Tuesday, September 2, 2008

Debt Rattle, September 2 2008: Schadenfreude

Detroit Publishing Co. Blackwell's Island Bridge, East River 1910
Blackwell's Island is now Roosevelt Island, and the bridge is called the 59th Street (Queensboro) Bridge.

Ilargi: I'm not a fan of expressions such as 'next shoe to drop' or 'next phase to enter', which are far too popular popular among reporters with limited imaginations and language skills.

But I do think that we are seeing a number of developments that herald a time of increased awareness of our economic reality. Not that it makes any difference to what The Automatic Earth has been saying all along. The funny virtual money will have to vanish, and we will then have to make do with what's left, which will be very precious little.

The main driver behind the global financial news in September and October, even though it may not be recognized as such, will be the central banks and their emergency lending windows and liquidity schemes.

A large percentage of the world’s main commercial and investment banks has been held above water through loans collateralized with essentially worthless securities of one kind or another.

The ECB has until now accepted paper with an A- rating, the pennies-on-the-dollar variety, a practice that has reportedly been the only thing standing between English and Spanish banks and their maker.

Now, both the ECB and the Bank of England are about to withdraw that level of support. In the meantime, what value was left in these securities has dropped further.

Long story short: we are about to see bank failures all over the world’s main financial centers. The only thing that can now prevent this from happening, and in some cases will, is consolidation: the left over "worth" of many financial stocks will be bought by stronger institutions for next to nothing, wiping out shareholders’ value in the process.

The OECD reports today that Britain will be the only major rich country to go into a recession this year. While that is an unbelievably silly statement, it does once more make clear how bad things are in Albion. It’s silly because many others are in recession as well; it just depends on the definition you use.

And I guess it’s nice for the other economic basket cases to have people focus on Britain. Which in turn is not so nice for the English government. The ministers’ position may well become untenable, and force them to step down, much sooner than you would have thought only a few weeks ago.

Even before Arnold Schwarzenegger?! California, the world's 8th largest economy, doesn't even have a budget... What a mess he's made in a few years, and it's just starting. Well, at least, Arnie know the proper pronunciation of "Schadenfreude".

Among the G7 list used in the OECD report, I'd say the US and Italy are now also certainly 'smack in recession', if not depression, while France, Germany and Japan will soon follow. That leaves only Canada, which gets a ridiculously high 2% growth number for Q4, but will see revenues plunge along with oil prices, as well as the US economic downfall. Canada’s rescession: Q1 2009 at the latest.

For the Americans, we can add that with stimulus checks gone and spent, US consumer spending will nosedive. And with the US dollar rising, American exports, the one thing that was up until recently, will dive right along.

Among countries not on the OECD list, Korea, Australia and Thailand -just to name a few- are in deep doodoo, and Spain is covered in quicksand, as is the entire Club Med region: we may not see much news from Greece and Portugal, but that’s not because they are doing so well; it’s because they're not.

PS: a little note on Fannie and Freddie, who escape the headlines today: their preferred stock was cut by Fitch this morning. Their debt is now estimated at $9 trillion, while the whole US public debt stands at $5.5 trillion. $9 trillion in debt, with only $5.3 trillion in mortgages insured, and a market cap of just over $10 billion. Just to let you think for a moment about the potential effects of nationalization.

UK is the only major economy to face recession this year, OECD warns
Britain is currently in the first throes of recession, according to one of the world's leading economic authorities. The UK's economy is now shrinking and will continue to do so into next year, the Organisation for Economic Cooperation and Development said.

It is the first time a major international forecaster has explicitly said Britain is facing a technical recession, in which the economy contracts for two successive quarters. Even more embarrassingly for Gordon Brown, the OECD forecast shows that Britain is the only major economy in the world which will face recession in the next six months.

The warning severely undermines his claims that the UK is well-placed to withstand the global downturn. The OECD forecast shows that Britain will shrink by 0.2pc between now and the end of the year - the worst performance since the severe recession in the early 1990s.

Jorgen Elmeskov, the OECD's acting head of economics, said: "Financial market turmoil, housing market downturns and high commodity prices continue to bear down on global growth, while at the same time evolving rapidly.

"Continued financial turmoil appears to reflect increasingly signs of weakness in the real economy, itself partly a product of lower credit supply and asset prices. The eventual depth and extent of financial disruption is still uncertain, however, with potential further losses on housing and construction finance being one source of concern.

"The downturn in housing markets is still unfolding, with reduced credit supply likely adding to pressures."
Alistair Darling will this autumn be forced to make the biggest downgrades to his a Treasury growth forecast in 16 years, slashing the projection by as much as 1.5pc.

The Chancellor has privately acknowledged that he will have to slash his forecast 2009 from 2.5pc to as low as 1pc, as well as putting a knife to his optimistic 2pc growth forecast for this year. The OECD said that it expected the economy would grow by just 1.2pc during 2008, compared with a previous forecast of 1.8pct.

Britain worst of many weak economies, first to fall into recession this year
The UK economy will fall into recession during the second half of this year, according to the Organisation for Economic Co-operation and Development (OECD) Britain is expected to perform the worst of the world's richest nations, with its economy predicted to shrink by 0.3 per cent in the third quarter and by 0.4 per cent in the final three months of the year.

The definition of a recession is two successive quarters of negative growth, according to the Paris-based economic organisation. According to official UK data released last month, the economy came to a standstill during the second quarter of 2008. The longest period of uninterrupted economic growth in British history has ended, leaving the country on the brink of recession.

Almost two decades of increasing employment, disposable income and house prices ground to a halt in June, figures from the Office for National Statistics showed. Now the OECD is forecasting that Britain will fall into a recession, although it does not use the word, while the US, Japan, Germany, France, Italy and Canada will slow, at worst, to a standstill during the rest of this year.

Jorgen Elmeskov, acting head of the economics department of the OECD, said that economic activity in the UK was expected to remain "broadly flat". "Financial market turmoil, housing market downturns and high commodity prices continue to bear down on global growth," Mr Elmeskov said in comments accompanying the OECD's latest interim assessment of the economic outlook for the seven member nations.

“The eventual depth and extent of financial disruption is still uncertain, however, with potential further losses on housing and construction finance being one source of concern,” he said. The US will see growth slow to 0.9 per cent in the third quarter and 0.7 per cent in the last three months of the year.

Europe’s biggest economy, Germany, will come to a standstill in the third quarter and edge ahead just 0.1 per cent in the fourth, the OECD said. The OECD is forecasting the UK economy to grow by just 1.2 per cent in 2008, well down on its earlier forecast of 1.8 per cent. Last month the International Monetary Fund predicted the UK economy would grow 1.4 per cent this year.

There have been a series of gloomy economic forecasts about the UK economy in recent months. Mervyn King, Governor of the Bank of England, said last month that the country would experience at least one quarter of negative growth in the coming year, while the British Chambers of Commerce has explicitly warned that Britain’s economy wil enter a recession within the coming year.

Tthe pound slumped today to its lowest level against the euro since the single currency was introduced in 1999, following a warning from Alistair Darling, the Chancellor, that the UK was facing its biggest economic challenge for 60 years. Mr Elmeskov said that the basic message from his organisation was that the economy of the G7 club of industrialised nations was very weak.

“Continued financial turmoil appears to reflect increasingly signs of weakness in the real economy, itself partly a product of lower credit supply and asset prices,” Mr Elmeskov said.

The monetary policies being pursued by central banks at the moment were appropriate in current circumstances, the OECD said, referring primarily to the United States and euro currency zone where the European Central Bank (ECB) sets rates for 15 countries. The Federal Reserve has slashed US interest rates while the ECB’s last move was a rise.

Sterling sell-off intensifies as investors turn their backs on Britain
The pound's slump accelerated for a second day in London as traders abandoned British investments following Alistair Darling's warning that the economy is facing its worst threat for 60 years.

After dropping below the $1.80 mark for the first time in more than two years yesterday, the pound lost another cent against the greenback within the first 30 minutes of the foreign-exchange markets opening in London today and was down a further cent bove $1.79. The pound was also weaker against the euro, with one euro worth 81.37p.

The slump leaves the pound worth the least - against a basket of world currencies - in 12 years. The dramatic sell-off comes after the Chancellor remarks about the state of the economy over the weekend. Mr Darling warned that the threats facing the world economy were "arguably the worst they've been in 60 years... and I think it's going to be more profound and long-lasting than people thought".

The warning sparked a major sell-off in the foreign exchange markets, which was compounded by fresh news that the housing market's slump is still worsening and that the wider economy is threatening to dip into recession.

The pound has fallen sharply in recent months, as investors bet on the UK economy suffering a major slowdown and that the Bank of England will at some point have to cut interest rates sharply. The dollar has also been strengthening against other world currencies.

Economists said that the Chancellor's warning could contribute to the economic slowdown by denting confidence and driving away investors. Conservative leader David Cameron said: "It's an extraordinary situation that we've got a Chancellor of the Exchequer effectively talking the economy right down.

US July construction down 0.6% vs 0.3% decline expected, despite sharp increase in government spending
US construction spending fell more than expected in July as housing construction fell to its lowest level in more than seven years, a decline made more pronounced by a large upward revision to June's spending tab, the Commerce Department said today.

Total US construction spending fell 0.6% in July, more than the 0.3% decline economists polled by Thomson Reuters IFR Markets had expected. Construction spending in June was upwardly revised to a 0.3% rise from a 0.4% decline. Total private construction fell 1.4% in July to the lowest level since June 2004.

Housing continued its steady contraction with private residential construction falling 2.3% to its lowest level since March 2001. Over the year, public and private homebuilding was down 27.1%. Private non-residential construction spending fell by 0.7% in July, the first decline seen in this category since December, when it fell 1.2%. Over the year, businesses increased their construction spending by 16.0%.

Overall spending on lodging construction fell 0.1%, the first time this previously strong category has fallen in six months. Declines were also seen in big categories like power, communication and manufacturing. Office and education construction spending increased in the month.

Construction by state and local governments rose 1.2% to a record high. Federal construction rose 3.9% in the month also to a record high.

U.S. Manufacturing Shrank in August
An index of manufacturing in the U.S. fell in August for the first time in three months as companies slowed production and cut payrolls in the face of weakening consumer spending.

The Institute for Supply Management's factory index fell to 49.9 last month from 50.0 the prior month, the Tempe, Arizona- based group reported today. The ISM gauge has hovered near 50, the dividing line between expansion and contraction, for the past year.

Manufacturers are receiving fewer orders as tumbling home prices and expensive gasoline weigh on consumer demand. Surging exports are keeping factories from stumbling as the broader economy slows. "Manufacturing has been rather flat," said Norbert Ore, chairman of the ISM survey, in a conference call from Atlanta. "It's a consistent story of slow contraction that's been going on for quite some time."

The ISM index was projected to remain unchanged at 50, according to the median of 72 economists' forecasts in a Bloomberg News survey. Estimates ranged from 48.5 to 52. The purchasing managers' gauge of new orders for factories increased to 48.3 from 45 the prior month, when it reached its lowest level since October 2001. The production measure dropped to 52.1 from 52.9.

Orders from overseas have helped some companies withstand slower U.S. sales. The group's export gauge jumped to 57 from 54 the prior month. The employment index dropped to 49.7 from 51.9 in July, further signs of weakness in factory employment. Ford Motor Co., the second-largest U.S. automaker, last month said it would lay off 300 workers at a Michigan engine factory as demand dwindles for vehicles equipped with V-8 engines because of gasoline prices.

The purchasing managers' index of prices paid dropped to 77 from 88.5. A government report today showed construction spending in the U.S. fell more than economists forecast in July as work slowed on homes, power plants and factories, a government report showed.

The 0.6 percent decrease followed a revised 0.3 percent gain that initially was reported as a 0.4 percent drop, the Commerce Department said today in Washington. Private residential projects declined 2.3 percent in July to the lowest level since March 2001, the start of the country's last official recession.

The economy will grow at an average 0.7 percent pace in the second half of the year, economists surveyed by Bloomberg News forecast in the first week of August. Last week, the government reported the economy grew at a better-than-forecast 3.3 percent annual rate in the second quarter, following 0.9 percent in the first three months of the year.

The smallest trade deficit in eight years was the biggest contributor to growth last quarter. The smaller gap added 3.1 percentage points to growth, the most since 1980. That is likely to diminish as overseas economies slow and the dollar strengthens.

Manufacturers have also turned cautious as consumer spending weakens with the fading effects of tax rebate checks. Tumbling house prices and gasoline that topped $4 a gallon two months ago are also holding back consumer demand. The auto industry is at the forefront of the manufacturing slump. Sales of cars and light trucks in July slid to a 12.5 million annual rate, the lowest level since 1993, according to industry figures.

General Motors Corp. Chief Executive Officer Rick Wagoner said Aug. 16 he's not yet seeing signs of a recovery in the U.S. economy or in vehicle sales. The sluggish economy helped push GM, the world's largest automaker, to a $15.5 billion loss in the second quarter. "It still feels to me like we're in it," Wagoner said of the economic slowdown.

Fitch cuts Fannie Mae, Freddie Mac preferred stock
Fitch Ratings on Tuesday cut its ratings on the preferred stock of housing finance companies Fannie Mae and Freddie Mac on concern a lack of access to fresh capital could lead the companies to suspend dividend payments.

The rating company lowered Fannie Mae's preferred stock rating to "BBB-minus" from "A-plus. It dropped Freddie Mac's preferred stock rating to "BBB-minus" from "A." Drubbings of the preferred and common stocks over the past two months have effectively limited potential issuance of new shares, Fitch said in a statement.

The sell-offs raise risks for the companies since sales of stock since November have been key ways for both to raise billions in capital needed to offset losses from the housing slump.

"The lack of reliable access to the public equity markets appears to be more permanent than Fitch had anticipated," the rating company said. "It now appears that Fannie Mae's and Freddie Mac's ability to access equity markets may need to be precipitated or replaced by more tangible forms of government support."

Fannie Mae and Freddie Mac common stock have declined about 80 percent since early May, but have erased some losses since Aug. 20 on emerging expectations a nationalization by the U.S. Treasury is not imminent.

Fitch said the capital at Fannie Mae and Freddie Mac remains adequate for the intermediate term. But neither company may post a profit this year or next, and the government may move to support the companies in a bid to buoy the U.S. mortgage market, it said.

Fitch also affirmed the "AAA" long-term debt ratings and "AA-minus" subordinated debt ratings of Fannie Mae and Freddie Mac. The subordinated debt ratings are based on expectations that the companies will maintain adequate capital.

Rival rating company Standard & Poor's last week lowered preferred stock and subordinated debt ratings of Fannie Mae and Freddie Mac on speculation both types of securities may not draw government support in any bailout. Moody's Investors Service on Aug. 22 cut ratings on Fannie Mae and Freddie Mac preferred stock.

Fitch Pegs Housing-Price Pressure From Option ARMs
Fitch Ratings said Tuesday that U.S. pay-option adjustable-rate mortgages face dramatically increasing defaults in the coming year and beyond.

Option ARMs allow the borrower to make a low minimum monthly payment, usually for five years, and the difference between the minimum payment and the full payment is added to the mortgage balance. At the five-year mark, the loan terms reset and the mortgage payment increases to ensure full payment of the loan by maturity.

The higher payments mean many option ARM borrowers will be left unable to afford their homes, and increased defaults will likely exert more downward pressure on house prices. Of the $200 billion of option ARMs outstanding, Fitch expects $29 billion to recast by the end of 2009 and another $67 billion to recast in 2010. The potential average payment increase on those recasting loans is 63%, or an extra $1,053 a month, on top of the current payment.

A feature of the loans, the negative amortization cap, causes the recasts to occur before the five years are up - once the balance of the mortgage grows by more than a certain percentage. This is especially expected to affect loans originated in 2005 and 2006.

Combined with the deteriorating outlook for home prices and lack of refinancing opportunities, these resets are “a significant cause for concern” for investors in option ARM residential mortgage-backed securities, Fitch said.

Ilargi: There’s nothing really new in this Financial Times piece, but still a good reminder for those who hope the economy will somehow "recover" in the near future. I won't, becuae it can't. It will get much worse. Option ARMs are the Katrina to subprime’s Gustav.

Reset loans add to US home woes
The stricken US mortgage market is set to suffer further setbacks in the next two years as $96bn of risky home loans sold with initial flexible payment options switch to more stringent terms. These will raise borrowers’ monthly payments by about 60 per cent.

The changing terms could more than double the number of borrowers falling behind on so-called “option adjustable rate mortgages” issued between 2004 and 2007. This is according to research published Tuesday by Fitch Ratings.

Option ARMs allow borrowers to choose a low minimum monthly payment that often falls short of the interest due on the loan, typically for five years. The difference between the minimum and the full payment is added to the mortgage balance. This ability to borrow more before having to start repayment is known as “negative amortisation”.

At the five-year mark, the loan terms are “recast” and the monthly payment is increased to ensure the full repayment of the loan by maturity. Late payments and defaults on such mortgages are already running as high as 24 per cent in some areas, said Fitch. It added that the potential average payment increase on recasting loans was 63 per cent. In cash terms this amounted to an average of $1,053 extra due each month.

“The combined impact of payment shock ... declining home prices and restricted availability of mortgage credit may leave many option ARM borrowers unwilling to continue paying their mortgage,” said Huxley Somerville, analyst at Fitch Ratings. “The current severe environment has left borrowers with few alternatives to foreclosure,” he added.

Mr Somerville said the ARM market had the highest proportion of borrowers with limited proof of income at more than 80 per cent of loans. This increased the likelihood of default. “Borrowers who used the [minimum payment] option to extend themselves into larger houses could easily be overwhelmed by the higher mortgage costs,” he said.

The bulk of the $200bn of outstanding option ARMs will not hit their five-year anniversaries until after 2010. Many option ARMs, however, have a limit on negative amortisation – typically between 110 per cent and 125 per cent of the original loan amount. If a borrower hits this limit, the loan can recast much earlier.

Fitch expects roughly $29bn of option ARMs to recast to higher monthly payments by the end of 2009 and an additional $67bn to recast in 2010. Fitch anticipates that more than half of these will be as a result of stressed borrowers hitting their negative amortisation ceilings.

About three-quarters of option ARM borrowers chose to make just the minimum payment on their loan over the last two years, according to LoanPerformance, a mortgage research provider. With many borrowers approaching their negative amortisation limits, accelerating loan recasts could exacerbate the housing slump in some of the most stressed markets, said Fitch. More than half of existing option ARM loans are in California, according to data from Barclays Capital.

“Because of their use as an affordability product, option ARM defaults will likely spread into higher priced neighbourhoods, as many borrowers leveraged the very low minimum monthly payment to buy more expensive homes,” said Mr Somerville at Fitch.

Lehman Brothers is still standing, but its foundations look shakier every day And Fannie Mae and Freddie Mac are doomed
Dick Fuld, the embattled chief executive of Lehman Brothers, has done well to keep his job for this long. Merrill Lynch and Citigroup ditched their bosses at the start of the global credit crunch while Bear Stearns boss Jimmy Cayne was forced out in January, shortly before his bank was bailed out by the Federal Reserve and JP Morgan.

Since that rescue, the smart money has been betting that Lehman and Fuld will be the next victims of the financial crisis but, six months on, both the bank and its boss are still standing, although they seem more rickety by the day.

Their foundations will get another knock next month, when the bank is expected to unveil further massive write-downs along with third-quarter figures - forecasts range from $3bn to $4bn (£1.5bn-£2bn) - which will push its losses for the six months to the end of September close to $5bn, or more than the $4.2bn net income it earned in 2007.

Lehman's shareholders will be hoping he can accompany that with some good news to help shore up the bank's plunging share price - they have lost more than three-quarters of their value over the last year.

The question is what good news? While there have been rumours that it is keen to sell its fund management business, Neuberger Berman, in order to shore up its balance sheet, analysts are not convinced this is a serious option.

For a start, its predictable earnings - one of the attractions for Fuld when Lehman bought the business for $2.6bn five years ago - are even more welcome when mortgage trading and other investment banking markets are crumbling: in the first six months of the year, Neuberger accounted for almost 40 per cent of its net revenues.

Fuld is believed to be trying to sell just a part of the business, or to take warrants allowing him to buy it back should the business climate, and Lehman's balance sheet, improve. But with write-offs and trading losses eating into the bank's already thin capital, its scope to negotiate that kind of deal is limited.

So, too, is the potential for selling a stake to the Korean Development Bank, another hot rumour of the last month. Even before the Korean authorities started pouring cold water on the likelihood of such a high-risk venture, Fuld's price expectations were already rather ambitious: one analyst says he was holding out for a price of between 20 and 50 per cent above the bank's book value of around $40 a share, or as much as four times its current share price.

Such optimism is understandable: Fuld was instrumental in creating the investment bank in its current form.With Cayne's departure, holds the record as the longest-serving chief executive in the business, having taken on that role in 1993, though some say his days at the top are numbered. Much of his wealth is tied up in the business - his 11 million shares represent 2.4 per cent of the business and he was paid $35m last year.

This will make him uncomfortably aware of the losses suffered by the many employees who also hold shares through bonus and incentive plans as the share price has collapsed. It has also slashed the value of his own pay-off arrangements: at the end of 2007, he would have collected $241m, based on a share price of around $63; at $15, that has sunk to $57m.

But Dick Bove, respected banking analyst with Ladenburg Thalmann, thinks a takeover of Lehman is inevitable, regardless of Fuld's reluctance to sell on the cheap. He points out that Lehman's value is only around $8bn, little more than private-equity firms have injected into much smaller banks like Washington Mutual. 'There is an opportunity to take the company and break it up and make much, much more by selling off the parts.'

And he does not rule out trade buyers: while he thinks a bid from an investment banking rival such as Goldman Sachs or JP Morgan, busy dealing with their own problems from the global financial crisis, is unlikely, Japanese or Canadian banks could well be interested. Britain's HSBC could also be keen, as could a break-up specialist such as Lazard or Greenhill, which could orchestrate a consortium bid.

There is unlikely to be such an easy exit for two of the other biggest casualties of the housing slump and credit crunch: Fannie Mae and Freddie Mac, the giants that back around half of all American mortgages. While they cannot survive in their current form, deciding what to do about them is one of the biggest headaches facing US Treasury secretary Hank Paulson.

Bove points out that their combined debts, including off-balance sheet borrowings and conduits, are around $9 trillion - almost twice the $5.5 trillion of US public debt. It is, he says, an 'outrage' that they were allowed to get this big. He thinks their accounting failures - Freddie Mac admits that its accounts for the past two years cannot be relied on - make it as big a scandal as Enron.

Ken Murray, chief executive of fund manager Blue Planet, a specialist in financial services funds, thinks that Fannie Mae may be able to trade its way out of the crisis provided signs of a bottoming in the housing market prove sustainable. Freddie Mac's survival is 'more tenuous as it has less capital'.

Citigroup analyst Bradley Ball is even more optimistic: 'Our analysis ... shows that both [Fannie] and [Freddie] should have sufficient capital through [at least] year-end 2008... under a variety of negative credit scenarios ... all parties could wait it out until market conditions calm.'

That may also be Paulson's hope - and there was encouraging news last week when Freddie Mac managed to raise new finance through a bond issue, albeit that it had to pay a punitive interest rate to do so. Their size means that unravelling them will not be easy: the market has been waiting for Paulson's decision for weeks.

Until then, says Andrew Milligan, head of global strategy at Standard Life, it is hard to know how it will affect the market. 'Many questions can be asked about the implications of a Fannie and Freddie bailout for equity markets in general, and financial stocks in particular, or how it would affect US growth, inflation, the budget deficit, bond yields and currency.'

Among the options are an effective nationalisation, refinancing the debt or encouraging the companies to work through their problems. But, he adds: 'Under few of [the possible] scenarios, though, do Fannie and Freddie return to their former clout within the marketplace.'

Blue Planet's Murray thinks we are entering the third stage of the credit crunch - that of write-downs of the ongoing loan book - having got through the first two phases of liquidity crisis and suffering losses on the financial instruments that exacerbated the downward spiral. The problems of Lehman, Freddie and Fannie suggest that this phase will be at least as traumatic as the first two.

Lehman may be subject of 'all-Korean' bid
The state-backed Korean Development Bank (KDB) is understood to be scrambling to assemble a consortium of up to three domestic private-sector financial groups to pull-off an "all-Korean" buyout of Lehman Brothers.

The last minute dash to put together a credible group is thought to have been prompted by South Korea’s Financial Services Commission, whose chairman, when asked last week about the discussions between Lehman and KDB, said "generally speaking, the private sector should be the leader in such a deal".

Sources close to KDB told The Times that the group is struggling to assemble a workable consortium, as Korea’s troubled economy and huge levels of household debt make its banks look vulnerable. The weakening economy has combined with dwindling foreign exchange reserves to make the Korean government reluctant to bankroll KDB for the full amount that would be required to gain control of Lehman. Instead, the government is pushing for KDB to assert itself as the "managerial leader" of the grab for the prime Wall Street brand.

One lawyer close to the potential bid said that there was a "strong school of thought" within Korea’s Financial Services Commission that was pushing for the creation of a national investment banking champion. The Commission confirmed yesterday that KDB was considering a possible investment in Lehman, as well as other banks, but declined to give further details. Lehman declined to comment.

Many suspect that KDB and Lehman are able to maintain a constant dialogue on the subject of cash injections or stake-building because of close ties. Min Euoo-Sung, KDB’s governor was, until earlier this year, the chief executive of Lehman’s operations in Seoul.

But there appears to remain substantial resistance within the government to any bid being mulled by KDB: Lehman is still regarded by some in Korea as an acquisition with unknown risks and the government is unwilling to let anything jeopardise its planned privatisation of KDB.

A potential bid to buy Lehman is one of several possible outcomes for the Wall Street brokerage, which is dedicated to boosting its balance sheet after suffering billions of dollars of losses on mortgage-related investments. The group, which is forecast in mid-September to announce a further loss, of about $3.5 billion for the third quarter, is already in discussions with KDB about the Korean bank injecting several billion dollars into Lehman in return for a sizeable, but minority, stake.

The group may also sell its asset management division, which includes Neuberger Berman, the fund management business. Kohlberg, Kravis, Roberts and Bain Capital, the private equity firms, are seen as the favourites to acquire the unit, should a sale go ahead.

Furthermore, Lehman is sounding out potential buyers for $40 billion of troubled commercial mortgages and property on its balance sheet, as well as an alternative proposal to spin off those assets into a separate entity. In a bid to cut costs, the group is poised to cut a further 1,200 jobs, or about 5 per cent of its remaining workforce.

Bond prices drop amid fears of bank defaults on interest payments
Bank shares enjoyed a 15 per cent bounce last week but holders of their bonds were not so lucky. Prices of the riskiest bank bonds have continued to plunge as investors prepare for a wave of new bank issues or, at worst, defaults by the more fragile players.

The interest rate on the lowest grade, or tier one, bank debt widened to record levels late last week against the rate at which banks lend to each other. Banks now have to pay as much as 1.5 per cent above Libor (the London Interbank Offered Rate). Before the credit crunch, the differential was as low as 0.1 per cent.

Ben Lord, a member of the bond team at M&G, said in a blog last week: 'There is growing concern in the market about banks' ability and willingness to repay investors.' He points out that the prolonged credit crunch means banks are likely to have to raise more capital.

So far, banks worldwide have raised just 70 per cent of the $1 trillion that has been written off against toxic loans and other bad debts. Shareholders, who have supplied the bulk of that, are increasingly reluctant to provide more funds. 'Banks therefore look set to issue even more in the way of tier one paper, and the huge supply that seems set to come to market is causing prices to fall further,' wrote Lord.

The situation could worsen as regulators withdraw the support mechanisms that were introduced at the height of the financial crisis. Robert Talbut, the chief investment officer at Royal London Asset Management, points out that the Bank of England has confirmed it will withdraw its special liquidity scheme at the end of October, despite hopes that the scheme would have been renewed.

The European Central Bank is also considering tightening the collateral which it will permit under its scheme, given concern about the amount and quality of lending it is having to accept. While the rescue of Northern Rock and Bear Sterns in the US - where no losses were suffered by bondholders - had persuaded investors that these loans were ultra safe, the scale of the credit crunch means that view is history.

Jim Leavis, the head of retail and institutional fixed income at M&G, points out that the riskiest tier one bonds will often include provisions allowing defaults on interest payments if the equity dividend is passed - something a growing number of banks are doing.

That will be tested next month when interest on £200m Northern Rock tier one bonds is due to be paid. City investors fear the government will opt to scrap that payment, although neither it nor Northern Rock will comment.

Scramble for cash as central banks dry up
British banks soon could be scrambling for short-term funding once more amid reports that supplies from Threadneedle Street and from Frankfurt may be drying up. The Bank of England explicitly ruled out extending its Special Liquidity Scheme (SLS), while the European Central Bank is reportedly considering tightening its lending criteria.

The two central banks have been huge suppliers of liquidity to British banks. The SLS is thought to have provided £50 billion or more, while the ECB has lent banks €467 billion (£378 billion) - much of it thought to have gone to UK institutions. Despite pressure from some British banks for an extension, the SLS will be closed to new applications from the week of October 20, the Bank said.

UK banks have been campaigning for an extension to the scheme, under which the Bank provides banks with highly liquid government bonds in return for illiquid AAA-rated mortgage-backed securities. As recently as Friday, Rod Kent, the chairman of Bradford & Bingley, called the SLS “a good idea” and contrasted its temporary nature with the permanence of the ECB liquidity window.

The ECB declined to comment on reports that it would change its rules soon, accepting only higher-quality collateral from borrower banks in exchange for cash. At present it accepts securities with credit ratings as low as A-. It also accepts private securities - instruments created by the banks and not traded on any public market. Some ECB officials are concerned that it has become a “dumping ground” for inferior mortgage-backed securities, according to The Wall Street Journal.

The reform could come as early as Thursday, when the governing council meets and the ECB makes its monthly interest-rate decision. While money market conditions have improved modestly in the past few months, banks are still hoarding cash. Three-month sterling Libor has been trading at 5.75 per cent, three quarters of a per cent above base rate, indicating continuing stress in the money markets. Before the crunch the margin was 0.1 or 0.2 of a per cent.

Spain Entering Recession, Unemployment to Jump, Survey Shows
Spain is probably entering into a recession that will push the unemployment rate to a peak of 14 percent, as a slump in the housing market spreads through the rest of the economy, a survey of economists showed.

The chances of Spain's economy shrinking for two straight quarters by the end of next year increased to 67.5 percent from 50 percent a month ago, according to the median of 14 responses in a Bloomberg News survey. Eight of the 10 economists who forecast the start of the recession predicted it would begin in the third quarter of this year.

Spain, which grew faster than the euro-region for more than a decade on the back of a construction boom, expanded at the slowest pace since a 1993 recession in the second quarter as banks reined in lending and higher living costs eroded incomes. Retail sales have fallen for eight months and data today showed Spain's jobless ranks swelled for a fifth month in August.

Unemployment in Spain, which created half the euro- region's jobs between 2001 and 2006, will rise to a peak of 14 percent, a median forecast from the survey showed. Joblessness reached 10.4 percent in the second quarter. "It's very difficult to see a corrective medicine in the short-term," said David Owen, chief economist for developed markets at Dresdner Kleinwort in London, who says the Spanish economy may not expand for five years.

Banks have seen loan defaults rise while real estate companies have written down the value of their assets. Property developer Inmobiliaria Colonial SA reported a net loss of 2.38 billion euros ($3.5 billion) for the first half as it wrote down the value of property assets and a stake in a construction firm.

The Spanish government has forecast economic growth of 1.6 percent for this year, 1 percent for next, and aims to return to growth levels around 3 percent from 2010. Finance Minister Pedro Solbes has said he is not forecasting a recession, even after the euro-region economy contracted in the second quarter.

Banks scramble for Bank of England's liquidity cash
The City's embattled banks packaged up the biggest amount of mortgage debt in history last quarter, in a desperate scramble to gain access to the Bank of England's Special Liquidity Scheme.

Banks issued a record £45bn in mortgage-backed bonds in the three months to the end of June - more even than at the very height of the housing boom in 2006 - according to figures from the Bank for International Settlements.

The figures are the first official indication of the amount banks have had to borrow from the taxpayer in order to firm up their balance sheets. They also show that the Government's mortgage rescue operation, launched in April, was responsible for fuelling the biggest ever boom in these securities, which lay at the heart of the credit crisis.

The BIS said that the amount of mortgage-backed bonds issued rose from $8bn in the first quarter of 2008 to $90bn (around £45bn at the time) in the second quarter - the biggest amount ever.

The Quarterly Review added: "Most of the UK issuance followed the Bank of England's announcement in April 2008 of a Special Liquidity Scheme (SLS) that enables UK banks to swap illiquid assets such as mortgage-backed securities against UK Treasury bills."

Since the instruments cannot be sold on the open market, the Bank has had to intervene to ensure many of the UK financial institutions can stay afloat. The Bank has maintained that it will keep secret the extent to which banks are using the SLS until it has closed in October, although Governor Mervyn King originally anticipated that it may be used for £50bn.

However, Simon Ward of New Star said the BIS figures show that the scheme may have already lent out even more. He said: "When you add these new issuance figures to the amount of paper available previously - around £15bn - clearly we are already getting close, or even beyond, that £50bn estimate."

He said that although banks were unlikely to have used the entire $90bn for the SLS, the vast majority was likely to have been pumped into the rescue operation.

British house price slump worse than feared
The housing market may now be destined for an even sharper correction than in the early 1990s, economists warned following new figures revealing the scale of the property slump.

The number of new mortgages approved by lenders dropped in July to 33,000 - the lowest level on record and a 71pc drop from last year, according to Bank of England statistics. The numbers coincided with fresh evidence that the manufacturing sector is in recession.

However, economists warned that the figures would not necessarily prompt the Bank's Monetary Policy Committee to cut borrowing costs from their current level of 5pc this Thursday. The Bank's figures also revealed a pick-up in consumer credit, which may indicate that the most hard-pressed families are having to borrow more, or to curtail their debt repayments, as they struggle to keep their finances afloat.

Households' consumer credit, which includes credit card and overdraft debt, increased by £1.1bn in July, compared with £906m in June. Most of the increase was accounted for by overdrafts and other unsecured loans. The amount banks lent in mortgages rose slightly to £3.2bn in July, compared with £3.1bn in June. This is sharply down from the £9.4bn 12 months previously.

Matthew Sharratt, economist at Bank of America, said: "The data are still showing a very gloomy picture. There's no signs of a bottoming out in the housing market." A number of sources, including Halifax and Nationwide, have reported that house prices are now more than 10pc down on last year, with most economists now expecting them to fall even further in the coming months.

"Activity in the housing market continues to be depressed, and the approvals figures suggest this is likely to continue for some time," said Adrian Coles of the Building Societies Association. "Recent falls in house prices have been widely publicised, reducing potential buyers' confidence and keeping them out of the market."

For the second month in a row, building societies saw their total mortgage lending contract as customers paid back a net £79m. However, the housing market is not the economy's only weak point. Figures from Markit and the Chartered Institute of Purchasing and Supply showed yesterday that the manufacturing sector shrank for the fourth consecutive month in August.

The purchasing managers' index rose slightly to 45.9 last month, keeping it well below the 50-point which separates expansion from contraction. In a further threat to the Bank's inflation-targeting regime, the PMI also showed that manufacturers were demanding record price increases for their goods.

A report published this morning by business advisers BDO Stoy Hayward also shows that both short- and medium-term confidence among a broader collection of businesses has plummeted. The report found that companies were at their most pessimistic about the medium-term outlook since the dotcom crash. Short-term confidence, meanwhile, is at its lowest level for 17 years.

The vast majority of economists nevertheless expects the Bank's MPC to leave borrowing costs on hold this week. However, they see a 45pc chance of the Bank cutting interest rates before the end of the year.

UK recession will bring big rise in crime and race hatred, says Home Office
Ministers are bracing themselves for a rise in violent crime and burglaries and a shift to far-right extremism as the effects of the economic downturn take their toll, a leaked Home Office report to the Prime Minister says.

In a series of warnings, the Home Secretary, Jacqui Smith, says that Britain also faces a “significant increase” in alcohol and tobacco smuggling, hostility towards migrants and even a potential rise in the number of people joining terrorist groups.

Revenue raised from issuing new visas is also set to fall as people stop travelling, passport fees will drop and police funding will come under extreme pressure, according to a copy of the report, Responding to Economic Challenges, seen by The Times. Most Britons had only considered the effects on the economic downturn on their food, fuel and housing bills but Ms Smith’s revelations show that the credit crisis is likely to affect them in other, more sinister ways.

Based on models from the last recession in 1991-92, Ms Smith tells Gordon Brown that violent crime is set to grow at a rate of 19 per cent while theft and burglaries could rise by up to 7 per cent this year and 2 per cent in 2009. “Our modelling indicates that an economic downturn would place a significant upward pressure on acquisitive crime and therefore on overall crime figures,” Ms Smith says.

The report reveals that the Home Office has allocated £300 million for security for the 2012 Olympics and that there could also be a rise in people turning to extremist groups and racism because of “a real or perceived sense of disadvantage held by individuals”. The report added: “Grievances based on experiencing racism is one of the factors that can lead to people becoming terrorists”.

The report highlights Pakistani and Bangladeshi communities as those most vulnerable to such effects because of low employment rates and having the highest percentage of children living in households with income 60 per cent below the average. A tightening in the economy is also expected to bring a significant rise in fuel, alcohol and tobacco smuggling and illegal-working migrant numbers could swell as job opportunities fall.

A Home Office spokesman said that the department did not comment normally on leaked documents but the report was a draft advice on which the Home Secretary had not yet signed off. It had not been sent to No 10.

“It is, however, appropriate that the Home Office considers the effects the economic climate may have on crime and other policy areas. We are confident that we have the right systems in place to respond flexibly to changing economic needs, and are well positioned to face future challenges.”

Dominic Grieve, the Shadow Home Secretary, said the Home Office was “patently not equipped to cope”. “It is deeply disturbing that a department as shambolic as the Home Office already is facing such problems as a result of the economic downturn. “Now we see that the consequences of Gordon Brown’s complete mismanagement of the economy will not just hit hard-working families in the pocket but will also threaten their security and safety.”

Damian Green, the Shadow Immigration Minister, said that ministers needed to come clean on which operations at the Border Agency were under threat and suggested scrapping the identity card scheme immediately.

Darling accused of prompting crisis in confidence
Signs of a split at the top of government and the claim by the Chancellor, Alistair Darling, over the weekend that the economic times "are arguably the worst they've been in 60 years" sent sterling plunging to a record low against the euro and its feeblest showing against the US dollar in two years.

The value of a euro rose to 81.39p, its highest since the single currency was launched in 1999. Against the US dollar, the pound was down to just over $1.80, a level not seen in two years. Sterling has seen a depreciation of more than 12 per cent since last summer.

The widely expected announcement of government measures to help the housing market had little effect on sentiment anywhere. The Conservative leader, David Cameron, accused Mr Darling of provoking a "crisis of confidence" and accused him of "talking the economy down".

The markets delivered a harsh verdict on the increasing disarray over economic policy, and mounting evidence of the manly friction developing between Number 10 and Number 11 Downing Street, as rumours that the Chancellor may soon be sacked or resign persist.

An extension of state support for the mortgage market is only the latest in a series of flashpoints between Number 10 and the Treasury, including the abolition of the 10p tax rate, the idea of a "stamp duty holiday", using public money to finance the mortgage market, and underlying tensions surrounding "spin" form various quarters that Mr Darling was about to be replaced by Ed Balls, the Schools Secretary and long-term Brown amanuensis.

The Treasury and the Bank of England seem united in their hostility to any extension of the Bank's Special Liquidity Scheme from Number 10 to "kick start" the mortgage market with taxpayers' funds. The release of more weak economic data also disturbed the markets, as traders again marked up the chances of the Bank of England having to slash interest rates to rescue a badly faltering economy.

Shares fared little better than sterling. The FTSE 100 opened sharply lower, with a 34-point fall in the backwash of Mr Darling's forecast of a downturn "going to be more profound and long-lasting than people thought". Stocks fell further with the release of depressed figures on the housing market, manufacturing and exports. The index of leading shares stands 12 per cent down in the year.

Consumer stocks and the mortgage banks were especially badly hit by the latest figures on mortgage approvals from the Bank of England. The number of new home loans slumped again, to 33,000 in July, below analysts' expectations and down more than 70 per cent on last year.

Alan Clarke, UK economist at BNP Paribas, called them "painfully weak" and "consistent with house prices continuing to fall at close to, if not faster than, their recent pace". Activity in the housing market, especially among first-time buyers, seems set to slow further in the face of falling prices and tighter mortgage lending conditions.

Changes in stamp duty and local authorities purchasing unwanted properties or those in mortgage arrears may provide some impetus in the short term, said economists, but few observers expect such initiatives to provide significant support for house prices. Nor is the £60 per basic rate taxpayer "windfall" likely to help, given that it is mostly a reversal of a previous tax hike.

Meanwhile, even the weaker pound seen over the past few months seems to have provided only limited relief for exporters. The Chartered Institute for Purchasing and Supply's monthly poll of managers revealed that export orders contracted again in August after sinking to a six-year low in July. Overall, sentiment among manufacturing firms is marginally improved in August, but is still pointing to contraction.

Roy Ayliffe, director of professional practice at the Chartered Institute of Purchasing and Supply, commented: "Purchasing managers reported that the weak domestic market and inflationary rises added further pressures. Costs continued to surge on the back of high energy, food and fuel prices, while the weak sterling also pushed up the cost of imports. Jobs were axed for the fifth month in a row."

City of London braced for fresh round of banking job cuts
The city is bracing itself for a further redundancies as Commerzbank prepares to cut more than half its workforce at Dresdner Kleinwort's London operation in its takeover of its German rival. Commerzbank plans to slash up to 1,200 London jobs at Dresdner in businesses such as trading as well as in support functions. About 2,000 of Dresdner Kleinwort's 5,500 staff are employed in London.

Proprietary trading will be the first casualty, with the division set to be shut down by the risk-averse bosses of Commerzbank, who have revived the once-troubled lender by scaling back investment banking and focusing on retail and commercial banking. No decision has been made about Dresdner's equities business, which includes sales, trading and research.

City job cuts, however, have been relatively muted despite the credit crunch and the worsening economy. Financial institutions have cut more than 100,000 jobs worldwide since the start of the credit crisis but London job losses at individual banks have been mostly in the hundreds rather than the thousands.

The Centre for Economics & Business Research has predicted a fall of about 20,000 in financial services jobs this year and next as banks slash costs to offset the effects of massive write-downs and frozen markets. But analysts at JP Morgan have predicted up to 40,000 redundancies at financial firms, which would have a huge effect on the economy.

Britain relies disproportionately on the earnings of workers in the financial services sector for tax and spending on services. Jill Andrew, a consultant in the employment department at the law firm Dawson's, said: "Generally, I don't think we have seen the floodgates open yet. The problem is that most bankers do not have transferable skills and so job opportunities outside the City are very thin on the ground."

City sentiment turned negative in the first half of this year, with the majority of hiring managers believing the sector would be weaker in the next year, according to the recruiters Morgan McKinley. Rob Thesiger, the chief executive of Morgan McKinley's parent company, Imprint, said: "There is no doubt that uncertainty within London's financial services industry and, in turn, the City jobs market continues."

He added that although hiring had slowed down in certain businesses there were still shortages of skills in some areas. Commerzbank agreed to pay €8.8bn (£7.13bn) to Allianz, Germany's biggest insurer and Dresdner's owner, and will cut 9,000 of the combined group's 67,000 staff, but no compulsory redundancies will be made before 2011.

Dresdner Kleinwort's business in the City will be merged into Commerzbank's corporates and markets division, which focuses on doing business for German clients. Dresdner Kleinwort had tried to compete as an international investment bank, acting as a corporate broker for companies in the UK. It recently jointly underwrote Bradford & Bingley's failed £455m rights issue.

The first senior casualty of the deal was announced yesterday: Stefan Jentzsch, Dresdner Kleinwort's chief executive, is to step down at the end of the first phase of the acquisition early next year. Dresdner Kleinwort has had a rocky ride since Dresdner Bank bought Kleinwort Benson, one of the City's oldest merchant banks, in 1995.

It bought Wasserstein Perella, the merger advice firm headed by the US dealmaker Bruce Wasserstein, in 2000. But after adding Mr Wasserstein's name to the bank he quit the following year. In 2001, Allianz bought Dresdner Bank but its hopes for combining banking and insurance never paid off.

The 222-year-old Kleinwort Benson name could survive in the form of Dresdner Kleinwort's private banking operation. Commerzbank has not yet decided what to do with that business. The deal proved unpopular yesterday with Commerzbank's investors, who sent the bank's shares down 10 per cent.

Will $7 billion debt plunge Korean won into crisis?
A seemingly insignificant event -- the maturing of $7 billion worth of foreign holdings of South Korean bonds this month -- is threatening to plunge the north Asian country into a full-blown currency crisis. The amount itself is tiny, under 3 percent of South Korea's $247 billion in currency reserves.

But the government debt is maturing at a crucial time. The won is already extremely weak, there is growing speculation that the Korean authorities have dropped their defence of the currency and simmering rumours that the government holds huge amounts of worthless U.S. agency debt.

Suddenly, the issue of a small amount of maturing bonds has transcended into more complex fears about the central bank's credibility and ability to defend its currency. As the won plunged 3 percent to 4-year lows on Monday, it appeared the damage had already been done.

The market buzz was capital flight. The stock market fell 4 percent. "It's not a great deal, but it is the trigger effect," said State Street strategist Dwyfor Evans, referring to the maturing bonds. "If people think money will be taken out of the country, it will inspire them to put on short Korea positions.

"Then there are technical levels, stop-loss levels and, before you know it, there's a momentum to the whole move driven primarily by speculation over the maturing bonds." But economists place the blame for letting the situation deteriorate to such an extent squarely on foreign exchange authorities, which in South Korea's case is both the finance ministry and the Bank of Korea.

Until August, their steadfast intervention had convinced market players that the won will not be allowed to decline past the 1,050 mark per dollar at any cost. The Bank of Korea is estimated to have spent about $10 billion defending the won in July, and double that amount if the drop in its forward positions is also taken into account.

But, in early August, the government hinted it may not intervene that aggressively. That spurred speculators into thinking the authorities will let the won weaken, either because they want a buffer for their exports or because they are loath to spend more of their reserves.

As Korean bonds, stocks and the won tumbled on Monday, the situation was an uncomfortable reminder of the capital flight seen in the 1997/1998 Asian financial crisis when the won plunged to near 1,900 a dollar from near 900 -- losing half its value.

"They have to do what they did in early July," said ING Bank economist Tim Condon. Nothing else but heavy-handed intervention would work at this point, he said "The last thing they need now is a disorderly decline in the currency. There is no upper limit on dollar/won and investors can get unnerved."

But the reasons for the central bank's indifference to the won's decline through August remain a mystery. The won is already Asia's weakest currency this year, having lost 16 percent of its value against the dollar so far. South Korean exporters are faring relatively better than their competitors in Singapore and Taiwan, with exports expanding at a pace above 20 percent from year-earlier levels.

Although the trade account has been widening since the start of this year, that by itself provides no justification for a run on the won. The question then becomes how liquid the government really is. Korea's short-term debt is high, at $222 billion, but 40 percent of that is debt owed by local branches of foreign banks.

There have been heavy outflows. Foreigners have sold a net $23 billion of Korean equities this year. But the bond market remains an attractive trade for foreigners, with yields at nearly 6 percent even at the short end. The scary possibility that investors will flee the country in droves had not seemed real.

Until Monday, that is, when the central bank's seeming reluctance to support the won transcended into panic-like concerns over liquidity and faith in the won. "There doesn't seem to be any love for Korea at all at the moment," said Evans "We've got the potential to unwind a lot of the secular bull run that we've seen in these Asian currencies all of this decade and it looks as if Korea is at the fore of all the countries and currencies that are at risk."

Ilargi: How about this for a sign of the times? Marc Faber of "Gloom, Boom and Doom" is becoming a mainstream media go-to guy.

Faber, along with the likes of George Soros, is one of a list of rich investors who saw the US collapse coming, and left the country because of it in the past decade.

Oil to Extend Drop With U.S. in Recession, Faber Says
Oil will likely drop further in the next three to six months, according to investor Marc Faber, who reiterated his forecast that the second half of 2008 won't be "favorable" for commodities.

The decline in crude, which today slid to a five-month low, is a "symptom" of economic slowdowns in the U.S. and Europe, Faber, who forecast the so-called Black Monday crash in 1987, said in an interview with Bloomberg Television from Bangkok.

"In the U.S., if statistics were compiled properly, the economy would be in recession. Same in Europe," said Faber, 62. "Oil coming down is a symptom of economic weakness." Crude oil for October delivery fell as low as $105.46 a barrel today, down 8.7 percent from the close of Aug. 29 on the New York Mercantile Exchange and the lowest level since April 4.

Faber said he favors shares of AMR Corp., American Airlines' parent company, even if the air carrier is "disastrous." The stock's 54 percent slump in 2007 and this year's 26 percent slide makes AMR appealing, he said.

The publisher of the "Gloom, Boom and Doom Report" newsletter also said investors expecting a "strong stock market" in Thailand will be disappointed. The country's SET Index dropped to a 19-month low today after Prime Minister Samak Sundaravej declared a state of emergency following clashes between pro- and anti-government demonstrators.

"People simply have to understand Thailand is essentially a political mess," he said. "The economy is not very dynamic and it will continue to kind of move ahead slowly. These people looking for a strong stock market, I think that will be misplaced."

Ilargi: Earlier today, the Thai army refused to act against the protesters who insist Samak leave. Thailand is so corrupt it's hard not to laugh.

Thai Baht, Stocks Slump; Samak Imposes Emergency Rule
Thailand's baht fell to the lowest level in more than a year and stocks dropped to a 19-month low after Prime Minister Samak Sundaravej declared a state of emergency. Government bonds fell, reversing an earlier advance.

The currency extended last month's 2.1 percent decline after clashes in Bangkok between thousands of pro- and anti-government demonstrators left one dead and 43 injured. The People's Alliance for Democracy, a group seeking Samak's resignation, has occupied Government House, where the prime minister's office is located, since Aug. 26.

"People simply have to understand Thailand is essentially a political mess," investor Marc Faber, who forecast the so-called Black Monday crash in 1987, said in an interview with Bloomberg Television from Bangkok. "The economy is not very dynamic and it will continue to kind of move ahead slowly. These people looking for a strong stock market, I think that will be misplaced."

Protests escalated in the past week, raising concerns that parliament may be dissolved, paralyzing government policies for boosting economic growth. Finance Minister Surapong Suebwonglee said last week growth may ease to 5.5 percent in the second half of the year because of a slowdown in exports. The economy grew 5.7 percent in the first half, a state agency said Aug. 25.

The benchmark SET Index fell 2.3 percent to 659.51 at the close today, the lowest since Feb. 1, 2007. It was the steepest decline since July 16. The baht fell 0.5 percent to 34.50 against the dollar in Bangkok, according to data compiled by Bloomberg.

"This is not helping the Thai baht," said Thomas Harr, a senior currency strategist at Standard Chartered Plc in Singapore. "We are short the Thai baht. Dissolution of the Thai parliament is the most likely scenario." The central bank has "intervened" to support the baht, Deputy Governor Atchana Waiquamdee said in Bangkok today. "We took care of the currency this morning because it fell a lot," she said. "We need to curb the volatility."

The events of the "past two weeks have raised the probability of a negative action on the sovereign credit ratings," of Thailand, Standard & Poor's credit analyst Kim Eng Tan said in report today. The debt is rated BBB+, the eighth highest investment rating, with a stable outlook.

"Economic growth could fall markedly as domestic demand weakens further," S&P said. "Inbound tourism and foreign direct investment would also decline. Even as revenue is expected to fall in this scenario, pressures for spending will increase."
Overseas investors sold $3.1 billion more Thai stocks than they bought this year, according to data compiled by Bloomberg.

Fed's Hoenig Says Institutions Must Be Allowed to 'Fail'
Federal Reserve Bank of Kansas City President Thomas Hoenig said for economies to work best, institutions must be allowed to `fail.' Economies must "find a balance between financial stability and a stable price environment and in doing so must be able to allow individual institutions to fail," Hoenig said in a speech today in Buenos Aires.

Turmoil in financial markets has persisted, even after the Fed started and expanded emergency programs to lend to commercial and investment banks. Changes in financial markets combined with the subprime-mortgage crisis have "raised anew questions about the role of central banks in maintaining financial stability," he said.

The subprime-mortgage collapse has taken a toll on banks and other financial companies, which have reported $514 billion of writedowns since the start of 2007. The Fed rescued Bear Stearns Cos. from bankruptcy in March, facilitating the firm's merger with JPMorgan Chase & Co. by lending against $29 billion of Bear securities.

"Financial crises will occur despite our best efforts to prevent them," Hoenig said in prepared remarks at an event hosted by Argentina's central bank. "The `Too Big to Fail' issue will only grow in importance as the consolidation of the financial industry grows in both size and scope in future decades." Hoenig didn't comment on the U.S. economic outlook or monetary policy in his remarks.

About 463,000 Americans have lost jobs since January as the worst housing recession in a quarter century has curtailed spending and bank lending. Economists expect annualized rates of growth of 1 percent in the third quarter and 0.4 percent in the fourth quarter, according to the median estimate in a Bloomberg Survey in early August.

Earlier today, Federal Reserve Governor Randall Kroszner said the U.S. housing slump and financial turmoil have rippled to global emerging markets, slowing growth and bringing stock market declines. The Fed said Aug. 11 in a quarterly survey that more banks tightened lending for homes, small businesses and credit cards. About 75 percent of U.S. banks indicated they raised standards on prime mortgage loans, up from 60 percent in the previous survey, the central bank said.

Federal Reserve Chairman Ben S. Bernanke said on Aug. 22 that financial turmoil has "not yet subsided," and is contributing to weaker economic growth and higher unemployment. Policy makers will "continue to review" the Fed's measures to ensure liquidity to determine "if they are having their intended effects," Bernanke said.

Hoenig, 61, dissented from a rate cut on Oct. 31 because of inflation concerns. Hoenig doesn't vote this year and will vote next in 2010. Dallas Fed President Richard Fisher has dissented from Federal Open Market Committee votes five times this year, preferring to raise interest rates last month.

Bonds can pay off, but not if there's a top-10 bank crash
Equity investors are not alone in closely monitoring the performance of banks: the fate of bond fund managers is also closely linked to how these financial institutions will fare over the next six months or so.

Opinions between fund managers vary sharply. Indeed, the level of exposure to banks has been a key determinant of bond-fund performance: those who decided that the US Federal Reserve's rescue of Bear Sterns in March marked the nadir for bank bonds and duly piled in have done badly.

After a brief fillip, prices continued to fall, while funds such as M&G's European Corporate Bond fund, which have resisted the temptation to buy bonds, have had a good year. Opinions on banks still vary wildly. Managers such as James Foster at Artemis and Nick Hayes at New Star think bank bonds are 'cheap and attractive'.

Cheap they certainly are: the yield on the bonds issued by some of our biggest banks is as high as 12 per cent, a level usually associated with basket-case companies poised to default. Yet, as Hayes points out, shareholders in Bear Sterns and Northern Rock may have lost their shirts when they were rescued by the US and UK governments, but bond holders have continued to receive their payments and, barring a global meltdown, should have their capital repaid when it falls due.

However, a couple of weeks ago, Kenneth Rogoff, a former chief economist at the International Monetary Fund, warned that the bad news was far from over. He predicted that a banking 'whopper' - a large investment or commercial bank - would go under within a few months. And the risk is growing that US home-loan giants Fannie Mae and Freddie Mac will effectively be nationalised.

Jim Leaviss, head of retail and institutional fixed interest at M&G, says that if a top-10 bank fails, the poor state of many governments' finances means they may not be able to keep on organising rescues: 'They can do it once or twice, but they can't keep on doing it.'

He also believes that the banks' own performances could deteriorate further, even though many are already suffering losses: 'The banks have got into this state before we are even in a recession. By the year-end, all industrial economies could be in or nearing recession, so banks' customers will start defaulting.'

Leaviss also questions the conventional wisdom that bank bonds are immune from default, pointing out that there are at least three layers of bonds, and that while the first two may be secure, the third layer often have clauses allowing a suspension of interest payments if, for example, the bank stops paying a dividend.

Over at Artemis, Foster thinks the price falls that have already affected bank bonds could spread to other industries. He points out that there have been few new issues so far, but that fund-raisings are likely to rise as banks cut back on the facilities they offer to corporate clients. 'When they do come, companies will be shocked at the price we [bond investors] will charge,' he adds.

These high rates will feed through to existing bonds, causing their prices to fall, which Foster says has already happened in the US after new issues such as that by insurer AIG. Foster is wary about predicting how long the uncertainty will last - 'I expect at least six months more' - and thinks that funds that can only buy corporate bonds will be in an uncomfortable place. His own strategic bond fund can buy a mix of assets - it has 10 per cent in government bonds and a further 50 per cent in investment-grade or highest-quality bonds, most of which are banks.

Leaviss also prefers government bonds, which have recovered sharply as investors have begun to bet that the inflationary spike could be ending as oil prices start to fall. John Pattullo, bond fund manager at Henderson, agrees: 'The market thinks inflation will peak next month or the month after. That means interest rates could start to fall, and that is good for bonds.'

Bond funds are offering decent yields at the moment - M&G's European Corporate Bond fund is offering a conservative 4.15 per cent, but Artemis's Strategic Bond offers almost 7 per cent, while New Star's High Yield Bond is over 8 per cent. Tim Cockerill, head of research at Rowan, likes the New Star corporate bond fund as well as Invesco Perpetual's corporate bond fund and says that, on a 12-month view, these may be producing good returns.

But if Leaviss and Foster are right, the capital value of these funds could fall further and, with many building society accounts offering more than 6 per cent, it may be too early to invest. Bond fund managers may think inflation has peaked, but that does not mean it has gone away. After years in which prices of everything from milk to microwaves have fallen, it may be time to come to terms with paying more for basic commodities.

Companies, too, are facing higher costs, which could mean lower profits and therefore lower returns for investors. Aruna Karunathilake, manager of Fidelity's UK Aggressive fund, has identified companies that could benefit from rising prices, and others that are insulated from their effects.

His largest holding is in Royal Dutch Shell - an obvious beneficiary of high oil prices - but he also looks for companies that will benefit indirectly, such as German fertiliser producer K&S. Some companies are effectively immune from price pressure, such as National Grid, whose regulatory regime means that its own revenues are linked to inflation, while others, such as Tesco, are able to pass on price rises to customers.

Hedge Funds Are Caught in a Tight Spot
Some of the biggest hedge funds are having their worst years, and the flood of new money going into funds has slowed. That is pressuring an industry bracing for investor withdrawals and worrying about how to survive without lucrative performance fees.

Some investors willing to put new money in funds are even beginning to ask about better terms, a contrast to the situation just last year, when investors needed to beg to get into hot funds.

Big funds run by star investors, such as Steve Mandel's Lone Pine Capital, Dinakar Singh's TPG-Axon Capital Management, Tim Barakett's Atticus Capital and Tom Steyer's Farralon Capital, have lost between 7% and 25% so far this year, investors say. Ken Griffin's biggest fund at Citadel Investments is down 6% this year, its worst performance in 14 years.

Overall, hedge funds -- private partnerships that invest money for wealthy investors and institutions -- are having their worst year since at least 1990, the year that Hedge Fund Research Inc. began tracking the data. The average fund lost 3.43% this year through July, faring better than the decline of 12.65% in the Standard & Poor's 500 but below the gain of 1.05% in the Lehman Brothers bond index. August data haven't been calculated yet.

"You would think that investors would view hedge funds as having a good relative year, but my strong sense, however, is that most people are not pleased," says Reid Bernstein, who runs OneCapital Management Partners, a New York firm that invests in hedge funds. "Down is down and as the saying goes, you can't eat relative returns."

Many funds have a Sept. 30 deadline by which investors need to give notice for year-end withdrawals. Investors themselves are concerned about what other investors might do, and some are considering pulling out of funds just to make sure they do it before their rivals. Recent memories of some high-profile hedge-fund blow-ups add to investors' anxieties.

The $1.9 trillion hedge-fund business received just $30 billion of net new money through the first two quarters, compared with $119 billion for the same period last year.

"The flow of capital into hedge funds has slowed," says Jack Inglis, chief executive officer of Ferox Capital Management, a $3 billion London hedge-fund firm, which says it has seen more money come in than leave this year despite losses in one of its two key funds. "There's clearly greater uncertainty about investment flows to the industry for rest of the year."

Even so, the industry is far from imploding. For many funds, losses come after years of heady returns. Large firms increasingly operate several hedge funds, much like a mutual-fund company, and some are proving big winners.

Two funds run by Mr. Griffin, for example, are up more than 20%. And for all their grumbling, many hedge-fund investors may be more likely to dump poorly performing funds and shift money to funds with better prospects, rather than pull out of the business entirely, in part because hedge funds continue to best the market. But because of the economics of hedge funds, it can be tough for some funds to stay in business if they're down too far for too long.

In exchange for a cut of trading profits that usually amounts to at least 20% of all gains, hedge funds generally promise their investors that they will recover any losses before they begin to take their share. So a fund that loses 10% won't be able to reap profits beyond a management fee until it recovers that loss, called a "high-water mark."

The problem is many funds pay their employees hefty bonuses out of that performance fee, so top analysts and traders may leave if they don't see a prospect of a big bonus for years to come. Also, it has become harder for some funds to borrow money on easy terms, limiting funds' ability to rack up impressive gains.

Deutsche Börse under siege from hedge funds
Deutsche Börse came under siege from activist shareholders for the second time in four years today as Atticus and TCI demanded that the German exchange operator take urgent action to improve shareholder value and threatened to call for senior heads to roll.

The move by the two powerful hedge funds, which together own 19 per cent of the Frankfurt-based börse, marks a repeat of their successful campaign in 2004 to derail its bid for the London Stock Exchange (LSE). The two funds forced Deutsche Börse to scrap its £1.3 billion bid for the LSE and forced Werner Seifert, then chief executive, out of his job.

The campaign sent a shock wave through German corporate culture and contributed to the revulsion expressed among certain political figures towards hedge funds and private equity, with the two firms and their peers nicknamed "locusts".

Today's renewed assault on the exchange, which also subsequently failed in a bid to buy the pan-European exchange Euronext, puts Kurt Viermetz, chairman of the supervisory board, under pressure. In a joint statement, TCI and Atticus said they would explore all options to improve the Deutsche Börse's ability to create shareholder value.

"This may include seeking to change some of the members of the supervisory board in order to ensure leadership and urgency regarding any appropriate action," they said. BaFin, Germany's financial regulator, would be informed of their position, they said, stressing that they retained the right to raise or cut their holdings.

Deutsche Börse operates the Frankfurt Stock Exchange and the derivatives platform Eurex. It also owns Clearstream, the clearing and settlement network for trades. This ownership has been criticised on monopoly grounds in the past. Its shares have fallen more than half since last December, in part because of the threat of competition from upstart rivals including Chi-X and Turquoise.

Deutsche Börse declined to comment specifically on TCI and Atticus. "However the company is in general in permanent dialogue with all of its shareholders," it said. It added that the exchange's supervisory board was up for re-election next May and that Mr Viermetz had already instructed a comission to seek potential candidates. "Additionally, all shareholders have the right to also make their own proposals for candidates," it said.

HSBC says super-rich clients moving into cash
Many of the world's wealthiest people have moved their money out of stocks and bonds and into cash, the head of HSBC's Swiss private banking unit said on Monday.

"The first half of 2008 has seen a notable change in client expectations and investment choices," said Peter Braunwalder, chief executive of HSBC Private Bank (Suisse), the British-based bank's main affiliate catering to the ultra-rich.

"Faced with inflation worries, volatile asset prices and sudden changes in exchange rates, a majority of investors have reduced their transaction volumes in equities, bonds, and structured products," he told a news briefing in Geneva.

This was particularly true for clients from Asia, whose demand for complex investment tools such as equity derivatives has "drastically decreased" in response to recent financial market upheaval, said Braunwalder.
"Concurrently, most clients increased their cash allocation and, for some, their leverage," he added.

Investors worldwide have been scrambling to find a safe place for their savings this year in the face of a global economic slowdown, a credit crisis that has spooked markets, and an energy price spike spurring concerns about inflation.

Alexandre Zeller, who will replace Braunwalder as HSBC Private Bank (Suisse) chief on October 1, said that concerns about inflation would dominate many investing decisions ahead. "My worry is that a lot of liquidity has been injected in the markets by central banks to solve the (credit) crisis," the former head of Banque Cantonale Vaudoise said, raising concerns about how that liquidity will be removed from the market, and whether interest rates would have to rise as a result.

HSBC Private Bank (Suisse), rated AA by Standard and Poor's and Aa3 by Moody's, has been more shielded from recent banking sector woes than its larger Swiss rivals UBS and Credit Suisse. But the Geneva-based bank said the first six months of 2008 were necessarily arduous in light of "the most difficult financial markets for several decades".

"Record levels of volatility across asset classes and markets have made clients more hesitant to move their assets between financial institutions," it said. Assets under management decreased by 13 percent to 23.8 billion Swiss francs ($21.7 billion) compared to December 2007, due both to unfavorable markets and the drop of the U.S. dollar against the Swiss franc.

Net new money flows were 6.9 billion francs in the first half, with most funds coming from Europe, the Middle East, and Asia, the HSBC unit reported. Zeller said he considered that inflow "substantial" and stood by the bank's goal to grow assets under management by 60 percent over the next three years. "I think this is something that we can achieve," he said.

Ilargi: Mish borrowed a 'nice' set of graphs. Trendlines are fortune tellers....

When Will Southern California Home Prices Bottom?
Were the Kuznets Cycle to confirm to past patterns, real median CA house prices will not again return to the '04-'06 levels for another 15-20 yrs., if then given the longer-term demographic profile, normalized lending standards, and likely slower real GDP growth trend (2% vs. 3-3.5%).

Seen another way, nominal SoCal median house prices will not bottom until prices return to the '99-'01 levels, implying another 20-30% avg. decline in prices hereafter; but even then nominal prices will likely not rise more than inflation for many years thereafter.

By the early to mid-'10s, CA mortgagees will have made no money in real terms on their real estate purchases for ~15-30 yrs. (worse when counting home-equity loans).

Cumulative Real Changes Of Southern California Median Home Prices

Real Annual Change Of Southern California Median Home Prices

California enters uncharted territory with no budget
As the Legislature lurched to its close Sunday with no budget in place, California toppled its own record for fiscal dysfunction. Never in recent memory has August ended without a spending plan, so the state is now thrust into uncharted territory.

Gov. Arnold Schwarzenegger's administration has been busily preparing a blueprint for keeping the state afloat through the fall. The governor told Fresno Bee editors last week that he would wait until winter to sign spending bills into law, if necessary, to get what he considers a decent budget.

That means one with a mechanism to limit future spending, with temporary taxes to help wipe out the state's $15.2 billion in red ink and without the multibillion-dollar borrowing from local government and transportation accounts that some lawmakers appear to favor.

Others in the Capitol say the stalemate may indeed last into next year, leaving the incoming class of legislators, many of whom will be rookies elected in November, to solve the problem. Meanwhile, hospitals, community colleges, day-care centers and other facilities dependent on state funds go without the money they need to operate.

"There is no victory for anybody when we . . . come into Monday and have no budget," said Mike Villines of Clovis, leader of the Assembly's Republicans. "I don't think Californians are sympathetic." With the deadline for legislative business passed, lawmakers can no longer work on regular lawmaking. But they will still be tethered to Sacramento as they wait for their leaders to strike a budget deal.

The past record for state budget delay was set in 2002, when Gray Davis was governor and the Legislature did not pass a spending plan until Aug. 31 -- the final day of its session. At the core of that impasse was a dispute over taxes. The same is true now, 63 days into the current fiscal year. The governor's office held a meeting last week with two former state finance directors and former Senate Republican Leader Jim Brulte, seeking advice on how to make it to November or beyond without a budget.

The group, according to some participants, discussed the state's options for getting cash once it runs out in a month or so; whether the governor has the authority to release emergency funds to health clinics and other programs; and how California will be able to repay arrears on state services once a spending plan is finally in place.

In the case of some large education and health expenditures, the state cannot make cuts retroactively. So some reductions that lawmakers hope to make to save money would apply only to the portion of the year when a budget is in place. Administration officials say the costs of delaying such reductions, together with the costs of securing short-term loans to keep the state solvent, could add as much as $1 billion to the budget shortfall if the impasse drags through the fall.

Meanwhile, the arguments continue. Republicans unveiled a plan Saturday that would rely on borrowing against the lottery and on deep program cuts. A vote on their proposal is expected soon, though it has no support from Democrats. "There is no doubt in my mind that the silent majority does not want taxes," Villines said.

Democrats and the governor say closing the budget gap without new levies would cripple state services. Republicans blocked the latest proposal that included them -- along with the spending restraints promoted by the governor -- in the state Senate on Friday. "We compromised more than we thought prudent," said Senate President Pro Tem Don Perata (D-Oakland). "We are done."

According to people involved in confidential budget talks, Democrats in the Assembly have been looking for ways to raise taxes without Republican votes. California requires a two-thirds majority to pass a budget or raise levies; in the existing Legislature, that means two GOP votes in the Senate and six in the Assembly.

Assembly staffers have been scurrying to find loopholes that might permit a tax hike on a simple majority vote, said those involved in the negotiations. One proposal would have the effect of increasing sales taxes by eliminating a tax cut put in place several years ago. Legislative lawyers have suggested the plan could be approved without Republican votes. But it would almost certainly wind up in court. Anti-tax activists hold the two-thirds vote requirement sacred.

As the standoff continued, some Californians had already begun paying the price. Earlier in the summer, checks stopped going to thousands of healthcare clinics, nursing homes, child care facilities and other providers of government services. The longer the delay, the more dire their situation.

By the end of September, according to state Controller John Chiang, $12 billion in payments will not have been made. "We had to suspend our payroll for the last week of August to all our staff and providers," said Amparo Ortiz, administrator of Casa Healthcare, which provides care for developmentally disabled children.

The state already has missed $250,000 in payments to her, and she is borrowing from friends and relatives. Her staffers earn the state minimum wage of $8 an hour and do not have savings to fall back on. "What are we to do? Where do we turn?" Ortiz asked. "If we take out loans, the interest rates will kill us, not to mention all the late charges we are going to receive for our mortgages we don't pay on time."

Deficit looms for California's unemployment benefit fund
With joblessness at a 12-year high and expected to head higher, California's fund for paying unemployment benefits is about to go broke. The fund, sustained mainly by taxes on employers, is projected to be deeply in the red as soon as March.

And the administration of Gov. Arnold Schwarzenegger is alarmed that it may have to keep the fund afloat by borrowing from the federal government and using state money to pay nearly $100 million in interest over two years. At stake is the stability of a 73-year-old program that began during the Depression. In July, California paid unemployment benefits worth $567.4 million and received 267,000 new claims for jobless benefits.

Under the program, eligible workers can receive maximum benefits of $450 a week, depending on their previous earnings. Benefits last as long as 26 weeks, and many out-of-work people can qualify for a 13-week extension, recently approved by Congress.

Unemployment checks won't bounce, even if the fund goes bust, the Employment Development Department says. But labor experts warn that growing deficits could prove costly to employers, workers and the state. According to the latest projections, which already appear optimistic, the hole in the fund could exceed $1.6 billion at the end of 2009 and $3.5 billion by December 2010 -- unless the economy turns around dramatically.

A threat to unemployment benefits is frightening, said John Menou, a union bricklayer from Corona, who's been out of work sporadically because of the drop-off in construction. "I can't believe it's going to be in the red. That's terrible," he said. "There are a lot of people who don't get on unemployment until they really need it."

Right now, the fund is out of whack, said Todd Bland, a labor issues specialist at the nonpartisan California legislative analyst's office. "The current system of benefits and revenues cannot be sustained over future business cycles." But a long-term fix will require the support of business and labor unions and could involve hiking taxes on employers, cutting benefits, tightening eligibility for workers or some combination thereof.

Policymakers have been reluctant to do any of those since facing a similar but smaller unemployment cash crunch four years ago. They ducked a decision because the fund's reserve began to grow in 2005, as the state recovered from the dot-com bust at the decade's start.

Negotiations on a long-term fix stalled once the economy turned around, said Robert Callahan, a lobbyist with the California Chamber of Commerce. "Rather than addressing the problem, it got put on the back burner," he said. "But this time, we don't anticipate having that good luck."

At the moment, little is being done to bolster the unemployment fund. Administrators at the Employment Development Department acknowledge that their system for financing benefits, unchanged for three decades, is outdated. The head of the program, Deborah Bronow, said her department was modeling various solutions and briefing legislators and their staffs as well as business and labor union lobbyists about the severity of the situation.

"What we've always consistently said is that the fund would eventually go broke," Bronow said. Don't expect a quick solution. Schwarzenegger is bogged down with the bigger problem of trying to pass a two-month-late state budget, and no negotiations are expected before next year. Avoiding insolvency in the unemployment fund will be an administration priority early in the 2009 legislative session, said Camille Anderson, a spokeswoman for the governor.

Passing any bailout plan won't be easy. Both political parties and business and labor interests must compromise. What's more, a two-thirds "supermajority" vote of the Legislature would be needed to approve any tax increase. That would mean some Republicans in the state Assembly and Senate would have to violate pledges to "vote against any and all efforts to increase taxes."

Business lobbyists are interested in reducing benefits and tightening eligibility. "Increasing taxes is not the answer," said Michael Shaw, legislative director of the National Federation of Independent Businesses, which represents 35,000 small companies in California.

One reason the fund got into trouble, he said, was the Legislature's approval of a 2001 bill that nearly doubled weekly benefits, making them the 12th-highest in the nation.

Labor advocates, however, are pushing for a tax increase. California, they note, taxes employers only on the first $7,000 of a worker's annual pay. That is the minimum allowed by federal law and far less than what's collected by 44 other states, the District of Columbia and the U.S. Virgin Islands.

The idea of reducing the level of unemployment payments angers organized labor. "Cutting benefits in the middle of a recession would be economically devastating," said Angie Wei, a lobbyist for the California Federation of Labor. "It would be politically stupid, and we will not stand for it."

Persian Gulf Countries Heading For Food Crisis
The oil-rich Persian Gulf states are making a headlong rush for farmland.  Most of these countries heavily rely on food imports at a time when global food prices surged 57% between Aprils 2007 to 2008, according to the United Nations. With food riots breaking out in impoverished countries, as well as rationing in industrialized nations such as the U.S., the Persian Gulf states have made food availability a high priority.

A report by the Gulf Research Center [GRC] revealed that Saudi Arabia is the largest Arab food importer in the Gulf Cooperation Council [GCC], followed by the United Arab Emirates and Kuwait. In 2007, total GCC food imports hit US$10 billion, US$3 billion of which accrued to the UAE.  Other GCC members include Bahrain, Kuwait, Oman, Qatar and the UAE.

The GCC states are especially susceptible to food shortages. Arid landscapes and of course water shortages make it difficult for them to grow their own crops. The GCC imports approximately 60% of its food. Worse, the total population of GCC members rose from around 30 million in 2000 to more than 35 million in 2006.

This numbers is expected to hit nearly 39 million by 2010 and 58 million by 2030, according to a Dubai-based Gulf Research Centre [GRC] report.

A regional food crisis is more fact than fiction. Only 1% of land in the UAE is arable, while in Saudi Arabia portion of arable land stands at about 3%. By comparison, 18% of the land in the U.S. is arable while the U.K. stands at 24%. For investors, this international land grab by the GCC could provide secondary investment opportunities in industries such as fertilizer, farm equipment and shipping. However, the clock is ticking….

It won’t be long before it becomes harder to secure farmlands in Africa, India, the Middle East and even Eastern Europe. The GCC is already engaged in bidding wars with China and private hedge funds. To leverage its natural resources, the GCC states could find themselves trading oil for food.

For example, Indian External Affairs Minister Pranab Mukherjee told the Emirates Center for Strategic Studies and Research last month, “I see India’s requirement for energy security and that of the Gulf countries for food security as opportunities that can be leveraged to mutual advantage.”

As part of this trend, Pakinstan’s Prime Minister Yousaf Gillani’s visit to Saudi Arabia in sought $6 billion in financial and oil aid in return for hundreds of thousands of acres of agricultural land, which could be used by the Saudis. Such arrangements are likely to become commonplace in mutually beneficial deals to close the gap between rising energy and food prices between the richest and poorest nations.

The GCC countries are increasingly receptive to such arrangements. It gives them a chance to import food at 20% to 25% less than the open market, addressing their own domestic inflationary pressures. Investors now face a new horizon of agricultural opportunities.

Countries that were once too poor to bring state-of-the-art farming into their countries suddenly receive a cash infusion to buy new equipment and supplies. It’s also very possible that the timing could be ideal. If you believe that the corn-based ethanol bubble will puncture a big hole in agricultural spending, the GCC may pick up the slack.

Dutch withdraw spy from Iran because of 'impending US attack'
According to reports in the newspaper De Telegraaf, the country's intelligence service, the AIVD, has stopped an espionage operation aimed at infiltration and sabotage of the weapons industry in Iran. "The operation, described as extremely successful, was halted recently in connection with plans for an impending US air attack on Iran," said the report.

"Targets would also be bombed which were connected with the Dutch espionage action." "Well placed" sources told the paper that a top agent had been recalled recently "because the US was thought to be making a decision within weeks to attack Iran with unmanned aircraft". "Information from the AIVD operation has in recent years been shared with the American CIA secret service."

Brig Gen Seyyed Massoud Jazayeri, deputy chief of the Iranian armed forces, warned at the weekend that military attacks against Iran would trigger a Third World War. "The exorbitant demands of the US leaders and the global Zionism which have created the current situation in Iraq, Afghanistan, Sudan and Caucasus are gradually directing the world to the edge of the cliff," he said.

The US has refused to rule out a military attack against Iran if its government continues to enrich uranium as part of its civilian nuclear programme, which the West suspects has the clandestine objective of developing atomic weapons. Iran has warned it would close the strategic Strait of Hormuz, the entrance to the Gulf and a major oil shipping route, if it is attacked.

On Friday, the Israel newspaper Ma'ariv reported that Israel has stepped up preparations for a contingency plan to attack Iran, should diplomatic efforts, via the United Nations, fail to derail Tehran's suspected nuclear weapons programme.

Extreme and risky action the only way to tackle global warming, say scientists
Political inaction on global warming has become so dire that nations must now consider extreme technical solutions - such as blocking out the sun - to address catastrophic temperature rises, scientists from around the world warn today.

The experts say a reluctance "at virtually all levels" to address soaring greenhouse gas emissions means carbon dioxide levels in the atmosphere are on track to pass 650 parts-per-million (ppm), which could bring an average global temperature rise of 4C. They call for more research on geo-engineering options to cool the Earth, such as dumping massive quantities of iron into oceans to boost plankton growth, and seeding artificial clouds over oceans to reflect sunlight back into space.

Writing the introduction to a special collection of scientific papers on the subject, published today by the Royal Society, Brian Launder of the University of Manchester and Michael Thompson of the University of Cambridge say: "While such geoscale interventions may be risky, the time may well come when they are accepted as less risky than doing nothing."

They add: "There is increasingly the sense that governments are failing to come to grips with the urgency of setting in place measures that will assuredly lead to our planet reaching a safe equilibrium."

Professor Launder, a mechanical engineer, told the Guardian: "The carbon numbers just don't add up and we need to be looking at other options, namely geo-engineering, to give us time to let the world come to its senses." He said it was important to research and develop the technologies so that they could be deployed if necessary.

"At the moment it's almost like talking about how we could stop world war two with an atomic bomb, but we haven't done the research to develop nuclear fission."

Such geo-engineering options have been talked about for years as a possible last-ditch attempt to control global temperatures, if efforts to constrain emissions fail. Critics argue they are a dangerous distraction from attempts to limit carbon pollution, and that they could have disastrous side-effects.

They would also do nothing to prevent ecological damage caused by the growing acidification of the oceans, caused when carbon dioxide dissolves in seawater. Last year, the Intergovernmental Panel on Climate Change dismissed geo-engineering as "largely speculative and unproven and with the risk of unknown side-effects".

Dr Alice Bows of the Tyndall Centre for Climate Change Research at the University of Manchester said: "I'm not a huge fan of messing with the atmosphere in an geo-engineering sense because there could be unpredictable consequences. But there are also a lot of unpredictable consequences of temperature increase. It does appear that we're failing to act [on emissions]. And if we are failing to act, then we have to consider some of the other options."

In a strongly worded paper with colleague Kevin Anderson in today's special edition of the society's Philosophical Transactions journal, Bows says politicians have significantly underestimated the scale of the climate challenge. They say this year's G8 pledge to cut global emissions 50% by 2050, in an effort to limit global warming to 2C, has no scientific basis and could lead to "dangerously misguided" policies.

The scientists say global carbon emissions are rising so fast that they would need to peak by 2015 and then decrease by up to 6.5% each year for atmospheric CO2 levels to stabilise at 450ppm, which might limit temperature rise to 2C. Even a goal of 650ppm - way above most government projections - would need world emissions to peak in 2020 and then reduce 3% each year.

Globally, a 4C temperature rise would have a catastrophic impact. According to the government's Stern review on the economics of climate change in 2006, between 7 million and 300 million more people would be affected by coastal flooding each year, there would be a 30-50% reduction in water availability in southern Africa and the Mediterranean, agricultural yields would decline 15-35% in Africa and 20-50% of animal and plant species would face extinction.

Martin Rees, president of the Royal Society, said: "It's not clear which of these geo-engineering technologies might work, still less what environmental and social impacts they might have, or whether it could ever be prudent or politically acceptable to adopt any of them.

But it is worth devoting effort to clarifying both the feasibility and any potential downsides of the various options. None of these technologies will provide a 'get out of jail free card' and they must not divert attention away from efforts to reduce emissions of greenhouse gases."

Mike Childs of Friends of the Earth said: "We can't afford to wait for magical geo-engineering solutions to get us out of the hole we have dug ourselves into. The solutions that exist now, such as a large-scale energy efficiency programme and investment in wind, wave and solar power, can do the job if we deploy them at the scale and urgency that is needed."


Farmerod said...

It seems doubtful to me that the ECB and BOE would stop short term emergency lending. I would expect just the opposite although I would expect them to continue threatening to cut it off. Kinda like the Fed talking about a strong dollar and the risks of inflation while presumably knowing better.

Ilargi said...


It's not so much that they will stop it, but that they have to stop inhaling all the toxic paper. A lot of this stuff exists only because it can be transferred to these windows. And it's still not worth anything. The central banks themselves are losing money hand over fist in all this. They can't continue it indefinitely. The BOE has been clear: In October, the special liquidity scheme is gone. And the ECB has far too much to do to keep propping up London.

Anonymous said...

Do like the blog, but the smug tone does grate a bit.

Ilargi said...

smug? moi?

oh, you must mean Stoneleigh...

Anonymous said...

ilargi's tone is not smug, in fact it has a distinct sadness in it. She/he finds no solace in the fact that they saw that the ship was sinking, screamed and yelled for folks to abandon ship. Yelled louder as folks refused to listen...and now sadly watches as they all sink.

No smug tone in that, only sadness and a silent wishing that things had gone differently.

Thank you Ilargi I have a very small life raft and I hope and pray it gets me and loved ones through.

Anonymous said...

I definitely don't see Ilargi as smug. On a bad day, irascible might be a better fit :-)

EBrown said...

I don't read smug - I read contempt for the abuse of power and position at many levels, and such behaviour deserves to be treated with contempt.

Anonymous said...

the word "smug" to me denotes condescension. I don't perceive that at all.

ilargi IS very confident-sounding, very assured in his doomerism, kind of like Kunstler without the art school snottiness and latent bigotry.

No, I vote thumbs up for ilargi.

Anonymous said...

Anonymous Anonymous said...

Do like the blog, but the smug tone does grate a bit.

Me too, I really hate being out-smugged.

Greyzone said...

You'll have to excuse me if I find the claims in the Reuters article that wealthy people are moving their assets into cash because of inflationary pressures to be laughable.

The writer of that article obviously doesn't understand what is in plain sight before all of us - serious deflation. Cash is the worst asset to hold during inflation. However, cash is among the best assets to hold during deflation.

The classic pattern you see is the wealthy invest in and hold physical assets (stocks, commodities, etc.) during inflations, sell out near the top, then hold the cash on the way down. The deflation vastly increases the value of that cash, which allows purchasing of physical assets at the bottom, just in time for the next inflationary wave.

Greenpa said...

yeah, no smug here. Ilargi does occasionally rage against the stupidity of man- something he has in common with all other known thinkers, philosophers, and prophets from the beginning of time. Duh.

Farmerod said...

ilargi wrote :It's not so much that they will stop it (short-term lending), but that they have to stop inhaling all the toxic paper

But the toxic paper is the only collateral banks have, presumably, to exchange for central bank funding. So how are central banks going to stop inhaling without stopping the lending altogether?

Anonymous said...

"The OECD reports today that Britain will be the only major rich country to go into a recession this year. While that is an unbelievably silly statement, it does once more make clear how bad things are in Albion. It’s silly because many others are in recession as well; it just depends on the definition you use."

Could it be that just as the financial language changed after the great depression (depression -> recession), that in the last year or so it has changed again: with 'recession' becoming code for depression, and 'everything is ok' being code for recession?

Ilargi said...


... how are central banks going to stop inhaling without stopping the lending altogether?

It's not that black and white. There are still institutions that are solvent, one way or another. Through a miraculous incident, they are the ones with the most lovingly healthy ties to the central banks.

I posted a graph from Mish a while ago that indicates that the Fed -at present moving rates- has one month left of treasuries to exchange for securities. And then it stops. The same goes for Threadneedle and Frankfurt. Central banks are not even allowed to operate at a loss. They certainly weren't established for it. The Treasury department in every country serves that purpose.

The lending will not stop altogether, but the vast majority of it will. Meanwhile the scraps falling off the table are for the dogs. Shareholder value is wiped clean and out, and what value is left that's tradable will be bought on the very cheap, secured by -future- tax revenue.

Ilargi said...


There are still definitions that sort of stick, like two negative GDP quarters in a row, But with all the 'massaging' of numbers going on, and the hedonistic definitions and core/more core CPI's, hey, who knows?

I don't even find it interesting anymore to worry about.

Good question though.

Ilargi said...

And just to make sure we're on the same page,

The Smugs are those little tiny blue overtly gay pesky guys with the white hats, right?

Anonymous said...

Smug once in a blue moon, contemptuous often, but so what!
I & S tell it straight and thats all that really matters.

Re: Bove in the Lehman article.
"while he thinks a bid from an investment banking rival such as Goldman Sachs or JP Morgan, busy dealing with their own problems from the global financial crisis, is unlikely, Japanese or Canadian banks could well be interested."

Could Japanese or Canadian Banks be that stupid to wade into the swamp (or should I say quicksand?) at this point in the game? I wonder.

EBrown said...

I couldn't agree more with your take on the "inflation" moves of wealthy clients. What kind of a fool says that intelligent and informed people would move into cash because of inflation? Central Banks (banks in general) like it when there is mild inflation due to its wealth eroding properties that encourage investment and borrowing.

Just the other day when I asked my wife's cousin, who works as a contract valuation analyst for various financial institutions, what he thought of the financial markets these days he gave me a pat answer about diversify and hold for the long term, "you'll be fine". When I laid out the laundry list of problems, first and foremost that the credit markets are disrupted he was unable to make a strong argument for why I should take money and invest it in the stock market today, and yet that is what he does with his own money, and he's a smart guy. I believe I made him think deeply about his position when I said, "I recognize full well that I am currently only 1:100 or 1:500 in my deep, deep pessimism, but with the way our system works (fractional reserve lending etc), how many others need to come to the same conclusions I have before a major disruption ensues? Not too many."

EBrown said...

didn't quite finish my inflation/deflation thought in a logical manner, sorry.
I think states and most banks fear deflation because it poses existential problems. Ilargi does a good job of demonstrating how the playing field in finance is far from level, which for many banks means a deflationary environment is catastrophic. Those that are well capitalized or that have rolodexes to make a head of state drool are the only ones to survive periods of deflation.

Obviously hyperinflation is a terrible outcome, and banks don't like it, for it means they lose big time, worthless money and no assets to show for it.

Given their druthers most banks and governments aim for mild inflation for all its stabilizing properties - most debts are paid back, most people can find work, society runs (relatively) well...

The fact that wealth clients of big institutions are raising cash is a sign that Ilargi and Stoneleigh's assesment of the situation is correct. A major deflation is at hand.

I do think about what the currency model will looks like in a few years once we've deleveraged a lot more. I wonder whether the clamor for the goverment to "do something" will grow loud enough for a fundamental shift to occur and the US goverment to attempt an actual currency inflation. I can see it being a possiblity. Anyone else have opinions on that?

Anonymous said...

If you are new to this site, I suppose it may sound "smug" to begin the day's blog with among reporters with limited imaginations and language skills. And then go on to say it as he (Ilargi) sees it. But if you stick around you will hang on every word I. utters and even laugh loudly at times. His personality isn't that of the average guy on the street, oh, no, it's much, much more. Cynical? Yes! Even-tempered? No! Smart? Yes! Presumptive? Yes! Mysterious? Yes! Teetotaller? No!

el gallinazo said...

What does it mean that Da Big Boyz are in cash? 100's stuffed in Basle vaults? Treasuries? Money markets? What makes a money market safe in times of financial collapse? For all you know, they are lending this money to hedge funds levered 100:1 in pork bellies.

Anonymous said...

I don't understand why you focus so extremly on deflation.
Our money is nationstate-issued money and our nations are highly indebted.
Why I should stay in paper-cash (which is per definition the other side of the debt)?

greetings from switzerland

EBrown said...

Anon Switz,
I don't have any great faith in nation-state denominated cash for the long haul. I know that cash is often (always?) fooled with by nations in dire circumstances.
I am however convinced that the imminent problem facing our financial system is deflation of the gigantic credit bubble that inflated over the last 20+ years. I don't see any way to dodge that bullet. Once the bubble pops I'll consider changing my savings plan. I'll also reconsider if oil and gold reverse course and gain for several months straight, if the Dow turns around and can hold onto gains for more than two or three months (with lower volatility than has recently been exhibited), if the US gov doesn't have to step in to rescue an insolvent institution for three or four months, or if I can find a really compelling couple of experts who make a strong case for a "return to norm".

Actually, I'm too invested in my current line of thinking to lend much weight to any so called expert who claims a "return to normal" is even possible at this point. Although I suppose "normal" leaves lots of room for interpretation. Barring the ongoing financial collapse we still face numerous ecosphere imposed limits to growth as the Club of Rome projected decades ago. The fact that I and S recognize peak oil, global warming, etc as problems gives their analysis of the financial markets more heft in my mind.

Having said that, the market makers have pulled rabbits out of hats before, so while it looks like this is the real deal to me I could be wrong.

weatherman said...

Rabbits out of hats is a plausible near term outcome. However, remember that sleight of hand results only in the illusion of reality, and should be used for entertainment purposes only.

Anonymous said...

Red dog,

Alas any fiat currency system is in large part illusion an exists only as the general public continue to accept that illusion. The bankers and other elites profit handsomely from the acceptance of this illusion while the public is crushed by the realization of said illusion.

Anonymous said...

smug??? Never ever. Try: Entertaining, encouraging, amusing. Sometimes a bit repetitive, but the base material provided by the press lacks the novelty on some days. It certainly almost always does lack the insight.