Monday, February 18, 2008

Debt Rattle, February 18 2008

“Horrible” fall-out scenario preoccupies market
Credit market participants took a shellshocked pause on Monday, with the spectre of more structured product unwinds hanging heavily over the market. Trade was thin in Europe, but spreads did not recede far from the record wides reached on Friday, when again the talk was that structured products – synthetic CDOs or CPDOs – were being liquidated.

“If these things do get unwound en masse, the effect on the market will be horrible,” said credit strategist Barnaby Martin at Merrill Lynch. “Between 1 and 2 trillion dollars of synthetic CDOs have been issued over the last four years. Any unwinding will likely be crammed into a much shorter time period.” A fire-sale is every market participant’s worst nightmare, but even the more orderly process of deleveraging will put pressure on spreads.

On Friday afternoon, Moody’s downgraded 16 CPDOs - all linked to corporate names. They are hovering near levels at which their arranging banks will be forced to delever, by buying up swathes of CDS protection. The iTraxx Crossover index of mostly junk-rated corporate debt edged 3.5 basis points tighter to 562bp. This means in costs €562,000 annually to protect €10 million worth of Crossover debt against default over five years.

Credit markets were also depressed by reports that FGIC, the fragile monoline, might be divided into a good municipal part and a bad structured finance part. “If this scenario were to be applied for MBIA and Ambac (this should be decided by the end of February), it would significantly expose the banks to further write-downs on structured finance securities wrapped by the bond insurers,” said analysts at BNP Paribas in a note.

Hard Times Heighten Long-Felt Unease
Even when experts were declaring the economy healthy, many Americans voiced a vague, but persistent dissatisfaction. True, jobs were relatively plentiful over the last few years. It was easy to borrow and very cheap. The sharp rise in the value of homes and plentiful credit cards encouraged a nation of consumers to get out and buy. But to many people, something didn't feel right, even if they couldn't quite explain why. Now the economic tide is receding, and the undertow that was there all along is getting stronger.

Take away the easy credit and consumers are left with paychecks that, for most, haven't nearly kept pace with their need and propensity to spend. The frustration of $3 gas and $4 milk, the worries about health care costs that have risen four times the rate of pay, become much more real. The retirement security that is only as good as the increasingly volatile stock market seems much less certain.

Americans' declining confidence in their economy is triggered by a storm of very recent pressures, including plunging home prices, tightening credit, and heavy debt. But it is compounded by anxiety that was there all along, the result of a long, slow drip of worries and vulnerabilities. "The economy is currently in recession or arguably close to recession and that's certainly weighing on the collective psyche," says Mark Zandi, chief economist of forecaster Moody's "But ... I do think there is an increasing level of angst that is more fundamental and is not going to go away even when the economy improves."

Much of that anxiety is the uncomfortable, but expected jolt of the economic roller coaster. During a downturn, people become less confident about keeping their jobs or being able to find new ones, meeting household expenses and about the prospects for the future. But there may be more to it than just cyclical ups and downs. What does the economic future hold? Many Americans feel increasingly unable to answer that question with assurance, and they appraise it with a sense that they are less in control of the outcome.

Welcome to a deleveraging world
The spectre of deleveraging haunts the financial markets. Rightly so, for the removal of credit from the global economy is a process which tends to feed on itself. That means that the credit crunch could easily turn into something much nastier.

Before the deleveraging came the leveraging. Take the US. The ratio of all sorts of debt to GDP rose from 160 per cent in 1975 to 342 per cent at the end the September 2007. Through to 2000, debt increased by 2.4 percentage points a year faster than GDP. But after the turn of the millennium, the excess of debt growth accelerated almost to 3.7 percentage points a year. The pattern was similar but less extreme in the eurozone, and similar but more extreme in the UK.

While it was happening, only a few sourpusses complained. Leverage, it was said, was a natural trend. As economies get richer, they have more need for debt-financed investments and debt-financed inventories. But lending grew much faster after 2000 than even the most gifted apologist could explain away. It was a bubble, which has now been popped. And leverage has turned into deleverage.

In leverage, one thing leads to another. I can bid more for a house because my bank is willing to lend me more. The house price rises, giving the bank more confidence about lending me yet more. So I buy some shares or a new car.

Multiply that by a few hundred million borrowers and hey, presto: asset prices go up and GDP growth is high. Banks rejoiced. They set up off-balance sheet vehicles which piled on debt. Leveraged buyout groups borrowed to take companies private; hedge funds borrowed to invest in assets. And so on.

In deleveraging, too, one thing leads to another. Start with a bank that has lost a few billion on sub-prime mortgages. The bosses are likely to decide that troubled times call for higher capital ratios. That means calling lines of credit. Some borrowers are forced to sell assets, pulling down prices. The banks then look at the value of their collateral and think: “Oh my god, it’s not worth what we thought”. They then cut their credit again – giving another turn of the deleveraging screw.

Ilargi: Take a look: "If Northern Rock had been worth £5bn it is understood that the government would only have received £500m in warrants, whereas the Virgin consortium could have made between £1bn and £1.5bn, causing huge embarrassment for the government."

I'd say pickpocketing £91 billion from the people who elected you, to pay for a bank that's worth only £5 billion is a much bigger embarrassment. But then I'm not British, and Gordon Brown wasn't elected. This could get really ugly for Mr. Brown, and he may not survive 2008 as prime minister, especially as the next UK bank, B&B, has already run into trouble, and more will follow.

Apart from that, the European Union has yet to grant permission for the Northern Rock nationalization.

Fury over Rock nationalisation
Alistair Darling on Sunday announced the first nationalisation of a sizeable British bank in a quarter of a century as he put Northern Rock into public ownership, infuriating shareholders and shocking the two private bidders hoping to take over the stricken mortgage lender. Visibly concerned to avoid queues forming outside branches on Monday, the chancellor and Ron Sandler, Northern Rock’s new executive chairman, insisted it would be “business as usual”.

Mr Sandler, who is to be paid £90,000 a month in his new role, insisted branches would open on time, customers would be able to withdraw and deposit money, and the government guarantees to depositors remained in place. News of an emergency loan to Northern Rock from the Bank of England last September triggered the first run on a British bank in more than a century. The government has been trying since then to find a buyer for the bank that would enable the £25bn in Bank of England loans to be repaid.

Shares in the bank, which closed at 90p on Friday, will be suspended on Monday morning and shareholders can expect virtually no compensation for their equity. Mr Darling said the legislation to be brought to parliament on Monday would appoint independent arbiters to determine what the shares were worth, but the legislation would propose that the government should not be required to compensate shareholders for any value that is dependent on taxpayers’ support.

The government’s move stunned shareholders, who were last night considering action. Jon Wood of the SRM hedge fund, the bank’s biggest shareholder, said: “This is a very sad day for the stock market, banking industry and the reputation of the UK as a financial centre.” Noting that the chancellor insisted the bank was solvent, he added: “We will pursue all avenues to protect that value for shareholders.”

Robin Ashby, founder of the Northern Rock small shareholders group, said he was “shocked and appalled” that shareholders “were having the bank stolen away from them”.

Mr Darling said that, although he had always preferred a private sector solution, “the numbers did not stack up” in either of two private sector proposals offered – one from Sir Richard Branson’s Virgin Group and another from the bank’s management. “I have a duty to the taxpayers of this country to make sure that I do the right thing by them and that is what I have done,” he said.

Sir Richard, whose group only found out about the government’s decision just before it was announced, said he was “very disappointed” in the decision and believed he had “a very strong proposal”. Virgin had been asked to pay £200m for a government guarantee and £100m-£200m for equity warrants but it is believed that it found this too difficult. If Northern Rock had been worth £5bn it is understood that the government would only have received £500m in warrants, whereas the Virgin consortium could have made between £1bn and £1.5bn, causing huge embarrassment for the government.

Rock shareholders may end up with nothing
Shareholders in Northern Rock may see their investments completely wiped out under the U.K. government's plan to nationalize the stricken mortgage lender, which has sparked threats of legal action and claims that the crisis has been mishandled.

Chancellor Alistair Darling announced the decision to nationalize the bank Sunday after private-sector bids weren't considered to offer a good deal for taxpayers. Darling also said an independent audit will work out what compensation is due to shareholders.

Analysts, however, believe there will be little or no cash left because the valuation of the shares will assume that around 25 billion pounds ($49 billion) of loans from the Bank of England have been withdrawn. "The valuation will be calculated assuming that the bank has not been supported by government loans, and on this basis the shares could have no value," said Bear Stearns analyst Robert Sage in a note to clients.

Brown faces grilling on Rock nationalisation
Prime Minister Gordon Brown faced a political and public backlash on Monday after his decision to take ailing bank Northern Rock into public ownership, the first UK nationalisation since the 1970s. The government will announce new legislation allowing it to take over Britain's fifth-largest mortgage lender after rejecting two private sector-led bids on Sunday and ending five months of uncertainty over Northern Rock's fate.

Even temporary nationalisation, however, will carry political and financial risks for a government already tarnished by the debacle, as it links its fate to a mortgage bank at a turbulent time for Britain's housing market, with home repossessions, bad loans and job cuts all set to rise. It is also facing the threat of a drawn-out legal battle with shareholders, who stand to lose most or all of their investment. Northern Rock has borrowed about 25 billion pounds from the Bank of England since the global credit crisis last year wrecked its funding model, sparking the first run on deposits at a British bank for some 140 years.

With a national election due by May 2010 at the latest, turmoil over the past five months has dented both the Labour government's popularity and the prime minister's reputation as a guardian of financial stability. Shareholders reacted with anger as the suspension of Northern Rock shares left them unable to sell their stock.

"We will wait to see the details of the nationalisation bill and after that we will pursue all legal and non-legal actions available to us to secure value for shareholders," Jon Wood, founder of the bank's top shareholder SRM Capital, was quoted as saying by the Daily Telegraph.

Northern Rock has been put on the government's books, classified as around 90 billion pounds of public debt, and the focus will now shift to how soon a buyer or buyers can be found for its assets. Analysts say that could be easier if lending slows over the coming years, shrinking the mortgage book as many of its customers remortgage with other banks, and as the funding model becomes driven by retail deposits not capital markets.

Chancellor Alistair Darling said he would welcome approaches. "At the moment because of the state of the financial markets it is not an ideal time to try and deal with a bank in the situation Northern Rock finds itself in, but of course I very much hope that over the coming period people will look at it," he told the BBC.

British pound dips on Northern Rock nationalization
The British pound weakened on Monday after the U.K. government's landmark move to nationalize mortgage lender Northern Rock. The government on Sunday nationalized the U.K. lender, arguing that offers from Virgin Group and the Newcastle lender's own management wouldn't have given enough value to taxpayers. The Bank of England has already provided billions of pounds in emergency loans to Northern Rock, a U.K. lender that needed emergency assistance last year when credit markets dried up.

The pound slumped to $1.9481 from $1.9613, and neared a fresh record low against the euro. "It's the least desirable outcome for the banking sector, it suggests the market can't find a market solution for this," said Rob Carnell, an economist for ING in London. "It also throws a doubt of credibility into the government's ability to manage the economy."

During a press conference, British Prime Minister Gordon Brown denied that London had suffered any damage to its stature as a financial center. Brown pointed out that problems with Northern Rock started with difficulties in the U.S. subprime mortgage market, and noted difficulties with U.S. bond insurers, the rogue-trading scandal at French bank Societe Generale and the bailouts needed at two state-backed German banks.

ING's Carnell said Brown's argument is a bit thin. "British banks have been reliant on wholesale markets for funding, you can't simply blame the U.S. because the problems initially came from there," he said. "It does look like (U.K. banks) are going to be quite exposed."

AIG’s losses show swaps next domino
Bank's losses, already exceeding $100 billion since the beginning of the credit crunch, are likely to grow much larger if the problems starting to show up in credit default swaps spread. That threat was underscored last week when insurer American International Group announced a larger than projected decline in the value of its CDS portfolio and said its losses could grow even larger by the time it releases 2007 results, which are due before the end of the month.

The problem is by no means limited to AIG. Indeed, banks are even more exposed as counterparties to CDS underwritten by bond insurers such as Ambac Financial Group and MBIA. CDS function as insurance contracts on the risk of default by bond issuers. AIG said last week that paper losses on its CDS portfolio climbed to over $5 billion as of the end of November from a previously estimated $1 billion. Counterparties to CDS contracts written by AIG are mostly banks, which bought them to hedge their exposure to collateralized debt obligations.

“Counterparties tend to be banks that wrote the mortgages and then packaged them,” said Chris Winans, spokesman for AIG, who said that AIG executives weren’t available to comment since the company is in a quiet period before releasing 2007 earnings. AIG said last week that the change in estimated losses came after its auditor, Pricewaterhouse-Coopers, noted a “material weakness” in AIG’s internal control over the financial reporting and fair valuation of the CDS portfolio, which is held by its subsidiary, AIG Financial Products. The AIG subsidiary writes CDS on the super-senior tranches of CDOs on residential mortgage-backed securities.

Bond Insurer Split May Trigger Litigation, Bank of America Says
Regulators' plans to break up bond insurers into "good" businesses covering municipal debt and "bad" businesses liable to subprime-related losses may trigger "years of litigation," Bank of America Corp. analysts said.
New York Insurance Department Superintendent Eric Dinallo and New York Governor Eliot Spitzer said last week that insurers may need to be divided if they can't raise enough capital to compensate for losses on subprime-mortgage guarantees. FGIC Corp., the fourth-largest of the so-called monoline insurers, asked to be split on Feb. 15 after Moody's Investors Service cut the Stamford, Connecticut-based company's top Aaa ranking.

"Despite the regulatory interest in separating the exposures, the essential fact remains that all policy holders, whether municipal or structured finance, entered into contracts backed by the entire entity," analysts led by Jeffrey Rosenberg in New York wrote in a note to investors dated Feb. 15. A breakup is "likely to lead to significant legal challenges holding up the resolution of the monoline issues for years."

FGIC, owned by Blackstone Group LP and PMI Group Inc., insures about $314 billion of debt, including $220 billion in municipal bonds. The company said last week it applied for a license from New York state insurance regulators to create a standalone municipal company and separate the unit that guarantees subprime-mortgage bonds and related securities that led to rating downgrades.

New York-based Ambac Financial Group Inc., the second- largest bond insurer, may also seek a split, the Wall Street Journal reported today, citing a person familiar with the situation. "The fact that one group of policy holders' exposures has imperiled the policies of the other does not mean they should forfeit the value of their claims altogether," the Bank of America analysts said.

Ambac in Talks to Split Itself Up
Ambac Financial Group Inc. is in discussions to effectively split itself up in a move aimed at ensuring that municipal bonds backed by Ambac retain high credit ratings, according to a person familiar with the situation.

A deal could fall apart because of the complexities in such a move, this person said. Bond insurers in recent weeks have become ground zero in the global credit crisis because the companies contractually have agreed to stand behind billions of dollars in securities underpinned by U.S. subprime mortgage loans.

A halving of Ambac would create one unit that insures municipal debt and one that would cover rapidly diminishing securities tied to the mortgages in a structure that effectively creates a so-called "good bank" and "bad bank." Bond insurers generate revenue by promising to cover bond payments on debt issued by a range of entities, including local governments. Bond insurers now are under pressure, though, because they also agreed to guarantee payments on mortgage debt or securities to banks, brokers and investors.

Ratings companies now are poised to further cut credit ratings on bond insurers because of those guarantees. Ratings downgrades can have chain reactions and lead to increased borrowing costs for municipalities and write-downs for banks that own debt backed by the insurance providers. To avert financial chaos, regulators in New York, including state insurance superintendent Eric Dinallo and Gov. Eliot Spitzer have pressured the companies to find solutions or else face regulatory action.

MBIA & Ambac: Wow!
MBIA (MBI) has now gone as far as to ask Congress to "reign in" Bill Ackman. I thought it was a joke until I actually read it. [..]

Let's go back. Ackman first began shorting the two in 2002. Now, the media constantly says Ackman has shorted MBIA and Ambac when in actuality, he has said countless times he is short the holding companies of both organizations. The holding companies rely on funding from both Ambac and MBIA. Ackman's bet is that the insurance regulators will require both companies to suspend dividends to the holding companies, so they are able to meet their capital requirements, thus starving the holdings companies of income and initiating their extinction.

MBIA actually declined to have an open phone on their last earnings call. They instead chose to take type questions to answer. This was done to enable them to cherry pick which questions to answer and which to decline.

Here is the thing, is there anything that Ackman said would happen that did not happen? Has there been any insider buying in shares of either company? Has management come out and done anything to prove him wrong, other than call him names? Haven't folks like Warren Buffett and Wilbur Ross looked into both organizations and said, "we'll pass"?

I am having a hard time thinking of the last time Ackman exited an investment on the losing end. Management at both companies can do one thing to prove him wrong, produce results contrary to his predictions. To date, they haven't.

Ilargi: And this is what the monolines debacle means in the real world. We’ll see so much more of this, you’ll get used to it.

Bond woes delay port's bid for state funds
Disarray among major municipal bond insurers this month has forced the Port of Galveston to regroup and find another guarantor as it seeks $28 million in state funding for dock improvements and dredging projects. Meanwhile, the county on Friday notified investors that the credit ratings of two of its debt insurers had been downgraded.

Port officials were supposed to go before the city council Thursday seeking permission to apply for what are essentially bonds administered through the Texas Industry Development loan program. But the port, which is a utility of the city, postponed the meeting until Feb. 28 after Ambac Financial Group and other municipal bond insurers saw their AAA credit ratings dissolve because of financial losses related to the far-reaching subprime mortgage fiasco. The bond insurers had guaranteed billions of dollars worth of mortgage-backed securities that lost value.

The port had planned to use Ambac Financial Group to insure the bonds. “We’re doing our due diligence,” said Port Director Steve Cernak. “We’re looking at alternatives.” The state, along with existing bond covenants, requires the port to have insurance in case it were unable to make debt payments.

Municipal bonds are issued by governments to finance projects such as hospitals, schools, streets and bridges. People buy bonds as investments, just as they would stocks. When investors buy bonds, they’re essentially lending money to the entity selling them. That entity pays interest over a period of time to the investor.

Insurance improves bond ratings, allowing governments to borrow at lower interest rates than obtainable without coverage. As regulators this week were urgently working with investors to stabilize the market, Galveston County began disclosing rating downgrades of its bond insurers. Ambac Financial Group insures $120 million in Galveston County debt; the troubled Financial Guaranty Insurance Co. insures another $55 million.

FGIC is working to split its municipal bond business from its riskier subprime assets, according to reports. County Judge Jim Yarbrough said the county’s direct creditworthiness is not harmed by the bond insurer turmoil. The county also is not at risk of defaulting on its debt-service obligations, Yarbrough said.

Still, bond counsel Andrews Kurth recommended the county disclose the ratings downgrades of companies insuring its debt. The county has posted a notice with the Nationally Recognized Municipal Securities Information Repositories and State Information Depositories.

Bernanke's Rate Cuts Force Asia Back to Price Limits, Subsidies
Under Bernanke's chairmanship, the Federal Reserve's steepest interest-rate cuts since 1990 are limiting his Asian counterparts' options to curb inflation. Instead of raising their own borrowing costs or letting their currencies appreciate faster, governments are resorting to regulating meat and egg prices in China, stockpiling cooking oil in Malaysia and subsidizing utility bills in Indonesia and the Philippines.

Such measures may backfire. Artificial price curbs and subsidies only feed more demand for oil and other commodities, and ultimately will make it harder to contain inflationary pressures worldwide, officials from the Group of Seven nations warned at their Feb. 9 meeting in Tokyo. "These policies run against the grain of what these countries, China for example, have been trying to do over many years, which is to move toward a more market-based economy," says James McCormack, head of Asian sovereign ratings at Fitch Ratings Hong Kong Ltd. "Price controls won't work because they don't address the issue of supply-demand imbalance."

In China, the worst snowstorms in five decades have stoked inflation that was already above the central bank's target. Consumer-price gains in Sri Lanka exceeded 20 percent in January, while inflation in Singapore has reached levels not seen in a quarter century.

Bernanke's Fed has added to Asia's dilemma by lowering its benchmark interest rate 2.25 percentage points since September, to 3 percent. The widening spread between U.S. and Asian borrowing costs draws more foreign money into the region, threatening to feed asset bubbles. That makes central banks such as China's and India's loath to fight inflation by raising rates, which would open an even bigger gap.

In the past year, stampedes in China for discounted food have also caused deaths and injuries, leading the government to increase controls on basic commodity costs. Since Jan. 15, the National Development and Reform Commission has required producers and sellers of grain, cooking oil, meat products, milk, eggs and liquefied petroleum gas to seek government approval to raise prices in an effort to cool inflation expectations and ease "social tension."

How Fed Rate Cuts Are Helping to Fuel A Hong Kong Boom
For months, Fion Lau and her boyfriend have been eyeing a small apartment here. But, with Hong Kong property prices climbing at double-digit percentage rates since this past summer, she has held off buying, waiting for the market to cool.

It hasn't, but the 25-year-old marketing assistant recently bought the place anyway. That's because two weeks ago and half a world away, the U.S. Federal Reserve cut interest rates again, hoping to stimulate an economy dragged down by a housing sector in disarray. Since Hong Kong pegs its dollar to the U.S. currency, it followed the Fed's lead, knocking the city's base rate down twice in less than two weeks for a total of 1.25 percentage points.

The unintended result: home-loan rates so cheap that they are throwing more fuel on an already scalding property market. A typical mortgage here -- which is pegged to the prime rate which, in turn, is tied to the base rate -- now carries interest of about 3.1%. But compared with Hong Kong's inflation rate of about 3.8%, which is hovering at a more-than-nine-year high, that looks especially inviting, creating a so-called negative real interest rate.

For many potential home buyers in Hong Kong, mortgage payments are now effectively cheaper than rents, which are slower to adjust to rate changes. Indeed, within hours of the Fed's latest rate cut, Ms. Lau was on the phone with the owner of the apartment in the Kowloon district of Hong Kong and signed the contract to buy it that night. She says she plans to rent the flat out to tenants for two years to make money on the mortgage/rent spread and then may move in herself.

Real interest rates have been in negative territory before here in China's international-finance hub. During the early 1990s, cheap home loans helped inflate a property bubble that hit records before bursting, with devastating effect, during the Asian financial crisis of 1997-1998. Prices have only now begun to touch those levels again, and further gains could be in the cards.

Credit Crisis Losses Will Put Black Monday in the Shade
Bank of America delivered a report last week highlighting the current losses of the "Credit Crisis". According to the report, the meltdown in the U.S. subprime real estate market has led to a global loss of $7.7 trillion in stock market value since October.

Quoting Bank of America chief market strategist Joseph Quinlan ,"The crisis, which has spread beyond U.S. shores to banks and other sectors worldwide, is one of the most vicious in financial history".
In his report, Joseph Quinlan states that the losses are worse than any in the past few decades, including Wall Street's Black Monday of 1987, the 1999 Brazilian real currency crisis, and the collapse of hedge fund Long Term Capital Management (LTCM) in 1998.

Quinlan quantifies the current credit crisis by determining that world market capitalisation is currently down 14.7 per cent three months after a peak in late October. He has compared this with similar losses three months down the road of 13.2 per cent after the LTCM crisis, 9.8 per cent for Black Monday and 6.1 per cent after the Brazil crisis. The losses were also greater than those suffered after the September 11, 2001 terror attacks, the Asian financial crisis starting in 1997, Argentina's default on its debt in 2001, and the 1994 Mexican peso crisis.

A report last week by Standard & Poors ratings agency showed global stock markets were devastated with a collective loss of $5.2 trillion in the month of January alone. This does not take into account all the further repercussions. Banks have been tightening their standards. Lack of counterparty integrity is a common occurrence.

So many are asking where the next surprise will come from. Or possibly one could even argue that it is not a surprise any more. Swiss bank UBS shocked markets on Thursday with tens of billions of dollars of new exposure to risky U.S. mortgages, leveraged finance and complex securities. It used to be that banks did not trust hedge funds, and now hedge funds are afraid of the banks.

One of the biggest problems is that it seems no one knows how to quantify the losses, or what is the true value of paper or derivatives that so many banks and institutions are holding. Using this a basis of thought, how could one expect the "Credit Crisis" to be solved in the near future. In comparison, (at least hopefully so), the Depression of the late 1920s to late 1930s lasted longer than anyone expected. There were rallies then as well as severe down drafts. One can also look at Japan: In 1989, the Japanese stock market was 39,000 and today it is at 13,600.

In the end, the current financial crisis could be one for the record books.

Lessons for Today: Bank Panics and the Great Depression
The Great Depression may be ancient history but interest in the subject is enjoying a revival, including at the Federal Reserve, now chaired by self-described “Great Depression buff” Ben Bernanke. A new research paper by staff economist Mark Carlson tackles a seemingly esoteric topic that could have useful lessons for the current crisis. In his working paper, recently posted on the Fed’s Web site, he investigates whether some of the thousands of banks that failed in the Great Depression could have survived if only they hadn’t been sucked down in a panic.

Previous research has found that banks that failed during the Depression started out weaker than banks that survived, suggesting a lot of the bank failures may have been unavoidable. But Mr. Carlson finds that “many of the banks that failed during the panics appear to have been at least as financially sound as banks that were able to use alternative resolution strategies,” such as merging, or suspending and recapitalizing.

When a failed bank was liquidated, its “assets [were] taken out of the banking system and frozen for extended periods. During a bank merger, the assets stay in the banking system continuously. For banks that suspended temporarily, the median length of suspension in this sample was about 5 months… Thus, to the extent that the panics prevented banks from pursuing less disruptive resolution strategies, then the panics of the early 1930s may well have played a role in prolonging and deepening the Great Depression.”

Mr. Carlson defines a panic as a period in which statewide bank failures are relatively elevated and there is “some clustering of failure-at least three failures or suspensions in the same county or more than one county with at least two suspensions or failures.” Using that method he finds 20 panic periods from 1930 to 1933 in the 21 states for which he has data. Almost a quarter of the more than 6,000 banks in those states failed in that period, and about a fifth of those failures occurred during panics. Comparing the banks that failed during panics to banks that found some other way to survive he found that the two groups were of roughly similar financial health.

The reason the first group failed and the second group didn’t was that they were swept under by the panic. “The financial turbulence associated with the panics may have resulted in some banks being placed in receiverships and liquidated instead of being able to resolve their troubles less disruptively.” These banks represented 30% of all failed banks’ assets -– a sizable portion.

Qatar Buys Credit Suisse Shares, Prime Minister Says
Qatar is buying shares in Credit Suisse Group and plans to spend as much as $15 billion on European and U.S. bank stocks over the next year, the Gulf state's prime minister said in an interview.
"We have a relation with Credit Suisse and we bought some of the stock from the market, actually, but I cannot say what percentage because still we are in the process," Sheikh Hamad bin Jasim bin Jaber al-Thani, who is also chief executive officer of the Qatar Investment Authority, said in an interview late yesterday in Doha.

Persian Gulf sovereign wealth funds, whose coffers are swelling from near-record oil prices, and counterparts in Asia have been snapping up stakes in banks battered by U.S. subprime mortgage losses. Citigroup Inc. received $14.5 billion from investors including Singapore and Kuwait since mid-December.

"Subprime losses are clearly not confined to U.S. banks and European banks are seeking funding," Giyas Gokkent, head of research at National Bank of Abu Dhabi PJSC, said in a phone interview today. "Gulf funds have surpluses to spend and are looking for long-term appreciation. If investments help develop their domestic financial markets too, so much the better."

Bruno Daher, Credit Suisse's Dubai-based co-CEO for the Middle East, declined to comment when contacted on his mobile phone today, as did Zurich-based spokesman Marc Dosch. Credit Suisse jumped 1.60 Swiss francs, or 2.9 percent, to 56.60 francs ($51.33) at 1:13 p.m. in Swiss trading.

Ilargi: The rumble down under starts for real....

ANZ Drops as CEO Says Credit 'Bloodbath' Cuts Profit
Australia & New Zealand Banking Group Ltd. fell to a 2 1/2-year low in Sydney trading after Chief Executive Officer Michael Smith said the "bloodbath" in debt markets will erase profit growth this year.
"Credit costs are going up, well above underlying earnings growth," said Smith, who joined ANZ from HSBC Holdings Plc last year, in a webcast briefing. The Melbourne-based bank, Australia's third largest, will make a $200 million provision for derivatives linked to U.S. debt insurer ACA Capital Holdings Inc.

A gauge of Australian financial stocks slumped to the lowest since November 2005 on concern that earnings growth at banks will stall. The U.S. subprime mortgage collapse that's spread through credit markets may lead to $400 billion of write-offs from financial institutions around the world, according to Group of Seven estimates.

"People are facing up to the fact that they've got to adjust their figures on the banks," said Angus Gluskie, who helps manage the equivalent of $500 million, including ANZ shares, at White Funds Management in Sydney. "Bad debts are going to be higher and the banks are going to wear them for the rest of the year."

Australia: Investors spooked by bad debt provisions
In a disclosure that shocked investors, ANZ's new chief executive Mike Smith yesterday signalled the group was in line to take one of its biggest financial hits since it was singed by the Russian bonds fiasco in the late 1990s. The revelation sent the bank's share price into a tailspin, with ANZ scrip closing down $1.45 or 6 per cent to a 30-month low of $22.46. It also triggered further selling in other banks amid fears that they would also have to review their exposures. ANZ will book an individual provision of $US200 million ($220 million) on a now troubled credit protection exposure.

Under a series of derivatives transactions entered into between 2005 and February last year, ANZ provided credit protection cover to a group of counterparties and simultaneously bought matching protection from US institutions to offset its risk. However one of the matching protection providers, the troubled US insurer, ACA Capital Holdings Inc, has come under severe financial pressure in the past week after racking up massive losses in the December half. Standard & Poor's last week slashed its credit ratings on ACA to junk bond status.

ANZ was advised by accounting specialists on Friday night that it would be required to make a provision for ACA being unable to meet its obligations under the agreement. "The uncertainty around the ability of that firm to meet its obligations under the hedging agreement has resulted in an accounting requirement to raise an individual provision of $US200 million based on the current mark to market exposure to that monoline (specialist insurer)," Mr Smith said.

Bank of China weathers the sub-prime storm
Bank of China, the Chinese bank worst hit by the sub-prime lending crisis, says that it is well-positioned to manage further deterioration in the sub-prime mortgage market and is on track to report marked profit growth for 2007.
The bank, which will unveil its 2007 financial performance next month, said that it has sufficient provisions to cover its shrinking sub-prime portfolio, according to Reuters. It is the largest holder of US sub-prime securities in Asia.

The chairman of China's third-largest bank told reporters at a forum today that marked profit growth would be revealed next month. “We have noticed the sub-prime market is worsening, but I want to say that our sub-prime portfolio has improved greatly," Xiao Gang, the chairman, told reporters. “Under the pre-condition of prudent accounting, we have set aside sufficient provisions for all our sub-prime holdings.”

He said that the bank had disposed of all its sub-prime-related collateralised debt obligations in the fourth quarter. At the end of June last year, those holdings were $682 million. The bank has reported that its exposure to sub-prime-linked securities at the end of September was $7.95 billion (£4 billion), well down on the $9.65 billion reported at the end of August.

More bad news for CIBC
More weakness for monoline bond insurers generally means more bad news for Canadian Imperial Bank of Commerce. Thursday’s announcement from Moody’s that it has downgraded monoline FGIC was no exception, prompting Blackmont analyst Brad Smith to issue a note on CIBC headed “Loss risk escalation continues.” CIBC has potential hedge exposures with FGIC of several hundred million dollars, says Mr. Smith.

The troubled bank is not the only Canadian company exposed to the monolines — U.S. companies that were set up to insure municipal bonds before they got into guaranteeing riskier and more complex investments like collateralized debt obligations backed by subprime mortgages. But CIBC’s performance has been tied to the ups and downs of the struggling monoline industry after first revealed the multi-billion dollar extent of its subprime related investment last year.   The bank has since written down its subprime investments by $3.3-billion, including $2-billion tied to a single failing monoline.

Proposed bailout plans for the monolines’ municipal bond business might not offer much comfort to CIBC either. “While a resolution would be good news for municipal bond investors generally, the newly emerging urgency could reduce regulator willingness to seek a broad-based solution,” Mr. Smith said. “This would result in a rising risk that weaker monolines could be sacrificed in the interest of stabilizing the muni bond market.”

In other words, municipal bonds would be saved, leaving the monolines’ riskier guarantees of subprime and the like still in limbo. CIBC has as much as $30-billion of subprime and non-subprime investments hedged with monolines, says Mr. Smith.

Canada's banks face more trouble, IMF says
The worst is yet to come for Canadian banks affected by the global credit market upheaval caused by exposure to U.S. subprime mortgages, the International Monetary Fund said on Wednesday. "The turmoil in global financial markets has thus far only had a modest effect on Canadian banks' financial soundness, but some further deterioration is in the offing," the IMF said in an otherwise favourable report on the health of Canada's financial system.

Canada's banking system is fundamentally sound and even in the case of a recession more severe than in 1990-91, most major banks' capital would drop below the required minimum but would still be "adequate," the Washington-based lender said. The report, based on visits to Canada in February and September 2007, anticipated a big credit writedown by at least one of the top five Canadian banks and smaller writedowns by others.

Canada: Flat incomes and steep spending equal record household debt
Canadians are juggling record debt loads averaging $80,000 per household, says the author of a new report who warns job losses would push many families over a fiscal cliff. "If we do have a recession, we wouldn't be as badly off as the U.S.," says Roger Sauve, a consultant who wrote "The Current State of Canadian Family Finances" released Monday. "But a lot of households couldn't keep up."

The report for the Vanier Institute of the Family describes a perfect storm of flat earnings, increased spending and plummeting savings. It comes as an economic slow-down in the U.S. spurs concern over a full-blown American recession and possible fallout north of the border. The Conservatives announced Monday they'll bring down a federal budget Feb. 26, but it's expected to include only modest tax relief after a mini-budget last fall slashed corporate and personal taxes by $60 billion over five years.

Total accumulated debt was 131 per cent of Canadian household income last year after income tax and transfers such as child benefits. That's up from 91 per cent in 1990, Sauve says. Many consumers borrowed cash at lower interest rates to buy more expensive homes as real estate prices steadily rise. But many Canadians, especially those earning net middle incomes of about $60,000 a year, have racked up credit-card debt that's almost doubled since 1990 to $22,500 from $12,000 on average, Sauve says.
"They've continued spending with more debt and less savings." Most households socked away $1,000 in savings last year, compared to an average of $7,500 in 1990, says the report.

The Slave Trade’s Impact on Africa
Volumes have been written about the cruelty of slavery, the economic impact of slavery on the U.S. economy and the lasting effects of slavery on African Americans. Now comes Harvard University economist Nathan Nunn with this argument: “The African countries that are the poorest today are the ones from which the most slaves were taken.”

Writing in the current issue of the Quarterly Journal of Economics, Nunn describes what he says is “the first empirical examination of the Africa’s slave trades in shaping subsequent economic development.” He painstakingly constructs – from shipping records and other all sorts of other documents — measures of the number of slaves exported from each African country between 1400 and 1900.

From 54 different samples of the transatlantic slave trade, he tracks 80,656 slaves from 229 distinct ethnic identities. He also has data on 21,048 slaves shipped across the Indian Ocean, 5,385 slaves who were moved across the Saharan trade and 67 slaves (with 32 different ethnicities) who crossed the Red Sea.

Nunn cautions that the data doesn’t prove that the slave trade caused today’s economic disappointments in Africa; it could be that slaves were drawn from the most unfortunate countries in the first place. But he argues that, in fact, the evidence shows that slaves tended to come from the most developed – not the least developed – parts of Africa. “The data are consistent with historic accounts suggesting that the slave traders impeded the formation of broader ethnic groups, leading to ethnic fractionalization, and that the salve trades resulted in a weakening and underdevelopment of political structures,” Nunn concludes.


Anonymous said...

Today's Kunstler:
"If a bunch of investors (depositors) all got nervous about the solvency of a given bank, they might try to slip in there during business hours and withdraw or redeem their "money" and perhaps translate it into items of value like gold coins, bottles of vodka, or cases of 9 millimeter pistol ammunition. And if enough of this bunch showed up at the same time, we would see a phenomenon called a "run" on a bank. And after that started at one bank, the thing Franklin Roosevelt called "fear itself" could easily spread to depositors in other banks pretending to be okay... and that would be the magic moment that the USA discovered it was no longer a rich nation.

That would be a very rude awakening. The whole world would know about it in about thirty seconds..."

When comparing bank failures in the 1930's to what's happening today, we have to factor in global telecommunications and the internet. Rather than a run at the county bank, we could be looking at a phase change of ... everything. Yesterday, in casual conversation my wife began asking questions about bank solvency....

Bigelow said...

Just love the way the media has steered the public into believing the credit crisis was all the fault of liar loans and poor people. Here is some more realistic coincidence theory…

“Key to the revolution in finance in addition to the unabashed backing of the Greenspan Fed, was the complicity of the Executive, Legislative and Judicial branches of the US Government right to the Supreme Court. In addition, to make the game work seamlessly, it required the active complicity of the two leading credit agencies in the world—Moody’s and Standard & Poors.

It required a Congress and Executive branch that would repeatedly reject rational appeals to regulate over-the-counter financial derivatives, bank-owned or financed hedge funds or any of the myriad steps to remove supervision, control, transparency that had been painstakingly built up over the previous century or more. It required that the major government-certified rating agencies give their credit AAA imprimatur to a tiny handful of poorly regulated insurance companies called Monolines, all based in New York. The monolines were another essential part of the New Finance.

The interlinks and consensus behind the massive expansion of securitization among all these institutional players was so clear and pervasive it might have been incorporated as America New Finance Inc. and its shares sold over NASDAQ.

In fact the Greenspan New Finance revolution literally opened the floodgates to fraud on every level from home mortgage brokers to lending agencies to Wall Street and London securitization banks to the credit rating agencies. Leaving oversight of the new securitized assets, hundreds of billions of dollars worth of them, to private “self-regulation” between issuing banks like Bear Stearns, Merrill Lynch or Citigroup and their rating agencies, was tantamount to pouring water on a drowning man.”

The Financial Tsunami Part IV: Asset Securitization – The Last Tango

Anon e Nony said...

TORONTO - Major North American stock markets are closed for holidays Monday.

U.S. markets are closed for U.S. Presidents Day, while the Toronto Stock Exchange is closed for Family Day, a provincial holiday.

Regular trading will resume Tuesday morning.


Family day?

When is decoupling day?

Ilargi said...


We ran the Engdahl piece when it came out. Not much use doing it all over again.

Anonymous said...

Hi Stoneleigh and Illargi,

Have you laid out a forecast detailing what you think we are all in for? Would you be willing to do this, understanding that the sands are shifting and without regard for timelines?

I'm reading you daily, but would like to know "who" I'm listening to. I understand the disclaimer on your site, and enjoy the tounge-in-cheek language about digging backyard cash holes. But seriously, are you digging?

Is there a spot online to get more information about your backgrounds and financial experience?

Thanks -
Forrest D

Bigelow said...


Many apologies, I missed that post.

And as Anonymous said what would that backyard hole digger be doing? I think I saw one burying Chinese stocks, gold and some peanut butter.

Anonymous said...

Having time to read today, here are some other links I came across:

U.S. Credit Markets Collapsing

Standard Chartered's Whistlejacket SIV May Default

There is a sense I think today that the credit snowball is picking up significant speed.


Stoneleigh said...

Forrest D,

Neither ilargi nor I are professional economists or financiers - we're curious big-picture people who've spent years studying these issues (and others) intently. I suppose calling us independent investigative journalists would come closest to the mark.

For what it's worth, I used to be a Research Fellow at Oxford University, before I emigrated from Britain because of its poor prospects. Now we have a farm in Canada where we're learning to be as self-sufficient as possible, while trying to warn others before it's too late.

Anon e Nony said...

Hi Anonymous,

I've been following the dynamic duo since well before before the sub-prime issue hit the markets last summer and was able to learn much and profit well by their teaching.

The main idea right now for protecting yourself seems to be that cash is king. Besides this site taking that stand is (note his financial credentials) and if you enjoy loud, brash and crude along with that theme of cash there is at Market ticker.

On cash in a hole I would advise smaller denomination notes using a plastic bottle without any detectable metal parts. Gold and silver could be buried near a foundation containing re- bar.

But better than cash though, IMO, is a good cash
of one type or another:)

Stoneleigh said...

Forrest D,

My take on the credit crunch can be found here:

The Resurgence of Risk - A Primer on the Developing credit Crunch

The article is more about what's going on and how we got here than a detailed look at where we're going, although I make it plain that I think we're heading into a second Great Depression worse than the last one.

For a very detailed look at where we're going that I'm broadly in agreement with, see Michael Panzner's book Financial Armageddon. However, Panzner's book is purely financial, whereas my worldview also factors in peak oil, over-population, environmental degadation, real politik and human herding behaviour.

Anonymous said...


Given all the detailed information you both have been providing lately, I actually went to TOD:C yesterday to dig up that post to re-read it to get the big perspective. It was very well written.

If visitors here haven't read it yet then I suggest that you do!

As for what's going to happen next, here's my (layman's) take: Mass Unemployment.

Imagine for a moment what it would be like to be out of work (loss of income as well as identity) with a pile of credit card and other debts that you can't repay, and the inability to pay for necessities and the most minor of luxuries.

Imagine you realize that far from being wealthy, you've been living large on the back of an unsustainable credit bubble that's never coming back, ever.

And also imagine that your house will never be worth what you thought it was worth, at least not in your lifetime. Now suddenly, the ATMs stop working (or will only give you miniscule amounts) and the bank won't give you back your savings, as they don't have enough cash to handle the mass withdrawals.

You're broke, busted, and out of luck.

God help us, as many people will not go down without resorting to desperate measures. And God help those who feel they have no way out other than suicide.

I hate to write that last line but I fear the loss will be too great for some people to handle.

(And I really, really hope I'm wrong.)

Anonymous said...


Is it possible for you to share your view as why CA is the place to be instead of places like NZ, AU or even AR, UY or BR?


Stoneleigh said...


I came to Canada because I had family here, and citizenship, which are both things that make it easier to get established. I speak both official languages and I'm familiar with the culture as well. Land was cheap compared to Britain, there's plenty of water and it was possible to obtain a measure of control over the essentials of my own existence.

I had thought about NZ, but I have no contacts there, and I'd thought about Iceland, but again I have no contacts, I don't speak the language and their economy has been in a huge bubble that's on the verge of an early meltdown.

Australia is too arid and too close to large numbers of people in Indonesia who might be tempted to over run it if they got desperate. In South America my grasp of the language is too limited and I don't think I would ever fit in culturally. Blending with the local population is generally a good idea IMO, or one can become a target.

Anonymous said...

My thanks to you two for this work,and the evaluations...information can be of the highest order,but useless unless in a context a person can comprehend,and digest.You comments make dry stats a feast for the mind...though it high calorie,and very rich.
Its seems written in stone that we are going to experience a "phase-change"that will affect every aspect of our respective lives.I have 3 acres of fruit trees outside of Portland Ore.Its fairly secluded,but I am not nearly as sure that our society here will last past the first 3-4weeks after the crash...about the time the chow gets thin,the kids get hungry,and everyone figures out there is no going back.How,and when "it" happens....or is the crash happening as we slow motion ,as we watch the daily destruction of company after company in financial soon before it starts to whack the others..How soon do you think the Real World"will see more of the true effects of this disaster?I am half hoping it will be hang it around the neck of every incumbent politician...Any guesses?

Anonymous said...


Thanks for sharing your view! If the US will be the epicenter of the unfolding events, wouldn't CA be too close to be of any comfort?

Anon e Nony said...

Stoneleigh/ilargi, if you are going to censor comments at least do a job of it and clear the deck, not just blow a bunch of blue smoke. I figured you guys above that sort of BS!

Stoneleigh said...

Anon e nony,

I'm not sure what you mean about censoring comments. We've never done that, and in fact I'm not sure it's even possible in this format. Even if it is, I wouldn't know how to do it.

Did something you posted disappear?

Stoneleigh said...


Canada may be too close to the US for comfort, especially since most of the population lives within 200km of the border. The problem is that nowhere else looks particularly secure either - Europe will be at Russia's mercy for energy and will probably end up balkanized, Asia is teeming with people, Australia is too dry....

I can speak a few languages other than English, but most of my family are unilingual and not at all linguistically inclined, which limits the scope a bit. Also, I have a bit of an aversion to living anywhere too geologically active, so living near the supervolcanos in NZ or South America would make me nervous.

It's just not going to be a safe world out there, no matter where you live, so the best bet is probably to live somewhere you know people who'll be prepared to help each other, and somewhere where you'll 'fit in'.

Anonymous said...


Thanks again for sharing your thoughts on the question of where to be.

Doug Casey of Casey Research had an article last year on why AR is the place to be. I wasn't sure the energy security there. Lately, AR and VZ did a deal on food, oil exchange so the prospect looks somewhat brighter.

Anon e Nony said...

If incorrect in my allegation of censorship, I sincerely appologise.

The message above, with the massive blue hot link to Market Ticker, was sent, after previewing it, with three links, not just one. As well names and words were deleted. I can readily understand the tags being garbled to produce that blue 'field' but have a harder time with word and name deletions. I also can see that as you say it would be very difficult to do what was done so I can only attribute it to forces beyond either of us.

Keep up your good work, despite the glitches.