Monday, September 15, 2008

Debt Rattle, September 15 2008: Think Again

Irving Underhill Wall Street 1911
Wall Street east from Nassau Street

Ilargi: Last Friday I said in We have spent our future: " It is clear that after this weekend, as the state of Texas will be hit by a storm the size of ... the state of Texas, -possibly large- parts of it will never recover, nor ever again be the same. There is a metaphor in there for the Wall Street banking system. After this weekend it will never be the same."

Well, that is very much true. Wall Street as we’ve known it in our lifetimes is no more, and it will never return. Allowing investment banks and commercial banks to become one single two-headed beast has been a predictable disaster, and the factor most responsible for the mayhem we’re all in.

Still, stealthily, under cover of the blinding noise over Lehman’s demise, the Fed has introduced a new book of tricks aimed at prolonging the model for a while longer, no matter that it’s obviously dead. And Bernanke, in order to achieve it, has resorted to illegal practices. He’s "drawn a line" all right, but not the one you think.

Banks can now get loans through the Fed’s newly enhanced "permanent emergency" credit windows, and pose as collateral equities (stocks) and even your deposits. Yes, you heard that right. That is the condition underlying Bank of America’s purchase of Merrill Lynch. BoA can -and will- use the money in your bank account to continue Merrill’s activities, the same ones that led to Lehman’s death: securitization, swaps and derivatives.

That is one frightening development. And so, for that matter, is accepting stocks for T-bills. What if those stocks plunge, as so many are doing lately? What if companies go bankrupt? In the end, through the Treasury, it’s once again the taxpayer who’s going to be presented with the bill.

You would think that the central banks and Treasuries in the world would see the light and the signs on the wall, and refrain from putting even more of the people’s money at risk. You need to think again.

Central banks today are pumping credit like mad into the markets. Like all similar actions in the past two years, it will not save anything, or make any difference other than that the system gets to roll on for a few more months. The system cannot be saved, but it can still suck more profits out of the public purse. If this is not perverse, I don’t know what is.

The exact fall-out from Lehman’s downfall won’t be known for quite a while; nobody really knows what assets they have, nor who are the counterparties to all the bets they have outstanding.

Besides the obvious big US candidates to fall within the next few days, and it looks very much like that is the new timeline we have to watch, such as AIG (down 50% today), WaMu and Wachovia, there are two other fields to keep an eye on.

Smaller US banks, many hundreds of them, are exposed to -potential- dangers that will start to take down victims at an accelerating rate. What I think may be even more susbstantial when it comes to impact, is the pressure on banks and other financial institutions outside the US. UK banks got hit badly today, and the same happened all over the European continent.

Wherever you are in the world, there are no safe banks anymore. When you hear a government spokesman or bank CEO talk about their banks and banking systems being "well capitalized", don’t believe a word they say.

There are incredible amounts of losses yet to come, far more than we’ve seen so far, and they have all, to one extent or another, had their sticky fingers in the same cookie-jar.

Update 6.00 PM EDT: DJIA Closing numbers

Wall Street model broken by credit crisis
The future of Wall Street is up for grabs -- and changing by the minute. In the course of a few hours Sunday, Lehman Brothers Holdings Inc, the fourth-largest investment bank hobbled by toxic real estate assets, was left for dead and may file for bankruptcy before Monday.

Merrill Lynch, the No. 3 investment bank and weakest remaining firm after $40 billion of write downs, rushed into the arms of Bank of America Corp for $29 a share -- less than half its 52-week high but almost $12 higher than its closing price Friday.

These moves, coming after the U.S. government's takeover of Fannie Mae and Freddie Mac and six months after the meltdown of Bear Stearns and its shotgun marriage to JPMorgan Chase & Co, renew questions of what Wall Street will look like in an environment of lower leverage and reduce appetite for risk.

Now there are questions whether any of the independent firms will still be around. Certainly, for those that survive the current 100-year storm, Wall Street will look a lot different.

"It seems perfectly clear leverage is going down, that banks will be more careful who they do business with, and that there is a desire to be more of an agent than a principal," said Donald Marron, head of private equity firm Lightyear Capital and former CEO of PaineWebber Group. "There will be a trend toward specialization. It's hard to be in too many different places. Firms will concentrate on their strengths."

After more than 13 months of a global credit crunch, the rules of the marketplace have changed. Capital is harder to come by and risk must be kept on a shorter leash. The engines that powered record profits for years -- leveraged deal finance, mortgage securities and all kinds of complex debt instruments -- have all seized up.

In recent months, Lehman CEO Dick Fuld and Merrill CEO John Thain had both said they could weather the storm. Now, recent events show it may be only the largest banks, such as Bank of America and JPMorgan Chase, that have the capital and deposit base to withstand rising flood waters.

Analysts also question whether No. 1 investment bank Goldman Sachs Group, which has avoided major damage so far and earlier this year considered acquiring a commercial bank to reduce reliance on market funding, can confidently stand above the crowd.

Goldman, which releases its third quarter results Tuesday, is widely expected to report lower profit with revenues down across the board. Morgan Stanley, the second largest, has been busy shedding assets since its brief flirtation with "the Goldman Model" three years ago, which prompted greater principal risk taking just as the market was peaking, and a Lehman-style expansion into the mortgage business.

Since suffering massive mortgage trading losses late last year, Morgan Stanley has been shrinking the balance sheet and pulled in its horns. When Morgan reports results on Wednesday, investors will decide whether they have come down far enough.

"There is a new way coming, but the old way is gone," said Robert Doll, chief investment officer at BlackRock Inc. "I think parts of the old model have been destroyed, or at least cyclically challenged. We'll have to figure it out when the dust settles."

Investors meanwhile have already seen the future of Wall Street in the form of small boutique advisory firms such as Lazard and Greenhill & Co. These smaller firms do not engage in trading or lending but rather focus on advice, much like the way Wall Street's big investment banks operated until the 1980s.

Having avoided credit losses or having assets mired on their balance sheets, listed and closely held boutiques are gaining advisory-business market share and snagging top-tier bankers now available amid the turmoil.
In a world where capital is constrained and relationships again paramount, their old school model suddenly looks very attractive to bankers and clients.

"I think we're going to see boutique firms growing in importance, the Greenhill type M&A firms as well as hedge funds that specialize in human capital-intensive trading," said Bill Wilhelm, a finance professor at University of Virginia's McIntire School. "We see dominating those firms with the view there are limits to what they can do."

Wall Street crisis deepens
Wall Street was in turmoil on Monday after Lehman Brothers filed for bankruptcy protection and Merrill Lynch agreed a $50bn takeover by Bank of America. Confidence in financial institutions around the world was shaken as central banks introduced a series of emergency measures to ease the crisis in the global financial system.

Equity markets fell heavily and debt spreads widened as banks, investment managers and insurance companies came under heavy selling pressure. BofA’s bold bid for Merrill came as the world’s top banks abandoned efforts to save Lehman and set out to build a firewall against further financial chaos with a $70bn liquidity pool to support other vulnerable institutions.

The moves capped a weekend of high drama that could lead to one of the most radical reshapings in Wall Street history. The Federal Reserve said it was making it easier for financial institutions to access Fed liquidity by easing terms on its borrowing facilities and accepting a much wider range of assets as collateral.

The Fed meets to decide on interest rates on Tuesday. It widened the set of assets eligible as collateral for loans of Treasuries to include all investment grade paper, and raised the size of these Treasury loans to $200bn. The Fed also suspended rules that prohibit banks from using deposits to fund their investment banking subsidiaries.

The Fed’s intervention was followed on Monday by the European Central Bank and the Bank of England. The ECB allotted €30bn ($42.04bn) in one-day liquidity at a marginal rate of 4.30 per cent and an average rate of 4.39 per cent. Altogether 51 banks bid €90.27bn. Meanwhile, the Bank of England said it would offer extra reserves to help stabilise conditions in sterling money markets. The Bank said it would auction £5bn through an exceptional fine tuning open market operation.

The weekend’s dramatic events undermined confidence in financial stocks across Europe. Banks and insurance companies were the heaviest fallers on Monday while gold prices jumped higher as investors sought the safety of the precious metal. The Markit iTraxx Crossover index, which measures the cost of insuring European junk-rated credit derivatives, widened 17 per cent on Monday to 640 basis points as the likelihood of defaults was perceived to be higher.

Monday’s market reaction will be closely watched by regulators and banking executives to gauge investor sentiment towards the credit crunch that has wreaked havoc on the financial sector for more than a year. BofA’s rapid U-turn, which saw it abandon talks to buy Lehman and move to Merrill in the space of a few hours, will throw the spotlight on Morgan Stanley and Goldman Sachs. The two could soon become the only independent investment banks in the US.

Merrill’s board voted on Sunday night to approve BofA’s takeover all-stock bid, which was pitched at $29 a share. That is a premium of 70 per cent on Friday’s closing price of $17.05. Merrill’s shares have fallen nearly 70 per cent this year. The sudden turn of events came at the end of a weekend which saw top Wall Street executives locked in increasingly desperate talks over the future of Lehman and the state of the financial sector with Hank Paulson, US Treasury secretary, and Tim Geithner, president of the New York Federal Reserve.

However, bankers familiar with the talks said a rescue plan for Lehman had been seriously undermined after suitors Barclays of the UK and BofA, had walked away. Barclays pulled out in the afternoon after the US government refused to provide a guarantee to enable Lehman to continue trading until a deal had been completed. Lehman said during the New York night that it would file for bankruptcy.

The filing is likely to cause thousands of job losses among Lehman’s 25,000-strong staff. On Sunday night a number of employees were seen leaving Lehman’s Manhattan headquarters with boxes stacked with their possessions, stationery and even some paintings. In a separate move, regulators had prepared the ground for a Lehman bankruptcy by asking its derivatives counterparties to settle trades between themselves in a special trading session in the afternoon.

Merrill’s decision to enter talks with BofA, which has long coveted its rival’s large retail brokerage business, came after it became apparent that Lehman’s woes could spread to the rest of the investment banking sector in the coming weeks. John Thain, Merrill's chief executive, who was attending the Lehman crisis talks, approached some rivals asking them whether they would be interested in bidding for his firm, according to people close to the situation.

Morgan Stanley, BofA and some foreign banks were contacted but many of them declined to pursue the talks because they had insufficient time to pore over Merrill’s complex trading books, they added. Merrill, Morgan Stanley and BofA declined to comment. A takeover of Merrill would be a victory for Ken Lewis, BofA’s chief executive, who has long wanted to combine the lender’s commercial banking operations with Merrill’s army of retail brokers.

However, a deal could saddle BofA with more troubled assets. The bank bought the stricken mortgage-lender Countrywide and a purchase of Merrill would force it to clean up the bank’s trading books, which have already cost Merrill some $52bn in writedowns and credit losses.

Mr Thain, the former Goldman Sachs executive and former head of the New York Stock Exchange who joined Merrill last year after the departure of Stan O’Neal, is almost certain to leave the firm if the BofA takeover goes through. He is a fervent supporter of John McCain, the Republican presidential candidate, and some experts expect him to seek a political career.

Lehman demise could end speculative raid on taxpayers
Letting Lehman Brothers fail is the lesser of two evils facing U.S. financial regulators trying to stop a textbook trading ploy dead in its tracks -- a private sector raid on the public purse. U.S. authorities have already been forced to pledge some $230 billion this year to restore calm in the wake of speculative attacks on investment bank Bear Stearns and Federal mortgage agencies Fannie Mae and Freddie Mac.

Market veterans say the classic trade was set to be repeated in the weeks ahead if any form of official assistance had been involved in a deal to save or restructure Lehman, the 158-year old finance house which fell victim to traders aggressively selling its stock in a bid to book a slice of profit supplied, or ultimately guaranteed, by the government.

"It's the taxpayer versus the speculator," Paul Markowski, president of New York investment advisory firm Global Research Partners, told Reuters. "The speculator doesn't always win, but clearly in this case the speculator has increased the bill of the U.S. taxpayer."

Speculators have a track record in correctly scenting the willingness of official institutions to commit public funds to try to sustain an ultimately unsustainable situation.

Friday's 31 percent plunge in the share price of U.S. insurer American International Group, which has been hit by $18 billion in losses over the past three quarters from guarantees it wrote on mortgage derivatives, suggests traders were already on the hunt for their next victim after Lehman.

So too does a rapidly stitched together weekend deal that will see Bank of America Corp buy Merrill Lynch & Co Inc, the world's largest financial brokerage that has written down the value of its assets by more than $40 billion over the last year.

Hedge fund manager George Soros cemented his reputation by famously "breaking the Bank of England" in 1992, forcing the central bank to spend billions to defend the pound's place in the European Union's exchange rate mechanism before the British government withdrew sterling from the scheme.

Currency traders employed similar tactics in Asia in 1997, scenting blood when they realized huge foreign currency borrowings were incompatible with the region's fixed and quasi-fixed exchange rates. Their huge bets against the currency pegs saw successive central banks empty their coffers trying to defend the indefensible and forced International Monetary Fund bailouts for the region of more than $100 billion -- money that traders had essentially sucked out of the system.

If a second successive weekend of talks between bankers and officials from the U.S. Treasury, Federal Reserve and Securities and Exchange Commission to keep the U.S. financial system functioning smoothly had resulted in more public funds being committed to a single institution, it could have pushed wide open the door to the oldest trade in the book.

"What is good is that the Fed dug in its heels, refusing to be dragged into a bailout. This was a test for the Fed and the Fed passed it," said Robert Brusca, chief economist at Fact and Opinion Economics in New York.

While there was no direct money for Lehman, the Fed did unveil several fresh initiatives on Sunday to support markets, broadening the type of collateral financial institutions can use to obtain loans from the central bank and increasing the amount of Treasury securities it auctions on a regular basis to help foster liquid markets.

Edward Grebeck, chief executive officer of Tempus Advisors in Stamford, Connecticut, reckons there is a bill and it's clear who is paying. "The Fed is using, one way or another, a printing press to bail out the banks." The U.S. government's seizure and backing of multi-trillion dollar mortgage lenders Fannie Mae and Freddie Mac last weekend essentially added $1.6 trillion to the debt burden, pushing it up to 44 percent of national output or around $6.3 trillion.

Meanwhile the sheer supply and demand dynamics of that shift suggest that the market rates of interest the U.S. government -- and ultimately the taxpayer -- will have to pay to finance the additional debt must rise. The credit crisis "would be an interesting sporting event if it weren't so costly," said Mark Grant, managing director of structured finance at Southwest Securities, based in Dallas.

"We are not just going through deleveraging, but through a castration of capital not seen during my lifetime."

Deposit insurance system may face WaMu test
Attention has focused on the danger presented by the failure of Lehman Brothers. But the failure of a commercial bank such as Washington Mutual can have systemic consequences if it threatens a run on other weak banks. Washington Mutual - the sixth largest bank in the US - has lost more than a third of its market value recently as investors fear it lacks liquidity and capital to survive the credit crisis.

The failure of a bank its size would test the strength of the US deposit insurance system and its ability to maintain the confidence of the nation's savers. The US Federal Insurance Deposit Corporation covers the first $100,000 in deposits held by each individual in a given bank. As of June 30, 64 per cent of the total $7,000bn deposits were insured in the US - a much larger proportion than in the UK at the time when Northern Rock. the commercial bank, failed.

Nonetheless, this still leaves $2,500bn in uninsured deposits. If a high-profile failure causes these uninsured deposits to shift abruptly in a flight to safety, it could be highly destabilising for the banking system. The US could be forced to adopt a de facto blanket guarantee on all bank deposits, as the UK did on a temporary basis during the Northern Rock crisis.

There are other precedents. At the start of the Asian financial crisis in the 1990s, the International Monetary Fund opposed extending deposit guarantees. But the IMF soon changed tack and told crisis-hit countries to issue full guarantees. A formal blanket guarantee in the US would require legislation.

But under a 1991 law, the FDIC could seek a systemic risk exemption to cover all the deposits of a failing institution, subject to the approval of its board, a supermajority of the Federal Reserve governors, and the Treasury secretary in consultation with the president.

The FDIC has no desire to invoke this authority - which has never been used; would be unpopular with taxpayers; and would carry a cost in terms of moral hazard. The FDIC is respected for its operational effectiveness. But its $45bn deposit insurance fund is underfunded according to its own guidelines, at 1.01 per cent of insured deposits.

The FDIC is preparing a capital replenishment plan that would involve raising premiums paid by banks. But analysts fear it may have to draw on its $70bn Treasury credit lines. Alan Avery, a partner at Arnold and Porter, said a single failure - if big enough - "would cause the FDIC to immediately draw on the Treasury credit".

Washington Mutual had $143bn in insured deposits on June 30 - about three times the size of the deposit insurance fund, but less than half of its $307bn assets.

Fed Expands Lending Facilities in Bid for Stability
The Federal Reserve will expand its lending facilities in the wake of the likely demise of Lehman Brothers Holdings Inc., taking a wider array of securities, including equities, as collateral for its loans, the central bank said late Sunday.

The move, another landmark step in the Fed's efforts to address the deepening credit crisis, is meant to calm markets as they head into one of the most perilous trading environments in decades with Lehman's massive market positions on the verge of being unwound. It also capped a weekend of brinksmanship with Wall Street.

After the rescues of Bear Stearns, Fannie Mae and Freddie Mac, Fed and Treasury officials were determined to avoid bailing out another struggling financial firm. They drew the line at Lehman and stood their ground through a high-strung weekend of negotiations, insisting they wouldn't put public funds at risk to finance the rescue of another financial institution.

The expansion of short-term lending facilities showed that while they were unwilling to back another bailout, they are still struggling to find ways to ensure broader market stability and are prepared to take new steps to do that. After the collapse of Bear Stearns in March, the Fed said it would make short-term emergency loans to investment banks under a lending facility called the Primary Dealer Credit Facility.

Late Sunday, the Fed said it would take a broader array of collateral from firms for the facility, including equities. Another facility, in which firms can swap risky securities for safe Treasury bonds, was also expanded. As of Wednesday, no firms had used the primary facility since July.

But amidst the uncertainty created by the likely demise of Lehman Brothers and the deal for Merrill Lynch & Co. by Bank of America Corp., there could be a rush to borrow from the Fed as trading resumes Monday. Bankers say the unwinding of Lehman Brothers' many trading positions could create a large need for short-term funds.

Fed officials have been concerned for months about the resilience of a short-term secured lending market known as "repo" loans. It is the lifeblood of the brokerage industry, through which firms fund their day-to-day operations. Repo lending is used by banks, brokers and hedge funds. Typically, a borrower hands over securities as temporary collateral for a loan. In normal times, the cheap funding is widely available.

"The steps we are announcing today, along with significant commitments from the private sector, are intended to mitigate the potential risks and disruptions to markets," Fed Chairman Ben Bernanke said in a prepared statement. All along, U.S. officials have been caught in a bind. If they go too far to support markets, bankers could become conditioned to expect a rescue whenever they wobble.

If they don't go far enough, the financial crisis could get even worse. "If I were at the Fed, I would be hoping for an opportunity to show the world that the Fed will not rescue every ailing institution but will let some go," said Douglas Elmendorf, a senior fellow at the Brookings Institution.

Lehman's collapse will send deep and painful ripple effects across the markets. The firm sat on $33 billion of commercial real-estate assets and $13 billion in residential mortgages at the end of August; a liquidation could mean forced sales of those and other assets, which could knock down the value of other firms' holdings.

Lehman is also deeply intertwined in many other markets -- most notably the vast market for credit-default swaps, in which it is a top-10 player. Even as they were holding the line about being involved in funding a rescue, Fed staff members over the weekend were working with Wall Street credit traders to help sort through their positions with Lehman in this market. Officials also were involved in discussions during the weekend of brinksmanship that brought agreement Sunday night on the sale of Merrill to BofA.

Fed officials have some confidence that they are better prepared to deal with the fallout from a failure than they were when Bear Stearns failed, and the Fed arranged a shotgun wedding to J.P. Morgan Chase & Co. The emergency lending facilities it set up after Bear could help cushion the blow to the market if Lehman now fails. But some areas, like swap trading, are still a huge source of uncertainty.

Market conditions until Friday had been mixed. The broader stock market so far has been relatively stable through this latest round of turmoil. But short-term lending rates such as the London Interbank Offered Rate, or Libor, are elevated relative to expectations for the Fed's benchmark federal-funds rate, but have been stable in recent weeks. Risk premiums on junk bonds also are back to levels they hit in March.

But trading Monday could change all of that, particularly in the credit-default-swap, or CDS, market, in which firms trade contracts tied to corporate default risks. It is an immense market that trades against $62 trillion of debt. Officials worry that the collapse of an investment bank could send problems cascading through the financial system by way of this market. The Fed has been pushing Wall Street to create a new clearinghouse to diminish that risk, but it isn't in place yet.

Sorting out Lehman's CDS positions promises to be difficult and time-consuming, because many of the contracts have different terms and maturity dates. In a survey last year by Fitch Ratings, Lehman was listed among the 10 largest CDS counterparties by number of trades and the amount of debt to which the contracts were tied.

European Central Banks Ready to Inject Billions
Major European central banks prepared on Monday to inject billions into global money markets to ensure that the weekend’s turmoil on Wall Street does not spread to the rest of world’s financial systems. The European Central Bank said that it lent 30 billion euros or $42.7 billion at 4.25 percent, in an almost identical repeat of an episode that started the financial crisis in Europe in August 2007.

Then, as now, the central bank was worried that banks would abandon the interbank lending market, a vital financial conduit in which banks lend to one another to keep the financial system running on a daily basis. However the central bank.’s latest injection was far less than the 94.8 billion euros it put into money markets in August 2007.

The central bank said it was “ready to contribute to orderly conditions in the euro money market” and that it would lend as much cash as banks wanted at its benchmark interest rate of 4.25 percent. The Swiss National Bank offered money at 1.9 percent, and said it would act “flexibly and generously.”

The Bank of England will also lend 5 billion pounds over the next three days at 5 percent. The loans will mature on Thursday, when the British central bank conducts its regular refinancing operation. “Following the announcements overnight, the Bank of England will be monitoring carefully the conditions in sterling money markets and will take appropriate actions if necessary to stabilize those markets,” it said in a statement.

Central bankers believe that a purging of losses and some bankruptcies will be necessary for the financial crisis to end. But the pace and scope of the changes in the United States over the weekend has opened the door to fresh turmoil with policy implications worldwide.

Some central banks are also banking supervisors, but all of them have to be worried about the potential for losses in the financial sector to result in a lending squeeze to the rest of the economy. So far, that has not been a problem in Europe.

The central fear in the current scenario would be that the bankruptcy filing by Lehman Brothers, combined with potential losses linked to the American International Group insurer, would drag down European banks. The extents of their exposure to the American crisis is hard to know.

“Is this part of the healing process _ some institutions need to go to get over this _ or does this have the potential to be a new source of uncertainty?” said Ken Wattret, chief Europe economist at BNP Paribas in London. The Bundesbank, Germany’s central bank, said German banks have “manageable” exposure to Lehman Brothers, Reuters reported.

In any case, European central banks — the lenders of last resort — seem to have opted for a policy of preventive action, rather than waiting for Wall Street’s woes to cause new cracks in the financial foundation. However, the central banks have resisted aggressive interest rate cuts as a solution to the financial crisis, an approach the Federal Reserve has embraced.

The Fed’s response at a meeting due to begin Tuesday is now a central question among investors, but few are daring to hope the central bank will cut rates. “The E.C.B. would probably need to be convinced that credit markets have seized up or see a vicious downward spiral in equity markets to participate,” said Jacques Cailloux, chief Europe economist at Royal Bank of Scotland, according to Reuters.

Mr. Wattret at BNP Paribas said: “There is an increasing pressure on central banks to act. The Fed is more likely to cut rates than the E.C.B. What the Fed doesn’t want is a sustained drop in house and equity prices at the same time. The E.C.B. won’t be at the forefront of cutting rates because it remains focused on inflation.”

Christine Lagarde, the French finance minister, said that European authorities pondered responses to the unfolding events in the United States at a meeting of finance ministers and central bankers at a weekend meeting in Nice, France.

“All the monetary, banking and treasury authorities have been consulting for several days, we worked again last night and the mechanisms are in place, the central banks are on alert, there is no panic,” she told Europe 1 radio.

Fed's PDCF, TSLF Pawnshop Limits Increased; Section 23A Rules Violated
The Fed is acting to prevent a spillover from the Lehman collapse, taking a series of emergency liquidity actions explained in Fed braces markets for likely Lehman collapse.
The U.S. Federal Reserve on Sunday launched a series of emergency measures to calm financial markets and ease any trading disruptions that could arise from a collapse of investment bank Lehman Brothers.

One of the biggest changes the Fed made was to accept equities as collateral for cash loans at one of its special credit facilities, the first time that the Fed has done so in its nearly 95-year history.

The most striking new Fed action was its decision to accept equities as collateral for cash loans under its Primary Dealer Credit Facility for investment banks. Until now, collateral was limited to investment-grade debt securities.

"The Fed's action allows dealers to pledge an asset class that is a significant part of the Street's securities positions," said Tony Crescenzi, chief bond market strategist, Miller, Tabak & Co in New York, giving them significantly more access to loans if they need them.

The Fed also said it was increasing the total amount that it offers under a separate program that lends out liquid Treasury securities to $200 billion from $175 billion. It will also begin holding auctions under this program more frequently.

In a third step, it said it will temporarily allow commercial banks to extend liquid funds to their brokerage affiliates for assets that would normally be accepted in tri-party repurchase agreements.

It said this would be permitted only until January 30, 2009, apparently reflecting the Fed's hope that stressed repo markets would be operating more normally by then.

Bernanke Violates Federal Reserve Act Section 23A

Allowing banks to extend funds to their brokerage affiliates is in violation of Federal Reserve Act Section 23A.
Section 23A of the Federal Reserve Act ( Act ), originally enacted as part of the Banking Act of 1933, is designed to prevent the misuse of a bank's resources through non-arm's-length transactions with its affiliates and to limit the ability of a bank to transfer its federal subsidy to its affiliates.

Bernanke's willingness to break the law is in strict accordance with Fed Uncertainty Principle Corollary Number Four.
The Fed simply does not care whether its actions are illegal or not. The Fed is operating under the principle that it's easier to get forgiveness than permission. And forgiveness is just another means to the desired power grab it is seeking.

Supposedly the Fed "will temporarily allow commercial banks to extend liquid funds to their brokerage affiliates for assets that would normally be accepted in tri-party repurchase agreements."

For starters I doubt it will be temporary. But the main point is the Fed is taking steps that it knows to be blatantly illegal.

Banks Fear Next Move by Shorts
In May, David Einhorn, one of the most vocal short-sellers on Wall Street, made no secret he was betting against Lehman Brothers.

Now, some investors are afraid that fund managers like him will take advantage of the climate of fear stirred up by the troubles of Lehman to target other weak financial firms whose declining share price would bring them rich rewards.

At emergency meetings over the weekend, the heads of major financial institutions urged Timothy R. Geitner, the president of the New York Fed, and Treasury Secretary Henry M. Paulson Jr., to consider having the Securities and Exchange Commission reinstate a temporary rule to limit the risky but potentially lucrative practice of betting on a firm’s falling share price, according to two people who were briefed on, but did not attend, the meetings.

They are concerned that short-sellers might fix their gaze on big financial institutions like Merrill Lynch and the insurance giant American International Group, which also need billions of dollars in capital to strengthen their businesses.

In July, the S.E.C. briefly halted a practice known as naked short selling after speculators placed large bets that shares of Fannie Mae and Freddie Mac, the troubled mortgage giants, would decline. That also made it harder to short the stocks of 19 financial institutions, including brokerage firms like Lehman Brothers and Morgan Stanley, although the curb wound up having little impact on the price of their shares.

The investment tactic of betting a stock will slide is not new, of course. But it has become particularly controversial in the last year, when Wall Street firms started to be targeted as the credit crisis turned the financial sector upside down. Short sellers and their free market supporters say they have done nothing wrong.

If anything, they say, they have merely spotted problems at financial institutions ahead of everyone else, making them a useful early warning system for the rest of the market. Critics believe they have contributed to the speed of the decline of any number of financial shares.

Short-selling against financial institutions has proven particularly lucrative for hedge funds. Mr. Einhorn’s accusations that Lehman was failing to properly account for its marks on troublesome holdings, which appear to have presaged the bank’s early report of a $2.8 billion loss for its second quarter, has presumably netted him a handsome return.

Lehman’s shares were already under pressure when he took the microphone at a large industry gathering in May to lay out his case against the investment bank. The firm, he told the crowd, had used “accounting ingenuity” to avoid large write-downs and remained tainted by bad commercial real estate investments.

Mr. Einhorn stood to profit by convincing people of his view: He had been betting against Lehman’s stock — it stood at around $40 when he spoke — since July 2007, when they traded for around $70 a share. On Sunday, Lehman filed for bankruptcy protection.

While Lehman’s shares have declined as investors lost confidence in its ability to repair its balance sheet, in the four months after Mr. Einhorn’s remarks, short-selling played a role in the erosion. A rapid plunge in the shares to below $4 last week ultimately created the conditions that brought the 158-year old firm to its knees on Sunday.

For all his boldness, Mr. Einhorn is aware of the havoc that bank failures can create. “We would not win if Lehman went down and took the whole financial system with it,” Mr. Einhorn said in an interview in June. “An actual collapse of Lehman — that would not be a good thing.”

Other hedge fund managers recognize the dangers and the harm that is befalling bank employees who have been paid in their companies’ stocks . “My children, their playmates’ fathers work at Lehman,” said one manager who is short Lehman and asked to remain anonymous, citing the sensitivity of the situation.

“Obviously I had nothing to do with what happened, and the idea that I profited, and they got clobbered, and
I’ve got to see them on Monday is awkward. I feel badly for them.” Mr. Einhorn was never shy with his criticism of Lehman. He pointed to the bank’s investments in two real estate companies, Archstone and Sun Cal, and said Lehman had not marked its mortgage assets down enough. “Lehman is one of the deniers,” he said in the June interview.

He first mentioned Lehman in a speech in October when he pointed out that the company had shifted $9 billion of mortgage securities into the “hard-to-value” category on its balance sheet. In April, he appeared unsure whether Lehman would suffer any time soon, saying “given that Lehman hasn’t reported a loss to date, there is little reason to expect that it will any time soon.” To many, Mr. Einhorn simply saw the writing on the wall early.

And, hedge fund managers say, Lehman executives failed to realize how much credibility Mr. Einhorn has in the investor community. Lehman might have fared better if it raised capital or took write-offs far earlier, as Mr. Einhorn suggested. But to some in the world of finance, Mr. Einhorn and investors like him are dangerous.

“It is really like taking a baseball bat to someone who is down,” said Jim Hardesty is president of Hardesty Capital Management in Baltimore. “A bunch of these guys with very large bats are circling around certain companies and banging them over and over again. It is unsportsmanlike conduct.”

Mr. Hardesty is among the investors who believe the S.E.C. made a mistake in allowing the temporary curb to slow the impact of short-selling to expire. Hedge fund managers who focus on shorting companies stand out in the industry in an otherwise terrible trading year. Hedge funds are down more than 4 percent but short-focused hedge funds are up 9.76 percent, said Hedge Fund Research, a firm in Chicago.

Ironically, Mr. Einhorn’s fund, Greenlight Capital, is down 4.3 percent this year through Aug. 22, according to HSBC (he also invests in stocks, as well as shorting them). His is a so-called long-short fund, which means he invests $2 buying shares in companies for every $1 he places shorting other companies. One company he took a positive view on in recent years was New Century, one of the first subprime mortgage lenders to file for bankruptcy.

AIG shares plummet, debt protection costs surge
Shares of American International Group fell nearly 40 percent in pre-market trading after reports that the insurer had turned to the Federal Reserve for $40 billion in bridge financing to ward off a liquidity crisis and ratings downgrades.

The up-front cost of insuring $10 million of AIG's debt for five years jumped to $3.05 million from $1.3 million on Friday, in addition to annual payments of $500,000, according to Markit Intraday. The insurer, which has incurred $18 billion in losses over the past three quarters from guarantees it wrote on mortgage derivatives, was hit on Friday by Standard & Poor's putting the company's credit ratings on negative watch, indicating a possible downgrade.

Over the weekend, AIG executives and New York state insurance regulators scrambled to hatch a plan that would boost AIG's liquidity. It was not clear early on Monday when AIG would reach a plan. A spokesman did not immediately return a call seeking comment. AIG shares have fallen about 80 percent since the start of the year.

Several analysts, in research reports on Monday, warned that the company is unlikely to resemble itself after a much-anticipated restructuring. AIG has been considering "a wide range of options," the company said, including selling off valuable assets.

AIG, until recently the world's largest insurer, does business in 130 countries and territories around the world, selling insurance to 74 million customers worldwide. It has also an aircraft leasing arm, an asset management business and a financial products unit. The latter holds a credit default swap portfolio that has triggered the large mortgage losses.

AIG Scrambles to Raise Cash, Talks to Fed
Insurer American International Group Inc., succumbing to relentless investor pressure that drove its shares down 31% on Friday alone, is pulling together a survival plan that includes selling off some of its most valuable assets, raising more capital and going to the Federal Reserve for help, people familiar with the situation said.

The measures are aimed at staving off a downgrade by major credit-rating firms. AIG executives worried that such an action would set off a chain reaction that could be fatal to the firm. The insurer, which has already raised $20 billion in fresh capital so far this year, was seeking to raise an additional $40 billion to avoid a downgrade.

During a weekend scramble to shore up its finances, AIG turned down a capital infusion from a group of private-equity firms led by J.C. Flowers & Co. because an option tied to the offer would have effectively given them control of the company, an 89-year-old giant that does business in nearly every corner of the world.

The proposed option would have allowed the firms to acquire AIG for $8 billion under certain conditions. That price is just one-fourth of AIG's current market value.

When AIG's board rejected the capital infusion, the company's recently appointed chairman and chief executive, Robert Willumstad, took the extraordinary step of reaching out to the Federal Reserve for help. Mr. Willumstad asked New York Federal Reserve President Timothy Geithner if the Fed could backstop some asset sales.

Two other private-equity firms -- Kohlberg Kravis Roberts & Co. and TPG -- offered to inject capital into AIG if the Fed agreed to provide the insurer with a bridge loan until its restructuring plan was completed. AIG viewed the request to the Fed not as a bailout but rather as a temporary measure that would give the insurer some breathing room until it was able to dispose of the assets.

As of late Sunday, the Fed had yet to decide whether to offer the assistance. The Fed usually deals with banks and brokers, and it wasn't clear what it could do. An AIG spokesman had no comment. The Fed may not draw the line with AIG's request for support as clearly as it has with Lehman, distinguishing between its lending programs and the use of taxpayer funds. But any Fed action to help the firm still would have a high bar.

Central bank officials took an extraordinary step in expanding the discount window to securities firms earlier this year. Expanding it to other firms would be another big step, though it could be considered if a case can be made for how such a lending lifeline would be critical to overall financial stability.

The assets AIG intends to sell include its domestic automotive business and its annuities unit, according to people familiar with the matter. It also looked into selling its aircraft-leasing arm, International Lease Finance Corp., but it isn't clear whether action on ILFC will be part of the emergency steps.

AIG also considered shifting assets from its regulated insurance business to its holding company, which would help the holding company respond to demands for cash or collateral. But that plan was met with resistance from regulators and by late Sunday it appeared unlikely it would come together.

The rush for cash represents a remarkable comedown for AIG, whose role in global finance is in many ways as critical as investment banks such as Lehman Brothers. AIG's troubles were one of the subjects at the weekend meeting of Wall Street chiefs and regulators at the New York Fed.

Eric Dinallo, the insurance superintendent in AIG's home state of New York, took a significant role in the talks over the weekend, according to a person familiar with the matter. One key issue, the person said, was the proposed shift of assets. Insurers typically face stringent regulations on how they use their assets, as regulators seek to make sure that they can meet their obligations to policyholders.

The turmoil in housing and credit markets has hammered AIG, largely because of contracts it sold protecting others against losses tied to subprime loans and other risky assets. AIG's stock has fallen nearly 80% this year. It reported a second-quarter net loss of $5.36 billion last month after a first-quarter loss of $7.81 billion.

Among its challenges: It doesn't have access to the Fed's lending window, as some other troubled financial firms do. It could face significant claims from Hurricane Ike, which battered the Texas coast over the weekend. It had to pay a stiff premium in August when it borrowed money in the corporate bond market.

As recently as Thursday, AIG said it was sticking to a schedule to unveil its strategic plan on Sept. 25. But its shares fell 31% on Friday alone. Late that day, Standard & Poor's warned that it could cut AIG's credit rating by one to three notches, citing concerns that AIG would have difficulty raising capital. Such a step would make it more expensive for
AIG to borrow and further undermine investor confidence in the company.

Earlier this year, AIG considered selling or spinning off ILFC, the aircraft-leasing arm, but it decided against the idea in June. Since then, AIG's position has deteriorated, making it more likely that it would try again to unload the unit.
AIG could also raise cash by selling its investments in Blackstone Group LP, which is also helping to advise the insurer on its restructuring. AIG owns a stake in Blackstone worth about $700 million.

It also has roughly $1 billion in investments in Blackstone's funds, according to regulatory filings, that it could sell in the secondary market. It's not clear whether AIG has buyers lined up for any of the assets it wants to sell. Also unclear is how much interest private-equity firms would take in an AIG investment, and whether they have enough capital to make a dent in AIG's problems.

"The numbers are too daunting," said a senior executive at a large private-equity firm. Given AIG's huge balance sheet, "we just don't have enough capital to fill the hole."

Over four decades, former Chief Executive Maurice R. "Hank" Greenberg built AIG into one of the world's largest financial firms. He made major acquisitions, and pushed AIG into businesses beyond the world of traditional insurance. For years, investors paid a hefty premium to buy AIG shares. Now AIG is not even the most valuable insurer in the U.S., as measured by market capitalization.

A 2005 accounting scandal precipitated Mr. Greenberg's departure. He has denied wrongdoing. A protégé, Martin Sullivan, ran the company until this summer when he was replaced under shareholder pressure with Mr. Willumstad, a former Citigroup Inc. executive who has been AIG's chairman since 2006.

When Mr. Willumstad said in June that he would release his turnaround plan in a few months, some wondered whether that gave him enough time to get his hands around such a multifaceted enterprise. But rapid shifts in the market have forced his hand.

Mr. Willumstad reached out to Mr. Greenberg after taking over in June, But a spokesman for Mr. Greenberg said the former CEO wasn't involved in the weekend talks, "though he repeatedly offered to assist in anyway he could" -- suggesting that Mr. Willumstad was pursuing his own strategy.

The aircraft-leasing arm could be part of his efforts. Founded in 1973, ILFC boasts a fleet of more than 900 airplanes valued at more than $50 billion. It is the largest single customer for both Boeing Co. and European Aeronautic Defence & Space Co.'s Airbus. Given that ILFC logged record operating income of $352 million in the second quarter, its value may be relatively high at the moment compared to some other AIG units.

S&P said AIG had enough money to pay claims and post collateral, if needed -- an important statement, given that AIG could have to post billions of dollars if it got downgraded. AIG had over $1 trillion in assets at the end of the second quarter. Its shareholders equity -- assets minus liabilities -- stood at about $78 billion at that point.

Can the Fed Help AIG? Will It?
It’s one fire after another for the Federal Reserve. As it sought to address the Lehman Brothers crisis over the weekend, the next big problem became insurer American International Group, Inc., which is reaching out the central bank for a loan. The request raises a host of questions, but the three most important are: Can the central bank lend to AIG? Will the Fed do it? And should it?

The answer to the first question is pretty clearly, “yes.” AIG doesn’t have access to the primary dealer credit facility, the Fed’s lending program for investment banks. The facility was set up in the wake of the collapse of Bear Stearns to allow securities firms that interact with the Fed daily but don’t fall under its direct banking supervision to have access to discount-window lending usually reserved for depsitory institutions. But, the Fed has the power to broaden access.

According to Section 13, paragraph 3, of the Federal Reserve Act, the central bank can lend to “any individual, partnership, or corporation” under extreme circumstances and under certain conditions. This is the paragraph that the Fed used to justify its intervention in the Bear Stearns deal, and also served as the basis for the PCDF, which has been extended to January 2009.

The paragraph has a controversial history and the Fed has denied direct lending before, such as a 1975 request from the city of New York. In the end, the central bank just acted as a fiscal agent for the government’s eventual loans to the city. The answer to the question of whether the Fed will act on its authority is less clear. The Fed may not resist AIG’s request for support as clearly as it has with Lehman Brothers, distinguishing between its lending programs and the use of taxpayer funds.

But any Fed action to help the firm still would have a high bar. Central bank officials took an extraordinary step in expanding the discount window to securities firms earlier this year. Expanding it to other firms would be another big step, though it could be considered if a strong case can be made for how such a lending lifeline would be critical to overall financial stability. The terms on any loan must come from the Fed’s Board of Governors, which must approve the move.

Another complication lies in the wording of that key paragraph in the Federal Reserve Act. The Act states that before agreeing to a loan “the Federal reserve bank shall obtain evidence that such individual, partnership, or corporation is unable to secure adequate credit accommodations from other banking institutions.” That might be a deal breaker with AIG, which turned down a capital infusion from a group of private-equity firms led by J.C. Flowers & Co. because an option tied to the offer would have effectively given them control of the company.

Finally, there is the question of whether the Fed should get involved. On the one hand, the Fed is dedicated to doing all that it can to maintain financial stability. If it deems AIG’s survival crucial to the overall health of the economy, it may need to step in, as it did earlier this year with Bear Stearns. However, further expanding the discount window to another class of firms has the potential to open a Pandora’s Box of companies looking to the Fed for funding.

Representatives of General Motors have already been sniffing around for government money, making Fed officials uncomfortable about public perception of the central bank’s role. If the Fed extends lending beyond its usual counterparties, they’ll be deeper into the question of where to draw the line. The central bank’s resources are great, but they aren’t infinite.

US government blocks Fannie, Freddie CEOs' exit packages
The federal government will not pay the ousted chief executives of mortgage finance companies Fannie Mae and Freddie Mac up to $24 million in exit packages.

The Federal Housing Finance Agency notified former Fannie Mae CEO Daniel Mudd and former Freddie Mac CEO Richard Syron that such "golden parachute" payments will not be paid. The housing agency, which took control over the companies earlier this month, made the announcement on Sunday.

"It would have been unconscionable to award these inflated salaries, particularly when the leadership of Fannie and Freddie can hardly be given good grades," Sen. Charles Schumer, D-N.Y., said in a statement. Mudd had been due to receive up to $8.4 million in compensation, while Syron was due to receive up to $15.5 million, according to calculations by David Schmidt, a senior consultant at executive compensation consulting firm James F. Reda & Associates.

Representatives of both Syron and Mudd declined to comment Monday morning. Mudd received $12.2 million in compensation in 2007, and Syron was paid $19.8 million. Herbert Allison was named the new chief executive of Fannie, and David Moffett the new CEO of Freddie as part of the government's bailout of the two huge mortgage financing agencies.

Fannie and Freddie own or guarantee about $5 trillion of the nation's outstanding mortgages, roughly half the nation's total. James Lockhart, the housing agency's director has said that compensation for the new executives will be "significantly lower than the outgoing CEOs

Goldman, Morgan Stanley face post-Lehman funding issues
Analysts expressed concern about the funding supporting the surviving independent Wall Street investment banks Monday, following the sale of Merrill Lynch & Co. and the bankruptcy filing of Lehman Brothers Holdings Inc..

Lehman's "apparent demise and the likely damage to its bondholders indicates significant spread-widening for independent broker-dealers and probably considerably narrower access to funds," Merrill Lynch banking analyst Guy Moszkowski said in a research note Monday.

Long considered two strongest of the major Wall Street investment banks, Goldman Sachs Group Inc. and Morgan Stanley now face increased selling pressure on their shares, according to analysts, as the departure of the investment banks' weaker competitors throws into question the viability of their independent business models.

Goldman shares fell 7.7% in recent premarket action to $142.37, while Morgan Stanley shares were off 9.7% to $33.61.
Moszkowski advised Merrill's clients to stop buying Goldman shares and cut his rating on the stock to neutral from buy. He said tighter credit market funding will drive a "tidal wave" of asset deleveraging and write-downs during the fourth quarter. He said Goldman's profitability next year likely will be harmed as a result and cut earnings estimates and his price target on the stock, to $159 from $187.

Also predicting funding problems for the major brokers and the financial system in general, banking analyst Dick Bove of Ladenburg Thalmann said Goldman and Morgan Stanley each may have to merge with a commercial bank to survive. "We are in uncharted territory but it seems likely that all financial firms that extend credit will be pulling back on their credit lines," Bove said.

"This will make it even harder for commercial firms and individuals to borrow money and it may result in demands for immediate debt repayment. This will harm the economy for an extended period." Bove said Goldman and Morgan Stanley probably would have to make an effort to develop core deposits, most likely by each buying a commercial bank, though he said they each also could be acquired by one, like Merrill Lynch.

Merrill Lynch agreed Sunday to be bought by Bank of America Corp., a giant commercial bank based in Charlotte, for about $50 billion, or $29 a share. Bank of America was considering buying Lehman Brothers as late as Friday but pulled out of discussions, forcing Lehman's Chapter 11 bankruptcy filing Monday.

Ten major banks announced Sunday night that they intended to pool together a $70 billion collateralized borrowing facility that would help them ride out the credit storm. They also agreed to work together to mitigate the fallout from exposure to Lehman's derivatives. The group included Bank of America, Goldman, Morgan Stanley, Merrill Lynch, Barclays PLC , Citigroup Inc., Credit Suisse Group, Deutsche Bank AG, JPMorgan Chase & Co. and UBS AG .

Lehman Files Biggest Bankruptcy Case as Suitors Balk
Lehman Brothers Holdings Inc., the fourth-largest U.S. investment bank, succumbed to the subprime mortgage crisis it helped create in the biggest bankruptcy filing in history.

The 158-year-old firm, which survived railroad bankruptcies of the 1800s, the Great Depression in the 1930s and the collapse of Long-Term Capital Management a decade ago, filed a Chapter 11 petition with U.S. Bankruptcy Court in Manhattan today. The collapse of Lehman, which listed more than $613 billion of debt, dwarfs WorldCom Inc.'s insolvency in 2002 and Drexel Burnham Lambert's failure in 1990.

Lehman was forced into bankruptcy after Barclays Plc and Bank of America Corp. abandoned takeover talks yesterday and the company lost 94 percent of its market value this year. Chief Executive Officer Richard Fuld, who turned the New York-based firm into the biggest underwriter of mortgage-backed securities at the top of the U.S. real estate market, joins his counterparts at Bear Stearns Cos., Merrill Lynch & Co. and more than 10 banks that couldn't survive this year's credit crunch.

"There is likely to be a domino effect as other firms and individuals who relied on Lehman for financing feel the effects of its meltdown," said Charles "Chuck" Tatelbaum, a bankruptcy lawyer with Adorno & Yoss in Florida and former editor of the American Bankruptcy Institute Journal. "The whole thing is frankly frightening for the U.S. economy."

Lehman's filing was made by lawyers from New York-based Weil Gotshal & Manges, led by bankruptcy lawyer Harvey Miller. The case was assigned to U.S. Bankruptcy Judge James Peck, according to court records. Peck was sworn in as a judge in January 2006. Before taking the bench, he served as co-chair of business reorganization at Schulte Roth & Zabel, and prior to that was a partner at Duane Morris, according to the court's web page.

Lehman shares at 9:39 a.m. dropped 92 percent in New York trading to 29 cents from their $3.65 close on Sept. 12. UBS AG, HBOS Plc and Axa SA led a decline of more than 3 percent for European stock markets on speculation a forced sale of Lehman's assets may lead to further writedowns at other banks.

Benchmark gauges of corporate credit risk rose by a record in Europe, and traded at an all-time high in North America as investment banks sought to minimize losses from Lehman's collapse. U.S. two-year Treasuries climbed, pushing yields below 2 percent for the first time since April, as investors sought the relative safety of government debt.

Lehman bondholders may get about 60 cents on the dollar if the investment bank is forced into liquidation, analysts at CreditSights Inc. said. The filing is by Lehman's holding company and won't include any of its subsidiaries. Lehman owes its 10 largest unsecured creditors more than $157 billion, including debts to bondholders totaling $155 billion.

The largest single creditor listed in today's filing is Tokyo-based Aozora Bank Ltd., owed $463 million for a bank loan. Other top creditors include Mizuho Corporate Bank Ltd., owed $382 million, and a Citigroup Inc. unit based in Hong Kong owed an estimated $275 million. Lehman listed $639 billion of assets. New York-based Citigroup and The Bank of New York Mellon Corp. are among trustees for bondholders who Lehman owed about $155 billion.

London-based Barclays, which emerged as a leading candidate to acquire Lehman, pulled out first yesterday, saying it couldn't obtain guarantees from the U.S. government or other Wall Street firms to protect against losses on Lehman's assets. Bank of America Corp. withdrew about three hours later, before saying it would acquire New York-based Merrill Lynch. Brokers sought yesterday to consolidate trades linked to Lehman to minimize the impact of a bankruptcy filing.

Founded in 1850 by three immigrants from Germany, Lehman has managed to avert previous potential disasters and was among the handful of U.S. financial firms that had endured for more than a century. Fuld, the longest-serving CEO on Wall Street, attempted to shore up the firm's finances in the second quarter by raising $14 billion of capital, selling $147 billion of assets, increasing cash holdings and reducing reliance on short-term funding to create a buffer against a bank run.

Instability in the financial and credit markets left Lehman officials struggling to keep the firm afloat, Ian Lowitt, the firm's chief financial officer, said in a court filing in the bankruptcy case. Liquidity problems plagued Lehman earlier this year, he said. "This loss of liquidity created a chain reaction of adverse economic consequences," Lowitt said.

Lehman, which has about 25,000 employees worldwide, last week reported the biggest loss in its history and said it planned to sell a majority stake in its asset-management unit, spin off real-estate holdings and cut the dividend in an effort to shore up capital and regain investor confidence. The efforts failed to stem speculation that the firm's mortgage holdings would lead to more losses.

"The uncertainty, particularly among the banks through which the company clears securities trades, ultimately made it impossible for the company to continue to operate its business," Lowitt said in the filing. The firm had sought about $4 billion for the asset-management unit, he added.

The U.S. Treasury and the Federal Reserve negotiated with Wall Street executives for the past three days in New York, trying to strike a deal that would prevent the investment bank from failing before markets open today. Treasury Secretary Henry Paulson indicated that he didn't want to use U.S. taxpayer funds to ease a sale of the company.

Fuld, 62, is exploring the sale of its broker-dealer operation and continues to hold talks on the sale of its asset- management unit, including fund manager Neuberger Berman, the company said today in the statement. The U.S. Securities and Exchange Commission said customer accounts at Lehman are protected and agency staff will remain at the brokerage firm in the coming weeks.

Securities rules require segregation of Lehman's securities and cash, and accounts are covered by insurance provided by the Securities Investor Protection Corp., the Washington-based agency said last night. SEC employees working inside the broker's office will continue that assignment, the agency said.

"We are committed to using our regulatory and supervisory authorities to reduce the potential for dislocations from recent events, and to maintain the smooth functioning of the financial markets," said SEC Chairman Christopher Cox in a statement yesterday.

Brokerage units that fail usually are handled by the SIPC, which appoints a trustee to liquidate the business and protect its customers. Lehman's customer accounts may also be farmed out to other firms that may protect cash and securities, on the model of the failed junk-bond firm Drexel Burnham Lambert, which filed for bankruptcy in 1990.

Lehman's trades in commodities, derivatives and other financial instruments may be unwound by the bank's counterparties, said Andrew Rahl, co-head of bankruptcy in New York at law firm Reed Smith and a specialist in financial companies. A liquidation of the brokerage unit might be "a big mess" if Lehman used customer accounts to raise cash, and sale and repurchase agreements had to be unwound, Rahl said.

The trigger for SIPC to take over the Lehman brokerage would be a freezing of customer accounts, or a Chapter 11 filing that implied the unit was insolvent and its customers might not be able to access their property, the official said. "First there will be chaos and then an adjustment process as losses distribute themselves through the market," said Gilbert Schwartz, a former Federal Reserve attorney and now a partner at Schwartz & Ballen in Washington.

"There won't be any lasting turmoil. Treasury and the Fed have determined that markets have adjusted to the situation since Bear Stearns. If every time a big institution went bust the markets expected the government to step in, no one would ever adapt." Ladenburg Thalmann & Co. analyst Richard Bove wasn't as sanguine. "We will be entering uncharted territory," he said. "Forcing liquidation will set off problems in other companies and markets everywhere."

Rival banks and brokers yesterday held a session for netting derivatives transactions with Lehman to reduce uncertainty in that market. That move means canceling trades that offset each other, the International Swaps and Derivatives Association said in a statement. The ISDA includes 218 banks, brokerages, insurance companies and other financial institutions from the U.S. and abroad.

In the U.K., the Financial Services Authority asked banks to disclose their exposure to Lehman, spokeswoman Teresa LaThangue said in a statement today. Any sale of Lehman's investment management units is subject to court approval and creditor scrutiny under bankruptcy rules, according to Tatelbaum.

"Bankruptcy severs all counterparty contracts, and therein lies the systemic risk," said David Kotok, chief investment officer of Vineland, New Jersey-based Cumberland Advisors Inc., which manages $1 billion. "This would be the first time we've tested how much damage will be done by a bankruptcy."

Lehman 2007 Bonuses?
Lehman paid out around $5.7 billion in bonuses in 2007. Are those bonuses safe? Maybe not. The bonuses might be recoverable as fraudulent transfers---transfers made while insolvent without receiving reasonably equivalent value. (UFTA 5(a)).

Thus, the key question is whether Lehman was solvent when it paid out the bonuses? (The statute of limitations goes back past 2007, fwiw.) On an equity basis, almost assuredly yes, but on a balance sheet basis, that might be a closer call, depending on how things like MBS and CDOs are valued.

If Lehman was not solvent when it paid the bonuses, then I think there's a fraudulent transfer. It's hard to see how a bonus could ever be paid in exchange for reasonably equivalent value, when an employee has already been paid a salary for their efforts. There are various defenses to FTs, but none would seem to apply here at first blush.

Of course, it takes a challenge by a creditor whose claim arose before the bonuses were paid, but per the rule of Moore v. Bay (which I am teaching tomorrow), it only takes one of them, owed a single cent, in order to challenge all the bonuses. The lack of a creditor might protect the bonuses, but as creditors look to carve up what's left of Lehman, the thought of recovering a decent chunk of $5.7 billion is going to look very appealing.

Industrial Production in U.S. Falls Most in Three Years
Industrial production in the U.S. fell in August by the most in almost three years as the slowdown in consumer spending prompted automakers to cut back. The 1.1 percent decrease in production at factories, mines and utilities was more than forecast and the biggest since September 2005, Federal Reserve figures showed today. Car output slumped 12 percent, the most in a decade.

Producers are hurting as the housing recession, shrinking credit and rising unemployment lead consumers and businesses to cut spending. The plunge in output, one of the measures that determines whether a recession has begun, fanned concern the economic slowdown will intensify following the collapse in financial markets that claimed Lehman Brothers Holdings Inc.

``We're seeing more pervasive weakness in manufacturing, going beyond autos,'' said Sal Guatieri, a senior economist at BMO Capital Markets in Toronto. ``The weakness will continue this month as the economy is taking a lurch downward. This is another report that points to a recession.''

U.S. Treasury securities, which had soared earlier in the day as Lehman filed for bankruptcy and traders forecast the Federal Reserve will cut interest rates as soon as tomorrow, maintained gains following the report. The benchmark 10-year note yielded 3.53 percent at 9:39 a.m. in New York, down from 3.72 percent late in the day on Sept. 12.

Industrial production was forecast to drop 0.3 percent, according to the median estimate of 68 economists surveyed by Bloomberg News. Projections ranged from a gain of 0.2 percent to a drop of 0.8 percent. July's reading was revised down to a 0.1 percent gain from the 0.2 percent previously estimated.

Capacity utilization, which measures the proportion of plants in use, decreased to 78.7 percent, the lowest level since October 2004. Capacity was estimated to fall to 79.6 percent, according to the Bloomberg survey median. Economists track plant operating rates to gauge factories' ability to produce goods with existing resources. Lower rates reduce the risk of bottlenecks that can force prices higher. The utilization rate has averaged 81 percent over the past 30 years.

Factory output, which accounts for about four-fifths of industrial production, dropped 1 percent after a 0.1 percent increase the prior month, the report showed. Production at utilities fell 3.2 percent, reflecting a cooler August than usual, economists said. Mining output, which includes oil drilling, decreased 0.4 percent. Shutdowns in the Gulf of Mexico as Hurricane Gustav approached may have contributed to the drop. Shutdowns ahead of Hurricane Ike will probably hurt mining output this month.

The slump in motor vehicle and parts production followed a 2.5 percent gain the prior month, the report said. Carmakers assembled just 8.19 million autos at an annual pace last month, the fewest since April 1991. Production of consumer durable goods, including automobiles, furniture and electronics, fell 6 percent.

Earlier today, a report from the New York Fed showed manufacturing worsened this month in that region. The Empire State general economic index fell to -7.4, the lowest reading since June, from 2.8 a month earlier. A reading of zero is the dividing line between growth and contraction.

Factories may slow further as sales weaken. Purchases at U.S. retailers fell 0.3 percent in August following a 0.5 percent decline in July as Americans retrenched in the face of mounting job losses and record foreclosures, Commerce Department figures showed last week.

Carmakers are struggling. General Motors Corp. and Ford Motor Co., the biggest U.S. automakers, dragged the domestic industry to its 10th straight monthly sales decline in August as consumers snubbed trucks because of high fuel prices. Ford this month further pared production plans for the rest of 2008.

``Not only is the U.S. in a recession, but the rest of the world is slowing down,'' Ford Chief Executive Officer Alan Mulally said during a speech on Sept. 8 in Dearborn, Michigan. ``I've never seen anything quite like it.'' Manufacturers are also cutting payrolls. Factories eliminated 61,000 jobs last month, the biggest decline in five years, Labor figures showed on Sept. 5. The drop included a loss of 39,000 jobs in auto-making and parts industries.

Other recent reports show American manufacturers have become more cautious as consumer spending weakens. The Institute for Supply Management's factory index fell in August for the first time in three months, the group reported on Sept. 2. Consumer spending, the biggest part of the economy, will stall this quarter, while economic growth will slow to a 1.2 percent annual rate, less than half the prior quarter's pace, according to a Bloomberg survey from Sept. 2 to Sept. 9.

The Fed's Next Move: Money Supply
While most of the business media is focusing on Lehman and troubled financials, they are forgetting about this week’s Fed meetings and how monetary policy will respond to the crisis. After almost 6 months of shrinking real money supply (nominal money supply adjusted for inflation), Fed policy makers are going to decide whether to push the economy by once again increasing real money supply.

The last 6 months of shrinking real money supply has created a scarcity of funds that halted the drop in the value of the US dollar and deflated the commodity bubble. However, too few dollars also attenuated the credit crisis. Monetary policy didn’t cause Freddie and Fannie’s failure, Lehman’s meltdown or Washington Mutual and AIG’s problems.

But the coincident timing of these failures is a result of 6 months of restrictive money supply causing investor risk premiums to increase and the weakest institutions being “closed” out of the market. For the last year the Fed has been trying to walk the economy across a monetary policy tightrope and knows that if we lean too far one way or another the economy will fall and break.

As our journey across the monetary tightrope started, the Fed pushed us by injecting liquidity into the financial sector through its “emergency” facilities so that troubled banks, brokerages and insurers could work out their problems without hurting each other. Increasing money supply (i.e., lots of liquidity being pumped into the banks) and a falling Fed Funds Rate bought time for the banks and brokerage to raise capital and deleverage.

But, by the middle of March, the dollar was tanking, commodity prices were beginning to spin out of control and the US risked triggering global runaway inflation. Beginning in the spring of 2008, the Fed started to push the economy in the direction of a more restrained monetary policy. Money supply growth stopped and the Fed made it clear that they were done cutting the Fed Funds Rate. The US Dollar strengthened, the commodity bubble deflated but stress in the financial sector returned. 

Now the economy is looking into a black hole of uncontrolled banking failures, potentially shrinking money supply, deflation and wealth destruction. Because of the fragile, and potentially insolvent status of many financial companies, if the Fed is too restrictive it risks creating a “domino effect” of financial failures which will destroy money supply and cause a depression.  

Many economists, such as Milton Friedman, have written extensively that the Great Depression could have been avoided if the Fed had focused on maintaining the amount of money supply as bank failures took place. Instead, during the Hoover Administration bank failures resulted in more bank failures and the financial sector deleveraged at an uncontrolled pace.  Money supply plummeted and by the time the Fed realized what had happened it couldn’t stop the damage.

As we move forward into 2009, if we fall off of the monetary tightrope on one side the economy is facing a deflationary cycle and a possible depression, and on the other side the economy is facing runaway inflation and a possible depression.  So it is important for the Fed to keep us on the tightrope and keep us from falling.  The Fed needs to increase money supply and cut the Fed Funds Rate, but not by too much. 

On the other hand, the Fed needs to be an aggressive inflation fighter and keep monetary supply reasonably restrictive, but not by too much.  The next move of the Fed will be to increase money supply which hopefully will have the effect of inflating (at least for a while) the banking sector. The Fed Funds Rate may be cut as well in an effort to pump operating profits into the banking sector.

For the week ending September 1, seasonally adjusted M2 (a broad based measure of money supply) remained essentially unchanged from the week ending March 24 and on a non-seasonally adjusted basis is actually lower than the week ending March 24.  This trend of no money supply growth will not continue for much longer, or the Fed risks repeating the mistakes of the Hoover era Fed.

China Cuts Rates as U.S. Turmoil Adds to Global Risks
China cut interest rates for the first time in six years and allowed most banks to set aside smaller reserves as worsening credit-market turmoil and weakening export demand dimmed the outlook for economic growth.

The People's Bank of China reduced the one-year lending rate to 7.20 percent from 7.47 percent, effective tomorrow, and lowered the reserve ratio at the nation's smaller banks by 1 percentage point. The changes were in a statement on the central bank's Web site today.

Lehman Brothers Holdings Inc. filed for bankruptcy today and Merrill Lynch & Co. agreed to be sold, adding to evidence that the credit crisis is deepening and threatening the global economy. The slowest inflation in 14 months has given China room to cut borrowing costs and protect jobs in the world's fourth- largest economy.

"Policy makers see the probability of a recession in the U.S. is higher now, so the outlook for Chinese exports has deteriorated," said Darius Kowalczyk, chief investment strategist at CFC Seymour Ltd. in Hong Kong. "This is the beginning of an easing cycle in China." He was the only one of seven economists in a Bloomberg survey last week to predict a rate cut this year or in the first quarter of 2009. The announcement came on a holiday, with markets closed.

The rate cut is "to help solve important problems in our economy for its continued stable and fast development," the central bank said. Inflation cooled to 4.9 percent in August, export growth slowed and industrial production expanded by the least in six years, according to data released last week. China's economy expanded 10.1 percent in the three months to June 30 from a year earlier, the fourth straight quarter of slower growth.

In the U.S., banks including JPMorgan Chase & Co., Goldman Sachs Group Inc. and Citigroup Inc. formed a $70 billion fund to ensure market liquidity as Lehman filed for bankruptcy and Bank of America Corp. agreed to acquire Merrill. The Federal Reserve has widened the collateral it accepts for loans to securities firms and boosted its program for lending Treasuries to bond dealers. It may reduce the benchmark interest rate tomorrow to 1.75 percent from 2 percent, according to the futures market.

China's central bank pushed the reserve requirement for lenders to a record 17.5 percent in June. The biggest banks are excluded from the reduction. Those exempted are: Bank of China Ltd., Industrial and Commercial Bank of China, Agricultural Bank of China, China Construction Bank Corp., Bank of Communications Co. and Postal Savings Bank of China. The requirement for smaller banks drops by 1 percentage point from Sept. 25. In areas affected by the Sichuan earthquake, the reduction is 2 percentage points.

The central bank left the key deposit rate unchanged at 4.14 percent, narrowing banks' margins on loans. Economists were split on whether the rate cut would cause the yuan to rise or fall. Mark Williams, of Capital Economics Ltd. in London, said "using interest rates to stimulate growth is pretty good for further yuan appreciation."

Falling interest rates are "obviously negative for the yuan," said CFC Seymour's Kowalczyk. The currency has climbed 6.8 percent against the dollar this year, the best performer among Asian currencies. It closed at 6.8450 against the U.S. currency in Shanghai on Sept. 12.

Zhu Baoliang, the chief economist at the State Information Center, a government research agency, said August's weaker economic data probably prompted today's moves, rather than events in the U.S. Capital Economics' Williams said it was "suspicious" that the central bank acted when the Shanghai Composite Index seemed set to drop below 2,000. It closed on Sept. 12 at 2,079.67 after slumping 60 percent this year on concern that measures to tame inflation will erode company profits.

The property market could be headed for a "meltdown" as home prices and sales decline, Morgan Stanley said Sept. 12. China's policy makers have already loosened loan quotas -- restrictions on how much banks can lend -- and raised export-tax rebates for garments and textiles to help exporters and small businesses.

Oil Falls to Six-Month Low as Refineries Escape Major Damage
Crude oil fell to a six-month low in New York and gasoline tumbled amid signs that refineries along the Gulf of Mexico coast will soon resume operations after escaping major damage from Hurricane Ike.

About 20 percent of the U.S.'s oil refining capacity was shut, limiting fuel deliveries and prompting the Department of Energy to release 309,000 barrels from its strategic reserves. New York Mercantile Exchange electronic trading opened early today to allow traders to respond to Ike.

"It looks like we've dodged another bullet," said Peter Beutel, president of energy consultant Cameron Hanover Inc. in New Canaan, Connecticut. "The refineries in the Houston area seem to have come out of the storm remarkably intact." Crude oil for October delivery fell $1.43, or 1.4 percent, to $99.75 a barrel at 7:55 p.m. on the Nymex. Futures touched $98.46, the lowest since Feb. 26. Prices are up 25 percent from a year ago. Gasoline for October delivery fell 9.46 cents, or 3.4 percent, to $2.6750 a gallon in New York.

CME Group Inc., the world's biggest futures exchange, began Nymex electronic trading of energy contracts at 10 a.m. New York time today. Oil in New York has fallen 33 percent from a record $147.27 a barrel on July 11 as high prices and slowing global economic growth reduce demand for fuels. Sales at U.S. retailers dropped in August for a second straight month and July inventories at American businesses increased the most in four years, Commerce Department reports showed last week.

"Growing fears about the economy are trumping any fears about the damage caused by Hurricane Ike," said John Kilduff, senior vice president of risk management at MF Global Inc. in New York. "The broader issue is the weakness of the financial system. Given the Lehman and WaMu watch, cash looks better than any speculative investment."

Fourteen refineries in Texas and Louisiana, including plants operated by Exxon Mobil Corp., Valero Energy Corp. and Royal Dutch Shell Plc, shut 3.57 million barrels a day of refining capacity as Ike approached the Gulf Coast. Valero said it found "no significant structural damage" at three Houston-area refineries shut before the storm. One Valero refinery had power, the company said. Marathon Oil Corp. and Motiva Enterprises LLC said they're evaluating their plants.

Colonial Pipeline Co. said today it restored operations to its gasoline and distillate pipelines, which carry from the Gulf Coast to the Northeast. Regular gasoline, averaged nationwide, rose 6.2 cents to $3.795 a gallon, AAA, the nation's largest motorist organization, said today on its Web site. Pump prices reached a record $4.114 a gallon on July 17.

Pump prices in the Southeast U.S. surged as the Ike made landfall. Regular gasoline in Georgia rose 16.2 cents to an average $4.025 a gallon, the AAA said today. In North Carolina the regular gasoline climbed 11.1 cents to $3.973 a gallon. "The crude oil price should be lower because with the refineries down, there is nowhere for it to go," Kilduff said. "The drop in product prices may be short-lived because some of these refineries could be down for weeks."

The storm idled about 99.6 percent of oil production and 91.9 percent of natural-gas output in the Gulf of Mexico, the U.S. Minerals Management Service said today. Gulf fields produce 1.3 million barrels oil a day, about a quarter of U.S. output, and 7.4 billion cubic feet of gas, 14 percent of the total, government data showed.

Natural gas for October delivery rose 0.9 cents, or 1.2 percent, to $7.456 per million British thermal units in New York. The Energy Department released 630,000 barrels of crude oil from the strategic reserve to Placid Refining Co. and Marathon Oil Corp. after Hurricane Gustav made landfall in Louisiana on Sept. 1. That brings the total release because of the two storms to 939,000 barrels.

UK unemployment to top two million by end of 2009
Unemployment in Britain will surge by 450,000 to 2.12 million by the end of next year, a level not seen since 1997, when Labour came to power, as the country endures its first recession since the early 1990s, the CBI forecasts today.

In a dramatically revised outlook for the economy, the employers' organisation says that Britain is already in a recession and will not recover until the middle of next year. It adds that homeowners will continue to suffer brutal falls in the value of their property.

The CBI says that the dismal economic conditions will lead to hundreds of thousands of job cuts by the end of 2009, forcing the number out of work above two million and taking the rate of unemployment up from 5.4 per cent to 6.8 per cent.
Richard Lambert, Director-General of the CBI, said: “We are now almost certainly in a mild recessionary phase.”

Earlier this year the CBI said that Britain would avoid recession, but it has drastically cut its forecasts after continued surges in energy prices and an economic slowdown that has been far sharper than expected. The Organisation for Economic Co-operation and Development and the European Commission have slashed their forecasts for the UK to show a recession in the second half of the year.

The British Chambers of Commerce has said that the recession could lead to more than two million people unemployed by Christmas. The CBI also forecasts that the Government will break one of its fiscal rules. It says that government borrowing is set to rise, pushing public net debt to more than 40 per cent of GDP.

The Government has often pledged that it would not breach this threshold over the economic cycle, but there is speculation that Alistair Darling is preparing to change this rule in his Pre-Budget Report next month to give the Treasury room over spending.
This comes days after Mervyn King gave warning that breaking the fiscal rules could lead to higher inflation.

The Governor of the Bank of England said: “The long-term risk is [that] a fiscal framework that is not perceived by financial markets to be credible does put up pressure on inflation expectations, because it undermines the market's belief in the credibility of both the monetary and the fiscal framework.”

The economy ground to a halt between April and the end of June, recording no growth at all, official figures show. The CBI believes that that it is set to shrink by 0.2 per cent between July and and the end of this month and contract by a further 0.1 per cent in the final three months of the year. A recession is defined as two consecutive quarters of shrinking output.

The CBI expects the economy to stall for a further three months at the beginning of next year, before growing marginally by 0.1 per cent between April and June. Mr Lambert said that while he did not believe that conditions would be as bleak as in the early 1980s and early 1990s, consumers and businesses were in for a tough time.

There was more bad news for homeowners as the CBI said that the value of an average house would tumble by about £33,000 from January's peak of £221,130, based on house price figures from the Department of Communities and Local Government. Ian McCafferty, chief economic adviser to the CBI, said: “The existence of the credit crunch has made the adjustment in the housing market more brutal than it would otherwise have been.” He said that the mortgage market would remain clogged up until next summer, as mortgage funding remained scarce.

Lehman latest sign of Street's shrink job
The credit crunch has turned Treasury Secretary Henry Paulson into the middlemensch.

The former Goldman Sachs CEO, who came to Washington as a critic of government intervention in financial markets, is now playing the role of the ultimate middleman, an i-banking shepherd whose central task has become culling weak financial institutions from Wall Street’s herd.

Potential buyers of Lehman Brothers, struggling last week with enormous write-downs of mortgage investments and evaporating investor confidence, reportedly turned to Mr. Paulson’s Treasury Department (along with the Federal Reserve) to help broker a deal. By working toward a deal, Mr. Paulson is reducing the number of big brokerages—and with it, the overall leverage in the financial system—to a more manageable level.

“Lehman shows that [the government] is in the business of brokering the consolidation of Wall Street—very much so,” said Joseph Mason, a former finance economist at the Office of the Comptroller of the Currency and now a finance professor at Louisiana State University.

The Federal Reserve and Mr. Paulson stepped in last March to help broker—and guarantee—J.P. Morgan Chase’s last-minute acquisition of a flailing Bear Stearns. Mr. Paulson last week indicated that regulators might be willing to help negotiate a deal for Lehman, too, but Reuters reported late Friday that Mr. Paulson was “adamant” that no public money would be used in a deal.

“You have to say no somewhere, and Lehman may be as good a place as any to say no,” observed former St. Louis Fed president William Poole, who added that simply putting buyers and sellers together in no way presents the same kind of risk that the Bear Stearns matchmaking did.

Since Bear Stearns’ troubles, Lehman and other investment banks have had access to the Fed’s discount window, a taxpayer-backed lifeline that allows them to take short-term loans using distressed assets as collateral. Fed statistics indicate no borrowing by investment banks in the week ending last Thursday.

Unlike Bear, which was rocked by concerns over its short-term liquidity, Lehman’s troubles revolved around questions about the soundness of its assets. Of all the potential buyers reportedly considering a bid for all or part of Lehman, including Bank of America, Barclay’s, HSBC, J.C. Flowers, Kohlberg Kravis Roberts and China Investment Co., some observers felt a big universal bank would be the best fit because its deposits would provide a much-needed infusion of sturdy assets.

“Ultimately all these monoline investment banks are an endangered species—they have to align themselves with a universal bank or they’re dead,” said Christopher Whalen, managing director of Institutional Risk Analytics. “They’re second-class citizens [because] they don’t have access to the Fed in normal times.”

The scramble to sell the firm came at the end of a week that saw the value of Lehman’s shares fall some 78%. About one-third of that loss came after Lehman decided on Wednesday to offer detailed preliminary third-quarter results more than a week ahead of its scheduled earnings release.

The news was grim. After taking a $5.7 billion write-down on its mortgage investments, Lehman lost $3.9 billion in the three months ended Aug. 31. The firm, founded in 1850 and publicly traded since 1994, when it was spun off from American Express, had never reported a quarterly loss before June.

In a hastily arranged conference call with investment analysts that day, Lehman CEO Richard Fuld announced the company would take dramatic steps in an attempt to save itself. Lehman would spin off from $25 billion to $30 billion in commercial real estate assets, forming a new company called REI Global and issuing its stock to Lehman’s shareholders. It would pay asset manager BlackRock to unwind some $4 billion in toxic mortgage investments in the United Kingdom (see the related story on Page 1). And it would sell a majority stake in its investment management division, including Neuberger Berman, a prized asset estimated earlier this year to be worth as much as $8 billion or more on its own.

Designed to cleanse Lehman’s balance sheet of potentially noxious assets, the moves were intended to reduce the risk that additional write-downs would be needed in the future, Mr. Fuld said.

Mr. Fuld may have coined a phrase when he said the moves would help “de-risk” Lehman’s balance sheet. That means cutting leverage and reducing assets in proportion to shareholders’ equity. A year ago, at the end of the third quarter of 2007, Lehman’s net leverage ratio was 16.1; when the firm unveiled this year’s third-quarter results last Wednesday, it had slashed that figure to 10.6.

Less leverage certainly means less risk. But just as leverage supports dicey investments like the potentially radioactive real estate holdings Lehman said it would rid itself of, it can also greatly boost the potential for profit. And for some businesses at the heart of what investment banks do, like trading and underwriting, leverage is key. Lehman’s share of the debt underwriting market fell this year to 3.2%, from 5.5% last year, according to research firm Dealogic. That dropped it from fifth place among debt bookrunners to 13th.

Lehman also foreshadowed its search for a buyer. “The firm remains committed to examining all strategic alternatives to maximize shareholder value,” it said in the statement announcing its quarterly results, repeating a phrase that’s often interpreted as the equivalent of hanging an “Everything Must Go” sign in a window.

The moves did not calm nervous investors, who continued to dump the stock and forced Lehman to move toward a sale more quickly. “You’ve got a valuable franchise but you’ve also got a risk of write-downs,” said Roger Lister, chief credit officer for U.S. financial institutions at DBRS. “We’ve gone from irrational exuberance to excessive fear.”

Mr. Paulson’s outsized 24/7 job these days is to find a way to curb that fear.

Paulson to face tough questions from Congress
Treasury Secretary Henry Paulson will likely face probing questions Tuesday about taxpayer liability when he makes his first congressional appearance since the government takeover of Fannie Mae and Freddie Mac.

A half-dozen Democrats and Republicans on the Senate Banking Committee, which will be questioning Mr. Paulson, have already voiced skepticism about his assurances that taxpayers are unlikely to foot any megabillion-dollar bills. Coming on the heels of Mr. Paulson’s earlier testimony in July that he saw no immediate need to use his new authority to rescue the mortgage giants, several senators on the panel expressed doubts last week about his credibility.

“Paulson won’t be treated as a hero,” observed Peter Wallison, former Treasury Department general counsel and White House counsel in the Reagan administration.

The Fannie-Freddie takeover plan authorizes the Treasury to buy up to $200 billion worth of stock in the mortgage guarantors to keep them solvent. Mr. Paulson has said it’s unlikely the government will have to use this authority, because its active backing of the companies will assure an infusion of capital.

“I’m skeptical; I’m skeptical, and I’m anxious about all of it,” Sen. Richard Shelby of Alabama, the ranking Republican on the banking committee, told the Public Broadcasting Service last week. “I hope that we don’t have to use the taxpayers’ money here to prop these entities up, but I fear that we will before it’s over with.”

Committee chairman Chris Dodd (D-Conn.) echoed Mr. Shelby’s concerns. Mr. Dodd and other senators also expressed pique that Mr. Paulson successfully appealed to lawmakers in July for authority to spend billions to rescue the companies while assuring them he didn’t intend to use that authority.

“He knew all along he was going to have to use this authority despite what he was telling Congress and the American people at the time,” Sen. Jim Bunning, a Kentucky Republican, said last week.

In the end, Mr. Paulson will try to assure the senators he had little choice but to step in because persistent doubts about Fannie and Freddie’s capital level and its ability to repay debt were roiling U.S. and international markets, observers said.

“We’re in uncharted waters about the economy as a whole and housing finance in particular,” said Douglas Elmendorf, a fellow at the liberal-leaning Brookings Institution who was deputy assistant treasury secretary in the Clinton administration. “What he arranged was an appropriate policy response to a very threatening situation.”

Even so, Mr. Paulson won’t be able to address longer-term questions about Fannie’s and Freddie’s structure, how the takeover will affect mortgage interest rates, and whether it will stabilize financial markets. By putting the companies in a government-run conservatorship, Mr. Paulson has left key decisions to Congress and the next administration.

“This plan will be met with broad acceptance in Congress because it doesn’t prejudge the ultimate fate of Fannie Mae and Freddie Mac,” said Sen. Charles Schumer (D-N.Y.).

That doesn’t mean the lame-duck Treasury secretary won’t be asked harsh questions, including:

1. How big will the tab be?

Whether taxpayers will have to pony up any of the $200 billion that the administration has authorized, and how much, hinges on Fannie’s and Freddie’s performance in the unpredictable housing market. Some experts think that taxpayer obligations may amount to little or nothing, while others say the sky’s the limit.

“It’s impossible to know,” said Josh Rosner, an analyst at the Graham Fisher independent research firm. “It depends on how much worse the financial markets get, how much worse the housing market becomes and how long it stays there.”

In July, the Congressional Budget Office estimated a possible $25 billion federal budgetary cost based on the companies’ projected losses. At the same time, though, it incorrectly predicted that Treasury would not use its authority for a takeover.

Under the administration’s plan, the Treasury will get $1 billion in preferred shares in each mortgage company, plus warrants that if exercised would give it an 80% stake in each company, without putting up any money.

The taxpayers would come in if either Freddie or Fannie becomes insolvent, that is, its liabilities come to exceed its assets. Then Treasury would have to step in to make up the difference by doing the equivalent of buying senior preferred shares at $1,000 a share.

“It’s entirely possible it could turn out to be a profitable investment, as the Chrysler guarantees of the 1980s turned into a profitable deal for taxpayers,” said Alex Pollock, an American Enterprise Institute fellow who was chief executive of the Federal Home Loan Bank of Chicago from 1991 to 2004.

2. What price will Fannie and Freddie management pay?

Mr. Paulson will be appearing on Tuesday with James Lockhart, director of the Federal Housing Finance Agency, which oversees Fannie and Freddie. Other questions the duo may be asked to focus on concern the compensation packages for departing CEOs of the mortgage companies, the prospect of layoffs, and their view of so-called covered bonds as alternative financing vehicles to securitizations typically sold to Fannie and Freddie.

Two Democratic senators on the committee, Mr. Schumer and Jack Reed of Rhode Island, wrote Mr. Lockhart last week urging a review of the pay packages for departing Fannie CEO Daniel Mudd and Freddie CEO Richard Syron. “We find it way out of line,” the senators wrote.

Mr. Bunning introduced legislation to bar the CEOs from getting severance payments. Presidential candidates Barack Obama and John McCain have also criticized the packages.

No final decision on the pay has yet been made. Mr. Mudd could receive more than $9 million in combined severance pay, retirement benefits and deferred compensation, while Mr. Syron may get as much as $15 million (see the Pay Matrix on Page 17).

Adding fuel to the fire is the pay the executives received in recent years, while their companies’ returns hit the skids. In 2006 and 2007, Messrs. Mudd and Syron got packages “that consistently exceeded levels for even large S&P 500 companies,” even as Fannie’s and Freddie’s shareholder returns declined, the Corporate Library, an independent corporate governance research firm, reported Friday.

3. How will Fannie and Freddie be restructured?

Key to an answer will be the success, or lack thereof, of covered bonds as a substitute for the securitization of mortgages with the help of Fannie and Freddie.

The bonds are issued by banks and backed by a pool of mortgages that the banks hold on their balance sheets. In contrast, mortgages are removed from the balance sheets through securitization. The big difference: With covered bonds, banks must replace defaulted mortgages in the pool with performing mortgages. Previously, they washed their hands of securitized mortgages, or at least told investors and regulators they had done so at the time.

Mr. Paulson has previously endorsed covered bonds, which have been widely used in Europe for two centuries, with $3 trillion of them outstanding today. Only two U.S. lenders now issue covered bonds: Bank of America and Washington Mutual, said Jerry Marlatt, a law partner at Clifford Chance who handled Washington Mutual’s issuance of the bonds. Rep. Scott Garrett (R-N.J.) introduced legislation last month to provide protections for covered-bond investors.

Proponents argue that they offer a safer and more efficient form of financing than securitized bonds packaged by Wall Street firms and sold to the mortgage giants. But there are serious questions as to whether investors will show sufficient interest in them. Unlike covered bonds in Europe, which are a general obligation of the issuers and thus backed by all of their assets, covered bonds as envisioned here would limit the collateral to mortgages.

Looking ahead to next year, Congress may consider a number of options for restructuring Fannie and Freddie, if it decides to reshape them at all. Among these options are shrinking the companies and turning them into public utilities, maintaining them more or less as is, or effectively liquidating them by selling off their assets.

Mr. Wallison, a senior fellow at the conservative-leaning American Enterprise Institute, sees in Mr. Paulson’s plan the seeds of a continuation of Fannie and Freddie in their current form.

“It appears Paulson is trying to resurrect the companies and return them to profitability,” he said. “If so, Congress will continue to exploit the companies for contributions and not make any changes.”

If Lehman collapses expect a run on all of the other broker dealers and the collapse of the shadow banking system
It is now clear that we are again – as we were in mid- March at the time of the Bear Stearns collapse – an epsilon away from a generalized run on most of the shadow banking system, especially the other major independent broker dealers (Lehman, Merrill Lynch, Morgan Stanley, Goldman Sachs).

If Lehman does not find a buyer over the weekend and the counterparties of Lehman withdraw their credit lines on Monday (as they all will in the absence of a deal) you will have not only a collapse of Lehman but also the beginning of a run on the other independent broker dealers (Merrill Lynch first but also in sequence Goldman Sachs and Morgan Stanley and possibly even those broker dealers that are part of a larger commercial bank, I.e. JP Morgan and Citigroup).

Then this run would lead to a massive systemic meltdown of the financial system. That is the reason why the Fed has convened in emergency meetings the heads of all major Wall Street firms on Friday and again today to convince them not to pull the plug on Lehman and maintain their exposure to this distressed broker dealer.

This bail-in of investors is the opposite of a bailout of investors like the one that was done in the case of Bear Stearns and Fannie and Freddie. It is thus akin to the bail-in of investors that was done in the case of LTCM in the summer of 1998 and the bail-in of the interbank creditors of Korean banks in the winter of 1997.

Since government bailouts put at risk public money and create moral hazard Treasury and the Fed decided that they need to draw a line somewhere after the bailouts of Bear Stearns creditors, of Fannie and Freddie and all the other actions aimed at backstopping the financial system.

These actions have included the creation of the TAF, TSLF, PDCF, the use of the FHLBs to provide liquidity to distressed mortgage lenders, the provision of Treasury liquidity to the FHLBs, the outright purchase of agency MBS by the Treasury, the swapping of two thirds of the safe Treasuries of the Fed for toxic illiquid securities of banks and non banks, etc. So after having created the mother of all moral hazard with their actions (including the biggest bailout of all, i.e. the rescue of Fannie and Freddie) the Fed and Treasury are playing a chicken game with the financial system.

Tim Geithner told clearly to the heads of all the major Wall Street firms that if they pull the plug on Lehman and Lehman collapses they are next in line for a run on their institutions. So if a buyer for Lehman is not found (or even if it is found and the counterparty lines are still pulled) not only Lehman will collapse but the run will extend to all of the other major broker dealers and banks that are the counterparties of Lehman.

The Fed may delude itself in thinking – as its stress models suggest – that the systemic risk of a collapse of Lehman are less serious than those of Bear Stearns: afterall Lehman is less involved into CDSs than Bear was and now both Lehman and the other major broker dealers have access to the discount window with the PDCF.

A collapse of Lehman instead will have as much of a systemic effect as the collapse of Bear for many reasons: Lehman is larger than Bear was; Lehman is a major player in a variety of key financial markets; all the other major Wall Street institutions are interconnected with Lehman in dozens of different types of counterparty activities; the PDCF support of the Fed is neither unlimited nor unconditional, i.e. investors cannot assume that Lehman or any other broker dealer can borrow unlimited amounts with no conditions from the discount window.

Thus, a collapse of Lehman would trigger a panic and a potential run on all sort of other broker dealers and also on other distressed financial institutions like banks (WaMu) and insurance companies (AIG) and smaller member of the shadow financial system (distressed and highly leveraged hedge funds, etc.).

The reason why Lehman is having a hard time to find a buyer is that it is most likely insolvent. If you had to mark to market the value of it illiquid and toxic assets (the $40 billion of commercial real estate assets, its remaining residential MBS and CDOs, its holdings of real estate private equity funds) Lehman is most likely insolvent (i.e. has negative net worth with liabilities well above its impaired assets).

So leaving aside the potential and now dubious value of its franchise (an option to the value of a much slimmed down financial institution) no financial institution should be paying even a single penny to buy an insolvent firm.

That is why all the potential suitors of Lehman (such as Bank of America and others) are waiting for the government to provide another sleazy Bear Stearns deal where the government would buy at higher than market value the toxic assets of Lehman (the commercial real estate assets for example) so as to make the net worth of the remaining institution positive and worth buying. But such action – borderline illegal in the case of Bear as pointed out by Paul Volcker – would be a scandal in the case of Lehman and severely exacerbate the moral hazard problem.

But here lies the conundrum of this Lehman crisis: no one seems to want to buy for a positive price Lehman unless there is a public subsidy (taking off their toxic assets off the firms’ balance sheet). The government cannot afford to provide the subsidy as the moral hazard problems are becoming severe. But then if on Monday no deal is done Lehman collapses and goes into Chapter 11 court and you have the beginning of a systemic financial meltdown as the run on the other broker dealers will start.

Thus, what Fed and Treasury are trying to do this weekend is another 1998 LTCM bailin or Korea 1997 bailin, i.e. trying to convince all the major institutions to either support a purchase of Lehman or maintain their exposure to Lehman if no buyers is found. Can this bail-in work? It is not clear as there is a major collective action problem: you can’t only convince half a dozen major Wall Street firms to maintain their exposure to Lehman.

You need also to convince all the other counterparties of Lehman (including the hedge funds and the other broker dealers and banks) not to roll off their claims and credit to Lehman. This is a much more messy collective action problem and coordination game than in the case of LTCM and Korea where the number of involved counterparties was more limited (less than 20 in each case).

Paulson and Bernanke and Geithner (the troika managing this financial crisis) have all made public statements in the last few month to the necessity of finding an orderly way to close down – rather than bailout – a major and systemically important non bank financial institutions: the embarrassment and losses for the Fed that the bailout of the creditors of Bear led made it paramount to avoid another Bear like bailout.

That is why they are now playing tough with Lehman and its creditors. But in this game of chicken the Fed and the Treasury may end up being the ones to blink. Faced with the risk of a generalized run on the other broker dealers they may decide that greasing again a deal for the purchase of Lehman may be less costly and less risky than testing whether the system can orderly work out a collapse of Lehman (something that is highly uncertain).

Even in the case of the Bank of America purchase of Countrywide such public subsidy was significant (the FHLB of Atlanta lent to Countrywide over $50 billion and Bank of America has most likely received plenty of tacit forbearance from the Fed to support its takeover of an insolvent Countrywide). So implicitly or explicitly the Fed and the Treasury may decide – however reckless and moral hazard laden that choice may be – to provide some explicit or implicit subsidy to a private purchase of Lehman.

The trouble is that, in spite of all public statements regarding the need to provide an orderly demise of large broker dealers, the Fed and the Treasury have done nothing to create such insolvency regime for such broker dealers. So the only option for Lehman – if a buyer is not found - will be the one of ending up in Chapter 11 and trigger massive losses on its counterparties that will in turn trigger a run on such counterparties.

In February of 2008 I predicted – in my “12 Steps to a Financial Disaster” – that one or two major broker dealers would go bankrupt. A month later Bear Stearns went bust and the collapse of the other ones was avoided for a time by the most radical change in monetary policy since the Great Depression, i.e. the creation of the PDCF that extended the lender of last resort (LOLR) role of the Fed to non-bank systemically important broker dealers (i.e. all of the bank and non bank primary dealers of the Fed).

I next argued in June that such action would not prevent a run on other broker dealers such Lehman as to avoid a run you need both deposit insurance and unlimited and unconditional access to the Fed LOLR support. I also discussed why Lehman was next in line for a collapse and why the PDCF would not prevent a run on Lehman.

I also argued in follow-up pieces that, in a matter of two years, no one of the remaining independent broker dealers (Lehman, Merrill Lynch, Morgan Stanley and Goldman Sachs) would survive as: 1. their business model is now impaired (securitization is semi-dead); 2. they will need to be regulated like banks given the PDCF support and thus have lower leverage, higher liquidity and more capital that will erode their profitability; 3. Their severe maturity mismatch – borrowing very short term and liquid, leveraging a lot and lending and investing in more long term and illiquid ways – makes them very fragile – in the absence of deposit insurance and in the presence of only limited LOLR support by a central bank – to bank like run that are destructive even of illiquid but otherwise solvent institutions.

Thus all such broker dealers need to merge with larger financial institutions that have a commercial banking arm and thus access to stable and insured deposits and to true LOLR Fed support. That process of unraveling of independent broker dealers started with Bear Stearns; now it is moved to Lehman; tomorrow Merrill Lynch will be on line; and Morgan Stanley and Goldman Sachs will be next. No one of them can and will survive as independent entities. So, the Fed and Treasury should advise them all to start finding a large international partner (international as almost no domestic partner is now sound to take them over) and merge with such partner before we get another Bear or Lehman disaster.

The step by step, ad hoc and non-holistic approach of Fed and Treasury to crisis management has been a failure so far as plugging and filling one hole at the time is useless when the entire system of levies is collapsing in the perfect financial storm of the century. A much more radical, holistic and systemic approach to crisis management is now necessary.

What we are facing now if the beginning of the unraveling and collapse of the entire shadow financial system, a system of institutions (broker dealers, hedge funds, private equity funds, SIVs, conduits, etc.) that look like banks (as they borrow short, are highly leveraged and lend and invest long and in illiquid ways) and thus are highly vulnerable to bank like runs; but unlike banks they are not properly regulated and supervised, they don’t have access to deposit insurance and don’t have access to the lender of last resort support of the central bank (with now only a small group of them having access to the limited and conditional and thus fragile support of the Fed).

So no wonder that this shadow banking system is now collapsing. The entire conduits/SIV system has already collapsed with the roll-off of their ABCP financing; next is the collapse of the broker dealers (Bear, Lehman and soon enough the other ones) that rely mostly on unstable overnight repos and other very short term funding for their financing; next will be hundreds of poorly managed hedge funds that will face a tsunami of redemptions; and finally runs on money market funds that are not supported by a large financial institutions or other smaller member of the shadow banking system as well as highly leveraged and distressed private equity funds cannot be ruled out either.

This is indeed the most severe financial crisis since the Great Depression and occurring at a time when the US is falling in a now severe consumer led recession. The vicious interaction between a systemic financial and banking crisis and a severe economic contraction will get much worse before there is any bottom to it. We are only in the third inning of a nine innings economic and financial crisis. And the only light at the end of the tunnel is the one of the incoming train wreck.


Anonymous said...

There must be so much going on behind closed doors today. By the tricks that keep coming out of Ben's and Hank's hats, it looks like they plan to bring us all down with them. Anybody know why the market is as resilient as it is today? Even the talking heads on CNBC seem mystified by that one.

Anonymous said...

So, when do I pull my deposits out of the bank?

rachel said...

In the end, through the Treasury, it’s once again the taxpayer who’s going to be presented with the bill.
Wherever you are in the world, there are no safe banks anymore. When you hear a government spokesman or bank CEO talk about their banks and banking systems being "well capitalized", don’t believe a word they say.

How to get the public to understand this and act with urgency to force Congress to stop it? Is it too late, I fear it is? Or what actions could minimizes the devastating that the crisis has finally gotten the Public's Attention?

I still have people telling me that my encouraging folks to take their money out of the bank or investments is "Part of the Problem" that it will cause a run on banks which will hurt everyone. Well it seems like everyone is going to get hurt expect those on the top who are running with their/our money right now!

Anonymous said...

Ilargi, thanks for the excellent post.

Ilargi: "Wherever you are in the world, there are no safe banks anymore."

True, true, true ... It is time to withdraw our cash before the bank runs start or the wicked financiers conniving with our govt. steal our hard earned cash.


Farmerod said...

Regarding bank runs, some wise man once told me He who panics first panics best. The line ups will be shorter this week than next week or month.

(Ilargi - a couple article links point back to TAE).

Anonymous said...

I'm confused by all this, and having trouble making sense of the Fed's actions.

Correct me if I'm wrong, but isn't the dollar backed by assets on the Fed Balance Sheet?

The FED is now accepting toxic stocks in exchange for cash. So when that stock nosedives, won't the Fed's balance sheet follow suit? Won't that destroy the value of the dollar?

The Lizard said...

Why no yellow tape around Lehman?

Anonymous said...


As Ilargi noted, not a good day for F&D banks.

BNP Paribas
Societe Generale

Hypo Real Estate
Deutsche Bank
Dt. Postbank


Anonymous said...

Having posted earlier that I didn't know why the market was so resilient today, I think I can answer my own question, now that its closed down much more. Answer: I just don't think the vast majority of people, even in the industry, realize the magnitude of what is in the process of happening. People, even today are still debating the inflation/deflation issue--unbelievably, when it couldn't be more obvious how this is playing out. They are just in the stage of "experiencing a wake-up call" to the possibility that the future economic stability won't be the same as the past. That is not to say that the "herd mentality" is not gaining a huge momentum (of fear).

westexas said...

This is a good time to use the "Generally Assume the Opposite Theory," to-wit, generally assume that the truth regarding energy & finance is the opposite of what public officials are telling you.

Anonymous said...


My proposal for a new definition of the word "diversify" for the 2009 Economics Dictionary;
to establish a variety of hiding places for your cash.


Dr. Lowe said...

Hi All

An anecdote from the halls outside my office. A colleague just reported that he has instructed his wife to take all of their money out of WAMU asap (they have less than the 100k limit).

Now the question I have is ... does he represent part of a trickle or a flood? We will know by week's end I suppose.

Anonymous said...

I&S have been describing a phase change from a growth state to deflationary state. People are slow to comprehend because we're experiencing the radical destruction of what we believe to be real. Even those who saw it coming are disoriented, (I know I am), because it's a hard thing to see happen. At the moment though, most are in a Wiley Coyote moment before they realize we've run off the cliff. Orlov suggests we are facing five cliffs:

Stage 1: Financial collapse. Faith in "business as usual" is lost.

Stage 2: Commercial collapse. Faith that "the market shall provide" is lost.

Stage 3: Political collapse. Faith that "the government will take care of you" is lost.

Stage 4: Social collapse. Faith that "your people will take care of you" is lost,

Stage 5: Cultural collapse. Faith in the goodness of humanity is lost.

We're started down the first cliff. He urges we hold the line between cliffs 3 & 4. Where I live, I imagine many will fall all the way down the fifth. These stages represent the collapse of what holds both our society and personality together. Seen in this way, we're not necessarily victims to collapse no matter what happens around us; afterall, faith in nonsense is still nonsense. As my wife says, "The only question now is how fast things happen." The more aware people are of what is happening, the better decisions will be and the more options we'll have. The more ignorant we are, the faster and further we fall.

Anonymous said...

A Said:

"People, even today are still debating the inflation/deflation issue--unbelievably, when it couldn't be more obvious how this is playing out.

Deflation is happening and will continue to happen. Massive deflation. And the US Government cannot inflate its way out of this.


The government can default on debt.

If the government defaults on debt, how will the bond markets react? Any better than with inflation?

Our T-bills will be worthless.

scandia said...

In my mind I've been calling this " The Crime of The Century".
Noticed Obama and McCain talking about the economy at last. They both ignore the fact that both were in gov't " not minding the store". Now they are going to pay attention? Ha! All incumbents should be removed from the ballot!
Can't count how many times to-day I heard, " Things are different in Canada. Our banking system is solvent and secure." Why don't I believe that? Because I see system,global system.
As for me I am completely risk adverse. I will be withdrawing my small stash to-morrow.
Call me chicken!

scandia said...

I'm feeling an emotional letdown. On reflection I realize that I came rushing home to get the news, I expected to finally know something. And I don't find out what I wanted to finally know.
I know Lehmans are bankrupt. I know BofA were forced to adopt Merril Lynch. I know Paulson changed the rules of the game again. But I still don't know what was on Lehmans books, the shadow system remains opaque even in death. World banks are denying that they are counterparty to Lehman or have manageable exposure. Can this be true? I don't think it is.See what happens when trust is broken. I only believe TAE.
I don't think we are anywhere close to transparency.

Anonymous said...

@anonymous 5:54pm
"The government can default on debt.
If the government defaults on debt, how will the bond markets react? Any better than with inflation?
Our T-bills will be worthless."

I have that fear too, but I am hoping that if T-bills become worthless, that will be the last thing to occur. Currently, I am more concerned that the bank I have will still be around in order to redeem the online T-Bills. I'd change to a different bank, but who knows if that bank will be viable.
Anonymous Reader

Bigelow said...

anonymous said:
"The government can default on debt.

If the government defaults on debt, how will the bond markets react? Any better than with inflation?

Our T-bills will be worthless."

There is DEFAULT and default. If the government defaults on short 3 month Treasuries it is out of money almost instantly, so they should be safest to the last moment. I reacted very badly to the default idea emotionally. I'd better try to think it through.

Jim Willie (Hat Trick Letter) thinks the government will default. He wrote "In all likelihood the Bank For International Settlements in Basel Switzerland ordered the United States to call in USTreasurys and USAgencys, the bond instruments, the financial weapons of mass destruction. The BIS ordered the financial leadership to call their damaged risky debt securities home, so that they can explode on US soil, so that their greatest concentration rests on US soil, so that the maximum loss occurs to US institutions, so that the risk can be kept to a practical minimum for foreign nations. The benefits given to Americans are two-fold, one a bizarre paradox, the other an open door to steal."
Calling US Bonds Home!!!

perry said...

Doesn't matter how many ways you try to re-arrange the deck chairs, the ship is still going to sink.


Pull your money out of the damned banks, and redeem those damned T-bills and everything else, and begin to take charge of your own financial life!


Anonymous said...

@ Ric: "I&S have been describing a phase change from a growth state to deflationary state. People are slow to comprehend because we're experiencing the radical destruction of what we believe to be real."

In his book, Reinventing Collapse, Orlov also suggests that:

"With the economy at a standstill, the old capital, consisting of stocks, bonds and cash, quickly becomes worthless" (pp. 61).


Jay Hanson, and now Karl Denninger, also believe our currency (along with our gov't) is headed for the rubbish bin -- sooner, rather than later.



Perhaps the difficulty in reconciling oneself to the possibility of a worthless US dollar stems from history and culture, not economics.

Unlike the Russians or Germans, whose historical memory includes one or more episodes of hyperinflation, it is hard for Americans to imagine living in a time when their paper money is not worth its weight in toilet paper.

But such conditions have been known to occur. Savings boil off into the ether."
(pp. 51)

Anonymous said...

Anonymous: "Jay Hanson [believes] our currency (along with our gov't) is headed for the rubbish bin -- sooner, rather than later."

An excellent and very short presentation:

Anonymous said...

Never in my wildest dreams would I have thought the landscape would exclude Lehman, Bear and Merrill.
Meredith Whitney
Whitney On Wall Street's Future

scandia said...

Ric,I liked Whitney for " feeling" for her compatriots at Lehman and Merrill Lynch. Made me aware of the broader impact when friends are packing up, lunch buddies no more. The change is breaking up friendships as well as firms.Must be a very hard time emotionally for everybody working on Wall St.
The human landscape has changed forever.

Anonymous said...


Never in my wildest nightmares would I have thought that Bank of America could buy Merrill with a Fed Discount Window loan, using the MER stock as collateral.


scandia said...

The bit of news that the Feds have said BofA can use deposits to shore up Merrill activities is nagging at me. This is a change in the pattern. To date shoring up money has come from the Feds, the Treasury. Now it may come from deposits. It's as if the depositors have become a " window", an apparently permanently open window as I didn't read of any time frame. what does this mean?
Can it be the collateral taken has deteriorated so much that the only pot left with enough money in it is the deposits account. If this should come to pass, deposits being used in this way, how is the reserve requirement affected. How will adequate reserve then be calculated?
Your thoughts on this question would be much appreciated.

Anonymous said...

So how can Bank America buy Countrywide and all its mortgage toxic waste, and now Bank America is buying Merrill and its toxic waste? How can Bank America not be toxic itself? What am I missing?
Anonymous Reader

Anonymous said...

Please don't tell mother I work on Wall Street. She thinks I play piano in a bordello.

Anonymous said...

Canadian bank exposure to lehman


Anonymous said...

The noose is tightening,it appears.I had not known of the ability to use depositors funds as collateral.This will not end well.We are witness to the movements of desperate men,seeking to hold the power wealth gives, that has been theirs,by birth in the right bed,criminality,or meritocracy's slow climb.Many had it,not so many now,far fewer in the immediate future.

I don't see a lot of fortunes being made out of this collapse,slow motion as it is.Many have already figured out were screwed.The big question is "How Much"/How much is left in the kitty ..for.. us?...the little know,the ones who build the buildings,sell and fix the cars,cut your hair,sell your food,and serve it.Here is the question...HOW MUCH IS LEFT?...After your stupid drunken binge,as bush put it.How much will be left to put our nation back together after you and your buddies finish looting,run,and spend the rest of your life 'looking over your shoulder' or waiting for another thief to steal your cut.Hot money is like that .Hard to hang on to.Dont be surprised if some folks get sent out to look for you either..Whom ever gets the booby prize in the next election had better have a large supply of scapegoats to give the crowd..they will want lots of blood...
....rant off..


Anonymous said...

Wow, not a lot of time these days, but thought I would mention a very few things:

- The notion that BIS ordered the US to do anything is laughable, beyond silly.

- For a blog that claims no particular agenda, there are an awful lot of sweeping generalizations posted, many of which aren't even accurate.

- Anyone who is thinking that we are facing a major dollar and/or banking crisis, who proceeds to withdraw all their money from the bank only to hold it as bills is an Idiot. Yes, fully deserving of the capital.

Pulling FDIC-insured deposits from the bank is a generally stupid idea, but if you must, at least do something like turn into gold. Or canned goods and ammo. Or gasoline, diesel, or something else that is a decent store of value. Holding money as little slips of green paper is stupid.

Consider, if the government makes depositors whole (FDIC insurance), anyone who is holding money in any form of dollars (in a bank or under a mattress) is paying the cost (an inflationary move, printing money to replace losses), so might as well be on the receiving end. The notion that the government would let FDIC fail and not honor the insurance is beyond consideration: if things are so bad, there is no reason not to honor the commitment, so even in the most extreme case, it makes sense to print money to honor the guarantee. Ditto for defaulting on Treasury debt -- better to let the currency take the hit than to default. If your "systems analysis" is telling you otherwise, time to re-examine your basic principles.

Anonymous said...

"...Bank America is buying Merrill and its toxic waste? How can Bank America not be toxic itself? What am I missing?"


On Sunday, Fed announced that they are now accepting equities (common stocks) as collateral.

Bank of America (BAC) bought Merrill. Merrill's equity stake is crap. But because of Sunday's new rules, BAC can march that crap on over to the Fed's Discount Window and exchange it for billions of dollars.

The more that BAC pays for Merrill stock, the more money they get from the Fed.

Pretty smooth huh.


Anonymous said...

Insider -- I am so glad you have it all figured out! Now all of us Idiots can rest easy! Please don't hesitate to come down from the mountain again, if only to briefly educate us!


P.S. Please tell Anon Critic I said hello (if you are not one and the same)...

Anonymous said...

The prospect of buying a house / property these days doesnt seem so bad, after all that we've been watching on Wall St.

After all, a house is a house and it's got much more value than printed paper.

Anonymous said...

Insider, You say:

You say that:

Pulling FDIC-insured deposits from the bank is a generally stupid idea,

Okay, I'll ask the 64 dollar question! "When do you consider it as not a stupid idea?

Anonymous said...

Anonomouys said:

The prospect of buying a house / property these days doesnt seem so bad, after all that we've been watching on Wall St.

After all, a house is a house and it's got much more value than printed paper.

One of the values of that printed paper is that it gives one mobility. Right now I would sell my house but for the fact that I can produce the food I need in necessity and with it's shops I am able to be productive in other ways. To own a house merely for keeping out the elements I would (myself) opt for renting and freedom of movement and opportunity. There are other reasons for owning but those I think come under the heading of 'Not by bread (or shelter or capital conservation) alone',


Anonymous said...

When you're intending on spending it in the immediate future.

If you're really concerned about bank failures, keep a week or two of cash on hand, cash to settle all of your needs for two weeks.

Anything more is pointless; if you are intent on unhooking from the financial system, then the only alternative is to do it for real, and ditch the dollar in toto for some value store of intrinsic value -- canned goods, ammo, fuel. Holding little green slips of paper is a fools' paradise -- makes you feel like you've accomplished something, but you're really worse off than either other situation.

Of course, putting all your money into delivered commodities is going to cost a lot in transaction fees (both on the way in, and, when the collapse doesn't come, on the way out), so best be certain that that's really the bet you want to place....

But OTOH, if you tell people that you pulled all your money out and are holding little green slips of paper, well, the humiliation will be rather priceless.

team10tim said...

Insider/Anonymous Critic about your tact,

First, a word on etiquette. Try to be nice. If you are honestly trying to help people make better financial decisions then calling them Idiots isn't going to win them over. It cheapens the dialog to lowest common denominator arguments where the harshest insult and the wittiest rejoinder trump substance and insight.

Second, your credibility derives from the caliber or your posts on this blog, not your insider status. Consider for a moment that we don't know what organization you belong to. If you are at Goldman Sachs, The Fed, or the Treasury then your thoughts and opinions are important to us, even if they are wrong. If, however, you are an insider at Freddie/Fannie, IndyMac, or Lehman then nobody gives a rats ass what you think.

Essentially, what I am saying is that you should join the discussion in earnest or go away. I, for one, would like you to join the discussion because we may both benefit from the exchange. But it will require patience because you and I have fundamentally different views of the world. We aren't gaining anything from you when belittle us, and neither are you.


Anonymous said...

You guys have got to read this.

Sent to me by a friend of mine. ( He figured I already knew about this from the talk I have been spewing from what I learn here )

Check the prediction for Sept 15th

Delete this if it is going to get us in trouble. Last thing we need is Palin trying to get us banned.

Anonymous said...


Here is the tiny url of the google finance thread posted above.

Anonymous said...

Anonymous Insider said...

When you're intending on spending it in the immediate future.

Right you are there.

Now on your worry that hyperinflation will be the measure of an FDIC payout, then I think I would definitely have the do-ray-mi in my own hands and not behind a government bureaucratic wall. While I don't think that inflation will be faster than the speed of market collapse or the effect of deflation, my move from a bank would be to various short term treasuries, I would say one month cash rather than two weeks.

I really should take a look and see how prices are for small 32 ft sail. Soon, my deflationary dream boat, soon you will be mine.


BTW team10tim's advice is good but feel free to call me an idiot any time you like, it has a ring of honesty and fits me well, also in small doses can be great vaccination against the disease of sycophancy.

EBrown said...

Thanks for coming to the site here - I also qualify as an Idiot, though I suspect I am a bigger Idiot than CR. I have more than a month of cash stashed away.
I don't care if you trade barbs with others on the site, Ilargi has control and I know he has the will to exercise it should things get too out of hand. Having said that insulting me and my choices in capital letters does make me take your analysis less seriously. Ad hominems in my experience are usually the last resort of someone who has lost a debate.

Anyway for those who care I have a cash stash for the following reasons -

1. I need to buy things for my daily life and if my bank goes under I don't want to jump through hoops waiting for the FDIC to finagle a workout on my account.

2. I currently bank with a private institution and don't have tremendous faith in its capitalization ratios. It might be above average, it might be below. I simply don't know.

3. If (when?) a rash of banks fail in a short amount of time the FDIC may very well be swamped, so even though my money is "garaunteed" I won't have access to it until after a workout.

4. I have a fairly large family and few have taken similar defensive action. If (when) it is more difficult to access money some of them might need some help, and I want to be able to do so.

5. I see cash as a very good diversification move. Financial planners harp heavily on the importance of diversity. Well, in a limited sense I agree. I've said it before and I'll say it again, "I'd rather be wrong and liquid than correct in my analysis and caught in a shitstorm with no way to raise money."

6. I agree with you that real goods are an important place to park excess dollars. I think S and I are entirely on board with people doing exactly that. I remember S posting several times to that effect a few weeks and months ago.

7. I don't have longterm faith in the value of the dollar, but through the rest of this year and part way into next year I think it's as good a bet as anything else.

Anonymous said...

To Insider:
You bless us with your wisdom here, however, this blog is for reading and making up one's own mind. You say, "Holding little green slips of paper is a fools' paradise -- makes you feel like you've accomplished something, but you're really worse off than either other situation."

So, say I have 40,000 in some questionable opaque regional bank right now, and they are paying me 1.5% interest for that privilege and charging great fees here and there besides, and you think I should be happy and smart to keep it there? Call me a fool, but maybe I've decided that $600 a year isn't worth the risk.


scandia said...

Insider, Do you have any information/insight into how bank reserves will be calculated from now on?
I have read of reserves being adjusted downwards due to current conditions(F&F).Also read that capital reserves often consist of tax credits not capital. How will tax credits cover deposits? In that light how can a depositor trust the solvency of a bank?I hear you saying that reserves don't matter, that the gov't will cover deposits.
Finally do you think transparency is lacking or does it only appear so to the financially illiterate such as myself.

Anonymous said...

ilargi: "Wherever you are in the world, there are no safe banks anymore."

how about the state-owned Chinese banks?


Bigelow said...

Insider said:
“The notion that BIS ordered the US to do anything is laughable, beyond silly.”
Economic warfare precedes deadly warfare. The U.S. is no longer the center of the universe. The world’s other money interests must be awfully tired of the U.S. by now.

“Nearly 97% of all U.S. bank-held derivatives are concentrated in the hands of just five major U.S. banks: JPMorgan Chase, Citibank, Bank of America, Wachovia and HSBC. […]

Big brokers are also loaded with derivatives. Merrill Lynch has $4.2 trillion. Morgan Stanley has $7.1 trillion. As best we can determine, Lehman Brothers has significantly less $729 billion. But in proportion to its dwindling capital, its exposure seems to be among the worst.”
The Ultimate Wall Street Nightmare

“A broker reported to me today that their clearing agent is requiring them to mark purchases of AAA sovereign bonds denominated in foreign currencies as “speculative” investments.
Pressure to do this apparently is coming form the U.S. Securities and Exchange Commission (SEC). This means if Congress and the administration request that the SEC take action to “stop speculation” a mechanism will be in place to insure that U.S. investors cannot protect themselves from a falling dollar.
Lest capital controls domestically inspire you to leave the country, you may want to educate yourself about the exit tax that was passed by Congress in the Heroes Act of 2008.”
Slow Burn Capital Controls

“By allowing Lehman to fail, the Federal Reserve has, perhaps inadvertently, embraced debt deflation. Now they are contributing to it. The net result of the failure of Lehman will be still more credit contraction and debt destruction.

Some will argue that by adding $25 billion to the now $200 billion Treasury lending facility, accepting equities as collateral and by cutting short term interest rates, which the FOMC will almost certainly do September 16, the Fed is making more credit available, but that credit is being absorbed by the financial system so quickly that the net result is a still ongoing credit contraction.
But that's only half the story. The other half is about the debt destruction responsible for making both dollars and treasuries dear.
"Stagflation is now a dwindling threat..." “
Five Things You Need to Know: It Was Fun While It Lasted

“In actual fact, this secret branch of government has a sophisticated war room using every state of the art technology to monitor markets worldwide. It has emergency powers. It doesn’t keep minutes. There is no freedom of information access to its deliberations. There are l47,000 entries in Google on this powerful body, but I could only access l0.”
As Lehman Faces Liquidation, Two Banks Bite The Dust Danny Schechter

Farmerod said...

To the regular readers of TAE, exactly why are you lending Insider so much credibility? Because he says he's an insider? I may missed a couple of posts in the last week or so but I have not read anything from Insider that suggests any superior intellect, any significant new information or any sense of tact, for that matter. I think we all want to hear contrary arguments presented well and, for that, perhaps the link Stoneleigh posted the other day to the oildrum would be a start. Also, I heard Denninger was contemplating a change of tune to hyper-inflation. He's got a lot of credibility in my books. If he's changing his mind, then I need to listen. And always keep an eye on Mish. He hasn't gone the other way but he's a good read and if something changes, he'll be on top of it, too.

But, frankly, giving Insider this much attention must be a little insulting to the moderators.

Anonymous said...

outofcontrol said:

But, frankly, giving Insider this much attention must be a little insulting to the moderators.

Why give 'insider' so much attention? That reminds me of Brendan Behan and his saying that "every cripple has his own way of walking". I think there are few non-cripples in this world.

Stoneleigh said...

Insider (and I do believe you are),

One potential problem with being an insider is that it can be very difficult to question the assumptions that the system one is a part of is based on. Those assumptions tend to be invisible and are taken completely for granted by almost everyone. So many practices and trends that have gone on for a very long time seem normal and unthreatening, even though extrapolating them into the future as a thought experiment clearly leads to potential problems. Exponential growth in many parameters would be a good example.

As you challenge us, we hope to challenge you to think about a few things from first principles as well. A good place to start would be ponzi dynamics. Hopefully, we'll all learn something in the process.

As for some of your specific points, we do suggest that people not place their trust in the banking system and the FDIC. We do this because the FDIC was never designed to cope with a systemic crisis such as we are currently facing. In theory, it could be bailed out, but the price the country would pay in the bond market would be horrendous. Imagine what very sharply higher interest rates would do to a debt-junkie economy already teetering on the brink.

I don't believe a bailout will happen. In other words, the depositors whose banks fail first may well be the lucky ones, as they will be made whole, if they are under the FDIC limit. Further down the line, all bets are off. Some may see some of their money, but even if they do, it may not be soon enough to prevent them from sliding into destitution.

There is a great deal to be said for having personal control of your assets, and in our present circumstances where access to liquidity will be so important, that means having cash and cash equivalents (ie short term treasuries) under one's own control in one way or another. I would personally suggest having at least three months cash float, and preferably more. For larger amounts, treasuries are probably a better bet for the time being.

Someone brought up the risk of default. We have never said that treasuries were a risk-free option or a permanent solution. We suggest that people buy short term T-bills because they don't involve a long term bet on the finances of the US government.

I do believe default is inevitable eventually, but not any time soon, and here we are discussing ways to ride out deflation over the next few years. There will come a time when holding treasuries will not be a good idea and people will need to move into hard goods, but that time is not now. For now, people need liquidity. I am expecting those little pieces of green paper to be worth a great deal in the relatively near future as credit evaporates.

You mention hard goods as a hedge against hard times, and we would agree with you. As we have said here before (but not recently I think, so you probably wouldn't have seen the discussion), what you can do to prepare yourself depends on what resources you have available to you.

This is the advice I have given here before (roughly in order of priority):

* Hold no debt (for most people this means renting)
* Hold cash and cash equivalents (short term treasuries) under your own control
* Sell equities, real estate, most bonds, commodities, collectibles (or short if you can afford to gamble)
* Don't trust the banking system, FDIC or no FDIC
* Gain some control over the necessities of your own existence if you can afford it
* Be prepared to work with others as that will give you far greater scope for resilience and security
* If you have done all that and still have spare resources, consider precious metals as an insurance policy.

Unfortunately, not everyone can get our of debt, hold liquidity and afford hard goods or buy control over the necessities of their own existence. Getting out of debt is very important as debt will be a millstone round the neck in years to come, as interest rates will be very high in real terms, even if they are relatively low in nominal terms. If they rise in nominal terms, to reflect increased risk, then they will be going through the roof in real terms against a backdrop of collapsing credit. Debt is a one-way ticket to destitution, especially as bankruptcy is likely to get more and more difficult and its consequences are likely to get progressively worse (indentured servitude, debtor's prison, being strong-armed into the military etc).

Liquidity will also be essential, as with credit drying up and bank failures looming, people will need access to cash in order to cope. Cash will also give them access to assets at an affordable price as prices fall. This is the cheapest way to purchase the hard goods that act as a hedge against disruption of our just-in-time economy.

For those who can easily afford to do so, purchasing some hard goods now is not such a bad idea. Right now, all you need for many things is the internet and a credit card, which may not be the case in the future. You'll pay more than you would if you waited, but you'll have time to learn to use what you've bought before you need to rely on it. Control over the essentials of one's own existence does entail a learning curve.

Paying off debt, holding liquidity and purchasing supplies (if you can afford it) come under the heading of minimizing the consequences of being wrong. If you assume, based on the evidence, that we are in for a financial meltdown, but do nothing to prepare and a financial meltdown does indeed happen, the consequences could be horrific. If, on the other hand, you prepare and things do not turn out nearly as badly as you thought, what have you really lost? Certainly there would be an opportunity cost that might trouble those who are driven to wring the maximum profit out of every circumstance, but you would be debt-free and perhaps partially self-sufficient, and that is no bad thing even under normal circumstances.

The other basic principle is to face uncertainty with flexibility and resilience, which usually means a measure of redundancy. That cost of course, and is hard for some to accept as it runs against the grain for those brought up on efficiency maximization. However, maximum efficiency means no resilience at all. Ideally you need to be able to do essential things in different ways, so that whatever inputs come your way, you will still be able to do what you need to do. Heating, cooking and providing water and electricity come to mind as candidate systems for this approach.

At the end of my list I put precious metals, partly because I think they will be much cheaper as deflation proceeds and partly because there are likely to be consequences to owning them and/or difficulties in using them to provide for yourself. There's no question mark over whether or not they will hold their value over the long term - they have and they will.

However, purchases are noted, so anonymous ownership is difficult, and during the last depression, gold ownership was outlawed and gold was confiscated without compensation. In addition, trying to trade in gold, especially if ownership becomes illegal, would be dangerous. If you can afford to sit on a supply of the stuff for years, it could be the foundation of a great fortune one day, but for most people, who need something they can readily trade, it wouldn't be very practical.

One point about holding fuel as a store of value. Even with stabilizers, gasoline has a limited tank life. Diesel lasts for longer, but can corrode the tank from the inside over time, leading ground-water contaminating spills. As groundwater matters a lot, much care with storage is required. Also, fuel stores could well make you a target for theft, as fuel tanks are usually fairly obvious. You can do it, but do it carefully. Investing in bikes and spare bike parts might be a better bet.

Finally, other people and established social structures are extremely important to any kind of overall strategy. Building small communities with pooled resources could help many people to get further down the preparedness list than they could hope to get on their own. Ilargi and I live in just such a communal arrangement on a small farm where we can grow our own food, produce our own electricity, pump and filter our own water, obtain our fuel wood by hand if necessary. We saw this coming years ago and have been preparing for a long time.

Ilargi said...


Thanks for standing up for me, though I don’t think there‘s a need.

I haven’t really followed it, only so much time in a day. At first I wanted to cut out that nonsense last week, but then I decided to provoke a discussion, and that obviously worked. Then I lost interest. If that discussion leads people to follow someone claiming that Fannie and Freddie were "over-collateralized", well, maybe that’s a good intellect filter.

But there is no place for that sort of blabber here, of course. As you know, I have never cut comments, I don’t like that at all. It’s for instance easy to make anonymous commenting impossible, but I prefer things settling themselves. Still, I don’t rule out anything in this regard. Maybe I have too high an opinion of my readers, and I need to crack a whip.

Mrs. Insider, of course, is not inside anything at all, or if she is, she never understood much about it. I thought that was so clear, there was no need to explain.

What is perhaps the factor that drives this, is that fear breeds religion. You don’t have to know diddly-squat, or have a direct line with God, you only have to make people think you do.

And there are a lot of people out there who are now beginning to get really afraid. That's why Stoneleigh and me started writing on finance a few years ago, after all.

I understand the fear knee-jerk very well, certainly enough to know that we will never reach more than a fringe audience, until it's too late for people to realize the consequences of what we have said all this time.

I know you have changed your life completely because of our message, and uprooted your entire life and moved your family thousands of miles away, simply because you realized the impact of what we were -and are- saying.

It’s all down to the old Groucho line:

The secret of life is honesty and fair dealing.. if you can fake that, you've got it made.

Ironically and fittingly, if you google that, you’ll find it attributed, on acting, to George Burns. Who only needed to fake it....

Anonymous said...

Yes, Insider is a dick. How is he any worse than our hosts? This place is knee-deep with dismissive, cocksure know-it-alls.

And to that I say, so what? I don't know about the rest of you, but I come for info & analysis, not for tact.

Anonymous said...

Thank you stoneleigh & ilargi for your expanded comments today.

Spouse and I are moving along in our preparedness. He chuckles at the toilet paper I have been buying on-sale. However, it is difficult to convince him that electricity is going away. He thinks he will be able to pull out his gasoline powered generator when the power goes off.

But what about a natural gas powered generator hooked directly into our gasline? Or is natural gas another item that also will be reduced/eliminated?

Or is it time to outfit our house in solar roof panels to generate heat and electricity?

Anonymous Reader

Anonymous said...

Stoneleigh, thank you deeply for the thorough comment and for sharing your personal story.

Ilargi, well said!

I had a feeling that AC or Insider might be the equivalent of the provocateurs infiltrating peace groups. I would suggest to other participants here not to engage her. If she persists in disrupting or preventing a genuine discussion, deleting her comments is totally appropriate.


Anonymous said...

"What we are witnessing these days in the US is a massive wealth transfer from taxpayers, savers, and retirees to banks, their creditors, and their managers." - Economist Rodrigue Tremblay



Stoneleigh said...

Anon Reader,

What it makes sense to do depends on what resources you have. I wouldn't put in solar panels if you have to go into debt to do it, for instance. If, on the other hand, you can manage no debt, liquidity on hand and in reserve, and you can still afford to buy solar panels, then doing so is probably a good idea.

We have a solar domestic hot water system for hot water in the summer (our water is wood-fired in winter), and solar panels and a battery bank for powering the essential loads all the time (water pump, sump pump, circulating pumps for solar and wood heat, security system, fridge, freezers etc). We also have a generator panel for less essential loads, and we can use either a gasoline of a diesel generator, depending on what we have to hand. Generators can be temperamental though, so you need to test them regularly, but leaving fuel in them leads to blockages.

I don't expect electricity to go away - after all even Baghdad gets some electricity - but I do expect it to become less reliable, and I do think backups are a good idea, especially if you live in a challenging climate.

One thing you could do that would be less expensive than generating your own power would be just to put a battery bank in the basement. If you wire it in as backup rather than for everyday use, you can get away with cheaper batteries. You'd need several days power storage for essential loads and it would cost a few thousand dollars, as opposed to a few tens of thousands of dollars for solar panels and/or wind turbines.

If you have batteries, then it doesn't matter when the power is available through the mains. Whenever it's there, it will charge the batteries. Don't try to run everything though as that would be too expensive. You could live without a lot of things that require electricity, so long as you have the basics. You couldn't really run anything that produced heat though - that's too big a power draw.

Having a woodstove is a good idea for backup heating, depending on where you live. It's by far the cheapest alternative, although for those with the resources, an efficient ground-source heat pump is a good idea, provided you have a backup for the power you need to run it. We have an old and inefficient ground source heat pump that came with the house, but we don't use it much as it's a power hog and won't keep the house warm by itself if the temperature is below zero. The newer models are much better, especially if your house is small and well insulated.

Our primary heat source is an outdoor wood-fired furnace that provides space heating and hot water in winter. We also have a small woodstove inside for when it isn't cold enough to run the big one. The outdoor one is capable of heating multiple buildings, and will be heating the radiant floor of our greenhouse as of this year.

As for your question about natural gas, it may well be problematic as natural gas has already peaked in North America and supply is declining while demand has grown hugely, for both heat and power. You might like to read High Noon for Natural Gas by Julian Darley for an eye-opening discussion on the matter. Natural gas depletion is much quicker than oil depletion, and I very much doubt if we'll ever see an international LNG market develop beyond what already exists (mostly in the far east).

For generators, diesel is probably best as it can be stored for longer than gasoline. For gasoline, you need chemical stabilizers and even then it wouldn't last all that long.

Farmerod said...

Yes, Insider is a dick. How is he any worse than our hosts?

First, can we all agree that Stoneleigh is NOT a dick, by any definition of the word?

Now, as for Ilargi, suppose he is a smug dick - a smick, if you will - at least his target for smickishness is the group of people who are wringing wealth out of poor people (who might not yet understand how poor they really are). The other person seems to only want to direct her insults at the messengers and the audience, to no one's benefit.

BTW, I'm certainly not convinced that Insider really is an insider. Insiders wouldn't waste time here when there's money to be made.

BTW2, Ilargi is also very much NOT a smick although I can understand how someone who only spent a little bit of time on the site might get that impression out of context. What I read is frustration, anger, sadness, exasperation etc., not smickishness.

Anonymous said...

anonymous said: Or is it time to outfit our house in solar roof panels to generate heat and electricity?

Hardly. Ecology activists are happy with fotovoltaic cells, but we technicians aren't.
They did not tell the whole truth about it. Manufacturing of fotocells will consume more power, than it will give you during the whole projected lifetime.

Also, how many sunny days are there in the place you live. Will they work during the winter, when the sky is cloudy most of the time and days are short? It may be interesting in Africa or central Australia, maybe at Florida but not in NY or Europe.

Greetings from Czech Republic

Anonymous said...

What's the newest messages about AIG? Is it walking in Lehman Bro's footprints?

Anonymous said...

Annonymous 11:20 says:

Yes, Insider is a dick. How is he any worse than our hosts? This place is knee-deep with dismissive, cocksure know-it-alls.

And to that I say, so what? I don't know about the rest of you, but I come for info & analysis, not for tact.

You come with a begging bowl to insult one and all?

Bite him insider, your teeth maybe oddly shaped but bite him anyway. You may not be one with us but you are one of us.

Anonymous said...

Thank you stoneleigh and anonymous from Czech Republic.
Your comments are much appreciated and gives me areas to research. Spouse is the construction worker and builder. Thankfully, we have no debt, and we have a bit of savings that could be well-spent in upgrading our house for alternative sources of heat and energy.
Anonymous Reader

Anonymous said...

Anon 12:33
What's the newest messages about AIG? Is it walking in Lehman Bro's footprints?

If its any use to you here is AIG

Stoneleigh said...

Anon from Czechia,

You're right that it depends where you live as to whether solar panels are any use. Where we live in Ontario, solar is not bad. Even in the winter we produce power, as the panels are more efficient in the cold, even though the daylight hours are shorter. Using a tracker improves power output, but they cost and have moving parts that can break. Changing the angle of fixed panels to suit the seasons, as we do, is probably better.

Autumn is the dark trimester here, where very little power is produced. It's true that solar is never enough on its own if you're off grid. You would need a wind turbine and backup generator with fuel supply. Good wind turbines are as expensive as a solar array, even though here you would get about 85% of your power from the sun and only 15% from the wind. That starts to get seriously expensive - really only justifiable if you're avoiding the cost of a very expensive mains power connection by doing so.

For most people who already have a mains connection, batteries are probably enough.

Stoneleigh said...

Anon Reader,

Marrying someone with construction skills was a great act of foresight on your part ;)

Seriously, practical skills will be very valuable. I doubt if many will be building houses, but they will be needing to repair them. Also, all manner of things you could do for your own house become far more affordable if you don't have to pay for the labour. Adding insulation is probably the most important (ie always reduce your demand before trying to provide your own supply).

goritsas said...


I just wanted to make one additional comment regarding fuel source. I don’t want to get into any debates about the relative merits of alcohol as a fuel. But, for folk in your situation, it’s entirely conceivable you could produce enough fuel to make sure you could always power those important ICE devices even should access to petrol or diesel become problematic. David Blume’s ‘Alcohol can be a gas’ is a pretty fun read and sure filled with enough info to get one started.

He points out the Model T began life as an alcohol fired machine and was a flex fuel motor car when petrol first found its way into use as a fuel; and that most farms produced alcohol for fuel until various “laws” prohibiting its production came into force effectively making petrol the only available fuel. (at least for sparking engines)

He also notes that Germany had a large alcohol production capacity that was widely dispersed during WWII, making fuel production very resilient to interruption.

It would also seem possible for suburban and urban folks to form ethanol CSAs, as it were, to help mitigate fuel issues that may become dominant in the future. I’m sure there are many “legal” issues but getting such projects under development now would speed their viability as and when the time comes.

Stoneleigh said...


Good point. We've never tried to produce ethanol, but it would certainly be possible. Alcohol is also a very effective method of sterilizing water if supplies are of questionable quality. In England in Shakespeare's time, everyone drank ale - even babies - because water was so contaminated. The younger members of the household would get the weaker pressings.

goritsas said...
This comment has been removed by the author.
Anonymous said...

"Insiders wouldn't waste time here when there's money to be made."

Not at all true, I've seen this in other areas, something clicks in their heads, they know things are seriously bad, they hear about a site, say this one, or in the case of oil supplies, the oil drum, then they come with exactly this type of attitude, believing that their 'insider' status actually means they are better qualified to grasp the larger situation.

However, their arrival, if they are actually insiders, is relevant, because it means that, though they do not yet admit it to themselves, they are in fact beginning to wake up, but they just can't bring themselves to really face up to what they see.

The next phase is, in the case of finance, a race between them starting to realize that the company view they had bought into, the system they believed in, is in fact in serious trouble, or getting a pink slip in a mass layoff as their company/business goes under.

I'd guess the next phase after that, logically speaking, would be active support for some type of proto-fascist political entity that promises to return their wealth and position to them in exchange for any remaining rights they might have.

One thing I have noticed, however, over the years, were that the people with the very worst macro views were mid-level employees, insiders, that is. Now and then you find major players able to actually think for themselves (ie, the derivative 'ticking time bomb' etc), but this is very rare.

I agree far too much attention is being paid to a person who has as of yet shown basically nothing of value, contributed nothing of value, and is merely resorting to simplistic statements that they may or may not believe, but which aren't being demonstrated in any convincing way.

Anonymous said...

I guess its time to eat a little crow (which I've done before on occasion)! If it takes a comment from Insider/Anon Critic to get Stoneleigh to expound in some detail -- well...I hope Insider/Anon Critic posts a comment everyday! (Yuk, crow is awful!)


Anonymous said...

It is too much! Just too much! Why should I have to suffer?

I went to all the right prep schools! I went to Yale and struggled mightily to keep my GPA down to a "C" average didn't I? I joined the national guard and then went AWOL didn't I? I did everything that was expected to of me didn't I?

How about bailing ME out? I'll settle for a measly billion!

This supposed to be a crisis only for those icky "little people", not for real people!

Starcade said...

anonymous: As soon as you can get to your bank to pull it...