Monday, July 14, 2008

Debt Rattle, July 14 2008: Quatorze Juillet

The Storming of the Bastille in Paris occurred on 14 July 1789. While the medieval fortress and prison in Paris known as the Bastille contained only seven prisoners, its fall was the flashpoint of the French Revolution. During the reign of Louis XVI, France faced a major financial crisis, triggered by the cost of intervening in the American War of Independence, and exacerbated by an unequal system of taxation.

On 17 June 1789, the Third Estate, the middle class, or bourgeoisie, reconstituted themselves as the National Assembly, a body whose purpose was the creation of a French constitution. The king initially opposed this development, but was forced to acknowledge the authority of the assembly.

The storming of the Bastille and the subsequent Declaration of the Rights of Man and of the Citizen was the third event of this opening stage of the revolution. The first had been the revolt of the nobility, refusing to aid King Louis XVI through the payment of taxes. The second had been the formation of the National Assembly.

Ilargi: Today, the French (as well as millions of bar patrons worldwide) celebrate the anniversary of the storming of the Bastille prison in Paris in 1789. The event itself was not that significant, but it has become a symbol for a people rising against oppression. The legacy has taken on the shape of a purely political event, but the true cause of the uprising was not politics.

It is familiar enough though: France was bankrupt and in a deep financial crisis. The King tried to get money out of the nobility, which refused to pay more taxes. The way of least resistance then looked to be to squeeze it out of the newly formed middle class. But that backfired: they joined up with the poor, and the French Revolution was the result.

Then of course that got out of hand, courtesy of Robespierre and co., and a few years after, a dictator -Napoleon- took over. History rhymes. There’s no saying whether we’ll see the same blueprint repeat in the US this time, but there’s no doubt it will somewhere in the world as a reaction to the finance crisis we are about to witness.

Today, -yawn, yawn- markets are starting off higher. Hey, if they wouldn’t, imagine the problems for the US government and the Fed. If giving Fannie and Freddie virtually unlimited access to public coffers couldn’t even raise a few numbers for a few hours.... And therein lies the bigger issue: yesterday’s announcement was all-out and take-no-prisoners, leaving the authorities with little or no room to move beyond where they are now: they’re fast running out of instruments.

We need to look beyond the first superficial impressions, and there is a lot of material that provides insights into the picture as it may emerge "on second glance". For instance, even as the bail-out plan was absorbed, Japan issued a stern warning on the global markets, indicating it has serious doubts about Washington and Wall Street’s grip on the economy.

A "nice" omen may have been that Paulson&Cie. rejected a plan to inject $15 billion directly into Fannie and Freddie, a sure sign that they didn’t believe it would have been enough, and that it will cost America way more than that to prop up the dead horses, even just for the summer.

All this is linked to earnings numbers coming later in the week from the likes of Citigroup and JPMorgan. What may do a lot of damage is the revelation that Citigroup holds $1.1 trillion in off-balance "assets", a large part of which will turn out to be highly toxic, and guaranteed to carry many billions in losses.

If Citigroup has that problem, there’s no doubt other banks do as well. And if that causes the values of bank shares to keep going down the way they did last week -why own bank shares if there’s always more monsters in the closets?-, the troubles we’ve seen so far will have been no more than miniscule bumps on the road.

The discussion on the smaller US banks has now turned into a quibble over whether "only" 150 will collapse, or whether perhaps 300 bank failures is still a too conservative number. The fact that this discussion has now gone mainstream points to a mountain of financial mayhem. And let’s not forget the -former- Wall Street powerhouses like Merrill Lynch, Wachovia and Lehman. There is very little space left for the Fed and the Treasury to step in if they drop any further; not just because capital is drying up, but most of all because the dollar’s value would rapidly approach the freezing point.

Update 4.05 pm EDT Ilargi: It's a mess out there. Fannie and Freddie are doing a roller-coaster, and financials are on average down yet another 5-6%, some far more. It can't go on like this... The Paulson bail-out announcement last night has not helped to shore up much of anything. So what's the next move? Armed robbery? The Masked Bernanke? WaMu and National City need a bail-out. Anyone? Here's some closing numbers and added articles, enjoy. (Dow down just 0.41%)

IndyMac borrowers line up in California to withdraw their cash
IndyMac Bancorp Inc. customers lined up outside a branch at the company's headquarters on Monday, hoping to withdraw their money after regulators seized what was once one of the largest mortgage lenders in the United States.

Several hundred people arrived around 4 a.m., five hours before the Federal Deposit Insurance Corp planned to open that branch.

Regulators seized Pasadena-based IndyMac on Friday after a bank run in which customers withdrew $1.3 billion of deposits over 11 business days, as worries about the company's survival grew, regulators said. The bank has 33 branches in Southern California.

The FDIC said the renamed IndyMac Federal Bank will cover insured deposits, mostly up to $100,000, and initially cover 50 percent of uninsured deposits. "I have $360,000 in this bank, and I was misled by this bank," said Robert Clark, a Glendale resident who was waiting on line.

"I gave the names of my mother, my sister and my brother on the account so I thought I would be insured. I don't know what to do. I really don't know what to do."

John Bovenzi, the FDIC's chief operating officer, talked with some customers and tried to reassure them as they waited for the doors to open.

"This bank is as safe and as sound as any bank in the country right now," he told one depositor. Bovenzi added that the FDIC was "going to get as much money as we can" to compensate investors with uninsured deposits.

Soros: Fannie, Freddie crisis not the last
Billionaire investor George Soros said on Monday the crisis over major U.S. mortgage financiers Fannie Mae and Freddie Mac will not be the last, and that the deepening credit crisis is a "serious one" that will impact an already slowing U.S. economy.

"This incident (with Fannie and Freddie) is not the last one," Soros told Reuters in a telephone interview. The U.S. Treasury agreed on Sunday to raise Fannie and Freddie's credit lines above the existing $2.25 billion apiece and buy shares, if asked, to strengthen their finances. The Federal Reserve offered to let the shareholder-owned but government-sponsored enterprises borrow at the rate it charges banks for direct loans.

"Freddie Mac and Fannie Mae have a solvency crisis, not a liquidity crisis," said Soros. "There's no problem in their borrowing. And in fact, insofar as there is a problem, the Fed is there to provide the liquidity." That said, both Fannie and Freddie are "extremely leveraged," he said.

"The deterioration in the housing market, the foreclosures, are going to cause losses which exceed their equity," said Soros, whose famous bet against the British pound earned his Quantum Fund $1 billion in 1992. In afternoon trade on Monday, Fannie Mae shares were down 3.75 percent while Freddie Mac shares were down 12 percent.

"This is a very serious financial crisis and it is the most serious financial crisis of our lifetime," Soros said. "It is inevitable that it is affecting the real economy. It is an idle dream to think that you could have this kind of crisis without the real economy being affected," he added.

Lehman Should Go Private, Fox-Pitt's Trone Says
Lehman Brothers Holdings Inc., the securities firm that tumbled 79 percent in New York trading this year, should go private to end rumor-mongering about its shares, Fox-Pitt Kelton Cochran Caronia Waller analyst David Trone said.

"Lehman's best course of action would be a `going private' transaction, since it is the public equity markets that are the threat to the company's survival," Trone wrote in a note today. "Without a public stock, there would be no shorting, thus no motivation for rumor-mongering, thus no source to spook the counterparties and creditors."

Lehman should be bought for 25 percent more than its shares are trading, Trone said. The shares fell as much as 15 percent today, sliding for a fourth day, amid concern bank failures will spread. The shares lost about 37 percent of their market value last week on speculation mortgage buyers Freddie Mac and Fannie Mae might fail.

"This would eliminate the disconnect between Lehman's true financial condition and current stock price by eliminating the run-on-the-bank discount in the process of the buyout," Trone wrote. "This value-release would be big enough to avoid the need for leverage."

Lehman has enough capital to survive, Morgan Stanley analyst Patrick Pinschmidt wrote in a note today. "While we recognize it is difficult to focus on fundamentals in the current market backdrop, we believe Lehman has both the capital and liquidity to weather near-term headwinds," Pinschmidt wrote. He retained his "overweight" rating on the shares.

"A return to profitability -- in the context of a healing credit market backdrop -- should be sufficient to drive valuation closer to book value," he added.

Avoid Financials as 'Fires' Continue, Birinyi Says
Investors should avoid most financial companies because their shares will probably keep declining, said Laszlo Birinyi, president of Birinyi Associates Inc.

"Stay away from these stocks and take a very low profile," Birinyi, who oversees more than $350 million in Westport, Connecticut, said in an interview on Bloomberg Television. "There's an awful lot of fires that need to be put out. I'm concerned about how we get them all out."

Birinyi's October warning that bank shares would fall preceded a 47 percent plunge in the Standard & Poor's 500 Financials Index. The index tumbled this year as asset writedowns and credit losses stemming from the subprime-mortgage market's collapse climbed to $410 billion worldwide, according to data compiled by Bloomberg. The index declined 5.1 percent today to the lowest level since October 1998.

U.S. stocks fell today, sending financial shares to their lowest level since October 1998, on heightened concern that bank failures will spread. Washington Mutual Inc. posted its biggest drop ever and National City Corp. tumbled to a 24-year low after last week's collapse of IndyMac Bancorp Inc. spurred speculation more regional banks may be short of capital.

Fannie Mae and Freddie Mac erased an earlier rally fueled by Treasury Secretary Henry Paulson's plan yesterday to help rescue the largest U.S. mortgage-finance companies. Paulson asked Congress for authority to buy unlimited stakes in the companies and lend to them, aiming to stem a collapse in confidence.

The market "is not happy" with the government's plan for Freddie Mae and Fannie Mac, Birinyi said. Fannie Mae retreated as much as 9.4 percent on the New York Stock Exchange, while Freddie Mac tumbled 21 perc

Fannie Plan an 'Unmitigated Disaster': Jim Rogers; Goldman Says Sell
The U.S. Treasury Department's plan to shore up Fannie Mae and Freddie Mac is an "unmitigated disaster" and the largest U.S. mortgage lenders are "basically insolvent," according to investor Jim Rogers.

Taxpayers will be saddled with debt if Congress approves U.S. Treasury Secretary Henry Paulson's request for the authority to buy unlimited stakes in and lend to Fannie Mae and Freddie Mac, Rogers said in a Bloomberg Television interview. Goldman Sachs Group Inc. analyst Daniel Zimmerman predicted the mortgage finance companies' shares may fall another 35 percent.

"I don't know where these guys get the audacity to take our money, taxpayer money, and buy stock in Fannie Mae," Rogers, 65, said in an interview from Singapore. "So we're going to bail out everybody else in the world. And it ruins the Federal Reserve's balance sheet and it makes the dollar more vulnerable and it increases inflation."

The chairman of Rogers Holdings, who in April 2006 correctly predicted oil would reach $100 a barrel and gold $1,000 an ounce, also said the commodities bull market has a "long way to go" and advised buying agricultural commodities.

Rogers, a former partner of hedge fund manager George Soros, predicted the start of the commodities rally in 1999 and started buying Chinese stocks in the same year. He traveled the world by motorcycle and car in the 1990s researching investment ideas for his books, which include "Adventure Capitalist" and "Hot Commodities."

Fannie Mae and Freddie Mac each surged more than 20 percent in pre-market trading today after Paulson moved to stem a collapse in confidence in the two companies that purchase or finance almost half of the $12 trillion in U.S. home loans.

"These companies were going to go bankrupt if they hadn't stepped in to do something, and they should've gone bankrupt with all of the mistakes they've made," Rogers said. "What's going to happen when you Band-Aid and put some Band-Aids on it for another year or two or three? What's going to happen three years from now when the situation's much, much, much worse?'

Fannie, Freddie rescue plan welcomed, but new warnings on global markets crisis
A U.S. government plan to rescue mortgage agencies Fannie Mae and Freddie Mac was welcomed by one of the world's biggest holders of dollar assets on Monday but fears remained about the state of the global financial system.

Japan said it hoped that a plan unveiled on Sunday by the U.S. Treasury and the Federal Reserve would support the troubled government-sponsored mortgage financiers, but a senior minister said that world markets were on the brink of crisis. The central bank of Singapore, another major dollar-asset holder, issued a similar warning about risks to financial markets and institutions.

The U.S. Treasury and Fed called late on Sunday for measures to lend money and buy equity if necessary in Freddie Mac and Fannie Mae, which are government-sponsored enterprises (GSE) owned by shareholders. Fannie and Freddie own or guarantee $5 trillion of debt, close to half the value of all U.S. mortgages.

Foreign central banks, mostly in Asia, hold $979 billion of the bonds and mortgage-backed bonds sold by the agencies. "We hope the move will have a positive impact on the world economy," Japanese Vice Finance Minister Kazu Sugimoto told a news conference in Tokyo.

The hope was peppered with caution, however. Japan's financial services minister, was quoted as telling a meeting of economic ministers that the world's financial markets were "on the verge of a crisis". The Monetary Authority of Singapore, meanwhile, was blunt. "Significant challenges and downside risks in the international financial markets remain and financial institutions and investors should stay vigilant," the central bank said.

The rescue plan was timed to soothe market nerves. Freddie and Fannie shares plummeted more than 40 percent last week on fears they were under capitalised. Freddie also is to sell $3 billion of three- and six-month bills on Monday in a test of market appetite for agency securities.

"(Their) continued strength is important to maintaining confidence and stability in our financial system and our financial markets. Therefore, we must take steps to address the current situation as we move to a stronger regulatory structure," U.S. Treasury Secretary Henry Paulson said in a statement.

Beyond the short term, however, a collapse of one of the agencies could unleash massive turmoil in the world's battered financial markets and inflict a deep recession on the United States that could chill growth everywhere. Allowing a failure is considered inconceivable by many investors because of the massive role played by the GSEs in the financial system.

"It's not just that they are too big to fail, it's that they are too important to fail," said Ramon Maronilla, portfolio manager at State Street Global Advisors, the $2 trillion money management unit of State Street Corp. Many financial markets did react positively to the plan. European shares where sharply higher, with the FTSEurofirst 300 up more than 1.5 percent and Wall Street looking set for similar gains at its open.

The dollar was also up across the board, gaining more than half a percent against a basket of six major currencies. "While this is positive, if they hadn't done it things would be a lot worse," said Sharada Selvanathan, a currency strategist at BNP Paribas in Hong Kong.

"At the end of the day, the holders of agency debt are significantly in overseas hands and foreign central banks. They had to do this because confidence could weaken further, and that would be very, very bad for the dollar," she said. Many investors were also keen to hang onto or buy Fannie and Freddie debt. Russia's central bank, which holds about $100 billion worth, said on Saturday it saw no problem holding the paper.

Bill Gross, who manages the $130 billion Pimco Total Return Fund, also said he expected regulatory changes for Fannie and Freddie that could make their bonds "look more like Treasuries in terms of yield and credit quality, as will the mortgages that bear their name".

White House, Fed will rescue Fannie, Freddie
The implicit government guarantee of Fannie Mae and Freddie Mac is now explicit.

In a dramatic statement released Sunday, the White House and Federal Reserve moved to give the mortgage giants the capital they need to survive the depression in the housing market and turmoil in financial markets that had left them dangling over a cliff. Of most immediate importance, the Fed's board of governors voted to open up its emergency discount window to Fannie and Freddie.

In addition, Treasury Secretary Henry Paulson announced that he will seek Congressional authorization to by stock in the two companies and increase the government's credit line to them. At the moment, each company may borrow only $2.25 billion. In return for the capital, Paulson said that the Bush administration would ask Congress to grant the Fed a "consultative" role in the capital standards of the companies.

The housing rescue package that is nearing final approval by Congress would put in place a strong independent regulator for the companies is slowly moving through Congress. Paulson says he wants a new provision allowing the Fed to work hand-in-hand with the new agency. That would be a bitter pill for Fannie and Freddie, which have been at loggerheads with the central bank over the capital issue for years.

It is not clear how Congress will react on Paulson's request. The Treasury secretary said he has been in close contact with the Congressional leadership over the weekend, so his request will not come as a surprise to lawmakers. It would be logical to attach the lifeboat for Fannie and Freddie to the housing rescue measure.

The Senate passed its version of the legislation last week and sent it back to the House of another vote. It is expected to get to President Bush for his signature before Congress leaves town for its summer recess at the beginning of August.

White House Press Secretary Dana Perino in a statement that the plan "will help add stability during this period." Paulson said the global reach of Fannie and Freddie necessitated unprecedented action. "GSE debt is held by financial institutions around the world. Its continued strength is important to maintaining confidence and stability in our financial system and our financial markets," Paulson said.

For years, Wall Street has believed that the government would never allow Fannie and Freddie to default. The companies have been able to sell debt at lower prices than their competition. But the agencies have grown to mammoth size. They own or guarantee $5.2 trillion of U.S. home mortgages. Investors have fled their stock in recent months as the housing market downturn and financial market turmoil have shown no sign of ending.

In the past week, the selling intensified and Freddie and Fannie each lost half their value in volatile stock trading. Talk of some form of government action rose as the week went on. In prepared statements, Fannie and Freddie said they welcomed the steps outlined by the Treasury and the Fed, while insisting that they were adequately capitalized.

Robert Mudd, the CEO of Fannie Mae, said the option to use the discount window should restore confidence of its stakeholders. Richard Syron, the CEO of Freddie Mac, said the company's quarterly results that are being finalized and would show "we have a substantial capital cushion above the 20% mandatory target surplus established by our regulator."

James Lockhart, the head of the Office of Federal Housing Enterprise Oversight (OFHEO) that regulates Fannie and Freddie, stressed that the two firms can survive. The two firms have "$95 billion in total capital, their substantial cash and liquidity portfolios, and their experienced management serve as strong supports for the Enterprises' continued operations," he said in a statement.

Federal Reserve bails out Fannie Mae and Freddie Mac
The US government last night moved to provide state support to ailing mortgage agencies Fannie Mae and Freddie Mac amid heightened concern over their solvency. The Federal Reserve took the unprecedented step of bailing out Fannie and Freddie in a move designed to prevent their collapse and with it to secure the stability of the wider mortgage market.

The board of the Fed, chaired by Ben Bernanke, voted to allow the New York Federal Reserve to lend to Fannie Mae and Freddie Mac should such lending prove necessary. Meanwhile, the US Treasury said it would seek approval from Congress to increase its long-standing credit lines with both agencies as well as approval to buy an equity stake in each company if necessary.

The decisions – similar to the earlier opening of the discount window to struggling investment banks – effectively ensures the future liquidity of the state-sponsored mortgage agencies, which in recent days have been the subject of intense speculation regarding their capital levels.

The Fed’s decision came after a weekend of intensive talks between it, the US Treasury and other parts of the Bush administration on what to do to stop further speculation harming the mortgage companies when the markets reopen this morning.

In the past week, Fannie and Freddie have seen their share prices fall more than 50pc on rumours that they did not have enough capital and speculation that the government planned to nationalise them. Treasury Secretary Hank Paulson was forced to deny the rumours, saying he was committed to supporting Fannie and Freddie “in their current form”.

As a direct consequence, the US Securities and Exchange Commission yesterday launched an immediate probe into the manipulation of stock prices amid fears that some in the market are deliberately spreading false information.

The SEC examination will focus on the compliance controls that traders and investment houses have in place. It follows similar attempts by the Financial Services Authority to crack down on rumour-mongering and short-selling in the UK in the wake of the March plunge in HBOS shares.

Meanwhile, the Treasury department has been working behind the scenes to ensure that Freddie Mac’s planned sale of $3bn of short-term debt today will be successful by ensuring banks that normally purchase such debt still place bids.

This is already expected to be a difficult week for the global economy. Investment bank Citigroup saw its shares fall to a 10-year low last week ahead of posting quarterly earnings that are expected to reveal further writedowns totalling nearly $9bn. Merrill Lynch is expected to announce up to $4.2bn of further writedowns as it posts its fourth consecutive quarterly loss.

"The bottom line is that we're in the middle of a financial tsunami. This is a storm the likes of which this country has never seen," said Peter Kenny, managing director of Knight Equity Markets. Google will report this week and its figures could be an acid test of the economy.

Government as the Big Lender
The desperate worry over the health of huge financial institutions with country cousin names — Fannie Mae and Freddie Mac — reflects a reality that has reshaped major spheres of American life: the government has in recent months taken on an increasingly dominant role in assuring that Americans can buy a home or attend college.

Much of the private money that once surged into the mortgage industry has fled in a panicked horde, leaving most of the responsibility for financing American homes to the government-sponsored Fannie and Freddie.

Two years ago, when commercial banks were still jostling for fatter slices of the housing market, the share of outstanding mortgages Fannie and Freddie owned and guaranteed dipped below 40 percent, according to an analysis of Federal Reserve data by Moody’s By the first three months of this year, Fannie and Freddie were buying more than two-thirds of all new residential mortgages.

A similar trend is playing out in the realm of student loans. As commercial banks concluded that the business of lending to college students was no longer quite so profitable, the Bush administration promised in May to buy their federally guaranteed student loans, giving the banks capital to continue lending.

In short, in a nation that holds itself up as a citadel of free enterprise, the government has transformed from a reliable guarantor into effectively the only lender for millions of Americans engaged in the largest transactions of their lives.

Before, its more modest mission was to make more loans available at lower rates. Now it is to make sure loans are made at all. The government is setting the terms and the standards of Americans’ biggest loans.

On Sunday, that federal oversight and protection was made more explicit, as the Bush administration sought to mount a rescue of Fannie and Freddie, asking Congress to devote public money to buying the two companies’ flagging stocks.

The new reality is scorned by libertarians and conservatives, who fear state intrusions on the market, and by populists and progressives, who dislike the idea of education and housing increasingly resting upon the government’s willingness to finance it.

“If you’re a socialist, you should be happy,” said Michael Lind, a fellow at the New America Foundation, a research institute in Washington. “But you should really wonder whether you want people’s ability to pay for housing and college dependent on the motives of people in Washington.”

The government is trying to support plummeting housing prices and spare strapped homeowners from the wrath of the market: last week, the Senate adopted a bill authorizing the Federal Housing Administration to insure up to $300 billion in refinanced mortgages, enabling borrowers saddled with unaffordable loans to get better terms.

How the government came to dominate these two crucial areas of American lending is — depending on one’s ideological bent — a narrative of regulatory and market failure, or a cautionary tale about bureaucratic meddling in commerce. Perhaps it is both.

To those prone to blame lax regulation, the mortgage fiasco was the inevitable result of a quarter-century in which American policy makers prayed at the altar of market fundamentalism, letting entrepreneurs succeed or fail on their own.

This was the spirit in which Alan Greenspan, the longtime chairman of the Federal Reserve, allowed banks to engineer unfathomably complicated webs of mortgage-based investments that, through the first half of this decade, sent real estate prices soaring and expanded homeownership.

The banks relied on these investments to raise money for the next wave of loans. The system worked so long as lenders could keep selling their mortgages, and so long as someone would guarantee most of the debts. Fannie and Freddie took care of both tasks. Together, they now guarantee or own roughly half of the nation’s $12 trillion mortgage market.

Belief in Fannie and Freddie gave banks a sense of certainty as they plowed more of their capital into residential mortgages. That easy financing, in turn, brought more and more people into the market for homes, generating a belief that American real estate prices could keep rising forever.

And that contributed to the banks’ ultimately making extraordinarily risky loans, which defaulted first when home prices started falling. As lending became conservative, the whole speculative bubble burst.

Fate of dollar depends on swift solution
Any sign that the US government does not back Fannie Mae and Freddie Mac, pillars of the US mortgage market with debt widely held by foreign investors, could place the already weak dollar under further pressure.

The dollar slid last week as the euro rose to a three-month high of $1.5946 to sit less than a cent below its record peak of $1.6018, set in April. Analysts blamed some of the dollar’s fall on the drop in Fannie and Freddie’s share prices amid further distress in the US financial sector.

Non-US investors hold close to a record $1,000bn (€625bn, £505bn) of debt issued by US government-sponsored enterprises (GSEs), according to data from the Federal Reserve. Over the past decade, non-US investors, including central banks, have increasingly sought the higher yields offered on this so-called agency debt compared with Treasuries.

In the past year, China has bought $66bn in agencies and only $12bn of Treasuries, while Russia bought $34bn of agencies and sold $22bn of Treasuries, according to Alan Ruskin, chief international strategist at RBS Greenwich. They, like other investors, have long assumed that the debt issued by the GSEs is implicitly backed by the US government, valuing it closer to low-risk Treasuries than higher-risk corporate debt.

Investors will likely want to see a clear and uniform response from policymakers, and any sign of delay or vacillation could prompt further weakness in the dollar and the selling of agency debt. “Some countries have made notable efforts to concentrate their buying in agencies,” said Mr Ruskin.

“The mix of large outstanding holdings and ongoing financing needs is one reason why a solution needs to be found fast, if the dollar is not to crack key levels, creating a wider problem.” The idea that policymakers would prompt a run on the dollar and US debt markets as they try to shore up the GSEs is unthinkable, analysts warn.

Ajay Rajadhyaksha, head of US fixed income strategy at Barclays Capital in New York, said: “I don’t see any circumstance where the senior agency debt would default. A default would call into question the full faith and credit of the US government.” The next test for the agency debt market looms today, when Freddie Mac sells $3bn of short-term debt.

A nagging worry for investors is that there is still no clear consensus about whether the GSEs can count on US government support. Mr Ruskin said: “Even if confidence is restored by making the government backing of this paper more explicit, it is bound to lead to some re-evaluation of the scramble for agency yield in a low yielding, high risk and weak dollar universe.”

Bank Fears Spread After Seizure of IndyMac
The federal government's seizure of IndyMac Bank is deepening worries among executives, regulators and consumers about the U.S. banking industry, which is in a tightening bind following a long run of prosperity.

Banks and thrifts are struggling against a rising tide of bad loans, and it is becoming increasingly clear that some lenders won't be able to escape. While fewer banks are expected to fail than the 834 that went under from 1990 to 1992, it will likely take several years for battered financial institutions to work through their bad loans and replenish their depleted capital.

Those gloomy scenarios could be avoided, however, if the U.S. economy and housing market rebound soon, which would help consumers and businesses that have fallen behind on their loan payments. Even signs that the worst is over could bolster the confidence of healthier banks enough to spark a flurry of takeovers that would rid the industry of some of its weakest performers.

But at least for now, as the turmoil worsens, signs are emerging that consumers, who generally thought little about the safety of their deposits when times were good, are having some second thoughts. More likely than the kind of exodus of depositors that quickly sank IndyMac is what some bankers are describing as a slow-motion "walk on the bank," which could cripple financial institutions already weakened by credit problems.

The Federal Deposit Insurance Corp. insures deposits of up to $100,000 per depositor per bank, or $250,000 for most retirement accounts, including any accrued interest. It guarantees that depositors with sums below those ceilings will get all their money back. But a surprising proportion of deposits exceeds those limits.

Indeed, the percentage of uninsured deposits has doubled since 1992, climbing to about 37% of the nation's $7.07 trillion in deposits at the end of the first quarter, according to an analysis of data reported to the FDIC. The figures are based on data submitted by commercial banks and savings institution.

It isn't clear what percentage of those uninsured deposits belongs to individual consumers. The figures also include large corporate and institutional deposits, such as payroll accounts. Amid the steady drumbeat of bad news about banks, some depositors are already shifting money to institutions they consider to be better equipped to weather the storm sweeping the industry.

Robert New, chief executive of First National Bank, said his Hermitage, Pa., bank, a unit of publicly traded F.N.B. Corp., is winning new customers -- including individuals and small businesses -- who are pulling deposits out of larger rivals whose well-publicized problems are making depositors nervous.

"Depositors are being more aware of the health of their banks," Mr. New said. Customers are saying, "I'm nervous, I'm moving my deposits," he added. The fast-moving decline of IndyMac Bancorp Inc., parent of IndyMac Bank and a mortgage lender that was one of the nation's largest savings and loans, illustrates that the problems in the U.S. banking system are much wider and deeper than a few months ago.

Although roughly a year has passed since credit conditions began to tighten, wreaking havoc on capital markets, many traditional banks are just now starting to feel the effects of a rising number of borrowers who can't pay back loans, ranging from mortgages to auto loans to small-business loans.

Adding to the problem is that banks that need to shore up their balance sheets are beginning to have trouble attracting capital from investors. Moreover, there is a lack of buyers who are financially able or willing to snap up wounded banks.

The shaky state of the industry will be on vivid display this week when banks start to report financial results for the second quarter. Those results are largely expected to weaken from the first quarter, when bank profits tumbled 46% from a year earlier to $19.3 billion, according to the FDIC. Slightly more than half of the nation's insured institutions reported profit declines in the first quarter.

"This is a very serious banking crisis. There's just no question about that," said Donald G. Ogilvie, a longtime president of the American Bankers Association and now a senior adviser at Deloitte LLP.

Many more bank failures likely after IndyMac
U.S. banks may fail in far greater numbers following the collapse of the big mortgage lender IndyMac Bancorp Inc, straining a financial system seeking stability after years of lending excesses.

More than 300 banks could fail in the next three years, said RBC Capital Markets analyst Gerard Cassidy, who had in February estimated no more than 150.

Banks face pressure as credit losses once concentrated in subprime mortgages spread to other home loans and debt once-thought safe. This has also led to investor worries about the stability of mortgage finance companies Fannie Mae and Freddie Mac; IndyMac is not related to either.

While analysts declined to say which banks will fail next, several smaller lenders and one large one, Washington Mutual Inc, appear already to have elevated levels of soured loans, relative to their sizes.

"You have to look at companies with the greatest exposure to the highest-risk assets, which include construction loans and exotic mortgages," Cassidy said. "The final nail in the coffin for any depository institution would be a funding crisis where it is unable to gather deposits at reasonable cost, or wholesale funding markets are cut off."

The Federal Deposit Insurance Corp seized IndyMac on Friday after a bank run in which panicked customers withdrew more than $1.3 billion of deposits in 11 business days. This followed comments on June 26 by U.S. Sen. Charles Schumer questioning the Pasadena, California-based thrift's survival. Some withdrawals also followed IndyMac's July 7 decision to fire half its work force and halt most mortgage lending.

IndyMac once specialized in Alt-A mortgages, which didn't require borrowers to document income or assets. It was founded in 1985 by Angelo Mozilo and David Loeb, who also founded Countrywide Financial Corp, once the largest mortgage lender. Bank of America Corp bought Countrywide on July 1.

As of March 31, the FDIC had put 90 banking institutions with $26.3 billion of assets on its "problem list." This excluded IndyMac, which alone had about $32 billion of assets, and close to $19 billion of deposits. Well over 2,000 banking companies failed in the 1980s and early 1990s. Cassidy said the government may need to set up a liquidator similar to Resolution Trust Corp, created for the earlier savings and loan crisis.

The largest U.S. bank failure is the May 1984 collapse of Chicago's Continental Illinois National Bank & Trust Co. IndyMac was roughly the same size as American Savings & Loan Association of Stockton, California, a September 1988 failure.

Cassidy called the probability of failure "very high" in which a bank's nonperforming assets exceed the sum of tangible equity plus reserves for loan losses. Richard Bove, a Ladenburg Thalmann & Co analyst, in a July 13 report titled "Who Is Next?" said a "danger zone" is where nonperforming assets, including loans at least 90 days past due, exceeded 40 percent of common equity plus reserves.

Citing FDIC data as of March 31, Bove said that IndyMac had been at the greatest risk among more than 100 of the largest U.S. lenders, with a 146.2 percent ratio.

Among the other banks high on the list include Newport Beach, California's Downey Financial Corp, with a 95.4 percent ratio; Fort Lauderdale, Florida's BFC Financial Corp, which invests in BankAtlantic Bancorp Inc; Coral Gables, Florida's BankUnited Financial Corp; Chicago's Corus Bankshares Inc; Los Angeles' FirstFed Financial Corp; Troy, Michigan's Flagstar Bancorp Inc, and Washington Mutual, at 40.6 percent.

The list also includes Puerto Rico's Doral Financial Corp, First BanCorp and Santander BanCorp. "We're surprised to be near the top of that list," said Bert Lopez, BankUnited's chief financial officer, in an interview.

"Our underwriting standards have been very conservative, we have insured a substantial portion of our loan portfolio, and our losses remain low on an overall basis." He declined further comment, citing a pending $400 million stock offering.

Feds to freeze IndyMac's home-equity credit lines
The Federal Deposit Insurance Corp. today provided more guidance for IndyMac Bank customers who are awaiting the bank’s reopening on Monday, after it was declared insolvent on Friday and seized by the government.

Some key points from a news conference the FDIC held today, as relayed by Times staff writer Kathy M. Kristof:

--Customers with home-equity credit lines will have their accounts frozen and "reviewed on a case-by-case basis," according to the FDIC. That’s a move by the agency to make sure its losses on the bank’s loan portfolio don’t balloon from the FDIC’s current estimates.

--Lines of credit to commercial construction contractors also will be frozen pending a review, but construction loans made to individual consumers won’t be affected.

--Customers of IndyMac’s reverse-mortgage subsidiary will continue to have access to their funds. Reverse mortgages provide elderly homeowners with either regular payments or a line of credit secured by their homes.

--For insured depositors, the bank will continue to honor existing terms on accounts, meaning the interest rates on outstanding certificates of deposit will be whatever IndyMac promised.

But that won’t apply to so-called brokered deposits -- funds brought in by Wall Street firms or other middlemen. Those deposits stopped accruing interest on Friday, and once the FDIC identifies all of the uninsured depositors the brokered deposits that are within insurance limits will be returned to their owners.

--Depositors with funds over the FDIC’s insurance limits will have access to 50% of the uninsured sum beginning on Monday. Whether they get any more of that money back will depend on how much the FDIC recovers in selling IndyMac assets in the next few months.

Citigroup's $1.1 Trillion of Mysterious Assets Shadows Earnings
At an investor presentation in May, Citigroup Inc. Chief Executive Officer Vikram Pandit said shrinking the bank's $2.2 trillion balance sheet, the biggest in the U.S., was a cornerstone of his turnaround plan.

Nowhere mentioned in the accompanying 66-page handout were the additional $1.1 trillion of assets that New York-based Citigroup keeps off its books: trusts to sell mortgage-backed securities, financing vehicles to issue short-term debt and collateralized debt obligations, or CDOs, to repackage bonds.

Now, as Citigroup prepares to announce second-quarter results July 18, those off-balance-sheet assets, used by U.S. banks to expand lending without tying up capital, are casting a shadow over earnings. Since last September, at least $100 billion of assets have flooded back onto Citigroup's balance sheet, accompanied by more than $7 billion of losses.

"If you start adding up all the potential exposures, it's a huge number," said Sam Golden, a former ombudsman for the U.S. Office of the Comptroller of the Currency who now heads the financial-industry practice for restructuring adviser Alvarez & Marsal in Houston. "The banks will say that it was disclosed. Investors are saying, `Yeah, but it was cryptic. We really didn't know what you were telling us."'

U.S. banks already are reeling from more than $165 billion of writedowns and credit losses, so shareholders are wary of unknown obligations that might force them to take responsibility for additional troubled assets. The risks have become so obvious that accounting officials are proposing new rules -- some of which Citigroup opposes -- that would force many assets back onto balance sheets.

Seven of the biggest U.S. banks, including Citigroup, are on the hook for at least $300 billion of credit and liquidity guarantees for off-balance-sheet loans and bonds, according to a June 30 report from consulting firm RiskMetrics Group Inc. in Rockville, Maryland. Such guarantees seemed remote when pledged as an inducement to bond buyers.

Now, the first year-over-year decline in housing prices since the Great Depression and rising home-loan, commercial-mortgage and credit-card delinquencies have begun to trigger them. "You will rapidly realize what a farce these off-balance- sheet things are," said Ladenburg Thalmann & Co. analyst Richard X. Bove. "You could pick up a lot of loan losses with the stuff you're putting back on."

It's impossible to predict what the losses might be from off-the-books assets or liabilities because disclosures are thin relative to what is required for balance-sheet assets, said Neri Bukspan, chief accountant for Standard & Poor's in New York. "A lot of information tends to disappear or becomes second or third class," Bukspan said.

Citigroup has had to bail out at least nine investment funds in the past year, including seven structured investment vehicles, or SIVs, whose funding withered. The bank had to assume $45 billion of securities from those SIVs, which are now included in the $400 billion of on-balance-sheet assets Pandit says he's trying to unload in the next three years.

The bank probably will report a second-quarter net loss of $3.7 billion later this week, according to the average estimate of seven analysts surveyed by Bloomberg. A loss would be the company's third straight and add to $15 billion of losses recorded during the previous two quarters.

Citigroup plunged 69 percent in the past year in New York Stock Exchange composite trading. It closed at $16.19 on July 11, down 52 percent from April 6, 1998, when Citicorp agreed to form the modern company by merging with Sanford "Sandy" Weill's Travelers Group Inc.

JPMorgan Chase & Co., which has more than $400 billion of off-balance-sheet assets, also reports second-quarter results this week. The New York-based bank, the largest U.S. bank by market value, may say second-quarter profit fell 55 percent to $1.9 billion, analysts estimate.

Merrill Lynch & Co., the third-biggest U.S. securities firm by market value, also reports results this week. New York-based Merrill had to buy about $4.9 billion of mortgage-linked assets last year from an off-balance-sheet financing vehicle, resulting in a $170 million loss. It may post a second-quarter loss of $1.56 billion after reporting about $14 billion of net losses in the previous three quarters, according to a Bloomberg survey of 11 analysts.

"The riskiest assets we had, our CDOs, weren't even on our balance sheet," Merrill Chief Executive Officer John Thain said on a June 11 conference call with investors. Merrill would have to provide $15 billion in financing for CDOs and related obligations under a "severe stress scenario," according to a Merrill regulatory filing published in May.

The Financial Accounting Standards Board, the five-member panel in Norwalk, Connecticut, that sets U.S. accounting rules, voted earlier this year to eliminate "qualifying special- purpose entities," or QSPEs, a category of off-balance sheet financing exempted from tighter standards enacted following the collapse of U.S. energy trader Enron Corp.

FASB also plans to clamp down on "variable interest entities," or VIEs, that banks used when their vehicles couldn't qualify as QSPEs. And it voted June 11 to force banks to consolidate off-balance-sheet assets whenever an "obligation to absorb losses can potentially be significant."

Banks are required to disclose their off-balance-sheet assets in annual reports. According to Citigroup's most recent financial statement, filed in May, the bank's $1.1 trillion of off-the-books assets as of March 31 included $760 billion of QSPEs and $363 billion of unconsolidated VIEs.

"Our quarterly financial report provides full disclosure of our off-balance-sheet assets, including our maximum exposure to assets in unconsolidated VIEs," Citigroup spokeswoman Shannon Bell said. That figure was $141 billion as of March 31 and included funding commitments and guarantees, company reports show.

To lose the full amount, all the assumed assets would have to be written down to zero. The figure exceeds Citigroup's market value of about $90 billion, which dropped more than $180 billion since the end of 2006. Citigroup's financial statement also says that about $517 billion of the QSPEs are related to mortgage securities, and that they are "primarily non-recourse," which means the risk of future credit losses is transferred to purchasers.

Merrill eyes sales besides BlackRock, Bloomberg
Merrill Lynch & Co Chief Executive John Thain is considering selling other investments to drum up capital aside from its stakes in BlackRock and Bloomberg, CNBC said on its Web site on Sunday, citing people familiar with the firm.

CNBC said ratings agencies are raising issue with the possible sale of Merrill's 49.8-percent stake in BlackRock -- the largest publicly traded U.S. asset management company -- because it is a core asset that produces a steady stream of revenue.

For these reasons, Thain is trying to minimize the amount of the BlackRock stake he has to sell to raise capital, CNBC said, citing sources. The report also said Merrill's write-down for the second quarter could exceed $6 billion, citing a person familiar with the investment bank.

If analysts' current estimates of up to $6 billion of write-downs are accurate, Merrill could need to raise roughly $5 billion of capital, one person briefed on the matter had told Reuters earlier this month. The company could reach that level by selling the 20 percent stake in Bloomberg, which Thain has said could be worth $5 billion to $6 billion.

Merrill has recorded more than $30 billion in write-downs since the third quarter of last year. Analysts say the third-largest U.S. broker-dealer suffered in the second quarter as bond insurers lost their top ratings and the structured credit market weakened.

Merrill Lynch: How Bad Is It?
Poor Merrill Lynch. Was it only three months ago that investors were buying shares of the nation's third-largest broker ahead of its first-quarter earnings announcement?

Not this time around. Since the beginning of May, Merrill's stock has dropped 45%—and touched a nine-year low of 26.50 on July 11, as investors continued to pound the stock in the days leading up to the company's July 17 earnings release. What has changed? Back then, optimistic investors hoped the worst was over. Now, they know it's not.

The taint of bad loans continues to linger on Merrill's balance sheet. Merrill owns some of the worst junk out there. As of Mar. 31, Merrill said it had $6.7 billion of exposure to complicated mortgage-backed securities (MBS) and collateralized debt obligations (CDOs), which remain difficult to price. They're also nearly impossible to sell.

Normally, distressed debt specialists would scoop them up on the cheap. But with many credit products damaged in one way or another, buyers are ignoring the ridiculously complicated ones and sticking with simple products like high-yield bonds. "Given the size of their exposures, some further writedowns seem inevitable," says Standard & Poor's credit analyst Scott Sprinzen.

Exacerbating the problem is Merrill's $3 billion of hedges with monoline insurers like MBIA and Ambac Financial. The monolines had their credit ratings slashed in June, and those downgrades may force Merrill to set aside extra cash reserves to cover the inability of the bond insurers to pay its liabilities, assuming there are any.

Like Lehman Brothers, which lost $600 million in the second quarter, Merrill is likely to find that the indexes used to hedge its exposure to certain assets and the actual assets no longer move together. That could force Merrill to announce even more losses.

Unfortunately for CEO John Thain, the credit problems will continue to overshadow Merrill's strong asset management and retail businesses, which continue to grow, if only sluggishly, and accounted for $3.6 billion in revenues during the first quarter of 2008.

Merrill is also diversified globally, with more than one-third of its sales coming from Europe and only 19% from the U.S. Unlike trading and fixed income, asset management is not capital-intensive, and Merrill would like to get to the point where it can rely on those businesses to generate a high return on equity—10% to 20%—that is its raison d'être.

But that plan could be upended if Merrill is forced to raise more capital on top of the $15.5 billion raised since the credit crunch began a year ago. That will depend on the size of the writedowns, which analysts predict could total as much as $6 billion. The per-share estimates, ranging from a loss of 70¢ to Oppenheimer analyst Meredith Whitney's prediction of a $4.21 loss, reflect the disparity in analysts' expectations for Merrill's writedowns.

Issuing common stock would be the easiest way to raise money fast, but Thain promised investors he would not resort to diluting their holdings, a promise he probably wishes he never made. If he keeps his word, Thain may have to resort to selling Merrill's two most valuable assets: its stakes in Bloomberg and BlackRock.

Estimates vary, but Merrill's piece of Bloomberg could fetch somewhere in the ballpark of $5 billion, but cost the company $300 million in profits, according to a Deutsche Bank report. Still, it's a more palatable solution than selling a piece of Merrill's 49% stake in asset manager BlackRock. Bloomberg is profitable, but not essential to Merrill's core business.

BlackRock has strategic value for Merrill and its plans to rely on asset management to improve profitability.
A fire sale would force Thain to reconsider the company's plans and delay a recovery. "It would be a real failure if they had to sell BlackRock," says Alliance Bernstein's Brad Hintz. "I hope it doesn't come to that."

Long Protected, Fannie and Freddie Ballooned
As the Bush administration scrambles to address the sudden decline of the country’s two largest mortgage finance companies, some of their longtime critics say the crisis has been building for years.

Among them is Jim Leach, a Republican former representative from Iowa, who began arguing two decades ago in Congress that the government-chartered mortgage companies, Fannie Mae and Freddie Mac, were unfairly insulated from the real world.

They were not subject to the same financial standards and tax burdens as their competitors, he warned, and if they ran into trouble, an implicit government guarantee to back them up meant taxpayers would be left with the losses. “There are times in public policy making that one can feel like Don Quixote,” Mr. Leach said of his repeated legislative battles to rein in the two companies’ growth.

Congress established Fannie Mae during the New Deal to make homes more affordable for lower- and middle-income Americans, and Freddie Mac was established later with a similar purpose. Neither provides home loans. Instead, the companies buy mortgages from banks and take on the risks of possible defaults — allowing banks to make even more mortgages.

Today they own or guarantee about half of the country’s $12 trillion in mortgage debt, so the free fall of their share prices last week amid concerns that they were undercapitalized has created chaos for Wall Street and Washington.

The dominant role Fannie and Freddie play today is no accident. The companies, Wall Street firms, mortgage bankers, real estate agents and Washington lawmakers have built up an unusual and mutually beneficial co-dependency, helped along by robust lobbying efforts and campaign contributions.

In Washington, Fannie and Freddie’s sprawling lobbying machine hired family and friends of politicians in their efforts to quickly sideline any regulations that might slow their growth or invite greater oversight of their business practices. Indeed, their rapid expansion was, at least in part, the result of such artful lobbying over the years.

And as Fannie and Freddie grew, so did the fortunes of Wall Street, which reaped rich fees from issuing debt for the two companies, as well as the mortgage and housing industries, which banked billions of dollars as the housing market boomed.

Even after accounting scandals arose at the two companies a few years ago, attempts to push through stronger oversight were stymied because few politicians, particularly Democrats, wanted to be perceived as hindering the American dream of homeownership for the masses.

Lots of perks came with Fannie and Freddie’s charters and government backing: exemptions from state and federal taxes, relatively meager capital requirements, and an ability to borrow money at rock-bottom rates.

Ilargi: Probing false information, surely a commendable step. Problem is, where to start? Banks, investors, politicians, media? They all lie incessantly, routinely even, to promote their respective agenda’s. The best advicel I can give the SEC is to start by investigating itself.

SEC to Probe Manipulation Through False Information
Wall Street's biggest regulators are examining whether securities firms adequately police rumor- mongering used to manipulate stocks after shares of Lehman Brothers Holdings Inc., Fannie Mae and Freddie Mac tumbled last week.

The U.S. Securities and Exchange Commission's inspections unit, the Financial Industry Regulatory Authority, which monitors brokerages, and the New York Stock Exchange's regulatory arm are checking whether firms have controls in place to prevent the intentional spread of misinformation, the SEC said in a statement today. They will also look at whether employees have been adequately trained.

"The examinations we are undertaking with FINRA and NYSE Regulation are aimed at ensuring that investors continue to get reliable, accurate information about public companies," SEC Chairman Christopher Cox said in the statement.

U.S. regulators are already hunting for traders who may have sought to illegally profit from the credit crisis by falsely stoking panics about the stability of companies including Bear Stearns Cos., which collapsed in March amid speculation that clients were pulling business.

Cox told the Senate Banking Committee April 3 the agency takes such manipulation "very seriously" and that lawmakers' hopes for a crackdown would be "met or exceeded." In March, the Washington-based agency opened probes into whether hedge funds and other traders spread lies about Bear Stearns and Lehman after those stocks plunged, people familiar with the matter said at the time.

Publicly declaring inspections "may be the most effective step they could take" to stem the malicious use of rumors, said James Cox, a securities law professor at Duke University in Durham, North Carolina, who isn't related to the SEC chairman. Still, "it's a little like the Dutch boy with his finger in the dike." Many traders, including hedge funds, aren't subject to the inspections, he said.

Finra and NYSE Regulation will join the SEC in examinations in addition to those already under way into manipulation of securities prices through rumor-mongering and abusive short selling, the SEC said. Finra and NYSE rules bar their members from spreading "sensational" rumors that can affect markets, even if people aren't using them to defraud.

Lehman's shares fell last week amid speculation that Pacific Investment Management Co., manager of the world's biggest bond fund, and hedge fund SAC Capital Advisors LLC, were backing away from the firm. The companies denied it, and Pimco fund manager Bill Gross told CNBC in an interview that there's "no question" about the Lehman's solvency. Its shares are down 78 percent this year.

"Lehman is very susceptible to any kind of negative talk," said Rebecca Engmann Darst, an options analyst at Greenwich, Connecticut-based Interactive Brokers Group Inc. "Its shares respond big and bad to any negative, more so than other brokers, because since March it's been perceived as the next in line after Bear Stearns to suffer a similar fate.

Bernanke Embrace May Turn as Fed Seeks More Powers
Federal Reserve Chairman Ben S. Bernanke picked a good time to ask Congress for the biggest expansion of his office's powers since the Great Depression. He has to make the most of an opportunity that may prove fleeting.

Bernanke, who testifies before Congress this week, has stored up goodwill with lawmakers after reducing interest rates at the most aggressive pace in two decades and acting to prevent a financial-market meltdown.

"The chairman has done a good job at crisis management," says Representative Carolyn Maloney of New York. "I like the moves he's made," says Representative Mel Watt of North Carolina. Both are Democratic members of the House Financial Services Committee, which will question Bernanke July 16 after he delivers his semi-annual report on the economy to Congress.

The favorable reviews on Capitol Hill will serve Bernanke, 54, well as Congress considers his bid to expand his authority over the financial-services industry, a debate that will probably continue into early 2009. The longer it lasts, the more he may find his popularity strained whenever he has to start taking the rate cuts back.

The chairman already faces pressure from some regional Fed- bank presidents to start raising the cost of credit to curb expectations of higher inflation. Such a move would test both his political skills and the Fed's independence, requiring him to justify higher rates to the same lawmakers he's asking for authority to help prevent future financial crises.

"From a political standpoint for the Fed, that's a bad position to be in," says Jay Bryson, global economist at Wachovia Corp. in Charlotte, North Carolina, who formerly worked at the Fed in Washington. "You're going to have senators and congressmen breathing down their necks."

While Watt, 62, and Maloney, 60, give Bernanke high marks for helping to keep the economy out of a recession and stepping in to prevent the bankruptcy of Bear Stearns Cos., both say it's much too soon to be talking about higher interest rates. Their support matters because the committee they sit on would decide on any expansion of the Fed's regulatory powers.

Although those powers and changes in interest rates "are unconnected on a policy level, they could be connected politically," says Senator Michael Crapo, an Idaho Republican who sits on the Banking Committee, which will be the first to hear Bernanke's report in a session tomorrow. Raising rates may lead some politicians to try "to stop efforts" to expand the Fed's authority, he says.

Silence of the Lenders: Is Anyone Listening?
Dan A. Bailey Jr. was desperate when he sat down on May 19 to send an e-mail message to his mortgage lender, the Countrywide Financial Corporation, pleading, yet again, for help.

Behind on his payments and fearful of losing his home of 16 years — a 900-square-foot bungalow in Wilmington, N.C. — Mr. Bailey had spent the previous six months unsuccessfully lobbying Countrywide, at the time the nation’s largest home lender and loan servicer.

Mr. Bailey, 41, promised in his e-mail message that he would pay every nickel he owed if Countrywide would modify his mortgage in a way that allowed him to keep his home. He sent the message to a grab bag of Countrywide e-mail addresses, which he had received from, an online forum for borrowers.

Among the recipients of his e-mail was someone he had never heard of before: Angelo R. Mozilo, Countrywide’s co-founder and chief executive. Lo and behold, Mr. Mozilo replied — inadvertently, as it turned out. “This is unbelievable,” Mr. Mozilo said in his message. “Most of these letters now have the same wording. Obviously they are being counseled by some other person or by the Internet. Disgusting.”

Within days, Mr. Mozilo’s e-mail was widely circulated on the Internet and in the news media, offering a rare instance when candid comments from a powerful C.E.O. entered the public realm. For Mr. Bailey, however, the disdain that Mr. Mozilo expressed was depressingly familiar.

After all, Mr. Bailey had received little else from Countrywide after he began trying to renegotiate an adjustable-rate loan that he could no longer afford. Until then, he says, the only guidance the lender provided was a suggestion from an employee of Countrywide’s “home retention team” that he cut back on groceries to pay his mortgage.

“I told her that I probably spend $10 a day on groceries,” Mr. Bailey recalls. “And she said ‘Maybe you can eat less.’ ” As record numbers of homeowners try to avoid foreclosure, the responses of big lenders and loan servicers like Countrywide are drawing increased scrutiny. While these companies maintain that they’re doing all they can to help imperiled borrowers, critics contend that homeowners routinely meet roadblocks.

Many borrowers have trouble even reaching a workout specialist; others soon find that the modifications they received are as unaffordable as the mortgages they replaced. Some homeowners, eager to sell their homes before the value falls further, say they are impeded by loan servicers’ inaction or incompetence.

“We continue to rely on lenders to fix the problems they created by making reckless loans in the first place, but it’s clear that foreclosures keep rising,” says Deborah Goldstein, executive vice president of the Center for Responsible Lending, a nonprofit group that assists borrowers. “We need federal regulators to step in or court-supervised loan modifications — any solution that might standardize the process better.”

With two of the nation’s most important mortgage concerns, Fannie Mae and Freddie Mac, continuing to falter last week — raising the possibility that they may need a federal bailout or takeover — foreclosure problems are likely to become even more complex.

Hot money poses risks to China’s stability
In 2006 China shocked the world by adding $247bn to what was already the largest hoard of foreign currency reserves. In 2007, if correctly counted, China took in more than twice that amount. So far this year it is on track to double yet again.

It is increasingly clear that this level of reserve accumulation is not sustainable. Besides the strains it places on the global balance of payments, the biggest problem it causes is within China itself. The People’s Bank of China, China’s central bank, has to purchase these soaring reserves by issuing a combination of local currency and central bank bills.

The ensuing monetary creation is fuelling rising inflation, systematic overinvestment and an overextended banking system. But while vast and growing reserves have been an issue for China for several years, in the past few months something new and highly destabilising has been added to the process. The source of reserve accumulation has become much more volatile and perhaps intensely procyclical (exaggerating the swings of the economic cycle).

For many years China’s reserve accumulation was largely powered by its high and rising trade surplus and its status as the favourite destination for foreign direct investment. These are relatively stable sources of inflow and are even likely to be neutral or slightly countercyclical. But in recent months it has been no longer the trade surplus, in combination with FDI, that is powering the increase.

The trade surplus is slightly down in 2008 compared with last year, as is the use of foreign-sourced funds for investment, even as the rate of Chinese reserve accumulation has doubled. During the first halves of 2005 and 2006, the trade surplus, FDI and estimated interest on China’s reserves accounted for 80-90 per cent of the country’s reserve accumulation. In the first half of 2007, these components accounted for about 70 per cent.

This year, however, their share has declined dramatically to 39 per cent from January to May (after we adjust China’s headline growth in reserves to account for a number of transactions that have in effect “outsourced” the job of reserve accumulation to other entities within China). Because there are likely to be speculative inflows buried in the trade and FDI accounts, their true share is probably even lower.

So what is powering China’s accelerating reserve accumulation? Probably hot money. As it becomes increasingly clear that China must revalue its currency sharply or else face surging inflation and the threat of financial instability, more and more investors, business people and ordinary households are bringing money into China to take advantage of profits associated with the expected appreciation or to protect themselves from the losses they will incur with the rising renminbi.

Consequently a flood of speculative money, amounting possibly to tens of billions of dollars every month, is pouring into China. There is no technical definition of hot money and of course, with much of it entering the country illegally, it is tough to measure, but it is possible to obtain rough proxies for speculative inflows and to track their change over time. In every case the proxy, however it has been derived, shows a startling increase over the past 12 months.

The fact that in recent months the authorities have taken increasingly desperate measures to staunch the inflows confirms this interpretation of soaring hot money proxies. If hot money is indeed increasing as quickly as the various proxies suggest, it indicates that not only is Chinese reserve accumulation going through a large quantitative change as it doubles yet again, it is going through an even more important qualitative change

UK house prices could fall back a long way after their excessive rises
Last week the penny finally dropped about the housing market. The Halifax numbers were awful. A 2pc fall on the month was bad enough, but this came after earlier large falls. Over the past three months prices have fallen by almost 6pc - which translates into an annualised rate of decline of over 20pc.

That is the fastest on record. But how large will the total drop in prices be? The place to start is with an analysis of why this is happening. The essential reason is that houses had become ludicrously over-priced, to the point where, in order to be able to afford one, you either had to own one already, to mortgage yourself up to the eyeballs or to win the lottery.

Many British people seem to believe that it is somehow inevitable that house prices rise by 10pc, 15pc or 20pc every year, thereby squirting money around for all who have been lucky or canny enough to position themselves under the shower.

You cannot shake off this sort of collective delusion without a painful adjustment. Not only Joe Soap, who can be readily forgiven, but mortgage lenders, house-builders, and estate agents, who should have known better, will have to re-acquaint themselves with the economic fundamentals.

GDP rises, on average, at 2pc to 3pc per year, as do real average earnings. Add 2pc to 3pc inflation to that and you have a good starting point for what you should expect for the progress of most money values over time - 4pc to 6pc per annum. So why should house prices rise by 10pc plus, year after year?

I saw a bubble blowing up in housing a few years ago but I seriously underestimated how much longer it would inflate. I therefore gave my warnings of the market's demise too early. In my defence, if you are a forecaster, being early ought to be a forgivable fault.

It is certainly much better than being late - like all those postcasters who are now jumping up and down and telling us the housing market is weak. My timing may have been bad but the analysis was essentially right. I thought that what was happening in the housing market was a repeat of what we had seen several times before in the UK's history.

As with other bubbles, prices went up much further than was justifiable on the economic fundamentals, as the experience of past price rises caused the expectation of further price rises, and as mortgage money became more freely available on extremely attractive terms.

This relaxation of lending criteria was itself a reflection of the bubble psychology and it became part of the mechanism that inflated the bubble. So it is ludicrous to say that it is only the dearth of mortgage money that is now undermining the market; it was the flood of mortgage money that drove prices up in the first place.

Since my original warning that house prices could fall by 20pc, they have risen substantially. I now think that prices may drop by about 35pc from peak to trough. That may strike you as extreme, but it is not. I regard it as conservative. It is fully in accordance with past experience.

As so often, inflation has played tricks on our understanding. The conventional wisdom is that house prices always go up, with the early 1990s the only exception. Then, from peak to trough, average house prices fell by 20pc.

But in real terms the fall then was 38pc. And it was 32pc in the mid 1970s, and 16pc in the late 1970s. It has been normal for house prices to fall back a long way after excessive rises. It is just that, in the past, high rates of inflation made it possible for this to happen in real terms without a fall in nominal prices, thereby sustaining the popular myth that house prices never go down.

By contrast, in the era of low inflation this disguise no longer works. And we are still in this era - even though inflation might this year briefly touch 5pc, before falling back next year. In these conditions, falls in real prices have to take place predominantly through falls in nominal prices.

Nor does the forecast of a fall of 35pc rest on a denial of the idea that the fundamental forces of supply and demand justify some increase in real prices. The fact that the population has risen while rates of house building have been low implies that the equilibrium level of house prices and the equilibrium level of the house price to earnings ratio have risen.

In fact, if house prices were to fall by 35pc over three years, then the house price to earnings ratio would only return to its long run average. In the recession of the early 1990s, by contrast, the ratio fell 25pc below its long run average. Accordingly, it is readily possible to imagine falls bigger than 35pc. Indeed, it is likely that just as the boom overdid things on the upside, so prices will fall too far on the downside.

Santander to buy Alliance & Leicester for $2.6 billion
Spain's Banco Santander said Monday it's agreed to buy Alliance & Leicester in a 1.3 billion pound ($2.6 billion) deal that should reduce funding pressures on the U.K. bank and help strengthen Santander's existing Abbey business.

The Spanish group said it's offering one of its own shares for every three shares of Alliance & Leicester. That values the offer at 299 pence, or a 36.4% premium to Friday's closing price. In addition, shareholders will be eligible for an 18-pence interim dividend, taking the total value for shareholders to 317 pence, or a 44.6% premium to Friday's close.

Alliance & Leicester had said earlier in the day it was in advanced talks over a deal on those terms. Shares of the U.K. bank soared around 47% to 322 pence in midday trading, helping boost the rest of the banking sector trading in London.
Shares of Santander slipped 0.3%. Andy Penman, analyst at Barclays Stockbrokers, said the deal would lift Santander's share of the U.K. mortgage market to a percentage in the low teens.

By combining the business with Abbey, its existing U.K. arm, Santander said it will be able to cut costs by 180 million pounds a year by 2011. It will also speed up the Spanish group's push to attract small and medium business customers. "A&L's shareholders, customers, employees and other stakeholders will also gain from the benefits of being part of a larger, more diversified banking group," the pair said in a statement.

"In particular, being part of the enlarged Santander group should, over time, enable A&L's cost of funding to be reduced," they added.

John McCain -silently- boots Phil Gramm
Sen. John McCain's top economic adviser, Douglas Holtz-Eakin, was on PBS Nightly Business Report on Friday night and was peppered about Phil Gramm's assertion that America is a "nation of whiners" whose economic travails are overblown.

There is no recession, only a "mental recession," the ex-Texas senator said - prompting one of this swiftest and tartest denunciations of a surrogate by a candidate this century.

According to Holtz-Eakin, that wasn't just hyperbole when McCain ruled out Gramm as a a prospect for Treasury Secretary, with the most he could hope for now if McCain wins is an ambassadorship to Minsk, capital of Belarus, Europe's last communist dictatorship.

PBS: That's very funny, but is he going to be talking to Senator Gramm? Is he going to have any role?

HOLTZ-EAKIN: Obviously, the senator doesn't endorse those views and he is not going to promote anything that looks like a mindset that suggests we don't understand that Americans are suffering. They need jobs, and the senator is focused on those kinds of efforts.

PBS: Is Senator Gramm still giving advice to Senator McCain?

HOLTZ-EAKIN: No. ... I haven't spoken to Senator Gramm since the comments took place, and I'm not expecting to.

Wall Street Turns Predatory Lender in Chilling 'Chain of Blame'
Every Wall Street scandal whelps a journalistic thriller that chronicles, detail by sordid detail, what went wrong and why. Insider trading inspired James B. Stewart's "Den of Thieves." Long-Term Capital Management LP's meltdown spawned Roger Lowenstein's "When Genius Failed."

Next up: "Chain of Blame," a ripping piece of reporting that shows how subprime-mortgage lending rose amid the ruins of the savings-and-loan crisis in the late 1980s and early 1990s, slithered throughout the financial system, and ended with some 1 million Americans losing their homes.

Authors Paul Muolo and Matthew Padilla introduce us to the bankers, non-bank lenders and loan brokers who drove the reckless practices that ultimately engulfed Bear Stearns Cos., brought down Wall Street bosses including Chuck Prince and Stan O'Neal, triggered more than $400 billion in writedowns and credit losses so far, and now threaten Fannie Mae and Freddie Mac.

Who's to blame? The authors identify swarms of culprits, from local predatory lenders and unscrupulous loan brokers to contract underwriting firms that, by this account, deployed armies of grunts with laptops to review billions of dollars worth of mortgages. Grunts were pressured, the book reports, to review one loan an hour.

Yet the ultimate subprime enabler, according to this book, is fingered in the subtitle: "How Wall Street Caused the Mortgage and Credit Crisis." "Wall Street was in charge -- lending money to non-bank originators (through warehouse lines), buying and securitizing the loans, designing the loan products, and then eventually owning some of the rank-and-file lenders," they write.

The authors know their stuff. Muolo, executive editor of National Mortgage News, has tracked the industry for years and is the coauthor of a bestseller on the S&L crisis, "Inside Job." Padilla is a business reporter for the Orange County Register, a newspaper published in the epicenter of the subprime market, Southern California.

"Chain of Blame" is an ambitious book, taking in the early history of subprime leading (picture repo men throwing bald grannies out their homes); the rise and fall of Ameriquest Mortgage Co., once the largest U.S. lender to people with credit problems; and the curious story of former HomeBanc Corp. Chief Executive Officer Patrick Flood, a born-again Christian who had prospective employees take a "values test."

We read about how O'Neal pushed Merrill Lynch & Co. into residential mortgages, identified here as the world's largest debt market, with Americans owing $8 trillion on their homes. And we learn a little-reported irony about the infamous moment in 2004 when Federal Reserve Chairman Alan Greenspan told Americans that the "the traditional fixed-rate mortgage may be an expensive way of financing a home."

Did Greenspan himself have an adjustable-rate mortgage? "No. I have a fixed rate," the Maestro is quoted as saying. "I like the certainty." Tying the whole story together is the rise and stumble of home-mortgage lender Countrywide Financial Corp., which grew from strength to strength until CEO Angelo Mozilo made the fatal error of entering the subprime market.

"Chain of Blame: How Wall Street Caused the Mortgage and Credit Crisis" is published by Wiley (338 pages, $27.95, 14.99 pounds).

Bankers Use Secret Clinics, Nurses to Beat Breakdowns
On a private island 20 minutes by helicopter from central London, a hovercraft sits on the lawn of a turreted Edwardian manor house as swallows swoop around. Trees and wildflowers line a lane that leads to a cluster of buildings that house a pool table, a 12-seat movie theater and an art studio. A yacht is moored nearby.

The island isn't a country hideaway. It's the Causeway Retreat, a mental health and addiction center that charges as much as 10,000 pounds ($20,000) a week for treatment away from the prying eyes of colleagues and the media. There is a waiting list for the facility's 15 rooms. "We get lots of CEOs of companies, traders, high-end business guys," says Managing Director Brendan Quinn. "They want treatment, but they want it to be discreet."

Financial services firms in the U.K. are trying to break the stigma of mental illness as the number of people seeking help increases. JPMorgan Cazenove Ltd. and Herbert Smith LLP sponsored a conference yesterday where employers were urged to do more to help workers with psychological problems and recognize they can still be productive.

Mental health is a growing concern as the credit crunch adds to stress in the City of London, the U.K. capital's financial district. The number of men in the City who sought help for depression and stress rose 47 percent from a year earlier in the past three months, according to British United Provident Association Ltd., the U.K.'s largest private health insurer.

About 40,000 people in the U.K. financial industry will lose their jobs during the next three years, according to Experian Group Ltd, with London bearing the brunt. "I'm getting three times as many referrals as I was a year ago, particularly from the corporate sector, and a lot of that's related to the financial crisis," says Bennedict Cannon, a London psychotherapist. "This has been the busiest early summer I've known in 10 years."

Don Serratt, chief executive officer of Lifeworks, a private treatment facility set in the countryside at Old Woking, southwest of London, says he saw a 20 percent increase in admissions of City workers in the first six months of the year compared with the same period in 2007.

"What happens in these environments becomes so unbearable when times are bad because everyone's really frightened that they're next and they're going to lose their job," says Serratt, who was the London-based head of European mergers and acquisitions for Creditanstalt Bank until 1998. He quit after a battle with addictions and severe clinical depression, which he says were exacerbated by the City's environment.

Even in a world of six-figure salaries, bankers report an atmosphere of unhappiness. Fifty-eight percent of people working in banking and finance say they have seen someone cry as a result of stress at work, according to an nfpSynergy report for the Samaritans, a confidential help line that fields more than 13,000 calls daily, 20 percent from suicidal people.

The industry was recently ranked last in the City & Guilds Happiness Index, based on a survey of 2,000 people in 20 professions. Beauty therapists were first.

A country for no money down
Sometimes, it helps to step back and see the big picture.

Let’s say that I serve as the depository for a large government and I also own the central bank. I get my partners appointed to run the government’s treasury and key funds on a regular basis so I can also control financial system policies and regulation that help me finance what I want to do and mess up my competitors. Even that is getting cumbersome so I am arranging to move most of the regulatory control over to my central bank because I can control all of it privately.

Frustrated with having to deal with democratic processes, I decide to move a significant amount of money out of the government between 1997 and 2001 for reinvestment abroad. I and my partners and our syndicates engineer a serious of steps to bubble the economy so that when I move the money out the currency is high and because everyone was making money they did not notice that lots of capital was leaving.

To ensure no one notices, I suppress the gold price which turns off the financial burglar alarm and shifst gold out of the government into my private control at below market prices. Normally moving money out of a government in excess of the total taxes that year would be hard to do.

However, I could use securities fraud. I could issue a lot more government securities and government agency (like mortgage agencies) securities than I recorded on the government books and sell them abroad. I would have to make sure not to publish audited financial statements as that would increase the liabilities of engaging in this kind of fraud.

It would help a lot if I could pool mortgages and sell government agency securities to finance those mortgages in a process where the same mortgage could be sold many times into the same pool. Investors would not notice or care because the securities were government guaranteed. I also engineer an internet and telecom stock bubble, and move trillions more out through that mechanism.

OK, so as I move the money out of the country at a high price because my currency is high, what do I invest? Well if places like Asia, Latin America and Russia experience economic crashes as a result of credit crunches that result as my cutting off credit, then their currencies will be low and they will welcome investment. Or if they don’t welcome investment, I can make sure that the IMF and World Bank can strong arm.

So I can buy in really really cheap. Meantime, these currencies rise as I move manufacturing and jobs into the places where I now have big investment positions. So my investments go up. Well, back in the U.S. the bubble bursts, and the institutions like Fannie and Freddie that financed the housing bubble experience significant losses.

Their stocks drop by a lot. That hits the pension funds, 401ks, IRAs and other savings of the people who have lost money on their homes. It’s a double whammy. A lot of them also lose their jobs. Triple whammy. The currency drops in value a lot. This means that the dollar I pulled out and put into other currency that has been going up, up, up, is now worth multiple dollars. As asset values drop, each remaining dollar can buy things cheaply.

Indeed, with Fannie and Freddie’s stock dropping like a stone, I could have one or more of my offshore investment vehicles fund a recapitalization plan and buy control of the senior positions directly or indirectly controlling 50% of the residential mortgages in the country with my profits — that is for a small portion of that which I shifted out of the government.

Think of it. The housing bubble has reached it’s logical conclusion. If you can get enough people to buy a home for no money down, you can buy their country for no money down.


. said...

Quadruple the average daily volume on Freddie Mac already and it's only noon? Interesting days we live in, in interesting days.

So how do we get out of this one? The stopgap on FRE and FNM flying to bits is wise but there must be an orderly unwinding of things, such as can be arranged, and I don't get the sense Ben and Hank are the ones to do it. The first step to resolving a problem is admitting that you have one ...

Anonymous said...

As I prepare to move assets from my recent home sale into treasuries direct, I read today's WSJ article about the increasing hedges favoring the default of US treasuries. Comments, anyone? I already feel a certain amount of nervousness regarding the electronic "funny money" nature of the treasuries direct program. Definitely feels like there's no place to run and hide right now and I keep thinking I'd rather be living in Bhutan.

EBrown said...

I have recently been sharing some of your concern about short term Treasuries. I wonder where (whether?) Paulson, Bernanke, et al. will stop in their bailout plans. If they do try to bailout all the big boys what will that do to the US Gov's ability to borrow? Will it make the yeild on treasuries rise favorably for us little investors, or will it cause an outright run on US Gov debt? I don't have the answer. However, I do think the ongoing removal of credit from the system has thus far dwarfed all government "printing". I am not basing that on actual research - just my understanding of how fractional reserve banking works.

I am going to proceed with buying Treasuries under the assumption that when push comes to shove the government will choose to protect its ability to borrow as more important than JPM or Citi's ability to raise cash. It's a risky choice sure, but so is everything else at this point.

. said...

Return of money is more important than return on money, no?

Get yourself a number of cashier's checks in hand and leave the receipts for them in the safe deposit box?

Bigelow said...

Thank you for Fitts piece Mortgage Market Musing
Helps to be reminded sometimes. These may be interesting too.

Police State USA: Spying as Law of the Land

To further define our state under illustrious market rule, these two charts from Fred's Intelligent Bear Site:
Medium Term Dow/Gold Ratio
Long Term Dow/Gold Ratio

Anonymous said...

Wamu looking more and more like its toast

Hope the FDIC can handle this one.

Anonymous said...

Here's what I did. Put my money in local banks under the FDIC limit. These small local banks (in New Mexico) are rated 4 and 5 stars by Not a very good interest rate, but I feel that my money will be safe (though actually losing value due to inflation....or is it deflation? Seems like it's a little of both). Then I bought some stocks that should do well in a peak oil environment. We shall see. This is really a mess.

Anonymous said...


In response to questions about what to do with money, people in the U.S. might want to think about going to Treasuries, but not in dollars.


Anonymous said...

Capital protection? Better to be early than late - and right now its not too late for gold and silver in your possession, and currency-in-hand (nothing wrong with a mattress :)).... every other option involves either an electronic bookkeeping digitized account or some kind of intermediate layer between you and your wealth. Everyone here is on the right track (IMHO)...

scandia said...

On Fridays our local newspaper inserts a real estate section with listings,photos.For years I have analyzed every listing looking for my dream home, fantasizing. In the past year I've noticed the listings change with larger homes on the increase,more estates with acreage in the country. When I went to the box to get the insert this Friday I was shocked by the weight of it. At least twice the size,many more listings. Wow! Such a sudden change from only a week ago!
I think main street( Canada) is waking up.

Anonymous said...

This rates credit unions

Farmerod said...

I check in on theoildrum once in a while, just to see what they're talking about.

...Now that $4 gas is here and looks like it might be a short stop before $5-$10 gas, Smart Growth is getting more attention as the best method to maintain a high standard of living and promote economic growth....

Sigh. Another wasted minute.

Anonymous said...

Hey OC,

I check TOD just about every day, mostly for the DB.

That being said, what do you think happened to Stuart S over there? He went wild couple of technocopian articles and then has been nowhere. His work on KSA about a year ago was a real awakening for me. Was he trying to get himself run out of TOD on purpose?

Is he just that diciplined and decided to spend his time doing what he can in NoCal to prepare rather than watching this slow mo train wreck? I think anyone who gets the energy problem could probably have come to same conclusion let alone the concurrent financial disaster. It's just so hard to look away when it seems like something you've known your whole life is being unveiled to the rest of the world.

Stuart are you out there?

Anonymous said...

The anonymous guy leads you to a site which charges you a fee for finding out your credit union rating. Very suspect.

Stoneleigh said...

Stuart resigned from TOD because he felt it was too informal. He wanted to concentrate on peer-reviewed academic papers rather than blogging, as he finds that more 'legitimate'. Personally I think it's a shame, as he did a few great pieces of work (notably on Ghawar and on the impact of biofuels) that I don't think anyone else could have done.

He simply doesn't believe we're headed for financial disaster though. I often got the impression that he thought I was being hysterical for suggesting we could see systemic bank failures for instance, although, to be fair, such things seemed implausible to many people in 2005 and 2006.

For Stuart (a physicist) the world is mechanical, rational and logical. Arguments based on human nature, positive feedback, market reflexivity (to use Soros' term for it), tipping points and social mood got nowhere with him.

I have no idea what he's doing these days, but I doubt very much if he would ever read this site.

Stoneleigh said...

Today's failed rally increases the odds that we have we could see quite a bit more selling pressure before we reach a short-term bottom. Trying to bet on such moves is dangerous though - traders call it 'trying to catch a falling knife'.

Fear is increasing, but has not yet reached a level quite comparable to previous market lows. When the next rally does begin (and I still think it won't be that far off), it may well be very sharp though. A typical bottom would be a spike low followed by a strong intraday recovery.

Anonymous said...

For TOD to ignore the economic side of the PO story is just incredulous to me. It renders the site inadequate and irresponsible, IMO. As for Stuart, when he wrote of a subject I was more informed about, that is agriculture, and I saw many holes in his logic (or should I say arrogant assumptions), I thought that it called into question the subjects he wrote about which I didn't know much about. S&I, you are amazing!

Anonymous said...

Its odd,
I have expected a collapse of this nature for 8-10 years,yet now,at the cusp of it,the only wish I have is for the fed and other entities to figure out a way to prevent it.I understand that at this stage it is like trying to hold the tide,but I have a good Idea of the misery that will soon find its way to every house,rich and poor in this nation.This first winter will see it start.The fuel prices alone will hurt .A lot.


Anonymous said...


Care to elaborate further on the misery that the rich will suffer?

Stoneleigh said...

Many people who are currently considered rich or upper middle class are actually quite over-extended in a debt to income comparison. Keeping up with the Jones in the pursuit of material possessions can be an expensive business, whatever income bracket one is in, and the temptation posed by easy credit has been enormous.

Relatively few have been able to resist its attractions, and those who are accustomed to relative wealth are hampered in their ability to adapt by having sky-high expectations and a paucity of practical skills. For them it will be a very rude awakening indeed, in the sense that they have so much further to fall - perhaps all the way to the nearest Hooverville, villa miseria, barrio or favela.

Even many of the truly rich will find that most of their fortune evaporates in the fight for every scrap of underlying real wealth that will ensue once the credit implosion reveals just how little wealth there actually is. The vast majority of wealth is an illusion, including most of what people currently invest in - stocks, real estate, most bonds, collectibles etc.

Some, in contrast, will find tremendous opportunity in the coming upheaval, and will manage to exploit the misery of others very successfully and with utter ruthlessness. I doubt if many of these people will turn out to be those who are currently rich though. The necessary mindset and skill set for the accumulation of riches under the coming circumstances are quite different from those that have prevailed in recent decades. Such people often have a real appetite for personal risk - finding it exhilarating - whereas most westerners today are extremely risk averse.

A few of today's super-rich will be hoping to live in their gated 'green zones', untroubled by the world outside, but they forget that true independence is not possible. Their wealth derives from their erstwhile ability to cream off surpluses from around the world through globalization, but that extractive ability is coming to an end. 'Green zones' can and will be over-run in a sufficiently chaotic world.

We will all have to get used to facing risk on a scale none of us is remotely mentally prepared for.

Stoneleigh said...


Stuart used simplifying assumptions, as all modelers must, but IMO wasn't always open to debating just how realistic those assumptions were, or to what extent the failure of those assumptions would affect the outcome he was modeling. I always took issue with the most basic assumption - that the world is an essentially rational and mechanistic place.

I do think some of his articles were truly works of genius, but in others he was overextended. (I have a background in electricity transmission from my energy days in academia, and one article on super-transmission systems based on solar power in deserts actually made me laugh it was so unrealistic). I think Stuart realized this, which is one of the reasons he chose to go back to peer-reviewed work where that is supposed to be less likely to happen.

I would argue, however, that peer-reviewed work almost inevitably means being constrained by consensus to the point where it becomes impossible to offer timely advice on important trend changes as that would be seen as too revolutionary.

I wouldn't want my work to be hamstrung by the 'consensus police', especially as I think the consensus is dangerously wrong on many fronts. In fact to me, the stronger the consensus, the closer I think we are to a discontinuity that will rewrite the rules. Consensus is about the past, not the future - it is reactive, not proactive.

In academia, it also places strong artificial divisions between academic fields, so that interdisciplinary big-picture work is undervalued. This is why I am now a blogger rather than an academic.

Anonymous said...

Not to push religion, but I think this passage from Isaiah describes where we are at:

Isaiah 28
15 Ye have said, We have made a covenant with death, and with hell are we at agreement; when the overflowing scourge shall pass through, it shall not come unto us: for we have made lies our brefuge, and under falsehood have we hid ourselves:
18 Your covenant with death shall be disannulled, and your agreement with hell shall not stand; when the overflowing scourge shall pass through, then ye shall be trodden down by it.
19 From the time that it goeth forth it shall take you: for morning by morning shall it pass over, by day and by night: and it shall be a vexation only to understand the report.

The water rises, you think you are on high ground, but find out you are not and your deal with the devil is washed away.

Anonymous said...

I think Molly Ivins penned the updated name for the Hooverville in honor of the man currently presiding: The Shruburb

Anonymous said...


"Some, in contrast, will find tremendous opportunity in the coming upheaval, and will manage to exploit the misery of others very successfully and with utter ruthlessness. I doubt if many of these people will turn out to be those who are currently rich though. The necessary mindset and skill set for the accumulation of riches under the coming circumstances are quite different from those that have prevailed in recent decades."

Well, I don't know how conservative our recent hedge fund billionaires are with their 100 to one leverages. Most of them will lose most of their ill "earned" money over the next couple of years though.

I think the super rich will hire Blackwater and their ilk as their private armies as we drift back into feudalism. Pitchforks will be no contest. Some people are naive about this.

Stoneleigh said...

El Pollo,

It's one thing to take abstract risks, and with someone else's money no less, but quite another to run personal physical risks on a daily basis. In a smaller world, far more risks will be of the up-close-and-personal variety. I doubt many hedge fund managers will have the stomach for it.

I agree that private security and private armies will be a growth industry, but there are limits to the amount of security one can purchase when the world around you is going to hell. Feudalism isn't a particularly secure arrangement, especially relative to what we're used to.

Of course wealth and privilege will always confer advantages - 'twas ever thus - but those advantages will have their limits. Asymmetric warfare can expose surprising vulnerabilities in supposedly superior forces - see The Transformation of War by Martin van Creveld for a fascinating discussion on the topic.