate another quarter point cut by the Federal Open Market Committee's Oct. 28-29 meeting.

Fisher said policy makers must work in concert to address the strains in the financial system. Treasury Secretary Henry Paulson is planning government investment in banks to help replenish depleted capital. The Treasury is also recruiting asset managers and other staff to carry out a $700 billion rescue plan approved by Congress, which will be administered by a newly formed Office of Financial Stability in the Treasury's headquarters in Washington.

Fisher said federal support for the banking system will help economic growth to resume. Paulson, the Congress and other officials will ``will engineer an appropriate recapitalization of the banking system in a manner that does not kill the goose that lays the golden eggs of the practice of capitalism,'' Fisher said. The Fed is facing increasing evidence that the U.S. is close to or already in a recession. Labor Department figures showed Oct. 3 that payrolls fell by 159,000 in September, the biggest drop in five years. The unemployment rate held at 6.1 percent, up from 5 percent as recently as April. Fisher said the turmoil may lead to ``sub-par and even negative growth for some time possibly into 2009.''

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Norway announces $57 billion bank liquidity plan

Norway's government and central bank introduced new measures on Sunday to boost banks' liquidity and their ability to fund themselves, including plans for up to 350 billion crowns ($57.41 billion) in new government bonds. The new bonds will be offered to banks so that they can swap covered bonds into government securities which can be used as collateral in central bank liquidity operations, officials said.

Because oil-rich Norway runs huge budget surpluses the amount of government bonds is limited. Analysts said the plan would help but it was not clear if it was sufficient. "The Norwegian authorities are prepared to launch the measures necessary to secure confidence in the Norwegian banking system," Prime Minister Jens Stoltenberg told a news conference.

"This facility is tailored to the needs of Norwegian banks and in conformity with the G-7 statement on financial stability earlier this weekend," he said and added that the government would monitor the situation and launch new measures if needed. The central bank, Norges Bank, said it would offer banks a new longer-term two-year liquidity loan, known in Norway as "F-loans". The new loan is aimed at smaller banks. Until recently, Norges Bank mainly offered daily and weekly liquidity.

"The overall effect of these measures will be to make it considerably easier for banks to fund their activities," central bank Governor Svein Gjedrem said in a statement.Norway has been less heavily hit by the global financial crisis than many other economies, but the central bank has had to inject large amounts of liquidity into the financial system as market rates have soared and banks have largely stopped lending to each other.

"Even if the Norwegian banks are fundamentally strong their funding situation has deteriorated significantly," the finance ministry said. Norway's money market is based on U.S. dollar swaps and has dried up along with global dollar funding. "The Norwegian money market isn't working," Gjedrem said, adding that the central bank had acted as a clearing house to provide commercial lenders with funding.

Finance Minister Kristin Halvorsen hoped parliament would pass the plan by Nov. 1 and said: "We expect this amount to cover all the banks' needs, and then some." Economists welcomed the measures but said they were not sure if they would be adequate to calm the financial markets. "It will ease the tension in the money market but it is difficult to say whether it will be enough," Nordea Markes senior economist Erik Bruce said.

"This is an important step," said First Securities chief economistHarald Magnus Andreassen. "It's the first important change and after a long delay ... I hope it will help but I'm not sure how much." The new government bonds will be made available to banks against collateral for periods of up to three years. "Banks may surrender covered bonds, including bonds issued by a mortgage association within the bank," the ministry said. "The facility will be made available against a market-based premium."

The announcement came three days before the central bank is due to hold an interest rate meeting where it is widely expected to cut interest rates by 25 or 50 basis points, following concerted rate cuts by other central banks last week. "I'm quite confident that if this is not enough another supply will turn up," Andreassen said, but added that it might become necessary to accept lower quality on collateral.

He said that the central bank could opt to cut rates by only 25 basis points to 5.50 percent instead of by 50 basis points, depending on the market reaction to the liquidity measures. But he said he would not rule out even a 100 basis point cut on Wednesday if global markets continued to plunge.

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GM balks at sticker price for Chrysler

General Motors, battling shrinking U.S. sales and a plummeting stock price, is discussing a possible combination with Chrysler, a person familiar with the talks said. A deal would make sense, but there’s no certainty the two companies will be able to make it happen, said the person, who didn’t want to be identified because the talks are private.

Other sources told Reuters that talks between Chrysler’s majority owner, Cerberus Capital Management, and GM began several weeks ago and were initiated by the private equity fund. But the talks got hung up on the question of how to value Chrysler’s loss-making auto operations, which include the Chrysler, Dodge and Jeep brands, two of the sources said.

The discussions add to the prospect of Chrysler falling under different ownership, 14 months after the third-largest U.S. automaker was sold to private-equity firm Cerberus Capital Management. GM explored buying its smaller U.S. rival in early 2007, before the former DaimlerChrysler AG announced the sale to Cerberus.

Chrysler’s U.S. sales have plunged 25% this year, the steepest decline of any major auto company. GM’s volume has dropped 18% as U.S. demand for new vehicles slides to the lowest levels since the early 1990s. The Detroit-based automaker hasn’t posted an annual profit since 2004, and its recovery efforts have been hampered by the global credit crisis. GM’s stock price fell to its lowest point in more than a half century this week, closing at $4.89 on Friday.

”Without referencing this specific rumor, as we’ve often said, GM officials regularly have conversations with other automakers about items of mutual benefit,” said GM spokesman Tony Cervone. He declined further comment. In a prepared statement, Chrysler’s communications director, Lori McTavish, said the automaker “as a matter of policy does not confirm or disclose the nature of its private business meetings.” She said the company is exploring several “potential global partnerships.”

”Beyond those partnerships already announced however, Chrysler has not formed any new agreements and has no further announcements to make at this time,” she said. A Chinese automaker and Renault-Nissan may also be interested in Chrysler, CEO Bob Nardelli said in an interview last week. He said any decision to sell Chrysler would be up to Cerberus. The private-equity firm owns 80.1% of Chrysler and recently offered to buy the remaining 19.9% from Daimler AG, spurring speculation Cerberus may be trying to sell the company.

Mr. Nardelli said his job is to execute Chrysler’s recovery plan. He said he has met Carlos Ghosn, CEO of France’s Renault and its Japanese Nissan affiliate, several times. ”Carlos could be a strategic buyer if anything you read in the paper is true about Renault wanting to get access to the U.S. market,” Mr. Nardelli said. “China could be a very strategic buyer for a totally different reason. ”It depends on who has a hoard of cash in this economy because they’re not going to get a lot of debt out there,” he said. Cerberus spokesman Tim Price recently told the Financial Times that Chrysler isn’t for sale.

In Tokyo, Nissan spokesman Simon Sproule said Renault-Nissan continues to talk about additional joint projects with Chrysler. “Anything beyond that is speculation,” Mr. Sproule said. “I’d just characterize it as background noise.” The New York Times late Friday cited people close to the talks saying that chances are 50-50 that the negotiations will lead to a GM-Chrysler merger. The Wall Street Journal said Cerberus offered to sell Chrysler to GM in return for GM selling its remaining 49% stake in GMAC to Cerberus. GM sold a majority of the finance arm to Cerberus in 2006.

But sources told Reuters that GM rebuffed that offer because it saw it as overpaying for Chrysler. It would also have meant taking on the challenge of cutting overlapping brands, dealerships, factories and union-represented workers, one source said.

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G.M. Said to Seek Merger With Ford Before Chrysler

Before General Motors began exploring a possible merger with Chrysler — talks that first came to light on Friday — G. M. proposed a similar deal with its other cross-town rival, the Ford Motor Company, two people with knowledge of the talks said Saturday.

G. M. executives approached Ford about a possible merger in July, but Ford rejected the idea and ended the discussions last month, these people said. After Ford decided to remain independent amid an increasingly difficult auto market, G. M. turned its attention to Chrysler. For the last month, it has been in preliminary merger talks with Chrysler’s owner, the private-equity firm Cerberus Capital Management. People with knowledge of the talks described the chances of a deal as “50-50.”

The behind-the-scenes maneuvering illustrates the mounting pressure on the Big Three Detroit automakers to solve their enormous financial problems and stave off bankruptcy. A G. M.-Chrysler merger, if it were to occur, would have a wide-ranging impact on the American auto industry at one of the most critical points in its history.

Both G. M. and Chrysler are losing market share in the United States and burning through billions of dollars in cash while they scramble to revamp their unprofitable North American operations. But they may be running out of time. With auto sales at their lowest level in 15 years, both companies face the possibility of bankruptcy before their turnaround efforts take hold.

“These are not normal times,” said David Cole, chairman of the Center for Automotive Research in Ann Arbor, Mich. “The biggest problem is cash and whether these companies will have enough to survive this downturn.” For G. M., which lost $15.5 billion in the second quarter alone, the strategy for survival appears to center on pursuing a mega-merger.

In July, G. M. approached Ford with a proposal to combine the operations of the two biggest American automakers. The talks involved several meetings between G. M.’s chairman, Rick Wagoner; its president, Frederick Henderson; Ford’s executive chairman, William C. Ford Jr.; and its chief executive, Alan R. Mulally, people with knowledge of the process said.

Ford broke off the talks in September, these people said. Mr. Ford and Mr. Mulally were said to have concluded that their company had a better chance to reorganize on its own than in tandem with another automaker. A Ford spokesman, Mark Truby, declined Saturday to confirm the discussions with G. M., but he said Ford was determined to remain independent.

“What we can say is that we are convinced our best opportunity is to continue to integrate Ford and leverage our global assets,” Mr. Truby said. “That remains Ford’s focus.” Talks between G. M. and Cerberus may take weeks to complete, and they could still be derailed by price issues and the challenges of integrating G.M. and Chrysler. The companies have held numerous meetings involving senior management on both sides but have yet to delve deeply into each other’s financial books and sales projections.

Cerberus is also talking with other automakers about a potential Chrysler deal, including Nissan Motor of Japan and Renault of France, people with knowledge of the situation said. Chrysler executives have already struck some deals on products and manufacturing plans with competitors, including a deal to provide a pickup truck to Nissan in exchange for Nissan building a small car for Chrysler.

A Chrysler spokeswoman, Lori McTavish, declined Saturday to discuss any merger talks with G. M. but reiterated the company’s strategy to grow through partnerships. “As we have said, the company is looking at a number of potential global partnerships as it explores growth opportunities around the world,” Ms. McTavish said. “Beyond those partnerships already announced, however, Chrysler has not formed any new agreements and has no further announcements at this time.”

Chrysler has struggled in the United States market since Cerberus acquired an 80.1 percent stake in the company for $7.4 billion last year from its previous owner, Daimler of Germany. Chrysler has cut thousands of jobs, slashed production and closed plants to try to balance the impact of a 25 percent drop in United States sales so far this year. But Chrysler has a substantial amount of cash, which probably would be of great interest to G. M.

As a privately held company, Chrysler is not required to disclose its financial results. In August, however, Cerberus said that Chrysler had about $11 billion in cash reserves. The merger talks between G. M. and Chrysler are playing out against a backdrop of radical downsizing by all three Detroit automakers. Since 2006, the companies have cut a total of more than 100,000 hourly jobs in the United States, leaving them with about 130,000 blue-collar workers in their home market.

But the companies have also experienced significant erosion in their sales in the United States. Last year, G. M. sold 3.82 million vehicles, compared with 4.81 million five years earlier. During that same period, Ford’s sales have fallen to 2.5 million from 3.57 million, and Chrysler’s sales have dropped to 2.07 million from 2.2 million. By contrast, Toyota’s sales in the United States have grown to 2.62 million last year from 1.75 million in 2002.

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Credit swaps dragged out of shadows

The push to bring credit default swaps out of the shadows gained momentum last week, with formal trading platforms for the esoteric derivatives winning fresh support from industry players and federal and state officials clamoring for more oversight of the $55 trillion market.

Some swaps watchers say an exchange or clearinghouse could satisfy the calls for regulation by addressing two of the biggest issues hanging over the swaps market right now: a lack of transparency and fears about counterparty risk. “There is so much need for a clearinghouse,” said Robert Claassen, a partner in the corporate practice of law firm Paul Hastings. “We are just getting inundated with questions about counterparty risk. There is so much concern about counterparty risk and a clearinghouse eliminates that.”

Counterparty risk is the possibility that one party to a financial contract won't be able to pay up. It had not been much of a factor in the credit swaps market before the meltdowns this year of brokerages Bear Stearns and Lehman Brothers and the near-collapse of insurer American International Group. All were major issuers of default contracts, and the downfall of these once-mighty companies has rattled the market for swaps, which are a kind of insurance that investors or companies buy to hedge against a bond defaulting.

Meanwhile, a lack of market transparency last week threw a kink into one of the swaps market's biggest tests to date: the settlement of contracts covering the $1.4 trillion in debt outstanding from mortgage giants Fannie Mae and Freddie Mac. Some buyers of protection covering Fannie and Freddie's subordinated debt were burned in an auction to determine the price at which those bonds would be settled. The junior bonds, which were expected to settle around 90 cents on the dollar or less, instead settled at 98 cents and 99.9 cents, due to unforeseen demand.

The run on Fannie and Freddie's junior bonds might have been avoided—or predicted—had there been some kind of platform that gave the market a good picture of the mortgage firm's outstanding CDS contracts, some industry experts say. The validity of the settlement process was expected to be tested yet again last Friday on swaps related to Lehman. The outcome of that settlement could further bolster the case for a trading system.

At least two such platforms have been proposed, and still others are in the works. It's still not clear which government agency will have oversight of these platforms, although at least two organizations have thrown their hat into the ring.

Last week, Securities and Exchange Commission chairman Christopher Cox for the second time called on Congress to pass legislation giving the SEC oversight to rein in the “regulatory black hole for credit default swaps.” And Eric Dinallo, superintendent of the New York State Insurance Department, told Congress that his agency would move ahead with plans regulate some New York-based swaps dealers as insurance providers by January “if there is not a more holistic solution through a central counterparty clearing or an exchange.”

At least one such solution will be in place by year-end. Chicago Mercantile Exchange parent CME Group and Chicago-based hedge fund Citadel Investment Group said last Tuesday they will launch an electronic exchange within 30 days to clear and trade swaps. The exchange will offer risk analysis, standard swaps contracts and procedures for settling credit events, among other things. It will also be integrated with a clearinghouse. CME and Citadel didn't say who would regulate the exchange.

Their plans were intended to put their platform ahead of a rival introduced days earlier by Chicago derivatives dealer Clearing Corp., which is in the process of securing a New York state banking license to set up a swaps clearinghouse that would clear U.S. and European swaps, swaps indices and tranches. Both proposals elicited mixed reactions from players in the swaps industry.

Swaps brokers favor a clearinghouse, as it would keep swaps in an over-the-counter market where they would continue to have control over margin levels, according to Brian S. Yelvington, a senior analyst at CreditSights. “It is to their benefit,” he said. “They maintain control over the reporting of the trades—the transparency.”

A clearinghouse has some drawbacks in comparison with an exchange, though, Mr. Yelvington said. An exchange would better mitigate counterparty risk, because brokers would have to conform to prescribed margin limits, and would make bid and ask prices more visible to market participants. Yet Mr. Claassen of Paul Hastings said an exchange could be unnecessary, because the swaps market is dominated almost entirely by institutions, not individual investors. An exchange ensures individual investors have access to a market, but there just isn't that kind of demand for swaps, he said.

In the end, it might not matter what type of platform wins out so long as one is established. Uwe Reinhardt, a professor of economics at Princeton University, said multiple exchanges or clearinghouses would be a healthy development for the swaps market and could appease regulators. “[Exchanges] are tougher than the government,” he said. “You can always purchase the soul of a congressman. You can't purchase the soul of an exchange. These are superb private-sector regulators.”

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Why there's a crisis -- and how to stop it

At this point in the credit crisis, at least one thing is certain: most policymakers lack a clue of what is really at stake. Those with some knowledge are driving policy looking through the rearview mirror. Begin with the U.S. Treasury's $700 billion bailout package. This was presented as some magic pill which, if gulped down, would quickly restore financial stability.

The "shock and awe" of the sheer size of the taxpayer-funded bailout would somehow restore confidence. Instead, stock markets collapsed and credit markets remained frozen. This is because the credit crisis reflects something more fundamental than a serious problem of mortgage defaults. Global investors, now on the sidelines, have declared a buyers' strike against the sophisticated paper assets of securitization that financial institutions use to measure and offload risk.

In recent years, our banks, borrowing to maximize the leverage of their assets at unheard-of levels, produced mountains of financial paper instruments (called asset-backed securities) with little means of measuring their value. Incredibly, these paper instruments were insured by more dubious paper instruments. Therefore, the housing crisis was a mere trigger for a collapse of trust in paper, followed by a de-leveraging of the entire global financial system. As a result, we are experiencing the painful downward reappraisal of the value of virtually every asset in the world.

So what are these paper instruments, these asset-backed or mortgage-backed securities? I like to use a salad analogy. Before the last decade, bankers simply lent in the form of syndicated loans. But with the huge expansion of the global economy in the 1990s, which produced an ocean of new capital, the bankers came up with an idea called securitization. Instead of making simple loans and holding them until maturity, a bank collected all its loans together, then diced and sliced them up into a big, beautiful tossed salad.

The idea was to sell (for huge fees) individual servings of diversified financial salad around the world. The only problem: under an occasional piece of lettuce was a speck of toxic waste in the form of a defaulting subprime mortgage. Eat that piece of salad, and you're dead. The overall salad looked delicious, but suddenly global investors were no longer ordering salad. No one knew the location of the toxic waste. This distrust heightened when global interest rates began to rise.

So what does this salad boycott mean for the future and why have financial markets collapsed so brutally? The markets are telling us the world will face a serious credit crunch in 2009 regardless of how much money government spends to remove the toxic salad from bank balance sheets. Policymakers have no means of forcing the banks to start lending short of nationalizing the entire financial system. After all, the U.S. banks alone so far during the crisis have lost upwards of $2 trillion from their collective asset base.

Most banks are leveraged by more than 10 to 1. Translation: The U.S. financial system will have a whopping $15 trillion to $20 trillion less credit available next year than was around a year and a half before. The cost of money is rising and the availability shrinking. True, the banks will still lend -- but the fear is they will do it only to people such as Warren Buffett, who don't need loans. What is uncertain is the amount of lending to borrowers engaged in entrepreneurial risk, the center of business reinvention and job creation.

Apart from the economic pain resulting from shrinking credit markets, we are about to see an earthquake in the relationship between government and financial markets. The great uncertainty is whether government has the power to rescue the financial system in times of crisis. It seems doubtful.

In the United Kingdom, for example, the collected assets of the major banks are four times the nation's gross domestic product (GDP). A similar situation exists in many Euro zone countries. This means government cannot bail out the system even if it wanted to. Given such massive exposure, government guarantees in a time of crisis become meaningless. Yet because of the interconnected web of global financial relationships, we are all vulnerable to the threat. The collapse of, say, a major European bank would hardly leave American workers immune.

Our policy leaders in Washington are thinking domestically when the solution to the credit crisis will be global. It is not that the world lacks money; it is that the world's money is sitting on the sidelines -- more than $6 trillion in idle global money markets alone. The challenge will be to reform our financial system quickly to draw that global capital back into more productive uses. The first step should be efforts to make the market for future asset-backed paper more transparent and credible.

We need a private/public global bank clearing facility. The bankers don't trust each other. The central banks, working with the private institutions in providing enhanced data, need to begin to refashion the world's financial architecture. And while that is happening, the major governments of the world, including the Chinese, should begin major fiscal efforts to stimulate their weakening economies.

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Hoping There's Hope

This is the first all-encompassing global dislocation of contemporary finance, impacting virtually all economies, markets and asset classes. The media is now all over the "Wall Street" and "banking" crisis. I am of the view, however, that the collapse of the hedge fund industry has moved to the forefront - that it is now at the epicenter of global market upheaval.

To watch silver lose more than 20% of its value today in intraday trading; to see the collapse in energy prices; to see the entire commodities complex absolutely routed; to view global currency markets in complete disarray, with double-digit intraday drops in the Brazilian real and Mexican peso; to witness major currencies such as the Australian and Canadian dollars suffer precipitous declines; for benchmark Fannie Mae MBS yields to surge 62 bps in three days; to see Brazilian dollar bond yields jump almost 200 bps in four sessions; for global equities indices to suffer rapid double-digit drops throughout both the developed and "emerging" markets; to witness a 1,000 point intraday swing in the DJIA.

All the favorite trades are blowing up, and the leveraged speculating community is in a panic de-leveraging. There is no doubt that markets are in the midst of an unprecedented liquidation of positions across virtually all asset classes and a vicious unwind of a multitude of investment and trading strategies. The Massive Pool of Global Speculative Finance is being drained. Investors and speculators alike are desperate to flee risk.

Having watched the ballooning of the hedge fund industry over the past few years in absolute awe, I can say today that an industry collapse would entail the sale (voluntary and forced by the margin clerk) and unwind of literally Trillions of positions. It has been history's most spectacular speculative Bubble and, especially over the past few years, it became very much global in nature and infiltrated virtually all asset classes. This Bubble is in a full-fledged collapse - entailing unprecedented liquidations - and it's taking global markets down with it.

The situation is dire, as is now commonly recognized. The media is in a tizzy, and Wall Street makes for an easy and generally deserving villain. I fear the rapidly mounting anger. But I guess for this evening there is something about coming home after a distressing week and spending time with my little four month old baby. My wife and I gave our smiling and laughing little guy a bath and I just kissed them goodnight. I just don't have it in me right now to analyze and to write gloom and doom. I'd rather Hope there is Hope.

Perhaps things will stabilize once the hedge fund liquidations run their course. Treasury (TARP) purchases will commence soon. It appears that Fannie and Freddie will be expanding their market purchases. The Fed is now buying commercial paper, and the Fed and Treasury are working to resolve the dislocation in the "repo" market. Across the globe, governments are in full crisis management mode. There appears universal resolve to bolster financial sectors and stem the collapse. And there were actually some positive indications of stabilization in our Credit system late in the week.

I also hold out Hope that the Trillions of reserves held by global central bankers will provide some buffer to stem financial system collapse. In particular, I am Hoping that China, India, Russia, Brazil and the Middle East have today sufficient reserves to somehow avoid a '90s style financial and economic meltdown. I am Hoping that demand from China, India, Asia and Latin America will help offset inevitable economic downturns in the U.S. and Britain and, hopefully to a lesser extent, Europe.

I am hoping that the collapse in energy and commodities prices is more a reflection of acute financial market dislocation rather than a harbinger of synchronized global economic upheaval. I am hoping there is more substance to the dollar's rally than simply an unwind of bearish dollar bets. And I am hoping that with large capital infusions our deeply impaired banking system will retain the capacity to finance a much less robust but at least functioning U.S. economy. I really Hope everything is not as dire as it appears.

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