Monday, September 22, 2008

Debt Rattle, September 22 2008: The Plan

Toni Frissell Lady in the Water 1947
A woman floating in the water at Weeki Wachee Spring, Florida

“Nancy, can you get Lloyd on the phone?"

“Lloyd who, sir?"

“Blankfein, the Goldman CEO, of course."

“Mr. Blankfein? The Treasury here, I have the Secretary on the line for you."

“Lloyd, Hank here. Just a quick call to let you know we’re on track. I’m pushing through the $700 billion, and they’re all so scared by now they’ll accept it too."

“But Hank, I see they’re all trying to change it in all kinds of ways".

“Don’t worry, I asked for all I could think of, but I don’t need every single bit. They’ll give me enough to work our plan."

“Well, you asked for total immunity, you really think you can get that?"

“Look Lloyd, it doesn’t matter, does it? They’ll give me immunity from the courts, for sure. And then they can have some token grip on what I’ve done, like some review 6 months after the fact. You know, democracy and all that, haha. It’ll be too late by then to turn anything back."

“If you can pull this one off, Hank, that’s quite a feat. Got to be honest, I didn’t think you could do it."

“They’re all the same, Lloyd, these people. You just scare the heebees out of them and they do everything you say. Besides, what do they know about securities and swaps? Their only source is our own Goldman people inside Congress. As long as our guys say jump, they jump. Their number 1 is: they want to keep their seats. And our donations."

“Oh, and before I forget, Lloyd, I also decided to go to the next step of the plan today. I’m going to make you and MS commercial banks."

“Weren’t we supposed to wait with that one, Hank?"

“Yeah, but time is of the essence. I don’t want more stock losses at the firm. Goldman hasn’t made a penny for too long now, and I’m going to change that. I’m losing too much on my own stock. You’ll get full Fed access, and a zillion in customer deposits you can use to write more paper. It’s brilliant, when you think about it."

“Sure, but we’ll get all that oversight and stuff."

“Lloyd, the only ones overseeing you will be me and the boys at the Fed. How bad could that be? Stop worrying, we got it all worked out."

“Well, if you say so, Hank, but it’s just four more months for you. What happens after that?"

“Don’t worry, four months is enough. And after that, another of our guys takes over. How about you, Lloyd, you might be good at it? What you need to do now is get the boys ready to start taking over all the banks I’m going to let fail. I’ll get Morgan and BoA some as well, of course, we have a free market here. Ha, I kill me sometimes. You’ll need some bright kids for that, Lloyd, it’ll be a lot of money for nothing. And have some token funds at hand to pay for it. You’ll get it all back, of course."

“I know the plan, Hank, no worries there, I’ll tell everyone to be prepared for something big."

“I got to go, Lloyd, Bennie boy just walked in, he’s waiting next door to do some more details. I’ll keep you posted."

“OK. One more thing, Hank, did you see the markets today? The dollar is falling, and so is the Dow, even with all the shorts covering their bee-hinds That’s going to cost us a lot of dough!"

“Lloyd, I don’t care anymore. I got the power now. It’s not going to cost me a dime. I’ll just make it tax-deductible, or ram it through Fannie, or the FDIC, or something. I can do whatever I want. And believe me, I will."

European Banks: Too Big to Rescue?
European banks face greater capital shortages than their U.S. counterparts, but have become too big for any one European country to save, according to an article published Saturday by European economists Daniel Gros and Stefano Micossi on the Centre for European Policy Studies’ Web site.

That means a rescue of the European financial sector like the $700 billion plan proposed by the Bush administration over the weekend would be difficult, requiring coordination by the European Central Bank with the participation of all European countries.

The “overall leverage ratio” - a measure of total assets to shareholder equity - of the average European bank is 35, compared with less than 20 for the largest U.S. banks, the economists say, and relatively small writedowns on their assets could have a devastating impact on a bank’s capital.

“If ever they were forced into a firesale, they could go very quickly into insolvency,” said Gros, who is director of the Centre for European Policy Studies. The problem for European regulators is that European banks rival or in some cases exceed the economic size of their native European economies, making a rescue package in Europe difficult, according to Gros and Micossi.

For example, Deutsche Bank, with an overall leverage ratio of 50, has liabilities of €2 trillion, over 80% of the entire German economy. The liabilities of Barclays PLC, at £1.3 trillion - with a leverage ratio of 60 - exceed the entire U.K. economy , they say.
So far European banks have been spared the convulsions that are ravaging the US financial system. This is surprising because some of the major European banks have leverage ratios (often over 30, in some cases close to 50) that must, under current market conditions, be considered a disaster in waiting.

The experience over the last year has shown that given the automatic feedback loops in a system of mark to market and ratings, any slight doubt about the solvency or liquidity situation of such highly leveraged institutions (see Figure 1) can lead to their demise in a matter of days.

The European Central Bank and European regulators are living on borrowed time.

Calling Paulson's Bluff
Treasury Secretary Hank Paulson spent the past two weeks playing a game of chicken with firms like Lehman Brothers and A.I.G. Now he is playing even higher-stakes chicken with Congress and the economy. Paulson's storyline is that the credit markets are frozen, and unless Congress passes a "clean bill" -- his way -- disaster lies ahead. He spent a busy Sunday morning on the talk shows ducking questions on what would happen if Congress didn't act -- and what might still happen if it did.

One senior Congressional Democrat told me, "They have a gun to our heads." Paulson behaved as if he held all the cards, but in fact the Democrats have a lot of cards, too. The question is whether they have the nerve to challenge major flaws in Paulson's plan as a condition of enacting it.

Paulson also faces serious defections in Republican ranks, with several key senators and congressmen resisting a bailout of this scale. Sen. Richard Shelby, the ranking Republican on the Senate Banking Committee, speaking on CBS's Face the Nation, flatly blamed the crisis on greed and deregulation, and questioned the terms of Paulson's plan.

Paulson's bill would give him carte blanche to spend up to $700 billion over the next 24 months to buy toxic securities from financial firms. This presumably would "unclog" capital markets, the financial economy would begin functioning normally again, and then the government would recoup what it could.

The plan is outrageous on several levels. It demands nothing from these firms in return. It holds the Treasury Secretary accountable to no one. And it extends the most generous terms to Wall Street while offering nothing to Main Street. House Financial Services Chairman Barney Frank, speaking Sunday morning on "Face the Nation," gave the flavor of what Democrats will demand, if they hang tough: An economic stimulus to go with the Wall Street bailout; more refinancing help for borrowers; and some limits on windfall gains to corporate executives.

These provisions would improve the bill, and Democrats would win either way: if they were included, more help would be on the way to working families. If they lost, and the bill passed without these provisions, it would make crystal clear the difference between the parties. Ideally, the Democrats should go even further.

The bailout bill should be explicitly tied to a commitment to re-regulate all types of financial institutions. The bill's authority should expire after six months, so that when the next Congress re-authorizes any bailout authority it would be combined with tough comprehensive regulation. Any private company that sells assets to the Treasury should be subjected to stringent limits on executive windfalls. The government should get an equity position in the firms it helps, proportional to the help that it gives.

Treasury should be authorized and directed to take controlling interest in some firms, and take over their management, if of course that provides the greatest potential savings to taxpayers. For example, when an FDIC-insured bank goes broke, the FDIC either merges it into a healthy bank, or takes it over and runs it for a time while it pays off depositors, to make sure that it is run properly. It does not just bail out the incumbent management that created, and profited from, the mess.

There should be a recapture provision, so that if firms end up profiting from this bailout, the government gets its money back. Part of the $700 billion should be for mortgage refinancing, and authority for cities and towns to acquire foreclosed properties and put buyers and renters back in them. The package should include at least $200 billion of new economic stimulus, in the form of aid to states, cities, and towns, for infrastructure rebuilding, more generous unemployment and retraining benefits, and green investment.

The Democratic leadership should force Republicans to take votes on provisions like these. The early signs were that they would be pushing hard for a two or three. Yesterday, a key lobbyist for the financial services roundtable, Scott Talbott, warned, "We're opposed to adding provisions that will affect [or] undermine the deal substantively," The Roundtable's members are banks, securities firms and insurance companies, the prime beneficiaries of Paulson's proposed bailout.

He warned that any effort to attach other provisions would be a deal breaker. But excuse me, it is the financial industry that is coming hat-in-hand to the government, not vice versa. The industry has no leverage here, except to the extent that Congress lets itself be intimidated. Paulson is insisting on a "clean" bill, but as Barney Frank put it, helping Main Street as well as Wall street does not dirty the bill.

The two precedents for large scale bailouts, Franklin Roosevelt's Reconstruction Finance Corporation, and the Resolution Trust Corporation of the 1980s, gave government much more authority over the firms that it bailed out. Paulson is playing this more as the investment banker that he used to be, than as a steward of the public interest. This is a dubious deal, with all the gain going to Wall Street and all the risk going to taxpayers. Congress should not be intimated by his threats to hold his breath and turn blue of he doesn't get his way.

Wall Street wiped out: Goldman and Merrill to change structure
Bloomberg News reports that Washington pulled another Sunday night special -- wiping out Wall Street as we have known it. Ironically, this move will put Wall Street back where it was prior to the Great Depression.

How so? Last night the Fed approved changing Morgan Stanley and Goldman Sachs from investment banks to commercial ones. Morgan Stanley -- which may sell up to 20% of itself to Mitsubishi UFJ and may put merger discussions on hold -- and Goldman Sachs now have greater odds of remaining independent.

Most significantly, the change will allow both banks to take consumer deposits and get short-term loans from the Fed. In exchange for that cheap money, they will need to increase the amount of capital they have, take less risk, and submit themselves to tighter regulatory scrutiny. The capital increases are the most significant piece of this new puzzle.

According to the New York Times, "Goldman Sachs has $1 of capital for every $22 of assets; Morgan Stanley has $1 for every $30. By contrast, Bank of America has less than $11 for every $1 of capital." Goldman and Morgan will be required to raise significant capital to reach that 11 to 1 ratio. How they do that still remains a mystery.

Ironically, prior to the Great Depression, banks like JPMorgan operated both commercial and investment banks -- taking deposits from consumers and doing stock offerings for business. I was surprised to learn that they already have billions in deposits. "Morgan Stanley had $36 billion in retail deposits as of August 31 and Goldman Sachs had $20 billion," according to the Times.

Now, they'll need to add branches and invest in marketing and systems to expand that amount. So, although the industry will return to its pre-Great Depression structure -- it will be more tightly regulated than it was back then. The implications of this change are significant for bankers and the cities where they live. That's because enormous bonuses for Wall Streeters are history.

In addition, this change will leave a huge hole in the economy of New York which depends so heavily on those big investment banking bonuses to fuel its real estate market, not to mention its expensive restaurants and other "finer things in life".

And this raises big questions about what will happen to all the MBAs who formerly streamed to Wall Street after graduation. If the global financial markets can survive this crisis, it would not surprise me to see investment banking revive in its current form through start-ups capitalized by institutional investors.

Some of these MBAs could go into hedge funds or private equity -- but a regulatory crack down on those market players could also be in the offing. This could mean that MBAs actually have to manage businesses instead of shuffling financial papers. Huge questions remain about whether we can make it through the current catastrophe. And for now this change in Wall Street is a bit of a side show.

Dodd Bailout Draft Could Give Government Shares of Companies
Senate Democrats want to add tough new measures to the Treasury Department's proposal to bail out financial firms, including strict limits on executive compensation and a provision that would allow the government to take shares of any financial institution that participates in the program.

Senate Banking Committee Chairman Christopher Dodd of Connecticut began circulating his 44-page draft Sunday night. The draft is likely to prove problematic for the Bush administration, which has tried to prevent lawmakers from making big changes to a much simpler proposal it unveiled over the weekend. Treasury's plan would allow the government to buy up to $700 billion in mortgage-related assets from banks and others to prevent a worsening of the financial market turmoil.

Lawmakers hope to finalize a plan by the end of the week, but multiple obstacles remain. Sen. Dodd's plan would not allow the Treasury Department to purchase any assets "unless the Secretary receives contingent shares in the financial institution from which such assets are to be purchased equal in value to the purchase price of the assets to be purchased." Treasury officials have not suggested that the government would receive any shares of companies that sell distressed assets into the huge government fund.

Democrats are also expected to clash with the Treasury Department on a separate provision that could limit executive compensation at firms that participate in the program. Sen. Dodd's plan would limit the pay "to exclude incentives for executives to take risks that the Secretary deems to be inappropriate or excessive." It would also allow limitations to senior executives as it is "determined to be appropriate in the public interest in light of the assistance being given to the entity."

The draft would also create a special inspector general program and a separate emergency oversight board, which would include top officials from the Federal Reserve, Federal Deposit Insurance Corp., and Securities and Exchange Commission. Sen. Dodd met throughout the weekend with other lawmakers in designing his plan. His counterpart in the House of Representatives, Financial Services Committee Chairman Barney Frank, is working on a separate plan that also includes limits on executive compensation. Rep. Frank's bill is expected to move faster than the Senate version and could see a vote in the next few days.

Earlier Monday, President George W. Bush said his administration and has made "good headway" on the plan, but urged lawmakers to keep legislation focused on the financial crisis. "Obviously, there will be differences over some details, and we will have to work through them. That is an understandable part of the policy making process," Mr. Bush said in a statement. "But it would not be understandable if Members of Congress sought to use this emergency legislation to pass unrelated provisions, or to insist on provisions that would undermine the effectiveness of the plan."

Mr. Bush said time is of the essence, warning that inaction would trigger "broad consequences far beyond Wall Street." "Americans are watching to see if Democrats and Republicans, the Congress and the White House, can come together to solve this problem with the urgency it warrants," the president said Monday. "Indeed, the whole world is watching to see if we can act quickly to shore up our markets and prevent damage to our capital markets, businesses, our housing sector, and retirement accounts."

Japan’s biggest bank to buy 20% of Morgan Stanley
Mitsubishi UFJ, Japan’s largest megabank, is poised to pay least $9 billion (£4.8 billion) for a stake of up to 20 per cent in Morgan Stanley, the troubled Wall Street lender. The Mitsubishi UFJ deal is expected to leave the Japanese bank with a stake of between 15 per cent to 20 per cent in Morgan Stanley. Mitsubishi UFJ is expected to make a decision on the exact price it will pay for the stake once it has completed due diligence.

The deal is the second struck within the last 24 hours in which a leading Japanese financial group has swooped on the troubled titans of Wall Street. Earlier in the day, sources at Nomura confirmed that the brokerage house would be buying the Asian and European businesses of Lehman Brothers.

A deal with Mitsubishi UFJ will allow Morgan Stanley to keep its independent status after a tumultuous week on Wall Street in which Lehman Brothers went bust, Merrill Lynch was acquired by Bank of America and the US Government unveiled a $700 billion bailout to rescue the creaking US banking system. It is understood that Morgan Stanley had been in talks with Wachovia, America's fourth largest bank, as well as China Investment Corporation, the Chinese sovereign wealth fund.

The deal has emerged hours after Morgan Stanley and its rival, Goldman Sachs, signalled the end of an era on Wall Street by abandoning their status as investment banks. The two investment houses yesterday received the regulatory approval to transform themselves into traditional bank holding companies.

While the change appears to be a technicality, it means that both banks have equal and permanent rights to access emergency funds from the US central bank, the Federal Reserve. They will also be far more tightly regulated. As revealed earlier this month by The Times, Mitsubishi UFJ has been increasingly keen to invest in the distressed “platinum” brands of the US financial sector.

Having escaped with only light financial damage from the sub-prime chaos and the credit crunch fallout, Japanese banks have emerged as some of the strongest potential bidders as the financial crisis continues to produce victims and the price of snapping up a premium international Wall Street name has plunged.

For months, Japanese banks have been preparing large warchests of cash with which to jump on any opportunity that arises. “We are now finally seeing the advantages of being boring, conservative and keeping our powder dry,” one senior Mitsubishi UFJ source told The Times.

U.S. Widens Scope of Bad-Debt Plan Beyond Home Loans
The Bush administration widened the scope of its $700 billion plan to avert a financial meltdown by including assets other than mortgage-related securities.

The U.S. Treasury submitted revised guidance to Congress on its plan late yesterday as lawmakers and lobbyists push their own agendas. The department also adjusted its plan to insure money-market funds to limit protection to balances as of Sept. 19, after complaints from bank lobbyists.

Officials made the changes two days after unveiling plans for an unprecedented intervention in financial markets. The change to potentially allow purchases of instruments such as car loans, credit-card debt and other devalued assets may force an increase in the size of the package as the legislation proceeds through Congress.

"The Treasury's thinking is to make it as big and wide as possible so they have the flexibility to act if need be," said Shane Oliver, Sydney-based head of investment strategy at AMP Capital Investors, which manages about $108 billion. "There have been losses on a whole range of U.S. debts and as the economy deteriorates in response to the housing slump those losses could escalate."

Treasury officials now propose buying what they term troubled assets, without specifying the type, according to a document obtained by Bloomberg News and confirmed by a congressional aide.

"The costs of the bailout will be significantly higher than originally considered or acknowledged," said Josh Rosner, an analyst with independent research firm Graham Fisher & Co. in New York. "How, given these changes, can the administration and Federal Reserve believe they are being forthright in their unrevised expectation of future losses?" Treasuries rose on speculation the Fed will cut interest rates to support the rescue plan.

Separately, the Treasury said in a statement late yesterday it would limit its $50 billion plan for insuring money-market funds to those held by investors as of Sept. 19, excluding any subsequent contributions. The American Bankers' Association, which had expressed concern about the plan last week, praised the move, saying it would eliminate an incentive for savers to shift out of bank accounts into money-market funds. The Treasury put no limit on the money-market fund insurance, while the Federal Deposit Insurance Corp. protects bank deposits up to $100,000.

"If all money market mutual funds had been included with the government guarantee moving forward, this proposal would have threatened to take money out of local FDIC-insured banks," Edward Yingling, president of the ABA in Washington, said in a statement. In its latest guidance on the bad-debt fund, the Treasury said firms that are headquartered outside the U.S. will now be eligible for assistance.

The changes come after two days of weekend talks between administration officials and congressional staff in Washington. Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben S. Bernanke told lawmakers Sept. 18 that a comprehensive attack on the worst financial crisis since the Great Depression was critical after a series of government interventions failed to normalize markets.

Paulson announced his intention to seek legislation from Congress on Sept. 19. Appearing on television talk shows yesterday he called for rapid passage of a bill. Congressional panels have scheduled two hearings this week on the crisis; Bernanke appears at a third hearing on the economic outlook. Lawmakers are also seeking changes to Paulson's plan.

Democrats are pressing for oversight through the Government Accountability Office, and for the inclusion of efforts to refinance mortgages for struggling homeowners. House Financial Services Committee Chairman Barney Frank wants limits on compensation of corporate executives who benefit from the program. Republicans are urging limits on how any profits from the program could be spent.

"Just about everyone in the markets agrees the Paulson plan needs to be simple -- unencumbered by complications and penalties," Christopher Low, chief economist at FTN Financial in New York, wrote in a note to clients. "Of course, Washington doesn't know how to do that."

It was the third straight weekend of crisis work for Paulson and his Treasury colleagues. The previous week, he and New York Fed President Timothy Geithner led talks with banks in an unsuccessful effort to avert the bankruptcy of Lehman Brothers Holdings Inc.

On Sept. 7, Paulson seized Fannie Mae and Freddie Mac, the largest sources of U.S. mortgage financing, after the government-chartered, shareholder-owned companies failed to raise sufficient capital from private sources to satisfy regulators. Late yesterday, the Fed approved requests from Goldman Sachs Group Inc. and Morgan Stanley, Wall Street's last two independent investment banks, to become bank holding companies.

"It's hard to say there are any illusions left" about the seriousness of the financial crisis, said Jason Trennert, chief investment strategist at Strategas Research Partners in New York.

Goldman, Morgan to Become Full-Fledged Banks
Goldman Sachs and Morgan Stanley, the last two independent investment banks, will become bank holding companies, the Federal Reserve said Sunday night, fundamentally altering the landscape of Wall Street.

The move fundamentally changes one of the mainstay models of modern Wall Street, the independent investment bank, soon after the federal government unveiled the biggest market intervention since the New Deal. It heralds new regulations and supervision of previously lightly regulated investment banks, as well as an end to the outsized paychecks that underpinned the traditional image of the chest-thumping Wall Street banker.

It is also the latest signal by the Federal Reserve that it will not let Goldman or Morgan fail. The move comes after the bankruptcy of Lehman Brothers and the near-collapses of Bear Stearns and Merrill Lynch. Now, Goldman and Morgan Stanley, which have been the subject of merger speculation in recent weeks, can become direct competitors to larger firms like Citigroup, JPMorgan Chase and Bank of America.

Those firms combine investment-banking operations with the larger capital cushions that come with retail deposits, giving them a stability that pure investment banks lack. JPMorgan acquired Bear Stearns this spring in a fire sale brokered by the federal government, while Bank of America has agreed to buy Merrill Lynch for $50 billion. Barclays of Britain agreed to buy the core capital-markets business of Lehman Brothers out of bankruptcy late last week.

Announced without fanfare on Sunday night, the move signals the final end to the Glass-Steagall Act, the epochal legislation of 1933 that signaled a split between investment banks and retail banks. A law passed in 1999 repealed the earlier regulation, though Goldman and Morgan remained independent investment banks.

Morgan Stanley had sought other ways to bolster its capital, and had been in advanced talks with China’s sovereign wealth fund and others about raising as much as $30 billion, people briefed on the matter said Sunday night.

“While accelerated by market sentiment, our decision to be regulated by the Federal Reserve is based on the recognition that such regulation provides its members with full prudential supervision and access to permanent liquidity and funding,” Lloyd C. Blankfein, Goldman Sachs’s chairman and chief executive, said in a statement Sunday night.

“We believe that Goldman Sachs, under Federal Reserve supervision, will be regarded as an even more secure institution with an exceptionally clean balance sheet and a greater diversity of funding sources.”

“This new bank holding structure will ensure that Morgan Stanley is in the strongest possible position – with the stability and flexibility to seize opportunities in the rapidly changing financial marketplace,” John J. Mack, Morgan Stanley’s chairman and chief executive, said in a statement. It also offers the marketplace certainty about the strength of our financial position and our access to funding.”

By becoming bank holding companies, Goldman Sachs and Morgan Stanley gained some breathing room in the immediate term. But it likely lays the groundwork for additional deal making. Given the expected bank failures this year, it is possible Goldman and Morgan Stanley could seek to buy them cheaply in a “roll-up” strategy.

Prior to the move, federal regulations prohibited the two investment banks from pursuing such deals. Indeed, Morgan Stanley’s recent talks with Wachovia revolved around Wachovia buying Morgan Stanley. Being a bank holding company would also give the two access to the discount window of the Federal Reserve. While they have had access to Fed lending facilities in recent months, regulators had planned to take away discount window access in January.

The regulation by the Federal Reserve brings a host of accounting rule changes that should benefit the two banks in the current environment. In return, they will submit themselves to greater regulation, including limits on the amount of debt they can take on. When it collapsed, Lehman had about a 30:1 debt-to-equity ratio, meaning it had borrowed $30 for every dollar in capital it held. Morgan Stanley currently has a debt-to-equity ratio of 30:1, while Goldman Sachs has one of about 22:1.

Bank of America, on the other hand, currently has about an 11:1 leverage ratio, while JPMorgan has about 13:1 and Citigroup about 15:1. Because they can borrow less, bank holding companies typically have lower earnings multiples.
In its statement, Goldman said that it will now become the nation’s fourth-largest bank holding company, with its small existing deposit-taking units to be rolled into GS Bank USA. Morgan Stanley will convert its Utah industrial bank into a deposit-taking national bank, to be called Morgan Stanley Bank.

Goldman, Morgan Stanley transform into Fed-regulated banks
Goldman Sachs and Morgan Stanley were granted approval on Sunday to become bank holding companies regulated by the U.S. Federal Reserve, effectively killing off the investment banking model that has dominated Wall Street for more than 20 years.

The move enables Goldman and Morgan Stanley to take deposits, gain easier access to financing and gives them more flexibility to buy retail banks. It was initiated by the only two big and independent U.S. investment banks left after the failure of Lehman Brothers and the agreed takeover of Merrill Lynch last week.

The change, part of a wrenching transformation of the Wall Street landscape amid financial markets turmoil in the past two weeks, means that previously freewheeling firms will be subject to much tighter regulation by the Fed, including tough capital requirements.

That could curb their ability to leverage up their proprietary trading and other activity with mountains of borrowed money. This will reduce their chances of producing the kind of mega profits they had been making until the credit crisis started to hit home this year.

"The timing of this move, in conjunction with all of the other unprecedented steps taken in the past week, shows the seriousness with which the government and the banks themselves are still taking the short-term risks to systemic stability in the financial markets," said Kirby Daley, senior strategist at Newedge Group in Hong Kong. "The implications of all these measures taken together are mind-boggling."

Under the new set-up, the primary regulator of the parent companies switches to the Federal Reserve from the Securities and Exchange Commission but the SEC continues to regulate their U.S. securities businesses. In exchange for the increased scrutiny, Goldman and Morgan gain long-term access to the Fed's discount window and access to bank deposits insured by the Federal Deposit Insurance Corp.

Morgan Stanley is also now less interested in a merger with the banking group Wachovia Corp. That is no longer Morgan's first priority, though talks with other parties continue, a person familiar with negotiations said.

It held a board meeting over the weekend to discuss Wachovia and the possibility that China's sovereign wealth fund China Investment Corp could increase its stake in Morgan Stanley, according to sources familiar with the situation.

Morgan Stanley declined comment on the talks but it did say in a statement that the new status would give it "flexibility and stability to pursue new business opportunities." "In some ways this makes it easier for them to buy a retail bank, but they may argue that this makes them self-sufficient and they don't need to buy a bank now," said the head of global mergers at a U.S. investment bank.

"But they can't raise deposits fast enough organically to stabilize their problems, it has to come through M&A," said the banker, who declined to be identified because he was not authorized to speak with the media. Goldman intends expanding its deposit base by acquiring deposits wholesale from other banks, particularly those in distress, said the firm's spokesman Lucas van Praag.

It began to feel that it needed to consider something like Sunday's move after the government-financed fire sale of another investment bank, Bear Stearns, to JPMorgan Chase & Co in March, and the events of the past week accelerated this thinking, he said. "Last week the markets were looking for a 'belt and braces' approach to safety and soundness -- now we have the central bank as our regulator and permanent access to the lender of last resort," he said.

Goldman saw its shares plunging as much as 45 percent in the first four days of last week as even once seemingly untouchable Wall Street firms appeared vulnerable to the financial crisis. Its stock partially recovered amid news of a planned $700 billion bailout of the U.S. financial system by the government and a ban on short selling of financial stocks.

To provide increased liquidity to the companies while they go through the transition, the Fed agreed to lend to the firms' broker-dealer subsidiaries on the the same terms as the Fed discount window for banks. The Fed said it was making the same collateral deals available to the broker-dealer subsidiary of Merrill, which is being acquired by Bank of America.

"It creates a perception of greater safety and supervision. It really rationalizes the regulatory system. It should be good for both Goldman Sachs and Morgan Stanley," said Chip MacDonald, mergers partner at law firm Jones Day. "It gives them better sources of funds through a commercial bank subsidiary." The approval by the Fed came at the request of Goldman and Morgan, according to a source familiar with the application.

Goldman Sachs said it would move assets from a number of businesses into an entity called GS Bank USA that would have more than $150 billion in assets, making it one of the ten largest banks in the United States. Under a commercial banking model Goldman and Morgan will be able to take deposits which during this shaky financial environment are considered a stable source of funding.

Their ability to take risks will not only be more thoroughly questioned but also be more measured because regulators will require stringent capital levels relative to the risks they take. They will also be required to maintain managerial and operational soundness and be subject to a strict regulatory ratings system.

Dollar May Get 'Crushed' as Traders Weigh Up Bailout
Treasury Secretary Henry Paulson's plan to end the rout in U.S. financial markets may derail the dollar's three-month rally as investors weigh the costs of the rescue.

The combination of spending $700 billion on soured mortgage-related assets and providing $400 billion to guarantee money-market mutual funds will boost U.S. borrowing as much as $1 trillion, according to Barclays Capital interest-rate strategist Michael Pond in New York. While the rescue may restore investor confidence to battered financial markets, traders will again focus on the twin budget and current-account deficits and negative real U.S. interest rates.

"As we get to the other side of this, the dollar will get crushed," said John Taylor, chairman of New York-based International Foreign Exchange Concepts Inc., the world's biggest currency hedge-fund firm, which manages about $15 billion. The dollar fell against 14 of the world's most-traded currencies on Sept. 19, including the euro, as Paulson unveiled the plan, while the Standard & Poor's 500 Index rose 4 percent. The plan may end the rally that began in June and drove the U.S. currency up 10 percent versus the euro, 2 percent against the yen and almost 13 percent compared with Brazil's real, strategists said.

Paulson's plan, sent to Congress Sept. 20, would mark an unprecedented government intrusion into markets and increase the nation's debt ceiling by 6.6 percent to $11.315 trillion. Officials may also start a $400 billion Federal Deposit Insurance Corp. pool to insure investors in money-market funds.

"The downdraft on the dollar from the hit to the balance sheet of the U.S. government will dwarf the short-term gains from solving the banking crisis," said David Woo, London-based global head of foreign-exchange strategy at Barclays, the third- biggest currency trader, according to a 2008 survey by Euromoney Institutional Investor Plc.

Paulson and Federal Reserve Chairman Ben S. Bernanke began plotting the rescue last week after New York-based Lehman Brothers Holdings Inc. filed for bankruptcy, the government seized control of American International Group Inc. and Merrill Lynch & Co. was forced into the arms of Charlotte, North Carolina-based Bank of America Corp.

Morgan Stanley dropped as much as 44 percent Sept. 17, the biggest one-day decline in its history, and Goldman Sachs Group Inc., where Paulson was chief executive officer from 1998 to 2006, lost 26 percent. Both are based in New York. In the four days following Lehman's bankruptcy, the ICE future exchange's Dollar Index, which measures the currency's performance against the U.S.'s six biggest trading partners, dropped 1.2 percent. It fell 0.3 percent today, leaving it 1 percent higher this year.

"After years of doubting the hegemonic status of the dollar, this proves it's still there," said Stephen Jen, London-based head of research at Morgan Stanley. "But of course this situation is definitely not stable. The capital leaving the emerging markets is only going into the dollar and that's a powerful force. It's a very uncomfortable balance." By the end of the year, the euro will weaken to $1.43 and the yen will trade at 108 to the dollar, according to analyst surveys by Bloomberg. The dollar will depreciate to 1.65 against the real, compared with 1.83 on Sept. 19.

Although the dollar may suffer short-term, at least one analyst says the U.S. government's planned rescue will strengthen the currency before long. Paulson's proposals will return foreign-exchange markets to the trend of the past months, according to Adam Boyton, senior currency strategist at Frankfurt-based Deutsche Bank AG, the world's biggest currency- trading bank. Since the end of June, the Dollar Index has gained 7.2 percent.

"It's a positive plan that's ultimately good for the dollar," said New York-based Boyton. "It reduces risk and volatility and gets the focus back on macroeconomic fundamentals, which suggest weakness throughout the rest of the globe next year, with returning strength in the U.S." The U.S. economy may expand 1.5 percent next year, according to the median estimate of 80 analysts surveyed by Bloomberg. That compares with 1.1 percent for the euro-region and 1.15 percent for Japan, the world's second-largest economy.

The rescue comes as the U.S. budget deficit and the current-account balance, the broadest measure of trade, grow. The Congressional Budget Office projects the spending shortfall will increase to $438 billion next year from $407 billion. The current account deficit is up from $167.24 billion in December.

"Investors may start to worry about the amount of debt the U.S. is taking on and its impact on the dollar," said Geoffrey Yu, a currency strategist in London at UBS AG, the second- largest foreign-exchange trader. "The fact that they mentioned taxpayer money implies that they're going to issue debt. If there's going to be a huge new supply of Treasuries, this will be dollar negative. It's too much for the dollar to take."

Traders are also concerned the bank bailout will spread to other U.S. industries suffering from the credit crunch that's holding back an economy growing at its slowest pace since 2001. Detroit-based General Motors Corp., the world's biggest automaker, said last week it will tap the remaining $3.5 billion of a $4.5 billion credit line to pay for restructuring costs.

Lower interest rates may also weigh on the dollar. Futures on the Chicago Board of Trade show there's a 38 percent chance policy makers will lower their target rate for overnight lending between banks to at least 1.75 percent by January from 2 percent currently. A month ago, they showed a 46 percent chance of an increase to 2.25 percent. Rates in the U.S. are already the lowest of any the Group of 10 industrialized nations except Japan, where they are 0.5 percent. The European Central Bank's benchmark is 4.25 percent.

Another drawback for the dollar is that the Fed's key rate is 3.4 percentage points less than the rate of inflation, the most since 1980, so investors lose money by investing in short- term U.S. fixed-income assets. "People thought that the Fed was done cutting," said Andrew Balls, an executive vice president and member of the investment committee of Newport, California-based Pacific Investment Management Co., which oversees almost $830 billion. "In the longer term the diversification away from the dollar will remain intact. The U.S. hasn't done itself any favors in making its assets attractive to foreign investors."

Almost Armageddon: Markets Were 500 Trades From A Meltdown
The market was 500 trades away from Armageddon on Thursday, traders inside two large custodial banks tell The Post. Had the Treasury and Fed not quickly stepped into the fray that morning with a quick $105 billion injection of liquidity, the Dow could have collapsed to the 8,300-level - a 22 percent decline! - while the clang of the opening bell was still echoing around the cavernous exchange floor.

According to traders, who spoke on the condition of anonymity, money market funds were inundated with $500 billion in sell orders prior to the opening. The total money-market capitalization was roughly $4 trillion that morning. The panicked selling was directly linked to the seizing up of the credit markets - including a $52 billion constriction in commercial paper - and the rumors of additional money market funds "breaking the buck," or dropping below $1 net asset value.

The Fed's dramatic $105 billion liquidity injection on Thursday (pre-market) was just enough to keep key institutional accounts from following through on the sell orders and starting a stampede of cash that could have brought large tracts of the US economy to a halt.

While many depositors treat money market accounts as fancy savings accounts, they are different. Banks buy a variety of short-term debt, including commercial paper, with the assets. It is an important distinction because banks use the $1.7 trillion commercial-paper market to fund their credit card operations and car finance companies use it to move autos.

Without commercial paper, "factories would have to shut down, people would lose their jobs and there would be an effect on the real economy," Paul Schott Stevens, of the Investment Company Institute, told the Wall Street Journal. Cracks started to show in money market accounts late Tuesday when shares in one fund, the Reserve Primary Fund - which touted itself as super safe - fell below the golden $1 a share level. It had purchased what it thought was safe Lehman bonds, never dreaming they could default - which they did 24 hours earlier when the 158-year-old investment bank filed Chapter 11.

By Wednesday, banks sensed a run on their accounts. They started stockpiling cash in anticipation of withdrawals. Banks, which usually keep an average of $2 billion in excess reserves earmarked for withdrawals, pumped that up to an astounding $90 billion by Wednesday, Lou Crandall, chief economist at Wrighton ICAP, told The Journal.

And for good reason. By the close of business on Wednesday, $144.5 billion - a record - had been withdrawn. How much money was taken out of money market funds the prior week? Roughly $7.1 billion, according to AMG Data Services. By Thursday, that level, fed by the incredible volume of sell orders pouring in from institutional investors like pension funds and sovereign funds, had grown to $100 billion. It was still not enough to stem the tidal wave.

The banks knew something drastic had to be done. So did Paulson. The injection of capital into the market was followed up by calls from Treasury Secretary Hank Paulson to major money market players like Bank of New York Mellon and State Street in Boston informing them that federal money was in the market and they should tell their clients the Feds would be back with a plan to stem the constriction in the credit market.

Paulson knew the $105 billion injection was not a real solution. A broader, more radical answer was needed. Hours after Paulson made his round of calls to calm the industry, word leaked out that an added $1 trillion bailout of banks was being readied. Investors cheered. At about 3 p.m., news of the plans was filtering up and down Wall Street, fueling a 700-point advance in the Dow Jones industrial average through 4 p.m. Friday.

By that time, Paulson had announced the plan. It included insurance on money market accounts, a move that started in quiet Thursday morning, when the former Goldman Sachs executive saved the country from a paralyzing meltdown.

Fannie, Freddie Subprime Spree To Add to Bailout
Freddie Mac Chief Executive Officer Richard Syron stood before investors at New York's Palace Hotel in May last year lauding his company's "cautious" avoidance of the subprime-mortgage crisis.

What Syron, who was ousted last week, didn't say was that Freddie Mac had been gorging on subprime and Alt-A debt. While it and the larger Fannie Mae bought the safest classes of the mortgage-loan pools, Freddie's purchases totaled $158 billion, or 13 percent, of all the securities created in 2006 and 2007, according to data from its regulator and Inside MBS & ABS, a Bethesda, Maryland-based newsletter used by Federal Reserve researchers. Fannie, which was also seized by the U.S. on Sept. 7, bought an additional 5 percent.

The purchases by Freddie and Fannie helped fuel the boom in lending that led to frozen credit markets, more than $514 billion in bank losses and the collapse of two of the country's biggest securities firms. The subprime overhang may determine whether the $200 billion U.S. Treasury Secretary Henry Paulson earmarked for the companies will all be used to rev up mortgage lending. He may have to spend about $300 billion, William Poole, the former Federal Reserve Bank of St. Louis president, said in a Bloomberg Television interview this month.

The final sum "is going to depend on how fast these losses accumulate," said Poole, 71. The deficit may grow quickly because the companies may be "carrying some of these assets at prices above where they should be." Treasury spokeswoman Jennifer Zuccarelli declined to comment. The department's capital injections will keep the companies from defaulting on their almost $6 trillion of debt and mortgage-backed securities.

Fannie Mae's 5-year yield traded at 0.78 percentage point above 5-year U.S. Treasuries at 9 a.m. New York time, compared with 0.94 before the bailout, according to data complied by Bloomberg. Fannie Mae of Washington and McLean, Virginia-based Freddie Mac held $114 billion of subprime and $71 billion in Alt-A securities as of June 30, according to the companies.

Subprime mortgages were given to people with poor credit scores. Alt-A loans, which rank between subprime and prime, were made to borrowers with better credit who provided no proof of income, bought property for investment or took out so-called option adjustable-rate mortgages.

"We've heard a lot of people stand up and say, `Fannie and Freddie really did not promulgate the problems; they weren't big players,"' said Joshua Rosner, an analyst with Graham Fisher & Co., an independent research firm in New York. "Actually, they were."

The biggest suppliers of the securities to Fannie and Freddie included Countrywide Financial Corp. of Calabasas, California, as well as Irvine-California-based New Century Financial Corp. and Ameriquest Mortgage Co., lenders that either went bankrupt or were forced to sell themselves. Fannie and Freddie were the biggest buyers of loans from Countrywide, according to the company.

Fannie and Freddie, which were taken over by the Treasury and the Federal Housing Finance Agency, the new regulator created for the companies last month, reported writedowns of less than $2.9 billion on those securities. Their actual value had declined by $40 billion more as of June 30, though the losses were deemed temporary, according to the companies. They've probably dropped at least an additional $5 billion in value since, according to Moshe Orenbuch, an analyst at Credit Suisse in New York.

"I'm sure there will be some sizable losses," Orenbuch said. The companies said actual losses on the securities aren't likely to be that large. Freddie won't lose anything on about 95 percent of its uninsured subprime bonds unless more than 90 percent of borrowers already two months late are foreclosed upon and more than half of the rest default, according to slides from a company presentation in August.

Fannie and Freddie also guaranteed from $470 billion to $873 billion of debt backed by borrowers with credit scores below 700 out of a possible 850, less than 20 percent of the starting equity in their homes, or both, according to calculations by FTN Financial based on public disclosures about their mortgage securities.

The companies face losses on those and other guarantees, Rosner said. FTN, the securities arm of First Horizon National Corp. in Memphis, Tennessee, has underwritten Fannie and Freddie debt sales. The two companies, created to increase home ownership and provide market stability in times of turmoil, own or guarantee more than 40 percent of U.S. residential mortgages.

They make money by buying both home-loans and mortgage- backed securities, funding their purchases with low-cost debt. They also guarantee home-loan securities, putting their AAA rating behind the debt to attract investors. The firms mainly buy debt guaranteed by each other and U.S. agency Ginnie Mae, known as agency mortgage securities.

The companies said they were urged to increase purchases of subprime debt by the Bush administration. The Department of Housing and Urban Development said in 2005 that Fannie and Freddie should increase financing for low-income areas or moderate-income regions with high minority populations to 37 percent of new business from 34 percent in 2001 through 2004. That rose to 39 percent last year.

The updated goals "were significant enough to force them to go down the credit curve to meet them, which meant participating in some way or form in the higher-risk areas of the mortgage market," said David Stevens, a former head of Freddie's single- family mortgage business who now runs lenders affiliated with Long & Foster Real Estate Inc. in Fairfax, Virginia. That included "the subprime business."

Leveraged loan values drop to record low: more bank losses
The value of leveraged loans fell to record lows during the past week, creating further potential mark-to-market losses for both investors and banks. The average bid on the most traded US leveraged loans dropped 330 basis points to an all-time low of 84.28 per cent of face value, according to data from Standard & Poor’s LCD and Markit.

The average bid for Europe’s most traded leveraged loans fell to its lowest level in seven months but, across a broader range of loans, the average price also fell to a historic low. Leveraged loans are those secured on assets generally to speculative grade borrowers and used primarily to finance buy-outs by private equity funds.

Loan market prices reached never before seen lows in February as a result of forced selling as falling prices led to the unwinding of market value-linked structures holding loans, which further exacerbated the downward spiral in prices. This left loan investors licking wounds and some banks that mark to market – mark their books according to the market value of the assets – having to make further writedowns on their leverage loan books in their first-quarter 2008 earnings.

Since the rescue of Bear Stearns in March, prices in the loan market had recovered as funds stepped in to pick up bargains. But last week’s global financial turmoil also hit the loan market and threatens to create further losses. Simon Hood, joint head of leveraged loans and mezzanine debt at European Credit Management, said: “With renewed volatility in the stock market and concern about the economic situation, a dawning of reality that the economy will get worse has taken over and we have seen a drift downward of prices, accentuated by recent events.”

The spread between the price at which traders were quoting bids and offers nearly doubled, indicating a level of uncertainty and illiquidity not seen since last August when the credit crunch hit. Mr Hood said buyers were sitting on the sidelines awaiting stability before investing. He said: “We are seeing some senior secured debt trade below 50 cents and some of the flow names [most traded loans] in the low-80s, which is extraordinary, presenting a buying opportunity”.

The average bid of most traded European loans fell 197 basis points, closing at 86.31 per cent, based on pricing from Markit.
LCD’s broader composite of loans fell to a new record low of 84.47 per cent, marking the sharpest weekly decline in six months, according to LCD. While the fall in loan prices threaten losses for banks that mark to market, banks’ funding needs are the main concern, according to Matt King, a credit strategist at Citigroup, particularly as much of the backlog of leveraged loans that had been weighing on banks has been reduced.
A sale of about $630m of the assets of a collapsed complex structured vehicle has highlighted that the value of this kind of mortgage-backed debt remains heavily distressed, writes Anousha Sakoui. Investors face losses of 75 per cent of the value of the once top-rated debt they bought issued by the Mainsail II structured investment vehicle, which fell into receivership after the credit crunch led to a fall in the value of its asset portfolio.

KPMG, the receiver, pressed ahead with an auction on Thursday illustrating investors’ eagerness to dump toxic assets, even at low prices, on expectations valuations would not improve. After indicative bids of about 20 per cent of face value on Monday for the securities, 12 banks bid 16.35 per cent at the auction, according to a person familiar with the sale.

Investors holding senior debt can hope to recover just over 25 per cent of the original investment by cashing out of the vehicle. The investors were described by one person close to the restructuring as treasury departments of some leading US companies and government entities. Some 45 per cent of the $1.4bn face value of the portfolio of assets were sold at the New York auction.

It is the third in a series of auctions held as part of a restructuring of five SIVs, holding about $18bn of assets, that collapsed as a result of the credit crunch. Mainsail II, a $1.4bn vehicle originally run by Solent Capital in London, was in April placed under the control of KPMG receivers who agreed in August to a restructuring arranged by Goldman Sachs.

Investors in the vehicle had a range of options, including taking a cash pay-out or reinvesting in a new vehicle through a so-called pass-through note. The assets not sold will be transferred to a new vehicle set up by Goldman Sachs, which will issue the pass-through notes.

Treasuries Irresistible as Deflation Trumps Paulson
As details of Treasury Secretary Henry Paulson's plan to revive the U.S. financial system by pumping as much as $700 billion into the markets emerged Sept. 19, bond investor Michael Cheah was reminded of Japan.

When that country's real estate bubble burst, leaving a trail of bad real estate loans, officials flooded the economy with cash only to see banks hoard the money instead of lending it out. The result has been a series of recessions and persistent deflation for more than a decade.

"Although the government tried to debase the yen by printing a lot of government bonds, the economy went into a standstill," said Cheah, an official at the Monetary Authority of Singapore from 1991 to 1999 who manages $2 billion at AIG SunAmerica Asset Management in Jersey City, New Jersey. "The banks used the money to buy safety. I see a repeat happening here. The banks will use it to buy Treasuries."

While U.S. bonds tumbled on the plan to buy soured mortgage-related assets from financial institutions in the most far-reaching federal intrusion into markets since the Great Depression, they still ended the week little changed. To investors such as Cheah, that's a clear sign the economy is facing many of the same risks that have afflicted Japan. The yield on the benchmark 30-year Treasury bond, which stands to benefit the most of any government maturity from a drop in inflation expectations, fell to 3.89 percent last week, the lowest level since the U.S. reintroduced the security in 1977.

Only Japan offers inflation-linked bonds that pay lower rates than similar securities issued by the Treasury. For maturities up to four years, the difference in yields between Treasury Inflation-Protected Securities and nominal bonds is 1 percentage point or less. The so-called breakeven rate represents the pace of inflation investors expect over the life of the securities.

"The current U.S. situation is the same as Japan's case," said Hiromasa Nakamura, senior fund investor at Tokyo-based Mizuho Asset Management Co., which oversees $36.5 billion as part of Japan's second-largest bank. "The economic slowdown and credit crunch are creating a downward spiral." Nakamura, who correctly forecast the rally in Treasuries last year, said two-year note yields will fall to 1.1 percent by year-end, while the 10-year will decline to 3 percent.

Just last month, traders, concerned that rising food and energy costs were trickling into the broader economy, saw a 65 percent probability the Federal Reserve would raise borrowing costs by the end of 2008 to contain consumer prices. Now, there's a 100 percent chance its 2 percent target rate will either stay the same or be cut, futures on the Chicago Board of Trade show.

The Labor Department in Washington said last week that consumer prices fell 0.1 percent in August, the first decline in almost two years, as fuel costs dropped from record levels. The yield on the 10-year Treasury is 1.55 percentage points below the consumer price index, the most since 1980 and a sign that traders expect inflation to slow. The yield typically averages about 3.4 percentage points more than inflation.

Traders think "they're looking at Japan," said Dominic Konstam, head of interest-rate strategy at Credit Suisse Securities USA LLC in New York, one of 19 primary dealers that trade with the Fed. The U.S. has far to go before matching what Japan has gone through. Since 1995, inflation in the world's second-biggest economy after the U.S. has averaged zero percent, while growth has averaged 1.4 percent. The Bank of Japan maintained what it called a "zero interest-rate policy" from 2001 through 2006 to try to stimulate the economy.

Rather than a decline in consumer prices, a more likely scenario is a slowdown in inflation, said Stewart Taylor, a senior investment-grade debt trader at Boston-based Eaton Vance Management, which oversees about $6 billion of taxable bonds. "Do we move into full-blown deflation as opposed to disinflation? I doubt it," he said.

Instead of a referendum on inflation, much of the rally in bonds may be tied to investors seeking a haven from financial market turmoil that led to the government's takeover of Washington-based Fannie Mae, Freddie Mac in McLean, Virginia, and American International Group Inc. of New York and the bankruptcy of New York-based Lehman Brothers Holdings Inc.

Some of that flight to safety was reversed Sept. 19 after Paulson and Fed Chairman Ben S. Bernanke announced a plan to buy troubled assets from financial institutions. The U.S. may have to borrow an extra $700 billion to $1 trillion to fund the rescue of the financial system, flooding bond investors with more supply, according to Barclays Capital Inc. interest-rate strategist Michael Pond in New York.

Bond bulls point to a still weakening housing market for why they expect inflation to slow and yields to remain low. Home prices have plunged 19 percent on average from their peak in July 2006, according to the S&P/Case-Shiller index of 20 cities. Economists at New York-based Goldman Sachs Group Inc. said this month they expect prices to drop another 10 percent.

Though consumer prices in the U.S. rose 5.4 percent in August from a year earlier, the Goldman economists noted it took almost four years "from the bursting of the financial bubble in 1990 until prices first fell on a year-over-year basis" in Japan. The housing weakness is causing consumers to cut back on spending. The Labor Department in Washington said last week that new-vehicle prices dropped 0.6 percent in August, the most since November 2006, and hotel fares tumbled 1.1 percent.

"There are deflationary events out there and debt default is one of the primary drivers," said Jeffrey Gundlach, chief investment officer at Los Angeles-based TCW Group Inc., which oversees $90 billion in fixed-income. "It's what they call a debt deflation cycle, and there's definitely one underway."

The percentage of Treasuries in a diversified bond fund Gundlach manages is the highest it's ever been, he said. The world's biggest banks have taken more than $500 billion in writedowns and losses on securities tied to subprime mortgages since the start of 2007, according to data compiled by Bloomberg. Almost a year ago, Goldman economists said just $400 billion of losses would cut banks' lending by $2 trillion.

"There's a huge amount of deflationary pressure when you get this kind of capital destruction," said Brian Edmonds, head of interest rates at Cantor Fitzgerald LP in New York, another primary dealer.

G-7 Leaders Welcome ‘Extraordinary Actions’
Anyone in Congress looking to stand in the way of the Treasury Department’s $700 billion Wall Street bailout proposal will have to dismiss the views of not just U.S. finance officials but those from other major economies. The G7 — a group of finance ministers from Canada, France, Germany, Italy, Japan, the U.K. and U.S. — issued a statement Monday morning after officials convened by conference call.

“We strongly welcome the extraordinary actions taken by the United States to enhance the stability of financial markets and address credit concerns, especially through its plan to implement a program to remove illiquid assets that are destabilizing financial institutions,” reads a statement by G7 finance ministers and central bank leaders. “We also strongly welcome the measures taken by other G-7 countries.

Major central banks have been coordinating to address liquidity pressures in funding markets, which has been critical in addressing disruptions in global financial markets. Several regulators have taken decisive actions to combat market manipulation and stabilize financial markets, including a temporary ban on short selling of financial stocks.”

Treasury Secretary Henry Paulson said over the weekend that mortgage securities owned by foreign financial institutions operating in the U.S. would indeed be eligible for the program. Lawmakers haven’t yet objected to spending taxpayer money on foreign banks. Mr. Paulson said U.S. officials are urging other governments to draw up similar plans.

The G7 statement said officials hope to improve regulation, risk management practices, disclosure and accounting frameworks. “We pledge to enhance international cooperation to address the ongoing challenges in the global economy and world markets and maintain heightened close cooperation between Finance Ministries, Central Banks and regulators,” the statement said.

“We are ready to take whatever actions may be necessary, individually and collectively, to ensure the stability of the international financial system.”

Paulson Says Several Countries May Adopt Bank Rescue Plans
Treasury Secretary Henry Paulson said he's confident several countries will take steps comparable to the $700 billion plan he proposed to buy bad mortgage-related securities to address the global financial crisis. "We are talking very aggressively with other countries around the world and encouraging them to do similar things, and I believe a number of them will," Paulson said on ABC News' "This Week" program.

Paulson yesterday asked Congress for unfettered authority to buy devalued mortgage-related securities from investment firms in an effort to keep the financial system from coming to a standstill. The proposal would prevent courts from reviewing the Treasury's actions while raising the nation's debt ceiling.

German Finance Ministry spokesman Stefan Olbermann said members of the Group of Seven industrial nations are in "ongoing talks about the situation on financial markets worldwide." Finance ministers from the G-7 countries meet in Washington on Oct. 10. Asked about the U.S. plan, Olbermann said, "We have to see if and to what extent those measures make sense for Germany."

The U.K. currently has no plans to set up such a fund, a British Treasury official said. Prime Minister Gordon Brown today said "in relative terms, we've done a huge amount" by giving banks access to more than 100 billion pounds ($183 billion) under a Bank of England program that allows them to swap bonds hurt by the collapse of the subprime mortgage market.

While a French finance ministry spokesman declined to comment on Paulson's latest remarks, Finance Minister Christine Lagarde spoke with U.S. officials during the week and told Europe 1 radio today that the U.S. response had "allowed us to avoid a systemic crisis." "We have obstacles to overcome," Lagarde said.

The U.S. Treasury late yesterday modified its proposal to allow for purchases from institutions outside of the U.S., a step Paulson today said was needed to mute the impact of the credit crisis in the U.S. "As you think about this, if a financial institution has business operations in the United States, hires people in the United States, if they are clogged with illiquid assets, they have the same impact on the American people as any other institutions," he told ABC News.

Lehman Sale to Barclays Challenged by Hedge Fund
Bay Harbour Management LC, a hedge fund that invests in the debt of bankrupt and distressed companies, challenged a court order approving the sale of Lehman Brothers Holdings Inc.'s North American business to Barclays Plc.

Bay Harbour didn't disclose the grounds for the appeal in a court filing today in U.S. Bankruptcy Court in New York. Bay Harbour and another hedge fund, Amber Capital, filed objections in Lehman's bankruptcy case last week, claiming $8 billion was improperly transferred out of the failed investment bank's European units prior to its collapse.

Bay Harbour, a customer of Lehman's prime brokerage business, said in a court filing that money it deposited with the New York-based bank "appears to have been siphoned from London to the United States as part of an $8 billion asset transfer and then 'trapped' by the midnight bankruptcy filing." This happened, "despite repeated assurances of the integrity of the cash," according to Bay Harbour's Sept. 19 objection.

Appeals of bankruptcy court orders usually go to the U.S. district court in that jurisdiction. Lehman filed the largest bankruptcy in history on Sept. 15. The bank won approval from U.S. Bankruptcy Judge James Peck on Sept. 19 for the $1.75 billion sale to London-based Barclays. Peck overruled objections from New York-based Bay Harbour and other Lehman creditors who said the sale was moving too quickly.

While Peck's approval was intended to clear the way for Barclays, the U.K.'s third-biggest bank, to quickly complete the transaction, appeals may slow that process. All creditors who filed an objection to the sale may appeal.

Banking Bailout, Danish Style
Another day, another banking bailout. Denmark's central bank said Monday it was securing liquidity at Ebh Bank, its second bailout of a struggling Danish lender in 10 weeks after it got Roskilde Banks out of trouble last August.

Ebh had experienced increasing loan provisions since it cut its profit outlook last Sept. 11, the bank said in a press release. "In this connection a number of banks and the central bank secured the needed liquidity so that Ebh Bank will be able to continue current operations."

The Fjerritslev, Denmark-based firm also said it was selling its subsidiary companies with the aim to prepare itself for a merger or sale. The bank has about 350 employees. At the end of last year, it had deposits of 3.6 billion Danish kroner ($703 million) and lending of 7.8 billion Danish kroner ($1.5 billion), according to its 2007 annual accounts.

The bank said it now expected a profit of zero crowns for the full year. On Sept. 11, it lowered its 2008 pretax profit outlook to between 110 million Danish kroner ($21 million) and 130 million Danish kroner ($25 million), due to continued negative development in the Danish property market.

Last August, the Danish central bank and several other private lenders announced they were paying 41.8 billion Danish kroner ($8.3 billion) to take over Roskilde Bank and effectively nationalize it in an effort to save the collapsed bank. Last week, two Danish lenders, Lokalbanken Nordsjaelland and Forstaedernes, agreed to be bought by larger peers.

But following the massive write-downs last week, the bailout plan by the U.S. government and the recent news on Ebh, are more banking bailouts on their ways in Europe? "It depends how these helping plans will be taken forward," said Nikolai Schill, an analyst with LBBW. "After the European Central Bank injected more liquidity into the banks last week, there is more security in the markets."

But David Powell, a banking analyst with Bank of America, believes banks are still in a fragile position. "From the outside, we don't know the risks of the banks' balance sheets. But we could expect further trouble in the banking sector as a result of risky positions."

"I hope we are not in the same roller coaster in the equity markets as last week. We will see an improvement in market sentiment as we get more detail of the U.S. government bailout plan," he added.

Oliver Gilvarry, head of research with Dolmen Securities in Dublin, believes the majority of banks are well capitalized. "The ECB cash injection has taken the pressure off the banks. But I would expect more consolidation in the banking sector," he said.

Measures taken last week may only be storing more trouble
Is that it? One minute, the world stands on the brink of financial apocalypse - the future of capitalism in jeopardy. The next, governments spend $1 trillion or so bailing out the lucky banks left standing; share prices bounce back with a single leap to where they were before the crisis and a few scapegoats are strung from the nearest lamppost. Dogs bark, the caravan moves on.
There are plenty who wish it so. In America, the official explanation for the events of the last seven days is that the crisis was a localised problem with the US housing market. Banks got into trouble because they were unable to trade the bad mortgages that had accumulated during the property slowdown. By placing all this debt to one side in a government-funded "bad bank", the obstruction is removed and the wheels of finance can turn again.

To the extent there was anything wrong with the rest of the engine of commerce, some regulatory tweaks are all that is necessary. Hank Paulson, the US Treasury secretary who was the architect of Friday's rescue plan, described the financial and regulatory system simply as "suboptimal, duplicative and out-of-date".

In the UK, the agreed script differs only in the prominence given to the scapegoats. Following the government-orchestrated rescue of Britain's biggest mortgage lender, HBOS, regulators moved quickly to stamp out the practice of short-selling: whereby hedge funds and other speculators make money betting that a company will go down and in doing so contribute to it going down. The message behind the ban was that otherwise solid institutions like HBOS were being brought to their knees by hedge funds.

Others believe there is much more to the story than a temporary bout of madness brought on by a few American mortgage defaults. Events have moved at such giddying speed over the last week that it has been hard even for market professionals to make sense of what was really behind the chaos.

But the ease with which the world's most powerful institutions were brought to the precipice suggests something deeper is to blame: "the banks fell over like fat Labradors running over a wet kitchen floor," as one hedge fund manager put it. Worse still, governments were powerless to stop the crisis spriralling out of control - right up to the point of suspending all the normal rules of the free market.

The original strategy had been to erect a series of firebreaks to protect healthy institutions from the contagion around them. Though Northern Rock provided a domestic foretaste one year ago, the first of the really big firebreaks came in March when New York investment bank Bear Sterns was rescued with the help of $30bn from the US Federal Reserve.

Next, US mortgage giants Fannie Mae and Freddie Mac had to be rescued two weeks ago with a further $100bn nationalisation. A week later, Lehman Brothers was left to burn in the hope of blowing the fire out. Then events really sped up. In the panic, Merrill Lynch and HBOS - two of the biggest names in finance - had to be sold to whoever would take them.

Another $85bn firebreak was hastily erected to protect AIG, the world's largest insurer, but it was too late: the inferno was raging right in the heart of the global financial system. Morgan Stanley, Goldman Sachs and, with them, every bank in the western world, felt the flames at their feet. Cynics will argue that Mr Paulson, a former chief executive of Goldman Sachs, concocted Friday's $800bn housing nationalisation to save his alma mater: in reality he had little alternative but to dynamite the capitalist edifice to save not just Wall Street, but the American way of life.

The fear was, and is, that a crisis so analogous to the Great Crash of 1929 could easily herald a repeat of the Great Depression of the 1930s. Then, the desire to punish banks and return to balanced budgets exacerbated the pain - encouraging protectionism, autarky and fascism. This time, central banks have heeded the advice of 19th century British writer Walter Bagehot, the father of modern central banking, who said it was the responsibility of governments to step in when things got really bad and restore confidence.

"Lend freely, boldly, and so that the public may feel you mean to go on," he wrote. Bagehot even predicted how ineffectual the firebreak approach might be: "To lend a great deal, and yet not give the public confidence that you will lend sufficiently and effectually, is the worst of all policies."

Still, Mr Paulson may be forgiven for wobbling. At the back of his mind will also be the knowledge that this approach can merely store up even bigger problems for the future. Many blame the recent debt bubble on Alan Greenspan, the former US central banker, who cut interest rates aggressively to save the world economy after the dotcom bubble burst in 2001.

Indeed, that bubble was blamed on Mr Greenspan's generous response to the Asian financial crisis and Russian default of the 1990s. The seeds of each successively larger financial crisis have arguably been sown by those who tried to minimise the pain of the last crisis: a cycle more accurately predicted by Karl Marx than Walter Bagehot.

Capitalism may not yet be destroying itself, but Anglo-Saxon finance is looking as weak as it has been for decades. What makes this far more than a bad debt problem is the inability of banks to work out their exposure due to the increased complexity of modern finance. AIG was so toxic to stability because it offered insurance on whether other companies would go bust.

These credit default swaps were then sold on to other investors, making it all but impossible to establish where the buck stopped. It is for this reason that many financiers worry whether their world will ever recover from last week's trip to hell. The vast majority of the growth in investment banking has come from these very derivative products that are now seen as too toxic to trade.

Throw in the devastating effect that the ban on short-selling will have on the hedge fund community and you have the recipe for job losses in the hundreds of thousands. The City and Wall Street may never look the same again.

Such doom and gloom might look overdone after a Friday when shares rose at their fastest ever rate, but it is hard to avoid the feeling that last week marked a shift in power away from the established financial centres and toward the emerging economic giants of the East. Though Russia went through its own crisis, China was remarkably unscathed.

The biggest irony is that just as the US Treasury is now standing behind the US banking system as the lender of last resort, the Chinese government stands behind the US Treasury as its lender of last resort. Were the Chinese to stop recycling their giant trade surplus by buying up US government debt, the resulting panic could make last week's crisis look like a storm in a teacup.

Given how bleak the picture still looks for the US and UK, the sight of bankers receiving billions of dollars of public support is unlikely to go down well with voters. With an election looming in America and a febrile political climate here, it is likely that politicians will extract a terrible price in return for their largesse - not just in the form of more regulation but in a direct challenge to the turbo-capitalism practised by the investment banks. Those with experience of both political and business worlds understand this challenge all too clearly.

"Our financial system cannot continue to stand this game of speculators preying on the weakest firms - and trying to destroy them for profit," said New York mayor Michael Bloomberg. "There will always be a weakest firm and we have to under-stand that our country's future is connected to our ability to work together instead of trying to tear each other down.

Short Sellers Keep the Market Honest
We are currently witnessing one of the periodic financial convulsions that inevitably follow eras of easy credit and lax regulation. As someone once said: "Politicians and people who lose money always need someone to blame." So who is to blame now? According to the guardians of our economy, it's the short sellers, those investors who believe certain stocks are overvalued for fundamental reasons.

In the latest of a series of constantly changing rules announced overnight without public comment or participation, the Securities and Exchange Commission has imposed a ban on short selling 799 financial companies through Oct. 2. But the regulator has yet to put forward any supporting data, or a clear justification, for this and prior emergency actions against short selling this summer.

Meanwhile, the causes of the collapse in the financial sector go ignored. Never mind that months ago short sellers were warning about the problems we now see undermining American capitalism. In the spring of 2007, I joined another fund manager in outlining to finance ministers and central bankers (at a G-7 finance ministers meeting) the looming crisis in credit structures and overleveraged banks and brokerage firms. Our audience listened politely, but, as events now show, failed to take any meaningful action.

These are extraordinary times, and, as participants in the capital markets, we need to support the commission's efforts to ensure that fraud and manipulation have no place in this market. But the haste, confusion and scapegoating that has ensued may well do more harm than good. Unfortunately, the recent spate of hurried actions may worsen the quality of our capital markets at a time when we need to attract investors -- both pessimists and optimists -- by promoting deep liquidity, vigorous price discovery and open competition. These are the key factors in determining the value of securities.

This tale is not a new one. Short selling has been misunderstood and maligned throughout history. In the 1630s, England banned short selling after tulipmania collapsed in the Netherlands to prevent a similar fallout in England. More recently in Malaysia and Pakistan, short sellers have been faulted for stock-market busts. In the U.S., we've seen how corporate executives have tried to place the blame for their failures on short sellers instead of on themselves.

In the end, short sellers -- not management -- defended honesty in the pricing of shares by demanding accountability. Short sellers openly warned about the problems at Enron, Tyco, Fannie Mae and Freddie Mac before their meltdowns. And when it comes to investigating corporate fraud, it's the short sellers who are the detectives, while all too often our regulators practice archaeology. Indeed, my firm was among the first to raise red flags about Enron's finances.

The vast majority of equity short sales are market neutral; the short seller has no fundamental view of a company's outlook but is taking a short position to hedge risks. A short seller may want to lock in a spread, hedge a convertible bond by shorting the same company's equity, or add liquidity in mergers by buying the target company and shorting the survivor. As Warren Buffett has acknowledged, though, "it's a tough way to make a living," because over time stock markets rise more than they fall, the transaction costs are high, and the risks great.

Regardless of the reasons why an institution may take a short position, there is an important fact to keep in mind: Compared to the total volume of securities transactions, short selling comprises roughly 4% of total shares outstanding on the New York Stock Exchange. Short-biased funds make up a small fraction of the $2 trillion managed by private investment companies.

Still, when times get tough, the accusations fly, even though most research suggests investors and financial markets benefit from short selling. Specifically, short sellers act as "safety valves." Their transactions help to bring share prices to levels supported by the fundamentals, decreasing the likelihood of price bubbles. Short selling also improves market quality and efficiency by narrowing spreads, improving the speed of price adjustments based on new information, and pumping liquidity into the market.

In the past, SEC Chairman Christopher Cox and Federal Reserve Chairman Ben Bernanke have both expressed their views that short selling is valuable. They make the point that overinflated securities prices waste valuable capital and harm investors, as occurred in the dot-com bust in 2001. "We need the shorts in the market for balance so we don't have bubbles," said Mr. Cox. But in a week when the markets froze, assets became untradeable, and investor trust plummeted, policy makers rushed to stop the bleeding. In the unfolding drama, short sellers were an easy target and quickly cast as the Darth Vaders of Wall Street.

I believe the SEC was tough but balanced with the three initiatives announced last Wednesday. Broker-dealers who lie about their ability to deliver borrowed securities should face the consequences under anti-fraud rules. And, broker-dealers should deliver stocks sold in a short sale within three days of a trade. But apparently this was not enough. After last Wednesday's announcement, pressure mounted for the SEC to do even more as its counterpart in London ratcheted up its regulatory responses. By evening on "Black Wednesday," the SEC had decided to require investment managers to publicly report their short positions weekly.

I believe the SEC has every right to obtain and review information about short positions for market surveillance purposes, but forcing public disclosure will have serious consequences for the market. Companies may retaliate against short sellers. Fund managers will lose their ability to manage assets without revealing their strategy. Other traders will "pile on," and may trigger panicky selling if an investor sees that noted short sellers have shorted the stock.

On Friday, the SEC went even further with its short-selling ban, following a similar move by the Financial Services Authority in the United Kingdom. Halting trading activity will only worsen market conditions and exacerbate volatility, hindering the ability of markets to do what they do best. Economists have long believed that market prices are best set by a variety of viewpoints, including by those with no previous ownership interest. In the financial markets, that latter group is the short-sellers.

As a former SEC chief economist aptly observed, "To ban short selling is to in effect say that the government is going to try to determine what stock prices should be."

For our investors and our country to emerge with strength from these extraordinarily difficult times, it is imperative that our regulatory bodies respond in a way that appropriately balances vigilant protection of investors with open, vigorous competition. Closing down short sellers will not work to help the U.S. maintain the freest, strongest and most liquid capital markets in the world.

Computers are the only worthwhile asset banks have left
Every cloud has a silver lining. Ask the cybersquatters. Even as the short-selling vultures began circling Lehman Brothers, HBOS, Merrill Lynch and co, a legion of entrepreneurs began betting on domain names for hastily merged financial institutions. For example, when Barclays and Bank of America began to emerge as buyers for Lehman, names such as and were promptly registered by enterprising hopefuls.

Some of these domains were being offered for sale on eBay last week. For example, was available at a starting bid of $1,500. 'With a deal between Bank of America and Merrill Lynch NOW ANNOUNCED', burbled the seller, 'this domain name will soon be incredibly popular. This is the only domain name that conveys the full picture, using the name of both firms... This is the most comprehensive and commonsensical domain name available concerning the MERGER OF BANK OF AMERICA CORP AND MERRILL LYNCH & CO.'

The last time your columnist checked, however, the auction had attracted no bidders. Still - nothing ventured, nothing gained. The proud owner of, for his part, disdained eBay and simply set up a website with lots of ad links, clearly hoping to squeeze some Google juice from his property while waiting for the lawyers to call. Hope springs eternal in some breasts.

But this is merely froth. Wall Street banks have become insatiable consumers of IT services and some of the fallen giants had built up formidable computational resources, which were viewed by their purchasers as virtually the only non-toxic assets that they possessed.

According to specialist website, Lehman Brothers' two data centres were central to the deal in which Barclays paid $1.75bn to acquire most of Lehman's North American operations. The data centres and Lehman's headquarters building 'accounted for $1.5bn of the deal's value, with the British bank paying just $250m in cash for Lehman's North American investment banking and capital markets businesses,' it said.

The breakneck consolidation of the banking sector is going to have a major impact on industries that supply banks with IT products and services. Within institutions, the imperative will be to minimise avoidable turmoil in the infrastructure. That means, for example, planned upgrades to Vista suddenly become non-starters - which implies that the related purchase of higher-specification PCs may also be postponed.

So the crash will affect Microsoft (which is refusing to reveal data about how many Vista licences have actually been activated) and hardware vendors such as Dell, Lenovo and HP. There will be pressure on IT departments to reduce headcount and budget. There are, of course, some areas where economising isn't an option: banks running trading systems with millisecond response times will still need very expensive, on-site technical support. But managers will be searching for ways of trimming the costs of supporting more routine office functions.

In those circumstances, options like 'grid computing' and web services - where IT services are supplied by servers over the internet - may suddenly begin to look more attractive. Harassed managers may also start to look at open-source software as a way of avoiding expensive licensing deals for proprietary applications.

The waves generated by Wall Street Crash 2.0 will also wash up on very distant shores. Expect to see them in Bangalore, for example, and other Indian centres that have ridden the boom in outsourcing of IT support. As Western institutions disappear or merge, there will be a need to liquidate or consolidate the service contracts they have with Indian companies. So service businesses that looked rock-solid six months ago are in for a turbulent time.

As always in financial crashes, there will be opportunities for those who - like Barclays with Lehman - can spot an opening. There's been a niche market for years in software for assessing credit risk. Developers who come up with smarter algorithms for spotting turkeys can expect to name their price. Oh - but if you were thinking of registering or, forget it: they're already taken.

A Sense of Resentment Amid the 'For Sale' Signs
The bailout doesn't smell right to the people of Manassas Park, where the foreclosure signs are as common as azaleas. They know all about bad debt here. This is a terrain of oversize dreams, misjudgment, financial calamity -- and empty houses. "Foreclosure. Foreclosure. Foreclosure," said Ed Merkle, 58, as he pointed to the "for sale" signs lining his street.

But Merkle, a defense contractor, said he has lived within his means in an era of easy credit. He didn't take on a huge loan even when his bank encouraged him to dream bigger. "I've been financially responsible with my own money. Why should I now be responsible for the fact that you were not?" he said.

This may be a Main Street bailout backlash in the making. The details of the financial crisis are still hard for most people to follow -- what with talk of exotic "derivatives" known as "credit-default swaps" and so on -- but the central fact of the matter hasn't been lost on anyone in this Northern Virginia community: The taxpayers are on the hook for the bad judgment of others.

And they say they don't like it. They didn't break it, but now they've bought it. Political leaders and financial titans say the bailout is necessary to save the economy, but on the ground, in such places as Manassas Park, people think that the bailout will reward the wrong people. There's a sense that too many folks bought houses they couldn't really afford, banks urged them on, common sense went on vacation, and now the grown-ups have to clean up the mess.

"If I spent more money than I have, I don't deserve to have somebody bail me out," said John Owens, 45, a developer who lives on Eagle Court, where three houses have gone through foreclosure. The anti-bailout sentiment appears to cut across class lines. You hear it from one end of Manassas Drive, the main drag through town, to the other -- from the small, Cape Cod-style homes built with G.I. Bill money after World War II to the muscle-bound houses newly risen along the golf course.

"I'm worried that the taxpayers are going to wind up paying for all this," said Arlena Elbaraka, 38, who lives in the manicured neighborhood of Blooms Crossing. "Who ends up losing from all this? Us, right?" asked Rogelio Benitez, 36, a home-improvement contractor who lives with his wife and six kids in a working-class neighborhood on the western edge of town.

"I'm not overextended," Merkle said. "I didn't buy a large home that I can't afford. I'm not behind on any of my payments. I'm not sure I want the government to take my tax dollars and buy someone else's house for them." The comments suggest that the bailout could pose a stiff new challenge for presidential candidates and anyone else running for office this fall. The wisdom of the government's massive financial intervention hasn't been marketed to the masses.

The nation's financial and political leaders are working round the clock to repair the shattered markets, and no one, from the White House on down, has spent more than a few minutes explaining to the American people why they're being asked to assume hundreds of billions of dollars of liabilities.

President Bush said little all week. Finally, in remarks in the Rose Garden on Friday, the president said, "These measures will require us to put a significant amount of taxpayer dollars on the line." All the rescue efforts combined may approach a trillion dollars.

In a press availability Saturday, standing alongside Colombian President Alvaro Uribe, Bush spoke to the concerns of "Main Street."
"You know, you hear them talking about Wall Street and Main Street -- well, this is Wall Street plus Main Street, and I'm worried about Main Street," he said. He recounted a conversation with Treasury Secretary Henry M. Paulson Jr. and other officials: "I said, what's it going to take to make sure Main Street doesn't get affected by the policies of Wall Street? And this is what they came up with, and this is a big ticket, because it's a big problem."

In Manassas Park and nearby communities in Prince William County, many people see the bailout as a violation of the basic rule that people and institutions must live within their means or face the consequences. Kevin Newman, 42, knows how hard up people can get. He owns Ace Pawn, in a shopping center on Route 28 next to a newly vacant Checkers fast-food outlet. Newman spends his day lending money to people. He sees them at their most desperate.

From a back room he pulls out a brand-new, sparkling Rickenbacker guitar that someone had gotten for his birthday and pawned just weeks later. His shop is filled with precious jewelry that people surrendered for cash. He had a customer -- he won't say who -- who pawned a Washington Redskins Super Bowl ring. And Newman knows what it's like to be broke. He went bankrupt after a daughter was born prematurely and he faced $1 million in medical bills.

"I've been on both sides of the counter," he said. Now, he never uses a credit card. If he can't pay for something out of his pocket, he won't buy it. He instinctively doesn't like the bailout. "I think our kids are going to be paying for it, and their kids are going to be paying for it, and probably their kids are going to be paying for it," he said.

Not far away, on Scott Drive, a side street off Manassas Drive, Charlie Crabill, 54, a landscaper, asks a common question in these parts: "Are they going to bail me out?" Crabill has benefited in one way from the mortgage meltdowns: He mows the lawns of about 70 houses in foreclosure, receiving a regular check from Fannie Mae.

Hours of interviews in Manassas Park turned up exactly one resident in favor of the bailout, a fellow in a Harvard T-shirt in a big house near the golf course. Richard Bejtlich, 36, who works in computer security for General Electric -- its stock jumped dramatically Friday when the government banned short-selling of financial securities -- says he's a libertarian and normally wouldn't support government intervention. But there's no other way at this point, he says, because we're in too deep of a hole and have been too profligate.

He recounts a conversation with a new neighbor who moved into a deluxe home: "How did you afford that house?" Bejtlich asked. "I don't know. I just signed," the neighbor said.


The Lizard said...

"..says he's a libertarian and normally wouldn't support government intervention."

And I'm an atheist who normally wouldn't support divine intervention.

Unknown said...

your daily writings are vital to me, and i thank you for your clarity.
i don't know how you do it, but i'm glad you do.

Anonymous said...

Oil has just jumped 20 dollars. Biggest increase ever.

rachel said...

BRILLIANT ilargi...I wondered what took you so long.

Anonymous said...

Great parody. Or did you really have their phones tapped?

This will go through with no substantive changes unless there's an uprising in the next few days--and more than the usual emails and calls to your Congressmen. They could care less.

I think they would listen to a threatened run on the banks. For example, people could all go take $700 out of their accounts in cash. Just to make a point, leave a roll of toilet paper at the bank to make the point that taxpayer dollars will go to buy securities worth less than toilet paper.

Just this once, buy your groceries and gas with cash, Maybe even pay your utilities.

The point would be:

Pass this law and we're pulling out of your fcuked system.

Safer than a general strike or taking to the streets, but it might get their attention.

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

20 dollar jump in oil, markets all wonky is this going to push that 700 billion through or what? Where did the money for oil come from?

September 22, 2008 4:12 PMCrude oil


Anonymous said...

Is this a power struggle between Bernanke and Paulson, or are they on the same page?

If reality was this easy to interpret:

Anonymous said...

ilargi: “Yeah, but time is of the essence. I don’t want more stock losses at the firm. Goldman hasn’t made a penny for too long now, and I’m going to change that. I’m losing too much on my own stock. You’ll get full Fed access, and a zillion in customer deposits you can use to write more paper. It’s brilliant, when you think about it."

Paulson sold all his GS stock before taking the current post. see KD's video yesterday.

Anonymous said...

I see your turning to those pornography girlie pics to get everybody's attention, good move, it's just like those dang country music videos, a little "T n A" to spice things up.

Anonymous said...

I am still pesimistic: The new Bush's administrative plan will do nothing but to magnify the debt. It will fail earlier than Mr. Bush will leave the throne.

phosk said...

PLEASE only show today's post on the front page. It takes two minutes to load this site on the iPhone (maybe longer on other mobile devices), due to limited CPU power.

Greenpa said...

Anonymous: "Paulson sold all his GS stock before taking the current post."

Yes, we know. Would that be Gilbert & Sullivan? And how about his friends, and his brothers, and parents, who still do own GS stock?

And so do his sisters, and his cousins, and his aunts!
His sisters and his cousins, Whom he reckons up by dozens, And his aunts!"

Ilargi said...


Thanks for the heads up. Something i hadn't thought about. I changed the setting to one day for the front page.

Anonymous said...

"This is a fine mess you've got us into Ollie!!"

For some reason, I think someone somewhere on Wall Street used that line last week...


Anonymous said...

Ilargi said...(September 19, 2008 9:31 PM
>That’s right Hyper-inflation is coming home to the grand old United States. Home of the brave, land of the debtors. <

"Please someone explain how hyperinflation is going to take place."

The US gov't will use any means to prevent deflation. The Fed can print as much money as it wishes. All it needs to do is change the laws. Unfortunately for Us Americans (and foriegns too!) Congress retains the ability to change the laws.

Already the gov't has stepped in by bailing out the GSEs, AIG, Bear Sterns (securities), and is backstopping Lehmans near worthless securities. It is also excepting everything except perhaps toilet paper as collateral for low interest rate loans (Subprime, junk-bonds, even stocks). If I recall correctly, already the US treasury dept and the Fed have commited $900 Billion in capital. Add in the $700 Billion + the $400 Billion for the Money Market Fund + $150 Billion in taxpayer stimulus, and we are over $2 Trillion in spending for 2008. I am sure that 2008 spending will be outdone in either 2009 or 2010.

Next on the list is bigger stimuleous and a long list of gov't spending programs (like the WPA, and other FDR programs of the 1930s), yet we aren't even in a serious recession yet! All this spending will expanding the money supply and result in high inflation. At some point foreigners will decide to abandon the dollar as the worlds reserve currency. When that happens, the dollar value will decline pretty rapidly, which can only lead to one outcome: hyper-inflation. The only reason why FCBs support the dollar is so that Americans can buy all there manufactured plastic pumkins. If the US did happen to enter deflation, few Americans will be buying foriegn goods. There would be no point for FCB's to support the dollar if Americans aren't buying their exports. Its likely when Americans stop buying imports that Foreign countries will be facing higher unemployment and will need to pump money into their own economies. Money that the FCBs pump into the US will evaporate. The loss of FCB support will cause the dollar to depreciate.


Welcome to the new Spendicrat party (the New Merged political party of the Republicans and Democrats). The spendicrat party only argues to supercede the spending.

[Blue Spendicrat]: we need to pass a big bailout bill to support the banks!

[Red Spendicrat]: Not so fast Blue! We need to bailout the small guy too. We want to spend some money to the working class

[Blue Spendicrat]: Buy Red, there isn't enough pie to go around to bailout both the banks and the working class.

[Red Spendicrat]: No Problem Blue, we'll bake some new pies so everyone gets some pie!

[Blue Spendicrat]: I like your idea red! This is turning into a fine piece bipartianship legisation!

Anonymous said...

The dollar and US bonds will collapse on the world stages before they 'hyperinflate' with a printing press.

The whole world is watching.

They are not as stupid as most DuhMericans.

They will stop investing in Anything US.

The deflation will be murder.

Farmerod said...

I see your (sic) turning to those pornography girlie pics to get everybody's attention

What did I miss? All I saw was the world economy, just barely afloat. Possibly dead already.

Good stuff, Ilargi.

Ilargi said...

"All this spending will expanding the money supply and result in high inflation."

And all your money are belong to us.

Look, I don't want to be harsh or nasty or anything, and I do understand that what we do here is try to explain matters. but we've gone through this for what at least feels line once a week or more, as long as we've been around.

You add up all the Fed and Treasury expenditures over the past year, and get to a total of $2 trillion, with a bit of exaggeration, and without taking into account that much of it will have to be repaid (the Fed has no links to the Salvation Army)

You have also seen on this site, if you have paid attention, that $19 trillion was lost in global stock market values over that same past year, and $3 trillion of that in the last week alone.

US domestic real estate values went down by $4-$5 trillion in the past year, UK homeowners lost about $40.000 in equity each in the same time period.

There are many more countries that already have , or are, or will, experience similar losses.

Let's say the US stock market is 20% of the global total. Sounds about right. That means close to $4 trillion was lost. Add the $4 trillion in the housing market. Add another $1 trillion for commercial real estate. And then add all the losses in company's assets, which I wouldn't even venture to guess at anymore.

We're looking at $10 trillion at the very minimum that has vanished, against which the US Fed and Treasury have injected $2 trillion, for which the taxpayer is largely responsible, so that's not really a plus either.

Hence, the money and/or credit supply, which would have to rise considerably if inflation, let alone hyper-inflation, were to become reality, is in fact plunging through the floorboards.

Even if the US would want to print itself out if this, there's no way. And no, it doesn't want to do it, nor try. But even if if if, the international bond market would hammer it down at lightning speed.

You can hyperinflate Zimbabwe, but not the US, not in an international economy.

Ilargi said...

"I see your (sic) turning to those pornography girlie pics to get everybody's attention

What did I miss? All I saw was the world economy, just barely afloat. Possibly dead already."

Not bad. All I could think of is that, unlike the commenter, I'm not nearly old enough to have known that Harper's Bazaar was a porn mag back in 1947.

You'd almost start to wonder how Americans manage to procreate. Then again, if in 2008, a comatose chick in a 1940's bathing suit gets you wound up, maybe that answers my question right there.

He's all yours now, Sigmund.

Anonymous said...

I thought the floating chick was Ophelia.

I never doubted you were high class.

Hamlet (Hank):
I did love you once.

Ophelia (Bank):
Indeed, my lord, you made me believe so.

Hamlet (Hank):
You should not have believ'd me, for virtue cannot so
inoculate our old stock but we shall relish of it. I lov'd you not.

Ophelia (Bank):
I was the more deceiv'd.

Hamlet (Hank):
Get thee to a nunn'ry, why woulds't thou be a breeder of

Blue Monday

Farmerod said...

You'd almost start to wonder how Americans manage to procreate.

Irrational exuberance.

Anonymous said...

Some one on a Nova M radio show I was listening to had a suggestion that I think might gain traction if is is spread around.It was on Mike Malloy show.He tends to be a bit of a firebrand.The suggestion was that every 100 years or so its necessary to bring back the guillotine,[just for a few weeks]To ensure the wealthy in this country understand what happens when they get too greedy....


Anonymous said...

I'm not nearly old enough to have known that Harper's Bazaar was a porn mag back in 1947

After losing sleep over the weekend and stressing most of today about the state of things Ilargi's response to the porn sheriff was so funny that I laughed til I cried. Thanks for the comic relief.

Also, thanks to Stoneleigh for comments on the Austrian School. I always found Austrian proponents interesting but felt slightly repelled at the same time and her answer rang completely true, that their is more to life than economics.

Anonymous said...

Doug Noland added some comments to his posting this week, well worth a read

Today’s efforts to sustain the Bubble Economy create an untenable situation. Washington is now in the process of spending Trillions to bolster a failed financial structure, while focusing support on troubled mortgages, housing, and household spending. Regrettably, this is a classic case of throwing good ‘money’ after bad. Not yet understood by our policymakers, literally Trillions of new Credit will at some point be necessary to finance an epic restructuring of the U.S. economic system. Our economy will have no choice but to adjust to less household spending, major changes in the pattern of spending (i.e. less “upscale” and services), fewer imports, more exports, and less energy consumption.

Sounds like he basically agrees with the deflation thesis.

Anonymous said...

Definitely worth the read… Noland writes: “With the monetary system breaking down, the federal government saw no alternative than to fill the void left by the impaired risk intermediators. Or, from a more theoretical perspective, our government would have to guarantee the “Moneyness of Credit” – assume the spiraling losses between the Trillions of risky system loans and the Trillions issued of perceived safe and liquid “money.” No systemic federal guarantee, no more “Moneyness” – and an immediate end to the last bastions of Credit growth that have been sustaining the U.S. Bubble Economy.

So what’s the problem with the government stepping up to guarantee “Moneyness”? How can it be inflationary, when Credit growth has slowed so dramatically, assets prices have come under such pressure, and confidence in the system has been so shaken?“
Changes made by Bush Secretary Paulson, Clinton’s Secretary Rubin, Chairmen Greenspan and Bernanke and Senator Phil Gramm fostered the conditions allowing the shadow financial structure which pretended to be banking. Should we believe any proposal from Paulson will improve the results of his creation?
The percentage of American paper money is tiny compared to the vast quantities of credit “dollars” created by bank loans AND compared to the even larger quantity of private derivative contracts. The contracts are considered to have a value of approximately seven hundred trillion “dollars”. Some of those loans and contracts are defaulting and just because of the shear quantity it only take a few percent to go bad with deflationary results.

EBrown said...

Food for thought. How many of the people on this blog talked with friends and family about the approaching disaster prior to the last two weeks of market upheaval? I certainly did, and now some of those I spoke with have called me. It boggles the mind how influential the television, radio, and print media are in shaping peoples' opinions of the goings on of the world. It is Stoneleigh's mirror neurons and herding behavior writ large. Only once the big players in the media put fear on the airwaves does it percolate into most minds... Of course, once the tipping point is crossed positive feedback loops are unbelievably powerful.

I'm in healthcare (an RN) and I have to say that most of my coworkers are pretty complacent. Few see an end to the system as it is currently structured - sure doctor's pay has gone down in recent years, nurses make middle class wages despite the recent years' price pressure on daily budgets, and all the ancillary techs and administrative staff make OK money. Most think Federal reimbursments will continue to shrink, but they don't see radical restructuring of the way healthcare is delivered (or not delivered) in the US. I think we run a real risk of having many hospitals and health systems close their doors once they're unable to secure ongoing financing. I hope we can muddle through in some way to keep many of our services open - but ultimately I think our healthcare system will morph towards the model found in many "developing" nations today. Meaning if you want, say an emergency service, you must pay up front. Right now it's illegal for a hospital to require payment in exchange for emergency services, but how long will that last in face of emergency rooms closing left and right? I don't know. Will the laws change to allow for greater service delivery flexibility? Or will docs and nurses refuse to practice in a foggy legal environment. And I haven't even touched on pharmacy and expensive radiology...

Stoneleigh said...

Doug Noland hits the nail on the head with the concept of the 'moneyness' of credit. Credit only has 'moneyness' during the expansion phase, during which credit can become the vast majority (perhaps 99%) of the effective money supply. Once expansion morphs into contraction, however, credit loses 'moneyness' remarkably quickly, causing the effective money supply to collapse. This is why deflation is an overwhelming and devastating force.

Paulson's bailout, as large as it seems, is only a drop in the bucket when it comes to trying to backstop the 'moneyness' of credit. Everything central bankers and governments pump into the system is disappearing into a black hole of credit destruction. Under those circumstances it is impossible to inflate.

Stoneleigh said...


I agree with you - healthcare will almost certainly become pay-as-you-go, as it is in most of the world. For the vast majority, access to anything remotely resembling the modern healthcare they're used to will be a thing of the past. They'll be lucky to get antibiotics or painkillers, while cancer treatment, dialysis, daily insulin injections, asthma puffers, MRIs etc etc will be rare and cripplingly expensive.

As the parent of an asthmatic child and a deaf child (who requires fancy hearing aids and a supply of batteries to function in the hearing world), this is a very personal issue for me.

Be glad you are an RN - you will be a very valuable member of any community you belong to (as will Marianne and Brenda who comment here). I sometimes wish I had gone to medical school as I originally intended (I did spend some time there, but as a graduate student in neuroanatomy, not a medical student), but moving from one jurisdiction to another can interfere with the best laid plans.

Anonymous said...

ilargi said:but we've gone through this for what at least feels line once a week or more, as long as we've been around.

Well I guess you can blame that on yourself for attracting so many new readers. That was a good explanation of how deflation work so why not just repost that piece ' once a week or more'?

Your piece also suggests to me that while we are beginning a world deflation some countries will deflate faster than others. I don't pretend to understand all this but, if the US dollar value drops on the suggestion of the 700 B. bailout, holding US (except for convenience sake) could make some real difference to the holder. To take this a bit On a side issue - using the argument of the bond market not allowing hyperinflation - I do not understand how Germany's 1923 deflation got so out of control compared to the rest of the world except that possibly things were not quite as interconnected?

If you or any one else can clear this for me it would be muchappreciated.

Unknown said...

I think CR has the right idea, Ilargi. Why waste your effort continuing to respond to the deflation question? Find a thread where you think you made your best summation and provide a link to it whenever anyone asks. Easy peasy, as they say.

Anonymous said...

That's right - to bail out the fat cats on Wall Street your taxes will almost certainly double within a year or two.

Are you still gonna let 'em pass this bill? Remember, Henry Paulson got $500 million personally out of this and Goldman Sachs paid out close to $50 billion in bonuses over the last two years alone.

Unknown said...

Paulson as Nigerian email scammer

EBrown said...

Healthcare is both my profession and it is personal as well since I have family members with various illnesses (type one diabetes and asthma). I worry about the cost of their maintenance regimes. Sure I could deliver them easily enough, but I can't manufacture insulin or albuterol. I am glad I have some skill in caring for hurting people, although I wonder how much good it will do without an equipped modern facility. I wonder though whether I'll just "know what is happening" with some of my loved ones, but be unable to halt their deterioration. Needless to say, I hope it doesn't come to that.

On the other hand, there ain't one of us that's gonna get out of here alive in the long run. Death is sad when it strikes young and/or otherwise healthy people, but it is perfectly normal for us to die. I think one of Western Culture's most deeply dissonant drives is the desire to conquer death. Many millions of healthcare dollars are spent every year stringing tired old bodies along for a few extra months. I hope (but do not expect) that some of that money can be redirected to clinics that improve quality of life for many, many people (like those with asthma and diabetes).

Anonymous said...

ebrown: "I hope (but do not expect) that some of that money can be redirected to clinics that improve quality of life for many, many people (like those with asthma and diabetes)."

Pure water, clean air and unadulterated food would go along way too.

Anonymous said...

I wonder though whether I'll just "know what is happening" with some of my loved ones, but be unable to halt their deterioration.

This seems to me the task many of us will have in a depletion economy. I cared for both my brother and father as they went through horrible pain with cancer. I could make them as comfortable as possible with the care (and drugs available, or not available in my brother's case)--but what I now carry with me is the memory of the relief in their eyes that they were not alone.

Stoneleigh said...

One thing that people can do healthwise is to get in as good a shape as possible now. To that end I started a fitness program called P90X in January. An hour of extreme fitness training a day flattened me at first. I was often unbelievably stiff and sore, but nine months later I'm still at it and am now in the best shape I've ever been in my life. I can do things I would never have thought possible, which is a wonderful feeling, and my doctor tells me I have the blood pressure of a teenager.

If I can do it, almost anyone can. I was dealing with weight issues, a bad back, neck problems that gave me migraines, knee problems, sleep apnea etc and I had no stamina at all. Now I feel healthy and durable, and most of those problems have resolved themselves. It's been a long, hard journey, and it isn't over yet, but I'm well on my way.

EBrown said...

Kudos on your improved physical fitness. I don't know whether your fitness program includes time for flexibility training, but I encourage everyone to stretch as well as performing rigorous exercise. I'm fairly fit but last year I had started to develop pain in my hips whenever I sat. Three weeks of daily yoga resolved the discomfort and now even though I don't practice daily the pain has not returned. I attribute much of the pain to years of past running, which tightened my hamstrings, hip flexors, and lower back. Loosening all those muscle groups up is taking a LONG time...

das said...

The 1920’s were a time of peace and great prosperity. After World War I, the “Roaring Twenties” was fueled by increased industrialization and new technologies, such as the radio and the automobile. Air flight was also becoming widespread, as well. The economy benefited greatly from the new life changing technologies.Stock Market Crash of 1929 ChartAs the Dow Jones Industrial Average soared, many investors quickly snapped up shares.



tanyaa said...

Debt restructuring plan will create plenty of near-term volatility in the telecoms sector regardless of its outcome, according to sellside credit analysts.
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