Thursday, August 28, 2008

Debt Rattle, August 28 2008: Tinkerbell

Arthur Rothstein Ambridge Alley July 1938
Housing conditions in Ambridge, Pennsylvania, home of the American Bridge Company

Ilargi: Some days it’s hard to know whether to laugh or cry. US GDP numbers look great, the markets are dancing and singing, and words like bottom and recovery are effortlessly drawn straight from the crocodile’s mouth.

Fannie Mae (with new/old leaders/bonuses) and Freddie Mac shares keep recovering, their market cap is back up over $10 billion, which obviously is more than enough to cover $5.3 trillion in obligations. They sold $2 billion more in debt, and the sun shines. Never mind that in the land where that same sun rises, Fannie and Freddie debt is thrown overboard like so many rotten eggs.

MBIA digs another very desperately deep hole for itself, but this time because it knows there’s $700 million hidden somewhere at the bottom. Wherever that bottom may be. And Kohlberg Kravis Tinkerbell buys Lehman. What a wonderful life it can be.

But then I see that the FDIC is estimated by Chris Whalen to need half a trillion dollars. That personal bankruptcies rise 29%, despite the 2005 legislation designed to make them much harder to come by.

And that delinquent construction loans rise more than 200% in just one year, a little feat that will drown more banks than I care to count.

Looking at all that, I know that what is happening on Wall Street today is that a lot of little people are losing a lot of big money.

Nothing much has changed since the 1930's; only this time around the amounts and the losses and the misery will all be much greater. A sure sign of all this is the falling dollar. Apparently not all investors have the same heysanna hosanna mood.

But enough of the US. We do a boatload of Europe today. In Spain, 2.5 million housing units were built in the past few years, and 1.2 million of them were never sold. Now that hurts. Certainly when the ECB credit tap is about to be shut off.

The first real reports about France are surfacing, and they're not pretty. Connections between French banks and US monoline insurers are getting mighty expensive. There'll be lot more from there soon.

And England finally gives up resisting the reality that it's about to fall into a very very deep hole. Not even the central bank tries to keep the dance going, while the big unelected leader hasn't been heard from in ages.

None of these countries, and their citizens, understand yet what is going to befall them. Maybe that's a good thing; many would be jumping out of windows if they did.

The FDIC Needs $500 Billion Backstop: Whalen
The Federal Deposit Insurance Corp.'s (FDIC) list of troubled banks has increased by 30 percent this quarter, and this jump is causing the FDIC and the banking community to prepare for tomorrow’s problems today.

The FDIC may have to borrow money from the Treasury Department to handle an expected wave of bank failures coming down the road, according to the Wall Street Journal.  It would not be surprising if this were to occur, according to Chris Whalen, managing director of Institutional Risk Analytics. In an interview with CNBC, Whalen said the FDIC needs a backstop.

"They need about a half a trillion dollars in borrowing authority, and they need a vehicle to own these banks while we triage them and sell them." Whalen added that he expects big bank failures might be on the way.

"It depends on the loss rate," he said. "If we are way over 1990s levels, by say the third quarter, then I would tell you there’s going to be some institutions that may not be able to raise private capital and may need a bridge."

The discussion was prompted by an announcement Tuesday by the FDIC that it was increasing the number of banks on its watch list to 117, up from 90 in the first quarter.

“We don’t think this credit cycle has bottomed out yet,” said FDIC Chairman Sheila Bair at a press conference Tuesday.  “I don’t like to make predictions, but I think it’s going to continue to be very challenging, and as I said I think the number of banks and assets on the troubled bank list will continue to go up.”

Lehman To Be Acquired by Tooth Fairy, Tinkerbell and a Crocodile
The market responded with enthusiasm to reports that the Tooth Fairy has agreed to acquire Lehman. The purchase price has not yet been determined and will be set by Dick Fuld wishing upon a star, clicking his heels three times, and being transported back to that magical place where Lehman still sells for over $70 per share.

In related news, Lehman has agreed to sell all of its level III capital, including CDOs, ABSs, pet rocks, baseball cards, slightly used condoms, and credit default swaps written by MBIA and Ambac. Lehman’s level III capital will be acquired for 150% of its face value by Tinkerbell, who will carry it off to Neverland to be fed to a crocodile.

Lehman is financing 90% of the acquisition at an interest rate that has not been announced; Tinkerbell’s up-front payment consists of a handful of pixie dust, three crickets, and a bullfrog. Analyst Dick Bove estimates that the bullfrog could eventually be transformed into three princes and a pumpkin coach.

The deal gives Lehman no recourse to any of Tinkerbell’s assets other than the Level III capital. If Tinkerbell defaults, Lehman’s successor entity will stick its hand down the crocodile’s throat and attempt to get it to regurgitate. The firm’s historical value-at-risk analysis shows that sticking your hand down a crocodile’s throat is completely safe.

Treasury Secretary Hank Paulson issued a statement: “I am delighted that SWFs (Sovereign Wealth Fairies) continue to express confidence in the terrific values represented by American financial institutions. As I have been saying since August of 2007, this shows that the crisis is now over.”

Meanwhile, the SEC has announced an investigation of mean, evil, bad short-seller David Einhorn. While out for a beer with a friend, Einhorn reportedly suggested that the Tooth Fairy does not exist and that wishing upon a star is not a wholly reliable price discovery mechanism.

Christopher Cox, chairman of the SEC, said, “Vicious rumors attacking the Tooth Fairy will not be tolerated. Our entire financial system and indeed the American way of life depend on the Tooth Fairy and wishing upon a star. How else could one value level III capital appropriately?” The SEC is reportedly planning to set up re-education camps for short-sellers.

Fannie Mae shakes up management team
Mortgage finance giant Fannie Mae shook up its executive ranks Wednesday, after shares in it and sibling company Freddie Mac rose for a third straight day as investors appeared less certain a government bailout of the two troubled companies is imminent.

Fannie Mae, the largest buyer and backer of U.S. home mortgages, said its chief financial officer and two other top executives are leaving the company. Three current executives were promoted to replace them. Fannie Chairman Stephen B. Ashley said in a statement that board members remain "firmly committed" to Chief Executive Daniel Mudd.

Mudd was elevated to the top post in December 2004 when former CEO Franklin Raines and chief financial officer Timothy Howard were swept out of office in an accounting scandal. Fannie and Freddie saw their stock prices plummet last week as fears mounted they would soon need government support and that any bailout would leave stockholders in the lurch.

The government-sponsored companies hold or guarantee half the U.S. mortgage debt and are considered crucial to the mortgage market's continued operation. But shares of both have climbed back in recent days, as analysts have cast doubt on whether any government rescue is truly inevitable.

Fannie shares rose 86 cents, or 15.3 percent, to $6.48 Wednesday, while Freddie advanced 78 cents, or 19.7 percent, to $4.75.
Fannie Mae said CFO Stephen Swad, who joined the company last year from Internet company AOL LLC, is leaving to "pursue other opportunities" in the private equity business. He is being replaced by David C. Hisey, formerly Fannie's senior vice president and controller.

Peter Niculescu, formerly head of the company's capital markets business, was named chief business officer, replacing the retiring Robert J. Levin. Michael Shaw, formerly a senior vice president for credit risk oversight, is taking over as chief risk officer for Enrico Dallavecchia, who is also leaving the company "to pursue other opportunities in finance and risk management."

But banking industry consultant Bert Ely, a longtime Fannie and Freddie critic, was unimpressed by the changes, noting that the company promoted current executives, rather than hiring from outside. "I don't see these changes making a dramatic difference in how the whole Fannie and Freddie fiasco plays out," Ely said.

The Bush administration last month unveiled a plan to provide unlimited government loans to the two mortgage giants and to purchase stock in the two companies if needed for a period covering the next 18 months. But Merrill Lynch analyst Kenneth Bruce wrote in a research note Wednesday that speculation about an infusion of capital by the U.S. government is "somewhat premature" as Fannie and Freddie's financial cushion against losses won't be depleted for several quarters. Investors "are overly discounting a possible catastrophic event," he wrote.

Similarly, Citigroup analyst Bradley Ball said in a research note Monday that Fannie and Freddie still have options despite their steep stock declines in recent weeks, adding that "we are not convinced that (the government) needs to take any action over the near term." Washington-based Fannie Mae completed a $2 billion sale of short-term debt on Wednesday, two days after McLean, Va.-based Freddie Mac sold the same amount of debt.

Large money market funds, which are major buyers of Fannie and Freddie's short-term debt, are still comfortable holding it, said Peter Crane, president of Crane Data LLC, which tracks money market mutual funds. "Most managers are taking the position that it would unthinkable to imagine a scenario where (the government) wouldn't back the debt," he said.

Other analysts, however, continue to express a gloomier outlook. Peter Schiff, president of Euro Pacific Capital in Darien, Conn., a longtime bearish investor, predicts that the companies' losses could eventually hit $1 trillion or more as housing prices fall far further than most analysts expect. "The end result is probably going to be that they go bankrupt and the government nationalizes the function," Schiff said. "There's no way they can survive."

Concern also has been growing that a government rescue of Fannie and Freddie could be costly for scores of investment, banking and insurance companies that hold billions of dollars in their preferred shares. The two companies had nearly $36 billion in preferred shares outstanding as of June 30, according to filings with the Securities and Exchange Commission.

Banks that could suffer the most include Gateway Financial Holdings Inc., Midwest Banc Holdings Inc., Financial Institutions Inc., Westamerica Bancorp. and Sovereign Bancorp Inc., analysts at Friedman, Billings Ramsey & Co. said in a research note Wednesday.

Fannie Mae held $47 billion in "core capital" — the main measurement of the company's ability to withstand losses — as of June 30, $9.4 billion above government requirements. Freddie Mac's $37.1 billion in core capital was $2.7 billion more than government-required levels. Still, many investors believe that cushion could wither away due to soaring losses from bad mortgages.

Why Fannie and Freddie Will Survive (Alas)
In the continuing drama of the housing market, let's recognize that Fannie Mae and Freddie Mac don't "need capital," at least not quite in the way you might think. It's their shareholders who need capital.

As long as Fannie and Freddie's debt is backed by the full faith and credit of the U.S. government, Fannie and Freddie don't need to be solvent. They can continue to function. The world's lenders will continue to lend to them. At this week's refunding, Freddie paid less for its money than a blue chip like IBM or GE would pay, even as Freddie's share price verged on penny-stock territory.

So the two mortgage giants don't need the capital-raising everybody urges on them -- but their shareholders do. An injection of new money is their best hope of avoiding a total wipeout in a government takeover of one description or another. Existing shareholders know this. Freddie was selling for $3.99 yesterday compared to $67.20 a share a year ago. Even a walloping dilution at the hands of new investors would leave plenty of upside for the existing shares.

Which brings us to the two Henrys -- Henry Waxman and Henry Paulson. What's foiling Mr. Paulson's "bazooka"-in-his-pocket plan for bailing out the two without taxpayer money is the failure of private investors to put up the necessary recapitalization so the government won't have to.

This, despite Mr. Paulson's assurances that he favors their survival in their "current form" and promise that any recapitalization with federal money would come only on terms agreeable to them. Ditto the fine print of the law Congress passed last month. Only their regulator, the new Federal Housing Finance Agency, appears to be unbound by any need to get their permission before finding them insolvent.

But any regulator, including the current James Lockhart, would surely defer to a broad governmental agenda at the highest levels to keep them in private hands. Enter Mr. Waxman, head of a key House oversight committee, who appears to want to blame unnamed White House whisperers for supposedly touting the nationalization option, frightening away investors.

C'mon, Mr. Waxman. How could their fate, now that the chickens have come home, not be a subject of scuttlebutt in every corner of the political universe? You might as well ask a democracy not to debate. Managing political risk, not financial risk, after all, has always been Job One for Fannie and Freddie CEOs.

Nonetheless, Mr. Waxman is exactly right that perceptions of political risk are the factor inhibiting the recovery in Fannie and Freddie's shares that Mr. Paulson so devoutly wishes, thus inhibiting the market from supplying the fresh private capital to get Treasury off the hook.

But notice Mr. Paulson's apparent equanimity. He's been conspicuously silent on the sturm and drang in the share market, except to dispatch a subordinate to reiterate that he sees no need to exercise the expansive "authorities" that Congress gave him to recapitalize them with public money.

There is a message in his muteness, and it's this: "I, Paulson, understand that their share prices are irrelevant as long as the government backs their debts. You, Mr. Market, are testing my will, but soon you will understand too. Then Fannie and Freddie shares will recover. Investors will realize their taxpayer-backed business model is going to survive and will step forward to provide whatever amount of capital their regulator specifies. Bill Miller, the Legg Mason fund guru who's been on a bad run lately, was prescient when he doubled down on Freddie's shares."

The key is Mr. Paulson, in whom the new housing bailout law invests near-monarchical powers. As Fannie's Daniel Mudd recently told the American Banker: "Hank Paulson ran an investment bank. He understands that . . . it's very important that there be an attractive shareholder proposition so that investment comes into the company so that the company's capital is built."

Regular readers will know we're predicting with our head, not our heart, here. But there's a strong chance Mr. Paulson's pocketful of bazooka will work. Fannie and Freddie's shares will begin to creep up -- or melt up -- as some brave, politically astute capitalist figures out that their privileged existence can be secured by putting the necessary money into them. Fannie and Freddie will survive -- and, tragically, America will have missed a rare opportunity to get rid of them.

Fannie-Freddie debt sale bodes well
Fannie Mae and Freddie Mac on Wednesday sold a combined $3bn of short-term debt, helping to reassure stock markets that the two beleaguered US mortgage financiers could still fund their operations without a government rescue.

Fannie sold $2bn in three and six-month bills and Freddie sold $1bn of one-month paper with stronger-than-usual investor demand as buyers were attracted by higher interest rates. The sales helped to boost Fannie’s shares by 11.4 per cent in early trade, while Freddie was 13.6 per cent higher. Michael Englund, analyst at Action Economics said of Freddie’s sale: “As a test of investor demand it would appear that the troubled housing agency passed this time.”

The debt issues came after Freddie conducted a similar sale on Monday and Citigroup analysts on Tuesday recommended the stock of both companies. Brad Ball, analyst at Citigroup, said the two US government-sponsored mortgage financiers could withstand losses up to the end of the year and an imminent government rescue was unlikely, particularly if they were able to maintain their access to the debt markets.

The US Treasury was granted powers late last month to extend its credit lines to Fannie and Freddie and invest in their debt and equity. Last week, expectations mounted that Treasury Secretary Hank Paulson could have to use these powers to rescue the two stumbling government-sponsored mortgage companies with taxpayer money. Fears that such an intervention would wipe out equity holders drove shares in Fannie and Freddie to lose around 40 per cent of their market value.

However, more positive sentiment has this week helped the two companies stage a strong recovery as investors have been comforted that Fannie and Freddie’s continued access to debt funding could stave off a government intervention. Freddie is up more than 50 per cent since Monday, and Fannie has risen by more than 20 per cent.

Japan's Net Sales of Foreign Debt Reach Record High
Japanese investors made the biggest weekly net sales of overseas bonds since at least 2001 on currency swings and concern the U.S. housing slump will worsen.

Sales of overseas securities exceeded purchases by 1.42 trillion yen ($13 billion) in the week ended Aug. 23, according to figures based on reports from designated major investors released by the Ministry of Finance in Tokyo. JPMorgan Asset Management Japan Ltd. said last week it was reducing its holdings of debt issued by Fannie Mae and Freddie Mac.

"Japanese investors have been constant sellers of agency debt," said Hideo Shimomura, who oversees the equivalent of $4 billion as a chief fund manager at Mitsubishi UFJ Asset Management Co. "Major Japanese institutional investors are likely to have sold agency bonds" in the week ended Aug. 23

In addition to being net sellers of foreign bonds and notes, Japanese investors also sold a net 82.8 billion yen in overseas stocks and bought 154.1 billion yen in short-term overseas securities, Finance Ministry data showed. That resulted in total net sales of 1.34 trillion yen.

"Although Fannie and Freddie are being aided by the government, there still is no guarantee on their debt, so it is difficult to hold it," said Daisuke Uno, chief bond and currency strategist at Sumitomo Mitsui Banking Corp. in Tokyo. "Without a guarantee, nobody will do anything as it's too risky, so they sold the bonds."

Local investors may also have sold overseas bonds due to increased volatility in major currencies, said Tsutomu Komiya, an investment manager in Tokyo at Daiwa Asset Management Co. "The forex market volatility has been so high that some investors are reluctant to hold foreign bond assets," said Komiya at the unit of Japan's second-largest brokerage, overseeing the equivalent of $88.7 billion.

Volatility implied by options for major exchange rates has risen nearly 2 percentage points from a year ago, according to data compiled by JPMorgan Chase & Co. The bank's index that tracks implied volatility on three-month options for the major currencies was 10.27 percent today, from 8.03 percent at the end of August 2007.

Overseas investors made net purchases of 557.9 billion yen of Japanese bonds in the week ended Aug. 23, sold 214.5 billion yen in stocks and cut holdings of short-term securities by 156.4 billion yen, the Ministry of Finance said. That resulted in total net purchases of 187 billion yen.

A Preferred Problem; Fannie, Freddie Downgrades Loom Large
Discussing the imminent future of either mortgage financial giant Fannie Mae or Freddie Mac these days is one thing; analysts remain strongly split over what lies in the crystal ball.

But discussing the effect of recent ratings downgrades to the preferred shares of both companies is another thing entirely. And unlike the discussion over future operations, it’s becoming clear that holding preferred interests in either GSE is going to be hazardous to Q3 earnings.

On Tuesday, Standard & Poor’s Ratings Services lowered Fannie and Freddie’s preferred stock rating to ‘BBB-’ from ‘A-,’ while cutting a host of other ratings as well, and warning that further cuts may be coming in the future. The ratings agency said it cut the ratings over “increasing uncertainty about whether government support will extend to these securities in the context of further deterioration” in each GSE’s assets.

JP Morgan Chase & Co. said late Monday in a filing with the Securities and Exchange Commission that it held approximately $1.2 billion par value of Fannie Mae and Freddie Mac perpetual preferred stock — now worth just $600 million.
The firm was the first large financial and major Wall Street firm to make such a disclosure, but it won’t be the last.

CEO Jamie Dimon has consistently kept his firm at the forefont of the credit crisis, staying well ahead of analyst and investor expectations; it’s a straight-shooting reputation the firm has developed that has served it very well within and outside of the Street, relative to peers.

As HW originally reported, Dimon famously said in a Q2 earnings call that prime mortgages looked “terrible.” The firm then disclosed an additional $1.5 billion MBS hit in July, while filing its 10-Q for the second quarter on Aug. 12.
Shares in JP Morgan rose 1.33 percent Tuesday to close at $36.61.

Other large shareholders are sure to report similar marks to their investment portfolio; among them is FMR, LLC, the parent of Fidelity Investments. FMR held more than $1.5 billion in common shares of Fannie and Freddie, according to SEC filings. Also in the group is Wells Fargo & Co., which holds a large preferred share position as well.

And, of course, there are more than a few smaller banks with positions in Fannie and Freddie stock that appear set to suffer as well: the New York Times on Monday cited Sovereign Bancorp, a regional lender in the Philadelphia area, as well as Midwest Banc Holdings, a community bank in Illinois, as other key holders of preferred shares in the GSEs.

Ilargi: Now why do I have this creeping notion that the Financial Times’ Krishna Guha is being used here to make the public believe that there has been no currency intervation?

Report of US currency rescue plan
The US, Europe and Japan discussed the possibility of co-ordinated currency intervention to support the dollar at the time of the Bear Stearns crisis in March, according to Japan's Nikkei online.

The US Treasury declined to comment on the report, which also claimed that the G7 had considered issuing an emergency communiqué during the weekend of March 15 to March 16. The Financial Times was unable independently to verify the Nikkei report. A G7 official said he understood that there were some preparations for possible currency intervention during that period, but did not comment on any international discussions.

As reported earlier in the FT, US and European policymakers have been concerned at various stages of the credit crisis about the possibility that, in an environment of persistent dollar weakness, a crisis at an individual financial institution could trigger a disorderly plunge in the US currency.

Such a disorderly decline would aggravate existing stress in other financial markets and could lead to foreign investors demanding a currency risk premium on all dollar assets, pushing up long-term US interest rates. It would also increase the stain on economies such as the eurozone that have floating exchange rates, pushing up their own currencies to unsustainable levels.

This concern was acute at the time of the Bear Stearns crisis. G7 policymakers were in contact during the crisis and discussed potential spillovers in international markets. However, in the event there was no emergency G7 statement. The G7 waited until their scheduled meeting on April 11 when they expressed concern about "sharp fluctuations in major currencies" and "their possible implications for economic and financial stability".

They added: "We continue to monitor exchange markets closely, and co-operate as appropriate." This statement marked a shift in international currency policy. Hank Paulson, US Treasury secretary, remained generally sceptical about currency intervention, but was careful not to rule it out in all circumstances.

Prior to March, US and European officials were at odds over currencies, with eurozone officials concerned about the decline of the dollar against the euro, but US officials broadly welcoming this as a prop to growth. However, following the April 11 G7 meeting, US and European officials told the FT they were united in their support for a stronger dollar. Ben Bernanke, Federal Reserve chairman, joined Mr Paulson in talking in public about the US currency.

Policymakers believe that a crisis at a financial institution is less likely to trigger a run on the dollar in an environment of general dollar strength. A stronger dollar also helps to curb oil and inflation, and support confidence in US assets. Without another Bear Stearns-style crisis, currency intervention remains unlikely, but if a similar crisis were to occur again and the dollar were to weaken precipitously, co-ordinated intervention is possible.

Euro prolongs recovery against dollar
The euro gained further against the dollar Thursday on market speculation that eurozone interest rate cuts are unlikely in the near future, dealers said.

In morning London deals, the European single currency rose to 1.4765 dollars from 1.4737 in New York late on Wednesday.
Against the Japanese currency, the dollar dropped to 109.08 yen from 109.47. The euro climbed further away from six month lows of below 1.46 dollars, reached on Tuesday in the wake of downbeat consumer confidence and business sentiment surveys in Germany, Europe's biggest economy.

"Anticipation of a quick rate cut by the ECB now seems to be fading on the back of comments by bank members and this has helped lift the euro away from recent dollar lows," said CMC Markets analyst James Hughes. The euro has been buoyed by comments from European Central Bank policymaker Axel Weber, who indicated the bank was unlikely to lower interest rates any time soon.

Up to now, markets have been expecting rate cuts from the ECB and hikes from the US Federal Reserve to narrow the rate differential in the two regions. The dollar was also being pressured by a fresh rise in oil prices on concerns that Tropical Storm Gustav could hit oil and gas installations in the Gulf of Mexico, dealers said.

Market players were looking ahead to another batch of US economic indicators, including second-quarter economic growth and a home price survey due Thursday. Dealers said the greenback could get a boost from the snapshot of economic second-quarter growth amid hopes it would be revised upwards from an earlier estimate of 1.9 percent.

But the market impact was unlikely to be huge as the growth figures were considered a lagging indicator, they added.
Meanwhile a report by the Japanese Nikkei business daily that the US, European and Japanese authorities drew up an emergency plan in March to rescue the plunging dollar brought some relief to markets, dealers also said. In the event no joint intervention took place.

But the report "suggests a more stable dollar in the long run, which should help keep overall foreign exchange market volatility low" and encourage risk appetite, a Tokyo trader told Dow Jones Newswires. Elsewhere on Thursday the British pound remained close to two-year lows versus the dollar as a survey from the Nationwide bank revealed that house prices continued to slump in August.

"The sharp decline in house prices persisted into August as weak buyer confidence and tight lending criteria continued to weigh on the market," said Capital Economics analyst Seema Shah. In London trading on Thurday, the euro changed hands at 1.4765 dollars against 1.4737 late on Wednesday, at 160.92 yen (161.32), 0.8030 pounds (0.8025) and 1.6136 Swiss francs (1.6161). On the London Bullion Market, the price of gold increased to 832.75 dollars per ounce from 827 dollars late on Wednesday.

Negative real interest rates may frighten Fed
All Federal Reserve board members reportedly want to raise interest rates -- albeit not just yet. Reason: behind the growth slowdown, real interest rates have turned dramatically negative.

Real interest rates are nominal interest rates less inflation. Negative real rates mean if you hold cash, and often all other financial assets as well, you're actually losing purchasing power. Negative real rates are often interpreted as a loss of confidence in the economy -- and a sign that inflation is getting out of control.

This week's release of minutes from the Fed's Aug. 5 meeting suggested more worry about the economy than did the Fed's policy statement at the time. But the fact that all Fed members think the next interest rate move should be up, and that a vocal minority think monetary policy is already too loose, is at least as significant.

Real interest rates have plunged abruptly and dramatically, deeper into negative territory than they've been for many years.
Our chart shows that real interest rates are already more negative than they were during the Great Stagflation of the 1970s. (And that episode, of course, lasted for several years).

Our chart also shows that real interest rates went sharply negative in the 1940s, reflecting a now-forgotten inflation spike during and after World War II. Some of this was probably statistical noise, caused by distortions introduced by wartime price controls and by the Fed's commitment to financing the huge wartime federal deficit.

But some of it was probably due to the "monetary veil" -- the tendency of investors unused to inflation to watch only nominal interest rates and to react slowly, if at all, when inflation's insidious impact begins to be felt. So marked is this tendency that the first edition of Sydney Homer's definitive survey, A History Of Interest Rates, first published in 1963 before the inflationary storm, did not mention the issue of nominal versus real interest rates at all.

Question: Are today's money managers, conditioned by more than two decades of positive real interest rates, ready to react quickly enough to negative rates? Our chart also shows the astonishingly high real interest rates in the 1930s. Nominal interest rates were low in the Depression. But prices were actually falling, a result of the Federal Reserve's fatally tight monetary policy.

If real interest rates are going to remain negative, on past form it will eventually provoke an epochal shift by investors out of financial assets and into tangible assets like gold and...real estate? Whatever happens, it's likely to be a worldwide phenomenon.

Real interest rates are historically low in most major economies, if not actually negative, as in the U.S. All over the world, central banks are trying to steer between recession and inflation. But they are running out of road.

Fed economists gave bearish growth outlook
The staff economists of the Federal Reserve presented a bearish growth forecast at the US central bank's last meeting on August 5, minutes of the meeting revealed yesterday.

The Fed staff cut their forecast for growth in the second half of 2008 and in 2009, citing a weak jobs market, unfavourable financial conditions, a lack of consumer and business confidence and falling manufacturing activity. The staff forecast that core inflation would "pick up somewhat in the second half of this year" then "edge down in 2009" as the impetus from past increases in commodity and import prices faded and widening economic slack moderated price pressures.

Fed policymakers meanwhile put renewed weight on financial sector stress and signs of softening global growth as they toned down the emerging hawkishness of recent months. There was extensive discussion of the danger of a renewed credit squeeze and a negative feedback loop from the financial sector to housing and back again.

Policymakers appeared less sure of the risks to growth and more concerned about the risks to inflation, with marked divisions between those close to the staff view and those who saw less danger from the financial sector. Fed policymakers expressed "significant concerns" about the risks to inflation and - with interest rates at 2 per cent - retained a de facto inflation bias towards raising rates.

While some thought the risks to inflation had eased with the decline in oil prices, others thought the risks to inflation had increased, and "a number worried about the possibility that core inflation might fail to moderate next year" unless interest rates were raised sooner than the market was expecting. But the central bankers made it clear that they would not move rates higher without regard to economic risks.

"Although members generally anticipated that the next policy move would likely be a tightening, the timing and extent of any change in policy stance would depend on evolving economic and financial developments," the minutes said. Fed officials focused on the "adverse financial sector developments" that had occurred since their meeting at the end of June.

Continuing "pressures" on Fannie Mae and Freddie Mac, the mortgage giants, had pushed up mortgage rates. Banks had reported that "terms and standards had been tightened on nearly all categories of loans". Declining prices of mortgage backed securities "increased capital pressures on lenders exposed to real estate markets" while a fall in bank stock prices meant "raising new capital had become increasingly difficult".

Meanwhile the broad stock market had declined, while borrowing costs for most companies had increased, with a "rise in corporate bond yields across most risk categories". However, the Fed was divided as to how great a danger this posed to the economy. Many Fed officials believed the worsening of the financial pressure would "restrain aggregate demand and economic growth". But some thought "the extent of such adverse effects was likely to be limited".

Ilargi: The US government has messed up its numbers so thoroughly over the past years, and its credebility in reporting them, that it’s hard to draw any conclusions from subsequent reports. One thing that irks me is the feeling that rising prices seem to raise GDP.

US second-quarter growth revised higher, could be high-water mark
U.S. economic growth in the second quarter was a whole lot stronger than previously believed, but it could represent the high-water mark for the economy for at least the next year.

The U.S. economy grew at a 3.3% real annual pace in the April-through-June quarter, the fastest pace in since the third quarter of last year, the Commerce Department reported Thursday. This was almost double the 1.9% estimate reported last month. Final sales increased 4.8% annualized, much better than last month's estimate of 3.9%. Core consumer prices rose at a 2.1% annual pace in the quarter, unrevised from the initial estimate. Economywide inflation jumped 4.2% in the quarter.

The upward revision to gross domestic product was largely due to increased exports and larger inventory accumulation. Economists surveyed by MarketWatch were expecting a revision to 2.7%. The strength in the quarter was powered by stimulus checks from Uncle Sam. The economy grew 0.9% in the first quarter after slipping 0.2% in the final three months of 2007. Over the past year, the economy has grown 2.2%.

In nominal terms, GDP grew at a 4.6% annual pace to $14.31 trillion annualized. In general, economists hold the view that the growth in the second quarter is not going to be matched or exceeded for the foreseeable future. Economists expect growth to slip to a 2% rate in the third quarter, and forecasts for fourth-quarter growth are downright grim. The Federal Reserve staff recently cut its forecast for growth over the next year, saying the economy isn't likely to rebound until next summer.

Weak banks, exhausted consumers and cautious hiring are expected to drag down growth in coming quarters. And with no end in sight for the drop in house prices, economists are unable to see an end to the financial-market stress that is holding back activity. Analysts are nearly unanimous in their prediction of no change in interest rates until next year, even though the central bankers will be uncomfortable leaving rates at the current 2% level for too long.

The economic growth mirage
Sure, the economy grew at a decent clip in the second quarter. But economists say the gain may be temporary and warn of tougher times ahead.

Despite all the talk about the U.S. economy falling on hard times this year, experts are predicting that the economy grew at a more solid pace during the second quarter. The government will release an update to the second-quarter gross domestic product report Thursday.

Economists surveyed by are forecasting an increase of 2.7% in the quarter, up from the 1.9% growth first reported last month. The GDP is the broadest measure of the nation's economic activity. Economic growth between 2.5% and 3.5% is typically viewed as the norm for a healthy economy.

But that doesn't mean that the United States has avoided a recession, some economists say. In fact, there are growing concerns that weakness will extend through the rest of this year and even into 2009. "My feeling is that the recession started in the fourth quarter of 2007," said David Wyss, chief economist with Standard & Poor's. "I think the worst quarter will be the first quarter of 2009, which would make it a long recession."

The National Bureau of Economic Research, a research group charged with dating the start and end of recessions, looks at factors such as payrolls, industrial production, real income and sales when determining when recessions begin and end. It has yet to make a ruling about the current state of the economy.

But many economists say temporary factors, such as the more than $90 billion in economic stimulus checks that reached taxpayers during the quarter, make the jump in the second quarter an anomaly. The economy grew at just a 0.9% rate in the first three months of the year and declined in the fourth quarter of 2007.

"Mostly what this report will say is, when you give somebody an $1,800 check, he spends it," said Wyss, referring to the tax rebate received by many families. Among the factors behind the likely upward revision to growth in the second quarter: more business inventories than originally estimated and improved trade figures.

The trade picture was helped by reduced spending on imports other than oil and by strong exports, due to a weak dollar, that made U.S. goods more attractive overseas. This may also prove to be fleeting. "With slowing of economies abroad, that gain from trade doesn't look sustainable," said Keith Hembre, chief economist with First American Funds.

With all this in mind, several economists say they are certain the United States is in recession, and that no one should be fooled into thinking otherwise by a strong second-quarter GDP report. That's because it will be hard for the economy to rebound until the housing, banks and credit markets start to recover from the upheaval of the past year.

"This is a head-fake," said Kevin Giddis, managing director of investment bank Morgan Keegan, about the expected rise in GDP. "You have to reach a bottom in housing before you'll see a turn." Lakshman Achuthan, managing director of the Economic Policy Research Institute, said that no matter how strong the second-quarter growth is, it is important for Congress to provide another round of economic stimulus to deal with continued weakness.

He argued that those who deny we're in a recession could delay the recovery because they are "not dealing with reality." To be sure, some experts remain convinced that the United States is not in recession. But even some more bullish economists said the second quarter gain is likely to be more of a brief spike than the beginning of a sustained pick-up.

Rich Yamarone, director of economic research at Argus Research, said that the economy, while not "tearing the cover off the ball", is not "striking out either." But he conceded that "conditions weren't that spectacular in the second quarter," mainly because of job losses and sluggish income growth outside of the tax rebates. 

Bankruptcy filings surge to 1 million - up 29%
As things in the economy have gotten worse, the number of people and businesses heading to bankruptcy court has spiked. Bankruptcy filings surged 29% in the 12 months that ended June 30, according to government figures released Wednesday. Total filings rose to 967,831 from 751,056 a year earlier.

Business filings jumped more than 41% to 33,822 from 23,889 in the year-ago period. Personal filings totaled 934,009, up 28% from last year. "As we continue to hear more bad economic news, we will continue to see bankruptcies spiral upwards," said Jack Williams, resident scholar at the American Bankruptcy Institute.

The bankruptcy group expects filings to reach 1.2 million this year, as problems in the housing market have "reverberated throughout the economy," he added. The data also showed that filings for Chapter 7 rose 36% to 615,748 in the 12 months that ended June 30.

Chapter 7 bankruptcy is designed to give individual debtors a "fresh start" by discharging many of their debts. Under Chapter 7 a filer's assets minus those exempted by his home state are liquidated and given to creditors first in line for repayment, while the rest of his debts are cancelled.

Another type of individual bankruptcy - Chapter 13 - requires debtors to pay back their debts over time. Total Chapter 13 filings rose 17% to 344,421 from 294,693 a year earlier. Filings for Chapter 11 bankruptcy, which is aimed at assisting struggling corporations or partnerships, rose more than 30% to 7,293.

The increase comes near the third-year anniversary of a congressional crackdown on filers of chapter 7 bankruptcy.
The Bankruptcy Abuse Prevention and Consumer Protection Act, which made it harder for individuals to receive Chapter 7 bankruptcy protection, went into effect in late 2005. Huge numbers of people rushed to file for bankruptcy before the deadline and then filings dropped off dramatically in 2006-07.

Proponents of the law argued that it would prevent consumers from using bankruptcy laws to clear debts that they actually have the ability to repay. Consumer advocates decried it as a boon to creditors - particularly credit card companies - that lose money when debtors declare Chapter 7 bankruptcy.

Williams said that Chapter 7 filings are starting to return to levels last seen before the 2005 law, which suggests that the decrease following its enactment "may have been an illusion."

Gruesome graphs from this week's FDIC report

Lehman: The History of Neuberger Berman Payouts
Wall Street is full of cliches repeated endlessly. One such cliche has surfaced in the talk surrounding the potential sale of Lehman Brothers Holdings’s asset-management arm, which includes Neuberger Berman. “Any buyer would have to pay for the firm, then pay again for the people,” the conventional wisdom goes.

But if Neuberger is sold and any buyer did pay out rich retention packages to Neuberger’s employees, it would be a nearly unprecedented coup for the firm’s money managers. They would have gotten huge payouts three times in 10 years: first in the October 1999 IPO that gave employees generous shareholdings; again through a $120 million retention pool and stock-option grants that Lehman set aside in 2003; and once more in any sale this year. All for just doing their jobs. This doesn’t even include retention/incentive payouts that Lehman made to all its employees in 2001 and this summer.

In 1999, Neuberger Berman paid $50 million of its IPO proceeds to repay subordinated debt the firm owed to some of its own principals, according to an August 1999 IPO filing. Additionally, employees sold a little more than 4.2 million of the 7.5 million shares in the IPO. Neuberger counted the value of those distributions at $134 million in its employee compensation and benefits costs in 1999.

Neuberger also took “reorganization charges” of $150 million in 2000 related to the IPO, mostly having to do with a defined contribution stock incentive plan to employees, severance costs and other staff payment purposes. The $134 million in employee stock granted in the IPO became fully vested Oct. 8, 2003, which means all the value from the IPO was distributed to Neuberger employees just 23 days before Lehman took over the firm.

On Oct. 31, 2003, Lehman closed its $2.6 billion for Neuberger. The price was considered by some analysts to be a rich one. Lehman paid about 5.3% of Neuberger’s assets under management, well above the then-average of about 3.2%, for a firm that was publicly traded but 69% owned by employees. Neuberger’s 32 partners converted their $941 million of Neuberger shares into Lehman stock. Lehman also set aside a $120 million stock retention pool to keep Neuberger staff. Marvin Schwartz, the firm’s biggest power player, saw the value of his 4.3 million shares in Neuberger jump 20% in one month to $178 million at Lehman’s buyout price of $41.48 a share.

Lehman has issued 14 million shares of its stock at various times under the Neuberger Long-Term Incentive Plan, according to an Oct. 10, 2007 regulatory filing. Since the lifetime maximum Lehman can issue under that plan is 15.4 million shares, the Neuberger LTIP, as it is called, is nearing the end of the line. Aside from the fact that much of their Lehman stock is now underwater (the stock is down 78% from the 52-week high of November), the complaints within Neuberger center around the coming end of those stock grants. Of course, it is not possible to know how much stock Neuberger employees have already cashed in.

In any sale, Neuberger’s employees don’t have many advocates within Lehman now, with the exception of Schwartz. Two of the architects of the deal have left Lehman. Former Neuberger CEO Jeffrey Lane left for Bear Stearns in July 2007 and this July became CEO of private bank Modern Bank. Last week marked the departure of Ted Janulis, who had been overseeing Lehman’s mortgage business but in 2003 was head of Lehman’s wealth and asset-management unit and helped guide Neuberger’s integration.

Neuberger’s performance has been strong compared with other fund managers, and it often is called the crown jewel of Lehman Brothers because of its strong growth over the past five years. Neuberger is currently at the tail end of Morningstar’s top-10 fund management companies as of July. Morningstar, which ranked U.S. equity funds, put Neuberger Berman in 10th place in July, up from no. 15 in April.

Any acquisition of an asset manager depends heavily on employee retention. It seems the savvy people at Neuberger have figured that out.

MBIA May Rise After Agreeing to Reinsure $184 Billion of Debt
MBIA Inc. may rise after the company agreed to reinsure $184 billion in municipal bonds for Financial Guaranty Insurance Co., demonstrating its ability to win new business after losing its top AAA rating.

MBIA, the largest bond insurer, jumped 12 percent to $13.40 in after-hours trading yesterday after the Armonk, New York- based company said it will receive premiums of about $741 million as part of the contract. "MBIA wouldn't do the deal unless they thought they were going to make money," said Timothy Graham, who as chief restructuring officer of LaSalle Re Ltd., helped the Bermuda- based reinsurer avoid insolvency. "So, they probably got a pretty good deal."

MBIA is seeking to show it can survive without the AAA rating it lost this year. The company is losing business to Warren Buffett's new insurance unit as well as Assured Guaranty Ltd. and Financial Security Assurance Inc. MBI led bond insurers posting record losses after straying from the business of backing municipal bonds to guaranteeing collateralized debt obligations that have tumbled in value.

MBIA, down 79 percent in the past year, rose $1.06 to $11.98 in regular New York Stock Exchange composite trading before the announcement. The stock is up from a closing low of $3.90 reached on July 11. "They're bringing on a huge surplus of unearned premiums," New York State Insurance Superintendent Eric Dinallo said yesterday during a conference call announcing the agreement he brokered as part of an effort to restore confidence in the bond insurers. The agreement may boost MBIA's credit rating, he said.

FGIC Corp., the parent of Financial Guaranty, has been among the worst hit of the bond insurers. The New York-based company, owned by Blackstone Group LP and PMI Group Inc., in the past few months, went from a top AAA insurance rating to being ranked below investment grade by the three main rating companies.

MBIA is rated A2 by Moody's Investors Service, five grades below Aaa, and AA at Standard & Poor's, two below AAA. S&P affirmed the company's credit rating on Aug. 15 and said bond insurers' are taking steps to shore up their businesses.
The agreement followed a "competitive process" overseen by Dinallo's office, the department said in a statement. Specifics of the transaction still must be submitted to the department for approval, the statement said.

MBIA is taking on the FGIC municipal business for about 80 percent of the unearned premiums. Buffett, whose Berkshire Hathaway Inc. started its own bond insurance business last year, said in February he would take on municipal bond obligations for MBIA, FGIC and Ambac Financial Group Inc. for 150 percent of the unearned premiums. Buffett's backing would have given the bond an AAA credit rating while MBIA's rating is five grades lower.

The reinsurance may give FGIC's municipal bondholders MBIA's higher rating on their bonds, Dinallo said. So-called cut-through insurance "could prove invaluable in helping lift the ratings of municipal bonds," he said. The cut-through reinsurance allows a policyholder to file a claim directly with either FGIC or MBIA and means bondholders can avoid delays in payment if FGIC becomes bankrupt.

The accord may not raise the price of municipal bonds because investors have been placing little value on some insurance guarantees, said Kenneth Naehu, who oversees fixed income investments for Bel Air Investment Advisors LLC in Los Angeles, which manages $5 billion.

"MBIA, Ambac and FGIC, all three are being thrown in the same bucket," Naehu said. "The bonds are trading as if they don't exist, as if there is no insurance." FGIC also said it has settled an agreement to provide $1.875 billion of insurance on mortgage-tied CDOs and will pay $200 million to Credit Agricole SA's Calyon unit. Ambac and Security Capital Assurance Ltd. over the past two months have extricated themselves from guarantees on $5.1 billion of CDOs with $1.35 billion of payments to Merrill Lynch & Co. and Citigroup Inc.

CDOs package pools of securities, including those backed by subprime mortgages, and slice them into pieces of varying risk.
`Severely Impaired' Moody's in June said its new B1 rating on Financial Guaranty reflects the unit's "severely impaired financial flexibility and the company's proximity to minimum regulatory requirements." FGIC has set up loss reserves to pay expected claims of $1.8 billion mainly on securities backed by home loans, according to Moody's.

The two transactions may be enough to prevent regulators from having to step in and take over FGIC, Dinallo said. FGIC focused on the municipal bond market until it was sold by General Electric Co. in 2003. Under its new owners, the company began insuring securities tied to assets such as consumer loans and mortgages, according to the company's Web site.

Kohlberg Kravis Roberts favourite to bid for key Lehman Brothers business
Dick Fuld, the chairman and chief executive of Lehman Brothers, is seeking to complete a crucial deal for the Wall Street bank within three weeks as Kohlberg Kravis Roberts (KKR), the private equity group, emerged as favourite to bid for the bank's asset management business.

Other private equity groups thought to be considering a move on Neuberger Berman, the lucrative fund management business acquired by Lehman four years ago, include Blackstone, although it is not known how serious its intentions are. TPG, another private equity group that has targeted weakened financial services assets, including banks, in recent months, may also be a contender.

Mr Fuld is considering a range of options for the future of Lehman that include the sale of Neuberger or the disposal of a stake in the entire bank. He has held conversations with a number of parties about both scenarios. Although Mr Fuld has strongly denied liquidity problems, he has decided recently to consider a drastic range of options for the bank.

Neither Lehman nor Wall Street believes that a sale of the entire bank is feasible because of the lack of confidence about how the bank's assets should be valued and because of the lack of a buyer prepared to take on such a substantial business.

It is believed that one of the most favourable outcomes for the Wall Street bank would be an agreement with an investor such as KKR to take a stake in Neuberger, or to try to float the asset management business and retain a holding in it. The bank is also believed to be considering the sale of its commercial real estate portfolio, estimated to be worth about $30 billion (£16.3billion), to raise capital.

The long-serving chief executive, who owns almost 3.9 million shares in the bank, is under intense pressure from Wall Street to bolster confidence in the group, whose staff and clients are nervous about its huge exposure to troubled fixed-income assets.

UBS, the Swiss bank, told its clients in New York last month that “time is not on their side” and that the “longer the concerns about [Lehman's] viability linger”, the more likely its own clients were to leave. That scenario led to a forced rescue of Bear Stearns this year, within a few days.

Lehman wants to secure a deal within three weeks, when the bank is scheduled to report its third-quarter earnings. Although it has not yet announced the precise date, it is understood that Lehman has ruled out the possibility of delaying the publication of its numbers to buy time. Wall Street has become increasingly anxious about the state of Lehman's balance sheet and the size of the loss the bank is likely to unveil for the present quarter.

Over the past month a handful of institutions, including Sanford Bernstein, Goldman Sachs and UBS, have updated their forecasts for Lehman. Some have told their clients that they expect it to write down $3 billion of distressed mortgage-backed securities and plunge into the red by about $2 billion for the three-month period.

Along with other broker dealers on Wall Street, Lehman is believed to be suffering from a slump in mergers and acquisitions activity, poor equity markets and near-frozen debt markets. Lehman remains the most heavily exposed of all the Wall Street banks to mortgage-backed securities. According to Sanford Bernstein,

Lehman's total estimated exposure to troubled asset classes was about $120 billion during the second quarter of the year.
Analysts appear to agree that one of the biggest hurdles facing Mr Fuld in the next three weeks is managing to agree on a valuation for both the bank as a whole and for Neuberger. Lehman Brothers shares have plummeted by as much as 90 per cent in the past 12 months, leaving the bank valued yesterday at only $10 billion.

It is believed that informal talks between Citic, the Chinese bank, and the Korean Development Bank over acquiring a substantial stake in the entire bank failed after a disagreement over price. Such a disagreement prompted another analyst to tell his clients that Lehman was ripe for a hostile takeover because its management appeared to be unwilling to sell at present levels.

Chris Whalen, co-founder of Institutional Risk Analytics in New York, said: “The real problem is getting a number. Ignoring the issue of state-run foreign banks, most other banks who would be looking at taking a stake in Lehman have shareholders, and they have to justify how they reached that valuation. Lehman is a very valuable business. It has a valuable franchise and culture. Another major bank taking a stake in Lehman as a whole would probably solve the problem.

“Broker dealers are an endangered species. Wall Street needs them to help the likes of the swaps market to function, to clear their trades and provide credit. Lehman is core to the whole liquidity issue on Wall Street. What makes them vulnerable is that, unlike banks such as Morgan Stanley, they have no retail business, no retail accounts. If institutions get scared, they can pull their money out in a phone call. It's not the same if you have a massive retail base.”

Although the US Federal Reserve, on whose New York branch Mr Fuld sits, has been in constant talks with all Wall Street banks throughout the credit crisis, it is understood that Lehman has not been singled out for special attention of late.

Delinquent US construction loans more than triple in one year
Late loan payments and defaults by commercial and residential developers have soared to the highest levels since the early 1990s, threatening the health of some small banks, regulators said yesterday.

The delinquency rate on construction and development loans hit 8.1 percent at the end of June, the highest rate for any category of bank loans, according to new data from the Federal Deposit Insurance Corp. The rate has more than tripled from 2.4 percent at the end of June last year. The missed payments are forcing banks to hoard money against possible losses and to tighten lending standards.

Some chastened banks have even curtailed lending to new customers in order to conserve available funds for existing customers. Small banks are hardest hit. Many concentrated in construction and development lending during the real estate boom, and they have less financial padding to absorb losses. Regulators said they had added 27 names to a list of troubled institutions in the second quarter, a 30 percent increase, largely because of problems with development loans.

Nine banks have failed this year, none in the Washington region. Abigail Adams National Bancorp, a small lender headquartered in the District, yesterday suspended dividend payments, saying it wanted to save cash for other needs, including potential loan losses. The company already holds more capital than required by regulators.

The downturn that began with homeowner defaults has now spread through developers and their banks to reach businesses as far removed from suburban foreclosures as a shoe store in Columbia Heights. Kassie Rempel, owner and founder of the boutique online retailer SimplySoles, went to the Bethesda-based Eagle Bank three months ago for a loan to build her first store, in Columbia Heights in Northwest Washington.

Despite growing sales that topped $2 million last year, bank officials required Rempel to personally guarantee the loan. They told her that because of credit conditions, the practice has become standard across banks, she said. "It gave me pause, but not enough to not proceed with the paperwork," said Rempel, who has been operating her online and catalogue business from her basement in Mount Pleasant.

"I'm breathing a sigh of relief that I applied and was approved three months ago, versus today, because I don't see on the immediate horizon any good news for the credit markets," she said. The rise in delinquent development loans follows a spike in home foreclosures that is unprecedented since the Great Depression.

The delinquency rate for mortgage loans that sit on bank balance sheets is relatively low. Most mortgage loans are made by mortgage companies and sold to investors. Overall, about 8.8 percent of home mortgages were delinquent or in foreclosure as of June, according to the Mortgage Bankers Association.

Delinquency rates on credit cards, home equity and other consumer loans continue to climb but remain lower. Mortgage loans for commercial properties and other loans to businesses have been relatively unaffected. Many small banks focused on construction lending because it was one of the few areas where they could compete with larger banks. In other areas, large banks used their scale to offer prices and products that small banks couldn't match, from free checking to lower rates on mortgages.

But construction lending was an area where smaller banks could compete by cultivating relationships with developers and embracing risk. And during the real estate boom, it was immensely profitable, leading, among other things, to the founding of many new banks, some of which appeared to be functioning essentially as real estate investment clubs. Now the tide appears to be turning.

The profit margins of small banks that focused on construction lending shrank below the margins for other small banks in the first quarter of 2008 for the first time since the real estate boom began, according to an analysis by the Office of the Comptroller of the Currency. Just as larger banks have struggled with defaults on loans to homeowners, smaller banks are now struggling with defaults on loans to home builders.

"We are starting to see the onset of a second round of effects primarily concentrated in residential and commercial development lending that affects more institutions and probably will play out over a longer period of time," FDIC officials said during a news conference yesterday.

A list of troubled banks kept by federal regulators included 117 names at the end of June, up from 90 institutions at the end of March. Those troubled institutions had total assets of $78.3 billion, up from $26.3 billion in March. The June numbers include some banks that have since failed, including IndyMac Bancorp, which had assets of $32 billion.

Further increasing the pressure on banks, FDIC officials confirmed that they will discuss in early October an increase in the insurance premium banks are required to pay on deposits to replenish the insurance fund after the expenses of recent failures.
Regulators and industry officials emphasized that the vast majority of banks remain in strong health. James Chessen, chief economist at the American Bankers Association, noted that total lending volume rose in the second quarter.

"The industry as a whole remains well-positioned to meet the credit needs of local communities," Chessen said. Federal regulators warned banks in late 2006 to avoid too much concentration in construction and development lending. Almost half the banks in Virginia and 40 percent of the banks in Maryland now have concentrations of such loans in excess of the standard suggested by regulators. Nationally, about a quarter of institutions are above that threshold.

Some bankers say the concern is hard to address. Small banks now exist to make real estate loans, and by nature they rise and fall with the local economy. "It's not an unfair concern, but I don't know how one really gets around it. We're located here, and this is our market," said John Shroads Jr., chief loan officer at Adams National Bank. "Your fortunes are tied to the place where you operate."

Adams National is the main subsidiary of Abigail Adams, which suspended its dividend yesterday. The holding company also owns a bank in Richmond. It is majority-owned and -operated by women, and it focuses on serving female- and minority-owned businesses.

The company most recently paid a quarterly dividend of 12.5 cents per share in June, and investors expected another payment in September. But the company said this morning that its board of directors had voted to suspend the payments. The company will save about $433,000 each quarter.

"Current economic conditions require prudent management and conservation of capital," said chief executive Jeanne Hubbard.
Banks are cutting back most dramatically on the business that burned them: development lending. Caruso Homes of Crofton filed for bankruptcy protection after cost-cutting failed to shore up its financial health. Others, such as Seville Homes in Virginia, have lacked the resources to finish some of the homes they started, which has left customers out in the cold.

James Williams, executive vice president of the Northern Virginia Building Industry Association, said banks are hurting builders by tightening lending standards unnecessarily, such as requiring larger down payments or an assurance that homes will sell faster, allowing the loan to be repaid more quickly. The new requirements feed a vicious cycle, he said. Builders can't borrow money, so their businesses struggle. That, in turn, makes it harder for them to meet their payments on outstanding loans.

"It's the action of the banks, not the performance of the builders," Williams said. "The builders are performing okay in general, but what the banks have done is changed the rules." But the lending drought could have an upside for the industry in the long run by giving builders time to sell off the excess inventory of homes, office space and storefronts.

Retailers' sales hit as US shoppers turn away from credit
Middle-class US consumers are increasingly leaving their credit cards at home when they go shopping, extending a trend first shown by Wal-Mart's low-income shoppers last year, and adding to the pressures on US retailers' sluggish sales.

Mainstream retailers are reporting that shoppers are opting for debit cards or cash instead of credit cards as they face tighter credit limits, illustrating how the wider credit crunch is being transferred to main street spending. Target, the discounter with over 1,500 stores across the US, said last week that it had seen the share of total payments made using credit cards fall for the first time ever in its second quarter, while the use of debit cards continued to rise.

The retailer said the resulting slowing of credit use has in turn hurt its sales performance - which saw a slight decline in sales at stores open for at least a year during the quarter. "Clearly the aggregate access that our guests have to credit cards... is one of the issues that is determining our same-store sales performance in the current environment," Doug Scovanner, Target's chief operating officer, told investors.

Lowe's, the US home improvement retailer whose sales fell 5.3 per cent year-on-year in the six months to August 1, also reported an increase in the mix of cash and debit card use during the latest quarter. Kohl's, the budget department store chain, reported an increase in the use of its Kohl's credit card, which rewards loyal shoppers with monthly savings.

But it said the share of payments made by regular bank credit cards and cash had both declined, while it also saw a rise in debit card use. The retailers' experiences on the shop floor reflect the broader slowdown in the growth of credit. MasterCard, the payments network, said US credit card use was virtually unchanged in the second quarter, with a slight 0.7 per cent increase in total payments, against a 16 per cent increase in debit card use.

Visa's US credit card payments increased 8 per cent, while debit card use increased by 16 per cent. In addition to accepting bank credit cards, most US retailers also issue their own charge cards and co-branded credit cards in partnership with issuing banks. Retailers use these own-brand cards to promote customer loyalty through offering discounts to card holders, and to gather data on their customers' shopping habits.

However, both banks and retailers have been tightening the terms both on their existing cards and on new applicants, in part to reflect declining credit scores that are the result of the increasing economic pressures on their customers. Lowe's said the share of payments using its own-brand credit card fell 100 basis points in the second quarter to 22 per cent.

Target, which co-issues store-branded credit cards with JPMorgan Chase, has followed other card issuers byincreasing interest charges on existing accounts and what it describes as "aggressive reduction of credit lines and significant tightening of all aspects of our underwriting".

Home Depot, the second largest US retailer, says it has seen "significant erosion" of credit scores which led it to reduce some credit limits on existing card holders whose cards accounted for almost 30 per cent of its sales last year. Wesley McDonald, Kohl's chief financial officer, noted that while its charge card performed strongly in the second quarter, accounting for 44 per cent of sales, the rate at which it is issuing new cards is slowing.

"Part of that is just obviously with people having more economic difficulties, their credit scores are falling across the country," he told investors this month.

Citigroup Settles Charges of Widespread Theft of Customer Funds
We can imagine how a large company might rationalize the actions that led to these charges. Customers have positive credit balances on their cards for a variety of reasons. Why not just "sweep" the cash into your own bank account, and use it as part of your leveraged reserves? The customer does not really need the money, right? Especially if they are "poor or recently deceased." You are merely 'borrowing it' with no harm done. Right? Clever. We're the Master's of the Universe, the smartest boys in the room.

We hate to use this example of Citigroup's bad behaviour when there are much better ones. Not all that long ago Citi was caught consciously manipulating the european bonds markets. They would come into a quiet market, sell a remarkably large amount of government bonds all at once to drive the prices down and run the stops of other traders, and then cover their shorts reaping a tidy little profit. Citigroup Embroiled in Bond Selling Scandal Sounds like standard operating procedure for the US futures and commodity markets to us.

But Citi is not an outlier. Anyone who thinks the brokerage and investment industry can be self-regulated, relying upon mature and enlightened self-interest, is either naive, corrupt, disingenuous, or misinformed. Wall Street has proven time and again that the lure of quick profits will cause them to subvert any and all oversight and prudent business principles. And there are many scams and frauds in the markets from a variety of smaller players as we all know. But it is the systemic frauds, the price manipulation and naked shorting, that is particularly insidious and destructive of free markets.

Strong independent regulators capable of investigating potentially criminal activity are needed and not a bunch of propeller heads or captive regulators. The Fed is utterly unequipped and incompetent to rein in these sharks as principle regulator. It would be like sending in the Schoolyard Safety Patrol to maintain order at a pedophiles convention.

Citi pays $18M for questioned credit card practice

(AP) -- Citigroup Inc. will pay nearly $18 million in refunds and settlement charges for taking $14 million from customers' credit card accounts, California's attorney general said Tuesday....

"The company knowingly stole from its customers, mostly poor people and the recently deceased, when it designed and implemented the sweeps," said Brown in a statement. "When a whistleblower uncovered the scam and brought it to his superiors, they buried the information and continued the illegal practice."

Citigroup, however, said in a statement that it voluntarily stopped the computerized "sweeping" practice in 2003, and that it also voluntarily began refunding customers before the settlement.

"We take issue with the state's characterization of our conduct and the parties' voluntary settlement," Citigroup said in a statement. "This agreement affirms our actions, and we are continuing to make full refunds to all affected customers," Citigroup said. Citigroup shares rose 2 cents to $17.63 in afternoon trading.

Citigroup settles with California over credit card skimming

(MarketWatch) -- Citigroup Inc. settled charges that it stole from its customers using a computer program that skimmed positive credit card balances into the bank's general fund, according to the California Attorney General's office Tuesday. Under the settlement, Citigroup will return more than $14 million to customers with 10% interest, and pay California $3.5 million in damages and civil penalties.

French banks stung by further credit crisis losses
France's third- and fourth-largest banks reported slumping results from the credit crunch on Thursday, with Credit Agricole revealing a 94% profit drop and Natixis swinging to a loss of about $1.5 billion.

The weakened results have also left both banks promising to refocus their investment banking operations to cut costs and risk.
Natixis said it swung to a bigger-than-expected net loss of 1.02 billion euros ($1.49 billion) in the second quarter, from a profit of 1.01 billion euros a year earlier.

The credit crisis led to write-downs of around 1.5 billion euros in the period, in line with the charges the bank announced in July when it said it would need to raise 3.7 billion euros of fresh capital. CEO Dominique Ferrero told analysts that its plans include "immediate measures that aim to significantly reduce the risk profile of the corporate and investment banking division and then more structural reforms aiming to focus resources on our strong points."

The immediate steps include a "significant decrease" in high volatility, proprietary trading activity, or bets the bank makes with its own money. In some areas proprietary trading could cease altogether, Ferrero added. The bank will also cap its risk exposure in certain sectors or geographic areas.

Over the longer-term it's planning to scale back the proportion of capital allocated to corporate and investment banking to 46% in 2010 -- from 52% in 2007 -- and is targeting annual growth in net banking income of 4%, excluding the impact of the credit crisis. Even excluding the effects of the credit crisis, net banking income at the investment banking unit was down 29% in the latest quarter at 689 million euros.

Shares in Natixis dropped 7.7% in midday Paris trading and are down more than 60% since the start of the year. Also weighing on the shares was the lack of any further comment on the group's planned rights issue -- the stock lost almost 5% on Wednesday after a report that the issue would be at a hefty discount to the current price.

Shareholders will meet Friday to vote on the rights issue. The bank's majority shareholders Banque Federale des Banques Populaires and Caisse National des Caisses d'Epargne have already agreed to back the share sale. But minority shareholders are less happy with the plans and U.S. activist-investor David Einhorn has urged Natixis to scrap the rights issue and consider selling its stake in its parent banks instead.

Like Natixis, Credit Agricole has had to ask shareholders for more cash, though its 5.9 billion euro rights issue has already been successfully completed. On Thursday Credit Agricole said its second-quarter net profit slumped 94% to 76 million euros. The result was below the 126 million euros analysts were expecting, according to a Dow Jones Newswires poll.

However, shares in the group rallied 5.9% as it reported a strong capital base and some progress in cutting expenses. The sharp drop in profit was largely due to around 1.1 billion euros of write-downs booked in the second quarter. The majority of those charges were due to the bank's exposure to bond insurers, also known as monolines.

These insurers offer protection on bonds by agreeing to keep up payments if the issuer defaults. But the credit crisis has damaged the financial strength of many monolines, devaluing the protection banks have bought from them. Like Natixis, Credit Agricole said it's developed a new strategy for its investment banking arm, which will be unveiled in September. It's also already begun a cost-reduction program that cut expenses in investment banking by around 11% in the latest quarter, the bank added.

Analysts generally agreed the headline figures were weak, hit by both the write-downs and a poor underlying performance in the investment banking division. Sabrina Blanc, an analyst at Societe Generale, said the unit's results were "clearly below the performance of French competitors."

Blanc noted revenue in investment banking was down 60%, while rival BNP Paribas had reported a revenue decline of just 9%.
On the other hand, Credit Agricole's French retail banking network performed better than expected, helped by strong growth in lending to small and medium companies, said Citi analyst Kimon Kalamboussis.

Spain: 2.5 million properties built, 1.3 milllion sold
A summer breeze blows a cloud of dust through the Spanish town of Sesena. Drifting along the empty streets and deserted playgrounds the eerie silence is occasionally broken by the slow creaking of an unused swing.

Like the housing market right now, little is moving in Sesena. Boom has turned to bust and the wider Spanish economy is suffering. Lying just 20 miles south of Madrid, Sesena was designed as a major urbanisation for professionals who could not afford city prices. But there are few signs of life at Sesena, now dubbed the Spanish ghost town.

The population of this town did not disappear, they simply never arrived. More than 13,500 apartments were built on this area of scrubland. But less than 3,000 have been sold. So far the number of people living in Sesena can be counted in the hundreds.

Developers are desperate to get people to move into the apartments and are slashing prices. Monica Torremocha Orocco is one of few who is interested in moving into the area. She says that rents there have fallen by more than 400 euros in a month.

"They've cut the prices of flats a lot because people don't have any money. You could say we are in poverty here," Ms Orocco adds. Sesena is just the tip of the iceberg.

Down on Spain's southern coastline, the signs of overdevelopment are plain to see. Cranes and apartment blocks under construction dominate the horizon. In many tourist communities on the Costa Del Sol, Britons and Spaniards have scrambled to snap up their dream holiday homes. But today many of the flats remain empty and developments unfinished.

Developers have gone bust and people who have put down deposits have struggled to get their money back.
David Busby, from Lancashire, bought a property on the outskirts of Marbella six years ago. Bought off the plans it took more than four years to complete and now he is struggling to find a tenant.

What was once his dream retirement home is now his Spanish nightmare. "We were looking for an investment for our retirement, but so far we've lost £90,000," says Mr Busby. Inez Rix, from Direct Auctions, says David Busby's situation is not unusual. His property will be hard to sell because there are simply too many others like it on the market.

"I think this is going to be the biggest fallout that anyone's ever seen because of the sheer amount of properties," she explains "That's been the problem, too much supply." In recent years Spain has built more houses than the UK, France and Germany put together. The construction industry has accounted for a fifth of all jobs created in Spain since 2000.

Its downturn is now having a significant impact on the economy. So is there an end in sight? Some experts say that holiday developments are worse affected than residential properties in urban areas. But nobody can deny that this is a market in trouble.

2.5 million dwellings built in Spain since 2004
Only 1.3 million properties sold
More new homes built than in the UK, France and Germany put together
Source: Capital Economics

The ECB walks a tightrope in helping banks
The ECB will find it tough to withdraw the financing life-support it has been offering banks, illustrating just how difficult it is to stave off a banking crisis without creating moral hazards. The ECB allows banks to post a wide array of assets as collateral for loans from the central bank.

While this has been important in helping European banks finance themselves in the past year, it has also arguably encouraged some to exploit the system by designing securities that meet European Central Bank criteria, but are filled with shakier loans that would be tough to finance in commercial markets at equivalent rates.

It has also created perverse incentives for institutions world-wide to tailor their collateral and route it via euro zone affiliates.
Securities tied to loans to consumers and for auto purchases in Australia and South Korea, for example, have been pledged as collateral, something the ECB probably did not anticipate when the rules were first put into place. ECB officials have laid down a steady drumbeat of warnings that they will move to reform the system, though it seems that a consensus has not been struck.

Yves Mersch, an ECB Governing Council member who was speaking at the U.S. Federal Reserve's Jackson Hole conference, said there was broad agreement among policymakers for some tightening of the ECB's rules. Michael Bonello, a fellow ECB member who is from Malta, told Reuters that changes would be moderate and aimed at heading off "undesirable practices."
But Axel Weber, a Bundesbank head and council member, talked a bit tougher.

"The collateral that we take must also be traded in the market because only then is it priced accurately," Weber said told Bloomberg News. Accepting only collateral for which there is a reliable market price could put banks in the euro zone in an uncomfortable position.

Many so-called "retained" deals have been designed to be financed with the ECB and would struggle to find a buyer. While there may be someone out there who would buy the paper, the banks and the ECB might find it is at a price far below where banks are now carrying them on their books. That could mean further write-downs for banks, further tightening of credit conditions and an increased possibility of systemic problems.

"Any changes from the ECB are likely to place further upward pressure on interbank repo rates," said Meyrick Chapman, a fixed income strategist at UBS in London. To be fair, the amount financed by the ECB is not much different than it was a year ago. What has changed is the composition. Banks have moved to park the tougher stuff with the ECB where possible, and gone to the open market for financing on safer assets.

Willem Buiter, a former Bank of England official and London School of Economics professor, took aim at the ECB's collateral policy in a paper presented to the Fed conference at Jackson Hole. He called on the central bank to publish the valuations it uses to lend against hard-to-price securities.

"There is therefore a risk that banks use the ECB as lender of first resort rather than last resort," Buiter wrote. "Since at least the beginning of 2008, persistent market talk has it that Spanish and Dutch banks may be in that game, getting an effective subsidy from the ECB and becoming overly dependent on the ECB as the funding source of first choice."

Of course we cannot know if there is a subsidy if we don't know how the securities were valued. It is also true that these securities are very hard to value, as the disaster in banking shows. It stands to reason, too, that the departments within the ECB and its member banks that do the valuing will not be paying salaries as high as the investment banks that are often on the other side of the transaction.

On balance, it seems clear that banks are taking advantage of the system and are thus being insulated from the consequences of their lending decisions. A pinch of moral hazard, however, may be overbalanced by the alternative; a more capital-starved banking sector, a more credit-starved economy and deeper recessions in parts of the euro zone.

It also highlights interesting tensions within the euro zone. Frankly, the interests of Spain, for example, and the interests of Germany are not very well aligned here. Spain needs this credit to keep flowing in a way that Germany simply does not. Finally, what the ECB does will have an impact on the economy. If it cracks down on collateral, it will be that much tougher to raise interest rates.

Spain To Suffer From ECB Lending Curbs as Expansion Falters
Spain's economy, brought to the brink of a recession by surging global credit costs, may find money even harder to come by when the European Central Bank tightens its lending practices.

Spain's banks have stored up 89 billion euros of their own asset-backed securities, more than any euro-region country, because the ECB accepts them as collateral in auctions, according to UniCredit SpA. Now the central bank wants to change the rules, ECB council member Yves Mersch said in an interview on Aug. 23, a move that may leave Spain holding the bag.

"This may affect negatively the profitability of Spanish banks and their ability to lend," said Willem Buiter, a professor at London School of Economics and a former Bank of England policy maker. "It could lead to slower growth."

Spain's banks have relied on cheap money from the ECB to help provide credit to consumers and companies even as the economy is buffeted by a real-estate downturn. Without the ECB, the country would be more dependent on foreign investors, who are demanding higher returns before committing funds.

ECB officials have agreed to adjust collateral rules in response to some banks' attempts at "gaming the system," Mersch told Bloomberg News at the Federal Reserve's annual retreat in Jackson Hole, Wyoming. Axel Weber, another council member, said in an interview published yesterday in Frankfurt that the ECB must ensure its rules are "not abused."
Fitch Warning

The share of asset-backed bonds in the collateral deposited with the ECB jumped by a third last year. What's more, the quality of the assets underlying those bonds has deteriorated, Fitch Ratings said in a report in May. Spanish banks are pooling "higher risk" mortgages and consumer loans to back the bonds, Fitch said. "We see bonds being issued just to forward them directly to the ECB," said Kornelius Purps, a fixed-income strategist in Munich at UniCredit, Europe's fourth-largest bank.

Holders of asset-backed securities can get money 39 percent cheaper at central-bank auctions than through investors. A Spanish mortgage-backed bond rated at the highest credit rating trades with a spread of about 2.8 percentage points to the euro interbank offered rate, or Euribor. The resulting rate of 7.76 percent compares with an average rate of 4.74 percent at yesterday's ECB auction for three-month money.

Since the credit squeeze began a year ago, Spanish institutions raised their monthly borrowing from the ECB by 31 billion euros to a record 49.4 billion euros, according to data compiled by Bloomberg based on central-bank figures. The increase is three times the size of Prime Minister Jose Luis Rodriguez Zapatero's fiscal stimulus package aimed at averting a recession.

"The economy is in a very delicate situation," said Jose Luis Martinez, a strategist at Citigroup Inc. in Madrid, who predicts a recession in Spain in the second half of the year. "One reason for that is the tighter credit conditions and anything which exacerbates that is bad news."

Spain's economy grew 0.1 percent in the second quarter, the slowest in 15 years. The euro region's gross domestic product shrank for the first time since the introduction of the single currency in 1999. One option for ECB policy makers is to reduce the amount of money that can be borrowed for every euro of asset-backed collateral, Natacha Valla, chief economist of Goldman Sachs Group Inc. in Paris, said in a report after Mersch's comments.

Buiter said the ECB may make it harder for banks to use as collateral bonds backed by loans they themselves granted. Banco Popular Espanol SA, Spain's no. 3 lender, tripled its holdings of assets eligible in ECB auctions to 15.2 billion euros since December 2006. The bank faces 7 billion euros of debt maturities over the next 18 months.

Spain's economy doubled in size over the past decade as the decline in borrowing costs brought by euro membership spurred construction and consumer spending. That spree saw Spain run up the world's second-biggest current-account deficit after the U.S., leaving businesses and consumers reliant on foreign lenders.

With household debt reaching 130 percent of incomes, consumption was already slowing when the global credit crunch began. The turbulence triggered a collapse in the housing market as investors became more reluctant to provide financing to Spanish lenders. Home sales fell by a third in May from a year earlier.

"If the ECB restricts the possibilities for using asset- backed bonds in refinancing operations, the market spread will widen again," said Sylvain Broyer, an economist at Natixis in Frankfurt. "Such a tightening will hurt the part of the euro-zone economy which is weakest right now."

Spain’s banking sector could be facing a death blow
Sometimes it's the most innocuous-looking headlines that spell the most trouble.

With most papers leading on "here comes the recession"-type stories, it would be very easy to overlook the report on page five of yesterday's FT that the "ECB is to tackle abuse of liquidity aid". And no wonder. The story sounds either a) very technical or b) something about the financial equivalent of binge drinking.

But there's a bombshell being delivered here - the European Central Bank is about to stop bailing out eurozone commercial banks. And that could mean another big lender going 'bust'. Time to reach for your tin hat again… The ECB is about to stop bailing out eurozone commercial banks.

The European Central Bank has said nothing official as yet about its plans to take a closer look at its support for European banks. In true eurozone style, the ECB's thoughts are being carefully leaked in a dull bureaucrat-ese that's easily ignored and designed not to prompt a panic.

ECB policymakers have agreed a "certain amount" of refinement to the central bank's rules," said the governor of Luxembourg's central bank, Yves Mersch, at the weekend. The changes under consideration weren't "a broad-based revolution", he added. However, as markets evolved, "we have to adjust our framework regularly to market practices" which would "concern some instruments".

Hardly a "stop the press!" moment. But fortunately, Not Wellink, the Dutch central bank chief and a major figure on the ECB council, has been a bit more specific. He said that banks were becoming addicted to the Frankfurt 'liquidity window'. That's where the ECB has been providing cheap funding for eurozone banks by lending against the collateral of a whole range of so-called asset-backed securities (ABS).

Let me explain. A number of European banks weren't able to borrow enough cash to keep their balance sheets balanced because other investors weren't prepared to lend them the money. The only way they've managed to keep their heads above water recently has been to shovel the dodgy loans they have made onto the ECB – a sort of financial pass-the-parcel. Without it, those banks would have gone bust, a la Northern Rock.

But the bad news for these lenders is that it looks like the party's over. "If we see banks dependent on central banks, then we must push them to tap other sources of funding", Mr Wellink told Dutch financial daily Het Finacieele Dagblad. "There's a limit how long you can do this. There is a point where you take over the market".

Exactly. I can't think why it's taken the ECB so long to work out that it's storing up problems for the future. After all, it was prepared to hike interest rates two months ago when worried about too much inflation. Perhaps it was because the Bank of England and the US Federal Reserve had to put in place their own panic measures – sorry, emergency funding arrangements - while the ECB already had something suitable in place.

But this is where the second part of the problem arises. Though its policy buys time, the ECB ends up with a shed-load of assets whose value is highly debatable at best. That's bad enough in itself, but there could be much more fallout. The Maastricht Treaty – one of the EU foundation stones - formally prohibits long-term taxpayer support of this kind for the EMU banking system.

"The ECB is in an unenviable situation", says Paul McCulley of Pacific Investment Management. "The lender of last resort should be just that, not a permanent provider of funds."

So it's starting to look like the game could be up for a large chunk of the Spanish banking system. We've written before about the parlous state of the Spanish property market and, as a result, the hole into which the country's banks have dug themselves. The latest Bank of Spain data shows that the country's banks have increased their ECB borrowing to a record €49.6bn (£39bn).

"A number have been issuing mortgage securities for the sole purpose of drawing funds from Frankfurt", says Ambrose Evans-Pritchard in The Telegraph. "These banks are heavily reliant on short-term and medium funding from the capital markets. This spigot of credit is now almost entirely closed".

But the ECB will have to end this bailing-out soon. Now it's possible - just – that the central bank can deal its way out of this mess, and somehow avoid the carnage that a Spanish bank bust would cause. But as the world's banking glitterati gather in Jackson Hole, they've got plenty of hard thinking to do. After all, if Spain's banking sector collapses, it would result in even tighter credit, less lending and less spending.

One – admittedly unorthodox solution – could be for the ECB to simply pretend that Spain doesn't exist. If that sounds silly, that's because it is. Yet, that hasn't prevented British buy-to-let lender Paragon from trying to disown an entire sector of amateur landlords who have fallen on hard times.

According to The Guardian, Paragon now says that investors in the kind of overpriced city-centre apartments which are now virtually unlettable and unsellable should not be classed as buy-to-let investors. "These properties were targeted by speculative purchasers who thought they could make a quick buck by flipping them. That is not the buy-to-let market. Buy-to-let investors do not own a property unless they can demonstrate that there is tenant demand".

It's an interesting solution to the housing bubble implosion – just stick your fingers in your ears and pretend it's not happening. But somehow we don't think it'll catch on.

UK retail sales hit 25-year low
British retail sales plunged to a 25-year low in August as soaring food and fuel prices and the housing slump discouraged shoppers, the Confederation of British Industry said. It was the second month of sharp falls in sales volumes and with a similar drop expected in September business confidence is very weak, the trade body said.

While growth in average selling prices has eased back from a 16-year high it remains strong. The trade body's survey of 153 retailers showed that 60pc of respondents said sales in the first half of August were lower than a year ago. Only 13pc sold more goods than a year earlier. The balance of -46 percentage points is the lowest since the survey began in July 1983 and compares with -36 in July.

The CBI Distributive Trades Survey also shows that weak demand has fed through to the volume of orders placed with suppliers, while a balance of 56pc reporting a fall in orders marks a survey record low. Retailers are also cutting jobs, with a net 31pc of retailers reporting that their headcount is lower than a year ago. This trend in employment is expected to continue into September.

Today experts warned that Britain is set to endure an even deeper recession than is currently thought next year, with the economy shrinking for the first time since 1991. Analysts at Capital Economics said the economy will contract by around a quarter of a percentage point next year, as it suffers the fallout from the collapsing housing market and a major jump in unemployment.

The British economy shuddered to halt between April and June, ending its longest stretch of economic growth for more than a century. Gross domestic product did not grow at all in the second quarter, the Office for National Statistics revealed this month, ending a record run of 63 consecutive quarters of growth.

The rate of inflation has also surged to a decade-high of 4.4pc in July, and the Bank of England predicts that the rate will rise to around 5pc, more than twice the 2pc target.

U.K. home prices see 10.5% annual drop, monthly decline of 1.9% in August
British house prices continue to fall at a rapid rate, with the average home in August fetching 10.5% less than it did a year ago, mortgage lender Nationwide reported Thursday in its monthly survey.

The average U.K. house price fell 1.9% from July to 164,654 pounds ($302,684). The average price had dropped 1.5% in July for an annual drop of 8.1%. The annual August decline marked the first double-digit drop in house prices on a year-on-year measure since the fourth quarter of 1990, Nationwide said.

"Today's figures defy hopes that the housing market is bottoming out any time soon and is in line with the Bank of England's downbeat economic assessment," said Joerg Radeke, economist at the Center for Economic and Business Research. The Nationwide data, one of the most closely-followed gauges of the U.K. housing sector, reinforces a long-running stream of weak housing data.

The British Bankers Association earlier this week said mortgage approvals by large U.K. banks totalled just 22,448 in July, close to June's all-time low and nearly two-thirds below year-ago levels. The less volatile three-month on three-month measure of activity saw house prices decline 4.5% in August from 4.6% in July. Consensus expectations were for a 1.6% monthly fall and a 9.9% annual decline, according to a Dow Jones Newswires survey of economists.

Official data show the British economy ground to a halt in the second quarter. And the Bank of England warned in its quarterly inflation report earlier this month that growth is likely to remain stagnant over the next year amid declining real incomes, further tightening of credit conditions and steeper-than-expected declines in home prices and activity in the housing market. British homebuilders have been hammered down amid the slump.

U.K.-based homebuilder Taylor Wimpey saw shares knocked down 15% Wednesday after reporting a 1.42 billion pound first-half loss tied to its 690 million pound write-down on the value of its land bank in Britain, North America and Spain. Echoing other reports, Nationwide Chief Economist Fionnuala Earley said activity in the housing market remains "very subdued."

House builders in particular have seen significant drops in site visits and reservations of new properties since last year despite a big jump in the use of sales incentives, she said. Data from estate agents, meanwhile, shows some interest may be returning to the market, with an improvement in inquiries by new buyers, she said.

Still, the number of transactions hasn't been encouraging, Earley said, arguing that current movements suggest the increased supply of properties will continue to dampen house-price growth in the short term.

UK most at risk of recession in Europe, warns S&P
Britain is more exposed to a looming European recession than its eurozone neighbours as the effects of the US subprime crisis spread across the Atlantic, the ratings agency Standard & Poor's said today.

Admitting that its initial optimism about Europe remaining relatively unscathed by the global slowdown had been misplaced, S&P said an over-valued euro, slowing global trade, tumbling asset prices and stagnant real incomes had put the brake on growth.

"As a result of this new negative data, consumer and business surveys consistently show that the fear of an actual recession dominates," said Jean-Michel Six, the chief economist for Europe at S&P. "With inflation doggedly remaining high, the question remains: will Europe enter stagflation-stagnation plus high inflation or, even worse, a genuine recession?"

Latest figures show that the eurozone contracted by 0.2% in the second quarter of 2008 and S&P said this pointed to a "major slowdown" in the second half of the year. Lower oil prices would help economies avoid recession by bringing down inflation and giving the European Central Bank scope to ease monetary policy. Until then, however, the ratings agency said Europe should "brace itself for a period of stagflation" but with some countries faring better than others.

Six said: "While Germany and, to a lesser extent, France are likely to show some resilience thanks to strong fundamentals, the Spanish economy is bound to experience at least two quarters of negative growth, which would qualify it as being in a technical recession."

He added that the elevated level of household debt and the sharp downturn in housing that S&P is forecasting meant the UK was more exposed to a true recession than the eurozone as a whole, although the shock would be less dramatic than previous recessions in the early 80s and 90s.

Deepening recession may throw Britain into full-year GDP fall
Britain's economy is set to shrink over the next year as a deepening recession inflicts the first full-year fall in national income since 1991, a leading forecasting group predicts today. In a dire assessment that will fuel fears over the growing severity of the downturn gripping the nation, Capital Economics becomes the first significant forecaster to project that the slump will lead to a full-year drop in GDP over 2009.

Its prediction that national income will decline next year by about 0.2 per cent is far bleaker than the present average City view, which still foresees meagre growth next year of about 0.9 per cent. Capital's forecast comes after updated official figures last week revealed that growth ground to a halt in the second quarter for the first time since the end of the recession in the early 1990s.

The group's grim prognosis for Britain will come as another blow to Alistair Darling and Gordon Brown as they struggle with the rapidly deteriorating economic prospects. The Chancellor is expected to bow to the inevitable in the autumn and downgrade drastically his present forecast that the economy will grow by at least 2.25 per cent next year.

Capital says that it was forced to cut its own assessment after the news that growth stalled in the second quarter, pointing to a new recession having probably begun in the present quarter. “Britain looks likely to be the first major economy to fall into recession,” it concludes.

The consultancy is also alarmed by signs that the credit crunch is set to wreak further serious damage through a prolonged lending drought. “There is a growing danger that the downturn will be exacerbated by a contraction in bank lending to households and companies,” it finds.

It says that with banks still struggling to raise fresh capital after heavy losses from the US sub-prime crisis and housing slump, they will be forced to further constrict lending, with serious adverse effects on the economy. At the same time, Capital sounds a warning that hopes of stronger overseas trade taking up some of the slack in the economy look set to be dashed as the eurozone, the destination for half of Britain's exports, also slides into recession.

Although a fall in GDP of about 0.2 per cent next year would mark Britain's worst annual showing since 1991, this would also spell a much milder recession than then, when national income plunged by 1.4 per cent in a year. Falls in GDP in the first half of next year would be offset by some recovery in the second half, Capital suggests, although it cautions that the outcome could be still weaker.

While Capital forecasts that the scale of the downturn will quell inflation, opening the way for steep interest rate cuts next year, hopes of any early move by the Bank of England will be dealt another blow today by figures showing a build-up of pay pressures.

Incomes Data Services, the pay adviser, reports that almost half of new wage deals in the past three months were for 4 per cent or more, while a tenth were at 5 per cent or above. The Bank has issued repeated warnings that excessive pay increases will only curtail scope for rate cuts and risk deepening the downturn.

Anxiety over the threat to jobs from Britain's economic woes is also emphasised today as a YouGov poll for the Trades Union Congress (TUC) shows that more than 3.3 million workers say they are not confident that they will still be in their jobs in a year's time.

'It's just the end of the beginning'
Here's some "big picture" numbers on the state of the world's financial system. According to ING, the total value of assets written down by Planet Earth's big banks is $502bn. The total value of capital raised by the same: $351bn. That deficit, of $151bn could easily get much much bigger.

No wonder the Deputy Governor of the Bank of England, Charlie Bean, said the other day that the slowdown may "drag on for some considerable time", while the IMF has called it "the largest financial shock since the Great Depression".

Now, shortly after the unhappy first birthday of the credit crunch we are at what we might call "the end of the beginning". Even though Ken Rogoff, a former chief economist at the IMF, has chillingly warned that a "whopper" major bank will go under in the next few months, at least we know the rough parameters of the sub-prime problem – usually neatly and memorably rounded to about $1 trillion ($1,000bn).

It may even be a little better than that: house prices are still falling in the United States, but mostly at a gentler pace. So some of the gloom may be lifting over there. What's next? Well, there are two new looming threats to keep us awake at night.

First, the certainty that what one might term the "normal" writedowns and losses associated with an economic downturn will add to the strains on banks' balance sheets just when they are at their weakest.

In the UK, we know these are on the rise because some banks have already declared such difficulties; because of the rising trend of redundancies, arrears and repossessions; because of the collapse in sentiment in the housing market and because the first-round effects of the credit crunch are now creating their own second-round effects, through the "mortgage famine" for first-time buyers, the main source of new funding to the residential property market.

That, by the way, is now being exacerbated by a fall in demand for new mortgages from those same first-time buyers, who judge that a falling market is one where they can afford to rent, wait and see. No matter, though; the picture is one where more people will find it more difficult to service their debts, from credit cards to car loans and mortgages, the banks will have to wait longer for their money and may see some of it lost for good.

Which brings us to the second nightmare. Will the banks be able to raise the capital required for them to regain their strength as losses mount? Now for the banks what we've seen is rather like suffering from a bad case of flu (sub-prime) and then catching a cold (normal downturn losses) on top.

Result: financial pneumonia. For which the well-known cure is plenty of liquidity fed to the system by assiduous central banks (see the Bank of England's patent Special Liquidity Scheme among other miracle cures) and a strong course of capital injections.

The latter is proving steadily more tricky to administer, as we see from those big numbers I quoted at the beginning and from the rights issue flops at HBOS and Bradford & Bingley, among others. It has been a laborious task even to raise the £20bn the British banks have now garnered for their balance sheets.

The team at Capital Economics calculates that £65bn more is needed in the way of fresh capital, that is if the banks are to carry on functioning at their current rates of lending and to sort out the remaining damage from the credit crunch.

Alternatively, the banks could simply reduce their lending. But that would mean an even bigger brake on growth than we have seen so far. Capital Economics says that for the banks to correct their balance sheets in this manner would imply a reduction in lending of £440bn (17 per cent of the balance sheet), a truly terrifying sum. Some mixture of the two seems more likely, but even that has some nasty consequences.

If the banks manage to raise another £20bn from disposals, conventional rights issues, Sovereign Wealth Funds in China and the Gulf subscribing for equity, and stake building and takeovers by foreign banks relatively unscathed from the mess (e.g., Banco Santander/Alliance & Leicester), this would still mean a contraction in balance sheets of £180bn, or 7 per cent – equivalent to 13 per cent of the UK's GDP.

I mention that just to illustrate the scale of the phenomenon, and is not meant to be a read off for the wider economic effects. Much of the contraction in lending will hit foreign entities, and bank credit is not the only source of spending in the economy. That is, despite appearances in recent years; some rebalancing away from our reliance on debt to fund growth is overdue and welcome, though it will be painful.

However, if UK bank lending drops by just 5 per cent, that will easily be enough to tip the economy into recession. Capital Economics says that it would mean business investment also down by 7 per cent, that housing market activity would "grind to a halt" with a 50 per cent drop in prices, and consumer spending down by 1.4 per cent, shaving 0.6 per cent off growth per annum, where it is already expected to be stagnant.

We last saw real terms lending by the banks go negative in the mid 1970s – not a happy precedent. So recession here we come. Is there a way out? Well, things may not turn out to be as bad as the pessimists anticipate.

But a third option, not up to the banks but available to the regulators, internationally, would be to ease the banks' capital requirements, altering the ratios to allow them to lend more on thinner capital, so-called "counter cyclical" regulatory action. Risky, perhaps, but maybe more welcome than their fourth option, of direct state intervention to support lending. That, we can confidently say might well be the beginning of the end.

Final pieces in jigsaw drop into place
If, like me, you are a sad addict of financial punditry across all media (I particularly enjoy some of the more eccentric websites), you will know there's currently an acute polarising of opinion between the Micawbers, who think that we're over the worst and foresee recovery next year, and those at the other end of the compass, busy filling cellars with tinned food and Evian.

The divide tends not to follow conventional political lines. Neither Left nor Right claims a monopoly on the likelihood, or otherwise, of apocalypse. The chief executive of a clearing bank tells me that he has never seen such marvellous "opportunities". By contrast, a leading City stockbroker grumbles: "No change. The godawful bear market goes on and on."

Government and its supporters are obliged to talk about Britain being well placed to weather the storm. They have to say that - don't they - or be forced to admit that Gordon Brown's stewardship has done for our economy what the crewmen on the bridge achieved for the Titanic. Against the grain of common sense, ministers cling desperately to Alistair Darling's Budget Day fantasy of 2.25pc-2.75pc GDP growth in 2009.

There are, however, plenty of liberal-Left observers who fear, and expect, an economic train wreck. Larry Elliott, a voice of reason at The Guardian, wrote of Britain's prospects last week: "Weak and almost certain to get weaker... there is nothing to fall back on... [it is] probably too late to avoid the two quarters of negative growth that constitute a technical recession."

Across the Atlantic, Paul Krugman, economics professor at Princeton and self-confessed "progressive", comments in The New York Times: "We've been experiencing a slow-motion meltdown...what we're suffering really deserves to be called a recession... there's no end to the pain in sight."

Elliott and Krugman, though engaging, are hardly my fellow travellers: they belong in the tax-and-spend school of social solutions. Nevertheless, I do not doubt their forecasts for the economies within the Special Relationship. As Krugman said of the US (it applies no less to Britain): "Things will probably get considerably worse before they get better."

For those of us who began warning about the new millennium's debt boom long before "credit crunch" earned an entry in the Oxford English Dictionary, watching Britain and America slide into economic mayhem has been like observing a group of heavy smokers insisting that fears about lung disease are overdone. There is a dangerous lag between inhaling and infection.

Until this year, the missing pieces in the doomsayer's jigsaw were falling house prices and rising unemployment. No matter that consumers on modest incomes were piling up credit-card obligations, taking out mortgages on five, even six, times their annual salaries, and redefining "affordability" to mean servicing rather than repaying debt, as long as house prices defied gravity and jobs were not vanishing, nobody wanted to hear alarm bells.

When the house-price bubble finally burst, it left last-minute players on Britain's mortgage merry-go-round - those who had borrowed the maximum to buy at the top of the market - betting their futures on staying in work. All would be well, as long as the pay cheques kept coming.

Unemployment has been slow, as it often is, to reflect fast-deteriorating corporate prospects. For a while, in the early stages of a downturn, companies tend to hoard labour in the hope that there will be a quick pick-up. When none arrives, they are forced to confront the personal and legal discomfort of chopping large numbers of workers.

This is the train that's hurtling down the track on which are tied hundreds of thousands of homeowners, lashed to the rails by unsustainable mortgage commitments they cannot undo. When the inevitable occurs, it will be bloody.

In case you missed Monday's news - you probably had better things to do on a bank holiday than trawl through the business press - allow me to pass on a report in The Financial Times: employment lawyers and legal helplines are experiencing a sharp rise in businesses seeking advice on how to sack staff. Ding dong! This is your wake-up call. The final piece in the jigsaw of gloom is about to drop into place.

The British Chambers of Commerce, which has been more alert than rival employers' groups to Mr Brown's mismanagement of the economy, predicts up to 300,000 fresh job losses. It sees unemployment breaking through the 2m mark if conditions continue to deteriorate.

I'm sure they will, not least because having wasted so much on crackpot welfare schemes, Labour has emptied the piggy bank and cannot afford to absorb the slack through more increases in public-sector employment.

With disposable incomes falling for the first time since 1997 (mortgage payments, taxes, fuel costs and food bills are rising sharply), the Prime Minister's private prediction that the corner will soon be turned looks even less credible than his Chancellor's assertion that taxpayers will get all their money back from Northern Rock.

According to the Bank of England's deputy governor, Charles Bean, the shocks impinging on Britain's economy are, "at least as challenging... as back in the 1970s". I lived through those calamitous times and, to be fair, today doesn't feel half as bad (the lights aren't out - yet). But the full horror of the Brown boom-to-bust is still emerging. Who knows, with the trade unions threatening a return to militancy, we may soon be searching for candles.

Having spent time at the Olympics, the Prime Minister cannot fail to have noticed that a distinguishing feature of many medal winners was their timing. They knew instinctively when to make the all-important move. By contrast, many of the competitors who failed to live up to expectations seemed not to recognise the moment of maximum impact.

Mr Brown's moment came and went last autumn, with the election that never was. From here, not only will he fail to achieve gold (victory at the next election), he's long odds against even completing the race.

Canada enters "one of those funny recessions"
Canadian economic growth probably slowed to a crawl in the second quarter despite a flood of cash from oil and other exports, but analysts said the country will narrowly avoid slipping into recession.

After a surprise contraction in the first quarter, GDP is expected to expand by 0.7 percent in the April-June period, according to the median forecast in a Reuters poll. Bank of Canada Deputy Governor David Longworth said on Tuesday that quarterly growth was "likely somewhat weaker than expected." The central bank has forecast 0.8 percent growth.

"I think in Canada, if we're not in recession, we're mighty close to it," said Carlos Leitao, chief economist at Laurentian Bank of Canada, who sits on the bearish end of the forecast range with his expectation of a stagnant second quarter. "It's one of those funny recessions though, in that domestic demand is still very positive and real incomes are actually rising because of the ... rising commodity prices."

Soaring energy prices have produced deceptively rosy numbers for Canada's economy. Exports surged by more than 3 percent in June in terms of value due to double-digit price hikes in energy products, but volumes actually fell. Various indicators of domestic demand, which has driven growth amid the U.S. housing crisis, are also looking softer.

Retail sales rose in June, but if the effect of higher gasoline prices is stripped out, consumers actually bought less with their money. Cracks are also starting to appear in Canada's robust housing market.

"While we think that growth will remain ever so slightly in the black, we wouldn't rule out a back-to-back negative print that would meet the definition of a technical recession," said Derek Holt, economist at Scotia Capital. "Either way, the Canadian economy has stalled."

Chinese Yuan Remains Suppressed
It’s been slightly more than three years since China freed the yuan from its peg to the dollar. From the early 1990s until July of 2005, the USD-CNY exchange rate was fixed at 8.27, giving China a distinct and consistent advantage when it came to international trade.

The US was, and continues to be, the major consumer of goods manufactured in China. The artificially weak yuan resulted in the US trade deficit ballooning, while China amassed a monster trade surplus and considerable dollar reserves. In the years leading up to the float of the yuan, China was under considerable political pressure from the west.
Don’t get the wrong idea though; the yuan is far from being free to find its proper value based on the fundamentals. The People’s Bank of China (PBoC) utilized a tightly managed float system to keep exchange rates from fluctuating too widely. Each business day the PBoC establishes a central parity rate for the yuan based on a basket of currencies. Today’s parity rate against the dollar was set at 6.8415. The yuan is only allowed to fluctuate 0.5% on either side of that parity rate.
Since the yuan was de-pegged from the dollar on 21-Jul-05, the currency has appreciated 17% against the dollar. China’s growth rate warrants substantially greater currency appreciation. However, a stronger yuan cuts into China’s already weakening export business.
While China seeks to spur domestic demand for its goods, it remains extremely reliant on exports as a means of growing the economy and creating jobs. As we discussed in yesterday’s report, China is faced with the daunting task of generating 10 million new jobs each year. The PBoC faces rather significant policy and political hurdles to facilitate that goal.
At this point the central bank must keep the yuan suppressed to the point where Chinese manufactured goods are still attractively priced, despite waning demand resulting from a contracting global economy. At the same time, they don’t want to risk trade sanctions from their biggest customers in the west who consistently point out that the yuan is undervalued and that their own export markets are suffering.
According to a recent Ambrose Evans-Pritchard article in The Telegraph, the PBoC has found some rather creative ways to manipulate the USD-CNY rate. It seems that Chinese banks are required to hold excess reserves in dollars rather than yuan. Since March, the central government has raised the reserve requirements five times.
Reserve requirements are now 17.5% of total lending. As the banks seek to acquire the mandated reserves it has the effect of lifting the dollar and suppressing the yuan, offering relief to China’s softening export market. Meanwhile the firmer dollar makes US goods more expensive for foreign buyers.
US exporters saw some relief in recent months as a result of the sharply weaker dollar, but much of that is being reversed out as the dollar has climbed. Yet there doesn’t seem to be much protest from the US regarding China’s efforts to weaken the yuan again.
This might be explained by the fact that there are political gains to be had. The dollar has firmed significantly in the last month and a half, meanwhile exporters are still reaping the benefits of recent record lows in the dollar. Headlines that can simultaneously tout a firmer dollar and a narrowing trade deficit certainly provide some benefit to the incumbent party.
Look for the trade and exchange rate rhetoric to start up again in earnest after the November election. That’s when things could get very interesting. Just be aware that China is going to come to that bargaining table wielding an enormous amount of clout as one of the primary financers of America’s massive debt.
The US may ultimately seek to weaken the dollar further to protect gains in exports. However, one can expect China to doggedly defend its exporters as well by continuing to suppress the yuan. To quote another recent excellent article by Mr. Evans-Pritchard: “What we are about to see is a race to the bottom by the world’s major currencies as each tries to devalue against others in a beggar-thy-neighbour policy to shore up exports.”
Whether that ‘race to the bottom’ is about to begin, or is already underway, the ones holding the pieces of paper with the colorful pictures are the ones who suffer, not the ones who issue those pieces of paper. Physical gold ownership is your best chance to reach the finish line with at least a portion of your wealth intact.

Days of Rage in Streets Start Derailing Asia
Asia has indeed decoupled -- not from the U.S. economy, but from political reality.

Thailand is Exhibit A. Three years ago, it was the post- Asian-crisis role model. Living standards were rising, investors were funneling in and Asian peers were envious of "Thaksinomics." The reference here is to the dual-track plan to boost domestic demand and export growth championed by Thaksin Shinawatra. The former Thai prime minister was removed in a September 2006 coup amid corruption allegations. Thaksin fled to the U.K. and bought soccer team Manchester City.

Yet the military leaders who replaced him were painfully inept. That paved the way for the People Power Party to be elected in December 2007. Its pro-Thaksin leader, former television chef Samak Sundaravej, is facing massive protests and calls for his resignation. And just like that, one of Southeast Asia's shining examples of stability, prosperity and democracy is descending into farce.

The joke among investors is which English Premier League team will Samak buy if he flees Thailand? It's less of a joking matter that strategists like Dwyfor Evans of State Street Global Markets in Hong Kong say Thailand's baht may slide more than 3 percent by year-end, leading global funds to pull money from the country.

Events in Malaysia also are troubling. Again, this is an economy than won kudos following the Asian crisis a decade ago. Malaysia's headline-grabbing backlash against the International Monetary Fund moved to the background as growth returned, stocks rose and commodity prices soared.

Now, headlines are filled with "sodomy" and "opposition official arrested" and "leadership crisis." The personality in question is Anwar Ibrahim, who's been accused of having illegal sex with a man. This week, Anwar won back a seat in parliament, increasing his chances of ousting Prime Minister Abdullah Ahmad Badawi. Malaysia's government is adrift when its economy can least afford it.

"At a time when Asia is under pressure from external forces, strong and stable leadership is crucial," says Simon Grose-Hodge, a strategist at LGT Group in Singapore. "Malaysia and Thailand seem unable to deliver that."

Politics often offer the biggest surprises in Asian markets. In recent years, investors have found themselves less shocked by reports on gross domestic product, inflation or stock movements than coup attempts, scandals or disagreements between neighboring governments.

Disputes abound: China and Taiwan over sovereignty, Japan and South Korea over rocks in the sea, Indonesia and Singapore over pollution, India and Pakistan over disputed territory, Thailand and Cambodia over borders and North Korea and the rest of Asia over nuclear weapons. The Philippines is often on guard for the next "people power" rebellion.

Politics is holding Asia back, distracting officials from spreading the benefits of growth, reducing poverty, improving education and upgrading roads, bridges and power system to compete in the global economy. It's also scaring away investors who are growing increasingly risk adverse as the global credit crunch worsens.

The region does have its success stories, like Indonesia. Rampant corruption and persistent poverty aren't undermining President Susilo Bambang Yudhoyono's efforts to put Southeast Asia's largest economy on a higher growth path. "Indonesia," says Bruce Gale, a political risk analyst based in Singapore, "is a lot more stable politically than many foreigners seem to realize."

Yet politics is even getting in the way of Asia's most developed nations. Take Japan, which is experiencing paralysis at the highest levels of government. Prime Minister Yasuo Fukuda's slipping political support is complicating efforts to shield Asia's largest economy from recession.

Recent declines in markets speak to how Asia hasn't decoupled from the U.S. economy, as pundits once asserted. This period of global instability would be less dangerous if governments were better equipped to handle them. The fallout from Wall Street's losses continues to flow this way. Michael Dee of Temasek Holdings Pte, Singapore's $130 billion sovereign wealth fund, yesterday found himself in the surreal position of voicing confidence in the once mighty Merrill Lynch & Co.
Merrill has a "great franchise which has existed through many crises through a long period of time," Dee, Temasek's senior managing director of international, told Bloomberg Television.

Since December, Temasek, Merrill's biggest shareholder, has invested about $5 billion in the third-largest U.S. securities firm. Dee said he has "great confidence" in Merrill Chief Executive Officer John Thain. Last year, Thain replaced the ousted Stan O'Neal, who oversaw the firm's largest quarterly loss in its 93-year history.

If Southeast Asia is to stand its ground amid a potential U.S. recession it needs more predictable and transparent government. Only then will economies have credible institutions like judiciaries, central banks, media and watchdog groups to weed out corruption. From there, more efficient and stable economic growth might follow.

All this sets Asia apart from many of the world's markets. Analysts typically assess economies by locking themselves in offices and studying government data, bond yields, stock valuations, and the like. Here in Asia, more luck might be had looking out the window at the street demonstrations below.

As food prices soar, Brazil and Argentina react in opposite ways
Luciano Alves planted beans, corn and grain on about 7,500 acres of his farm in southern Brazil last year. This year, he is planting 8,600 acres. And he credits Brazil's president, Luiz Inácio Lula da Silva, with the increase.

"The government is helping us finance the purchase of new machinery," said Alves. "They reduced the interest rates we pay and have given us more time to pay off the loans. It's vital." Rising food prices mean many farmers around the world are reaping record profits. And South America's agricultural powerhouses, Brazil and Argentina, are responding to the farming windfall in opposite ways.

da Silva's government recently announced record farm credits, a form of indirect subsidy, to encourage Brazil's farmers to produce more while the price of their exports are high on world markets, a move that should improve Brazil's economy. But Argentina, Brazil's economic and political archrival, decided to share the agricultural windfall at home.

Worried about the wave of inflation rippling around the world, the government of President Cristina Fernández de Kirchner of Argentina increased export taxes on some crops, a move meant to keep down domestic food prices by encouraging farmers flush from global profits to sell more at home.

"In our country the government is trying to get money to subsidize other sectors of the economy," said Eduardo Cucagna, president of FN Semillas, an Argentina seed company, objecting to the policy. "I think Brazil is doing the opposite, adapting to what the world is offering now. They're doing it right."

In the race to take advantage of the tight global food market, Brazil has a number of advantages over its southern neighbor. It is much bigger, with around 173 million acres of land currently under cultivation, more than twice that of Argentina. It has a wider range of agricultural exports. And while Argentina is the world's second biggest exporter of corn and the third biggest exporter of soybeans, Brazil is the world's first or second largest exporter of beef, soybeans, orange juice, chicken, sugar and coffee.

The government in Brasília wants it to stay that way. Last month, it announced a $49 billion credit line for farmers, up 12 percent from last year's total. Officials said farmers needed the credit to buy tractors and other machinery, pay for seed and fertilizer ? which have also risen in price ? and to increase productivity.

"We need to give incentives to producers because people are buying and eating more," said Reinhold Stephanes, Brazil's agriculture minister. "This is our opportunity to produce and export more, and help to reduce hunger in the world."
Most of the credit line comes in the form of reduced interest rates and longer payoff periods for loans. More than $40 billion is earmarked for larger agribusiness concerns, and the rest is to help small farmers.

The government's main goals are to help producers expand onto available land and increase productivity on their current land. It estimates there are up to 220 million unused acres available for planting. "Our productivity can't remain the same if people are going to eat more," said da Silva, referring to the growing and increasingly affluent populations in China, India and Latin America. "We have to plant more."

Alves, the southern Brazilian farmer, has already bought a tractor and a combine for the equivalent of $512,000. He put 70 percent down and financed the rest. Many of his colleagues in Brazil's agricultural heartland are doing the same.

In Argentina, the Kirchner administration tried to raise taxes on grain and soybean exports in line with rising world prices. The decision was intended to force Argentine farmers into selling their wares at home, thus creating a domestic glut that would keep prices down and inflation in check.

But instead of reaping the windfall, the government reaped a whirlwind of protest. The sliding tariffs pushed the tax on soybeans, Argentina's most important export, to almost 50 percent. It also infuriated farmers, who took to the highways in sometimes violent demonstrations. After weeks of tense debate, the Senate narrowly voted against the measure on July 17. The rate is now fixed at 35 percent.

While that wave of turmoil has subsided, farmers said suspicion and uncertainty remain. "The feeling is that they are going to screw us again and so it is difficult to plan our short- and medium-term future," said Sean Cameron, a grain farmer who is also president of Aprotrigo, an farm industry organization. "The problem has not been solved and it needs to be solved quickly."

Many Argentine farmers agreed. Some farmers are pressuring government officials to enact policy changes that would actually make it easier and more profitable to export. Some trade experts say Argentina needs to enact such changes. But many trade analysts believe both countries will eventually benefit from the run-up in global food prices.

"They have different approaches to what is happening in the world agricultural markets," said Simla Tokgöz, an international grain analyst at the Food and Agricultural Policy Research Institute, an research center based in Iowa. But "short-term volatility happens in all countries. In the long term, Argentina has great potential to increase production and to continue to be a major exporter of grains and oil seeds."

"The swelling tide of toxic home loans is proving to be even more worrisome than initially feared"
It would be nice if some of the people who get paid big dollars because they supposedly have high skills could acknowledge that they messed up. It would also be nice if the national media did not consider it part of their job to cover up for powerful people who messed up on their job.

Yes, that headline is a a direct quote. It also is the sort of statement that has no place in a serious news article. The swelling tide of toxic loans is not proving to be more worrisome than feared. The problem is that the people who were supposed to be regulating the financial system did not know what they were doling.

The people who did understand the economy knew that an unprecedented run-up in house prices, with no remotely plausible explanation based on fundamentals, with no corresponding increase in rents, was a bubble. We also knew that bubbles burst. And, we knew that when bubbles in a highly leveraged asset like housing burst, that lots of debts go bad and that banks then take really big hits.

The NYT should be exposing the incompetence of people who were paid big dollars to know the housing and financial markets (this includes both bankers at place like Citigroup, Merill Lynch, Bear Stearns, Fannie Mae and Freddie Mac, as well as the top regulators) and completely failed in their responsibilities.

It should not try to tell readers that the housing crash was somehow an unforeseeable event that came out of the blue. It was an entirely predictable event and it was only incompetence that prevented these people from seeing it. Unfortunately, unlike dishwashers and custodians, bank executives and regulators are not held accountable for their performance. Instead, the media covers it up for them.


Anonymous said...

Disciple: "Master Master, will the winds be so mighty as to lay low the mountains?"

Master: "Well no, they won't be quite so mighty as that."

illargi That is a bit from memory of an 'End of the World' skit by (I think)the Goon Squad, I have been looking for it on the internet for ages but no luck. I think it would be perfect for days like this if anyone can find it.. Ends with the Master and disciples planning to meet again next week and try again.

Personally I have been waiting since sometime in the 80's for the wheels to come off, so am used to these little setbacks ... not like these modern dilettante doomers.


Ilargi said...

Yes sure CR
Now go do twelve Hail Mary's and leave me alone
I gots to do me this choir boy

bicycle mechanic said...

The London Telegraph is reporting Russian sources who claim Putin has put in place orders, and has alerted the oil companies to shut of oil to the west. This in response to Nato actions in the Georgian conflict, and the EU meeting and talking about sanctions on Russia.

"Fears are mounting that Russia may restrict oil deliveries to Western Europe over coming days, in response to the threat of EU sanctions and Nato naval actions in the Black Sea.

Any such move would be a dramatic escalation of the Georgia crisis and play havoc with the oil markets.

Reports have begun to circulate in Moscow that Russian oil companies are under orders from the Kremlin to prepare for a supply cut to Germany and Poland through the Druzhba (Friendship) pipeline. It is believed that executives from lead-producer LUKoil have been put on weekend alert.

"They have been told to be ready to cut off supplies as soon as Monday," claimed a high-level business source, speaking to The Daily Telegraph. Any move would be timed to coincide with an emergency EU summit in Brussels, where possible sanctions against Russia are on the agenda.

Any evidence that the Kremlin is planning to use the oil weapon to intimidate the West could inflame global energy markets. US crude prices jumped to $119 a barrel yesterday on reports of hurricane warnings in the Gulf of Mexico, before falling back slightly.

Global supplies remain tight despite the economic downturn engulfing North America, Europe and Japan. A supply cut at this delicate juncture could drive crude prices much higher, possibly to record levels of $150 or even $200 a barrel.

With US and European credit spreads already trading at levels of extreme stress, a fresh oil spike would rock financial markets. The Kremlin is undoubtedly aware that it exercises extraordinary leverage, if it strikes right now.

Such action would be seen as economic warfare but Russia has been infuriated by Nato meddling in its "backyard" and threats of punitive measures by the EU. Foreign minister Sergei Lavrov yesterday accused EU diplomats of a "sick imagination"."

As a side note, I tried to order some bicycle tubes today from a supplier. All out of schrader valves, only a few presta valves. And the cost of tubes has jumped enough that wanting to keep stock makes it a tough call to invest.

Price increase and availability due to petroleum cost, and the carbon needed to make them black. Plus the demand is up due to people dragging out old bikes.

The want add pages in my paper with a town over a million people are so few its scary. During the week maybe a little over a page. For Sunday, about two pages worth. Most jobs are in the medical sector.

Fed X is based here and they have a hiring freeze I was told from an employee I know.

Pay raise granted earlier for County Police was canceled because they see now they can't give any county employee a pay raise.

The reality for public officials is beginning to creep into their decisions.

The county mayor sounds, "aware" and his voice and face say he knows political doom is around the corner, no matter what they do.

Anonymous said...

It's the 'End of the World' sketch from 'Beyond the Fringe' circa 1960. See:

The cast: Peter Cook, Jonathan Miller, Dudley Moore and Alan Bennett. They are seated, huddled, on the top of a mountain...

Jon : How will it be, this end of which you have spoken, Brother Enim?

Omnes: Yes, how will it be?

Peter : Well, it will be, as 'twere a mighty rending in the sky, you see, and the mountains shall sink, you see, and the valleys shall rise, you see, and great shall be the tumult thereof.

Jon : Will the veil of the temple be rent in twain?

Peter : The veil of the temple will be rent in twain about two minutes before we see the sign of the manifest flying beast-head in the sky.

Alan : And will there be a mighty wind, Brother Enim?

Peter : Certainly there will be a mighty wind, if the word of God is anything to go by...

Dudley : And will this wind be so mighty as to lay low the mountains of the earth?

Peter : No - it will not be quite as mighty as that - that is why we have come up on the mountain, you stupid nit - to be safe from it. Up here on the mountain we shall be safe - safe as houses.

Alan : And what will happen to the houses?

Peter : Well, naturally, the houses will be swept away and the tents of the ungodly with them, and they will all be consuméd by the power of the heavens and on earth - and serve them right!

Alan : And shall we be consumed?

Peter : Con..sum..éd? No, we shall not be consuméd - we shall be up on the mountain here, you see, while millions burn, having a bit of a giggle.

Jon : When will it be, this end of which you have spoken?

Omnes : Aye, when will it be - when will it be?

Peter : In about thirty seconds time, according to the ancient pyramidic scrolls... and my Ingersoll watch.

Jon : Shall we compose ourselves, then?

Peter : Good plan, Brother Pithy. Prepare for the End of the World! Fifteen seconds...

Alan : Have we got the tinned food?

Dudley : Yes.

Peter : Ten seconds...

Jon : And the tin-opener?

Dudley : Yes.

Peter : Five - four - three - two - one - Zero!

Omnes : (Chanting) Now is the end - Perish The World!

A pause

Peter : It was GMT, wasn't it?

Jon : Yes.

Peter : Well, it's not quite the conflagration I'd been banking on. Never mind, lads, same time tomorrow... we must get a winner one day.



Anonymous said...

I am starting to think Bush/Cheney may get their/his wish and get a show down with Putin a little quicker than everyone realizes.Like ww3 in a couple of weeks.No kidding.Putin has bush&Cheney nuts in a vice over Georgia,and now is playing hardball w/the threat of no oil at the start of what might be a real cold winter.
Try this tinfoil on....

The need is to re-inflate the economy.I just heard the acceptance speech by Obama.

If they need inflation,wouldn't the spending of a WHOLE lot of money by the .gov here,in the states do the trick?

You mentioned the congress...If they pass all this nice stuff for the middle class of this care,alt [anything]energy research grants by the billions on everything,hell,fire up the moon colony project by 2...spending like the proverbial drunken sailor

Run the presses full speed till the 000 run out....

Not saying it would work for a long time....but it might delay the explosion?

'how bout it?


Anonymous said...

Thanks bobe, very much appreciated!

For years and especially now in these days of the renting of veils, I have been frustrated with the limitations of my memory to fully relate that skit. Now my son will be able to see with his own eyes whereof I have been giggling as my eyes roll about their sockets and I speak of doom plague and locusts.

Now if you could just direct me to the Norman Wisdom movie where, after a concatenation of events, he ends up upside down on a stretcher while two ambulance attendants rather forcefully try to slide him head first into the back of the ambulance, then death would have no sting and I could go to any doom grinning like a maniac.

I better get out of here now or ilargi will having me doing hail Marys for a week and the choir will go silent and sullen.
Thanks again :-)

Anonymous said...

How about 'A Stitch in Time', 1963?


Anonymous said...

my prediction is more simple:

More and more oil producers will change from dollar to any national currencies payments and the America will be sent to the 2nd rail.

I do believe that the USA's end will be very similar to USSR's end. The total state bancrot followed by the separation to the discrete states.

Many countries died this way: USSR, Yugoslavia, Czechoslovakia...

Greetings from behind the Druzba pipeline :-)