Friday, September 26, 2008

Debt Rattle, September 26 2008: Absurd Theatre

UPI "Hooverville" New York City, 8 December 1930

Ilargi: You know that you’re in deep trouble when you have no choice but to leave solving your problems in the hands of the very people who got you into the mess you’re in.

Now, you don’t get to pick the swollen fatheads that lead the private banking sector, even if you can switch banks. And you have no say whatsoever in what happens at the Federal Reserve, the private organization that happens to have absolute control over the money supply in the country. As for appointing the people who run the huge number of regulatory agencies specifically designed to check if laws are upheld, you’re utterly powerless.

What you do have some control over is the government. You get to elect the president, and the guys and dolls who sit in Congress and the Senate.

What I’m saying is: don’t you find it a little bit ridiculous to realize that the very people you have voted into their seats, are the very same people responsible for the economic disaster that has only just started and will gain strength soon and fast?

Still, when you think about it, that in itself is not nearly as ridiculous, no contest, as the fact that you now are forced to let those same very people bicker and blabber about the best way to get you out of the mess they created.

I have talked about the legitimacy of a government losing control of its economy before. As I look around me this morning, it’s getting sillier by the minute. John McCain dishes Letterman, where he announced his candidacy not long ago(!), and goes to Washington to solve your problems. He cancels a debate, and then cancels the cancellation. How flop can one man flip?

That is the same John McCain who himself just very recently stated that he knows very little about economic matters. Come to think of it, that may well have been the last honest thing he has said.

And now, with the ink just barely dry on that statement, he has become the go-to guy in the worst financial mayhem in global history? Say what? I mean, how does that make you feel?

And then there’s president Shrubmeister II. How much confidence do you have in his knowledge of, and insight in, financial matters? If you ask me, the only people who have any trust in that at all, are the ones who believe he has a reborn direct line to God. Which at last count was, what, 40% of Americans? Hey, I’ll gladly admit, with connections like that, who needs to read reports?

Obama has been in the Senate long enough to be just as guilty as everyone of his peers. I never heard him raise his voice about what was very obviously coming, all throughout his time as your representative. In a word, useless. Just like the rest of them. They are all either clueless, or born liars, and in most cases both. But you can’t get rid of them; they’re all you have, and you are responsible for putting them where they are.

And now they are sitting down with bankers, both those that actually run banks today and those that have infiltrated the government, like Paulson, to put a spin that they think you will find palatable on a plan that they claim is intended to heal you, but was never meant to do that, from a disease they themselves passed on to you.

I’ll ask one more time: what is their legitimacy? Many of them were there when the Glass-Steagall Act was murdered in 1999, and when Greenspan and Shrub actively pushed people to buy homes with rivers of funny money. Who protested back then? Who stood up and left the circus in disgust?

No, they are all accomplices. And that means they need to draw the only possible conclusion in a democratic system: they need to step down. If they do not, the system is being eaten from within. A democracy cannot function, cannot hold, if elected officials remain in place after committing gross errors. This is such a situation, and very much so. Be they errors of judgment, or of character, that's not the point.

I don’t know how many of you are familiar with Absurd Theatre, a genre of plays by writers such as Ionesco and Samuel Beckett. I’m starting to think you might want to read some of their work, or even go see a performance of, for instance, Waiting for Godot. It might be the best way to get a grip on what is going on.

NOTE: Did you see what happened yesterday in the largest bank failure in history? (Weirdly underreported, by the way). Washington Mutual has (or had, or has had) $307 billion in assets, and $188 billion in deposits. Last night, its banking assets were sold to JPMorgan Chase & Co for $1.9 billion. I told you, Absurd Theatre.

If I may simplify this somewhat (like in terms that even McCain can understand), I would suggest we use that sort of re-valuation for all so-called "assets" in all financial institutions. Now that is a plan.

WaMu deal suggests home prices may fall a lot further
When buying Washington Mutual's banking business, J.P. Morgan Chase & Co. weighed the risks of the deal using some worrying assumptions about house prices and future losses on mortgages.

That's sparked concern that mortgage-related assets held by rival banks including Wachovia Corp. may be worth less than previously thought. Late Thursday, J.P. Morgan announced an agreement to buy WaMu's banking subsidiary after the nation's largest thrift was seized by the Federal Deposit Insurance Corp.

In a presentation on its WaMu acquisition, J.P. Morgan forecast a 58% peak-to-trough slump in California home prices if the U.S. enters a severe recession. In Florida, house prices could fall 64% in such a scenario, while nationwide prices could drop 37%, the bank said.

J.P. Morgan also immediately wrote down the value of WaMu's assets by more than $30 billion, mainly because the giant bank expects losses on the thrift's mortgage holdings to be higher than previous expectations. The write-downs assume that cumulative losses on WaMu's $51 billion option adjustable-rate mortgage portfolio will reach 20%. That's a lot higher than the 12% cumulative losses that Fred Cannon, an analyst at Keefe, Bruyette & Woods, was expecting.

Wachovia has more than $100 billion of option ARMs. These types of mortgages allowed borrowers to choose between several different monthly payments. The lower payment options increased the total amount owed, which is known as negative amortization. Wachovia stopped offering these home loans this summer.

"We expect this deal to have a negative impact on the value of credit-impaired banking institutions," Cannon wrote in a note to investors on Friday. Wachovia shares slumped 28% to $9.78 during afternoon trading. Credit default swap spreads on the bank's debt surged by more than 800 basis points and now trade at distressed levels, according to Credit Derivatives Research.

J.P. Morgan assumes cumulative losses of at least 20% on WaMu's home equity lines of credit and home equity loans. KBW's Cannon was expecting cumulative losses of 10%. J.P. Morgan's projection of losses on WaMu's prime and subprime mortgage exposures were also higher than Cannon's estimates, the analyst said.

After just 18 days on the job, CEO could exit WaMu with $11.6 million
With J.P. Morgan’s takeover of Washington Mutual, it’s unclear what role Alan Fishman—who was hired only 18 days ago as WaMu’s new CEO—will play in the combined company. But if Mr. Fishman leaves the thrift, it’s pretty clear that he would be well-compensated for his short stint on the job.

Mr. Fishman appears set to collect a payout worth $11.62 million if he leaves the company “with cause” or because of “constructive termination,” according to a copy of his employment agreement, which was disclosed un a regulatory filing on Sept. 11.

The agreement calls for Mr. Fishman to earn 2.5 times his base salary of $1 million, or $2.5 million, plus another payment that is 2.5 times his annual bonus. He has earned no bonus in his brief tenure, but the agreement states that if Mr. Fishman is terminated in 2008 or 2009, he should receive 2.5 times 365% of his annual salary, which would add up to $9.12 million.

This $11.62 million, of course, would be in addition to the $7.5 million signing bonus he was awarded when he joined WaMu earlier this month. Derek Aney, a WaMu spokesman, was not immediately available to discuss Mr. Fishman’s new role in the merged company or whether Mr. Fishman will be eligible to retain all of these payouts.

David Schmidt, a senior consultant at compensation firm James F. Reda, noted that AIG’s former CEO Robert Willumstad rejected his $22 million severance package earlier this week after the firm was bailed out by the government. Mr. Schmidt said he wouldn’t be surprised if Mr. Fishman forfeited some or all of his compensation if he doesn’t join J.P. Morgan. “It’s entirely possible,” he said. “That’s a significant payment for an incredibly short period of time on the job.”

Central banks rush to keep system solvent in crisis
Central banks across the world scrambled to meet desperate demand for cash on Friday, just a day after Washington Mutual collapsed in the largest ever U.S. bank failure.

As investors focused on the prospect of a $700 billion bailout for Wall Street, the European Central Bank, the Bank of England and Swiss National Bank collectively put up $74 billion of one-week funds into the markets. The Federal Reserve was actually forced to drain some of its recent reserve injections to keep its overnight borrowing target at 2 percent.

Banks were finding other ways to tap into Fed loans, borrowing a record $187.75 billion per day on average directly from the central bank -- four times the previous record set one week earlier. Global money markets dried up, forcing increased injections of cash from central banks as dollar borrowing rates remained high, particularly for three-month money. The market's stress was aggravated by the looming quarter-end next week.

As they worry about potential exposure to downtrodden real estate assets, banks and other financial services companies are generally worried about lending to one another despite the best efforts of monetary authorities. "The markets are just caught like a deer in the headlights, watching Washington, trying to figure out what the next step is," said Boris Schlossberg, director of currency research at GFT Forex in New York.

The key three-month Euribor rate jumped to the highest level since early 1995, hitting 5.142 percent. The interbank cost of borrowing 3-month dollars was broadly unchanged, according to the British Bankers Association's latest daily fixing.

But the spread of three-month London interbank offered rates over OIS rates -- which expresses the three-month premium paid over anticipated central bank rates and is seen as a gauge of banks' willingness to lend to each other -- hit a record high 202 basis points from Thursday's 197. The U.S. Treasury market reflected the yearning for safety, with two-year notes surging 9/32 and offering a yield of just 2.04 percent.

Stress was exacerbated by the approach of the quarter-end. Any three-month lending will then mature over the Christmas period, when markets are either closed or highly illiquid. "These operations are designed to address funding pressures over quarter-end," said a statement from the Federal Reserve, which expanded dollar swaps facilities with other central banks.

"Central banks continue to work together closely and are prepared to take further steps as needed to address the ongoing pressures in funding markets." With commercial banks everywhere hoarding cash, central banks were almost the only game in town. Uneasiness intensified after Republicans balked at Treasury Secretary Henry Paulson's plan to buy bad debt from banks and instead floated an idea of their own for mortgage insurance.

The Reserve Bank of Australia launched its first-ever repurchase operation in U.S. dollars and all $10 billion on offer was hungrily snapped up. The RBA established a U.S. dollar swap line with the Fed earlier in the week. In South Korea, the Finance Ministry said it would inject $10 billion or more into the local swap market until the middle of October to stave off persistent dollar funding shortages. The RBA and the Bank of Japan also kept adding extra cash to their own banking systems on Friday.

Citi could sell up to $80 billion in assets to Uncle Sam
Fox-Pitt said about $79.4 billion of Citigroup’s (C.N: Quote, Profile, Research, Stock Buzz) troubled assets may be eligible for sale under the government’s proposed bail out plan, adding the company need not raise capital to remain “well-capitalized.”

Analyst David Trone noted Citi may however raise capital just to appease market concerns about its risk and soundness. The brokerage estimates that of the $79.4 billion worth assets, $22.4 billion will be in sub-prime and $21.5 billion in residential loans.

The analyst said Citi may have to take a pre-tax charge of $21 billion if assets were to be transferred to Troubled Assets Relief Program (TARP) at market prices. “However, if assets are transferred at near held-to-maturity price levels, this charge could be significantly lower or possibly, result in a gain,” Fox-Pitt said in a note to clients.

In a pessimistic scenario, the brokerage estimates asset valuations at 10 percent below its clear the market prices resulting in a $27.0 billion pre-tax charge. Fox-Pitt’s rating and price target on Citigroup remained unchanged, it said.

At White House, McCain Plays Bailout Spoiler
Inside an intense White House meeting over the financial crisis on Thursday, where nearly every key player came to an agreement on the outlines of the bailout package, Sen. John McCain stuck out. The Republican candidate, according to sources with direct knowledge, sat quiet through most of the meeting, never offered specifics, and spoke only at the end to raise doubts about the rough compromise that the White House and congressional leaders were nearing.

McCain's reluctance to jump on board the bailout agreement could throw the entire week-long negotiation into a tailspin. Sen. Chris Dodd, after leaving the White House, suggested on CNN that the tenuous process could be derailed by what he viewed as McCain's political motives.

"What happened here, basically, if you want an honest appraisal of the thing, we have been spending a lot of time and I am tired. I have spent almost seven straight days at this in trying to come out with a workout plan for our economy a rescue plan," said Dodd. "What this looked like to me was a rescue plan for John McCain for two hours and took us away from the work we are trying to do today. Serious people trying to do serious work to come up with an answer."

According to the source with knowledge of the White House gathering -- which featured both presidential candidates, congressional leaders and the President -- virtually ever key figure in the room, save McCain and GOP Sen. Richard Shelby, were in agreement over a revised version of Treasury Secretary Hank Paulson's plan.

Towards the end, McCain finally spoke up, mentioning a counter-proposal that had been offered by some conservative House Republicans, which would suspend the capital gains tax for two years and provide tax incentives to encourage firms that buy up bad debt. McCain did not discuss specifics of the plan, though, and was non-committal about supporting it.

Paulson, however, argued directly against the conservative proposal. "He said that he did not think it would work," according to the source. At another point in the meeting, President Bush chimed in, "If money isn't loosened, this sucker could go down" -- and by sucker he meant economy.

ABC News reported that, following the meeting, Paulson "walked into the room where Democrats were the White House and pleaded with them 'please don't blow this up.'" But this story isn't incomplete, according to sources. Democrats stayed talking in the Roosevelt room and Paulson approached them. After his comment, Speaker Pelosi and Rep. Barney Frank shot back that the real problem was with House Republicans. Paulson replied, "I know, I know," as he got down on one knee to lighten the mood. Pelosi joked back, "I didn't know you were a Catholic."

After the White House meeting, Shelby, the top Republican on the Senate Banking Committee, restated his long-standing opposition to the bailout, and suggested that a deal was not, as reported earlier in the day, imminent. But Shelby's no. 2 on the committee, Sen. Bob Bennett, supports the compromise principles, as do other top GOP House and Senate leaders. Dodd himself was incensed that the hard work he and others had put in could be undermined at the last minute.

"We were told it came out of the Republican House. We were told at this one point that this was maybe John McCain was floating the idea that Hank Paulson was considering it," Dodd said of the proposal, which he did not elaborate upon. "And of course Barney Frank and I, along with Republicans from the House and the Senate, had spent three hours this morning working on a different core.

We were told for the last seven days it was the core issue to give the Secretary authority to move with the crisis, but simultaneously protect the taxpayers and accountability and deal with foreclosure issues all of the things the president mentioned last evening were going to be important as well."

Obama himself did not directly take McCain to task at his post-meeting press avail, but suggested that his methods were not helping the process. "What I found and I think was confirmed today when you inject presidential politics into delicate negotiations it is not necesary as helpsful as it could be," he said, according to Politico's Carrie Budoff Brown. "When you are not worried about who is getting credit and who is getting blamed you tend to move forward more constructively."

UPDATE: CBS News reports that McCain's alternative proposal includes "fewer regulations and corporate tax breaks":

US taxpayers are being enrolled in an economic chain gang
"To preserve their [the people's] independence, we must not let our rulers load us with perpetual debt. We must make our selection between economy and liberty, or profusion and servitude" - Thomas Jefferson
There was a time, early in America's history, when its leaders believed in financial discipline. No more. Perpetual debt, which Jefferson feared would enslave future generations, is clamped on Uncle Sam's undercarriage like a ball and chain. US public borrowing is $9.8 trillion - and rising.

Jefferson, America's third president (1801-09), is widely regarded as the White House's most intellectually gifted occupant. He believed that "banking institutions are more dangerous to our liberties than standing armies", and that "the principle of spending money to be paid by posterity … is but swindling futurity on a large scale."

If Congress approves the Treasury Secretary's $700 billion bail-out of dysfunctional banks, it would be hard to invent a better example of what Jefferson foresaw: authorised "swindling". Tomorrow's Americans and those who come after them will pay and pay for the grotesque excesses and self-indulgence of today's flim-flam merchants.

As Jefferson put it: "If we run into such debt, as we must be taxed in our meat and in our drink, in our necessaries and our comforts … [we will have] no means of calling our mis-managers to account but be glad to obtain subsistence by hiring ourselves to rivet their chains on the necks of our fellow sufferers."

Having failed to deliver victory in the War on Terror, President Bush is hoping for better luck in the War on Error. His goal is to limit damage from the egregious mistakes of sub-prime mortgages; his tactics are to carpet-bomb the banking system with federal funds. The upshot, in Jeffersonian terms, is that US taxpayers are about to be enrolled in an economic chain gang.

The prospect is unappealing, but, we are told, there's no alternative. Hank Paulson's plan offers fewer details than his weekly milk bill, but now, it seems, is no time for nit-picking. Having collected sacks of gold at Goldman Sachs, this former champion of free markets wants to nationalise assets at a pace not seen since Che Guevara was lighting cigars with Batista's legacy.

No wonder so many Congressmen look queasy. They must persuade constituents, many of whom are losing jobs and homes in the credit crunch, that it is a bright idea to rescue those who profited hugely from the creation of dark instruments. Not for the first time, Wall Street is bilking Main Street.

For those who work in the fast lane of finance, the speed of decline has been ear-popping. Less than a year ago, America's investment banks were wallowing in record bonuses, totalling almost $38 billion. Yes, billion. Their pool of monopoly money was greater than the GDP of Bulgaria. Split among 186,000 workers at Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers and Bear Stearns, it equated to an average of more than $200,000 per person, about four times the median US household income.

Goldman's chairman, Lloyd Blankfein set a new standard in executive gluttony, collecting $68 million (about one third in cash), but at least his bank is still standing. Richard Fuld, Lehman's chief executive, trousered $41 million. Nice work, except that he took the lot in the bank's shares. Nine months later, when Lehman went bust, Fuld's bonus joined his reputation, in the trash-can.

Banking's bacchanalia has morphed into a therapy group for manic depressives. Those still in work look around the room and wonder how many will be flipping burgers by Christmas. In an interview with Fortune magazine, Mr Paulson admits: "Raw capitalism is a dead end. I've seen it." Now I have heard it all. What next?

In place of rip-roaring markets, according to a Wall Street trader, America has embraced "trickle-down communism". This system involves the state paying "cash for trash" to benefit a few miscreants, and then hoping that some of the taxpayers' largesse will trickle down to the masses.

Toxic rubbish will not be made to disappear by Mr Paulson's proposals. All that will be different is ownership. It will be like removing nuclear waste from a failing business and parking it in a government building. The risk moves from private to public.
It is this form of regressive redistribution that Messrs Bush and Paulson are peddling as the road to redemption for Western finance. Excuse my cynicism, but would you buy a used derivative from either of them?

After Hurricane Katrina and the flooding of New Orleans, Mr Bush's record on rescue missions does not inspire confidence. As for Mr Paulson, if he's so insightful, why, when he was earning an $18 million bonus at Goldman in 2006, did he not spot the radio-active dump piling up in his industry's back-yard?

Mr Paulson's sales pitch is essentially: "American capitalism, I love you! But we only have 14 hours to save the Earth!" In return for a promise to head off financial obliteration, he is demanding a cheque of disturbing blankness. It is to be a bail-out with precious few strings, plus immunity from review "by any court of law or administrative agency". His legal team must have chuckled when they slipped in that one.

The scheme is under attack from right and left. George Soros, the investor who helped break the pound in 1992, is in favour of action to stem insolvencies, but insists that Paulson's plan falls short. Paul Krugman, professor of economics at Princeton, has little faith in Paulson as a fixer: "He's making it up as he goes along, just like the rest of us."

Outside Washington, in the real world, there is a growing clamour for something to be done. Ordinary voters are in pain. They want government to make it go away. But there is no magic powder. Those who borrowed to buy assets at the wrong prices will have to suffer, as financial gravity re-asserts its downward pull. There is no policy yet invented that can make fifty cents worth two bucks forever.

Any long-term solution will have to recognise that contraction cannot be deferred in perpetuity. Having restored stability, it should punish those who created the mess. Where's the retribution in Paulson's package? It looks too much like a parachute for his chums at the back of a burning plane. Finally, there needs to be an overhaul of banking governance. The rules of the game were, in effect, made redundant by the ingenuity of financial engineers. We do not need more regulation, but more appropriate regulation.

Which brings us back to Jefferson. Two hundred years ago, he demanded: "The issuing power should be taken from the banks and restored to the people to whom it properly belongs." Twas ever thus.

Federal Reserve leads central bank injection of billions
"Apocalyptic" and "money market meltdown" were phrases used to describe the distress at the heart of the financial system - the interbank market where banks lend to each other. After a US debt-rescue deal stalled overnight, the US Federal Reserve moved rapidly this morning with the European and Swiss central banks to deliver a further $13bn (£7bn) into crippled money markets.

Commercial banks usually seek extra funds at the end of each quarter, but credit has all but dried up as banks demand higher interest for the loans they make to each other as fear that another lender may collapse stalks the market. "The problem is neither a lack of liquidity nor a question of the level of interest rates," said Stephane Deo, an economist at UBS. "It is essentially a problem of trust between banks."

Instead of lending money to each other over periods of a week or more, banks now focus on the short-term. "This is a sign [that] the lack of confidence in the system has reached extreme levels," Mr Deo said. The Bank of England, which has been criticised by some for not moving quickly to assist banks, also said that from Monday it will hold auctions for three-month loans, starting with £40bn. John Wraith of Royal Bank of Canada said: "The BoE's action should take some heat out of the situation."

The three-month London interbank offered rate, or Libor, soared yesterday by the most in almost a decade - an indication of tight lending conditions. Libor did ease marginally today to 6.2550pc, although the equivalent rate in Europe did widen to 5.1387pc. Mr Wraith said that effectiveness of the BoE's action is likely to be limited because it is maintaining a strict list of the collateral it will accept in return for the loans. The BoE only accepts the Government bonds from G-10 countries and AAA+, top-rated debt.

The central banks used the reciprocal currency arrangements – or swaps – with the Fed to keep eurozone money markets primed as banks closed out their third-quarter books. Under separate techniques, the Bank of England provided $30bn for a week, and the South Korean central bank said it would inject at least $10bn.

The latest injection brings the total number of central bank "swap" deals to make dollars available outside the US to $290bn.
Fears that a massive US plan to bailout the financial sector might be delayed or watered down "have exacerbated money market tensions even beyond the extreme levels touched a week ago when the mood in financial markets was apocalyptical," said Marco Annunziata, an economist at UniCredit Markets.

UK banks could qualify for $175 billion of US bailout plan
Britain’s five leading high street banks have as much as £95.3 billion ($175 billion) of distressed assets on their books that may qualify for the American bailout scheme.

If the British banks tap the rescue fund being set up by the US Treasury and the Federal Reserve to the maximum, they could secure one quarter of the $700 billion being made available. Under the terms of an outline agreement that appeared to have been reached by US policymakers last night, Britain’s lenders will be able to use the facility.

However, the prospect that the US Treasury could pay for UK banks’ bad assets is likely to infuriate some American politicians and taxpayers, who would foot the bill. As Congress edged closer to agreeing a plan for the central bank to take on lenders’ toxic assets, HSBC appeared to be the UK-based bank best placed to benefit.

Combined, the five British lenders hold securities worth $175 billion, which they could transfer to a federally backed Treasury fund. Under the proposed terms of the rescue package, non-US financial institutions must have significant operations in America to qualify.

According to analysts’ estimates, and the banks’ own recent filings, HSBC has as much as £45 billion in structured mortgage debt and other soured assets sitting on its balance sheet that it might look to exchange with the Fed under the plan. Next are Barclays, with £17.4 billion; Royal Bank of Scotland, with £16.2 billion; and HBOS, the UK’s largest mortgage bank, with £13.3 billion, analysts said yesterday. Lloyds TSB, which agreed to buy HBOS for £12.2 billion last week, follows some way behind in its exposure to the troubled mortgage securities, with assets of about £3.4 billion.

The estimates are based on banks’ balance-sheet exposure to sub-prime and the better alt-A mortgage securities, as well as leveraged finance, commercial mortgage-backed securities, collateralised debt obligations and monoline insurance as of June 30.

Henry Paulson, the US Treasury Secretary, and Ben Bernanke, the Chairman of the Fed, tabled the proposal, known as the Troubled Asset Relief Programme (Tarp), last week in an effort to stabilise the financial system and free up capital markets.
Alex Potter, a Collins Stewart banks analyst, said: “HSBC, RBS and Barclays would be the clear main beneficiaries if the facility is approved, they are allowed access to it and if they chose to place some of their securities there.

If they have a substantial enough presence in the US — HBOS has a limited treasury function, for example — they should be eligible. The question then will be: ‘What are the qualifying instruments?’.”

A high street bank executive questioned how beneficial Tarp would be to UK lenders. “The key question if it was used would be: ‘What kind of haircut do you have to take?’,” the banker said. “If you’ve got $100 million of mortgage-backed securities that have been marked down twice and are on the books at 80 cents in the dollar, it’s unlikely that the Fed is going to be offering a better price for them. So you’d hold on.”

Stresses in the money markets remained severe. The cost to banks of borrowing from one another for three months in dollars, euros and sterling rose again. Elevated money market rates are increasing the cost of bank borrowing and feeding through to higher mortgage rates. HSBC and Woolwich increased rates on some mortgages by up to 0.35 percentage points.

— While Republicans and Democrats pledged to try to vote through the bailout within days, it became clear that Mr Paulson had been forced to back down on key demands. Banks that benefit from the bailout would have a cap imposed on golden parachute pay deals, but it is not clear if the Treasury would have the right to veto a pay deal for an executive working for a bank outside the US. Washington would also have the right to take equity stakes in those financial institutions. The issue of whether to allow bankruptcy judges to force banks to cut mortgage rates for troubled borrowers was unresolved.

Ireland leads euroland into recession as property crashes
Ireland has become the first country in the eurozone to slide into recession as the torrid housing boom of recent years turns into a deep slump.

The economy shrank by 0.5pc in second quarter, according to the statistics office, marking an emphatic end to the stellar years of the Celtic Tiger. It contracted 0.3pc in the first quarter. A clutch of eurozone states are expected to follow in short order as the oil shock, surging credit costs, and the global downturn all combine to choke growth across the region. Denmark is already in recession, but is not a member of EMU.

"Italy will definitely be next, and probably Germany," said Julian Callow, Europe economist at Barclays Capital. "Ireland is suffering from a massive reliance on real estate. Construction was 21pc of GDP at the peak last year, which is even worse than Spain (18pc) and far worse than America (11pc) at the height of the bubble," he said . House prices have fallen for eighteen months in a row, according to the tsb/ESRI index. Average values are now down 13pc from their peak of €311,000, and show no sign of stabilizing.

Over 55pc of all mortgages are taken out at floating rates so home-owners have been squeezed by the relentless rise in bechmark Euribor rates. Three-month Euribor hit an eight-year high of 5.119pc as the violent ructions in the credit markets continued to shake Europe. The decision by the European Central Bank to raise its benchmark rate a quarter point to 4.25pc in July could hardly have come at a worse time.

The Irish authorities are almost powerless to act as the ECB tightens monetary policy into the downturn, highlighting the perils of a one-size-fits-all regime for a bloc of economies exposed to quite different problems. Unemployment has jumped from 5pc to 6.1pc since January.

Mr Callow said Ireland had been hit harder than core eurozone states in what amounts to an "asymmetric shock" as a result of its heavy reliance on the Dublin financial centre and trade ties with the Anglo-Saxon world. Banking and financial services make up 9.8pc of GDP, compared to 7.8pc in Britain. Almost half of Irish exports - or 17pc of GDP - go to the sterling or dollar regions, making Ireland acutely sensitive to the currency effects of the strong euro.

The government cannot resort to fiscal stimulus to cushion the downturn since it already risks breaching the EU's budget deficit limit of 3pc of GDP. Instead it is having to enforce austerity measures, starting with a pay-freeze last week for public sector workers. "The Irish boom has well and truly turned to bust," said Jonathan Loynes at Capital Economics "We now predict that Irish house prices will fall by 30pc from peak to trough, but even bigger falls are perfectly possible."

Falls of this magnitude would put severe strains on the banking system. Serious doubts have already surfaced after Bank of Ireland warned that it would slash the dividend by half and was "battening down the hatches to increase capital". A clutch of hedge funds have been betting on a further falls in the share price of Irish banks, according to disclosures made under the temporary ban on short-selling. Led by Tiger Global Management, they have targeted Anglo Irish, Bank of Ireland, Allied Irish, and Irish Life & Permanent.

There are suspicions that Irish banks have not marked down their toxic debt by nearly enough to reflect true market conditions. Premier Brian Cowen says the banking system is sound but nevertheless introduced bank deposit insurance last week worth €100,000 (as a preventive measure.

Despite the crisis, Ireland's underlying economy is still in rude good health. It has transformed itself from a high-tax backwater in the early 1980s to a model of free-market vitality. Its national debt is just 25.4pc of GDP, one of the lowest of the AAA club. It is unclear whether Dublin could have dome more to cool the housing bubble in the earlier part of this decade when the ECB cut rates to 2pc -- far below the safe speed limit for a young, dynamic, fast-growing economy.

The ECB's super-lax policy caused credit expansion of 30pc a year in Ireland, and pushed household debt levels to 190pc of GDP. The hangover has now begun in earnest. The deepening recession almost certainly kills any chance of a fresh referendum in coming months on the Lisbon Treaty, which Irish voters have already rejected once. Even diehard officials in Brussels now recognize that no Irish government could win a `revote' in the current economic crisis.

Homes sell for $1500 as tide of foreclosures ends American dream for millions
It doesn't cost much to snap up a house these days in the down-at-heel motor city of Detroit. Agents advertise two-bedroom properties for as little as $1,500 (£800). "It's a phenomenon that's unreal that's going on at the moment," said Lolita Haley, owner of Prime Financial Plus Realty in suburban Detroit. "Foreclosed homes are constantly coming on to the market."

In cities throughout America's heartland, the crisis-stricken housing market is worsening by the day as struggling families abandon property because they are unable to keep up mortgage payments. Some 6.41% of US home loans are in arrears - the highest figure since records began in 1979 - according to the Mortgage Bankers Association.

More than 2 million Americans lost their homes to foreclosure last year and the figure is set to be far higher in 2008. Last month alone, repossession papers were filed on 303,879 properties. As politicians in Congress thrashed out the details of the Bush administration's $700bn bailout plan for the banking industry, homeowners protested outside congressional offices yesterday.

The Neighbourhood Assistance Corporation of America, which helps people to negotiate with lenders, has derided the rescue package as the "leave no banker behind" plan, and is demanding a moratorium on repossessions. "Washington is about to reward Wall Street and predatory lenders for their greed and irresponsible lending tactics which created the mortgage crisis," said Naca's chief executive, Bruce Marks. "We cannot let this pass without help for the millions of homeowners at risk of foreclosures."

The worst-hit regions in the crisis fall into two categories. There are states that were already economically deprived, such as Mississippi, Michigan and Ohio, where job losses have made it tough for people to keep up mortgage repayments. Then there are relatively well-off areas in Florida, Nevada and California where a particularly aggressive housing boom collapsed catastrophically, leaving millions of people with mortgages far higher than the value of their homes.

In several cities, foreclosure bus tours do a steady trade, taking sightseers and potential investors to gawp at bank-owned properties. A Boston estate agent, John Pace, operates a bus tour every other weekend. "It's a tough situation. You'd rather see someone living in these houses than them vacant," he said.

In parts of California, more than half of all home sales are of bank-owned property. East of San Francisco, the city of Stockton has the highest foreclosure rate in the US. City authorities are struggling to cope with vandalism and neglect, as hundreds of homes are abandoned every month.

There are fears that the West Nile virus could spread aggressively as mosquitoes breed in the stagnant water of swimming pools at bank-owned homes. In San Diego, pest control officers have seen a surge in calls to deal with bees and wasps which are nesting undisturbed in vacant houses.

One sign of hope, according to some, is that the monthly increase in foreclosures has slowed. Filings last month were only up 27% year-on-year, compared with rises of 60% to 65% in previous months, said RealtyTrac, which compiles a national database. But the fall is largely due to legislation in many states which has made eviction a longer process, rather than any reflection of a genuine market improvement. In worst-hit regions, courts are struggling to keep up with a backlog of foreclosure paperwork.

Those on the ground doubt that the Bush administration's banking bailout will chime agreeably with struggling families. Drew Sygit, a property consultant at The Lending Edge in Detroit, said: "I don't know if anyone in the Detroit area cares, or can see that this package is supposed to be in their best interests. For many people, it's a case of, 'Hey, I lost my house and some of the people who put us in this situation are being bailed out'," he said.

WaMu is largest U.S. bank failure
Washington Mutual Inc was closed by the U.S. government in by far the largest failure of a U.S. bank, and its banking assets were sold to JPMorgan Chase & Co for $1.9 billion.

Thursday's seizure and sale is the latest historic step in U.S. government attempts to clean up a banking industry littered with toxic mortgage debt. Negotiations over a $700 billion bailout of the entire financial system stalled in Washington on Thursday.

Washington Mutual, the largest U.S. savings and loan, has been one of the lenders hardest hit by the nation's housing bust and credit crisis, and had already suffered from soaring mortgage losses. Washington Mutual was shut by the federal Office of Thrift Supervision, and the Federal Deposit Insurance Corp was named receiver. This followed $16.7 billion of deposit outflows at the Seattle-based thrift since Sept 15, the OTS said.

"With insufficient liquidity to meet its obligations, WaMu was in an unsafe and unsound condition to transact business," the OTS said. Customers should expect business as usual on Friday, and all depositors are fully protected, the FDIC said.

FDIC Chairman Sheila Bair said the bailout happened on Thursday night because of media leaks, and to calm customers. Usually, the FDIC takes control of failed institutions on Friday nights, giving it the weekend to go through the books and enable them to reopen smoothly the following Monday.

Washington Mutual has about $307 billion of assets and $188 billion of deposits, regulators said. The largest previous U.S. banking failure was Continental Illinois National Bank & Trust, which had $40 billion of assets when it collapsed in 1984.

JPMorgan said the transaction means it will now have 5,410 branches in 23 U.S. states from coast to coast, as well as the largest U.S. credit card business. It vaults JPMorgan past Bank of America Corp to become the nation's second-largest bank, with $2.04 trillion of assets, just behind Citigroup Inc. Bank of America will go to No. 1 once it completes its planned purchase of Merrill Lynch & Co.

The bailout also fulfills JPMorgan Chief Executive Jamie Dimon's long-held goal of becoming a retail bank force in the western United States. It comes four months after JPMorgan acquired the failing investment bank Bear Stearns Cos at a fire-sale price through a government-financed transaction. On a conference call, Dimon said the "risk here obviously is the asset values." He added: "That's what created this opportunity."

JPMorgan expects to incur $1.5 billion of pre-tax costs, but realize an equal amount of annual savings, mostly by the end of 2010. It expects the transaction to add to earnings immediately, and increase earnings 70 cents per share by 2011. It also plans to sell $8 billion of stock, and take a $31 billion write-down for the loans it bought, representing estimated future credit losses.

The FDIC said the acquisition does not cover claims of Washington Mutual equity, senior debt and subordinated debt holders. It also said the transaction will not affect its roughly $45.2 billion deposit insurance fund.

"Jamie Dimon is clearly feeling that he has an opportunity to grab market share, and get it at fire-sale prices," said Matt McCormick, a portfolio manager at Bahl & Gaynor Investment Counsel in Cincinnati. "He's becoming an acquisition machine."

The transaction came as Washington wrangles over the fate of a $700 billion bailout of the financial services industry, which has been battered by mortgage defaults and tight credit conditions, and evaporating investor confidence.

"It removes an uncertainty from the market," said Shane Oliver, head of investment strategy at AMP Capital in Sydney. "The problem is that markets are in a jittery stage. Washington Mutual provides another reminder how tenuous things are."

Washington Mutual's collapse is the latest of a series of takeovers and outright failures that have transformed the American financial landscape and wiped out hundreds of billions of dollars of shareholder wealth.
These include the disappearance of Bear, government takeovers of mortgage companies Fannie Mae and Freddie Mac and the insurer American International Group Inc, the bankruptcy of Lehman Brothers Holdings Inc, and Bank of America's purchase of Merrill.

JPMorgan, based in New York, ended June with $1.78 trillion of assets, $722.9 billion of deposits and 3,157 branches. Washington Mutual then had 2,239 branches and 43,198 employees. It is unclear how many people will lose their jobs.

Shares of Washington Mutual plunged $1.24 to 45 cents in after-hours trading after news of a JPMorgan transaction surfaced. JPMorgan shares rose $1.04 to $44.50 after hours, but before the stock offering was announced.

The transaction ends exactly 119 years of independence for Washington Mutual, whose predecessor was incorporated on September 25, 1889, "to offer its stockholders a safe and profitable vehicle for investing and lending," according to the thrift's website. This helped Seattle residents rebuild after a fire torched the city's downtown.

It also follows more than a week of sale talks in which Washington Mutual attracted interest from several suitors. These included Banco Santander SA, Citigroup Inc, HSBC Holdings Plc, Toronto-Dominion Bank and Wells Fargo & Co, as well as private equity firms Blackstone Group LP and Carlyle Group, people familiar with the situation said.

Less than three weeks ago, Washington Mutual ousted Chief Executive Kerry Killinger, who drove the thrift's growth as well as its expansion in subprime and other risky mortgages. It replaced him with Alan Fishman, the former chief executive of Brooklyn, New York's Independence Community Bank Corp. WaMu's board was surprised at the seizure, and had been working on alternatives, people familiar with the matter said.

More than half of Washington Mutual's roughly $227 billion book of real estate loans was in home equity loans, and in adjustable-rate mortgages and subprime mortgages that are now considered risky. The transaction wipes out a $1.35 billion investment by David Bonderman's private equity firm TPG Inc, the lead investor in a $7 billion capital raising by the thrift in April. A TPG spokesman said the firm is "dissatisfied with the loss," but that the investment "represented a very small portion of our assets."

The deal is the latest ambitious move by Dimon. Once a golden child at Citigroup before his mentor Sanford "Sandy" Weill engineered his ouster in 1998, Dimon has carved for himself something of a role as a Wall Street savior. Dimon joined JPMorgan in 2004 after selling his Bank One Corp to the bank for $56.9 billion, and became chief executive at the end of 2005.

Some historians see parallels between him and the legendary financier John Pierpont Morgan, who ran J.P. Morgan & Co and was credited with intervening to end a banking panic in 1907. JPMorgan has suffered less than many rivals from the credit crisis, but has been hurt. It said on Thursday it has already taken $3 billion to $3.5 billion of write-downs this quarter on mortgages and leveraged loans.

Washington Mutual has a major presence in California and Florida, two of the states hardest hit by the housing crisis. It also has a big presence in the New York City area. The thrift lost $6.3 billion in the nine months ended June 30. "It is surprising that it has hung on for as long as it has," said Nancy Bush, an analyst at NAB Research LLC.

Exploiting FDIC Loopholes Enriches Former U.S. Bank Regulators
As chief of staff of the Federal Deposit Insurance Corp. from 1999 to 2002, Mark Jacobsen was responsible for a safety net that protects U.S. savers. He now runs a company that critics say is designed to stretch that net to its breaking point.

Jacobsen, 42, is president and co-founder of Arlington, Virginia-based Promontory Interfinancial Network, a company that makes it easy for a wealthy depositor to keep FDIC-insured cash in separate accounts at multiple banks. It offers customers up to $50 million of FDIC insurance, 500 times the single-account limit approved by Congress.

"When I first saw Promontory, I was amazed that the regulators would let it fly," says Sherrill Shaffer, a former chief economist at the New York Federal Reserve Bank. "It undermines a lot of the safeguards around the FDIC deposit fund. I'm astounded that the FDIC has not picked up on that and tried to shut down that loophole."

The loophole Promontory exploits is the FDIC rule that allows an individual to open up federally insured accounts of up to $100,000 at an unlimited number of banks. Promontory has contracts with 2,350 banks. It advertises to wealthy investors who want to insure more than $100,000 in certificates of deposit. Customers tap into Promontory's network through their home banks.

Promontory arranges for the customer's money to be divided among banks, with each receiving less than $100,000 so all of the cash is FDIC insured. The receiving banks pay Promontory a fee, and in return, Promontory directs deposits to them.

Promontory is peopled by former federal banking officials. Jacobsen started the company with Alan Blinder, who was vice chairman of the Federal Reserve from 1994 to 1996, and Eugene Ludwig, who was Comptroller of the Currency from 1993 to 1998. William Seidman, the FDIC's chairman from 1985 to 1991, is a board member. William Isaac, who chaired the FDIC from 1981 to 1985, is chairman of the company's bank advisory board.

"These guys know how to work the system," says Shaffer, who's now a professor of banking at the University of Wyoming in Laramie. "They saw a good buck in it for themselves." Seidman says he knows Promontory has critics. "The question can be raised, `Is this what the government wanted when they put in deposit insurance?"' he says. "One man's loophole is another man's God-given right."

Jacobsen says the company provides a service for investors and does nothing improper. Individuals could open accounts on their own or through brokers at hundreds of banks. Promontory does the legwork at no cost to depositors and helps community banks compete for deposits with large money-center banks, he says. The firm calls its system CDARS, an acronym for certificate of deposit account registry service.

"What we're doing is no different from what others have been doing for many decades," Jacobsen says. "We just make it a little bit easier. Instead of having to knock on the doors of 20 banks to deposit $2 million, or going to a broker to do the same on your behalf and collect a big fee, we allow banks to offer the service directly."

Isaac says he's not sure what role he plays at the company. "I think I'm some kind of an adviser or director," he says. "I'm not really involved. The board of advisers has never met. I allowed them to make me the chairman of a bank advisory board that has no members."

Blinder, Promontory's vice chairman, says the company has eliminated any need to increase the $100,000-per-account ceiling on what the FDIC covers. "It's not so important anymore, because any depositor who's worried about that can, through CDARS, get very significant amounts of deposit insurance," he says.

Edward Kane, senior fellow of the FDIC's Center for Financial Research, says CDARS intercepts FDIC premiums. "It's portrayed as a public-spirited way to help customers as opposed to a way to game the system," he says. "They've decided there's a loophole that they're in charge of."

More than 50 banks joined Promontory after IndyMac Bancorp Inc. collapsed in July. Promontory placed more than $10 billion in August. That's up from $1 billion a week in January, says spokesman Phil Battey, who worked in public relations for the FDIC from 1994 to 2003. Promontory charges banks more in fees, about $12.50 per a $10,000 one-year CD to get access to federally insured funds, than the FDIC itself charges in insurance premiums, typically $5-$7 per $10,000 deposited.

"We take the tiniest nibble," says Ludwig, now Promontory's chief executive officer. FDIC Chairman Sheila Bair says she's surprised that Promontory gets a higher fee than her agency. "That's an interesting question," she says. "I'll have to look into that."

Bailout Could Deepen Crisis, CBO Chief Says
The director of the Congressional Budget Office said yesterday that the proposed Wall Street bailout could actually worsen the current financial crisis.

During testimony before the House Budget Committee, Peter R. Orszag -- Congress's top bookkeeper -- said the bailout could expose the way companies are stowing toxic assets on their books, leading to greater problems. "Ironically, the intervention could even trigger additional failures of large institutions, because some institutions may be carrying troubled assets on their books at inflated values," Orszag said in his testimony. "Establishing clearer prices might reveal those institutions to be insolvent."

In an interview later yesterday, Orszag explained using the following example: Suppose a company has Asset X, whose value is recorded on the books as $100. Because of the current economic decline, Asset X's real value has dropped to $50. If the company takes part in the government bailout and sells Asset X for $50, the company has to report a $50 loss on its books. On a scale of millions of dollars, such write-downs could ruin a company.

Such companies "look solvent today only because it's kind of hidden," Orszag said. "They actually are insolvent" already, he said.

In hearings on Capitol Hill so far this week, criticism of the bailout plan put forward by Treasury Secretary Henry M. Paulson Jr. and Federal Reserve Chairman Ben S. Bernanke has largely been restricted to the shape of the $700 billion proposal, how the money will be spent and what sort of oversight Treasury should have. But Orszag yesterday questioned the wisdom of the plan itself, testifying that "it therefore remains uncertain whether the program will be sufficient to restore trust."

In yesterday's interview, Orszag said, "The key question is: What are we buying and what are we paying for it?"
Orszag offered alternatives, such as equity injections into particularly troubled companies, but allowed that those could lead to further problems, as well. In the end, he said, Congress must pass some sort of relief, if only because Wall Street is expecting it.

"If we did nothing, there is a significant risk of another collapse of confidence in the financial markets," he said.
Then, there is the paperwork cost of the bailout. The budget office "expects that the administrative costs of operating the program could amount to a few billion dollars per year, as long as the government held all or most of the purchased assets," he testified, without defining what he meant by "a few."

Even as the financial markets rallied Thursday and Friday, Orszag said, the credit situation was so dire that "short-term lending was virtually shut down." He said that the Treasury was acting as a go-between in short-term lending between banks. Instead of Bank A lending directly to Bank B, as is customary, Bank A no longer had confidence that Bank B could repay the loan.

So Bank A would give the money to the Treasury, which issued a security that was put into the Federal Reserve, which then issued the cash to Bank B. If the government is forced to intermediate such ordinary transactions, commerce slows, credit confidence remains low, and operational strain is placed on the Treasury and the Fed. "You don't want them in the middle of every short-term financial transaction," Orszag said.

During questioning before the Joint Economic Committee earlier yesterday, Bernanke acknowledged concerns about the bailout's effect on the budget. "I think those concerns are very serious," he said. "But it's really a question of alternatives."

Grand Theft
Reports of the Treasury Department’s proposed bailout legislation are focusing on the cost to the US taxpayer, the "socialist" nature of this intervention in the supposedly free market, and the question whether it will work, but not on exploring just how it’s going to work.

It is important to understand just how far the proposal is from real socialism, because it is actually far more shocking than socialism. It’s a continuation of what we already have – creating profit-making opportunities for the wealthy off of the backs of taxpayers.

Socialism – actual nationalization or governmental joint ownership – would at least theoretically be an improvement over the current bailout proposals, because the government might then demand actual financial integrity and actually prosecute company officers and managers whose misdeeds and recklessness cause the government to lose its share of the company’s profits.

There is nothing in the proposed legislation that indicates that the federal government will end up with ownership interests in financial institutions. The bailout is controlled by the Federal Reserve, which is a private organization looking out for private interests, NOT a government entity supposedly protecting the public interest.

The reality of how the bailout is actually going to work is highlighted by a provision found in Senator Dodd’s proposed alternative to the Treasury’s bailout legislation. To my knowledge, the significance of this relatively obscure provision has escaped media comment. But first, some context. A 1932 provision of the Federal Reserve Act allows the Fed to lend funds to non-banks (e.g., private companies and partnerships) at a discounted rate "in unusual and exigent circumstances." Specifically, 12 U.S.C. 343 provides, in pertinent part, as follows:
In unusual and exigent circumstances, the Board of Governors of the Federal Reserve System, by the affirmative vote of not less than five members, may authorize any Federal reserve bank, during such periods as the said board may determine, at rates established in accordance with the provisions of section 357 of this title, to discount for any individual, partnership, or corporation, notes, drafts, and bills of exchange when such notes, drafts, and bills of exchange are indorsed or otherwise secured to the satisfaction of the Federal reserve bank: Provided, That before discounting any such note, draft, or bill of exchange for an individual or a partnership or corporation the Federal reserve bank shall obtain evidence that such individual, partnership, or corporation is unable to secure adequate credit accommodations from other banking institutions. All such discounts for individuals, partnerships, or corporations shall be subject to such limitations, restrictions, and regulations as the Board of Governors of the Federal Reserve System may prescribe.
[Editorial comment: note that the Fed prescribes its own rules and is "regulated" by itself, not by Congress. In other words, it does what it likes. No one in Congress and neither McCain nor Obama is talking about changing this.]

Section 19(a)(2) of Senator Dodd’s original bill provides that if the Federal Reserve Board exercises this authority, it must notify the Senate Committee on Housing, Banking and Urban Affairs and the House Committee on Financial Services of "the specific terms of the actions of the Board, including the size and duration of the lending, the value of any collateral held with respect to such a loan, the recipient of warrants or any other potential equity in exchange for the loan, and any expected cost to the taxpayer for the cost of such exercise."

The first thing to notice about the Dodd language is that it contemplates the possibility that both stock or other equity and warrants may be acquired and transferred by the Board to private parties, and not to the government. Under 12 U.S.C. 343, the Fed already has this power to structure loans as it sees fit in unusual and exigent circumstances. The Dodd bill simply requires that the Senate and House be informed what the Fed has done, and provides no authority to Congress to control it.

So the vaunted Congressional "oversight" consists simply of being informed of what has been done after the fact. But note this well: The bailout bill provides no mechanism for assuring that the federal government acquires any ownership stake in the companies it bails out for the funds it provides. It is not nationalization. What will happen is that the Fed will have the power to preserve and make new kings of finance on the backs of taxpayers.

Some examples, all of which appear to be permissible under the terms of the proposed bailout bills, will help illustrate how this is going to play out. In order to save a financial institution that is actually bankrupt because it doesn’t have the reserves to absorb the losses from the toxic $500 million mortgage-backed security portfolio, the Fed purchases the $500 million portfolio at face value.

In order to minimize the Fed’s ultimate loss, and because the Fed is not equipped to actually deal with the mortgages in this pool, the Fed sells the portfolio to some other institution or a new private vulture fund created for this purpose. Naturally, the mortgage pool is risky, so it has to be sold at a deep discount with sufficient room in it that the private interests that will purchase it can expect to make a profit from taking this on.

Let’s suppose that the Fed sells it at $.20 on the dollar. The taxpayers have therefore lost $400 million on the bailout. Ultimately, the pool collects $.60 on the dollar and makes a profit of, say, $.20 on the dollar. By shifting the losses to the taxpayers (for which they receive nothing), a new profit making opportunity has been created for the big boys. Essentially, the taxpayers financed the new profits by absorbing losses in excess of the amounts that are fully and finally realized. Congress receives a report.

Suppose, instead, that the Fed, using its authority to lend money to businesses "in unusual and exigent circumstances," loans a troubled financial institution $500 million at a very low interest rate secured by $500 million, face value, of the company’s "toxic" mortgage backed securities. The terms of the loan provide that as payments are received on the securities, they are applied against the interest and principal amount of the loan, and that the loan is otherwise nonrecourse, that is, the company is liable only to the extent of the value of the collateral pledged as security.

Thus the U.S. treasury can expect to recoup some portion of the funds and the taxpayers are only on the hook ultimately for the portion of the loan that can’t be paid for from collections on the securities and for the time value of the money, which is hopefully substantially less than the full amount loaned. In addition, suppose that part of the deal is that the Fed also receives warrants (options) to acquire, say 50%, of the company’s stock at $X per share, which can be paid either in cash or, by what is its equivalent, by canceling the same amount of debt on the loan. The warrants are transferable, as is the stock that is obtained by exercising the warrants.

Perhaps you begin to see the possibilities. First, suppose the ailing company needs even more money. The Fed exercises the warrants and pays even more taxpayer money to purchase the company’s stock. Thus, the $700 billion bailout is in fact only the beginning, and this eventuality is expressly acknowledged by the Dodd proposal. But consider the next step. The Fed now holds 50% of the company’s stock, which it may sell at a price determined by the Fed in order to recoup part of the loss on the loan.

Naturally, the company still may not be in the greatest shape, so the stock has to be sold at a depressed value, with sufficient margin so that the purchaser will be motivated to buy because he expects to make a handsome profit. Again, because the loss was shifted to the taxpayers, a new profit making opportunity has been created for the big boys. Congress receives a report.

Or finally, consider this alternative variation on the loan scenario just mentioned. The Fed’s financial analysts issue a report concluding that, ultimately, the toxic mortgage-backed securities that are collateralizing the Fed’s $500 million loan will pay $.0.80 on the dollar. Let’s assume that the exercise price on the warrants is effectively $0.10 on the dollar amount of the debt, and the Fed sells the warrants for $0.05 on the dollar amount of the debt, or an amount which, when added to the exercise price the warrant holder will have to pay to buy the stock, effectively equals $.15 on the dollar amount of the debt. (The Fed can’t ask for too much, because investors won’t buy if they don’t have a realistic chance of making a profit!)

The Fed reports to Congress that it expects that the loss to the Treasury on this transaction will only be 15%, because it expects to collect $.80 and it has sold the warrants at $.05. A few years go by. It turns out (who knew?) that that the toxic mortgage-backed securities are only yielding $.40 on the dollar, and since this is a nonrecourse loan, the remainder of the debt is just a loss to the US taxpayers. Meanwhile, the company, freed from its toxic contingent losses, has been able to rebuild itself into a financial titan. Turns out that the warrants are now worth five times the amount the investors paid for them, and the investors are going to make a killing! Ha ha! Now that’s what America is all about! Being rewarded for taking risks!

With hundreds of billions at its disposal, the Fed has the ability to preserve and create new titans of finance. The bailout process will not be unlike Russia’s creation of overnight billionaires through the public sale of rights to its national resources for ludicrously low sums of money, all accomplished at the expense of the taxpayer. I believe we here in the US call this "crony capitalism" when practiced in Russia. The taxpayers will bear the losses, receive nothing for it, while new profit opportunities are created for the ruling class. Nothing prevents this. Congress will receive reports.

This is not socialism, but pure Americanism. The people trying to perpetrate this grand theft would like you to continue to think it’s socialism, because that mistake hides the reality of what it really is. Nowhere does the federal government end up with an actual ownership stake in the companies it is bailing out that would permit it, ultimately, to continue to recoup losses and even profit on its loan, theoretically lessening the burdens on taxpayers (way) down the road. I am not saying this rosy scenario would ever come to pass – we’re talking about government here after all – but that would be socialism.

The proposed bailout solutions are more of the same – plus ça change you can believe in. The game is rigged and we are the losers. Neither Republicans or Democrats are proposing to do anything to fix the real source of the problem that impoverishes all but the most wealthy – fractional reserve banking and the Federal Reserve. Without eliminating that system, more "regulation" can never eliminate the moral hazard or power to create unearned wealth that comes from the power to manufacture credit out of thin air.

"Regulation" is just the mantra that politicians reach for to mollify you with a promise to prevent a recurrence of a nightmare enveloping us that they have helped create, in this case while they completely ignore or fail to see the real cause of the problem, guarantying that it will recur. Think about what politicians are actually promising. Regulation! Solution to all future problems! It does nothing for you now, it does not ameliorate one iota the suffering brought down on you now.

For you, what's done is done and you just have to suck it up! The politicians will take care of it by protecting you in the future! And if it doesn’t work, we won’t know that until later, when the next disaster occurs, when the politicians will promise more regulation or better regulation again! Eventually, after you’ve lost everything, they’ll get it right! Maybe! We’ll have to wait to see! For the titans of industry though, what's done is not done, For you, regulation, for them, money. You will remediate them, now, for the damage they have inflicted on themselves, and pay for it the rest of your lives. It's not socialism, it's the American way of business.

The only candidates who are actually promising to address the root cause of the current financial disaster are third-party candidates Ralph Nader, Chuck Baldwin, and Cynthia McKinney who have signed, with Ron Paul, a statement of agreement on the actions they will take in the areas of foreign policy, privacy, the national debt and the Federal Reserve. To the American voter I say, if the bailout discussions don’t show you what the System really is and your place in it, your eyes are unopenable.

But if this disgusts you, if you really want change and not more of the same ("regulation!"), if you really want to vote your pocketbooks and place yourselves on a path to financial security, you will have to abandon your favored system of Voting Only for Someone Who Can Win (yes, even though the winners will receive reports about what the Fed has done!), and vote for someone who will really address the conditions of your bondage to this country’s ruling class.

Clarification: In my article above on the "crony capitalism" aspects of the proposed bailout, I failed to make clear that, under the Dodd proposal, the Secretary of the Treasury would indeed be required to make arrangements on terms that could result in the acquisition by the Treasury of securities in financial companies that received bailout funds, complete with protective anti-dilution measures.

As of yesterday, this was being vehemently resisted by the Secretary of Treasury Paulsen and by Federal Reserve Chairman Bernanke. The analysis in the article therefore reflects the possibilities inherent in the powers that Henry Paulsen and Bernanke are seeking to obtain from Congress, and which were included in their original proposal (which granted them unreviewable power), not what the original Dodd proposal mandated.

Today, House leaders and others are meeting behind closed doors to hash out a final bill. Only the final bill will reveal whether the government may end up owning actual securities in companies that are bailed out, and what freedom the Treasury or Federal Reserve will have to price and sell the securities. Even if the Treasury obtains the securities, as long as it has the freedom to sell them on terms it deems acceptable, the "crony capitalism" possibilities inherent in government acquisition of these securities survives.

Category 5 Credit Market Hurricane! 
I'll never forget Hurricane Jeanne, which struck Florida four years ago this week. My wife, young daughter, and I huddled in the shower of our older house as the battery-powered TV flashed tornado warnings and updates on the storm's 115-MPH winds.

Every now and then, I'd peek out the only unshuttered small window we had, only to see it raining sideways and watch electrical transformers exploding in flashes of blue flame. And I'll always remember how the walls of the house practically "breathed" — flexing inward and outward ever so slightly — as Jeanne's winds tugged at them.
Scary times, to say the least. It reminds me a lot of what's happening in the credit markets right now, only what we're seeing there is no Category 3 like Jeanne ... It's the Biggest, Baddest Category 5 Financial Cyclone The Markets Have Ever Seen!

Just look at what's happening out there ...

#1. London Interbank Offered Rates (LIBOR, for short) are surging. For instance, three-month U.S. LIBOR jumped 29 basis points (0.29 percentage points) today after rising 27 basis points yesterday. At 3.77%, LIBOR is well above the federal funds rate of 2%. These are the rates at which banks lend short-term money to each other. The surge in rates shows that banks are hoarding cash, rather than lending it out.

#2. The yield on the 3-month Treasury Bill is plunging — to as little as 0.46% this week from 1.66% two weeks ago. This is the lowest T-Bill rates have been since at least 1954. This shows that investors are fleeing any and all forms of risk, pursuing safety above all else.

#3. A major U.S. money market fund — the Reserve Primary Fund — recently "broke the buck." In other words, losses on Lehman debt forced its net asset value below the $1 level. Money market funds are supposed to be extremely safe, and breaking the buck is exceedingly rare.
#4. The TED spread — the difference between the yield on three-month Treasury bills and three-month LIBOR rates — blew out to 326 basis points. That's the highest level I can find, and my Bloomberg data goes back to 1984. Think of this as a risk spread — how much riskier financial institutions think it is to lend money to each other rather than the U.S. government. The fact it's off the charts speaks volumes.

#5. Two-year swap spreads have exploded, hitting 166 basis points at one point this week. This is the highest level in at least a couple of decades. And it's yet ANOTHER sign that financial market players are panicking over the credit quality of their counterparties and the possibility of a full-scale meltdown. Clearly, the credit market problems Martin and I have been warning about over and over again for the past few years are coming home to roost.
We suggested some ways for Congress to deal with the crisis without busting the U.S.'s own credit and causing counterproductive moves in interest rates. It appears that the actual bailout plan is somewhat different, though final details and all the implications of them are still being worked out.

The Biggest Question of All: Will the Bailout Work? That Depends on Your Definition of "Work" ...

it may help some banks avoid some additional losses, but it won't help all banks do so. Depending on what the government pays for these crummy assets going forward, the plan could actually cause even MORE losses. Plus, the sheer magnitude of bad debt out there is enormous. Even if the government buys some bad paper, plenty more loans will still sour, plenty more banks will see earnings tank, and plenty more banks will fail.

Second, the bailout package won't magically make lenders take on huge risks again. After all, they've been burned big time. I don't think we'll see the ridiculously easy residential mortgage, commercial mortgage, auto loan, credit card, and leveraged buyout lending that we saw from 2002 through 2007 for a long, long time. I'm talking years, not months or quarters.

Third, the cost of this bailout will be gigantic. Even before this latest proposal, the U.S. had committed hundreds of billions of dollars to various rescues. That includes more than $25 billion to bail out Bear Stearns, $100 billion each for Fannie and Freddie, and $85 billion for AIG.

Treasury is also talking about spending at least another $50 billion to backstop money market funds (the ultimate cost is unknown). Not to be left out, the auto industry looks like it's getting its own $25-billion bailout in the form of government-supported low interest loans. And of course, the latest package has an initial price tag of up to $700 billion.

All told, we're looking at more than $1 TRILLION in bailouts — and it's not like we have all that money sitting in a bank somewhere. We're a nation that spends much more than it earns, and borrows the rest.

The White House was ALREADY projecting that the 2009 federal deficit would be $482 billion. Now, with the additional bailouts announced and proposed, we could be looking at tacking another $1 trillion — or more — onto that number. This would push the budget deficit so far into the red, we'll all be swimming in crimson ink.

To fund those deficits, we're going to have to borrow an ASTRONOMICAL amount of money. The Treasury just held a record $34 billion sale of 2-year Treasury Notes. That was followed by a $24 billion sale of 5-year Notes, the biggest such sale in more than five years. Those numbers will only go higher with time. In fact, Congress is raising the federal debt ceiling to a whopping $11.3 TRILLION to account for this additional borrowing.

The likely impact: All the additional supply will drive bond prices LOWER and interest rates HIGHER. Heck, 10-year Treasury Note yields have already surged from around 3.4% to almost 3.9%. That will blunt the impact of the bailout by driving financing costs higher on all loans whose rates are benchmarked to Treasuries.

Last, this crisis long ago stopped being just a financial one. This bailout bill won't prevent the "real" economy from sliding into recession. Factories are closing. Layoffs are rising. Spending is slowing. And the downturn that began in the U.S. is spreading to other economies overseas.

Heck, just yesterday we learned that durable goods orders plunged 4.5% in August — more than double the decline economists were expecting. Meanwhile, initial jobless claims soared to 493,000, the highest since the period right after the 9/11 terrorist attacks. Some of that gain stemmed from Hurricanes Ike and Gustav. But the trend higher is clear, and a sign of real economic weakness.


Anonymous said...


Apparently Orlov wrote:
In the meantime, enjoy Stage 1. You will miss it once it's over.

Funny, that thought has been fleeting through my mind for about a year, particularly when I lie back in bed just before drifting off. As if I knew this short period had to end and was feeling nostalgic in advance.

Elsewhere, Stoneleigh, you use the term "imputable" in "We do not believe that current rules and regulations are imputable by any means". I am unfamiliar with that usage. Did you mean "irrefrangible" or perhaps "irrefragable"? ;-)

Concerning the BBC article on France, that is good news, but the article does not go beyond household debt. No data on the banks themselves. So with Fortis going down today, I am still on the lookout for BNP, SG and CA.

Now, an update on our efforts to sell our house. Met with the realtor today and told him I wanted to stay ahead of the price curve by dropping our sale price. He said OK, but not too much because prices are rising in our area! Nationally, prices are down about 4% over the past few years, but that is primarily because prices are way down along the Mediterranean. Elsewhere, they are pretty stable.

What news from other house-sellers here? Any luck?


P.S. Almost 10 000 words of commentary yesterday!

Anonymous said...

Big banks eat smaller banks in a relentless pursuit of actual financial substance.

I'm sure that someone must have pointed it out already but it's very like the 'Sea of Monsters'in the 1968 Beatles film 'Yellow Submarine'. Psychedelic dinosaurs wander a white landscape peppered with black holes. Big monsters eat little ones. Then comes the vacuum-cleaner monster steadily hoovering up all others until there are none left. It then hoovers up the entire backdrop. Perplexed it looks around for something else to swallow and sees the end of its own tail. Whoosh - it's all gone. Nothing left.

I think the next sequence is something to do with the very clever, but rather sad, 'Fool on the Hill' (whoever that might be).


Anonymous said...

Has anyone done a comparison of loss during the depression era and now. All I here is "things arent bad, only a few banks have gone down,there were thousands in the 1930's

The # of banks seems irrelevant when considering the $ losses, inflation adjusted or other wise



Anonymous said...

Up until yesterday, it seemed that all here would have considered opposition to the bailout proposal a good thing. Where would Sen. Shelby, Bunning and Rep. Boehner stand in the theater of the absurd? Anywhere? Any expert opinions here of their alternate proposal? Since we're damned if we do and damned if we don't which proposal would be less injurious to our future generations?

Anonymous said...

Your work from the past two days is huge. As anonymous said "they are all accomplices" - it is fascinating really at how dangerous those who abuse their power can be.
Re: your blog post yesterday on Pakistani and American Troops Exchange Fire ---- the American Govt who considers themselves to be the pillar of democracy --- are ruthlessly brutal. This is in the name of "oil" and not "humanity".
There is an American man named Greg Mortenson who wrote a book entitled "Three Cups of Tea" --- the premise of the book is that peace is not achieved through war, but rather through education, and that includes the education of women.
But of course those in great power really have little concern with the masses of humanity - it's all about them. They never made it out of Freud's id stage.
It is very disconcerting to think what skeletons are hiding in our Canadian closets and becoming anxious to show off their bones.

Anonymous said...

Obama has spoken about financial recklessness before now. He also is the one who proposed the legislation to close the Enron loophole, which is the real reason oil prices went down (the drop was not a response to the proposal for ineffective offshore drilling).

I know this isn't everything we have needed over the last few years, but it's lightyears better than "all deregulation all the time" McCain...

Unfortunately, our political system is bedevilled by "tree falling in the forest" syndrome - if it's not reported, no one hears it.

A quote from last march (

Sen. Obama laid out a mix of initiatives aimed at preventing housing foreclosure rates from worsening and heading off future crises through tighter supervision.

He also said he would support raising the capital gains tax above the current 15%. He told CNBC that a tax rate between 20% and 25% probably wouldn't distort economic decision making and would "help out the federal Treasury, which is running a credit card up" with China and other countries.

The senator called the current regulatory framework disjointed and ineffective and called for a more focused, consolidated regime to better handle risks in the markets.

"When subprime-mortgage lending took a reckless and unsustainable turn, a patchwork of regulators were unable or unwilling to protect the American people," Sen. Obama said to a crowd of around 200 at the Cooper Union in Manhattan.

His most far-reaching plan would allow the Fed to set capital and liquidity requirements for securities firms that borrow money from the central bank. Currently, the Fed only has such power over commercial banks.

"When the Fed steps in, it is providing lenders an insurance policy underwritten by the American taxpayer," Sen. Obama said. "In return, taxpayers have every right to expect that these institutions are not taking excessive risks."

Anonymous said...

Since Ilargi brought up the theatre of the absurd I can't resist posting this link. Though not targeted at the current crisis it captures the feeling of it.

Stoneleigh said...


If I wrote 'imputable' then it was a typo. I meant to write 'immutable', meaning unchangeable.

Anonymous said...

What you do have some control over is the government.

You've also got some control over your tax dollars. In other words, if you do not want them to be spent pulling the fuck-sticks' irons out of the fire, then DO NOT PAY THEM.

War Tax Resisters have been refusing for decades. On somewhat different grounds, of course; but that's no reason not to put their knowledge to good use.

Big banks eat smaller banks in a relentless pursuit of actual financial substance.

Or, as Radiohead put it:

Big fish eat the little ones

Have had that song running through my head all week...

The Lizard said...

LIBERTY, n. One of Imagination's most precious possessions.

The rising People, hot and out of breath,
Roared around the palace: "Liberty or death!"
"If death will do," the King said, "let me reign;
You'll have, I'm sure, no reason to complain."

-- Bierce, Devil's Dictionary

Anonymous said...

"they are all accomplices"

Yes, but when one does resign (it is very rare), another accomplice takes his place. It's not like we don't try in our elections to get new blood. We do, and sometimes we are successful, but then, they all seem to join the club anyway.
Anonymous Reader

Anonymous said...

Hi François,
You mention "feeling nostalgic in advance" about these times. I've had a similar reaction, as though we're participating in something that is so terrible and awe-inspiring that it has an operatic, tragic beauty. I'm struck by how "comfortable" I am, while at the same time not expecting this comfort to last much longer.

Regarding selling a house--we live in the Inland Empire of Southern California. Not too far from where I live, 70% of home sales are foreclosures. Two years ago I realized I had to sell my mother's property, but was restricted by the courts. (There was a court trial as I battled a mentally-ill family member who accussed me of heinous crimes.) In the meantime I was aware that property values were falling. I spent another year preparing her property for sale and arguing with my own attorneys to push the sale through the legal system. The day a judge finally allowed me to sell her property, I listed it priced to sell, below all comps. (The last thing I wanted was to chase the market down and her property was costing her a lot of money.)

We received a cash offer that same day and I had to go back to court to defend the offer. All the while, we were aware that the majority of the attorneys and judges had no clue on what was going on with the market.

Since then, all property in mother's area has sold significantly below what we received. Most homeowners hold onto their "peak" price, waiting for the cows to come home. Now, we don't have the expense of the estate, Mom is cared for, and her assets are as secure as we can make them, thanks to TAE. (I then had to battle my attorneys, bank managers, and judges all over again about how best to manage her assets, but it worked out in the end.) My lead attorney is an ex-Econ prof and he's read many, many of the articles Ilargi has posted in the last year (I keep feeding them to him) and says he appreciates them very much--(We pay him a great deal of money, so perhaps he's not completely honest about this.... ;-)

Anyhow, good luck with your house!

Anonymous said...

Just was reading a Mother Jones piece on privization of water,and this jumped out (last sentence ref. to GS)... "In September 2005, RWE/Thames cited growing "public resistance to privatization schemes" in its decision to get out of the water business. In leaked minutes from an executive board meeting in Essen, Germany, then CEO Henry Roels complained that the water business required too much long-term investment in plant and equipment and offered little hope for once anticipated quick profits. But there was an ominous note in the RWE minutes. An unidentified board member cited a Goldman Sachs prediction that the "water business would become the oil business of the decade from 2020 to 2030."

And so a new stage in the water privatization wars beckons as Goldman Sachs, Macquarie bank, huge pension funds, and billionaire investors hop on the infrastructure bandwagon."

Article is here:

Not surprising HP is going to the mat for GS. Control the world?

Anonymous said...

You might find the following interesting:

China Banks Cut Currency Trading With Foreign Lenders
Bank borrowing from Fed reaches record $188 billion a day
Friday, 26 September 2008
Learning from Rudi Bogni: The Thin Space of Financial Activity
Brad Setser: Extraordinary Times

“My response:

Excellent and timely, Brad. I’ve been speculating all week that the pressure being used on the Congress to pass the Paulson Plan is the threat of Fed illiquidity. As of two weeks ago, the Fed had lent out more than $600 billion of its $800 billion balance sheet Treasuries against crap MBS collateral.

The Paulson Plan would have allowed the banks to unwind the repos putting the Treasuries back in the Fed, get cash for the crap MBS, and get more Treasuries from the issues financing the $700+ billion funding of the Plan. As a bonus, the Paulson mark-to-maturity price becomes the implicit Level 3 price for capitalisation of all the firms and banks in the system, giving them some breathing room to stay in business. Everyone wins except the poor American taxpayer.

The Fed is very close to being illiquid. That is the fear factor we are seeing at work, and the reason no one will discuss why the bailout is needed - only emphasise the urgency.”

Anonymous said...

...many of the articles Ilargi has posted in the last year

Oops! Just realized my mistake! This should read....

...many of the articles Stoneleigh and Ilargi have posted in the last year...


Anonymous said...

Anonymous 7:20 thanks for posting that water article. Here is a half hour video by Maude Barlow of The Council of Canadians: : Looming Global Water Crisis Pt 1

There will be quite a few out there that will be much better off with a global economic collapse, as long of course as it takes global corporatism with it.

Farmerod said...


My wife and I are off to 'Frisco mid-October on business/pleasure for 5 days. If you're within reasonable driving distance, it would be cool to meet a fellow automatic earthling (to steal someone else's clever handle). S&I can vouch for my sanity...I think. If you're interested, contact me at

bicycle mechanic said...

Purchasing Water Rights, yes it is the new oil. Boone Pickens appeared on CNBC often and other shows telling people about oil problems. The he told them that he was off oil and was busily buying oil rights, at least two years ago.

The debate, was interesting. Watching the obvious stagecraft, while using other previously staged stagecraft used to move all the stagecraft forward.

conclusion, the plan moves forward,

Economy tax cuts in, trillions out, no problem. Why? Because the US audience doesn't know what a Trillion is. ..YET>>

bicycle mechanic said...


Pickens was off oil rights and busily buying lots of water rights.

Anonymous said...

For further interesting comment, see Arthur Silber's column today:

Anonymous said...

Blogger bicycle mechanic said...


Right on man, exactly my feelings about Pickens too!

Anonymous said...

Sold-Out Buffalo Coin Is Gold Standard of Loose Change

"The U.S. Mint is temporarily halting sales of its American Buffalo 24-carat gold one-ounce bullion coin because "inventories have been depleted," Mint spokesman Michael White said yesterday. The coin, based on a 1913 design, was released in 2006.

The Mint cannot keep up with demand from panicky investors looking for something -- anything -- that seems safe during the current market crisis. Auric Goldfinger would be proud. "