Wednesday, August 20, 2008

Debt Rattle, August 20 2008: The New Untouchables

Arthur Rothstein Cimarron 1936
Farmer and sons walking in the face of a dust storm. Cimarron County, Oklahoma

Ilargi: I wouldn’t be surprised if Wall Street Journal affiliate Barron’s wasn’t merely reporting over the weekend, but was in fact used to bring Fannie and Freddie shares down to the point where the Treasury can claim force majeure and start spending taxpayers’ money.

As I’ve said before, Fannie and Freddie are a political issue, not a financial one. The amount of money about to be thrown at the swine is so substantial that a lot of spinning and scheming is required.

Regardless, we’ll see mega billion bail out action very soon; shares of the two firms stand to lose another 20% today.

New York attorney general Andrew Cuomo, as previously noted, is posing as Robin Hood, taking money away from banks he accuses of auction-rate securities fraud.

I’m still waiting for an explanation as to why the fines the banks pay for their criminal acts amount to about 0.5% of the amounts involved in the fraud. Never seen a fraud case with that level of fines; for all I know it makes it a profitable crime.

I’m also still waiting for the first individuals in the banks to be brought to court. And for the first bank to admit their guilt in the case. But I'm not holding my breath.

Today, the Washington Post reports that Fannie Mae accelerated its purchases of subprime and Alt-A loans in early 2007. CEO Daniel Mudd claims that in those days, it wasn’t clear to anyone that these loans were shaky at best, and carried the risk of default.

Since Fannie had a "very clever" model to get rid of the risk, it didn’t matter much anyway, or so he says.

In the real world, in early 2007, it was very clear that subprime was crashing. Many analysts had warned about it. So Mudd is simply blatantly lying.

Perhaps he can claim that he didn’t pay attention to analysts. That would merely make him totally unfit for his job; a CEO needs to know his market, after all, above all.

However, it doesn’t stop there. A tight spot that Mudd cannot wiggle his fat slimy ass out of rests in the fact that inside Fannie Mae, his own firm, there had been warnings floating around about subprime mortgages since 2005. And not just among the lower minions; management was acutely aware of the risk.

I’m convinced that whatever anybody says to the contrary, Fannie and Freddie have been used for at least 2 years to dump losses incurred by Wall Street’s largest lenders, including Countrywide.

I’m equally convinced that the Treasury and the Federal Reserve knew about this, and gave their permission. Perhaps the scheme even originated there.

The key line in the Washington Post article is this one: "Fannie Mae Executive Vice President Thomas A. Lund said the company pursued the purchase of subprime loans in 2006 and 2007 at the request of lenders, who wanted Fannie Mae to take the loans off their books.".

They don’t even try to hide it much. And why should they? After all, they can continue to claim, as the Post quotes from an internal Fannie document, that "The company recognized the already weak performance of subprime loans but predicted that they would get better in 2007".

That statement is so outrageous as to constitute a crime in and by itself. But how do you prove that?

Therein lies a task for the likes of Andrew Cuomo.

Still, looking at the free passes he’s busily handing out to every individual fattened goose in the ARS field, I’d urge you don’t hold your breath for this to happen. Better hold on to your wallet instead.

Years ago, Elliot Ness' original Untouchables fought on the side of the law, and against the criminals. Times have changed. Today's New Untouchables ARE the criminals.

Fannie's Perilous Pursuit of Subprime Loans
In January 2007, as years of loose mortgage lending were about to send the nation's housing market into devastating decline, Fannie Mae chief executive Daniel H. Mudd wrote a confidential memo to his board.

Discussing the company's successes, Mudd said one of Fannie Mae's achievements in 2006 was expanding its involvement in the market for subprime and other nontraditional mortgages. He called it a step "toward optimizing our business."

A month later, Fannie Mae outlined plans to further expand its activities in the subprime market. The company recognized the already weak performance of subprime loans but predicted that they would get better in 2007, according to another Fannie Mae document.

Internal documents show that even late in the housing bubble, Fannie Mae was drawn to risky loans by a variety of temptations, including the desire to increase its market share and fulfill government quotas for the support of low-income borrowers.

Since then, Fannie Mae's exposure to loosely underwritten mortgages has produced billions of dollars of losses and sent its stock price plummeting, prompting the federal government to prepare for a potential taxpayer bailout of the company. This month, Fannie Mae reported that loans from 2006 and 2007 accounted for almost 60 percent of its second-quarter credit losses.

Fannie Mae documents from the period, obtained by The Washington Post, paint a picture of a company with the dual incentives of fostering affordable housing and making money, and of one caught between the imperatives of increasing its market share while avoiding excessive risk. In a bid to juggle these demands, the company's executives took on risks they either misunderstood or unduly minimized.

Fannie Mae aimed to benefit from subprime loans and expand the market for them -- and hoped to pass much of the risk on to others, documents show. Along with subprime loans, which were typically issued to borrowers with blemished credit, the company targeted so-called Alt-A loans, which were often made with no verification of the borrower's income.

"By entering new markets -- especially Alt-A and subprime -- and guaranteeing more of our customers' products at market prices, we met our goal of increasing market share from 22 to 25 percent," Mudd wrote in a 2006 year-end report to the Fannie Mae board dated Jan. 3, 2007. In other internal documents, there was a common refrain: One of Fannie Mae's objectives for 2006 was to "increase our penetration into subprime."

In an interview, Fannie Mae Executive Vice President Thomas A. Lund said the company pursued the purchase of subprime loans in 2006 and 2007 at the request of lenders, who wanted Fannie Mae to take the loans off their books. He said Fannie Mae hoped to bring higher standards to the market, and he added that the loans helped the company in its struggle to meet goals the government had set for Fannie Mae's advancement of affordable housing.

Fannie Mae spokesman Brian Faith said that as early as 2005, the company's management was publicly expressing concern about loans with layer upon layer of risky characteristics. At a conference in spring 2005, Lund warned about the danger to borrowers, asking, "Are we setting them up for failure?" according to news reports. Despite such reservations, Fannie Mae moved ahead.

In 2006 and 2007, Fannie Mae "carefully broadened our entry into the subprime market," Faith said in a statement. At the time, it wasn't clear how severe the problems in the housing market would become, he said.

In a written statement provided for this story, Mudd said, "In 2006 and early 2007, the industry, many analysts and market observers were generally not predicting a downturn in the housing and credit markets to the magnitude of what has since emerged, and outlooks for particular market segments at that time varied significantly."

Compared with the broader market for Alt-A loans, Fannie Mae "was more conservative in its approach and the loans have continued to perform better," Mudd added. Chartered by the government to keep mortgage money flowing, Fannie Mae buys loans from lenders, enabling them to make more loans.

It also packages loans into securities for sale to other investors, guaranteeing it will make the payments if borrowers default. Its mortgage-related investments and guarantees total $3 trillion. During the peak years of the housing bubble, the company was distracted by an accounting scandal and its fallout.

For much of 2006, the company was focused on a continuing effort to correct years of false financial reports, a massive project that cost more than $1 billion and ultimately revealed that Fannie Mae had overstated past profits by $6.3 billion.

Mudd promised his employees a celebration when the restatement was done, and he delivered. In December 2006, the company threw a holiday bash at a Washington hotel with entertainment by Earth, Wind & Fire, the '70s group known for such hits as "Boogie Wonderland" and "Fantasy."

"I hope you had a fantastic time at the holiday party. I sure did. And my feet still hurt. Thank you for making the party a blowout," Mudd wrote in a year-end message to employees. In his year-end memo to the board, Mudd said he hoped the completion of the accounting corrections would prove to be a turning point -- "a time when we began to put a difficult past behind us and also to build for the future."

Mudd said he worried that while the company focused on its accounting problems, "the business itself would get away from us." He said the company avoided that pitfall but now faced another: intense competition from "usurpers and innovators."

Buying Alt-A and subprime mortgages was part of Fannie Mae's effort to meet the challenge. Fannie Mae sought to reap the rewards and protect itself from the downside of the investments through a feat of financial engineering it called its "Risk Transformation Facility," which was meant to transfer the riskiest elements to other investors.

"We engaged in the subprime market, for the first time closing deals to guarantee and securitize subprime loans, with help from the new facility that allows us to sell off the riskiest layers," Mudd wrote. By October, the company had signed $3 billion of such deals.

Although the deals discussed in Mudd's memos were small in relation to the overall scale of Fannie Mae's business, they reflected the company's appetite for subprime and Alt-A mortgages. The company had a long and deep involvement in this market through a different form of investment.

Instead of buying the loans and securitizing them itself, Fannie Mae had invested in securities packaged by others from pools of these loans. Going back at least as far as 2002, Fannie Mae had taken on tens of billions of dollars of such securities, according to regulatory data.

Fannie Mae's investment in Alt-A and subprime securities issued by others would later prove costly. But in Mudd's January 2007 report, as he reviewed the company's business, they didn't even draw a mention. A month later, Fannie Mae management outlined a plan to acquire $11 billion more in "subprime/non-prime mortgages" in 2007 and expressed confidence in its ability to handle the risk.

The company had "approached its expansion of this business cognizant of the relatively weak credit performance of recent subprime originations, which were affected by issues relating to underwriting quality, home price de-appreciation . . . and risk layering," one February 2007 document said, referring to loans with multiple risky characteristics. "However, management expects improvement in the quality and credit performance of subprime mortgages originated this year."

By March 2007, when Mudd sent the board an update, major subprime lenders were failing, delinquency rates were climbing, and the emerging crisis was impossible to ignore. The subprime sector "is in partial meltdown," Mudd wrote. He reported to directors that Fannie Mae's investment in subprime mortgage assets totaled about $55 billion.

Mudd told the board that Fannie Mae had run its subprime portfolio through a stress test to determine the losses in a hypothetical scenario that involved a two-percentage-pointrise in interest rates and two years of 5 percent declines in home prices. The resulting prediction: "zero credit losses net of earnings."

Mudd remained so sanguine about Fannie Mae's outlook that he asked the board to consider giving up its special status as a government-sponsored enterprise -- an advantage that helped the company borrow money at low rates by leading investors to believe the government stood behind its obligations.

Since then, the government's more explicit support has provided a crucial backstop for the struggling company. As it turned out, Fannie Mae did not buy as many subprime loans as it intended in 2007 because few of them met its criteria and the market worsened, Lund said. The subprime loans the company did buy in 2006 and 2007 performed as expected, Faith said, declining to say whether they had produced profits or losses.

But the continuing purchases of securities backed by loosely underwritten loans have been a source of trouble.
Though the deterioration in home prices has not been as extreme as the hypothetical "stress test" scenario Mudd cited in his memo last year, Fannie Mae has incurred losses of $3.4 billion on securities backed by subprime and Alt-A loans since the beginning of 2007, the company reported last week.

Alt-A loans accounted for almost half of the red ink the company attributed to foreclosures and other bad loans during the quarter ended June 30. Faith declined to discuss the stress test. At the end of June, Fannie Mae owned or guaranteed $388.3 billion of Alt-A and subprime mortgage investments.

In comparison, it said its capital -- the financial cushion that enables it to absorb losses -- totaled $47 billion, which exceeded the government's minimum requirement by $9.4 billion. In his statement to The Post, Mudd said Fannie Mae's Alt-A investments have been hurt "by the most severe decline in home prices since the Great Depression."

Making matters worse, the investments are concentrated in states "where home prices have fallen further and faster than in the rest of the nation," he said. This month, Fannie Mae said it would stop taking on new Alt-A loans by the end of this year.

How Fannie and Freddie will fail
Henry Paulson is maneuvering himself into the history books by forcing Fannie Mae and Freddie Mac into a spiral of doom from which they can't recover. He had plenty of help from the directors and executives who sit atop them.

But it's becoming clear that since Saturday's Barron's article, laying out the path to failure, events are spiraling out of Fannie and Freddie's control.

The anonymous senior government source in the Barron's article said that unless Fannie and Freddie could raise at least $10 billion each, the government would bail them out while wiping out common shareholders and eliminating the preferred dividend. This would lead to a sell off of bad loans, a split into smaller pieces, and maybe selling those pieces back to the public. All these activities are a government gift to Wall Street, which will get to do all these deals.

Events are following this predicted pattern as Fannie and Freddie struggle to raise capital. The New York Times reports that investors are not enthusiastic about the most recent efforts to raise capital by Freddie Mac. It reports that on Tuesday, Freddie Mac raised $3 billion in five-year debt but the "1.13 percentage points [premium] over the rate the federal government pays for comparable borrowing" was more than double the "0.6 points" premium it paid earlier in the year.

As their higher debt costs become common knowledge, fewer investors will show up to buy their debt and their borrowing costs will become prohibitively high. Nor can they issue common equity because as their share prices drop on news of their financing problems, the massive number of shares they would need to issue to raise meaningful amounts of capital would severely dilute existing common shareholders.

And as their costs of borrowing rise, they will need to pass those higher costs onto people seeking mortgages, which will put further downward pressure on housing prices. Just as Bear Stearns did, Fannie and Freddie may not be able to obtain the short-term financing they need to continue to operate.

Bloomberg News reports that their ability to roll-over -- exchange for new notes -- by the end of September their $223 billion worth of notes will soon test whether Fannie and Freddie suffer Bear's fate. To be sure, Bear failed when holders of its overnight repos -- nightly loans backed by securities -- refused to roll them over for Bear.

While the Fannie and Freddie notes in question are longer term than repos, the concept is the same. In a recent case, the holders of that short-term debt were Asian investors who are getting less and less enthusiastic about owning Fannie and Freddie securities. Bloomberg reports that Asian Investors bought far less of the recent $3.5 billion Fannie offering -- 22% -- which is "almost half the demand of three months ago and about two-thirds of Asia's usual purchases."

Unless the U.S. government steps in to explicitly guarantee those notes, Fannie and Freddie could soon hold an offering for their short-term debt and nobody will show up. And that's how Fannie and Freddie will fail.

Fannie, Freddie Bailouts May Hinge on $223 BillionDebt Rollover
Fannie Mae and Freddie Mac's success in repaying $223 billion of bonds due by the end of the quarter may determine whether they can avoid a federal bailout.

Fannie, based in Washington, has about $120 billion of debt maturing through Sept. 30, while McLean, Virginia-based Freddie has $103 billion, according to figures provided by the government-chartered companies and data compiled by Bloomberg.

Rising borrowing costs and evidence that demand for their debt was waning last month led Treasury Secretary Henry Paulson to seek the authority to pump unlimited amounts of capital in Fannie and Freddie in an emergency. Their interest costs are again increasing amid concern that credit losses are depleting the capital of the beleaguered mortgage-finance companies.

Rolling over the debt "is the single most important factor to their ability to remain liquid," said Moshe Orenbuch, an analyst at Credit Suisse in New York. "So far, they've been able to do that." Investors in Asia, the biggest foreign owner of Fannie's $3 trillion of bonds, are reducing their share of purchases, potentially increasing the need for Paulson to make good on his pledge to backstop the companies.

"This whole backstop mechanism was set up so the actual need for it could be avoided," said Mahesh Swaminathan, a mortgage strategist for Credit Suisse in New York. "The market is testing the Treasury's resolve."

The companies, responsible for 42 percent of the U.S. home loan market, need as much as $15 billion each in fresh capital to reserve against losses on mortgages and related securities that they either own or guarantee, Paul Miller, an analyst with Friedman Billings Ramsey & Co. in Arlington, Virginia, said.

The Treasury will probably be forced to buy as much as $30 billion of preferred shares in both Fannie and Freddie by the end of next month, according to Bill Gross, who manages the world's biggest bond fund at Pacific Investment Management Co. "Treasury is monitoring market developments vigilantly. We are focused on encouraging market stability, mortgage availability, and protecting the taxpayers' interests," Treasury spokeswoman Jennifer Zuccarelli said.

Freddie Mac "continues to have strong access to the debt markets at attractive spreads," spokeswoman Sharon McHale said. Fannie spokesman Brian Faith declined to comment.

Investors this week demanded an extra 104 basis points in yield to own Freddie's five-year debt rather than Treasuries of similar maturity, the most since reaching a 10-year high of 114 basis points in March. The gap narrowed to 74 basis points after Paulson's announcement. A basis point is 0.01 percentage point.

Fannie spreads approached a 10-year high of 104 basis points on Aug. 18, from 74 basis points on July 28. In the decade before 2008, the spread averaged 43 basis points. "The fixed-income markets are starting to lose faith," Miller said.

JPMorgan Asset Management Japan is reducing its holdings of Fannie and Freddie debt, according to Shinji Kunibe, a senior money manager at the firm in Tokyo. And Yuuki Sakurai, the general manager of financial and investment planning in Tokyo at Fukoku Mutual Life Insurance Co., said his firm is also "a little bit worried about the fate of" Fannie and Freddie.

"The conditions don't seem to be turning into a good environment," Sakurai said. Fannie fell 14 cents to a 19-year low of $6.01 yesterday in New York Stock Exchange trading. Freddie was at its lowest level since January 1991, dropping 22 cents yesterday to $4.17. Both have tumbled more than 90 percent in the past year.

Fannie's market value has shrunk to $6.47 billion and Freddie's declined to $2.7 billion, making it increasingly difficult for the companies to raise equity through public markets, Miller said. The companies have reported a combined $14.9 billion of net losses the past four quarters.

After receiving authority last month to inject unlimited capital into Fannie and Freddie, a Treasury spokeswoman this week said Paulson had no plans to use his new power. Initial optimism that Paulson's proposal would bolster confidence in the companies has vanished on concern that the deteriorating housing market may force a bailout, a move that would likely wipe out common shareholders and potentially some preferred stockholders, Miller said.

"It hasn't restored any faith, it just highlighted their problems," Miller said. "The market has come to accept the fact that the government has got to do something." Freddie's 5.57 percent perpetual preferred shares are trading at $9.37 to yield 15.3 percent, compared with $17.99 and a yield of 7.77 percent on June 30 before the crisis erupted. Fannie's 5.5 percent preferred shares yield 16.4 percent, up from 7.83 percent on June 30.

Fannie was created as part of Franklin D. Roosevelt's New Deal in the 1930s and became a publicly owned company in 1968. Freddie was started in 1970 during the Vietnam War, primarily as competition for Fannie. The companies, which own or guarantee about $5 trillion of the $12 trillion of outstanding U.S. home loans, help expand financing to homebuyers by purchasing home loans from lenders and packaging other loans into securities that they then guarantee.

The companies, which have a combined $1.7 trillion in outstanding unsecured debt, issue new debt to pay off outstanding obligations as they mature. The companies can also sell securities to raise cash.

"While the plan was extraordinarily aggressive, it seems that the market is looking for something even more explicit and more guidance about what form that will take," said Margaret Kerins, the managing director of agency debt strategy at RBS Greenwich Capital Markets in Greenwich, Connecticut.

Freddie had $70 billion of cash and non-mortgage investments on June 30 and $470 billion of agency mortgage securities that it could pledge for secured borrowing, the company said Aug. 6. Fannie paid a record high yield in a $3.5 billion sale of three-year benchmark notes last week that drew less demand from Asia. Investors in the region bought 22 percent of the offering, almost half the demand of three months ago and about two-thirds of Asia's usual purchases.

"The 22 percent of Asian participation is worrying," said Ajay Rajadhyaksha, the head of fixed-income strategy for Barclays Capital in New York. Freddie's latest auction of short-term notes attracted less interest from investors for the second straight week.

Freddie this week said it sold $4 billion of short-term notes in a weekly auction, where investors bid for 2.19 times the amount of three-month securities available, down from 2.73 times last week. The bid-to-cover ratio on the company's six- month securities was 2.42 times, down from 2.92 times, while the ratio on 12-month debt sold was fell to 1.75 times, from 2.50

Calling all cash: please report to AIG
Bloomberg on Monday:
The one financial industry that seems to be dodging the subprime bullet is insurance. Only a handful of companies have had their safety ratings knocked down because of an excessive exposure to Wall Street’s toxic waste. The vast majority has enough capital to withstand the known problems on their balance sheets, the rating companies all say.

Turns out: not so much.At least, not so much for AIG. The world’s largest insurer.AIG is, in fact, a trainwreck, and the market is only just waking up to this. A note from Goldman analysts this morning might just be the wake up call investors need. For an idea of tone, let’s flash through some of the headers:
Don’t buy AIG.
A dangerous balance sheet posing as an inexpensive entry point.
There’s nothing to be feared except fear itself…and mortgages.
Raising capital: Ultimate number too difficult to quantify.

The “base case” scenario for AIG under Goldman’s analysis is a further $9bn in losses on their CDS contracts. That widens to $20bn under the more likely “stressed” scenario. As the note makes clear, $20bn isn’t the end of it either: there are so many unknowns, particularly given the physical settlement nature of AIG’s CDS contracts:
The idea of physical settlement in AIG’s CDS is often overlooked. Given the very substantial amount of cash AIG could be forced under the terms of its contracts to purchase protected securities at par, we are concerned with the lack of discussion around this topic by the firm and the rating agencies.

Our understanding is that if AIG provided protection on a $1,000 security with an event of default, AIG would have to pay $1,000 to the holder of the security and then take physical possession of the security. Thus, a $1,000 security with a $100 loss does not imply a $100 cash outlay - in fact, it implies a $1,000 cash outlay in receipt of $900 of collateral.

Given the “securities” in this example are mostly CDOs and the “collateral” is largely mortgage-based, we suspect the regulators and the rating agencies will not look kindly on AIG’s swapping cash for mortgage assets. Of even more concerning relevance, the majority of the CDS written on CDOs require this form of physical settlement.

A $25bn loss on CDS alone isn’t out of the question. With that then, in mind, rating agency downgrades become an inevitability. And if AIG is downgraded, then the rest of its business will falter and its business model will come off the rails.
The rating agencies themselves are behind the curve. As Goldman note:
The central tenet of our “Don’t buy AIG” argument is simple: the intricacies of AIG’s business are so complex that management may not even know the extent of the company’s ultimate exposures, let alone losses… Thus, if management cannot accurately assess its ultimate exposures or losses, then how can one expect the rating agencies to do so?

Is any of this ringing any bells?
After another surprisingly negative quarter, it appears that investor confidence in AIG is damaged. We believe the stock may continue to drift down as investors remain wary of the possibility of a dilutive capital raise, the potential for ratings downgrades, and the corresponding effects on the underlying business. Put simply, we have seen this credit overhang story before with another stock in our coverage universe, and foresee outcomes similar in nature but on a much larger scale.

Goldman won’t say it, but we will. AIG is going the way of the monolines… but on a much larger scale.

Prospects uncertain for Fannie, Freddie
As mortgage financiers Fannie Mae and Freddie Mac struggle with continuing credit losses, their ability to raise needed capital is uncertain and, analysts say, is complicated by the possibility of a government bailout of the two companies.

"We're in uncharted water with this," Bert Ely, an Alexandria, Va.-based banking industry consultant and longtime critic of Fannie and Freddie, said Tuesday. Published reports about a possible bailout, continued quarterly losses at Fannie and Freddie and further deterioration in the credit markets have investors concerned about the mortgage companies' solvency.

Those worries have sent the companies' prices tumbling, with Fannie falling another 4.49% and Freddie sliding 5.01% on Tuesday. In the latest sign of trouble, Freddie had to pay its highest borrowing premium in 10 years when it issued $3 billion worth of five-year debt on Tuesday, according to The New York Times.

Freddie had to pay an interest rate that's 1.13 percentage points higher than the rate the federal government pays for similar borrowing, the report said. A government bailout is widely considered the least attractive alternative to help the mortgage financiers shore up their balance sheets because investors are worried that federal intervention will wipe out the holdings for any non-governmental investors, said Brian Gardner, a senior vice president with Keefe, Bruyette & Woods Inc.

Last month, the Treasury Department agreed to provide support to Fannie and Freddie, which collectively own or back about $5.3 trillion in mortgages, about half the nation's mortgage debt. The support could come in the way of loans or an equity investment by the government to help support the mortgage companies.

It is widely assumed any equity investment by the government would take a senior position above all other investors - in other words, should the companies become insolvent, the government would recover money before others who have invested in Fannie and Freddie.

Over the past year, homeowners have increasingly defaulted on mortgages, which has led to billions of dollars in losses for the pair of government-sponsored enterprises. That trend has also been one of the leading culprits in the deterioration in credit markets that has made it more difficult for companies in general to raise new capital.

Freddie has said it is committed to raising $5.5 billion to help shore up its troubled balance sheet - that is nearly twice the size of Freddie's current market capitalization of about $2.84 billion. Fannie's market capitalization is about $6.58 billion. Friedman, Billings & Ramsey Co. analyst Paul Miller estimates Fannie needs to raise between $5 billion and $10 billion in new capital.

But the prospect of government help has been one of the greatest hang-ups in efforts to raise capital from other investors. Fannie and Freddie could raise those funds through non-governmental investors, but the cost would likely be severe in terms of interest or dividend payouts depending on the structure of the capital raise and in terms of dilution to current shareholders, analysts said.

"The cost of capital of this nature is just staggering," said Ladenburg Thalmann Inc. analyst Richard Bove. Fannie and Freddie could likely raise capital, but it would cost them so much during the current downturn in the credit market that it is unattractive, Bove said.

At a certain price, though, analysts said the companies would find investors. It is just a matter of what costs and stock dilution investors are willing to incur. Any non-governmental investor is going to want a senior position, said Walter O'Haire, a senior analyst with consulting firm Celent.

Potential investors might also approach the government to provide some financial guarantees to help protect against losses, O'Haire added. "They will want as much assurance as they can possibly get," O'Haire said. If Fannie and Freddie cannot find outside investors, the government's offer of support will likely come into play.

Ely said that if the government gets involved, the first option would be to provide the mortgage companies with loans, likely through the Federal Reserve or possibly the Treasury Department. That option would help the Treasury Department avoid an outright takeover of the company, Ely said.

Fannie or Freddie would likely pledge mortgages and securities from their portfolios as collateral in return for the loans. That would help avoid a complete government takeover. The Federal Reserve opened up a similar lending option for investment banks in March shortly after the collapse of Bear Stearns. Previously only retail banks were able to borrow money from the Fed, using loans as collateral. 

Rising Cost of Debt Stokes Fears On Freddie's Prospects
Freddie Mac was forced to offer unusually rich terms to investors in a $3 billion auction of its debt, raising anew concerns about the health of the mortgage giant, a vital prop for the U.S. housing market.

Investors increasingly believe the U.S. government will take steps to rescue Freddie Mac and its sibling, Fannie Mae. The Treasury Department recently received authority from Congress to bail out the two companies, although it stopped short of doing so. Both now play a dominant role in financing mortgages. A rise in the companies' borrowing costs could translate into higher mortgage rates for consumers, prolonging the housing slump.

The worries about Fannie and Freddie and the weak U.S. housing market in general contributed to a global stock market selloff that left major indexes down about 2%. In the U.S., the Dow Jones Industrial Average fell for the second day in a row, dropping 130.84 points. Shares of banks and brokers declined, with Lehman Brothers Holdings leading the retreat, falling 13% to $13.07.

Shares of Freddie and Fannie, which were down more than 20% on Monday, fell 5% and 2% on Tuesday, respectively, as investors worried that a government aid plan would wipe out the value of their stock holdings. The decline in the companies' share prices and the high interest rates they have to pay for their bonds could themselves hurt Freddie and Fannie by causing investors to lose confidence.

Last month, Congress granted Treasury the temporary authority to take an equity stake in the firms or loan them an unlimited amount of money. Treasury Secretary Henry Paulson has said the government has no plans to use the authority granted by Congress to shore up Freddie Mac and Fannie Mae.

But Mr. Paulson wants a plan ready in case the government has to step in, according to people familiar with the matter. The Treasury Department has been wrestling with how to structure such a rescue, should one become necessary, these people say.

One concern at Treasury is that market conditions can deteriorate quickly, necessitating a fast response. Mr. Paulson was heavily focused on the question during his long return flight home from the Beijing Olympics last week. A key consideration is whether the companies can fund themselves, which Freddie Tuesday demonstrated it was able to do.

The company, however, had to pay hefty interest rates. The five-year notes were priced to yield 4.172%, or 1.13 percentage point above yields on safe Treasury notes, the highest "spread" Freddie has ever paid on such debt.

Underscoring the significance of any government intervention, senior Wall Street executives have suggested to Treasury it might look to historical examples such as the 1984 rescue of Continental Illinois, a Chicago bank whose collapse still represents the biggest-ever bank failure.

Both Treasury and the companies are in somewhat of a bind. The government is reluctant to intervene and had hoped to reassure markets by asking Congress for temporary authority to take an equity stake in the firms or loan them money.

Meanwhile, Freddie's ability to raise capital, and therefore avoid a bailout, is constrained by the uncertainty created by the government's deliberations, according to people familiar with the matter. Investors are unlikely to buy new Freddie shares if they fear the government might mount a rescue that would hurt the value of those shares.

Freddie executives are due to meet with Treasury officials Wednesday to discuss the situation and the two sides may explore whether the Treasury could clarify its intentions in a way that would reassure investors. Mr. Paulson asked for the authority as a means to reassure the markets that the government wouldn't allow the companies to fail.

But the companies' share prices have continued to fall as investors fear that the two won't be able to avoid a government bailout. Fannie and Freddie own or guarantee more than $5 trillion of home mortgages or nearly half the total outstanding.

The companies' increasing financing costs tend to push up mortgage rates paid by consumers. Mortgage applications are at their lowest levels since December 2000. For the week of Aug. 8, applications were down about 37% from a year ago, with purchase applications off 32% and refinance applications down 44%, according to the Mortgage Bankers Association.

Two weeks ago, Treasury hired investment banking giant Morgan Stanley to help it "analyze and understand these authorities, should circumstances ever warrant their use." Morgan Stanley bankers are working with Treasury staff to come up with a series of options it could use to shore up Fannie and Freddie depending on various market conditions.

Among the issues being debated is whether to force out management as part of any investment or loan. There is also debate about what to do about the companies in the long term. If Treasury were to take an equity stake at a high price, it would benefit shareholders.

Coming in at a low price would essentially wipe out the shareholders, making the government the de facto owner of the firms. It's not clear whether Treasury would treat both companies equally or devise a rescue for one and not the other.

Some market observers say an investment or a loan from the government will perpetuate a model that no longer works. Fannie and Freddie are government-sponsored enterprises -- meaning they were chartered by Congress -- and yet also public companies. "The better step would have been to have legislation that would have permitted them to be taken over immediately," said Peter Wallison, a former Treasury general counsel and critic of the companies.

As home prices continue to fall in much of the country, the collateral backing loans guaranteed by Fannie and Freddie is dwindling in value., a provider of real-estate data, released an estimate Tuesday that 14% of U.S. homeowners -- about one in seven -- owe more in mortgage debt than the current market value of their home.

One option for both companies is to reduce their purchases of home loans and related securities to conserve capital. But that would reduce the flow of money into the market and push interest rates up for consumers, perhaps prolonging and deepening the housing slump.

Still, investors did show up for Freddie's Tuesday auction. Asian investors, traditionally large buyers of agency debt, made up 30% of the demand, while European investors made up 10%. North American investors, including many investment managers, picked up much of the slack; they contributed 59% of the demand. In Freddie's previous note auctions over the past year, total Asian and European investor demand averaged 51%, versus the 40% this week.

Most central banks and foreign investors fully expect the U.S. government to stand behind Fannie and Freddie's debt obligations. But many are already holding significant amounts of the companies' debt and are unwilling to add to their positions at a time of uncertainty.

"The worry is not that they won't get their money back, but that negative headlines will continue and it will be hard for them to explain why they are adding to their positions at this time," says Ajay Rajadhyaksha, head of U.S. fixed-income research at Barclays.

Some analysts think Treasury needs to act faster to put its plan into action by injecting fresh capital into Fannie and Freddie as soon as possible. Freddie's auction was a "litmus test of support from Asian investors," said Michael Cheah, a bond-fund manager at AIG SunAmerica Asset Management in Jersey City, N.J. "The market dodged the bullet today, but from now on, is going to be a cliffhanger," he added.

Freddie officials were upbeat about the sale. "We are pleased with how it went down," a spokeswoman said. "It was a large offering, and that it was oversubscribed points to the fact that our liquidity position and access to the world's capital markets remains very strong."

She noted that spreads on the debt of many other financial companies have been widening in recent weeks, and that August is typically a slow month for the markets in Asia.

Markets tumble as Rogoff warns worst of credit crisis still to come
Renewed fears about the length and severity of the financial crisis sent shivers through markets yesterday after an influential economist predicted a big American bank failure and said the worst was yet to come.

Kenneth Rogoff, the former chief economist at the International Monetary Fund, warned that the financial sector was probably only halfway through the year-old crisis.

"We're not just going to see mid-sized banks go under in the next few months, we're going to see a whopper. We're going to see a big one, one of the big investment banks or big banks," Mr Rogoff, who is now an economics professor at Harvard University, told a conference in Singapore. "We have to see more consolidation in the financial sector before this is over."

American financial stocks suffered for a second straight day amid concerns about the financial strength of Fannie Mae and Freddie Mac, the government-sponsored mortgage finance companies. After each lost about a quarter of their value on Monday, the companies' shares fell again yesterday, with Fannie down 2.3 per cent – to its lowest for 19 years – and Freddie losing 5 per cent to its lowest since 1991.

Mr Rogoff added to fears about the giant companies, which underpin the US mortgage market. "Probably Fannie Mae and Freddie Mac – despite what US Treasury Secretary Hank Paulson said – these giant mortgage guarantee agencies are not going to exist in their present form in a few years," he said.

The financial sector was also spooked by an analyst's note predicting writedowns of up to $4bn (£2.1bn) in the third quarter by Lehman Brothers, which was the biggest underwriter of mortgage bonds before the credit crunch took hold. "It will be another difficult quarter for Lehman" after benchmark commercial and residential property indices plunged, the JPMorgan Chase analysts said.

Investor fears hit bank shares on both sides of the Atlantic. In London, Barclays and Royal Bank of Scotland shares fell by more than 5 per cent, and HSBC fell more than 4 per cent. In New York, Lehman shares plunged more than 13 per cent, leading other big financial stocks such as Merrill Lynch and Citigroup lower.

The FTSE 100 index closed down 2.4 per cent at 5,320.4. The Dow Jones Industrial Average fell 1.1 per cent to 11,348.5. Top bankers, including John Varley, the chief executive of Barclays, have lined up recently to say that the biggest threat to the financial system had passed after financial institutions took about $500bn of charges from the turmoil.

Though lenders will have to cope with rising bad debts from the slowing economy, central bank action and the easing of money market pressure had reduced the chances of a big bank failing, they said. Bear Stearns was rescued in March after the US Federal Reserve arranged for it to be bought at a knockdown price by JPMorgan. IndyMac, a regional US bank, was taken over by US regulators last month.

Mr Rogoff said that state-owned wealth funds, which have injected capital into banks such as Citi, Merrill Lynch and Barclays, did not offer an answer to the financial crisis. "There was this view early on in the crisis that sovereign wealth funds could save everybody: investment banks did something stupid, they lost money in the sub-prime, they're great buys, sovereign wealth funds come in and make a lot of money by buying them.

That view neglects the point that the financial system has become very bloated in size and needed to shrink," he said.

Fannie, Freddie and Countrywide Issues Affect Everyone
Of late, “What will happen to Freddie Mac and Fannie Mae preferred shareholders?” and “What will happen to Countrywide debtholders?” seem to be the most pressing questions on the minds of credit market participants.

At least to me recent history is not helpful in answering those questions. The bailout of Bear Stearns, in which creditors were made whole and common shareholders received not only something, but a bigger something than originally offered -- all at the expense of the US government -- seems unlikely to be repeated any time soon. Back in March, the bailout was viewed by most as an “event.” Clearly, since then, we have entered an “era.”

Given the magnitude of the credit losses both incurred to date and yet to be incurred, I believe market participants would be far better served by spending more time trying to figure out how these losses will be allocated and far less time trying to project whether those losses will total $500 billion, a trillion or even 2 trillion.

The reality is that at this point everyone, from the senior-most debtholders to the most junior-shareholders, to individual borrowers to the US and foreign governments, will incur losses. And as we have already seen with the various bank takeovers by the FDIC, each situation will be handled differently. So how do I think these two specific burning issues will be resolved?

On Freddie and Fannie I expect that the government will invest in those entities at a capital level just below the now explicitly US guaranteed senior debt – think “super-senior" subordinated debt with warrants. To do anything different would provide a windfall to existing subordinated debtholders and preferred and common shareholders, which I believe would be politically unpalatable. 

At the same time, though, while common dividends will be eliminated, I expect that the existing preferred stock dividends and subordinated debt interest coupons will be paid.  Why? Because most of those securities are owned by other financial institutions.  

I don’t think the US government will needlessly inflict more pain to the already wounded, given that it is already standing by to bail them out thanks to the FDIC insurance program. (I would also add, given that most banks have already re-classed their Freddie and Fannie preferreds to held-to-maturity from held-for-sale, cashflows on those securities matter a whole lot more than market values.) Finally, on the warrants, I expect that Treasury knows that Congress will demand some level of upside in exchange for the bailout.  As a result, common shareholders will be eviscerated.

On Countrywide, I have always felt that the question was never “Will Bank of America buy Countrywide?” but “At what price will BofA buy Countrywide?” Well, it has now become clear that the price to be paid is going to come not just from BofA and Countrywide shareholders, but from Countrywide debtholders as well. My best guess is that BofA will drag the uncertainty out as long as it can, continuing to release more and more troubling data about the Countrywide portfolio.

Ultimately, though, I expect that BofA will tender for the bonds – at a substantial discount to par – and book some level of gain in the process. Remember, having closed the deal that no one thought he should close, Ken Lewis needs to find some way to save face with his board of directors.

But I hope by walking through these two examples, you can see that every deal will be different, and more importantly, given the magnitude of pain to be inflicted, everyone will be impacted.

Company Bond Risk Rises on Concern Bank Credit Losses Widening
The cost of protecting corporate bonds from default rose after analysts predicted Lehman Brothers Holdings Inc. may write down about $4 billion in assets, signaling losses at the world's largest banks and financial companies will deepen.

Credit-default swaps on Lehman and Merrill Lynch & Co. climbed to the highest in more than three weeks and contracts on Citigroup Inc., the biggest U.S. bank by assets, jumped to a five-week high. Contracts linked to the subordinated debt of Fannie Mae and Freddie Mac, the two biggest U.S. mortgage-finance companies, reached record highs for the second day on concern the government will be forced to bail out the companies, subjecting subordinated debt holders to losses.

Lehman has already reported $8.2 billion in writedowns and losses on securities linked to mortgages and other credit assets and will need to take more writedowns as "the credit environment continues to be difficult," according to a report by JPMorgan Chase & Co. analysts led by Kenneth Worthington. Financial companies worldwide have recorded $503 billion in writedowns and credit losses since the start of 2007.

"There are concerns about financials and the fact that they are definitely not out of the woods yet," said Olivia Frieser, a financial credit analyst at BNP Paribas SA in London. Credit-default swaps, contracts conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements. A rise indicates deterioration in the perception of credit quality; a decline signals the opposite.

The credit crisis that began last year after the collapse of the U.S. subprime mortgage market may topple some of the nation's biggest banks, Kenneth Rogoff, former chief economist at the International Monetary Fund, said in an interview in Singapore today.

"The worst is yet to come in the U.S.," said Rogoff, a Harvard University professor of economics. "The financial sector needs to shrink; I don't think simply having a couple of medium- sized banks and a couple of small banks going under is going to do the job."

Contracts on Lehman, the fourth-largest U.S. securities firm, increased 40 basis points to 375 basis points, according to CMA Datavision in London. They have climbed 71 basis points the past two days. Credit-default swaps on the Markit CDX North America Investment Grade Index, a benchmark gauge of credit risk linked to the bonds of 125 companies in the U.S. and Canada, rose 5.7 basis points to 143.6 basis points, according to CMA composite market quotes.

Contracts on the Markit iTraxx Financial index tied to the senior bonds of 25 European banks and insurers jumped 8 basis points to 88 basis points, JPMorgan prices show, a five- week high.

Bernstein cuts outlook on U.S. investment banks
Lehman Brothers Holdings Inc may post a third-quarter loss and incur fresh write-downs of about $3 billion, according to Sanford C. Bernstein & Co analyst Brad Hintz, who also cut his earnings estimates for Goldman Sachs Group Inc and Morgan Stanley.

Weakening credit market conditions in the third quarter indicate that more write-downs and hedging failures will likely impact U.S. investment banks' performance for the period, the analyst said Wednesday.

"We expect the quarter will again be characterized by mark-to-market valuation adjustments in mortgage-backed securities, commercial mortgage-backed securities and collateralized debt obligations holdings, as well as ineffective hedge performance," Hintz wrote in a note to clients.

Fixed income environment "substantially" weakened this quarter, and spreads for many credit market instruments are approaching their March highs, he added. The analyst forecast a third-quarter loss of $1.40 a share for Lehman. He earlier saw a profit of 74 cents a share for the fourth-largest U.S. investment bank.

Hintz is the latest in a string of Wall Street analysts to forecast a third-quarter loss at Lehman. Since last month, his rivals at Merrill Lynch, Deutsche Bank, Fox-Pitt and J.P. Morgan Securities have forecast a quarterly loss for Lehman.

Bernstein's Hintz also reduced his third-quarter earnings estimates for Goldman to $2.50 a share from $3.35, and for Morgan Stanley, to 81 cents a share from $1.04. According to Reuters Estimates, analysts expect Lehman to post a third-quarter loss of 95 cents a share, while Goldman is expected to earn $3.05 a share and Morgan Stanley is seen earning 88 cents a share.

For 2008, Hintz cut his earnings outlook for Goldman to $14.50 a share from $15.34, and for Morgan Stanley to $4.50 a share from $4.73. He widened his 2008 loss estimate for Lehman to $4.65 a share from his prior estimate of a loss of $2.24 a share.

Analysts expect Lehman to post a loss of $4.78 a share for 2008, while Goldman is expected to earn $15.90 a share and Morgan Stanley is seen earning $4.45 a share, according to Reuters Estimates. Hintz rates Lehman and Goldman "market perform," and has an "outperform" rating on Morgan Stanley.
He cut his price target on Lehman to $28 from $4

Goldman cuts projections for Lehman, others
Lehman Brothers Holdings Inc. received more bad news on Tuesday after another analyst projected that the investment bank will unveil a big third-quarter loss.

William Tanona, an analyst at Goldman Sachs, said after the market closed he believes Lehman will post a $2.5 billion-to-$3.5 billion loss during the quarter. He also believes that any recovery for the troubled industry is still a few quarters away, and that many Wall Street banks will focus on purging their books of risky mortgage securities.

He also lowered third quarter and full-year estimates for Merrill Lynch & Co., JPMorgan Chase & Co., and Morgan Stanley. Major investment banks have written down more than $300 billion since the credit crisis began last year, with several posting the first losses in their company's history.

"Once again, the majority of our negative estimate revisions are being driven by higher than estimated write-downs on mortgage assets," he said in the report. "In addition though, we are also seeing results being negatively impacted by slower levels of client activity and expenses and fines from auction rate securities."

Tanona expects Lehman will be "very aggressive" in cutting its exposure to mortgage-backed securities through asset sales _ and that would follow a similar move made by Merrill Lynch last month. Lehman could reduce its overall mortgage exposure by 20 percent, or about a $15 billion reduction, he said.

This was the second analyst on Tuesday to issue a report warning of big losses at Lehman. JPMorgan analyst Kenneth Worthington said before the market opened in New York that he expects a $4 billion loss for Lehman during the current quarter. Similar projections have been made by analysts at Merrill Lynch, Deutsche Bank, and Fox-Pitt.

"We believe the management wants to leave its mortgage troubles behind and restore confidence, which it can best accomplish by reducing its higher-risk credit exposure," Worthington said in a research note. Also on Tuesday, Standard & Poor's kept its "Hold" recommendation on Lehman Brothers.

Beyond how much risk Lehman might cut from its balance sheet, and the amount of losses and write-offs it could potentially take, analysts are also speculating about how the company will raise fresh capital. There has been heavy speculation in the past few weeks that Chief Executive Richard Fuld might be considering the sale of all or part of Lehman's investment management business.

Such a deal could include the sale of Neuberger Berman, which it bought five years ago, to a private-equity company.
A spokeswoman for Lehman Brothers declined to comment. The company will report quarterly results in mid-September.
Lehman shares, already down 80 percent from its 52-week high of $67.73, took another beating on Tuesday. Shares closed down $1.96, or 13 percent, at $13.07. It gave up another 33 cents, or 2.5 percent, to $12.74 in after-hours trading. 

JPMorgan Warned California as Auction Market Neared End
JPMorgan Chase & Co., one of five banks to settle claims they misled investors who bought auction- rate debt, told California days before the market collapsed to be "vigilant" to the potential of further deterioration.

"The State must remain vigilant going forward because of the continued possibility of failed auctions," the New York- based bank wrote on Feb. 1 to State Treasurer Bill Lockyer. The $330 billion market for auction-rate securities collapsed on Feb. 13 when the Wall Street banks that ran the sales stopped propping up the market by using their own money to bid for unwanted bonds, a practice that had prevented auctions from failing during the market's three-decade history.

The collapse surprised thousands of investors, who found their money stuck in securities they couldn't sell. JPMorgan and UBS AG are among the banks that have agreed to buy back bonds and pay fines to settle with state and federal regulators who say the banks misled investors by selling auction-rate securities as liquid alternatives to cash even as the market veered toward collapse.

Lockyer received similar advice about the market's growing trouble from Zurich-based UBS and Bank of America Corp., based in Charlotte, North Carolina, as early as November, according to memos released today by the treasurer. Of the three, only Bank of America hasn't yet settled complaints it fraudulently marketed the long-term bonds as the equivalent of cash even as the market faltered.

"We heeded the negative signals that were in the market," Lockyer's spokesman, Tom Dresslar, said in an interview today. While the state began plan to refinance the debt in early January, it didn't pass along the warnings to other issuers in California, he said. The state refinanced $1.25 billion of the securities in the weeks after the market collapsed.

UBS said in a Nov. 30 memo sent to Lockyer's office to "expect auction-rate yields to continue creeping up" through March 2008. On Dec. 7, UBS said "We see continued pressure on ARCs, and expect further rate deterioration," referring to auction-rate certificates.

Bank of America told Lockyer in a Dec. 17 presentation that there was "significant uncertainty" surrounding demand for the securities because companies were selling the debt and "new retail demand is a little weaker," a reference to individual investors.

Bank of America's warning was reported today by the Boston Globe, which last month said JPMorgan, Lehman Brothers Holdings Inc., Morgan Stanley, Bear Stearns Cos. and Merrill Lynch & Co. warned Massachusetts Treasurer Timothy Cahill about faltering auction-rate demand as early as Jan. 10.

JPMorgan's memo said "issuers are reviewing their current exposure and considering whether the time may be right to exit the ARS market for another mode with less volatility or risk." By then, the yield on one series of the state's auction-rate securities was 3.58 percent, compared with a market average of 2.2 percent on variable-rate municipal debt, the bankers said in the memo. Even so, California should stay in the market unless demand worsened.

"Should conditions change, JPMorgan is available and stands ready to assist the State," the bankers wrote. JPMorgan agreed on Aug. 14 to buy back $3 billion of auction-rate securities and to pay fines of $25 million. UBS, Switzerland's biggest bank, said on Aug. 8 that it will redeem $18.6 billion of debt and pay $150 million in penalties. Morgan Stanley, Citigroup Inc. and Wachovia Corp. have also agreed to settlements.

Municipalities, student loan organizations and closed-end mutual funds used the auction-rate market for more than two decades, selling bonds maturing in as much as 40 years with interest rates set every seven to 35 days. New York State Attorney General Andrew Cuomo, the U.S. Securities and Exchange Commission, and other state regulators have been investigating the banks.

Single-family housing permits fall to 26-year low
U.S. home builders sharply reduced the number of new homes starting construction in July and dropped the number of new single-family permits to the lowest level in 26 years, the Commerce Department estimated Tuesday.

Housing starts fell 11% to a seasonally adjusted annual rate of 965,000 in July, close to the 960,000 expected by economists surveyed by MarketWatch. It marked the lowest level for housing starts in 17 years. June's starts were revised higher to a 1.084 million annual pace. Housing starts are down 29.6% in the past year.

Builders are frantically cutting back their production of new homes, trying to work off a mammoth glut of unsold inventory. Rising foreclosures on existing homes are complicating the builders' efforts to bring supply back down to meet sluggish demand.

"The drop is good news because what is sorely needed in the housing market is a decrease in supply, not an increase," wrote Tony Crescenzi, chief bond market strategist for Miller Tabak & Co. "The lower the better." In a separate report, the Labor Department said the producer price index jumped 1.2% in July, while core wholesale inflation (which excludes food and energy prices) rose 0.7%, far above expectations.

The big decline in July was largely payback from a surge of permits and starts in June sparked by a new building code in New York City that provided a big incentive to rush major condominium and apartment-building permits through before July 1. The number of building permits for single-family homes and condos fell 17.7% to a seasonally adjusted annual rate of 937,000, down 32.4% in the past year.

For single-family homes only, permits fell 5.2% to a 584,000 pace, the lowest since August 1982. Single-family permits have plunged 41.4% in the past year. The number of permits for single-family homes in the West region fell 10.8% to the lowest level in at least 20 years.

"We look for the single-family category to decline by another 15% to 20% before reaching a trough later this year or early next," wrote David Greenlaw and Ted Wieseman, economists for Morgan Stanley. The number of single-family homes under construction in July fell 3.5% to 491,000, the lowest in 16 years. The number of single-family homes completed dropped 7.2% in July to a 791,000 annual pace, the lowest since March 1983.

The government cautioned that its monthly housing data are volatile and subject to large sampling and other statistical errors. In most months, the government can't be sure whether starts increased or decreased. In July, for instance, the standard error for starts was plus or minus 9%. Large revisions are common.

It can take four months for a new trend in housing starts to emerge from the data. In the past four months, housing starts have averaged 1 million annualized, down from 1.01 million in the four months ending in June. On Monday, the National Association of Home Builders said builder confidence remained at an all-time low in August, although expectations for future sales improved slightly.

National City Bonds Show Defaults KeyCorp Can't Deny
Never have regional banks been so disrespected by bondholders. National City Corp. Chief Executive Officer Peter Raskind says Ohio's biggest lender is the "best capitalized of all major U.S. banks" after raising $7 billion this year, yet its bonds show it's at risk of default.

Cleveland-based National City's bonds have plummeted as much as 17 cents on the dollar since June and yield more than 10 percentage points above Treasuries, similar to Ford Motor Co. debt. KeyCorp, Comerica Inc. and Fifth Third Bancorp have also tumbled, falling as much as 14 cents.

The declines underscore growing speculation among investors that the more than $500 billion of credit losses and asset writedowns sparked by the collapse of the housing market are nowhere near ending, and there is little Federal Reserve Chairman Ben S. Bernanke or Treasury Secretary Henry Paulson can do.

"It's like catching a falling knife and I'm not real interested in that," said Eric Johnson, president of Carmel, Indiana-based 40/86 Advisors Inc., which manages $25 billion in fixed-income assets. Until yields on corporate credit and mortgages stabilize, "it's still going to be too early to buy."

More than a dozen regional banks have been closed by state or federal regulators since 2007. The number of lenders on the Federal Deposit Insurance Corp.'s "problem" list climbed to 90 in the first quarter from 76 in the fourth quarter, the agency said in May, without naming the firms.

Pacific Investment Management Co., manager of the world's biggest bond fund, is buying "global national champions" like New York-based Citigroup Inc. while avoiding regional banks, said Mark Kiesel, executive vice president. He doesn't find smaller institutions attractive even with the increase in yields because the government isn't necessarily willing to bail them out.

"I don't think every bank out there is too big to fail," Kiesel said in an interview from his Newport Beach, California, office. The global banks are "more diversified, they have more stable deposit bases and larger capital bases. They're more stable and under the direct influence of the Fed."

Kiesel, who oversees $180 billion in corporate bonds, said he's concerned the housing slump will spark losses on consumer loans, including credit-card and auto debt. Payments were late by at least 30 days on 4.03 percent of all credit-card debt in June, up from 2.92 percent in May 2007, according to the six largest U.S. credit-card lenders.

"Everything's still negative to me when I look at the fundamentals of where housing prices are going to go," Kiesel said. "There's still a lot of potential shoes to drop." He predicted housing prices will fall at least another 10 percent. Investment-grade bank bonds yield 4.02 percentage points more than Treasuries on average, the most since at least 1996, according to Merrill Lynch & Co.'s index containing $514 billion of the debt.

A year ago, the spread was 1.44 percentage points. The bonds trade at an average of 92 cents on the dollar, down from 98 cents at the end of 2007, the index shows. Yield spreads widened even after the Fed cut its target rate for overnight loans between banks 3.25 percentage points the past 11 months to 2 percent as losses on subprime mortgages led to a downturn in housing and slowing economic growth.

In an effort to bolster confidence in the housing system, Paulson asked Congress on July 13 for emergency powers to inject "unspecified" amounts of government funds into Washington-based Fannie Mae and McLean, Virginia-based Freddie Mac if necessary. Even so, the Fed said Aug. 11 that its quarterly survey shows most "domestic institutions reported having tightened their lending standards and terms," making funds scarcer for consumers and small businesses.

"I've been at National City for 30 years and a month and for 29 of those we've seen nothing like it," Thomas Richlovsky, National City's 57-year-old treasurer, said in a telephone interview. "In past cycles certainly lending, or credit, has gotten more difficult. The cost of credit would go up. In this particular phenomenon of the last year it's not like you can borrow money and the price went up. No, the market's closed."

National City on July 24 reported a $1.76 billion second- quarter loss and increased its 2008 forecast for uncollectible debt to as much as $2.9 billion. The Cleveland-based bank raised $7 billion of capital in April, which Richlovsky said is more than enough to weather the seizure in the credit markets.

The stock sale wasn't enough to stop National City's bonds from tumbling. Its $700 million of 6.875 percent notes due in 2019 traded last week at 61 cents on the dollar, down from 77.5 cents in June and 99 cents at the beginning of the year, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

The debt yields 14 percent, or 10.2 percentage points more than Treasuries, Trace data show. Bonds that trade at a spread of 10 percentage points or more are considered "distressed." Such bonds default within one year 22 percent of the time, compared with 1 percent for non-distressed junk bonds, according to Martin Fridson, chief executive officer of New York-based research and investment firm Fridson Investment Advisors.

National City's bonds are rated A3 by Moody's Investors Service and A by Standard & Poor's, the seventh- and sixth- highest investment-grade rankings. "The one thing that is distressed is the bond market itself," said Richlovsky. "From a traditional corporate finance perspective this is an investment-grade company: The rating agencies say so and the balance sheet says so."

US Mortgage Applications Fall To Lowest Level Since December 2000
Mortgage applications in the U.S. declined last week to the lowest level since December 2000 as fewer homeowners sought to refinance their mortgages.

The Mortgage Bankers Association's index of applications to buy a home or refinance a loan dropped 1.5 percent from the prior week to 419.3. The group's purchase index fell 0.4 percent and its refinancing gauge slumped 3.7 percent.

Higher borrowing costs, stricter loan standards and falling property values are preventing owners from tapping into home equity, raising the risk that consumer spending will slow even more. The worst homebuilding recession in 26 years is likely to remain a drag on growth.

"The biggest threat to the economy is the fragility in the financial system, which stems largely from the deteriorating performance of residential real estate credit," Michael Feroli, an economist at JPMorgan Chase & Co. in New York, said before the report. "That performance is unlikely to improve until there are signs of some stabilization in house prices."

The purchase index fell to 314 after no change the prior week. The refinancing measure declined to 1034.5, also the lowest level since December 2000, from 1074.6 the prior week.

The share of applicants seeking refinancing fell to 34.8, the lowest since July 2006, from 35.2 percent the prior week.
The average rate on a 30-year fixed loan dropped to 6.47 last week from 6.58 percent, the report showed. In mid January, the rate was at an almost three-year low of 5.5 percent.

At the current rate, monthly borrowing costs for each $100,000 of a loan would be $630, or up about $62 from the January low. Borrowers face stiffer lending guidelines, according to the Federal Reserve's quarterly survey of bank loan officers published last week.

About 75 percent of the officials indicated they tightened standards on prime mortgage loans, up from 60 percent in the April survey, the Fed said. Banks that originate non-traditional mortgage loans also toughened lending rules. The average rate on a 15-year fixed mortgage decreased to 5.99 percent from 6.17 percent. The rate on a one-year adjustable loan dropped to 7.07 percent from 7.15 percent. It had reached a seven-year high of 7.25 percent in July.

Homebuilders are struggling to boost earnings amid the housing slump. The five largest U.S. homebuilders reported a combined $1.08 billion in losses in their most recent quarters. The Washington-based Mortgage Bankers Association's loan survey, compiled every week since 1990, covers about half of all U.S. retail residential mortgage originations.

Federal foreclosure-purchase program may fall flat in California
To Congress, it looked like a way to both ease blight and provide affordable housing: give local governments $4 billion to buy, repair and resell homes lost to foreclosure.

But the program -- included in the landmark housing bill signed by President Bush last month -- faces growing doubts among real estate experts and economists, who point out that the government will now be competing with lenders and private homeowners who have been struggling to sell in a depressed market.

What's more, an analysis by The Times shows that the California communities with the most foreclosures -- and therefore likely first in line for federal aid -- already have a relatively ample supply of affordable housing. Of the top 12 counties in California with the highest foreclosure rates, only Sacramento County has a similarly high need for affordable housing, according to records from MDA DataQuick and the California Assn. of Realtors.

"I'm not sure this is the most cost-effective use of these funds," said Kerry Vandell, director of the Center for Real Estate at UC Irvine. "Sometimes an experiment like this is just that, an experiment. And you don't find out until later that it doesn't really work out too well."

Local governments, meanwhile, appear to have had little input into the program, even though they would play a central role in implementing it. The Times contacted housing officials in the 12 California counties with the highest concentrations of foreclosed properties. Most of them said they had not lobbied for the bill, and several wondered whether they even had the staff to make use of the funding.

In Kern County, housing authority director Stephen Pelz thinks Congress may have been focused more on showing its concern with the foreclosure crisis than on finding an effective solution.

"There was a sense that they needed to put some money toward the problem and do that fairly quickly before the election," Pelz said. "That's probably why there wasn't as much of a consultative process as there might have been had they had more time to put something together and really vet it out."

The purchase program was a hotly contested provision of the housing bill. President Bush threatened a veto over the issue, claiming the $4 billion would be a bailout for banks and others who made bad lending decisions.

Bush dropped his opposition after Congress agreed to include a potential $25-billion safety net for mortgage giants Fannie Mae and Freddie Mac, which are federally chartered but investor owned. The bill also aims to stave off foreclosure for 400,000 or more homeowners by allowing them to refinance into low-cost government-backed loans.

The purchase program was first championed by U.S. Rep. Maxine Waters (D-Los Angeles). On a 2006 visit to Cleveland, Waters said, community activists drew her attention to neighborhoods dotted with vacant homes and foreclosure signs. Waters said she later talked with people in Riverside and San Bernardino who complained about the same thing. "These empty homes are creating nesting places for criminals," Waters said. "Later I discovered that this was a result of the subprime meltdown."

Under the legislation, the Department of Housing and Urban Development must devise a plan by Sept. 28 to equitably distribute the funds to local governments. After purchasing the vacant homes, cities and counties would work with private nonprofit and for-profit groups to make any needed repairs and sell or rent them to low- and moderate-income home buyers.

These nonprofit groups, including the New Orleans-based Assn. of Community Organizations for Reform Now and Enterprise Community Partners in Columbia, Md., were among the provision's biggest supporters. An umbrella organization, the National Housing Conference, took out ads targeting members of Congress who were fighting the $4-billion aid package.

"ACORN's interest is in making sure that the cities that are developing plans to use this money put it to good use," said Austin King, the group's Financial Justice Center director. But King also acknowledged that the dual problems of rising foreclosures and a lack of affordable housing cannot be easily fixed with one spending program.

In California, for example, most of the foreclosed homes are in areas such as the Central Valley, the Inland Empire and the Antelope Valley, locales known for their large stock of low-cost housing. If anything, these areas are becoming more affordable because of foreclosures, and sales have picked up in large part because of the availability of these homes at discount prices.

"Those foreclosures are being purchased at a very rapid rate, and they are going to families who have been previously price-excluded out of the market," said Mark Boud, a consultant who runs Real Estate Economics in Irvine. In Palmdale and Lancaster, among the state's cities with the highest percentages of foreclosed homes, Realtor Joe Mayol at Keller Williams said he's selling foreclosed homes at the rate of five a week.

"One comes on the market, and it's gone seven days later," Mayol said. June sales in the Antelope Valley were up 214% from the number in January. "Things are starting to turn around," said Pamela Vose, chief executive of the Greater Antelope Valley Assn. of Realtors. "I think if the government had wanted to buy homes a few months ago, maybe it would have helped, but if they're going to start six months from now or later, it can only hurt."

Vose and others are concerned that the government will be negotiating to buy homes in bulk from banks that own properties in multiple states, further weakening prices and providing competition to homeowners trying to sell in a down market. The new law mandates that local governments demand a price cut, and that could mean that new appraisals on all the properties near a government-purchased home would be dropped by a similar amount.

Median home prices in Southern California have fallen about 30% from their peak last year. Further price drops also could make it more difficult for people who are teetering on the edge of foreclosure to refinance their loans. And, with governments acting as buyers, they could shove aside renters who have been waiting for prices to drop and are just now deciding to buy a home.

"The truth of the matter is, any time the government gets involved, they distort the market," said Rep. Tom Feeney (R-Fla.). Feeney also wonders which local agencies are in a position to buy homes and oversee their redevelopment on a large scale. Typically, housing authorities help homeowners with loans and down payments, particularly in smaller, more recently established communities like the ones that have seen the most foreclosures.

"Who from these cities is in a position to do this work?" asked John Burns, an Irvine-based consultant who works with home builders. "On the surface it sounds like a good thing, but the logistics of it make it almost impossible."

Kern County's Pelz said that's a good question. Had they taken more time, he said, legislators might have found one key stumbling block in the bill: the requirement that 25% of the money be spent helping families that earn 50% of the median income. Most housing programs work with families that earn 80% or more.

The reason? When a low-income family moves into a home, it needs to have enough income to maintain it and thrive in the neighborhood. "Once you get to 50% of the median income, home ownership becomes difficult to stretch to. Even rentals can be exorbitant," said Eva Yakutis, the city of Riverside's housing director.

"Your water pipes break and you need to have the wherewithal to get them fixed. If you have a really low income, that could be tough."

SEC May Propose New Short-Sale Rules Within 'Weeks,' Cox Says
U.S. Securities and Exchange Commission Chairman Christopher Cox said his agency will propose new rules aimed at curtailing manipulative short sales of stocks in the "next few weeks." "Our proposals will be designed to ensure the smooth functioning of markets and to support equally the important role of bets on the upside and the downside," Cox told reporters in Washington today.

The SEC imposed a temporary measure last month that made it harder for traders to bet on declines in shares of Freddie Mac, Fannie Mae and 17 brokerages. The agency said the order was meant to prevent traders from driving down stocks considered at risk of manipulation after Bear Stearns Cos. and IndyMac Bancorp Inc. collapsed amid speculation they were faltering.

The measure, which expired Aug. 12, targeted so-called naked-short selling by requiring traders to actually arrange to borrow stock before executing a short sale. Prior to the SEC's order, investors were only required to locate shares in advance.

"We are looking to see what were the consequences of doing that," Cox said in a Bloomberg Television interview. The agency is also considering rules that would curtail short selling in all companies, not just a select few, he said.

Hedge funds at a loss to cope with mood swing
The hedge fund group that took a huge bet on Northern Rock as it was imploding last autumn has reportedly lost 85 per cent of its investors' money, amid evidence of a terrible spell this summer for many hedge funds.

SRM, the Monaco-based group that raised $3 billion from investors in September 2006, is down by 85 per cent, according to The Wall Street Journal, including a minus 77 per cent performance in the past year. Tight lock-up terms prevent investors from withdrawing their money.

SRM, which was founded by Jon Wood, the former UBS investment star, is also thought to have been burnt by disappointing investments in Countrywide Financial, the American mortgage group; Bear Stearns, the investment bank rescued by JP Morgan; and Cheniere Energy, a struggling Houston-based energy company.

The news from SRM, which bought more than 10 per cent of Northern Rock only to see it nationalised, comes as many rival hedge funds post losses after being wrongfooted by the sudden change in sentiment over energy prices, financial stocks and the dollar.

Many alternative asset managers, who pride themselves on their ability to make money regardless of market conditions, posted their worst figures for years in July and most are nursing losses for the year to date. Paragon Global Opportunities Fund, which is run Polar Capital, the London-based hedge funds group, was down 12.41 per cent in July to $897.2million.

The United States-based Pequot Global Fund is believed to have been badly hit, with one expert claiming that the fund suffered a “significant double-digit” percentage loss in July, which Pequot refused to comment on. Another big loser is Ospraie Management, which is 20 per cent owned by Lehman Brothers. Reports suggest that it has had $1billion, or 20 per cent, knocked off the value of its Ospraie Fund this year.

For months hedge funds made money positioning themselves for energy prices and mining stocks to rise and financials to fall. But that trend reversed in July. Similarly, the US dollar regained investor popularity two weeks ago, badly burning anyone positioned for it to remain weak.

John Godden, a hedge fund consultant with IGS Group, said: “Commodity trading funds, which had a storming year till June, have been hit by the falls in energy prices. They make money on trends and when trends unwind, they lose money.”

Christopher Fawcett, the head of Fauchier Partners, a London-based hedge funds investment group, said: “There was a tendency for funds that did well in June to do badly in July.” Nevertheless, Absolute Return Trust, Fauchier's listed vehicle, was up 1.8 per cent year to date at the end of July.

Hedge fund returns sank by 2.82 per cent in July, according to the HFRX index of hedge fund returns, leaving year-to-date returns at minus 3.83 per cent, a poor performance by the standard of recent years. So far in August, returns are down by 1.59 per cent.

Mr Godden said that other hedge funds were doing well, with merger arbitrage funds and dedicated short sellers “making out like bandits”.

Fed's Lacker Clashes With Paulson on Fannie, Freddie
Richmond Federal Reserve Bank President Jeffrey Lacker called for "demonstrably" privatizing Fannie Mae and Freddie Mac, becoming the first Fed official to publicly clash with the Bush administration's strategy of keeping them as federally backed firms.

"I would prefer to see them credibly and demonstrably privatized," Lacker said today in an interview with Bloomberg Television. He agreed with former Fed Chairman Alan Greenspan's view that the two largest U.S. mortgage finance firms ought to be nationalized, then split up and sold off.

Treasury Secretary Henry Paulson by contrast has tried to keep Fannie Mae and Freddie Mac in their current form as government-sponsored companies owned by shareholders. Lacker's remarks come as a slide in the firms' stocks and increase in their borrowing costs spur speculation the Treasury will intervene.

Lacker said financial-market turmoil shouldn't keep the Fed from raising interest rates to bring down inflation, becoming at least the fourth Fed official to make that point in the past five weeks. "It is important to withdraw this monetary-policy stimulus in a timely way," Lacker said. "That may require us to withdraw before we are certain all of the weakness is behind us and before we are completely certain that financial markets are as tranquil as we would like to see."

Federal funds futures traders expect no change in interest rates through year's end. The Fed has reduced its main rate 3.25 percentage points over the past 11 months to 2 percent. "I certainly don't think the federal funds rate should be any lower given where we are," said Lacker. `Monetary policy is very stimulative."

Lacker also said he would be surprised to see a large U.S. bank fail. "I am broadly confident in the ability for commercial banks to weather the storm," he said. Still, there is "substantial uncertainty" around the losses and writedowns that will result from mortgages originated in 2006 and 2007, which could cause "other shoes to drop," he added.

Lacker's comments on Fannie Mae and Freddie Mac echoed the views by some former Fed officials, led by Greenspan, that the companies' links with the federal government ought to be severed. The firms package mortgages into bonds for sale to investors. They traditionally borrowed more cheaply than private companies because of an implicit government backing.

"It was an unusually straightforward answer for a Fed official," David M. Jones, president of DMJ Advisors LLC in Denver and author of four books on the central bank, said in an interview with Bloomberg Television. "There's still a debate over this issue" of addressing Fannie Mae and Freddie Mac, he said.

Paulson last month won the authority to inject capital into Fannie Mae and Freddie Mac, in legislation aimed at restoring confidence in the firms. Stocks and bonds issued by the two have since declined amid continued concern they lack sufficient capital.

"Treasury is monitoring market developments vigilantly," spokeswoman Jennifer Zuccarelli said in a statement. "We are focused on encouraging market stability, mortgage availability and protecting the taxpayers' interests." Lacker, 52, heads a district that is home to two of the four biggest U.S. banks, Bank of America Corp. and Wachovia Corp., both based in Charlotte, North Carolina.

A former head of research at the Richmond Fed, he alone dissented in rate votes at the Fed in late 2006, advocating higher rates to stem inflation. He votes again in 2009. The Richmond Fed president warned in June that the Fed, by expanding its financial safety net, may prompt investors to take on excessive risk.

Central bankers in March opened the discount window to investment banks and loaned $29 billion against a portfolio of Bear Stearns Cos. securities to facilitate a merger with JPMorgan Chase & Co. Since Lacker made the June 5 speech in London, the Fed has made available the discount window to Fannie Mae and Freddie Mac and agreed to a change in the law making it easier for the central bank to loan to failed banks under government control.

The Fed has also extended the availability of discount window lending to investment banks until January 2009. Fed Bank Presidents Gary Stern and Tom Hoenig have also expressed concerns about the expansion of federal safety nets for financial institutions.

"The too-big-to-fail problem has once again gotten worse," Stern said in an Aug. 14 speech in Three Forks, Montana. Lacker said in a separate interview with Bloomberg Radio he was wary of the Fed gaining more regulatory power. Congress, the Treasury Department and the central bank are reviewing regulation in light of the credit crunch. The Treasury has proposed giving the Fed more authority to safeguard market stability.

"Our ability to exercise independent judgment about the level of the policy rate I think is quite important," Lacker said. "I do see some merits to the argument that adding responsibilities could threaten to dilute the independence" that the Fed needs for monetary policy.

Lacker said he expects economic growth of about 1 percent over the next year, hampered by the continued slump in housing. Still, economic weakness shouldn't deter the Fed from its focus on inflation, he said. Inflation excluding food and energy prices is likely to rise to about 2.5 percent before moderating, Lacker said in his radio interview.

Lacker said consumers' expectations of inflation are "elevated" and show "fragility." "We are still in a fairly risky situation" on the inflation front, he said. The Fed can raise rates without impeding a credit market recovery and such a rate increase may occur sooner than many people expect, said Dallas Fed President Richard Fisher, who dissented Federal Open Market Committee votes five times this year, preferring to raise them last month.

Atlanta Fed President Dennis Lockhart said in an Aug. 15 interview he expected that "the reasonable policy debate will be around holding versus raising rates." Philadelphia Fed President Charles Plosser said July 23 that policy makers should act before inflation expectations become "unhinged."

Lacker's advocacy for an early rate increase may not prevail on the committee, according to Robert Eisenbeis, chief monetary economist at Cumberland Advisors, and former research director at the Atlanta Fed. Lacker "saw prospects for slower growth in the future," Eisenbeis said. "Yet he was also concerned about rising inflation. I think growth is going to be the dominant concern and that's what's going to carry the day for most of the people there."

Merrill's research may slow auction-rate settlement
The legacy of Henry Blodget may haunt Merrill Lynch & Co Inc as it negotiates a settlement with regulators for the way it sold auction rate securities to investors.

Blodget, you'll recall, was a Merrill analyst who earlier became the poster boy for the excesses of the Internet era when he was caught publicly recommending stocks he privately dismissed in e-mails.

While five other banks have settled with state regulators over their sales practices for the notes, legal experts say a deal with Merrill Lynch may take longer because of the firm's history of tainted research and evidence research may have been influenced in this case.

Documents seem to show Merrill Lynch analysts were pressured to write positive reports about auction rate notes, which were sold to investors as safe cash equivalents, but have proven increasingly difficult for investors to sell at face value over the last year.

That pressure on analysts follows Merrill's 2002 settlement with regulators over conflicts in research and could make settlement talks with New York Attorney General Andrew Cuomo much more drawn out and acrimonious.

"I think the attorney general is going to come down pretty hard on Merrill," said Jacob Zamansky, a securities attorney representing investors and auction-rate securities holders. "The research element looms large in the stalemate." A spokesman for Cuomo's office declined immediate comment, while Mark Herr, a spokesman for Merrill, also declined comment.

Wall Street firms have broadly been accused of understating the risks of owning auction-rate securities.
Last month, Massachusetts Secretary of State William Galvin charged Merrill Lynch with separate counts of fraud and dishonest and unethical conduct in relation to selling auction- rate securities after he amassed e-mails and research documents as evidence.

Cuomo's office said on Friday it is also preparing legal action against the bank after rejecting Merrill's settlement offer earlier this month. The New York attorney general said at the time that Merrill had five days to agree on a settlement plan before his office sues.

Merrill agreed in 2002 to cut links between research and banking to avoid conflicts of interest and Blodget was eventually barred from the securities industry and ordered to pay $4 million. "Merrill does have a tawdry history with this," said Steve Thel, professor of securities law at Fordham University, referring to Merrill's settlement in 2002 with then attorney general Eliot Spitzer.

E-mails show a senior banker directed Merrill's research department in 2007 to revise a report seen as undermining the auction-rate securities market. In another e-mail in January, a senior research analyst passed a report to bankers for review, writing: "I want to make sure research cannot be accused of causing a run on the auction desk, like was the case in August."

Lance Pan, director of investment research at Capital Advisors Group, said Merrill was "a bit more aggressive in using the research arm in obtaining a positive light before the market collapsed." But for regulators, this apparent use of research is likely to be key.

"This company was aggressively selling (auction rate securities) to investors and its auction desk was censoring the research analysts to make sure they downplayed ARS market risks in research reports up to the day Merrill pulled the plug on its auctions," Galvin said in a statement in July.

Ilargi: Anyone who claims the credit crisis is "only half-way over" either has no idea what’s going on, or is not telling the truth. The mere suggestion that some sort of recovery will be reached a year from now is ludicrous. What, pray tell, would be the foundation for that recovery? In August 2009 the situation will be much worse than today, and with no end in sight.

Half-time in the credit crisis and the score is only going to get worse
It is a natural instinct to see anniversaries as turning points. But it is already clear that the credit crunch's first birthday 10 days ago was not the moment when the global economy started putting the crisis behind it.

Indeed, former IMF chief economist Kenneth Rogoff warned yesterday that the worst may yet be to come – sparking another sell-off on world markets already spooked by concerns about the scale of the problems at the US state-backed mortgage giants Freddie Mac and Fannie Mae.

Could we really only be half way through this cycle, as Mr Rogoff suggests? The answer is yes, now that what started as a banking crisis has spread throughout the economy. The first phase of this grim period was marked by disastrous losses on mortgage-backed securities. But now banks are facing up to a much more conventional source of write-offs – mounting bad debts.

On both sides of the Atlantic, unemployment is continuing to rise while house prices keep falling. The result can only be further increases in the number of people unable to service the record levels of personal debt taken on over the past 10 years. That means further pain for the financial sector, further pressures on consumer confidence and further setbacks for sectors from construction to retail.

Britain and America have already taken different views on how to tackle the crisis. Only yesterday, Tim Besley, a member of the Bank of England's Monetary Policy Committee, was warning that we cannot give in to the temptation to cut interest rates sharply to counter an economic downturn, because doing so would risk a return of 1970s-style inflation.

The US Federal Reserve, on the other hand, has been less cautious, and the US Government has also done its bit with generous tax incentives designed to get people spending. The consequences of these two approaches have been as you might predict. The US is battling a much worse inflation problem than the UK – look at yesterday's producer price figures, for example – but economic growth in America is holding up better than here.

We'll get an idea today of whether Mr Besley and his colleagues are moving closer towards the American view when the Bank publishes the minutes of the MPC's last meeting. We know, of course, that the MPC voted to hold rates at 5 per cent, but did anyone join David Blanchflower in the corner clamouring for a reduction (or for that matter Mr Besley's corner, where the call was for a rate rise)?

It is harder for the MPC to throw caution to the wind on inflation, because it is held to account very publicly every month on its performance. Still, while the Bank's inflation report last week suggested it now sees inflation peaking at a higher rate, it also expects this peak to be reached more quickly.

The currency markets interpreted that conclusion as a signal that interest rates will fall sooner than had been previously expected. Even so, cuts in the cost of borrowing are unlikely to come in the next couple of months. And despite recent corrections on global commodity markets – the original source of the West's inflation problem – price rises, as the Bank acknowledges, are set to continue.

The most recent figures did not even include the latest price hikes from the likes of British Gas. What this means for household finances is pretty simple – the squeeze on disposable income is set to continue. And as more and more borrowers come off cheap mortgages, arrears levels will increase.

So too will repossessions. Then the second phase of the crisis will really take hold. Mr Rogoff thinks a major US investment bank will be the next victim of this affair. But closer to home, there will be many much smaller victims before this downturn is over.

UK mortgage lending slump to continue
Homebuyers may find it even more difficult to get a mortgage in the next few months, the Council of Mortgage Lenders has warned, suggesting the slump in house prices will deepen.

Latest figures from the CML show that mortgage lending was down almost 30 per cent in July compared with the same month last year - to the lowest July figure since 2002. The latest decline stands out because July is typically one of the busier months for mortgage lending.

The CML blamed the shortage of mortgage funding and slower demand among home owners for the worsening conditions. Bob Pannell, CML head of research, said: "In the absence of fresh interventions from the authorities, mortgage lending activity is set to worsen in the second half of 2008."

He explained there is a "dampening of consumer demand due to tightened lending criteria, declining house prices and pressures on household finances from higher food and energy costs". While gross mortgage lending is down 27 per cent from July last year, it actually increased by 5 per cent the previous month to £24.8 billion in July.

But Mr Pannell added: "While there was a small month-on-month increase in activity, it represented a notable decline from a year ago. "This continues the weaker picture seen in June and points towards the more subdued levels of lending we are likely to see in the second half of 2008."

His comments come just a day after Kenneth Rogoff, chief economist to the International Monetary Fund between 2001 and 2004, told an audience in Singapore that "the financial crisis is at the halfway point, perhaps."

Now an economics professor at Harvard University, Mr Rogoff said. "We're not just going to see mid-sized banks go under in the next few months, we're going to see a whopper, we're going to see a big one, one of the big investment banks or big banks."

The economic gloom threatens more misery for homeowners who have already seen the value of their properties plunge at the fastest rate since the crash of the early 1990s. The CML said its mortgage lending figures - based on completions - are expected to get worse because the Bank of England said last month that mortgage approvals had plummeted by more than two-thirds in a year.

Mortgage approvals were down from 41,000 in May to just 36,000 in June - the lowest level since records began in 1993, the bank said.

France calls emergency economic meeting
French ministers have been summoned back from their holidays for an emergency meeting in a bid to head off recession after the economy shrunk for the first time in six years.

But after approving €13 billion of tax reductions last summer, Francois Fillon, the Prime Minister, had little to offer his compatriots except long-term structural reform. He ruled out a cash injection similar to the €20 billion package ordered by Jose Luis Zapatero, his Spanish counterpart, in an attempt to pull Spain's economy out of crisis last week. “We don't need an economic stimulus plan, which would be an artificial plan,” said Mr Fillon.

He said he would push ahead with implementation of President Sarkozy's programme, which includes pledges to modernise the economy, reduce state spending and introduce flexibility into a rigid labour market. “We are not relaxing in our effort” to cut public expenditure, Mr Fillon said.

He added that he would call European Union finance ministers together in the search for a “common response” to the slowdown.
EU countries should “commence this attempt at coordination which, it has to be said, hasn't happened yet,” he said. With the French economy shrinking by 0.3 per cent in the second quarter and the Bank of France predicting growth of just 0.1 per cent in this quarter, the country is teetering on the edge of recession.

The meeting in Paris - called in the middle of the sacrosanct Gallic holiday season - amounted to a tacit admission that the Government has abandoned hopes of escaping the global economic crisis. After claiming for months that France would enjoy growth of about 2 per cent this years, Mr Fillon accepted that the figures would have to be 'adjusted'.

Most economists say the French economy will grow by between 1 per cent and 1.5 per cent. The details of today’s Bank of France survey showed a rise in spare capacity at businesses, which is already above its long-term average as activity slows. The results also showed the outlook for the intermediate goods sector, car making, and consumer goods sectors suggested declines over the coming months. The only brighter spots were in capital goods, food and agriculture.

Companies’ order books fell, although orders remained above normal levels, while stocks of completed goods posted a small rise. Activity in the market services sector, ranging from hotels to computer and engineering services, showed moderate growth but the survey found forecasts pointing to limited growth over the coming months.

With consumer spending drying up, the trade gap heading towards €50 billion over the past year, and business confidence dropping by three points in July, Liberation, the left wing daily, said Mr Sarkozy's dream of kickstarting France was “turning into a nightmare”.

Shirakawa Moves to Demystify Bank of Japan Policy in Transparency Push
Bank of Japan Governor Masaaki Shirakawa, after four months on the job, is making one of the world's most opaque major central banks more transparent.

When policy makers kept the benchmark rate at 0.5 percent yesterday, they listed the reasons for the decision. Until July, they said nothing when they held rates steady. The bank is increasing the number of forecasts it publishes, and instead of just signaling the direction of borrowing costs during his press conferences, Shirakawa tries to explain his thinking about the economy.

The changes by the University of Chicago-educated Shirakawa, 58, bring the Bank of Japan into line with moves worldwide to help outsiders better understand how decisions are reached. Clear communication helps to anchor inflationary expectations and makes it easier for investors to predict rate changes, said Nariman Behravesh, chief economist at Global Insight Inc. in Lexington, Massachusetts.

"There is a sense of mystery about what the BOJ does, more so than with other central banks, so this is Japan's attempt to follow" its counterparts, said Behravesh. Shirakawa is tackling tradition even though he came to the job by default in April. Prime Minister Yasuo Fukuda's first and second picks were rejected by the opposition parties that control Japan's upper house of parliament. That left Shirakawa, who became deputy governor only weeks earlier.

Japan's central bank has been independent from the government for only 10 years, and Shirakawa's predecessor, Toshihiko Fukui, 72, made some moves toward transparency. In July 2005 the bank started publishing the number of votes for and against a move at the time it announced a decision. In February 2007, it began to identify, on the day of the decision, how each member voted.

Shirakawa has already established a style that some economists welcome for its clarity. He "provides detailed explanations and solid logic, though his language is more boring than Fukui's," said Mari Iwashita, chief market economist at Daiwa Securities SMBC in Tokyo. "He also tries to avoid comments" that may mislead markets, she said.

Iwashita cites the June 13 press conference as an example. Asked about the risks of rising commodity prices on inflation, Shirakawa said the bank was more focused on their effect on growth. His answer damped speculation that he might raise borrowing costs after a report two days earlier showed producer prices climbed at the fastest pace in 27 years.

"Shirakawa carefully avoided commenting on inflation risks and instead underlined that Japan's economic situation is different from those of the U.S. and Europe," Iwashita said. "If it had been Fukui, he would have made more hawkish remarks."

Benchmark 10-year bond yields retreated after he spoke, falling to 1.74 percent in the following week from 1.88 percent before the briefing. The steps toward more openness follow greater disclosure at other central banks. In May 2007, Sweden's Riksbank started holding press conferences after all meetings. In November, Ben S. Bernanke increased the number of forecasts the Federal Reserve issues each year to four from two.

"At last, major central banks have given up secrecy," said Allan Meltzer, a Carnegie Mellon University professor who was an honorary adviser to the BOJ between 1986 and 2002. For all the efforts at transparency, Shirakawa said he doesn't plan to flag rate decisions, in contrast with ECB President Jean-Claude Trichet, who has used the phrase "strong vigilance" to indicate increases.

"De facto announcement of the future level of the policy interest rate means disregarding the changes in economic conditions after such an announcement," the governor said in a July 18 speech. Central banks' efforts to be more open have sometimes backfired.

In April 2006, Bernanke said the Fed might suspend rate increases even if risks between inflation and growth weren't "entirely balanced." Some people said this meant he was less worried about inflation, only to find in August that the Fed still identified prices as its chief concern.

An increase in transparency may help to insulate the BOJ from political interference. Three days before the policy board met in January 2007, Hidenao Nakagawa, then the ruling Liberal Democratic Party's secretary general, said the government might ask the bank to postpone a rate increase in comments interpreted at the time as an attempt to meddle in the board's decision.

At the meeting, the bank held the benchmark rate at 0.25 percent, waiting until the following month to double it.
"With a clearer picture of the BOJ's intentions, investors can be more confident about their own forecasts, which makes it harder for politicians' comments to sway markets," said Hiroaki Muto, a senior economist at Sumitomo Mitsui Asset Management in Tokyo.

Of 26 economists surveyed by Bloomberg News this month, 21 said there will be no increase in borrowing costs by June 2009, four projected higher rates and one forecast a cut. n"Shirakawa's true test will be whether he can properly manage investors' expectations when the bank starts to prepare for a rate-policy change," said Seiji Adachi, a senior economist at Deutsche Securities in Tokyo. "That we have yet to see."

Finns Sell Out as Russians With Money Snap Up Lakeside Cottages
Arja Viitikko agonized before selling her home and land to Russians. Then she took the money.

"I thought about it -- am I selling piece by piece the land my grandfather fought for?" said Viitikko, 45, who in November 2006 sold a 21-hectare (52-acre) island and, later, a house in Savonlinna, north of Helsinki, to Russian buyers. "But these days, someone is going to sell anyway, so why wouldn't it be me?"

Buoyed by rising oil wealth, Russians are snatching up lakeside cottages and building single-family houses in Finland, whose border lies just 200 kilometers (124 miles) from St. Petersburg, Russia's second-biggest city. On the dirt roads of Eastern Finland, Jeeps and sport-utility vehicles driven by the new buyers mix with Toyotas and Volkswagens owned by locals.

Russians spent 76 million euros ($111 million) on Finnish property last year, accounting for three-quarters of all property sales to foreigners, up from one-quarter four years ago. The purchases illustrate the double-edged sword Finland faces as Russia, 50 times larger in land mass and 27 times larger in population, reasserts itself in European affairs.

Finland enjoys Russia's money while treading quietly on the political front. Prime Minister Matti Vanhanen, for instance, avoided condemnation of Russia's invasion of Georgia this month, saying, "We aim to be as equal as possible." "The more Russia engages in power politics either through economic, political or military means, the more cautious" Finland becomes, said Risto Penttilae, director of the Finnish Business and Policy Forum EVA in Helsinki.

Russia is one reason why Finland has stayed out of the North Atlantic Treaty Organization, one of only six European Union members to do so. Finland supports Russia's bid for membership in the World Trade Organization, as well as the natural-gas pipeline being built under the Baltic Sea off Finland's coast to connect Russian supplies with the German market, Vanhanen, 53, has said.

Finland depends on Russia for two-thirds of its energy imports by value, including all of the natural gas it uses, according to Statistics Finland. Russia became Finland's biggest trading partner in the first quarter for the first time since the collapse of the Soviet Union. At the Finnish-Russian border, truck lines sometimes stretch for miles, angering locals sandwiched between large Russian transports.

"They're dangerous. And it isn't right that when we now finally have good roads, they're being turned into parking lots for Russian trucks," said Lappeenranta resident Reijo Litmanen, 55, who drives his van past the queues daily. The surge in trade and property purchases comes six decades after two wars between the countries ended in the Paris Peace Treaty of 1947, which ordered Finland to surrender an area the size of Denmark to the Soviet Union and pay reparations of $300 million. Finland was neutral in the Cold War.

While Finland's 1995 EU entry was a step toward the West and a security-policy statement, that goal was never openly spoken, said Liisa Jaakonsaari, a member of Parliament since 1979. "We don't react like that to any other country,", said Jaakonsaari, who chaired Parliament's Foreign Affairs Committee from 1999 to 2007. "There's too much sensitivity" toward Russia.

Finland's strategy has been to curry favor by maintaining constructive and friendly relations, the EVA Forum's Penttilae said. It doesn't always work: Russia has imposed duties on the exports of timber from the country to help modernize its pulp and paper industry. For the Finnish forest industry, which relies on Russia for 16 percent of its raw material, the tariffs will increase costs by about 150 million euros each year, Finland's foreign ministry estimates.

"I think it's clear that this strategy hasn't produced results," Penttilae added. "Finland is minuscule and insignificant from the Russian perspective." Not to Russian real-estate buyers, though. In Savonlinna, 335 kilometers northeast of Helsinki, Russians bought 15 percent of all properties sold last year, according to the National Land Survey of Finland.

"I'm up to my neck in work now," said Tatjana Ivanova, 37, who started a business in Imatra, in southeastern Finland, scouting for cottages and acting as an intermediary between Finnish real-estate agents and Russian buyers. "Business has soared from absolutely no demand five years ago."

Down the road in Taipalsaari, near the border, Mayor Jari Willman says the influx of Russians is tricky business.
"The price level has gone up," Willman said. And because the homes are only used in the summer, "the houses stay dark, snow isn't plowed and the town gains no economic benefit."

But in Imatra, St. Petersburg construction-company owner Valeri Kutakov relaxed on the lawn of his new cottage and said he couldn't be happier. "Finland's so clean and safe," said Kutakov, 52, as he looked at the pale green wooden house he had just renovated for his family. "Finns are law-abiding, and there is little crime."

The return of stagflation? No, it's just the end of inflation
Bloomberg Headline: Housing, Price Reports Raise Stagflation Fears

Grim as expected, housing starts fell 11% in July as builders broke ground on the fewest homes in 17 years. That's good. It demonstrates that even blind faith optimists have a pain threshold that cuts against denial. I was beginning to think some of these builders lacked the spasmodic gulping reflex that prevents normal human beings from drowning themselves to death while simply trying to get rid of the hiccups.

Meanwhile, the Labor Department reported producer prices soared nearly 10% higher than last year. The snap judgment that follows is that this cocktail of data has plunged us deep into Stagflation. "There's no doubt we're in a period of stagflation now," Bank of America senior economist Peter Kretzmer told Bloomberg.

For all I know he's probably right, but stagflation is a transfer station, not a hub, and we have a long, long way to... Holy Mother of Mary and Revelations!!! There's this bizarre news on the wire RIGHT NOW about a Dallas fisherman claiming something about snagging a feverish BEAST with digestive problems and some kind of ooze seeping from bursting pustules...

Never mind all that. I misread something in the story. It was not a Dallas fisherman at all. It was the President of the Dallas Federal Reserve, Richard Fisher, who in a speech earlier today said, "The recent burst of cost-push inflation is giving the beast digestion problems that might manifest themselves in the form of a lingering inflationary fever."

Clearly, things are even worse than I thought. When GOVERNMENT officials talk publicly and openly about strange BEASTS and FEVERS and things BURSTING open it means the whole train is off the rails. There's no stuffing talk of beasts back into the bottle and pretending you were joking. I once read a study claiming that the average person hears only about every seventh or eighth word of a 2,000 word speech.

But they will latch onto something like BEAST and FEVER and ACT accordingly. This can only mean terrible things are in store for Dallas. But I am only one man, and so from here in New York City I have no choice but to focus on the things within my immediate reach that I can control; various liquids and food items, scissors, assorted gels and the raw data release from the Labor Department focusing on the Producer Price Indexes.

I've always had a thing for numbers, a fascination with how dangerous they are, how easily they can be used to both shade the harshness of truth and char the eyeballs of bald-faced liars. Make no mistake, when a cop shines a Pelican 7060 LED Flashlight (130 lumens) in your eyes and asks how many drinks you've had, there's nothing haphazard or hollow about the question. Years of intensive psychological and physical training have gone into that tactical procedure, and the only answer under such dire circumstances is the right one, the truth.

So what's the truth behind these Producer Price Index numbers? Highest annual rate in 27 years? We better stop the car before we get the full-on Pelican 7060 treatment. Twenty-seven years? 1981? That's probably a felony. Clearly, there are some things we need to understand about this datapoint, so let's take a look.

The Producer Price Index tracks the prices producers receive for the stuff they make. It used to be called the "Wholesale Price Index" up until the late 1970s, but the name was changed to "Producer Price Index," probably because advertisers created widespread confusion and hysteria among government data collectors by offering stereos and eight track tapes at wholesale prices instead of retail prices.

Think about it. If you are the poor bastard at the Labor Department charged with collecting producer and consumer price data, you can't have retailers selling Uriah Heap eight tracks for wholesale - $6.99, maybe even less. That's the kind of steep price discounting that confuses the numbers and ruins everything. But that's neither here nor there. We're supposed to be focusing on the Producer Price Index... and what it all means.

The Bureau of Labor Statistics tracks Producer Price Index data through a sampling of producers in the manufacturing, mining and service industries. Together, we're going to comb through this thing like the professionals we are. Then, you can feel free to abuse yourself at your own discretion, on your own time, by looking at the report each month here. 

First, there is the so-called "headline" number, which is typically the first sentence in the Labor Department's release:  "The Producer Price Index for Finished Goods advanced 1.2 percent in June, seasonally adjusted..."  Because food and energy prices are volatile and show large fluctuations month-to-month, most economists pay closest attention to the "core" Producer Price Index, which excludes food and energy. The "core" reading today was an increase of 0.7%. 

Believe me, although there is widespread vicious antagonism and demented hatred toward the Federal Reserve and economists for their reliance on the use of "core readings," you'll want to think long and hard before hitching your cart to that strange tractor.

Trying to forecast inflation based on data that includes food and energy is like trying to judge how drunk you will be this evening by how much whiskey you had last night. It simply can't be done. There are too many competing factors involved, notably how much food you are going to eat today and how much energy you are willing to expend tonight in your efforts at intoxication.

In addition to the headline and the core reading, the PPI breaks down price data based on the stages of processing: Finished Goods, Intermediate Goods and Crude Goods.  Why?  For one thing, this helps sort out where pricing pressure - or the lack of pricing power - are building in the so-called "pipeline," a fancy term for the many different stages of production - from obtaining the raw materials, to processing the raw materials, to products that are finally "finished" and ready for sale. 

In today's PPI report, the Finished Goods PPI was up 1.2%. The Intermediate Goods PPI was up 2.7%. The Crude Goods PPI was up 4.2%. What does this mean? Think about it for a moment. 

If the prices you receive for your finished goods are rising at 1.2% month-over-month, while the prices for intermediate and crude goods are rising at a faster level - as they have been for almost six consecutive years now -  then that means you are finding it difficult to pass through price increases to your customers.  Below is a chart showing the spread between the Crude Goods PPI and the Finished Goods PPI.
The important thing to take away from this from a forecasting sense is the implied deflationary pressures that continue to build. The spread is now at its greatest point, a new high, which means that despite the "inflation" in the headline, there is an inability to pass through costs.

Marry that inability to pass through costs with ongoing housing price deflation, the balance sheet restructuring going on with banks, the reduction in credit availability to both Wall Street and Main Street and you can begin to understand how the obsessive focus on inflation is like a weird obsessive focus on the sun setting in your rear view mirror while you drive straight over a cliff


Anonymous said...

I look back at Spain's half century dance with low rent fascism and economic stagnation only to go hog wild over 'freedom' and 'democracy' and put themselves into a black hole of debt.

The US, who had 'freedom' and 'democracy for quite a while prior to the present criminal orgy it now finds itself mired in, is about to go over the event horizon.

Outright fascism seems to be in the air for the I.O.U.S.A. as a direct consequence of it's grossly irresponsible actions.

They will have to change the name from Homeland Security to Fatherland Security.

EBrown said...

Hi all,
I am wondering... how severe will the next leg down be? I'm of the opinion that only 1000 plus points dropping off the Dow in less than a week is enough to set off panic selling enough to drive us toward 8,000 at year's end. I think this because the stock market is the most widely followed barometer of "fiscal health" in the US, and there are many people out there who are quite anxious about their portfolios, particularly as they pertain to retirement. Unfortunately I think most of the people I talked to at my former job will not do anything with their funds until most of the value is gone.

I also wonder when I will start to meet more people directly affected by the current crisis. I still only have one friend who is out of job (mortgage related, and unable to find a new one yet). How long will it take for stock market tanking and cash hoarding to filter into the larger economy? A few days? A few weeks? A few months? We're over a year into the current crisis and it has only forced people in a few industries to dramatically change their lives (cut spending, move, live from cars, etc). I anticipate the same changes becoming widespread and pervasive soon, but how rapidly will it unfold?

On the positive side I have moved to a new town (in up state NY). I have unloaded one of our cars, we can walk to a local grocery, to a local farm that sells raw milk and frozen meat, and our rental house is small. On the downside, the house is heated with gas (the cook stove is gas too). I have cash at home, but I jsut can't get comfortable. I really want a piece of my own land... Ah well, I'm hoping the crash isn't so precipitous that I can find some bargains on fertile land in a year or two.

Anonymous said...

The Barrons article seemed very suspicious to me also. I wouldnt be surprised to see more nails in the coffin coming from other media sources soon to completely obliterate the meager stockholder confidence left in F&F.


Anonymous said...

ebrown,yours is the question we all ponder,as we proceed with our daily lives.We[our minds] know the economic outlook is beyond bleak,and that terrible things are waiting in the wings.Waiting...but it does not look too bad now right?

Maybe the fixes their doing will work right?

Everything looks fine ,right?


This is one of the hardest things I personally have to cope with about this ongoing,slow motion nature of this catastrophe

We,as a species,are designed to deal with threats to our physical well being almost instantaneously,because in that natural world from whence we came,not to do so would result in becoming food.
We don't do so well with long term stuff.At all.[Witness the ongoing "debate" on climate change.]
I am starting to see more folks that are affected,and the first whispers of a slowdown at my company,although,due to the nature of its business[tech support for government entities]we should have seen more it a while back.Oregon is strange in that manor.We are always the last to recover from a downturn,and last to show the signs of a downturn.

I suspect this time however,the bad stuff will start blindingly fast,and,after the "trigger" event,

[either a start of a Iranian/US confrontation,or a butterfly fart,as some chaos theory people believe]

Things will come unglued really really fast...

Its a very good idea to start to stockpile[NOW!},prep for disruptions,think some about how you,[and yours] are going to eat when the trucks stop....


Anonymous said...

In regard to the question - "When does the big leg down start?" - take a look at the link I've attached to my name (no relation).

Ignore the article it comes from, just look at the graph of stock prices from 1929 to 1934.

You can see that the market retraced 60% of the initial fall by June 1930, and as late as a year after the crash it looked like a bottom had been reached.

Then the real slide starts.

If this is any guide (the psychology of denial, perhaps?) we could well see the market hold up until the first aniversary of the recent top - Novemember, in our case.

Anonymous said...

Feeling the pain in China?

I know the US press loves :D!!!! CHINA! Nothing ever bad happens there... right?

I have a good friend who talks to his lady friend almost daily (a respected academic lawyer in Beijing). People are losing everything in the Shanghai meltdown. They all leveraged themselves to the hilt and got in too late to make any money, no one expected the market to crash like it has. Sound familiar?

China is heading into a massive depression. Do not let the la la land gang tell you any different.

When the Olympic tide goes out, most of the boom boom will be going with it.

Anonymous said...

It looks like central banks around the world have decided to emulate Bernacke by establishing a facility where Residential Mortgage-Backed Securities could be accepted from financial institutions as collateral for cash.

The New Zealand Reserve Bank today set up such a facility. Its head of prudential supervision, Toby Fiennes, said,"This facility, like those used by other central banks, has been designed in case the global credit markets deteriorate further and make cash difficult to access. But the likelihood of this being needed remains extremely low," [Yeah, right!]

He also stated, "We are monitoring the situation closely and are in regular contact with key players, including other regulatory authorities."

EBrown said...

I watched the Elliot wave video "History's Hidden Engine" last night after reading some of the comments from previous days and noticing your recommendation. I found the hypothesis interesting and found myself with many questions. If social mood is the major determinant of such disparate areas as fashion and the stockmarket, what causes social mood to shift? I have a hard time buying the fibonacci explanation because it seems like there are little waves within bigger waves - how on earth can one determine which point corrosponds to each given elliot pattern? I guess some people must have success with it (by that I mean making money in the stock market or predicting social trends), but I would have a hard time predicting anything with certainty using such methods.

I get the herding instinct, and the triune brain. I'm totally on board with human emotions being very powerful drivers of behavior. For years I have thought that we humans kid ourselves about "how rational" we are. Many decisions I make in life are rationalized post hoc, not carefully plotted in advance. Somehow we maintain a myth of rational behaviour about ourselves even when it's commonly accepted that greed and fear rule in the trading world.

So I do think the socionomists are onto something in seeking the proximate cause of the Elliot waves in that area, but I can't understand garnering any specific predictive ability from such knowledge about how the human brain works.

Anonymous said...

Anonymous said...


The last 5 minutes of the interview is moving. Andrew Bacevich hopes we the people will look ourselves in the mirror and change. He says we need to have a conversation about the wars and the State similar to the one we had about Vietnam in the 1960's. I just don't think he understands the NationalSecurityState won't allow that kind of conversation any more.