Saturday, September 27, 2008

Debt Rattle, September 27 2008: Borrowing money and time

Jakarta, 2002

Ilargi: Longtime Santa look-alike peak oil writer Professor Ken Deffeyes said when he perceived the peak moment had arrived, as he had predicted, that he had changed from a forecaster into a historian.

I was thinking about Deffeyes because I think something similar is happening with me and Stoneleigh. Only, amid the similarities, there is a different twist as well, and I’m not so sure I’m comfortable with it. You see, the energy ploy is one that unfolds relatively slowly, and Deffeyes has it easy. The credit and finance one is definitely not.

For me, that means I’m starting to feel like a two-bit beat reporter sent out to do a play-by-play in the most godawful traffic accident the world has ever seen. And as the vehicles and dead and dying bodies are piling up, and the desperate cries for help fill the air along with the stench, the smoke and the fires, I don’t have enough eyes to follow all that goes on, and I’m losing my voice trying to describe it, and think I had perhaps better get out of the way, to take care of myself and those closest to me.

The US may reach an accord on a plan to pour what will eventually be trillions of dollars into its economy. I think all involved in the talks understand that they need to come up with something by Sunday night. I do not think, however, that it will do anything but buy more than a few more days or weeks of borrowed time, and I mean that literally. If time is money, than borrowed money, in the end, can buy you nothing but borrowed time.

The credit markets are dead and gone. The plan being negotiated in Washington is aimed at reviving them. But it will do nothing to solve the problems that have started, indeed caused, the demise of credit. In order to accomplish that, it would have to force all funny casino paper, all securities and derivatives, to be put on the table in broad daylight, valued at current market prices, and sold at those prices. If a buyer could be found at all.

The reason they are so reluctant to do that is that it would be the end-all for most banks, pension- and money market funds etc. Not a pretty sight, for sure. It would, for one thing, wipe out most of those who are around those tables today. So they’re looking for an alternative. The problem with that is that there is, as far as I can see, no alternative. All there is is lipstick.

The credit market, in the last few days, has gotten much worse and was rushed into the emergency room, as evidenced by the violent surges in Libor and TED spreads, both of which mainly signal banks’ fear to lend to each other.

An adapted Paulson plan will try to address that issue by buying up frozen assets, and the idea is that that will make banks whole again, and take away the fear. But that can’t be done with $700 billion, it can’t even by done with $7 trillion. There is far too much of that funny frozen paper in the world, it’s more like $700 trillion, and it is indeed all over the world, which compounds the problem, for all intents and purpose, to infinity and beyond.

The plan inevitably will give a species of dictatorship the power to choose who shall live and who must die in the US banking community. And it will do so at a more than enormous cost to US citizens, who are already in dire financial straits. The people around the Wasington tables are first of all afraid for their own positions, but there are now a few who realize the gravity of the situation, and whose conscience tells them it would not be appropriate to use what little money their constituents have left, on a gamble that has virtually no chance of succeeding.

Republicans want "protection" of troubled homeowners in the plan, but by now it has gotten through to them that such protection is useless if real estate values go down another 20%; there’s a limit beyond which no help does actually help. They also know that the probability of such an additional price drop is very high. Make that inevitable.

There are two kinds of people in those talks: the ones that are all set and ready to make a killing off the disaster, and the ones who only just now are starting to realize how bad that disaster is. And they will end up deciding to take that gamble with your money, because they see no other way out.

But the derivatives monster is about to be let loose on the planet, gaining strength with every single bank failure, like a virus feeding off weakened hosts. The UK government is about to nationalize another Northern Rock, in Bradford and Bingley, Belgian giant Fortis Bank is on life-support (its liabilities are three times the GDP of Belgium), and in the US Wachovia may have been sold as we speak.

We haven’t even started. And when the monster is done, we will have very few banks, if any at all, left. Not a lot of jobs either, for that matter. Retirement funds? You go to be kidding. By Christmas, you'll be lucky if you recognize the town you live in.

Update 4.00 PM EDT

Bailout Negotiations Move Forward
"If you think about it, it doesn't really make much sense,"

Key House and Senate negotiators were scheduled to meet Saturday afternoon to iron out the final details of a $700 billion rescue package for Wall Street, with a goal of being able to announce a final agreement before Asian markets open Monday morning.

Senate Majority Leader Harry Reid (D. Nev.) in an appearance on the Senate floor, said there are only a "handful of issues still lingering" for lawmakers to finalize. He said he hopes Congress and the Bush administration can at the very least release an outline of the bailout plan by Sunday evening to send a reassuring message to global stock markets.

Still, there were signs that lawmakers and the Treasury Department remain divided on how the $700 billion authority to buy up toxic assets will be meted out. Lawmakers want Treasury to receive the authority in tranches, receiving $250 billion immediately and another $100 billion if needed as certified by the president. The remaining $350 billion would be subject to a congressional vote, giving lawmakers the opportunity to vote to rescind the funds.

But a Senate aide familiar with the discussions said Treasury is pushing for a larger initial authority, likely around $500 billion.
Congressional and Treasury staff members tried to resolve the issue in talks Friday that extended into the wee hours of Saturday morning to no avail. The issue is one of the handful the four key negotiators from the House and Senate are expected to discuss at a meeting beginning at 3 p.m. EDT.

The bailout negotiations took a step forward Friday, when Senate Democrats have agreed to include an insurance-based scheme as an option as part of the Wall Street bailout package in a bid to win support of House Republicans, who have been the main obstacle to reaching an agreement. Sen. Charles Schumer (D., N.Y.) said that while Democrats would allow the insurance idea to be included, he didn't think that any financial firms would choose to take part in such a scheme.

"I offered on behalf of Sens. [Christopher] Dodd (D., Conn.) and Reid, that we would put their proposal in as an option," said Sen. Schumer. "No one would have to use it, but it would be there as an option." According to lawmakers on both sides of the aisle, the plan proposed by Treasury Secretary Henry Paulson, which would see the federal government buy up to $700 billion in toxic mortgage-linked assets, will form the core of any solution.

Sen. Judd Gregg (R., N.H.), who will be one of four lawmakers who will formally sit down to thrash out an agreement, said that when the four principal negotiators sit down later Saturday, they would stay in the meeting until an agreement is reached. "The basic understanding is once we get into that room we are going to stay there until we have an agreement," he said. Senate Minority Leader Mitch McConnell (R., Ky.) said he hoped that if a deal could be reached Sunday, then lawmakers could vote on it on Monday.

The four lawmakers -- one representing each party in both houses of Congress -- are Gregg and Dodd in the Senate and Reps. Barney Frank (D. Mass.) and Roy Blunt (R., Mo.) in the House. Rep. Frank is the chairman of the House Financial Services Committee, and Rep. Blunt is the minority whip. They have been tasked with resolving the impasse over how any federal government rescue plan for financial firms paralyzed by the seizing up of the credit markets should be restructured.

After an apparent agreement was announced by lawmakers on Thursday, House Republicans threw a wrench into the process by saying they would not support the deal, proposing instead their own alternative plan. That plan would be based around the idea of an industry-funded insurance pool to provide certainty to the markets, rather than a taxpayer-funded scheme.

Sen. Kent Conrad (D., N.D.), the chairman of the Senate Budget Committee, said the insurance proposal had come up earlier in the negotiations, but that Treasury and the Federal Reserve rejected it. "If you think about it, it doesn't really make much sense," Sen. Conrad said. For banks, "insurance does nothing for them, in fact it extracts more fees out of them." Sen. Schumer said it could end up bankrupting firms, given the premiums would be so high.

Even Senate Republicans cast doubt on the validity of the idea. "A lot of ideas end up getting thrown out and sometimes they sound great," said Sen. Bob Corker (R., Tenn). "But when you try to sit down and work through them in a practical manner, sometimes they don't sound so great."

Despite the apparent willingness of all sides to come to the negotiating table, there remain significant issues to be resolved.
Sen. John Thune (R., S.D.) said the issue of how to limit the compensation of executives whose firms benefit from the rescue plan "is one of the more complicated and difficult issues to resolve." Republicans say they want don't want restrictions to inhibit companies from buying ailing firms. "I'm not sure they've come to an agreement on how they'll proceed on that," Sen. Thune said.

Lawmakers appear to have agreed the funding would be disbursed in two tranches of $350 billion. They continue to negotiate how the second tranche could be "fenced off," as Thune put it, while still being available quickly if there's a need for it. "Would it take action by Congress?" he said.

Markets face major crash if US bail-out plan collapses
A leading investor predicted that the FTSE 100 could drop by as much as 1,000 points on Monday if Treasury Secretary Hank Paulson’s $700bn (£380bn) plan fails. Such a fall would come close to matching the stock market crash of 1987. The warning came as markets lurched their way to the end of another fraught week amid fears that the White House rescue operation could be derailed in Congress by conservative Republicans.

However, hopes that a deal might be imminent spurred a last-minute rally on Wall Street, with the Dow Jones Industrial Average jumping 121.07, or 1.1pc, to 11,143.13. Financial stocks led the recovery following an early 158-point fall after news filtered out of Washington late on Thursday night that talks on the Paulson plan had broken down at an emergency White House summit. The collapse of talks prompted the Bank of England to step forward yesterday with an emergency liquidity injection.

The central bank has now effectively taken the place of large swathes of the interbank market, lending medium-term funds to banks that now refuse to lend to each other on anything beyond an overnight basis. The Bank ordered drastic measures to prevent the City’s money markets collapsing, organising a £40bn auction of medium-term funds for Monday. Experts warned that unless the unusually large offering reignites the interbank markets that underpin the entire financial system, the Government may be forced into a US-style bail-out of its own.

One senior money market trader said: “If the US bail-out fails this weekend, I don’t know if there’s any point coming in on Monday.” The mood in equity markets was hardly more upbeat. Bryan Johnston, investment director at Bell Lawrie, said: “If Paulson’s plan fails we will see a collapse in the markets and taxpayers will effectively pick up the tab. We could also see 1,000-point falls on the FTSE on Monday and we would be out of a job, while the banking system would freeze up.”

The FTSE dropped 108.55 points to 5088.47. With traders heading for safe haven investments, gold prices rose, with an ounce of the precious metal up $21.1 to $897.10. However, oil prices dropped as traders worried that world economic growth could be under threat. Brent crude dropped $3 before settling $1 down at $103.5. Meanwhile, the dollar slipped lower against other currencies.

George W Bush insisted that despite differences over the plan, “there is no disagreement that something substantial must be done”. He added: “The legislative process is sometimes not very pretty, but we’re going to get a package passed. Republicans and Democrats will come together and pass a substantial rescue plan. Our proposal is a big proposal because we have a big problem. We need to move quickly.”

Gordon Brown, who was in New York yesterday, said: “In the short term, each country is taking action to deal with the fallout of the credit crunch. America deserves support from the rest of the world as it seeks to agree in detail what all parties have agreed in principle.”

Mr Brown and Bank of England Governor Mervyn King have come under increasing pressure to consider implementing further measures to revive money markets. Money market traders said interbank lending for terms of anything other than a day had effectively ceased, with lenders fearing their counterparties could become insolvent imminently.

The Bank co-ordinated its liquidity package with the US Federal Reserve, the European Central Bank and the Swiss National Bank, offering $30bn in cash for a week against eligible collateral. The European efforts coincided with growing fears that Fortis, the Belgian-Dutch banking giant, faces a liquidity crisis. In response to a collapsing share price, it pledged to speed up a planned €5bn-€10bn (£4bn-8bn) of asset sales and named a new chief executive.

Expectations are rising that Fortis will be taken over either by France’s BNP Paribas or Dutch rival ING. The Belgian and Dutch governments have both convened to discuss the options for Fortis.

Power Shifts From N.Y. to D.C.
After Wall Street's Quake, Manhattan Braces for Financial Tsunami

This is the town of money -- freewheeling, high-stakes, high-risk and big-spending. The home of the $20 martini, the seven-figure bonus, the multimillion-dollar condos owned by the titans of the Street.]

Washington is the town of politics -- bureaucratic, stodgy, conservative. The home of cheap happy-hour beer and clean-cut young interns living in cramped quarters on the Hill, who are about making a difference, not making money.

But with Wall Street hobbled by the biggest financial crisis in generations, the culture of big money has lost some of its luster. And with the Street now looking to the U.S. Treasury for an unprecedented bailout, it's suddenly Washington that has become the center of financial action -- creating, at least for this instant, an unlikely shift of power and influence.

"The financial capital just underwent a huge downsizing," said James Parrott, chief economist of the Fiscal Policy Institute, which analyzes New York's tax structure and finances. "When you're drowning and at the risk of going under completely, the taxpayers as embodied by the government in Washington are the only place to turn to." He added: "It may not be a bad thing that more decision-making rests with people in Washington rather than New York."

Besides the bailout negotiated between the White House and Capitol Hill, there was also the stunning specter this past week of Wall Street's two remaining big investment banks -- Goldman Sachs and Morgan Stanley -- asking to be transformed into more traditional banks with deposits, and subjecting themselves to greater Washington strictures.

"I've never seen anything like this," said a veteran investment banker of more than 20 years, who spoke anonymously to be able to speak candidly. "You've got two big investment banks saying, 'Please regulate me!' . . . It will be interesting to see how they implement this thing. Will the Treasury and Washington tell investment banks what to do?"

Asked whether this realignment signaled a shift in power, he paused and ruminated for a few seconds. "What does power really mean?" he replied at last. Nicole Gelinas, an analyst with the Manhattan Institute for Policy Research, said: "It's kind of amazing. You had these guys who said, 'We can buy and sell companies.' . . . But suddenly when their industry is in need of consolidation and facing failures, they're very willing to take the Washington handout."

Gelinas questioned how, precisely, the Treasury plan would work, with specialists -- presumably from Wall Street -- helping the federal government manage its massive new asset-backed holdings. "It's kind of bizarre for them to go down to Washington and work on a government contract," she said. "The fast train will be busy -- unless they make them take the regional."

This is not the first time New York has been forced to turn to Washington for a bailout in a crisis. It happened in 1980 and, most famously, in 1975, when the city was facing bankruptcy and went begging to President Gerald R. Ford for a federal rescue. Ford initially demurred, leading to the iconic New York Daily News headline "Ford to City: Drop Dead." (For the record, Ford never said that, although he later blamed the headline for costing him the election to Jimmy Carter.)

"I think it was a humbling experience," said George Artz, who was a young political reporter during the 1975 financial crisis and later press secretary to Mayor Edward I. Koch. With the contraction on Wall Street threatening New York with a new fiscal crisis, given the city's heavy reliance on the financial sector for a large chunk of its tax revenue, Artz said, "I think people who went through '75-76 fear a recurrence and are watching it carefully . . . with a slight feeling of deja vu all over again."

Mayor Michael R. Bloomberg (I) is already warning residents to brace for the worst. Anticipating a big drop in tax receipts from Wall Street, Bloomberg has ordered all city agencies to cut spending by a total of $1.5 billion over the next two years. Earlier this week, he floated the idea of a 7 percent increase in property taxes to make up for the expected shortfall.

There are signs that the sagging fortunes of the Wall Street titans are already being felt in myriad ways in the city. Renowned defense lawyer Edward W. Hayes, a self-described night owl, long ago developed two measurements for gauging the ups and downs of Wall Street: the HEGI and the HESI, which stand for High End Girlfriend Index and High End Stripper Index. When the financial sector's business is good, he said, the traders and bankers spend huge sums on high-end girlfriends and in the VIP rooms of Manhattan's pricey strip joints.

Now, said Hayes, who represents many of the woman in the business, he is seeing evidence of the downturn.
"The strippers are getting killed -- it's terrible," he said. "It really started in the last month. What they really need are the guys who go in and spend $500."

In fact, while New York City has for years enjoyed the fruits of Wall Street's decade of dizzying success -- an estimated 10 percent of all tax revenue comes from the Street -- the highflying traders and financiers are far from loved in this city. For many, who didn't share in the spoils, there is a certain sense of schadenfreude -- enjoying the new misery of the formerly wealthy.

"I do have a vengeful streak in me," said Rachelle Pachtman, a public relations consultant who lives in an Upper West Side building heavily populated by some of the rich and privileged financial titans. "I know that there's going to be a glut of apartments that are going to be dumped in the multimillion-dollar range," Pachtman said. "They pay a lot for their mortgages. They've all got their children in . . . private schools. They all have a lifestyle. How are they going to keep this up?

"It's going to take their breath away, because they're going to have to deal with the reality that all the rest of us do," she added. "I think there's going to be a lot of people on the therapist's couch -- a very typical New York thing. People are going to start drinking a lot."

Douglas Muzzio, a professor of political science at the City University of New York's Baruch College, agreed that the fall from grace is likely to be hard for the formerly well-heeled. "This mythology of the swashbuckling capitalist entrepreneur and trader, that may be damaged," he said. "They screwed up. And they're asking us to pay for their mistakes."

Credit Rout
Have you ever walked up to a diner really hungry and seen a "closed for business" sign on the door?

Welcome to the credit market, folks - it's officially closed. After Lehman, Fannie Mae, Freddie Mac, AIG and Washington Mutual debt and preferred holders have been unmercifully tossed under the bus so Jamie Dimon can be given banks, do you really think many want to get in front of this train wreck?

Me thinks not.
  • For what it's worth, I was just offered Wachovia 5.8% hybrids at $0.10 on the dollar, and I passed. A block of 30-year Wachovia paper just traded at $0.35 on the dollar.

    This is not preferred stock or hybrid, folks, this is subordinated debt.
  • Washington Mutual sub paper? $0.01 on the dollar. This is what a credit rout looks like. And until this ship is righted, watch out. There are others trading similarly, like Morgan Stanley and, while I have no positions, it's quite interesting to watch.
  • So the few that can raise capital, like JPMorgan and Goldman Sachs will survive, but many failures lie directly in front of us.

Many regional banks are likely next.

Risks remain high, and the stock market, in my opinion, still has blinders on.

House Republicans Support a Plan That Would Insure Troubled Mortgages
After temporarily derailing the Bush administration’s $700 billion proposal to bail out the financial system on Thursday, House Republicans pared back their goals on Friday and demanded that the plan rely at least partly on an industry-financed insurance program for troubled mortgages.

Issuing a vague declaration of “economic rescue principles” to limit the use of taxpayer money, the Republican lawmakers focused primarily on the insurance program. The proposal would have banks and investment firms that own mortgages and mortgage-backed securities pay premiums for insurance that would guarantee them against losses if the mortgages default.

Supporters of the plan said it would restore confidence in mortgage-backed securities without putting taxpayer money at risk. “Instead of making the taxpayers pay, the securities holders would pay,” said Representative Paul Ryan, a Wisconsin Republican who helped create the plan.

That would be sharply different from the plan developed by Treasury Secretary Henry M. Paulson Jr., which would have the government buy up to $700 billion worth of currently unsalable mortgage-backed securities. Treasury officials have argued that their plan would address the heart of the financial crisis, which is that banks and investment firms are holding vast quantities of securities that have little or no market value.

By having the government buy up and hold those securities until the panic dies down, Mr. Paulson has been hoping to free the balance sheets of financial institutions, allow them to raise fresh capital from investors and start making loans again.

But Republican lawmakers said on Friday that they were not trying to scrap Mr. Paulson’s plan entirely. Instead, they said, they would simply try to insert an insurance program into the overall package. “We don’t want to undermine the negotiations,” Mr. Ryan said. “We want to honor the spirit of the negotiations.”

That was a retreat from Thursday, when John A. Boehner of Ohio, the House Republican leader, told President Bush and Democratic Congressional leaders that most House Republicans would oppose the administration’s plan. The idea of the insurance plan, championed by Representative Eric Cantor of Virginia, was to reduce uncertainty and restore confidence without actually using taxpayer money.

The federal government would guarantee the underlying mortgages in a mortgage-backed security, much as Fannie Mae and Freddie Mac have done for years and as the Federal Housing Administration does, as well. In theory, the cost of that insurance would be borne by the companies that hold the mortgages or mortgage-backed securities.

Treasury officials had already told Republican lawmakers they had considered an insurance approach, but rejected it. The problem, from Mr. Paulson’s standpoint, was that insuring against mortgage defaults would do little to increase liquidity, or the amount of money available for making loans. By contrast, the Treasury plan would inject hundreds of billions of dollars in fresh, although borrowed, money into the marketplace.

But the insurance plan could pose other risks to taxpayers. The government would be insuring the riskiest and most default-prone mortgages made during the housing bubble, including loans that required no down payment and no income verification by the borrowers.

The allure of insuring mortgages, rather than buying them as Mr. Paulson would, is that the government would not have to put up any taxpayer money. But because the government would be guaranteeing nearly all mortgages in the country, since it already owns Fannie Mae and Freddie Mac, taxpayers could face big losses if losses from defaults turn out to be higher than expected.

Many House Republicans, including Mr. Ryan, had come up with a far more detailed rival plan earlier in the week that included Republican policy evergreens like new tax breaks and more flexible regulation as well as the insurance idea. Some lawmakers wanted to at least temporarily eliminate taxes on capital gains and dividends, though senior Republicans knew they had no chance of getting that past Democratic leaders.

Members of the Republican Study Group, a group of conservative House Republicans, proposed lifting the mortgage market by letting companies reap retroactive tax rebates from their current losses. A company would be able to apply its losses this year against its profits from any of the last five years and get a rebate for taxes it had already paid.

But with lawmakers hoping to wrap up their work by Monday, Republicans dropped the idea as impractical because it would take too long for the Joint Committee on Taxation to estimate the measure’s cost. On the regulatory front, some House Republicans championed the idea of relaxing what are known as mark-to-market rules that require investment firms to revise the value of their securities in line with changes in market prices of those securities.

Over the last year, Wall Street’s biggest investment banks have been forced to take huge write-downs on mortgage-related holdings, not because the securities were actually losing money but because the securities had become almost impossible to sell in the open market. For many securities, especially the arcane derivative securities known as “collateralized debt obligations,” there are virtually no buyers and no market prices.

“If you don’t have to sell the securities today, you shouldn’t have to mark it at today’s value,” said Peter Ferrara, a senior researcher at the Institute for Policy Innovation, a research group in Virginia with ties to many Republican lawmakers.

But Mr. Ryan said the issue was complicated. While critics of the current rules complained that they artificially understated a company’s financial position, other experts argue just as vehemently that marking to market is a crucial way of preventing companies from covering up bad investments.

Confidence in US banks nosedives after Washington Mutual collapse
The failure of one of America's biggest retail banks undermined confidence in a fresh clutch of US household names today as investors digested the implications of the biggest collapse of a high-street bank on record.

Washington Mutual, which was bought by the banking giant JP Morgan for $1.9bn after being seized by the US authorities late yesterday, had a stockpile of controversial mortgages known as "option ARMs" that allow borrowers huge flexibility in setting the level of their own repayments.

While popular at the height of America's housing boom, the mortgages have proven to be a huge liability for banks and other firms known to have exposure to them were struggling to stem an erosion in credibility. Wachovia, a national chain with 3,000 branches and assets of $812bn, saw its shares dive by 27% and by the end of the day, it was casting around for a buyer. Reports in the US suggested that talks were underway with Citigroup, Wells Fargo and Spain's Banco Santander.

National City Corporation, a regional bank based in Ohio, suffered a sell-off that pushed its stock down by 25% amid fears, as yet unjustified, that customers could begin withdrawing their deposits. Details emerged of the extent of a run on the assets of Washington Mutual, known as WaMu, in the days leading up to its demise. The Office of Thrift Supervision said customers withdrew $16.7bn of deposits in 10 days beginning on September 15 - the day Lehman Brothers declared itself bankrupt, sparking a crisis of confidence in the banking system.

Sheila Bair, chairman of the Federal Deposit Insurance Corporation (FDIC), said the outflow alarmed WaMu's creditors, who became increasingly reluctant to extend funds. "Those who were willing to lend to them were no longer willing to do so," she said.

The FDIC reassured customers that all their money was safe. But it was clear that JP Morgan's offer to buy the Seattle bank's assets was a profound relief to regulators as America's insurance fund for banking deposits would have struggled to meet the bill - potentially requiring taxpayers to pick up any shortfall. "We were fortunate: this is huge," said Bair. "We've protected taxpayers, we've protected depositors and we've protected the deposit insurance fund."

Last month the FDIC said it had a "watch list" of 117 potentially troubled banks, holding a total of $78bn in assets. Bair said the list was growing as the financial crisis deepened. WaMu's senior executives were caught on the hop when their firm was seized by the Office of Thrift Supervision. At the moment of the seizure, much of WaMu's leadership team were on a plane from New York to Seattle.

The bank's failure could generate a fresh outbreak of fury over executive compensation. WaMu's chief executive, Alan Fishman, joined the bank only three weeks ago from a rival, Sovereign Bank. He received a $7.5m signing-on bonus and could be eligible for $11.6m in severance pay.

WaMu has its roots in a savings association created to help Seattle residents rebuild after the city suffered a catastrophic fire in 1889. The bank has 2,239 branches across the US and employs 43,000 people. It is widely known for its television jingles which celebrate the bank's nickname, WaMu, with chants of "woo-hoo". In Seattle, there was gloom about the firm's demise.

"It's devastating" Steve Leahy, chairman of the city's chamber of commerce, told the Seattle Post-Intelligencer newspaper. "They've been here since the Seattle fire. The suddenness of all this, it's just taking our breath away."
JP Morgan's decision to ride to WaMu's rescue was the second time this year that it has snapped up the assets of a troubled rival. Aided by a Federal Reserve guarantee, JP Morgan bought Bear Stearns when it was at the brink of bankruptcy in March.

Financial historians pointed to a proud history at JP Morgan of acting to avert crisis. The bank's founder, John Pierpont Morgan, was credited with bringing together Wall Street bankers to come up with a rescue package to prop up failing finance houses at the height of a stock market panic in 1907.

Wachovia Credit-Default Swaps Soar to Record After WaMu Failure
The cost to protect against a default by Wachovia Corp., the fourth-largest U.S. bank, soared to distressed levels after Washington Mutual Inc. was seized by regulators and its deposits sold off to JPMorgan Chase & Co.

Credit-default swaps protecting $10 million of Wachovia bonds from default for five years traded for as much as the equivalent of $3.5 million initially and $500,000 a year, according to broker Phoenix Partners Group. That compares with $670,000 a year and no upfront payment yesterday.

Wachovia's 2006 purchase of Golden West Financial Corp. saddled the company with option adjustable-rate home loans that allow borrowers to make minimum payments less than what they owe, which is then added to their total debt balance. With JPMorgan saying they expect 20 percent losses on WaMu's option ARM portfolio, Wachovia may need to raise $11 billion in capital to protect against losses from its loans, Deutsche Bank AG equity analyst Mike Mayo said in a note to clients today.

Wachovia is an "attractive target," though "it's not clear who wants to take them on at this time," Bert Ely, president of consulting firm Ely & Co. in Alexandria, Virginia, said today in a Bloomberg Television interview. Seattle-based Washington Mutual was taken over by the government yesterday after customers had withdrawn $16.7 billion from accounts since Sept. 16. New York-based JPMorgan acquired WaMu's branch network for $1.9 billion.

The initial cost for credit-default swaps on Wachovia bonds dropped back to 25 percentage points, or $2.5 million, after the New York Times reported the Charlotte, North Carolina-based bank is in preliminary talks to merge with Citigroup Inc. Wachovia has entered into preliminary discussions with banks including Spain's Banco Santander SA, San Francisco-based Wells Fargo & Co. and New York-based Citigroup, the Wall Street Journal reported, citing a person familiar with the situation.

Morgan Stanley broke off merger talks with Wachovia to focus on a partnership with Japan's Mitsubishi UFJ Financial Group Inc., CNBC reported earlier this week. "We may yet see that type of deal," Ely said. Morgan Stanley, along with Goldman Sachs Group Inc., "at some point in time need to acquire a large banking franchise, and Wachovia certainly becomes a very attractive target."

Wachovia's credit-default swaps are trading at levels that imply a 63 percent chance the company will fail within five years, according to a JPMorgan valuation model. That assumes bondholders would receive 30 cents on the dollar in the case of a default.

Wachovia's $750 million of 4.375 percent bonds due in 2010 plunged 29 cents to 51 cents on the dollar, as of 1:03 p.m. in New York, according to Trace, the Financial Industry Regulatory Authority's bond-pricing service. The yield increased to 51.6 percent, or 49.6 percentage points more than Treasuries with similar maturities.

"We are focused on managing our company and serving our customers with excellence," Wachovia spokeswoman Christy Phillips-Brown said. "Our core franchises -- retail banking, the nation's third largest brokerage firm, wealth management and our commercial and corporate banking activities -- are extremely valuable and continue to operate well relative to our competition."

Chief Executive Officer Robert Steel, a former Treasury official who was hired to replace Kennedy Thompson in July, has said he's firing workers and cutting more than $1.5 billion in annual costs to cope with losses from the loan portfolio.

Credit-default swaps on Morgan Stanley also rose to distressed levels today, coming close to a record high reached last week after Lehman Brothers Holdings Inc. filed for bankruptcy protection. Morgan Stanley and Goldman both won approval from the Federal Reserve to become bank holding companies, moving away from a business model that investors have deemed too dependent on borrowed money, or leverage.

Morgan Stanley contracts traded at 17.5 percentage points upfront in addition to 5 percentage points a year, according to Phoenix Partners. That compares with 783 basis points a year and no upfront payment yesterday, CMA data show. They earlier traded at a record 22 percentage points upfront, Phoenix prices show.

Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company's ability to repay debt. They were conceived to protect bondholders against default and pay the buyer face value in exchange for the underlying securities should the company fail to adhere to its debt agreements.

Credit-default swaps on other banks also rose today. Contracts on Merrill Lynch & Co., which agreed to sell itself to Bank of America Corp. last week as Lehman collapsed, rose 94 basis points to 415, according to CMA. Goldman contracts rose 86 to 449. Contracts on Citigroup jumped 115 basis points to 325 basis points, CMA data show. Bank of America rose 13 basis points to 161 basis points, Wells Fargo increased 38 to 159 and JPMorgan climbed 34 basis points to 156 basis points.

Contracts on the Markit CDX North America Investment Grade Index, a benchmark gauge of credit risk linked to 125 companies in the U.S. and Canada increased 2.5 basis points to 163.5 basis points, Phoenix prices show. Contracts on WaMu traded at 61 percentage points upfront today, Phoenix prices show, down from 74 percentage points earlier.

After JP Morgan Chase's Washington Mutual deal, rescue talk turns to Wachovia
JP Morgan Chase is raising $10bn (£5.4bn) to strengthen its balance sheet after buying the banking operations of Washington Mutual (WaMu), the lender seized by US regulators on Thursday night in the biggest bank failure in American history.

The fundraising came as speculation mounted that Wachovia was in talks with several potential suitors about a sale. Abbey’s Spanish owner Santander is among the banks reported to be considering a bid, alongside Citigroup and Wells Fargo. Fears that it could be the next US banking giant to be engulfed in the crisis hammered Wachovia, whose shares tumbled 36pc before closing 27pc lower on the bid rumours. Earlier this month, it was considering a rescue deal for Morgan Stanley that would have seen the two banks merge.

“Washington Mutual showed that one of the big ones can go down, and if you are looking at who else in the top 10 is facing the most pressure, Wachovia is right there,” Stan Smith, a banking professor at the University of Central Florida in Orlando, said. WaMu was taken over by regulators on Thursday after customers of the Seattle-based lender withdrew $16.7bn, according to the Office of Thrift Supervision (OTS), making it the biggest US bank failure in history.

JP Morgan is paying $1.9bn to the Federal Deposit Insurance Corporation (FDIC) for all deposits, assets and certain liabilities of WaMu’s banking operations in a deal brokered by the American government. Under the deal, JP Morgan will not acquire claims by equity, subordinated and senior debt holders, the FDIC said.

JP Morgan is offering 247m shares at $40.50 in the fundraising, plus potentially 37m more shares if there is demand. JP Morgan shares rose 91 cents to $44.37. WaMu specialised in providing mortgages, credit cards and other retail lending products. The shares collap-sed amid the carnage caused by distressed home loans. The OTS said: “With insufficient liquidity to meet its obligations, WaMu was in an unsafe and unsound condition to transact business.”

The FIDC, which insures US citizens’ bank deposits of up to $100,000, immediately auctioned WaMu. Analysts said a complete failure could have used up half the money in the FIDC insurance fund. JP Morgan has long had its eyes on the failed bank’s branch network in California, Florida and Washington state.

JP Morgan said the deal would add $176bn in mortgage-related assets and would be “marking down the acquired loan portfolio by about $31bn” – a figure that could change if the US government succeeds with its $700bn bail-out. Together, the two banks will have more than $900bn of customer deposits.

Banks Bog Down
Washington appears poised to rescue the banking system with a $700 billion bailout, but are banks ready to help themselves? Judging from activity (or, rather, non-activity) in the credit markets Thursday, the answer is not quite yet.

The difference between rates in the overnight lending markets and rates in the longer-term markets, a gap that is widening, suggests banks aren't willing to lend much to each other. That is the type of activity needed to break the logjam in the credit markets.

The Federal Reserve has been flooding the banking system with cash, so much so in the last week that it has pushed the effective overnight interest rate below the central bank's target 2%. On Thursday it announced a $20 billion reverse repurchase program with banks to try to narrow that gap.

Meanwhile, the London interbank offered rate, which is the rate at which banks lend to each other, continues to rise. The three-month Libor is at 3.77%, according to UBS, and the difference between that and the overnight rate suggests "interbank lending is broken," said William O'Donnell, the head of U.S. interest rate strategy at UBS. Rather than extend credit for longer than overnight, banks appear to be hoarding cash.

"I hope the Fed has a lot of thumbs, because there is water breaking through the dikes everywhere," O'Donnell said. Expectations rose Thursday that the Fed could jump in with a rate cut, either on or before its next scheduled meeting in late October. According to the futures market, the expectation of a cut jumped to an 85% chance, from a 30% chance just last week.

The tumultuous events in the credit markets last week and this week "give the Fed cover to go ahead and cut rates," says Aaron Smith, a senior economist at Moody's Investors Service's The grim news in the credit markets has been overshadowed by euphoria in the stock markets, which rallied Thursday on news that Congress was near agreement to approve Treasury Secretary Henry Paulson's $700 billion bank rescue plan, with revisions.

How else to explain a 300-point rally on a day when new-home sales in August showed an 11.5% decline, a 17-year low, and General Electric, a market bellwether, cut its forecast and suspended stock buybacks because of a bleaker outlook for its financial services business?

Signs of stress abound. According to data released by the Federal Reserve Wednesday, short-term debt known as commercial paper contracted by $61 billion over the last week and $113 billion over the last two weeks, a period marked by the bankruptcy of Lehman Brothers and the government rescue of American International Group.

Companies sell commercial paper, which is essentially a short-term IOU, to fund daily cash flow activities, like payroll. Financial companies use it to fund pools of car loans, student loans and the like. A contraction in the commercial paper market suggests either a lack of buyers or a lack of lending, or both.

Standard & Poor's said in a worst-case scenario, defaults on junk bonds of non-financial companies could rise to 23% between now and 2010, which would make the next three years the worst period since 1981. Consumer-sensitive sectors--such as consumer products, media and entertainment, and retail and restaurants--will be among the worst hit, S&P says, in line with what happened in 1990-91.

The Fed and the Bush administration have been scrambling to shore up the banking system or, at the very least, put a floor under the housing market, which the banks' fate hangs on. In July Congress passed sweeping plan to boost the housing markets, or at the very least stop the bleeding. Just a couple of weeks after that, however, the government had to rescue mortgage finance titans Fannie Mae and Freddie Mac with a $200 billion bailout. Then, in a three-day span, Lehman failed; Merrill Lynch, fearing a funding crunch, sold itself to Bank of America; and AIG had to be taken over.

In testimony to the Joint Economic Committee Wednesday, Fed Chairman Ben Bernanke cast a grim assessment of the near-term economy. "Ongoing developments in financial markets are directly affecting the broader economy through several channels, most notably by restricting the availability of credit," he said. The $700 billion bank rescue effort, in which the Treasury will buy up toxic assets from banks in the hopes of kick-starting the credit markets, will help bank balance sheets, but that doesn't mean banks will play along.

Banks lend when they feel confident, and when they are making the profits that allow them to expand their business. The industry is in contraction mode at the moment. "Once spurned, twice shy," UBS's O'Donnell said Thursday. The Treasury's lending program and other attempts to jump-start the economy "are the first bricks laid in what is likely a very long path for banks and the economy," he added.

Even Hank Paulson's bail-out plan cannot detox global banking
Even if Congress backs the Paulson bail-out, the $700 billion blast cannot save the US, Britain or the world from the deepest economic slump since the Thirties. If Congress balks, God help us. The credit system is suffering a heart attack. Inter-bank lending is paralysed. Funds are accepting zero interest on US Treasury notes for the first time since Pearl Harbour, because no bank account is safe.

Wherever you look – dollar, euro, sterling Libor (the rate at which banks lend to each other), or spreads on credit derivatives – the stress has reached breaking point. If borrowers cannot roll over the three-month loans that are the lifeblood of business, they will default en masse.

“Money markets are imploding. If no action is taken very soon, there is a significant risk that the global economy will collapse,” says BNP Paribas. Almost every trader says much the same thing. So does US treasury secretary Hank Paulson, who as Toby Harnden reports, literally dropped on bended knee to beg help from Democrats on Capitol Hill.

Republican refuseniks – defying their president – have a grim responsibility if they now tip America over the edge, setting off the “adverse feedback loop” that so terrifies the US Federal Reserve. Like players in a Greek tragedy, they seem determined to repeat the “liquidation” policy that led to the Great Depression – and to Democrat ascendancy for years.

Lehman Brothers’ collapse showed the chain of inter-connections that can cause mayhem across a clutch of different markets. That was just one bank – albeit with $630 billion or so in liabilities.

Credit is the lubricant of a modern economy. A seizure now would probably lead to the bankruptcy of General Motors and Ford in short order, but it would not stop with the US car industry. Waves of job losses would set off a self-feeding spiral. Yet more people would default on their mortgages (and car loans), driving house prices down even further. That, in turn, would threaten the solvency of the best banks. That is the way to Armaggedon.

As Mr Paulson says, US taxpayers are on the hook whether they like it or not. A $700 billion fund to soak up toxic debt and stabilise the credit market is the cheapest way out. It is certainly cheaper than Depression. Hopes that the world can cruise happily on as the US buckles have been dashed by the violent downturn across Europe and Asia over the summer.

The Baltic Dry Index measuring freight rates for ships has plummeted by two thirds since May. Japan’s economy is already contracting. China’s may be close behind: a third of all textile factories in Guangdong have closed this year. House prices are tumbling in Shenzen, Beijing, Shanghai.

Albert Edwards, global strategist at Société Générale, says Asia built its boom on shipping goods to the US: “The emerging market boom is going to collapse and this will shake investors to the core. The great unwinding has only just begun.” In Europe, an arc of states from Scandinavia down through the core of the euro zone is already sliding into recession. German GDP shrank by 0.5 per cent in the second quarter. Its manufacturing orders have fallen for eight months in a row, for the first time since records began. Spain is at the onset of a calamitous bust after a property bubble that surpassed even the excesses in America.

This is debt deflation – partly imported from America, partly home-grown. It is global. There is nowhere to hide. Even oil-rich Norway took emergency action this week to shore up its banks. How will it all end? Europe assumed – wrongly – in the early Thirties that it could withstand the Atlantic gales after the collapse of the Bank of the United States in December 1930. However, Austria’s Credit-Anstalt failed in the early summer of 1931, setting off contagion across the central European banking system.

In the end, it was America that muddled through. The US produced Roosevelt: Europe lost half its democracies. We now live in more benign times, but unlike America, it is far from clear whether the eurozone has the machinery to rescue its economy in a fast-moving crisis. EU rules prohibit big fiscal bail-outs. There is no EU treasury to take charge.

America’s serial bail-outs – nearing $1.6 trillion, or 12 per cent of GDP – are playing havoc with the US budget. The deficit is above 6.7 per cent, near a 60-year peak. But claims that the US is going bust are frivolous. The US Treasury is not taking on permanent debt: it is behaving like a giant wealth fund, hoovering up mortgage securities selling far below their real value for reasons of panic. Famed investor Warren Buffett expects it to make “a considerable amount of money”.

The system will recover, but it may take a slow purge for a decade or more to rid us of the debt toxins. There will be no quick rebound this time

U.S. GDP Deflates
The bad news for the U.S. economy kept rolling in on Friday, with slower-than-expected growth in the second quarter and less confidence from consumers than had been expected. America's second-quarter gross domestic product grew only 2.8%, not the 3.3% first thought.

Wall Street had expected the revised figure, which was reported by the U.S. Commerce Department Friday morning, to remain unchanged. The Reuters/University of Michigan Surveys of Consumers reported the final reading of its index of confidence rose to 70.3 in September from 63.0 in August, the highest final reading since 70.8 in February.

While that may have been nice, the figure was still below economists' expectated 71.0, according to Reuters. It was also down from 73.1 recorded in a preliminary report released on Sept 12. "The rebound in consumer confidence ended amid heightened concerns about the growing financial crisis, although these concerns arose too late in the month to completely erase the earlier gains," the report said.

The yield on the benchmark 10-year U.S. Treasury note dropped to 3.81%, from Thursday's 3.86%. According to the U.S. Commerce Department, the overall gain of the GDP was primarily due to exports, personal consumption expenditures from special tax rebates and government spending, which offset such things like private inventory investment.

Wall Street is already feeling the sting, with massive turmoil in the financial markets, frozen credit and continued high unemployment. The nation's unemployment rate jumped to 6.1% in August, a five-year high. So far this year, a staggering 605,000 jobs have vanished. The economy needs to generate more than 100,000 new jobs a month for employment to remain stable.

There are fears that the United States might fall into recession at the end of this year. Data on Thursday was similarly discouraging.

SEC ends oversight program for Wall Street banks
The Securities and Exchange Commission said Friday it was ending a program of voluntary oversight for Wall Street investment banks that its chairman said clearly has not worked. It was the latest shift in the regulatory landscape stemming from the financial crisis that has gripped the markets and thrown Washington into fevered negotiations over a $700 billion bailout plan.

SEC Chairman Christopher Cox announced the agency's decision to end the program under which SEC examiners inspected the five biggest Wall Street banks: Goldman Sachs Group Inc., Lehman Brothers Holdings Inc., Merrill Lynch & Co., Morgan Stanley and Bear Stearns Cos.

The financial upheaval of the last six months has "made it absolutely clear that voluntary regulation does not work" for the bank supervision program, Cox said in a statement. The program "was fundamentally flawed from the beginning, because investment banks could opt in or out of supervision voluntarily," he said.

The SEC inspector general, meanwhile, found that the agency's oversight of Bear Stearns - which nearly collapsed into bankruptcy in March and was purchased by rival JPMorgan Chase with a $29 billion federal backstop - and the other four banks was lacking.

The SEC's oversight of the firms "should be improved" and the guidelines covering their capital and liquidity requirements should be reevaluated, according to the report by Inspector General H. David Kotz made public Friday. Cox said the report "validates and echoes" the concerns he has expressed to Congress. The weakness of the supervision program stems from the lack of specific legal authority for the SEC or other agencies to act as regulator of big investment-bank holding companies, he said.

In recent days, Lehman Brothers buckled under bad mortgage debt and filed the biggest bankruptcy in U.S. history, and Merrill Lynch agreed to sell itself to Bank of America Corp. That left only two independent investment banks standing on Wall Street - Goldman Sachs and Morgan Stanley - and they won approval from the Federal Reserve last week to change their status to bank holding companies in order to stay in business.

The seismic regulatory shift allows the two firms to create commercial banks that can take deposits, thereby bolstering their resources. It also puts them squarely under the regulatory jurisdiction of the Fed. Earlier in the year, Cox told Congress he wanted the SEC to supervise big investment banks at the level of their parent holding companies. Fed officials said the prevailing system, in which the central bank is the primary overseer of those firms, generally works well.

The Bush administration has proposed giving new powers to the Fed to oversee financial institutions and supplanting the SEC as primary supervisor of Wall Street investment firms. That change could only come through legislation - something that will have to wait until after the presidential election and the installation of a new Congress next year.

Nationalisation looms for Bradford & Bingley
Alistair Darling is close to ordering the nationalisation of Bradford & Bingley as a search for a private sector buyer for the stricken lender becomes increasingly desperate. Seven months after Northern Rock was taken over, the Chancellor has ordered officials to prepare to take a second financial institution into public ownership, although Treasury officials last night stressed no decisions had been taken.

Last ditch talks to find a buyer are set to continue through the weekend but officials did not deny that Mr Darling was considering using new powers to nationalise banks passed after the run on Northern Rock. "You would expect us to have contingency plans," said a Treasury spokesman.

The seizure of B&B would be explosive, taking more than £40 billion of assets and liabilities on to the Government balance sheet and would be certain to trigger a backlash from shareholders who have only just injected £400 million into the business to beef up its balance sheet.

Ministers are acutely conscious of the danger of sparking a depositor panic. However, deposits of up to £35,000 at all banks, including B&B, are anyway guaranteed under the Financial Services Compensation Scheme. Nationalisation would make deposits even safer.

B&B, which specialises in buy-to-let mortgages and other higher-risk lending, has been beset by difficulties for months, culminating this week in a series of credit rating downgrades by influential ratings agencies. Its shares fell to a new all-time closing low of 20p yesterday from a high of 536p in March 2006.

The Financial Services Authority has been reportedly attempting to line up a "white knight" bidder to rescue the bank. Banco Bilbao Vizcaya Argentaria and Banco Santander of Spain and ING of the Netherlands, have been mooted as possible saviours. But with markets so febrile and banks so nervous about conserving cash and not taking on additional risk, a rescue bid has been looking increasingly unlikely, even at a rock-bottom price.

B&B is seen as an unknown quantity because of its aggressive expansion into buy-to-let lending and because of its huge portfolio of "self certified" mortgages - home loans where the borrower has not been required to provide proof of income and known sometimes as "liars' loans".

While reasonably strongly capitalised, following a £400 million injection of fresh capital in August, it is still relatively highly dependent on wholesale funding - a weakness that led to Northern Rock's demise last year. The downgrades by the ratings agencies have left it with the lowest ranking investment-grade score of BBB-. Any further downgrade would see it dubbed "speculative grade" or "junk", an untenable position for a deposit taking institution.

A B&B spokesman said last night, "We do not comment on market rumour or speculation." After emerging from his 90-minute meeting with President Bush in Washington last night Gordon Brown also refused to comment on "speculative statements".


The Lizard said...

The downfall of many's the fire & brimstone preacher was when they lifted a calendar and pointed to Judgement Day. When it passed, the pews emptied and the radio tuned elsewhere.

I&S have here committed to a winter freeze, regardless of temperatures outside.

Like The Oil Drum site where believers and cornucopians argue while the herd struggles for answers, there seems to be here a bit of what I might call an excluded muddle (not a typo).

It's surely possible that "the bailout plan" neither flops nor cures cancer, but simply does nothing but provide political theatre while the system slumps and then recovers again.

Setting a date for Ragnarok not only pisses off the gods, but is a political act.

Bigelow said...

Thanks again to Ilargi and Stoneleigh. So maybe Winter solstice will be a natural point to cease your Herculean reporting...
BTW, George Ure (UrbanSurvival) has posted Oct. 7 as a particularly inauspicious day watch out for.

Anonymous said...

If it were done when 'tis done, then 'twere well it were done quickly --Macbeth, Act I

Whazzat did the ghost of D.Matthew just whizz by?

The Lizard said...

"RUIN, v. To destroy. Specifically, to destroy a maid's belief in the virtue of maids."

- Ambrose Bierce; Devil's Dictionary.

Anonymous said...

So, uh, I'm getting the impression that things are bad. Is that correct? :-)

What is the next shoe(s) to drop? What will be the event where main street comes to understand that we are already well on our way to a financial collapse? How will average people react when it becomes all too clear?

As with peak oil, I don't worry so much about the event as I do about how the people around me are going to react to it. There are millions of white collar, middle class slobs that are going to be really pissed off when they discover that their comfortable lives are about to come to an end. It took me about a year to come to terms with it, and start to think about how I could manage in a low-energy, low-capital world. For people who are just now starting to grasp the events unfolding around them, it looks like they won't have a year to adjust.

Ilargi - Excellent post, as always. You are far more than a "two-bit beat reporter"... You and Stoneleigh saw the writing on the wall, and decided that the best use of your time was to help as many of us prepare as possible. For that, I thank you both; there are many of us that would rather go into the abyss with eyes open, maybe even use this time to prepare as much as we can for what comes next.

In the end, the only true test of character is the positive impact you had on those around you. You and Stoneleigh are way ahead of the game in this regard.

Again, many thanks :-)

Anonymous said...

Speaking of collapse, wait, check that... Today is a Great Day to make that EZ donation to the tip jar you have been meaning to you know.

Anonymous said...

What is the next show to drop?
Roubini thinks it is hedge funds.
He says "The next stage will be a run on thousands of highly leveraged hedge funds. After a brief lock-up period, investors in such funds can redeem their investments on a quarterly basis; thus a bank-like run on hedge funds is highly possible. Hundreds of smaller, younger funds that have taken excessive risks with high leverage and are poorly managed may collapse. A massive shake-out of the bloated hedge fund industry is likely in the next two years."

Hopefully it is a non-event, but the last redemption date this year for a lot of hedge funds is this coming Tuesday (Sep 30).


EBrown said...

After my prediction of WaMu failing in the first or second week of Oct being the catalyst of a further big leg down on the stock market I have been hunting around for the next proverbial "shoe". I was a bit late with the timing of WaMu and a bit early with the cliff diving of the market, but give or take two weeks ain't TOO bad (assuming the market drops soon too, which is a real possibility).

I now think the next bad news event is going to be either a run on hedge funds or a big drop in the stockmarket without an obvious spark. Sure, after the fact reporters will blame the cliff dive on this or that (oil prices, continuing financial turmoil, hedge funds running for the door, etc), but really it will be due to the permeation of fear deeper into the collective conciousness. Many people I talk to are afraid, and I don't talk to that many "investors". Rather I circle with average working Americans who are now scared for their pensions and retirement accounts. Most of them are going to be caught out in the cold both literally and figuratively. Oh well, I say my piece and then let them make up their own minds about the severity of the approaching hurricane.

Anonymous said...

Regarding the Wamu takeover...
"In the process the OTS and the FDIC have effectively removed the main low-cost source of funds of pretty well all banks in America. They will have put the fear-of-Government into such people globally. This is the opposite of moral hazard. In the Moral hazard case people take too many risks because they believe the government will reimburse their losses. But in this case people are going to take too few risks because they know that government might unilaterally remove their rights and property.

This was – by far – the least justified government action of this credit cycle. And it spells doom for any bank in America that is ultimately reliant senior (and hence well protected) but unsecured financing because it is so capricious.

Those banks are many – but we can start with Wachovia whose destiny (failure) is now nearly certain – and for whom the precedent is set. But after that we can go for all the banks including the champions such as Bank of America and Citigroup. Creditors now face confiscation of their rights by the US Government without oversight or audit or even process.

At that point there is no creditors and the economy collapses. The trust needed to make capitalism worked has been removed. I am not a conservative - but I will argue - along with many conservatives - that the most important function of government in a capitalist society is provision of a framework by which property rights can be defined and enforced as this is the key to making a capitalist society function. The Government is now acting as if the framework does not apply to them. That is bad whatever your political persuasion.

What next

The FDIC and OTS have won the battle with respect to WaMu. They got rid of WaMu without any cost to the taxpayer. The WSJ lauded that achievement. They really did get out of their WaMu risk quite neatly – and I will be the heads of those organisations went to bed feeling pretty pleased with themselves.

But in the process they have doomed about two thirds of the US banking system.

I am still a believer that government – whilst not stuck with great incentives will grope for right solutions. But that belief of this former (competent) public servant is being shaken to the core.
And whilst Wachovia and dozens of others will eventually hit the wall because of this decision the Government will work out that it has a bad process before Bank of America fails.

But I think it is time that the process is short circuited. The heads of the OTS (John Reich) and of the FDIC (Sheila Bair) should be sacked now and for cause. Mr Paulson better get control of this situation and let it be known that the US has a process for dealing with senior creditors and making sure that their rights are honoured.

Otherwise heaven help us."

Anonymous said...

thank you so much for your reporting, Ilargi and Stoneleigh!
I'm not sure I've enjoyed it but it;s definitely educational.

I'd be sorry to see y ou stop reporting but you both need to take care of yourselves, too.


Anonymous said...

You may be two-bit reporters or you may be worthy of a (never to be delivered) Pulitzer prize but you're one of the few games in town. We can't get, as Nick Danger said, "The bird's-eye lowdown on this caper" anywhere else. Please ride the locomotive until you see the washed-out bridge ahead...then jump off at the last minute. You certainly have my (un-required) permission to take weekends off but I love every dot and tittle...even though it's about the end of the world as we know it.

My quote for the moment:

"Better meat for the mind than smoke for the large intestine".

Anonymous said...

So finally there are some around those Washington tables who truly realize the gravity of this credit bubble. No wonder they are working thru the weekend, it might be their last session? I would think they are also trying to figure out a way for one political party to blame the other for this mess when the bubble bursts.

Thank you ilargi and stoneleigh. Much appreciate your reporting as it has helped me to think and prepare for what is about to befall all of us. Please take care, we need you to be around to guide us further.
Anonymous Reader

John Bayley Matthews said...

I very much appreciate the collection of articles and particularly the commentary by Illargi and Stoneleigh.

I live in New Zealand and things have not got dire here yet, but I really like keeping a close eye on what is going on globally, and especially the USA as it has been a financial powerhouse for so long.

I do not have many assets to manage but have relatives who do and I feel informed enough to give a little advice now and then.

Anonymous said...

Stoneleigh & Ilargi,
Your insight is appreciated. Ilargi your reporting is first rate all the way!!!
Clearly, both of you practise your craft with excellence!
Marianne and Brenda

perry said...

When will the oft-promised [since Y2K] "Redbacks" begin to be issued, and the old (and current)"Greenbacks" be confiscated?

When will the tax on using Greenbacks begin to be implimented?


Anonymous said...

Anonymous said...

Their Party Crashed. Ours May Too.
The task facing business in the 1920s was replacing the work ethic with a consumption ethic. If the American people were to be made into insatiable consumers, traditional values would have to be undermined and reversed. The means of accomplishing this? Advertising. The Mad Men of the '20s made over the traditional wisdom of "Waste not, want not" into the essential message of the consumption economy: "Waste and want." Bruce Barton of Barton, Durstine & Osborn, for instance, famously portrayed Jesus as the ultimate advertiser and businessman in his 1925 bestseller, "The Man Nobody Knows."

But wanting isn't enough. If the masses are going to be able to buy what they've been persuaded to want, they have to receive a sufficient share of total income to do so. Yet the opposite happened in the '20s. President Calvin Coolidge and his Treasury secretary, Andrew Mellon, drastically reduced taxes on the highest incomes. Meanwhile, anti-union policies produced less income for worker-consumers. The share of total national income going to the very richest grew enormously, peaking in 1928, just months before the economy began to contract in the summer of 1929. The top 10 percent of American earners then were getting 46 percent of total income.

Providing large tax cuts for the richest was precisely the wrong policy. To stimulate consumption, taxes should have been cut at lower income levels. Cutting taxes on higher incomes stimulated speculation instead. Sound familiar?

"Don't kill the goose that lays the golden eggs" is one of the favorite sayings (and warnings) of champions of high profits, low taxes on the rich, concentrating wealth and income at the top, and the rest of trickle-down economics. But when profits become too high and taxes on the very rich too low, the geese get obese, eventually stop laying eggs and develop coronary problems.

What the economy needed was an effective weight-loss program for the monetarily corpulent and a program to help underweight consumers put on a few pounds (i.e., dollars). Yet those who argued for such an approach, such as progressive Republican Sen. George Norris of Nebraska, were ridiculed by the followers of the god of the unfettered market.

Instead, 1920s financiers gave consumers an injection of the economic steroid known as credit. And the economy temporarily became extremely robust. Sales of automobiles, radios and other new products to people who couldn't actually afford them soared. The ratio of private credit to GDP nearly doubled between 1913 and 1929. During the '20s, short-term personal loans from personal finance companies ballooned by more than 1,200 percent.

But a steroid-induced burst of great strength is always likely to be followed by impotence. Sooner or later the limits of consumer credit are reached -- consumers find themselves with more debt than they can repay, sales decline and banks, left holding bad loans, begin to fail.

"Sooner or later" arrived in October 1929, as it has again in September 2008.


Here's the main lesson the Great Depression taught us: Capitalism is the best economic system just as democracy is the best political system, but both contain inherent dangers that require checks and balances to ensure that they work properly. One of the most prominent dangers of capitalism is that income will become too concentrated at the top, undermining the functioning of a consumer-based economy. The fruits of this lesson were put into effect during the New Deal through higher taxes on the rich, support for unions to help working people get a larger share of the national income, social programs to aid the poor, and such regulatory agencies as the Securities and Exchange Commission. A system of regulated capitalism was in place and worked very well from World War II to 1980.

Anonymous said...

Once again I would thank you, I&S for your insightful and damning evaluation of the slow motion train wreck that is our current state of affairs.

For the record,should things hold together[that we be so blessed]'till Christmas,I would still "tune the radio",as too much truth wanders thru these pages,with analysis better that I could afford to find.
Ure's "time monks" may have something..most of those who signup stay...and they have had some interesting "hits"

I am starting to think the impact of the speech's,dire warnings,dissolving equity, 3rd quarter high-explosives hidden in the books of many firms will be enough to trigger a phase-change that will "pull the curtain"on the shadow game we have called a economy for so long.We don't make things here anymore,so the game is very important.Problem is,eveyone knows its rigged now

Denninger is screaming his head off about the destruction that Paulson is doing to the equity lines.I understand enough to know how serious this is,and how fast folks overseas may dump anything that Paulson can touch.

Many have said that they could not see anything that Bush could do the last few weeks of his term...

It now appears as if a whole lot of people who are wealthy republican types are going to get skinned by Bush and Paulson,on their way out the door.In the process,they are going to cut the financial heart out of America.Their actions in the wamu takeover show a government force being used badly a terrible abuse of power.


Anonymous said...

What's going to happen if (when?) the $500+ trillion derivative market goes pop?

Total world derivatives

Anonymous said...

Anonymous said...

[I] think I had perhaps better get out of the way, to take care of myself and those closest to me.....

If time is money, than borrowed money, in the end, can buy you nothing but borrowed time.



Our revels now are ended. These our actors,
As I foretold you, were all spirits, and
Are melted into air, into thin air: And like the baseless fabric of this vision,
The cloud-capp'd tow'rs, the gorgeous palaces,
The solemn temples, the great globe itself,
Yea, all which it inherit, shall dissolve,
And, like this insubstantial pageant faded,
Leave not a rack behind. We are such stuff
As dreams are made on; and our little life
Is rounded with a sleep.

[The Tempest]


TheHangedMan -- My apologies in advance for using a much over-used historical event that has now (unfortunately) become somewhat of a cliche for any disaster. But it fits. When the Titantic hit the iceberg, its fate was sealed and there were those on-board who knew the end within an hour of the beginning ... and spoke of it only amongst themselves. If we, in this day, have not hit another iceberg, I cannot fault Ilagri and Stoneleigh for thinking that we have...and caring enough to speak of it...not just amongst themselves.


Anonymous said...

You have done a real service here, providing us with accurate insights that few others had. I hope that before you would decide to quit doing this altogether you might just phase out in someway or another. Once a week, or just a couple paragraphs each day without bothering to post the news articles, or just write when you have the time or desire. Though I watch these events unfold, it always helps me so much to get your overview, and summarizing of some of the absurd mathematics that go with the stories when you point them out for us. Things are bound to get more interesting by the day. Thanks so much.

Anonymous said...

So I take it that we're at the point where as Orlov puts it:

"People stop intellectualizing their predicament and start trying to escape it - through drink or drugs or creativity or cunning - but have no time to ponder the larder context."

A toast to our financial Samizdat writers!

Anonymous said...

You can't leave... all the plants will die!
(Bill Murray - Stripes)

Well, best wishes if you should decide to stop posting.

Anonymous said...

I & S, perhaps you might consider writing a blog fewer times per week as Sharon Astyk has done.

If you feel you must dedicate more time to yourself and your family, then you must. I empathize.

Thank you for all you do and all you have given us.


Anonymous said...

Corrected washington post link to their party crashed

New prudentbear credit bubble bulletin, if you haven't read this stuff before, his actual comments are always at the very bottom of the page.

Unless some dramatic development reverses the current course, it will not be long before a self-reinforcing cycle of company payroll and spending cutbacks takes hold. At the same time, the municipal bond market is in disarray. The economic impact from major cutbacks in state and local government spending will be significant. Today’s finance-related economic headwinds are Cat-4 (and gaining) Hurricane Systemic Credit Seizure, compared to last year’s Tropical Storm Subprime. Federal Reserve-dictated interest rates are extremely low – and the Fed and global central bankers have injected unfathomable amounts of liquidity – yet Credit Conditions have turned the tightest they’ve been in decades.

The Lehman bankruptcy marked a major inflection point in the confidence of contemporary “money.” It was a decisive blow against trust in various money market instruments – the very foundation of our monetary system. “Money” has now tightened significantly for virtually all players that had previously enjoyed cheap short-term financings. This list certainly includes the hedge fund community.

Re taking breaks from very intensive volunteer work, do whatever you need to do ilargi, very few people actually understand how much work and time this type of stuff takes on a daily basis, I do.

However, I tend to agree with some of the posters here in this thread, your writing is very good, and it could be a help as things unfold, however that will be.

One thing that's been funny is to watch Kunstler sort of run out of gas totally as pretty much everything he's been talking about starts to happen. It's hard being so right sometimes, when reality finally catches up, it can kind of throw you off I think.

Anonymous said...

I was drinking a wonderful cup of freshly roasted coffee today, feeling the warm autumn sun. I held the moment knowing that one day soon it would be a fond memory. I am as prepared as I can be, mostly because of your 'reporting.'

Many thanks and many blessings to you and yours.

Anonymous said...

Loved this weeks New Rules on Bill Maher's show. Watch the part about the bailout near the middle:

New Rules (9/26/08)

Anonymous said...

Ilargi and Stoneleigh,

I want to thank you for all your work alerting us. Because of you, I've managed to get my ducks in a row and alert friends and family too . It's a tremendous service you do, and I didn't want it to be thankless as well. I will miss your reporting and insight should you decide to quit, but I sure understand if you have to. I tossed a bit in your tip jar in July, and considering that you have saved me much money, not to mention grief (though there is still some of that!) I am making another contribution.

Much obliged,

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

ilargi, no idea what your personal situation is but if you are serious about the need to tend to family and all, and as events are unfolding I've no reason to doubt this, you gotta do what you must but you two have put together a good and growing site and to trash it would be a shame. As those business guys are so fond of saying restructure' might be the word. Anyway whatever you find you need to do, even if it means not publishing for the moment, keep writing, you have a talent.

Anonymous said...

Over on Dennigers market ticker forum..

From Genesis (denniger) "The draft on the Banking Commitee website allows bank reserves to be set to ZERO.

If this is done it will cause the entire banking system to collapse.

This is mathematics - the lower the reserve requirements the closer to "coffin corner" you get in the banking system. Set to zero you have the ability to create infinite circulatory velocity but you also have the millstone of imminent collapse from even a tiny devaluation in what you hold.

If this passes the nation's banking system is ****ed."

Some over there think that the rest of the $700B proposal was just a smoke screen and this is what they really wanted.

But I dont understand why this is important. Anyone who knows?


el gallinazo said...


Well, the first thing you learn in Calculus I is that anything divided by zero is "undefined" in an infinite sort of way. May be their final vain attempt to inflate to counteract the deflationary implosion. Only I&S know for sure :-)

el gallinazo said...


Well losing you would be like dropping our GPS in the lake. May I suggest to all lurkers who have yet to visit the Tip Jar, that now is the time. Finding brilliant Austrian economists with an actual human heart rather than a flint transplant is indeed a singularly rare event.

Anonymous said...

Where did I&S say they were quitting? I believe that Ilargi was using an extended metaphor. At least, I hope so. Best blog on the net and best view of the current state of affairs which, if it wasn't so serious, would be almost comical.

Anonymous said...

@ ff:

I think I understand this, so I'll give it a shot, although anyone PLEASE correct me if I'm getting it wrong or not being subtle enough. (And no, I've never posted here before, but I'm an avid follower.)

As I understand it, when a bank lends out money, they are in essence creating the money out of whole cloth--this is what their Banking Charter allows them to do. Since this is a fairly insane thing to allow, there are restrictions, the main one being the Fractional Reserve system. Having a fractional reserve system means that banks must maintain a certain ratio of deposits on hand to the amount of money they create via lending. Traditionally this ratio is 1 part deposits to 9 parts newly-created loan money. So if the bank has $1,000 in deposits, they are entitled to loan out an additional $9,000 in loans. I've heard that this ratio has gone as high as 1:12, but that's about it.

Setting the reserve amount to ZERO, on the other hand, is essentially saying "Sure, banks can just go and create as much money as they want--have fun!" In other words, banks can leverage themselves out as far as they want, with no restrictions. But the more you're leveraged, the more the risks multiply, and the more your losses multiply if your position ever devalues. Note Fannie & Freddie, which according to Denninger were at one point leveraged to 1:80. So the banks would stand to drastically increase their asset balance sheet, since the loans due to them get to count as a positive on their balance sheets. This would also unfreeze the credit market (gee, just what we need, more lending), but when the assets devalued (as they almost certainly would, given our overall economy), those losses would pile up massively due to the multiplying effect that leveraging causes.

If you haven't already, google "Money as Debt" and watch that video. It was incredibly helpful to me for learning how our monetary system actually works. I am seriously contemplating showing that video on my last day of class for my Critical Thinking classes--damnit, they are going to learn *something* of value from me!

Best, R.

Anonymous said...

I believe the Canadian banking system has had zero reserve requirements since about 1996, IIRC. They also are required to settle all outstanding accounts at the end of every day. So the lack of a reserve requirement does not necessarily mean more craziness, in and of itself.

Stoneleigh said...

Thanks very much for all the kind words - we're happy to be of service. People have worked too hard for what they have to allow it to disappear into the ether (so to speak), or have it confiscated by those higher up the financial food chain. The little guy needs a break.

We aren't planning to abandon our computers for gardening tools imminently. Ilargi was musing out loud about what use commentary would be if it were already far too late to do anything other than watch the traffic accident unfold. We aren't about rubber-necking at highway pileups, but warning people in time for them to do something useful.

Personally, I think we can still be useful for quite a while yet. IMOs there's enough inertia in the system for there to be significant time lags before the real economy craters. Where finance leads, the real economy follows, but not immediately. For leading indicators of trouble watch credit spreads widen as this is a sure sign of a trust hemorrhage. As trust and confidence are vital determinants of liquidity, their loss is a huge red warning flag.

I enthusiastically second the recommendation for the Money as Debt video, which is available free on the net. It's well worth 45 minutes of your time.

Anonymous said...

If this were true, that banks needed to have no reserves, wouldn't it be the opportunity of the century for credit unions and "real" safe lending institutions to put all of these other banks out of business? Talk about precipitating runs on the banks...

Anonymous said...

You might this of interest:
The Canadian Solution

Stoneleigh said...

Mish (from more than a year ago): The study does not say it explicitly but I will. There are essentially no bank reserves. Wait a second, I take that back. The combination of fractional reserve lending and sweeps really means there are negative reserves. Far more money has been lent out than really exists.

All formalizing the lack of reserve requirements will do is to accelerate the loss of confidence, causing the excess claims that leveraged debt represents to be extinguished that much faster. I never underestimate the ability of the powers-that-be to make things worse.

Bigelow said...


“Let’s flush out the three credit-crisis catalysts that have remained hidden for too long, thanks to Wall Street protectionism and myopic regulation. Those catalysts - which brought us to the brink of a financial meltdown - are structured collateralized debt obligations, credit default swaps, and the horrific offspring of the two - credit default swaps on structured collateralized debt obligations.


It’s a vicious cycle - one that’s eroding our faith in our banks, and worse, banks’ faith in other banks. As a result, banks have ceased lending to each other out of the fear that the next round of write-downs and losses may imperil some of the trading partner banks that they used to lend billions of dollars to every night.

Not anymore.

It would be bad enough if that were the only problem facing the securities market. On top of these overly engineered structured securities I’ve just discussed, we also have credit default swaps with an estimated notional value of $62 trillion out in the marketplace. A credit default swap (CDS) is a financial derivative that’s akin to an insurance policy that a debt holder can use to hedge against the default by a debtor corporation, or a sovereign entity. But a CDS can also be used to speculate.

[…] [You might ignore this last bit.]

The free market - with the oversight of good governance practices mandated by effective regulators, who should not be empowered to kill entrepreneurial capitalism - will once again rise to the occasion and prove America’s robustness and indefatigable spirit.”
How Complex Securities, Wall Street Protectionism and Myopic Regulation Caused a Near-Meltdown of the U.S. Banking System Part 3

Anonymous said...

Thanks for the info re:bank reserve requirements.