Friday, July 4, 2008

Debt Rattle, July 4 2008: Nothing we can say is going to change anything now

Pieter Bruegel the Elder The Tower of Babel 1563
Brueghel's painting seems to attribute the ultimate failure of the Tower to engineering difficulties rather than to sudden, divinely-caused linguistic differences. Although at first glance the tower appears to be stable series of concentric pillars, upon closer examination it is apparent that none of the layers lie at a true horizontal; rather, the tower is built as an ascending spiral. However, the workers in the painting have built the arches perpendicular to the slanted ground, thereby making them unstable, and a few arches can already be seen crumbling. More troubling perhaps is the fact that the foundation and bottom layers of the tower had not been completed before the higher layers were constructed.
The painting was meant to demonstrate the dangers of human pride and perhaps the failure of Classical rationality in the face of the divine. Also, it is an allegory to the Habsburgs' proud international Empire, based on a unified creed, with bankers, ministers, churchmen and military men, and sycophant humanist thinkers tamed to such project. Wiki

Independence Day

Well papa go to bed now it's getting late;
Nothing we can say is gonna change anything now
I'll be leaving in the morning from St. Mary's Gate
We wouldn't change this thing even if we could somehow
Cause the darkness of this house has got the best of us
There's a darkness in this town that's got us too
But they can't touch me now And you can't touch me now
They ain't gonna do to me What I watched them do to you

Now the rooms are all empty down at Frankie's joint;
And the highway she's deserted clear down to Breaker's Point
There's a lot of people leaving town now, leaving their friends, their homes
At night they walk that dark and dusty highway all alone

So say goodbye it's Independence Day
Papa now I know the things you wanted that you could not say
But won't you just say goodbye it's Independence Day
I swear I never meant to take those things away
Bruce Springsteen

Ilargi: 4 million UK households that can’t pay their mortgages without loans and plastic, that is a stark number, and one that should wake up people to what is happening in the British Isles. But not, apparently, the Chancellor of the Exchequer, who has this to say:
"The UK economy is fundamentally far, far better than it ever was in the past."
That points to a stratospheric level of disconnect and cynicism, and to the kind of blunt lying that makes noses grow, and which is increasingly hard to tolerate. Britain is fast falling apart, into tiny hurting broken pieces, and the people charged with solving problems instead make them worse, by continuing to live and speak in a bleak state of denial. Time for pitchforks yet?

Over 4 million British households turn to loans and credit cards to cover mortgage bills
More than four million households have resorted to personal loans or credit cards to cover mortgage or rent payments in the past year. The financial comparison site said that many more homeowners could be sucked into a spiral of servicing long-term debt with expensive short-term borrowing when about £30 billion of mortgage deals come to an end this month.

It pointed out that homeowners who take a personal loan to repay a mortgage, but lie about the reason, risk being charged with fraud. Tim Moss, head of loans at, said that the findings of a survey by the site were shocking. “Having a roof over your head has to be your top priority but funding that with a loan you might default on or a credit card that will eventually charge you interest of over 15 per cent isn't the solution.”

James Gordon, retail director at Ernst & Young, the accountants, said family finances were under enormous strain as the rising cost of living squeezes their budgets to breaking point. “The consumer economy is undoubtedly on a knife-edge,” he said. This week the Bank of England revealed that credit card borrowing staged its sharpest rise in May for almost two and a half years. A survey by E&Y found that households were 15per cent worse off than they were five years ago.

Homeowners are spending 78 per cent more on mortgage repayments, paying an average of £735 a month. Energy bills have jumped 100 per cent, petrol is up 29 per cent and council tax 25 per cent. The squeeze on households was underlined by the Bank of England's latest report on credit conditions. It showed that home loan payment defaults were rising faster than banks and building societies had expected.

More evidence also emerged that the credit crunch is continuing to hit the real economy with an influential survey showing that the dominant services sector shrank last month at its fastest pace in seven years. Overall services activity tumbled during June at a rate not seen since the aftermath of the September 11, 2001, attacks on the US, according to the latest CIPS purchasing managers' survey of the sector.

The news followed the CIPS manufacturing and construction surveys this week, which showed those sectors contracting. It was the first time that all three industries have shrunk simultaneously in any month since November 2001. The Chancellor insisted yesterday that the economy would not slip into a recession, despite mounting evidence that the outlook is worsening.

Alistair Darling said: “The UK economy is fundamentally far, far better than it ever was in the past. “We're going through a very difficult time at the moment, along with every other country in the world. I believe that our economy will continue to grow ... although the rate of growth will be slower.”

Ilargi: In case it’s hard for you to understand what exactly is going on, and how bad it all is, try this:

The European banks Goldman tracks have lost $900 billion of their market value since the credit crisis began last year

Global financial stocks have led declines that wiped about $11 trillion from equity markets worldwide this year.

European Banks Need $141 Billion, Goldman Says
European banks may need to raise as much as 90 billion euros ($141 billion) to restore their capital after the U.S. subprime mortgage collapse caused credit markets to seize up, according to Goldman Sachs Group Inc. European banks have already raised $115 billion from investors to replenish capital after reporting $134 billion in writedowns, Goldman analysts led by Christoffer Malmer said in a note to clients today.

They may now seek more than 60 billion euros to increase their Tier 1 capital, a measure of financial strength, to about 9 percent, the analysts said. They could need to raise as much as 90 billion euros were credit losses to rise to levels last seen in the recession of the early 1990s. "Regulatory pressures and a sharp turn in the European credit cycle are the two main causes for concern,'' the London- based Goldman analysts wrote in their note.

The European banks Goldman tracks have lost $900 billion of their market value since the credit crisis began last year. Anshu Jain, head of global markets at Deutsche Bank AG, said this week that that contagion is "by no means over,'' and Europe's banks have lagged behind the U.S. in raising money from investors.

The Goldman analysts cut their recommendations on Carnegie & Co. and Swedbank AB of Sweden to "sell'' from "neutral.'' Banco Santander SA, Spain's largest bank, was downgraded to "neutral'' from "buy.'' Goldman's analysts said in their report that "access to liquidity, capital adequacy and post-crisis profitability are the key areas of near to medium-term uncertainty'' for European banks.

Global financial stocks have led declines that wiped about $11 trillion from equity markets worldwide this year. Credit- related losses, surging oil prices and rising inflation have also stoked concern policy makers will have to raise borrowing costs as the global economy slows. Separately, Credit Suisse Group AG had its price estimate cut by Citigroup Inc. earlier today, which also reduced its expectations for earnings-per-share at Switzerland's second- largest bank.

European Stocks Fall, Led by Banks
European stocks fell, heading for a fifth weekly decline, on concern banks will post more writedowns and near-record oil prices will curb earnings at airlines. Most Asian stocks dropped.

Banco Santander SA led financial firms lower after Goldman Sachs Group Inc. downgraded the shares and said European banks may need to raise as much as $141 billion. Bradford & Bingley Plc tumbled to the lowest since 2000 after TPG Inc. dropped plans to buy a stake in the mortgage lender. British Airways Plc slumped as crude traded above $144 a barrel.

Europe's Dow Jones Stoxx 600 Index slipped 1.1 percent to 280.01 at 1:45 p.m. in London, extending this week's retreat to 2.6 percent. The fifth straight weekly drop is the longest losing streak since a seven-week slump ending Jan. 25. "We're remaining cautious on banks for the moment," said Alain Bokobza, a Paris-based strategist at Societe Generale SA, which has about $660 billion under management. "What's putting the brakes on the stock market is the high oil price."

The MSCI Asia Pacific Index was little changed today as the index completed a four-week, 12 percent slide, the longest losing streak since the period ended Feb. 8. Nine stocks fell for every eight that rose. U.S. markets were closed today for Independence Day. Futures on the Standard & Poor's 500 Index fell 0.4 percent.

Stocks slumped worldwide this week, sending the MSCI World Index to its fifth weekly drop, its longest retreat since August 2007. More than $11 trillion has been erased from global equity markets this year as concern deepened that credit-related losses topping $400 billion, record oil prices and accelerating inflation will stifle economic and profit growth.

Earnings for Stoxx 600 companies will fall 2 percent this year, according to data compiled by Bloomberg. That's down from 11 percent growth predicted at the start of 2008. National benchmark indexes fell in 15 of the 18 western European markets that were open. Germany's DAX lost 0.9 percent, as Deutsche Lufthansa AG and Continental AG declined.

The U.K.'s FTSE 100 slid 1 percent as Marks & Spencer Group Plc fell for a seventh day. France's CAC 40 slipped 1.3 percent. Banco Santander, Spain's biggest bank, lost 3.8 percent to 11.40 euros, after Goldman downgraded the shares to "neutral" from "buy."

European banks may need to raise as much as 90 billion euros ($141 billion) to keep their financial ratios at current levels amid a decline in credit markets, Goldman said. Swedbank AB, the largest bank in the Baltic states, dropped 4.4 percent to 113.25 kronor. Goldman lowered its recommendation for the shares to "sell" from "neutral."

Bradford & Bingley fell 11 percent to 54.25 pence, the lowest since its initial public offering in December 2000, after TPG withdrew a 179 million-pound ($354 million) offer for a 23 percent stake in the Bingley, England-based lender. Britain's largest lender to landlords will continue with the capital-raising announced June 2 through an enlarged rights offer, the bank said. The rights offer is supported by some of the largest shareholders, including Legal & General Group Plc, Standard Life Plc., M&G Investment Managers and Insight Investment Management.

British Airways, Europe's third-largest airline, dropped 5 percent to 198.5 pence. Air France-KLM Group SA, Europe's biggest airline, declined 1.3 percent to 14.22 euros. Lufthansa, the region's second-biggest airline, retreated 1.3 percent to 13.51 euros. Continental, Europe's second-largest tiremaker, fell 4.6 percent to 59.90 euros.

Ilargi: Hello, anyone there? Anyone been paying attention?

Freddie Mac lost 25% of its value IN ONE WEEK!!!

All the while it keeps on buying up loans left right and center. Why do you think investors dump the stock of a company that is government chartered?

Freddie Mac Unlikely to Raise Capital Until August
Freddie Mac, the second-largest U.S. mortgage-finance company, said it's "unlikely" to raise capital until after reporting second-quarter earnings next month. Executives, to combat loan delinquencies, told investors in May that the McLean, Virginia-based company would secure $5.5 billion in additional reserves by "mid-year," after registering its common stock with the Securities and Exchange Commission.

"We still feel the SEC process is going well and we believe we will make our mid-summer time frame," Sharon McHale, a spokeswoman, said today in a telephone interview. "Given how close we are to releasing our earnings, it's unlikely we would do the capital raise prior to the release of our 2Q earnings."

Freddie Mac has tumbled 25 percent in New York trading since the company disclosed June 25 that it expanded its portfolio to the highest level while the quality of existing investments deteriorated. Freddie Mac's $770.4 billion in mortgage holdings, which grew at a 53 percent annual pace that month, surpassed rival Fannie Mae for the second month in a row.

"We are becoming increasingly concerned about a series of risks at Freddie Mac," Moshe Orenbuch, an analyst at Credit Suisse Group in New York, wrote in a June 26 research note. The $6 billion of preferred stock that Freddie Mac raised in November hasn't been enough to buffer losses as mortgage delinquencies climb.

The company, which owns or guarantees more than 20 percent of the $12 trillion in U.S. home loans outstanding, is expected to report its fourth straight quarterly loss next month, according to analysts surveyed by Bloomberg. Freddie Mac dropped $1.42, or 8.9 percent, to $14.50, a 13- year low, in a shortened session of New York Stock Exchange composite trading. Freddie Mac has lost 77 percent of its market value in the past year. Fannie Mae dropped 65 cents to $18.78.

Washington-based Fannie Mae, which sold $7 billion of preferred stock in December, raised at least $6.5 billion more since reporting a $2.19 billion first quarter net loss and cutting its dividend for a second time in a six-month period. Freddie Mac since 1970 has been exempt from registering its common stock and debt securities with the SEC because of its government-chartered status.

The company, under pressure from lawmakers, agreed in 2002 to register its stock, a plan that stalled when Freddie Mac's auditor uncovered $5 billion in accounting errors and forced an overhaul of internal controls. Freddie Mac said in May it was "moving ahead" with plans to register and had begun the process in March. The Wall Street Journal reported earlier today that investors were concerned about the timing of Freddie Mac's plans.

Congress created Fannie Mae and Freddie Mac to promote home ownership by increasing financing and providing market stability. The companies own or guarantee almost half the U.S. residential mortgage debt outstanding. They profit by holding assets that yield more than their debt costs and from fees charged to guarantee bonds they create.

The companies have reported three straight losses totaling $7.1 billion at Fannie Mae and $4.6 billion at Freddie Mac amid the worst housing market since the Great Depression. Freddie Mac now owes more on its liabilities than its holdings are worth as its fair value of assets dropped to negative $5.2 billion in the first quarter. Fannie Mae's fell 66 percent to $12.2 billion.

Bear Stearns Assets Accepted By Fed Lose $1 Billion in Value
Assets the Federal Reserve agreed to accept in March from Bear Stearns Cos. to facilitate its sale to J.P. Morgan Chase are now worth about $1 billion less than estimated at the time of the transaction.

The decline, to $28.9 billion from $30 billion in mid-March, is not yet enough to put U.S. taxpayers on the hook for any losses; J.P. Morgan, under an agreement with the Fed, would take the first hit once the assets are sold. In addition, the assets are expected to be sold over the coming decade in a way that's designed to minimize losses and market disruption.

Late last month, the Fed contributed $28.8 billion to a newly created firm, Maiden Lane LLC, to finance the assets and provide a loan. J.P. Morgan supplied $1.15 billion, which would cover the first losses from any decline in the assets' value. Maiden Lane is a street running alongside the New York Fed's headquarters.

The Fed agreed to extend the loan in March with Bear Stearns on the brink of bankruptcy. Central bank officials feared that the sudden downfall of the nation's fifth-largest investment bank would wreak havoc on broader financial markets and the economy.

The Bear Stearns portfolio at the time largely contained mortgage-related assets, which are riskier than other investments, but did not include subprime mortgage debt. It was originally valued in part by Bear Stearns, while the recent valuation was conducted by the Fed and its adviser, BlackRock Inc. The Fed plans to release an updated value of the portfolio quarterly.

Lawmakers have appeared uncomfortable with the transaction. "What it looks like ... is that we've socialized risk and we've privatized reward," Sen. Christopher Dodd (D., Conn.), chairman of the Senate Banking Committee, said at an April hearing while acknowledging that the Fed had little time to carry out the deal. "We're on the hook. Hopefully it doesn't happen, but we're on the hook."

Fed Chairman Ben Bernanke has said that BlackRock is "reasonably confident that we will be able to recover the full amount if we dispose of these assets on a measured basis, rather than to sell them all at once." The Fed may even turn a profit, he said. The agreement to lend to Bear Stearns was followed by an extraordinary new program to lend directly to investment banks. Securities firms have been using the opportunity for months, but borrowing related to the Bear Stearns portfolio appears to have been a part of that use.

Direct borrowing by investment banks under that primary dealer credit facility dropped to an average of $1.74 billion a day in the week ending Wednesday, down from $6.1 billion in the prior week. Total borrowing outstanding as of Wednesday had dropped to zero. Borrowing by commercial banks averaged $14.86 billion a day during the week under the Fed's primary credit program, up slightly from $14.7 billion a day in the prior week.

World Bank chief urges G8 to act now as "world entering danger zone"
World Bank President Robert B. Zoellick has called on leaders of the G8 as well as the major oil producers to act now to deal with surging food and energy prices, warning that the world is now "entering a danger zone." Zoellick's call is contained in a July 1 letter to the head of the upcoming G8 summit in Japan, in which the Bank, World Food Program (WFP) and International Monetary Fund estimate that about 10 billion dollars is needed to meet short term needs of people hit hardest by the crisis.

"What we are witnessing is not a natural disaster -- a silent tsunami or a perfect storm: It is a man-made catastrophe, and as such must be fixed by people," Zoellick said in the letter made available to Xinhua on Wednesday. "I urge the Group of Eight countries, in concert with major oil producers, to act now to address this crisis. This is a test of the global system to help the most vulnerable, and it cannot afford to fail," said the World Bank chief.

He said the G8 made a commitment at the Gleneagles Summit in 2005 to boost overall development aid, to Africa in particular, by2010, noting such aid was needed now, more than ever, as Africa accounted for two thirds of the countries most under stress by the food and fuel crisis.

"For 41 countries, the combined impact of high food, fuel and other commodity prices since January 2007 represents a negative shock to GDP of between 3 and 10 percent," he said. "These numbers translate into broken lives, and stunted potential. For the most vulnerable, especially poor children, they mean malnutrition, reduced resistance to disease, and too often death."

"Record oil prices and high and rising food costs threaten a growing number of countries with rising poverty and social instability. Already we have seen food riots in over 30 countries, and unrest over high fuel prices is spreading. The urban poor are especially affected by the double hit of food and fuel," he warned. In his letter, Zoellick urged the G8 to consider two new measures to "improve the world's ability to cope with an on-going food crisis."

The first was a UN assessment on guaranteeing a portion of funding for the World Food Program. The second was to study the merits of an internationally coordinated "virtual" humanitarian strategic reserve system for food emergencies. "The international community is facing an unprecedented test in this new era of globalization: the question is whether we can act swiftly to help those most in need, "he said.

"For globalization to work successfully and achieve its promise, it must be inclusive and sustainable. This means acting now in the interests of the poor who are most affected by this double jeopardy of food and fuel crisis, and who are least able to help themselves," he added.

Britain is edging closer to recession, economists warn
Britain is edging closer to recession, economists warned yesterday, after two bleak reports showed that activity in the country's vital services sector has slumped to its lowest level since 2001 and the credit squeeze on businesses is worsening.
In the stock market the FTSE 100 fell 67.8 points to 5,358.5 in early trading - a fall of 20pc since last June and into bear market territory - before recovering to close up 50.3 at 5476.6. Stock market historian David Schwarz said: "History tells us that long bull markets in the UK are virtually always followed by bear markets where shares fall by at least 25pc."

Lehman Brothers joined those predicting an economic slump. Peter Newland, the bank's economist, said recession this year is "more likely than not" due to the "broad-based contraction in activity". His comments were echoed by Capital Economics, which declared that "the economy has ground to a halt [and] seems to be heading for recession".

Fears were stoked by the lowest level of UK services activity since the 9/11 terrorist attacks, according to the Chartered Institute of Purchasing & Supply (CIPS). Its index of sales and business conditions, based on responses from 700 companies, fell to 47.1 in June, down from 49.8 in May. A reading below 50 shows contraction.

Adding to fears was the Bank of England's credit conditions survey, which provided clear evidence that the credit crisis is far from over. It found that banks reined in business lending over the past three months and expect to do so again in the coming quarter. Economists are concerned that further credit tightening will force companies to cut jobs and investment.

Despite the deepening gloom, high oil and commodity prices are stopping the Bank taking its natural remedial action of cutting interest rates. Howard Archer, chief UK economist at Global Insight, said: "Weak service sector activity yet still rising price pressures encapsulates the extremely difficult position the Bank is in."

Even so, Lehman's Mr Newland forecasts interest rates ending next year at 3.5pc, having revised his position from 4pc and against the current 5pc base rate. The Bank is still expected to leave rates on hold next week, according to a poll of 72 economists. The CIPS service sector survey is a closely watched guide to output growth and follows even weaker CIPS reports earlier this week on the manufacturing and construction sectors.

The survey indicated that both orders and employment are falling in the services sector, which stretches from airlines to banks and is the bedrock of Britain's economy, increasing the pressure on the Bank to cut rates. The Bank's own credit conditions survey also made for bleak reading, predicting "increases in defaults on secured and unsecured household lending and lending to corporates", adding that the anticipated jump in bad debts means banks plan a "reduction in corporate credit availability... over the next three months".

Credit crunch: short and sharp is better than long and drawn-out
The credit squeeze is painful and will get worse. There's barely a crumb of comfort to be had from the Bank of England's latest credit conditions report. Debt is being increasingly rationed, it is costing more and banks are demanding greater concessions from anyone with the temerity to request a loan. Meanwhile, defaults and loan losses are rising and going to rise farther.

Individuals and businesses have grown accustomed to debt being plentiful, keenly priced and liberally supplied with few strings attached over the past decade. The adjustment to this new world is difficult. Some 27,000 families a week are coming to the end of benign mortgage deals and discovering that the cuddly lender of two years ago has turned into a stern puritan who wants a great deal more interest - if he's prepared to extend a loan at all.

The measures put in place by the Bank of England in April do not seem to have had much effect in getting banks to keep the lending spigot switched on, but nor were they meant to. The £50 billion Special Liquidity Scheme - where take-up is thought to have been steady rather that spectacular - was meant only to restore confidence to the banking system and relieve strain in the wholesale money markets.

When ministers tried to suggest that the lifeline would help to bring back the days of plentiful cut-price mortgages, Mervyn King, the Bank Governor, was quick to contradict them. It would be “a serious mistake” to go back to those lax conditions, he said. This was an adjustment that needed to take place. He is right. Loans need to be a bit harder to come by and a bit more expensive to help to iron out the economic imbalances built up over a decade and more.

Saving needs to be better rewarded and spending cut back - putting mortgage payments on the credit card will only postpone the pain, and probably make it worse. House prices - whisper it quietly - do need to come down. And growth needs to slow to help to keep the lid on inflation. The danger, however, is that the pendulum swings too far. Since the credit crunch hit last August, the real economy had until recently seemed to react in slow motion.

Given the earthquake in credit markets, the surprise was how resilient consumer spending remained and how cheerful business leaders outside the City continued to be. But in the past few weeks there has been a marked speeding up in the souring of confidence among consumers and businesses. The shock profit warning this week from Marks & Spencer, the best thermometer for measuring the economic temperature in Middle England, perhaps marked the moment when it became apparent how abruptly the economy is coming to a standstill.

The slowdown in the services sector has also been very sudden, figures showed yesterday. It's going to be unpleasant, but there may be some advantages to a very abrupt slowdown, as distinct from a gentler but more prolonged decline. First, it may be enough to prevent base rates being raised here - something the eurozone nations, where rates were lifted by a quarter-point yesterday, have not been able to avoid in the face of rising inflation.

Secondly, the faster the deterioration, the sooner the bottom is reached and markets can find a new equilibrium. Until house prices find a floor, the credit system and the wider economy will continue to flounder. It may just be better to get there sooner rather than later.

Banks bail out Bradford & Bingley after TPG walks away
Texas Pacific Group has walked away from a deal to inject cash into Bradford & Bingley, forcing the stricken bank to fall back on investors for an emergency cash injection. TPG decided just before 10pm yesterday evening to abandon its deal to buy 23pc of B&B for £179m after learning that the ratings agency Moody's was about to downgrade the bank for the second time in five weeks.

Under the terms of its contract, TPG was allowed to terminate the deal if B&B's credit rating fell by two notches. Its decision to walk away was revealed by Robert Peston's blog on the BBC website last night. In an extraordinary turn of events, B&B will now receive a capital injection of about £400m from four large investors - Standard Life, Legal & General, Prudential and Insight, part of HBOS.
B&B said today that details of the enlarged rights issue will be released in due course. The same four had backed a plan by entrepreneur Clive Cowdery to inject £400m, but B&B's board rejected the proposal. Mr Cowdery walked away last Friday.

In the past few days, it has become clear to B&B and those close to the bank that Moody's was going to downgrade B&B. Moody's had already cut B&B's rating on June 3, citing its rising arrears and uncertain outlook. As it became clear late yesterday afternoon that the second downgrade was coming, the City regulator, the Financial Services Authority, asked TPG to make its intentions clear.

TPG's investment committee convened an emergency meeting and the decision went right up to the US firm's head, David Bonderman. The firm decided that the investment, at 55p a share, was too expensive.
The FSA put TPG under pressure for a definite answer because it wanted to be able to present a stable solution to the stock market this morning.

Sources close to the regulator believe its biggest fear at the moment is a repeat of the Northern Rock crisis, which led to hundreds of customers queuing around the block. Northern Rock was nationalised in February.

The FSA is angry with TPG's decision to walk away. B&B's shares are expected to fall significantly this morning. Close to midnight the bank issued a statement saying: "The Board has been informed by Moody's of its decision to downgrade inter alia the Group's senior unsecured and long-term debt ratings from A3 to Baa1 and to maintain the short-term rating at P2.

In light of this downgrade, TPG has informed the group that it intends to enforce its right to terminate the Subscription Agreement entered into on 2 June 2008 with respect to its £179m investment." B&B's chairman Rod Kent is expected to be forced to resign by B&B's shareholders, who have been furious with the way the bank has handled its search for new capital.

An extraordinary general meeting planned for Monday to vote on the TPG deal and a rights issue to raise £258m will be scrapped. The four new backers will also put their cash in at 55p a share. The bank will rush through the new capital raising as quickly as possible. Mr Kent said last night: "Bradford & Bingley continues to be well-funded and the capital raising will reinforce our position as one of the better capitalised banks and one of the leading mortgage and savings banks in the UK."

Deutsche Bank’s Jain: Crisis is Solvency, Not Liquidity
Anshu Jain, head of global markets at Deutsche Bank AG, said in remarks Thursday that most financial institutions are now facing a solvency issue around housing — a surprising assessment, to say the least, and one that underscores just how damaging the continued freefall in U.S. housing is likely to be for financial outfits that invested heavily in the area during the recent run-up.

Of course, that banks are now facing a so-called solvency challenge isn’t really the surprising part — HW wrote about the issue after the Bear Stearns bailout back in early March; what’s surprising is that Jain would publicly remark on the matter, sources told HW Thursday morning.

Jain was among the first major Wall Street executives to call the subprime slump in mid 2006, and usually tries to stay out of the limelight; sources suggested that he usually attempts to avoid sounding too extreme, as well, a viewpoint buttressed by a 2007 story at the Financial Times that said Jain was “keen to avoid sounding alarmist about market woes.”

All of which makes his alarming take on the state of the capital markets worth noting. Bloomberg News reported Thursday morning on his remarks at a Euromoney conference in London, in which the Deutsche Bank exec said that the crisis was one of the “three biggest crises faced by the insurance industry” and that “it’s by no means over.”

Jain reportedly declined to predict when all of the current mess will be over, an increasingly common trend among market participants; it’s clear at this point that even the market experts aren’t sure what’s going to be coming next, only that something will be coming. At least one common thread throughout this mess continues to be that until housing recovers, neither will banking and finance — a sentiment Jain echoed Thursday as well.

“Banks continue to need and raise equity capital, and the proportion of equity capital which is required is directly driven by the further drop in assets they own,” Jain was quoted as saying. “One of the assets which continues to be in free fall is U.S. house prices.”

Ilargi: How convenient, the Swiss government hands out tax credits when they’re most needed. Certainly in a country the size of Switzerland, that’s real money. If they make the same credit available to other banks, it might add up to something.

UBS avoids losses through $3 billion tax credit
UBS, the Swiss bank battered by the mortgage crisis, today insisted it would not need to raise more funds through a rights issue after being saved from announcing further losses by clawing in SwFr3 billion (£1.5 billion) from a tax credit.

The bank, which has already raised $16 billion through a rights issue, said the tax credit would offset further investment banking losses meaning that, at worst, it would post a small loss in the second quarter compared to analysts' expectations of a SwFr5 billion loss. UBS said: “The results reflect positive contributions from global wealth management and business banking and from global asset management, offset by a loss in the investment bank. “In connection with the losses to date, the second quarter results include a tax credit of approximately SwFr3 billion."

However, it said that further market deterioration led to write downs and losses on previously disclosed investment bank risk positions, in particular in its monoline insurance exposures. Monoline insurers underwrite one type of debt, bonds, against default. The bank also said that net new money for the period was also negative after private clients withdrew cash from the bank's wealth management arm.

It said its Tier 1 capital ratio, which is a closely watched measure of balance sheet strength, would be approximately 11.5 per cent at the end of the first quarter. With write downs of $37 billion, UBS has been Europe’s hardest hit bank of the subprime crisis so far.

Fed Ponders Private Equity In Banks
The U.S. Federal Reserve has already taken several unprecedented steps to assist investment banks, including allowing them to access its short-term lending facilities, collateralize their borrowings with illiquid securities of questionable market value, and brokering and funding the sale of Bear Stearns to JPMorgan Chase.

Now the Fed is believed to be considering easing rules to allow private equity firms to take substantial holdings in bank shares, as banks are finding themselves increasingly unable to attract traditional sources of capital.
  • Ordinary investors have little appetite for investing in bank shares. Banks with the greatest need for capital are therefore unlikely to seek additional funding via a public share offering, especially as nearly all bank shares issued in the last year are currently trading below their offering price.
  • --Sovereign wealth funds have made significant investments in bank shares, and these trends can be expected to continue. However, the appetite of these entities for bank investments is limited, particularly in the weakening investment climate and the conditions that some in Congress seek to impose.
  • -Other than JPMorgan's emergency acquisition of Bear Stearns, strong banks have been unwilling to burden their balance sheets by acquiring weaker banks or their subsidiaries.
    Given these constraints, the Fed is considering easing rules that limit the ability of private investors to take significant investments in banks without subjecting themselves to federal regulatory scrutiny. However, any move to allow private equity funds to increase their bank investments will carry major regulatory implications, forcing an uneasy marriage between lightly regulated private equity firms and the highly regulated banking sector.
  • Transparency. One major driver of the credit crisis has been a lack of transparency, with investors unable to value and weigh the merits of respective investments. Private equity firms are typically very secretive about their investments. Increasing the involvement of private equity firms in banking operations could exacerbate market transparency concerns.
  • Market manipulation. Additionally, securities regulators are understood to be investigating an alleged upsurge in insider trading and other forms of market manipulation. Ample anecdotal evidence suggests that some hedge funds may be taking large short positions in banking shares and then spreading rumors to drive share prices down. Increasing reliance on capital sources accustomed to light regulatory scrutiny could further market innuendo that makes such manipulation possible.

Yet given the magnitude of the credit crisis and the more general concerns over U.S. investment prospects, the Fed is not in a strong position to impose stringent conditions for receipt of investments from such sources. Indeed, expectations of weak second-quarter bank earnings may force the Fed to accelerate its plans.

The Wheels Are Coming Off
U.S. Treasury Secretary Hank Paulson has a certain blunt style of speech, both in carefully-chosen words and a Soprano-like delivery, as exemplified by his speech at Chatham House in London yesterday. This mode was clearly amplified by the fact that he had no real good news, at least concerning anything on the foreseeable horizon, and even the sweeping reforms in the U.S. regulatory system he proposed won't translate into law any time soon.

So, as he was speaking of merely "limiting the impact of market stresses" by, for example, under the best of circumstances, "allowing major financial institutions to fail," even a pale improvement in the day's Dow performance turned sharply south, heading toward that seemingly-mythical "bottom" that may still be nowhere in sight. Paulson's candor could be called refreshing, if hardly encouraging. Those listening carefully to his remarks found them veritably dripping with pessimism and nowhere indicating either a silver lining or reference to a turnaround.

So much for the second-half rebound that pundits were promising when the market first started to dive earlier this year.
The fact is that a "perfect storm" is taking shape, identified by Paulson as the triple threat of housing, energy and credit crises all deepening simultaneously. It's the environment that's making the arguments of Michael J. Panzner's impending "financial Armageddon" forecast (as outlined in his book by that name) seem more and more credible.

The fact is that for the last few years, the feisty and prophetic Falls Church News-Press, my paper circulating its 35,000 or so copies weekly inside the Washington, D.C., beltway and getting even more attention, globally, on its web site, has been alone among general interest newspapers anywhere to provide routine coverage on the emerging energy crisis, in the form of Tom Whipple's weekly column on "Peak Oil."

The fact is also that everything Whipple began describing in his weekly columns in April 2005 is proving true in spades. Even while Brookings Institution and other so-called experts categorically dismissed the notion of "peak oil," the proposition that as extraction capacity for oil passes its peak, prices rise and scarcity ensues, it is far more widely acknowledged today. The consequences of "peak oil," of course, loom far more ominous than what can be described in terms of a mere "business cycle."

The planet is running out of oil, plain and simple, and even tapping new offshore or Alaskan fields would only temporarily postpone that reality. Given the lack of cyclical references in Paulson's speech yesterday, it is plausible to assume that he recognizes this fact, even if not explicitly acknowledging it publicly. So, the entire foundation of the U.S. economy in the post-World War II period, of unimpeded consumption, rooted in oil, is now beginning to crack.

It started with President Eisenhower's substitution of a national interstate highway system for rail as the nation's primary transportation mode in the 1950s. Anyone who profited from the subsequent orgy in oil consumption, from oil producing nations and multinationals to car manufacturers and suburban development magnates, joined in promoting boundless American consumerism, its cornerstone being longer and longer commutes to further and further-distanced suburbs, in bigger and bigger cars, with larger and larger credit card spending limits.

There can be little doubt that the three-headed hydra of economic distress now threatening to devour the nation is all connected to the overextension of this one post-war process, exacerbated by greater global competition for depleting resources. It's like somebody forgot to pay the electric bill at the biggest shopping mall in America. All of a sudden, it's lights out. It may take awhile, but the outcome is inevitable.

Lighting candles in the individual retail outlets at this mall will not replicate the conditions before the blackout. That's most likely what the U.S. economy now faces. Moreover, the rest of the planet is not immune from the same fate, as even emerging economies depend on exports that become prohibitive as the price of fuel continues to rise.

ABCP group expected to move quickly
Investors stuck with frozen asset-backed commercial paper could begin to see their holdings thawed not long after an appeal court ruling that's expected in a matter of days.

The committee overseeing the $32-billion restructuring of the frozen paper is planning to move quickly to close the deal should the Ontario Court of Appeal dismiss a challenge to the fairness of the proposal, rather than wait for any further appeals to run their course, said two people familiar with the strategy.

Lawyers expect the appeal court will decide on the challenge by a group of corporations by the middle of next week.
The committee doesn't want to wait on a possible appeal to the Supreme Court of Canada by the challengers, the people said. That would force the challengers, who include companies ranging from small miner Redcorp Ventures Ltd. to airport manager Aéroports de Montreal Inc., to try to stop the closing of the deal with an injunction.

The plan as it stands calls for swapping the seized-up paper, which investors have been saddled with since last August, for new notes that should trade freely, albeit at a discount to their face value. However, the challengers are upset because the plan grants a measure of legal immunity to players in the ABCP business, which the appellants say is unfair and unlawful.

After a lower court approved the plan in early June, the committee held off on closing the transaction because of the pending appeal. However, with the courtroom drama dragging on, the strategy now is to try to get the swap done without further delay. That would be a relief for investors who bought the paper last year, thinking it was a short-term place to park cash, only to find themselves mired in a restructuring that has locked up their money for 11 months.

“The idea is to move to hit the switch and start paying,” said one person familiar with the situation. The legal strategy is based on the view that an appeal by the corporate challengers to the Supreme Court would be a long shot if the plan is upheld at both the lower and appeals court levels. Much will depend on the wording of the appeal court's ruling, no matter which way it goes. If it's a split decision by the three-judge panel, that would likely open the door to a Supreme Court bid.

“There are still enough challengers that I think if their appeal is thrown out by the Court of Appeal, I think some of them will still try to get leave to appeal to go to the Supreme Court,” said Colin Kilgour, a consultant who has advised many corporations on their ABCP holdings.

BCE, Ontario Teachers' Reach Final Agreement on $51 Billion Sale
BCE Inc., Canada's biggest phone company, said it signed a final agreement with a group led by the Ontario Teachers' Pension Plan to complete the world's largest leveraged buyout. The stock had its biggest gain in more than six years.

The C$52 billion ($51 billion) purchase of BCE, first announced a year ago, will be done by Dec. 11 at the original price of C$42.75 a share, the Montreal-based company said in a statement today. BCE shares traded as much as 25 percent below the offer price last month on concern that banks funding the purchase, including Citigroup Inc. and Deutsche Bank AG, may back out or reduce the price as financing costs rise and the U.S. economy slows.

"The signing of the financing and credit agreements and the resolution of issues involved in funding this transaction are the essential milestones to closing," BCE Chief Executive Officer Michael Sabia said in the statement. BCE rose C$4.15, or 12 percent, to C$39.30 in 10:11 a.m. trading on the Toronto Stock Exchange, after touching C$39.75. More than 4 million shares traded in the first seven minutes after a trading halt was lifted.

The Supreme Court of Canada on June 20 approved the takeover, reversing a lower court ruling that said the deal didn't treat bondholders fairly. BCE said after the Supreme Court victory that it expected the purchase to close by Sept. 30. The buyout group and the lenders have agreed to finance the takeover, according to the statement today.

The break fee payable by the buyout group if the deal isn't completed was raised to C$1.2 billion. The telephone company won't pay dividends on its common shares until the sale is done. BCE rose as high as C$41.74 in July 2007 after the company agreed to the takeover by Teachers' and its U.S. partners, which include Providence Equity Partners Inc. and Madison Dearborn Partners LLC.

Gulf’s SWF funds turn to investing in Asia instead of US, EU
As politically motivated restrictions on investments by oil-rich countries intensify in the West, the sovereign wealth funds (SWFs) of the Gulf countries could opt to invest in Asia and other emerging markets despite attractive valuations in the slowing US and European markets.

The United Arab Emirates and a few other countries sought at this year's World Economic Forum in Davos in January to allay Western fears by stressing that the funds were strictly commercial and not political threats. Sultan Ahmad bin Sulayem, chairman of the Dubai World holding company, warned that Gulf funds could stop investing in developed markets if their motives were continuously questioned. "There is the policy of these government fund managers to go where they are welcome. If [rich nations] say 'we don't want your money', fine. We will invest in China and India. They all want investment."

Dubai International Financial Center (DIFC) governor Omar bin Sulaiman voiced a similar opinion in November. "If you need foreign direct investment, you need to be welcoming, not scaring investors off. Talk about the SWFs is creating a lot of sensitivity, even for private investors. They are already looking elsewhere to hedge their positions." Sulaiman added that Borse Dubai, a government unit partly owned by the DIFC, was likely to invest in an Asian exchange. "It's only logical. It's a matter of when rather than whether we will."

Reflecting this sentiment, which also indicates the economic, not political, leanings of Gulf SWFs, Dubai International Capital (DIC) purchased a "substantial" stake in Sony in November, which reports estimate to be worth between US$500 million and $1 billion. In fact, when DIC was launched in 2004, its strategy was to channel a third of its overseas investments to Asia. So far, the DIC is estimated to have invested about $2 billion in Asia.

Explaining Western governments' concerns that major shifts in international finance could involve power politics, Eckart Woertz of the Gulf Research Center in Dubai told Inter Press Service: "They are particularly worried about the possibility of the SWFs buying up Western assets, putting them at the disposal of potentially 'unfriendly' regimes."

The SWFs, some of which have existed for a long time, have attracted attention recently because they have grown bigger than the world of hedge funds and other private institutional investors. They are owned by governments of countries that have substantial current account surpluses - mainly industrializing countries in Asia and oil exporters - and are used to acquire assets abroad that have potential for better returns than shares and bonds.

Currently, more than 20 countries have these funds. Funds from the Gulf countries are estimated at $1.6 trillion, with the leader, the Abu Dhabi Investment Authority, having about $900 billion. Singapore's Temasek and the official reserves of China and Russia, which are being moved from central banks to the SWFs, are other big players. The US, in particular, feels that large amounts of its securities in the hands of those who are not necessarily allies is "financially imprudent", as a sell-off by such nations could lead to falling bond prices and rising interest rates, thus hurting its economy.

Such attitudes have encouraged South-South economic cooperation through mechanisms aimed at diversifying trade and investment. According to a report by the United Nations Conference on Trade and Development, trade volume fueled by cooperation among developing countries tripled to reach $2 trillion between 1996 and 2006. Further, partly as a result of the fallout of the September 11 attacks in the US in 2001 and partly due to the surge in Asian economies, the East is now the Gulf's market of choice.

The Gulf countries export about two-thirds of their oil to Asia, which could double during the next two decades. Half of Gulf exports go to Asia and a third of Gulf imports are from Asia. Gulf-Asia trade currently exceeds $300 billion, tripled since 2000. Amid mounting US Congressional scrutiny of foreign government funds, the US Treasury in March signed a series of agreements with the Abu Dhabi and Singapore SWFs covering investments in US markets.

These state that SWFs investment decisions should be based on commercial grounds rather than geopolitical strategies of a controlling government; second, funds should be more open about their finances and investment aims, should run strong risk management programmes and respect other governments' laws; and finally, countries receiving investment flows should not erect protectionist barriers against foreign investment and should not discriminate.

Yet, a Congressional hearing in May debated how investments by the funds of Middle Eastern countries "have raised questions about the power they may have over US national security interests", especially since some of these funds are controlled by governments that are "sometimes unfriendly, sometimes untrustworthy". Elsewhere, Germany is discussing a special law to ward off unwanted foreign buyers of strategic national companies. In 2006, German Finance Minister Peer Steinbrueck asked, "What would happen if they [SWFs] invest 10-20% of their foreign reserves instead of just 0.3%?"

Even Libya's $100 billion fund is considering buying stocks, bonds, real estate and banks in Asia and South America. "The only market which is unfortunately not a pleasant market is the United States. It's a very active market, but it is full of politics and unpleasant actions," Shokri Ghanem, chairman of Libya's National Oil Corporation said in February, according to media reports.

Reacting to Western concerns, economist Woertz said, "The politically weak and less ambitious Gulf countries have no political axe to grind. Yet, they are part of an instable region and its power politics and major foreign holdings in strategic companies raise concern." One controversial unrealized deal involved Dubai Ports World - which took over British-based Peninsular & Oriental Steam Navigation Co in 2006 but was blocked from the American segment of the deal after US politicians opposed it on security grounds.

Part of the Western worries stem from the future enormity of the funds. The SWFs, which held about $500 billion worth of assets in 1990, and manage about $2.5 trillion currently, are likely to grow annually by $1.2 trillion over the next five years, and are expected to reach about $27 trillion by 2022.

The gullible and the greedy
Every year, the world's most boring people, namely its bankers, await their version of the "Swimsuit edition", the annual report of the Bank of International Settlements or BIS. The latest version [1], produced on June 30, provides a fascinating glimpse into the thinking of the people who are often described as the central bankers to the world's central banks. Of course, I use the term "fascinating" quite loosely here.

The report was widely anticipated for two reasons; first as it represents the BIS view on the global financial crisis that unfolded over the 2007-08 period and second because the world's bankers really have nothing else to do these days than to sit around reading biopsy (or, more cruelly, autopsy) reports on their sector. Instead of reading a lengthy volume over the course of summer though, bankers need to read just a part of one sentence: "... loans of increasingly poor quality have been made and then sold to the gullible and the greedy, the latter often relying on leverage and short-term funding to further increase their profits".

This is really a wonderful sentence for the succinct way in which it describes the goings-on for the wider masses, therefore appearing like a wonderful bikini on the beach. But like a bikini, it conceals some vital aspects while revealing a fair bit. In this case, the BIS has avoided mention of the real source of all the dumb money that swirled around financial markets in the first place, flooding banks and investment managers with more funds than could be invested with reasonable returns.

That would be where central banks in the Middle East and Asia come into the picture, as they retained their significant trade surpluses on account in a bid to maintain currency parity, especially against the US dollar. As I have written before on these pages, the idea for Asian economies makes some kind of "I missed a few classes in economics" sense as officials attempted to keep their exporters happy. For the economies in the Middle East that export nothing but commodities, the idea of a US dollar peg represents nothing other than the subservience of Arab rulers to US interests.

The connection to the banking crises sweeping the US and Europe now is that much of private wealth generated in the Middle East found its way to banks in those countries, and was in turn diverted to "safe" choices like money market funds - the short-term funding sources the BIS discusses above - that invested in the best quality triple A securities. I discuss ratings a bit later in this article.

Back to the Middle East though. US officials led by Treasury Secretary Hank Paulson recently completed a trip around the region, where they urged Gulf countries to avoid changes to US dollar pegs, even as these countries struggle to contain double-digit inflation that they are importing due to the pegs. It is even thought in some circles that the whole idea of "containing" Iran may have come as a quid-pro-quo from these meetings.

Anyway, oil prices surged to a new high of over US$145 a barrel on Thursday morning (July 3), just in time to remind Americans driving around in their wasteful sports utility vehicles (SUVs)for the July 4 Independence Day weekend the sheer futility of their lifestyle choices going forward. Non-farm payroll data out later in the day may prove to be another nail in the coffin of the American dream, not that I feel this is something to celebrate rather than introspect about.

Back to the BIS report though, this glaring error of omission on the main source of market liquidity that prompted the excess of greed and gluttony not to mention gullibility makes the rest of the report rather pointless. It may seem understandable that an agency concerned with the actions of commercial banks doesn't focus so much on policy institutions such as central banks, but in ignoring the role played by the People's Bank of China, the US Federal Reserve, the European Central Bank and others, the BIS has essentially dumbed down the report.

Even as the BIS makes an attempt to draw a line between incompetence, greed and perverse incentives, the world's governments continue to avoid taking responsibility for their own actions. In a recent speech [2], India's Finance Minister P Chidambaram took the cake in calling for a price band on oil that would act much like today's currency peg bands, setting both a floor and ceiling price for oil.

This kind of market intervention is always to be expected from socialist clowns during times of crisis, as we saw during the Asian financial crisis 10 years ago. The reason that the Indian finance minister's remarks rankle are of course the huge fuel subsidies that persist in India, at the cost of strategic priorities such as education and infrastructure.

Such fuel subsidies, as China is also now discovering to its peril, help to keep demand artificially high while disallowing attempts to improve efficiency. This is what the US faced because of decades of governments not imposing a fuel tax as they feared a popular backlash, thereby mispricing a negative economic good (air pollution) at zero; in turn prompting citizens to increase their usage exponentially.

(I dare say that if you buried a few of America's biggest SUVs today for future generations of humans (if any) to find, archaeologists in the year 3000 will have a tough time explaining quite what they were used for; most logically they will conclude that the average American was three meters tall and weighed about the same as a rhinoceros. Strictly speaking, that view wouldn't be entirely wrong, but I will desist from making statements about fat people in this article.)

The idea of calling for a price band to eliminate fuel price speculation conveniently shifts the burden of responsibility from consumers of a scarce natural resource to the people making prices on the commodity. This is stupid for any low-level official to attempt and much more silly for the top finance official of any country to suggest. An Indian journalist of my acquaintance told me this week that he was "deeply embarrassed" by the finance minister's performance, even likening the speech to the infamous "Zionist plot" speech of Malaysia's Mahathir Mohamad during the Asian financial crisis 10 years ago.

In addition, our Indian eminence also ignored the role of currency pegs to the US dollar. In an environment of a falling US dollar that doesn't necessarily translate into demand/supply changes (those that could affect future prices of processed items) the only alternative for anyone intending to hedge inflationary spirals would be to buy physical commodities such as gold and oil.

I have written previously about global banks attempting to kick down the price of gold to keep their own relevance intact; that leaves oil as the most sensible diversification tool in a world with too many dollars floating around. That's why the price of oil has gone up, not speculation or rapacious market traders or aliens from Mars.

In times of crisis, there are some curious market rituals to be observed, by far the most entertaining of which would be to observe what investment banks say about each other. Research reports from analysts employed by investment banks who write about other investment banks have become headline news items, with Bank A "downgrading the forecast earnings of Banks B, C and D" while the analyst from Bank B does the same for A, C and D and so on. At the end of this spectacle you have the wonderful feeling that all of them are in big trouble.

This is exactly where we are now, as the most entertaining of reports make their way suggesting that investment banks would have to cut about 25% or more of their staff into the global downturn. Most of the business models are irreparably broken, according to the analysts.

This presents a logical, if somewhat perverse question. If the analysts in question are so smart, why then do they work for an investment bank themselves? And if they aren't smart enough to have decamped to a hedge fund or climbing Mount Everest, why then should normal equity investors listen to them?

Another curious market ritual is what happens with the rating agencies when they finally fess up to their mistakes as they do in every crisis. In the last round, they came out about how the rating processes for companies like Enron would be changed, while also showing the limitations of rating more than US$100 billion of debt issued by telecom companies that had to be serially downgraded in 2002.

This time around, Moody's announced that a computer model used to rate Constant Proportion Debt Obligations (CPDOs) had been faulty, but the rating company then took the extraordinary step of firing key people in its European unit for violating procedures. What seems to have transpired is that once the errors were discovered, instead of going forward with downgrades, these officials may have "consulted" with the banks issuing (or worse, holding) the CPDOs to discuss financial implications. A downgrade from triple A to something more reasonable for the risk, around single-A, would have meant losses of more than 30% of the principal amount, according to some observers, so clearly the decision wasn't an easy one to make.

The point though is that this particular ritual exposed the rating agencies for what they are - a bunch of businesses that make money providing so-called independent opinions that really only represent the best interests of the investment banks selling those products. This attitude at the heart of one of the more stable money-making businesses on Wall Street - fixed income - says more about the future of the investment banks than any of the research reports do.

Thus it is that starting with the BIS, then harkening to the Indian Finance Ministry, and going on to investment banks and to the rating agencies, we find it is not what people say that matters - it is almost always what they don't.

Lehman's Hedge-Fund Deals Leave Public in Dark
So let's say you're a big shot at Lehman Brothers Holdings Inc., trying to keep your firm from becoming the next Bear Stearns Cos. The stock has tanked. The market has doubts about your balance sheet. What do you do?
One step to avoid would be any action that might create needless public uncertainty about your company's finances, because investors' greatest fear is of the unknown.So what does Lehman do? It sells billions of dollars of assets to a newly formed hedge fund that:
  1. counts Lehman as a significant investor;
  2. is run by seven recently departed Lehman executives;
  3. is operating out of Lehman's office space, three floors down from the office of Lehman's corporate secretary.

You don't need to know much more about Lehman's transactions with the fund, R3 Capital Partners, to see the problem.
There's no way for outsiders to ascertain whether Lehman's dealings with R3 were at arm's length, as Lehman and R3 say they were. And the last thing Lehman needs is for skeptical investors to be worrying about whether it is engaging in any opaque related- party transactions.

Lehman isn't providing much information about its dealings with R3, and hasn't mentioned the fund in its Securities and Exchange Commission filings. Some details about their relationship have been trickling out in news reports, including a June 18 article by Bloomberg News reporter Yalman Onaran. Here are the basic facts I was able to gather:

As of June 12, one fund managed by R3 had raised $1.08 billion from a single unidentified investor and was seeking to raise $4 billion more from others, according to a Form D disclosure that R3 filed with the SEC. Lehman has invested about $1 billion in R3, said Thor Valdmanis, a spokesman at R3's public relations firm, FD. (After he told me this, Valdmanis asked me not to use the information, saying he wasn't authorized to divulge it.)

Later, in a written response to my questions, R3 said it "is a wholly independent fund and has raised money from a variety of outside investors" and that Lehman "is one of several passive, minority investors in the fund." A Lehman spokeswoman, Catherine Jones, declined to say whether Lehman was the unidentified investor cited in R3's SEC filing. Jones said Lehman "has sold approximately $4.5 billion of assets to R3 since its inception in May 2008," all of which "were previously managed by R3 Capital team members when they worked at Lehman."

Jones declined to say whether the $4.5 billion was how much R3 paid for the assets or the value at which Lehman had been carrying them on its balance sheet. She also declined to say whether Lehman will treat R3 as a related party for accounting purposes. Companies must disclose the effects that any material related-party transactions have on their financial statements, under generally accepted accounting principles.

"R3 is an independently managed fund in which Lehman Brothers is a limited partner and holds a passive, minority stake in the general partner," Lehman said in a July 1 statement read over the telephone by Andrew Gowers, a spokesman. "Lehman Brothers has no control rights, and all transactions are on an arm's-length basis." So, what are we supposed to make of all this? Beats me.

We have no idea if Lehman recorded gains or losses on these sales, how much money R3 paid for the assets, where it got the money to buy the assets, or the fiscal quarter in which the sales occurred. We don't know whether Lehman plans to disclose any of this. There is no way to determine with the information available whether this is a related-party deal.

Even with more information, the relationship might not be transparent. The trouble with related-party deals -- if that's what these are -- is that they "cannot be presumed to be carried out on an arm's-length basis, as the requisite conditions of competitive, free-market dealings may not exist," as Financial Accounting Standard No. 57 says.

Under the accounting rules, if Lehman's stake in R3 were 20 percent or greater, this would lead to a presumption that Lehman could exercise significant influence over its policies. In that case, R3 probably would be deemed a related party.
As for the space R3 occupies on the 39th floor of the Time & Life Building in midtown Manhattan, it's in the middle of a 10- floor block Lehman began subleasing from Time Inc. last year. R3 and Lehman say the fund is paying rent to Lehman at market rates.

R3's chief executive officer, Rick Rieder, a 21-year Lehman veteran, sent me a letter explaining that the name R3 comes from the phrase "Reading, wRiting and aRithmetic." He wrote that the fund's creation "was in discussion for years," that he won't take a bonus from R3 this year, and that "a substantial portion of future profits" will go to a new foundation to support "improvement in urban education in this country and abroad, a cause I have long supported."

That's all nice stuff. What's important about R3 to Lehman investors, though, is how the transactions affect Lehman's financial statements. Lehman is scheduled to file its second- quarter earnings report with the SEC later this month.
"Based on the information that's publicly available, you can't tell whether these are related parties, although there are indications there could be significant influence," said Douglas Carmichael, the former chief auditor of the Public Company Accounting Oversight Board, now an accounting professor at Baruch College in New York and a litigation consultant.

And there lies the problem: You just can't tell. That won't keep investors from forming their own conclusions. If Lehman doesn't like what they decide, it will have only itself to blame.

Middle East war threat rattles oil markets
A supply crunch and mounting fears of an Israeli air strike on Iran propelled oil to $143 a barrel at one stage yesterday, prompting warnings from the International Monetary Fund (IMF) of a severe economic crisis in poorer regions.

"Some countries are at a tipping point," said Dominique Strauss-Kahn, the IMF's managing-director. "If food prices rise further and oil prices stay the same, some governments will no longer be able to feed their people."

The energy markets have been seriously rattled by comments from a top Pentagon official warning that Israel may launch raids on Iran's Natanz nuclear facilities to pre-empt its acquisition of Russian air-defence missiles. The source told ABC News that Israel would not wait until the Ahmadinejad regime had accumulated enough enriched plutonium to make a bomb. "The red line is not when they get to that point, but before they get to that point," he said.

Iran has threatened to close the Straits of Hormuz if attacked, cutting off a quarter of the world's oil supply. Such a move could drive oil to $200 or higher, bringing the global economy to its knees. The International Energy Agency yesterday slashed its forecast for oil demand growth by over 3m barrels per day (bpd) by 2012 as economic growth slows and consumers take drastic steps to cut fuel use, but said the oil market would remain "tight" because of supply shortfalls.

"Over 3.5m bpd of new production is needed each year just to hold steady," it said. China's imports will rise from 4m to 5.7m bpd within four years. "With oil prices hitting $140 we are clearly in the third oil shock. Truck drivers are going on strike. Airlines are closing down," said Nobuo Tanaka, the IEA's director. Lower demand may help ease strains in the crude markets - lifting spare capacity to 4m bpd - but will merely defer a deeper crisis caused by lack of investment.

The Kashagan oil field in Kazakhstan is unlikely to produce much before 2013, while Russia has hobbled its oil sector with a costly tithe. Its output will fall below 10m bpd a year by next year. Matters would be worse without biofuels, which will reach 1.9 bpd in four years and make up almost half the growth in non-OPEC supply growth.

Even so, Sheik Ahmed Yamani, Saudi Arabia's former energy tsar, said the oil spike feels very different from the 1970s when there was a lack of supply. "Now it is because of problems with the price-setting system in the futures market. Traders buy and sell depending on rumours, not supply and demand. So much money is flowing into the market, it's almost like gambling," he told Japan's Nikkei Net. This is the "OPEC View".

The big western oil companies, however, blame the demand in Asia, the Mid-East, and Latin America - and the refusal of the petro-states to open up to western know-how. The IEA said it was facile to blame speculators. "All producers are working virtually flat out and there is no sign of any abnormal stockbuild giving a strong indication that current prices are justified," it said.

Hedge fund managers questioned this on Capitol Hill last month, saying the price would fall to $60 overnight if there was a clampdown on trading. It is a fine line between speculation and the activities of pension funds buying long-term futures, but there can be little doubt that financial flows have begun to distort the market.
Spain's industry minister, Miguel Sebastian, told the World Petroleum Congress that investors were using 850,000 bpd, enough to upset the wafer-thin balance.

The US Congress passed a bill last week authorising - or pushing - the Commodity Futures Trading Commission to take "emergency" action to halt the alleged abuses. This has not been done for nearly 30 years. The most likely option is to tighten margins on futures trading, which was used in 1980. It is unclear whether this would work today.

Paul Horsnell, commodity chief at Barclays Capital, says speculators are now net "short". If so, higher margins would force them to cover positions, pushing prices even higher.

Iran Gives 'Constructive' Reply to Incentives Package
Iran has given a "constructive" response to an incentives package from world powers intended to persuade the Persian Gulf nation to suspend uranium enrichment, the country's chief nuclear negotiator said. The government in Tehran has prepared and presented its reply "with a focus on common ground and a constructive view," state television cited Saeed Jalili, secretary of Iran's Supreme National Security Council, as saying today in a telephone call with European Union foreign policy chief, Javier Solana.

Jalili didn't elaborate on the terms of the response nor say whether Iran might be prepared to call a halt to its atomic work. The U.S. and many of its allies accuse Iran of trying to develop nuclear weapons. Iran, under three sets of United Nations sanctions for refusing to stop the program, insists the work is aimed at producing electricity.

Crude oil fell from near a record after Jalili said the Iranian response would be delivered today. A compromise may allay concern that Israel is ready to attack Iran's nuclear installations, starting a conflict likely to cut supply from OPEC's second-largest oil producer. Crude oil for August delivery fell as much as $1.41, or 1 percent, to $143.88 a barrel in electronic trading on the New York Mercantile Exchange, trading for $144.14 at 2:03 p.m. London time.

Solana presented the package of economic and technology incentives to the government in Tehran on June 14 on behalf of the five permanent members of the United Nations Security Council plus Germany. Enriched uranium, the material the UN partners want Iran to stop producing, can fuel a power station or arm a nuclear weapon.

The plan includes an offer to recognize Iran's right to develop nuclear energy for peaceful purposes and to support the construction of a light-water reactor. The world powers have also proposed steps toward the normalization of trade and economic relations, greater Iranian access to international markets, and support for its admission to the World Trade Organization.

"We can confirm that there was a phone conversation this morning. Mr. Jalili called Mr. Solana. They had a good conversation and it was decided that they would remain in contact in the coming hours," Solana's office in Brussels said in a statement. Iran's response to the incentives package was delivered by the country's ambassador in Brussels, the state-run Islamic Republic News Agency said, citing an unidentified official at the Supreme National Security Council.

ranian Foreign Minister Manouchehr Mottaki signed a response letter, the news agency said, adding that Jalili and Solana are scheduled to hold talks later this month. Iran will view an attack on its nuclear facilities as an act of war and will respond, the head of the country's Revolutionary Guard Corps said earlier.

"Any act on Iran will be considered the start of war," General Mohammad Ali Jaafari told reporters yesterday in response to questions about the threat of an Israeli strike on Iranian atomic sites, according to remarks carried today on IRNA. Jaafari also said he thought it is unlikely such an attack would be carried out.

Reports that Israel may attack Iran have boosted oil prices. If attacked, Iran will "impose control" on the Strait of Hormuz, Jaafari said on June 28. About 20 percent of the world's daily supply of oil passes through the strait. Crude for August delivery rose $5.08, or 3.6 percent, to $145.29 a barrel this week on the New York Mercantile Exchange. Futures reached $145.85 a barrel yesterday, the highest since trading began in 1983.

Iranian Oil Minister Gholamhossein Nozari, who was in Madrid for the World Petroleum Congress, yesterday reiterated his nation's pledge to respond to any strike. "Iran's stance in this connection against enemies is clear, vivid and strong," Nozari told the Iranian news agency before leaving Madrid. "Oil is an energy and industry for peace and its durability depends on peace and security. So, any tension in any region, especially in the Persian Gulf, which is the major supplier of the main part of the world's energy, will have an impact on the energy market which is principally unpredictable."

More than 100 Israeli F-16 and F-15 fighter planes took part in a military exercise over the eastern Mediterranean and Greece during the first week of June, the New York Times reported on June 20. U.S. officials told the Times the maneuvers appeared to be training for a possible attack on Iran's nuclear sites. Israel is increasingly likely to attack Iranian nuclear facilities this year, an unidentified Pentagon official told ABC News.

The official said an Israeli strike might be triggered by Iran's production of enough enriched uranium to make a bomb, or by Iran taking delivery of a Russian SA-20 air-defense system, according to ABC's June 30 report. The State Department dismissed the report, while spokesmen for the Pentagon and the White House declined to comment.

Former Israeli Air Force General Isaac Ben-Israel, now a lawmaker in Israel's ruling Kadima party, told Germany's Spiegel in an interview published this week that his nation is "prepared" for an attack if diplomacy and United Nations sanctions fail to stop Iran from making a nuclear weapon.


Anonymous said...

Hello Ilargi,

You write:
"I think maybe you confuse capital creation with credit creation."

I asked myself precisely that question, but thought that perhaps the author meant that the money created would be invested in capital goods. My understanding of finance is not yet good enough that I can navigate this type of distinction very confidently.

A further problem is terminology. For example, look at the use of the word "inflation". Many authors (I do not mean Feteke) and most journalists use it when in fact they mean "price increase". I systematically stop and think through whether the person really means "inflation". Generally, they should have written "price increase".

The same goes for "capital creation". I was unsure how Feteke was using the term.

You continue:
"Capital can only be created by real work, which involves the use of any number of real natural resources, not by sitting behind a desk and punching a keyboard."

I think I understand what you meant, but being a translator who punches a keyboard for a living, your statement makes me wonder about the "value" of my work. I feel that it is work because it is difficult, not many people can do it, I am generally proud of the result and companies pay a great deal for it. Does the document produced (essentially just a rearrangement of bits in a computer file) represent capital? I think yes, but would be hard pressed to prove it.

Then you write (about house prices):
"You know what it is? Inflation, pure as it comes, that's what."

Now let me think a minute, did you mean… ;-) Just kidding.


Anonymous said...

I'm sure it's just "coincidence", but Britain also has the most number of CCTV "security" cameras, if I'm not mistaken. A good weekend to watch "V for Vendetta" again, I think.

Anonymous said...

“HERE'S a Yankee Doodle Doozy of an idea from the taxman: if you've had enough of the United States and choose to renounce your citizenship, you will now have to give up a large chunk of your assets.

The same new tax also will hit foreigners who are living and working in this country legally - with a so-called green card - once they decide to return home.”

Anonymous said...


What do they call it - the ex-Patriot Act?

I plan to bail in the next few of years, though in many respects, living in the US Virgin Islands, I am already out the the USA. I have to clear customs on my infrequent trips to the mainland. I like the mountains of Peru. My net assets are a bit under this $600,000, but my financial index short ETF's might put me over. Are they gonna put an IRS collector next to the ticket collector at all the outbound international flights? Probably farm it out to KBR with shuttle flights to their concentration camps in the South West.

Anonymous said...

This is someone else's post, but anyhow, I found it sooo funny!

To know where to put my money, now that all stocks seem to be crashing, I'm studying hard the periodic table of the elements!

. said...

I'm surprised we got through our markets being closed and the global markets being open 7/4/2008 without something coming down. I figured someone would unwind something at this time as they have an advantage over U.S. traders ... perhaps the signal won't show until next Monday? Or did everyone successfully hold their breath for another week?

Anonymous said...

To el pollo and Iowa boy:

The beast is squirming in the dead spasms...

greatings from Prague