Thursday, October 23, 2008

Debt Rattle, October 23 2008: A Massive Ugly War

Arthur Rothstein Iron City 1938
Swimming pool for steelworkers' children in Pittsburgh.

Ilargi: US home prices have a record drop, and foreclosure filings have a record surge, to 10.000 every day. James Lockhart says the Freddie and Fannie debt is explicitly guaranteed by the US government, while the September 7 legal document that outlines the takeover of Fannie and Freddie explicitly denies any such guarantee.

Meanwhile, the FDIC claims that the US government will start guaranteeing bad mortgages. That may seem nice and all, but is it really such a great idea for the US taxpayer to start buying up grossly overvalued real estate, that will keep on losing value regardless?

Bond markets are busy preparing for a collapse by Argentina, Pakistan, Hungary or another country on a by now long list of crash candidates. Belarus was added to the list today, and filed for IMF funds. Depending on which country falls first, and on the size of its economy, a sovereign debt default event could lead to unpredictable panic.

Hedge funds as an industry may be a relic of the past, but they will not go quietly. On the one hand to need to get rid of leverage, and therefore sell their assets, including lots of gold. That’s why the demand for gold soars, while its price plummets. On the other hand, the funds are circling above countries in distress. Betting against the Hungarian forint looks like a money maker. And Pakistan may have more people than Russia, it still is a small enough economy to make shorting it attractive.

Alan Greenspan needs to be arrested, for fraud and treason. The fact that this man, who has deliberately gutted the US economy over the past 20 years, is hardly under any sort of serious scrutiny, and is not only allowed to remain out of prison, but gets the chance to go public with ever more lies about his actions, points to troublesome inadequacies in the political system that some still refer to as a democracy. The same goes for Hank Paulson, who can't just walk free, but was even appointed dictator over Washington.

And that is why Nouriel Roubini predicts war.

Nouriel Roubini: Crisis could lead to a "massive, ugly war."
The world is heading for a nasty, protracted recession that marks the beginning of the end of America's dominance of global finance, according to leading economist Nouriel Roubini.

“It’s the beginning of the decline of the US financial empire. The Great Depression ended in a massive war. I hope that’s not going to happen but it’s pretty ugly now,” said Professor Roubini, an academic and former US Treasury adviser. He expects a global recession to last for at least two years and said the current crisis could lead to a "massive, ugly war."

“We’re now paying the price for the biggest asset and credit bubble in history," Professor Roubini said at a hedge fund conference in London. "The bail-outs have not worked because the markets are no longer rallying, and the policymakers have run out of options.”

The global financial meltdown accelerated this month, with the UK and US governments being forced to take stakes in some of the world's biggest banks. Stock markets around the world have fallen sharply this month as investors' concern switches to the impact on the wider economy.

Professor Roubini, who is known for predicting some of the trouble engulfing the financial system, said he would not be surprised if the US and other countries soon had to close their stock markets for more than a week. “It’s like we’re walking blind in a minefield. Every situation has become risky and no-one can trust each other,” Mr Roubini said.“The banks are too big to be allowed to fail, but they’re also too big to be saved.”

He said that the problems were not just caused by the US sub-prime market, but all kinds of risky lending the world over - from mortgages and cars to student and commercial loans. Investors, according to Professor Roubini, should stay clear of risky assets and keep their money in cash.

Roubini Says 'Panic' May Force Market Shutdown
Hundreds of hedge funds will fail and policy makers may need to shut financial markets for a week or more as the crisis forces investors to dump assets, New York University Professor Nouriel Roubini said.

"We've reached a situation of sheer panic," Roubini, who predicted the financial crisis in 2006, told a conference of hedge-fund managers in London today. "There will be massive dumping of assets" and "hundreds of hedge funds are going to go bust," he said. Group of Seven policy makers have stopped short of market suspensions to stem the crisis after the U.S. pledged on Oct. 14 to invest about $125 billion in nine banks and the Federal Reserve led a global coordinated move to cut interest rates on Oct. 8. Emmanuel Roman, co-chief executive officer at GLG Partners Inc., said today that as many as 30 percent of hedge funds will close.

"Systemic risk has become bigger and bigger," Roubini said at the Hedge 2008 conference. "We're seeing the beginning of a run on a big chunk of the hedge funds," and "don't be surprised if policy makers need to close down markets for a week or two in coming days," he said. Roubini predicted in July 2006 that the U.S. would enter an economic recession. In February this year, he forecast a "catastrophic" financial meltdown that central bankers would fail to prevent, leading to the bankruptcy of large banks exposed to mortgages and a "sharp drop" in equities.

The comments preceded the collapse of Bear Stearns & Cos. and Lehman Brothers Holdings Inc. as well as the government seizure of Freddie Mac and Fannie Mae. The Dow Jones Industrial Average, a benchmark for American equities, has lost 37 percent this year, including its biggest daily drop in more than twenty years on Oct. 15. Italian Prime Minister Silvio Berlusconi roiled international markets on Oct. 10, first saying world leaders were discussing shutting down global financial exchanges, and then saying he didn't mean it.

"In a fairly Darwinian manner, many hedge funds will simply disappear," Roman said, speaking at the same event as Roubini. The hedge fund industry is stumbling through its worst year in two decades and posted its biggest monthly drop for a decade in September. Hedge funds are mostly private pools of capital whose managers participate substantially in the profits from their speculation on whether the price of assets will rise or fall.

"Things are getting very ugly also in the emerging markets," Roubini said. "The usual saying is when the U.S. sneezes, the rest of the world catches a cold. Unfortunately, this time around the U.S. is not just sneezing, it has a severe case of chronic and persistent pneumonia. It's becoming a mess in emerging markets."

Developing nations' borrowing costs jumped to the highest in six years today as Belarus joined Hungary, Ukraine and Pakistan in seeking a bailout from the International Monetary Fund to help weather frozen money markets and a slump in commodities. Argentina risks defaulting for the second time this decade. "There are about a dozen emerging markets that are now in severe financial trouble," Roubini said. "Even a small country can have a systemic effect on the global economy," he added. "There is not going to be enough IMF money to support them."

Roubini, a former senior adviser to the U.S. Treasury Department, earlier this month said that the world's biggest economy will suffer its worst recession in 40 years. "This is the worst financial crisis in the U.S., Europe and now emerging markets that we've seen in a long time," Roubini said. "Things will get much worse before they get better. I fear the worst is ahead of us."

Ilargi: I bet OPEC memebers will not honor agreements on cuts: recent price falls have already cut their revenues by a huge amount.

Venezuela minister: Oil price could drop to $10 a barrel
OPEC needs to act very fast, beginning with an output cut of at least one million barrels per day (bpd), Venezuela's oil minister said on Thursday, adding it was possible oil could fall to as low as $10 a barrel. Energy and Mines Minister Rafael Ramirez said there would be a consensus within OPEC to reduce output when it holds emergency talks on Friday in Vienna. 'There's going to be consensus to take a very, very, very fast action,' Ramirez said.

His view was OPEC needed to agree on Friday to cut oil production by at least one million bpd and that could be followed by further action.
Oil prices were around $68 a barrel on Thursday and have fallen by more than 50 percent from a record of $147.27 struck in July. The slide has revived bad memories for The Organization of the Petroleum Exporting Countries of the Asian economic crisis of the late 1990s, when the oil price fell below $10.

'The financial and economic situation is very dangerous. We believe we have to do something ... at this meeting,' Ramirez told reporters.
'We have to handle the situation in a very, very responsible manner as OPEC.... that way we can avoid a price collapse like 1998.' To ensure investment in the oil industry, Ramirez said he believed an oil price of at least $80 was necessary and he believed OPEC could revive its previously discarded idea of a price band, this time with a lower end of $80.

'I think we could establish a band of $80-$100. It's important to the whole economy to avoid the collapse of prices,' Ramirez said. OPEC previously adopted a price band in March 2000 and abandoned it in 2005. Under the informal price band mechanism, OPEC could in theory raise or reduce oil production if the target price slipped outside the set range for a specific number of trading days.

Fannie, Freddie Debt Guarantee Is Explicit (?!)
Debt issued by Fannie Mae and Freddie Mac has the explicit backing of the U.S. government, the regulator for the government-sponsored mortgage giants told a Senate panel Thursday.

The companies in September were placed under conservatorship by their regulator, the Federal Housing Finance Agency, and they were given a credit line with the Treasury, which together confer a federal guarantee of their debt, FHFA Director James B. Lockhart told the Senate Banking Committee in prepared remarks. "The conservatorship and the access to credit by the U.S. Treasury provide an explicit guarantee to existing and future debtholders of Fannie Mae and Freddie Mac," Mr. Lockhart said.

The comment was music to bondholders ears, who have been concerned about the lack of an explicit guarantee from government officials. The government's presumed backing long gave Fannie and Freddie an advantage in debt markets, but that has been eroded by competition now that the government is explicitly guaranteeing some new debt to be issued by banks. Risk premiums on Fannie and Freddie debt narrowed sharply after the comments. Yet despite Mr. Lockhart's assurances, some investors were still doubtful, suggesting the gains may be hard to build on.

"It's the first time we've heard the term explicit guarantee in a public testimony, and the market is reacting to it," said Margaret Kerins, head of agency strategy at RBS Greenwich Capital. "There's clearly better buying across the board," she said. Risk premiums or spreads on Fannie and Freddie debt securities tightened sharply over comparative Treasury yields as a result. Fannie's two-year benchmark note was 6.8 basis points tighter at 133 basis points over comparative Treasury yields. The Freddie 10-year note was 7.5 basis points tighter at 87.5 basis points over comparative Treasury yields midday, according to data provider TradeWeb.

That marks a turnaround from the selling that has taken place since last week, which pushed risk premiums on agency debt to historic wide levels. That made it costlier for these firms to raise fresh debt in the market at a time when they are being tasked with supporting the ailing mortgage market.
Investors feared agency debt may not carry the full backing of the U.S. government. This stands in sharp contrast to the explicit guarantee offered by the Federal Deposit Insurance Corp. for new bank debt. The clamoring for clarity on whether such a guarantee exists prompted Mr. Lockhart to state that the debt carries explicit government backing at a testimony Thursday.

Despite the market's strong initial response, investors remain doubtful. Many market participants give little weight to Mr. Lockhart's comments, seeing them as an attempt to shore up investor confidence and calm the market. "Until you see a legal document from the U.S. government that directly contravenes the outstanding legal document on Sept. 7 [that outlined the takeover of Fannie and Freddie] that explicitly denies there is any guarantee whatsoever, you must not believe what Lockhart says," said Jim Vogel, an agency strategist at FTN Financial.

Some participants also question whether Lockhart has the power to guarantee debt on the two mortgage finance giants. Another point to ponder, RBS's Ms. Kerins said, is the recommendation by regulators to lower the risk weighting on Fannie and Freddie debt to 10% from 20% for banks holding these securities. "The question remains that if it is government guaranteed shouldn't the risk be zero?" she asked.

FDIC To Guarantee Home Loans
The U.S. government may start guaranteeing the mortgages of some homeowners who are heading for default, in hopes of convincing lenders to renegotiate the terms of troubled loans and avoid more foreclosures, Federal Deposit Insurance Corp. chairman Sheila C. Bair said today.

Bair told the Senate Banking Committee that the recently approved economic bailout package included authority for the Treasury Department to offer government loan guarantees and other incentives as a way to encourage banks and mortgage lenders "to prevent avoidable foreclosures." There has been a "failure to effectively deal with" the mortgage foreclosure problem, Bair said.

The FDIC chairman has argued that the extensive set of financial rescue strategies deployed in recent weeks needs to do more to get at what she called the "root cause" of the crisis -- millions of households heading for default on their mortgages and potentially foreclosure on their homes.

Falling home values have been a key part of the dynamic. Some families took out loans with adjustable or low introductory rates, convinced that rising home values would let them refinance or sell before higher interest rates kicked in. When home values fell and credit markets froze, those same homeowners found themselves owing more on the property than it was worth, unable to refinance or cover their loan through a sale.

Bair said new efforts to stem foreclosure are needed, even if it means the Treasury offering to absorb losses on some soured mortgages. "Loan guarantees could be used as an incentive for servicers to modify loans," Bair said. "Specifically, the government could establish standards for loan modifications and provide guarantees for loans meeting those standards."

Questioned by Sen. Chris Dodd (D-Conn.) as to whether the FDIC has the capacity to handle such a program, Blair said the Treasury Department would be in charge, and the FDIC would act as a contractor to help guarantee loans. One big hurdle for private mortgage companies looking to restructure loans is that no industry-wide framework has been established to guide the process. "They've been doing it ad-hoc," Blair said.

Neel Kashkari, the interim head of the government's $700 billion rescue effort, said the Treasury Department is still in the "policy process" of figuring out how the program would work. Bair said the program would be short-term, with federal assistance ending June 30. The temporary nature of the program, she said, is the key to preventing private banks from depending on federal help for all of loans.

Kashkari said the restructured loans would be handled by the banks themselves, but with "very specific instructions consistent with our objectives." Although the program is first focusing on the residential housing market, there is a possibility it could be extended to the commercial real estate market as well, officials said.

Dodd emphasized a sense of urgency. "There are more than 10,000 foreclosures a day," he said. "I hope there's a deep appreciation that we need to get this moving." Also today, RealtyTrac reported that U.S. foreclosure filings increased 71 percent in the third quarter from a year earlier, reaching the highest on record. A total of 765,558 U.S. properties got a default notice, were warned of a pending auction or were foreclosed on in the quarter, the most since records began in January 2005.

Crisis mounts in Eastern Europe after shock 3% rate rise by Hungary
Hungary has raised interest rates by three percentage points to 11.5pc in a drastic move to stop the collapse of its currency peg against the euro, raising fears of a crunch across Eastern Europe as a string of states are forced to follow suit to stem capital flight. The fast-moving crisis echoes the final days of the Exchange Rate Mechanism in 1992, when Britain, Italy, and Sweden raised rates to extreme levels to defend their currencies despite economic recession, with little success.

Hungary's premier Ferenc Gyurcsany said the county was left with no choice as the forint went into a free-fall. It has dropped 16pc against the euro since the start of the month and is now at the bottom of its ERM band. "There is still an exceptionally large speculative pressure on the forint. We will take every measure necessary," he said. It is unclear whether the move will prove enough to prevent a forced devaluation. The treasury had to cancel a bond auction yesterday as buyers stayed away.

"We doubt the effect will be long-lasting," said Lars Christensen, East Europe strategist at Danske Bank. "The markets are very likely to test how far the central bank is willing to go." Simon Derrick, from Bank of New York Mellon, said the rate rise was probably doomed to failure. "As soon as you see aggressive actions like this when the economy is not strong to take it, you know it is unsustainable," he said.

There is a risk is that hedge funds will pick off those East European states with big current account deficits that rely on foreign financing, smashing the pegs or 'dirty-floats' one by one. The deficits have reached 23pc of GDP in Bulgaria, 16pc in Estonia, and 16pc in Romania. Investor flight from stocks, bonds, and currencies across the region has become a stampede. Contagion hit Turkey and South Africa yesterday, while credit default swaps on Russian debt jumped to 817 basis points, signalling extreme fear.

Hungary has already received a €5bn loan from the European Central Bank and is in talks with the International Monetary Fund. Ukraine has requested an IMF bail-out, and Belarus joined the queue yesterday with a plea for a $2bn loan. Maya Bhandiri, from Lombard Street Research, said Hungary was primed for crisis after letting rip on foreign credit, letting net external debt reach 90pc of GDP.

Some 60pc of all mortgages and car loans are funded in foreign currencies, mostly euros or Swiss francs. Hungary's government is now letting debtors switch franc loans into forints and even forgive debts in what amounts to a bail-out of the most reckless. Unicredit warned that this may cause markets to question the credit-worthiness of the state itself.

The Baltic States, Poland, Croatia, and Romania have also let foreign mortgages proliferate. Mr Christensen says the region is even more overstretched than East Asia on the cusp of the 1998 crisis. "Imbalances have grown to unsustainable levels. The unwinding is likely to be painful and disorderly. There is a clear risk of the situation getting out of hand, with serious implications for Western Europe," he said.

Veterans of the ERM crisis in 1992 say the process could spiral out of control quickly. If hedge funds taste blood knocking out the pegs in Eastern Europe, they may turn their attention to those eurozone states inside that have rely on foreign funding to plug their huge deficits - notably Spain, Portugal, and Greece.

UK food sales fall for first time in at least 22 years
The amount of food bought in Britain fell for the first time in 22 years in the three months to September, at a time when soaring costs were taking a larger than ever bite out of disposable incomes. The volume of sales at food stores dropped 0.1pc, the first quarter-on-quarter decline since records began in 1986, according to the Office for National Statistics.

Retail sales overall fell 0.4pc between August and September, not as big a fall as expected, prompting economists to again questioned the accuracy of the official figures. Evidence from surveys conducted by the CBI and British Retail Consortium, as well as reports from individual retailers, suggests that the real picture is weaker. The ONS figures showed that retail sales almost ground to a halt in the third quarter, rising by just 0.1pc compared with the second quarter, and economists warned that worse is yet to come.

Capital Economics is predicting that consumer spending will fall by around 1.5pc next year, with a possible sharper drop in retail sales.
The latest ONS data show that sales of household goods were particularly hit as a result of the sharp downturn in the housing market, and the recession that the UK now faces is likely to exacerbate the trend. "The prospects for consumer spending look bleak as the financial crisis adds to the intense pressures already facing households. This is particularly worrying for retailers as the vital Christmas period looms," said Howard Archer, chief economist at Global Economist.

"High food prices and rising utility bills currently continue to squeeze purchasing power, while muted wage growth, faster rising unemployment, sharply falling house prices, plunging equity prices, very tight credit conditions, increased mortgage repayments for many householders as a result of the credit crunch and higher debt levels are also combining to weigh down heavily on consumers."

Credit-Rating Agencies 'Sold Their Soul to the Devil', Employees Said
Employees at Moody's Investors Service told executives that issuing dubious creditworthy ratings to mortgage-backed securities made it appear they were incompetent or "sold our soul to the devil for revenue," according to e-mails obtained by U.S. House investigators.

The e-mail was one of several documents made public today at a hearing of the House Oversight and Government Reform Committee in Washington, which is reviewing the role played by Moody's, Standard & Poor's and Fitch Ratings in the global credit freeze."The story of the credit rating agencies is a story of colossal failure," Committee Chairman Henry Waxman, a California Democrat, said at the hearing. "The result is that our entire financial system is now at risk."

Moody's and S&P in recent months had to downgrade thousands of mortgage-backed securities, many of which were originally given top AAA ratings, as delinquencies on the underlying loans soared well beyond the companies' estimates and home values fell faster than they expected. The downgrades contributed to the collapse of Bear Stearns Cos. and Lehman Brothers Holdings Inc., and compelled the U.S. government to set up a system to buy $700 billion of distressed assets from financial companies.

The Securities and Exchange Commission in a July report found the credit-rating companies improperly managed conflicts of interest and violated internal procedures in granting top rankings to mortgage bonds. An e-mail that a S&P employee wrote to a co-worker in 2006, obtained by committee investigators, said, "Let's hope we are all wealthy and retired by the time this house of cards falters."

Former executives from S&P and Moody's told lawmakers today that credit raters relied on outdated models in a "race to the bottom" to maximize profits. Jerome Fons, a former managing director of credit policy at New York-based Moody's, told lawmakers that originators of structured securities "typically chose the agency with the lowest standards, engendering a race to the bottom in terms of rating quality."

The top executives of the credit-rating companies said in testimony that they were unprepared for the sharp drop in home prices and that their systems failed. "Events have demonstrated that the historical data we used and the assumptions we made significantly underestimated the severity of what has actually occurred," said Deven Sharma, president of New York-based S&P.

"It is by now clear that a number of the assumptions we used in preparing our ratings on mortgage-backed securities issued between the last quarter of 2005 and the middle of 2007 did not work," Sharma said in a written statement provided to the committee. The company has improved its ratings process and transparency, Sharma said, and makes its criteria, analytics, and methodologies available to the public.

Stephen W. Joynt, president and chief executive officer of Fitch Inc. in New York, said it "is clear that many of our structured finance rating opinions have not performed well and have been too volatile." "We did not foresee the magnitude or velocity of the decline in the U.S. housing market, nor the dramatic shift in borrower behavior brought on by the changing practices in the market," Joynt said in a written statement to the committee. "Nor did we appreciate the extent of shoddy mortgage origination practices and fraud" between 2005 and 2007.

Raymond W. McDaniel, chairman and CEO of Moody's Corp., said his company observed weakening conditions as early as July 2003. "We saw and took action to adjust our assumptions for the portions of the residential mortgage backed securities market that we were asked to rate," McDaniel said in written testimony. "We did not, however, anticipate the magnitude and speed of the deterioration in mortgage quality or the suddenness of the transition to restrictive lending."

"We have learned important lessons from these fast-changing market conditions," McDaniel said. The company has refined its rating methodologies, increased transparency of its analysis, and adopted new policies to avoid conflicts of interest, he said.

Company Bond Risk Surges to Record on Argentina, Pakistan Default Concern
The cost of protecting corporate bonds from default surged to a record on concern Argentina and Pakistan may default, worsening global economic turmoil.

Credit-default swaps on the benchmark Markit iTraxx Crossover Index surged above 800 basis points for the first time, and was trading 22 basis points higher at 813, according to JPMorgan Chase & Co. prices at 2:30 p.m. in London. Contracts on Glencore International AG, the world's largest commodities trader, jumped 248 to a record 1,111, CMA Datavision prices show.

The global slump is driving up the cost of insuring assets from Argentine government bonds to the debt of ArcelorMittal, the world's largest steel producer. OPEC may cut production for the first time in two years tomorrow as it seeks to staunch a collapse in oil prices. "This is not just a European problem, or a U.S. problem, this is a global problem," said Puneet Sharma, London-based head of European investment-grade research at Barclays Capital. "There is an increased probability of default."

Credit-default swaps on the CDX North America Investment Grade Index of contracts linked to 125 companies in the U.S. and Canada, rose 16 basis points to 220, according to Barclays Capital. Contracts on Computer Sciences Corp., the manager of networks for NASA and the U.S. Navy, jumped to a the highest in seven months after the company tapped $1.5 billion of backup credit lines because of "instability" in the commercial paper market. Credit-default swaps linked to the Falls Church, Virginia-based company climbed 42 basis points to 145, according to CMA.

Dealers in New York are holding an auction to determine the price at which contracts tied to bankrupt Washington Mutual Inc. will be settled. More than 500 banks and investors signed up to adhere to the price, which will determine how much sellers of protection must pay, according to the International Swaps and Derivatives Association's Web site. A final price, which typically is announced at about 2 p.m. in New York on auction days, will be posted at

The prospect of a prolonged global recession is driving up the cost of default protection on producers of raw materials. Credit-default swaps on ArcelorMittal increased 68 basis points to 674, according to CMA. Contracts on Xstrata Plc, the world's fourth-largest copper producer, jumped 102 to 675 and Anglo American Plc, the world's fourth-biggest diversified mining company, rose 92.5 to 450. The cost to protect debt payments by 14 emerging-market governments from Argentina to Ukraine jumped 200 basis points to 1,088 basis points, according to Credit Derivatives Research LLC prices on the CDX Emerging Markets Index. Credit-default swaps on Japan's benchmark investment-grade index increased 32 basis points to a record 260, Morgan Stanley prices show.

Argentina's planned takeover of pension funds heightened concern the government is headed for its second default this decade. The probability the country will fail to meet its commitments has soared to 94 percent, according to CMA data. Pakistan central bank Governor Shamshad Akhtar is flying to Dubai today for talks with the International Monetary Fund on a bailout. Hungary, Iceland, the Ukraine and Belarus are also seeking assistance from the IMF to help weather the global financial crisis.

"People are seeing economies decelerating everywhere," said Brayan Lai, a credit analyst at Calyon in Hong Kong. "With fear of defaults from Argentina and Pakistan, everybody is a net protection buyer in the emerging world." Credit-default swaps, contracts conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements. An increase indicates a deterioration in the perception of credit quality; a decline signals the opposite.

The Markit iTraxx Europe index of contracts linked to 125 companies with investment-grade ratings jumped 13.5 basis points to 164.5, JPMorgan prices show. A basis point on a credit-default swap contract protecting 10 million euros ($12.8 million) of debt from default for five years is equivalent to 1,000 euros a year.

Dollar roars back as global debts are called in
For six years the world has been borrowing dollars to bet on property, oil, metals, emerging markets, and every bubble in every corner of the globe. This has been the dollar "carry trade", conducted on a huge scale with high leverage. Now the process has reversed abruptly as debt deflation - or "deleveraging" - engulfs world markets. The dollars must be repaid.

Hence a wild scramble for Greenbacks which has shaken the global currency system and shattered assumptions about the way the world works. The unwinding drama reached a crescendo yesterday as the euro fell to $1.28, down from $1.61 in July. The slide in the Brazilian real, the South African rand, the Indian rupee, and the Korean won, among others, has been stunning.

Stephen Jen, currency chief at Morgan Stanley, said US mutual funds, pension funds, and life insurers invested a big chunk of their $22 trillion (£13.5 trillion) of assets overseas to earn a higher yield during the boom. They are now in hot retreat as the emerging market story unravels. "There is a complete rethink going on. People are bringing their money back home," he said.

Hedge funds are 75pc dollar-based, regardless of where they come from. Many are now having to repatriate their dollars as margin calls, client withdrawls, and the need to slash risk forces them to cut leverage. The hedge fund industry had assets of $1.9 trillion at the peak of the bubble.

Data collected by the Bank for International Settlements shows that European and UK banks have five times as much exposure to emerging markets as US and Japans banks, with surprisingly big bets in Latin America and emerging Asia - where they rely on dollar funding rather than euros.

The fear is that deflating booms in these frontier economies will have an 'asymettric' effect on the currency markets, setting off another round of frantic dollar buying. "It is not impossible that the euro could collapse completely against the dollar, going back to 2001 levels," said Mr Jen.

He said the "composite" dollar-zone including China, the Gulf oil states, and other countries locked into the US currency system, will together have a current account surplus next year. The de-facto euro bloc of the core euro-zone and Eastern Europe is moving into substantial deficit. This creates a subtle bias in support of the dollar.

Of course, much of the currency shift this year is a natural swing as the crisis rotates from the US to Europe and beyond. The dollar was pummelled in the early phase of the crunch when economists still thought Europe, Japan, China and the rest of the world would decouple, powering ahead under their own steam. The Federal Reserve's dramatic rate cuts were seen then as a reason to dump the dollar.

The decoupling myth has now died. The euro-zone and Japan appear to have fallen into recession before the US itself, led by a precipitous fall in German manufacturing. The ultra-hawkish stance of the European Central Bank - which raised rates in July - is now viewed as a weakness. Foreign exchange markets are no longer chasing the highest interest yield: they are instead punishing those where the authorities are slowest to respond to the downturn.

A hard-hitting report by Citigroup this week said the ECB had unwisely ignored screaming signals from the bond markets earlier this year for a rate cut. "The ECB did not listen. Not only did they no reduce rates as they should have but they increased them in one of the biggest policy mistakes of 2008," it said. The spectacular dollar rebound has geostrategic implications. Heady talk earlier this year that dollar hegemeny was coming to an end - or indeed that the US was losing its status as a financial superpower - now seems very wide of the mark.

Protesters Block UBS Branch, Seek Return of Bonuses
Protesters blocked UBS AG's private banking branch on Zurich's Paradeplatz and more people are scheduled to gather in the Swiss financial center to seek curbs on executive pay after the country's largest bank was forced to ask for government aid.

Several dozen people sat on the steps of the bank's entrance from around 12:30 p.m. today, shouting "return bonuses" and waving red flags at bystanders and TV cameras. Unia, Switzerland's largest trade union with more than 200,000 members, has called a rally on the square from 5:30 p.m. today. "UBS shouldn't be allowed to just continue this way," said Olivier Vogel, a 24 year-old politics student at Zurich University and a member of the Social Democratic party's youth organization, which organized the protest. "If the bank won't come around, there will be more actions."

UBS's $59.2 billion government aid package, announced last week, has prompted a popular backlash against executive pay in a country where tax evasion is not a crime and local governments offer tax breaks to lure millionaires. The bank paid about 12.5 billion francs in performance-related compensation for last year. Switzerland's biggest daily, the tabloid Blick, published letters to former UBS Chairman Marcel Ospel, for readers to tear out and sign, to demand the repayment of his bonuses. The Swiss government said yesterday it wants to make reclaiming compensation easier.

The protest organizers had asked UBS to limit compensation to 500,000 Swiss francs ($429,000) and stop donations to political parties. Cedric Wermuth, head of the group, handed over a giant bank deposit slip for UBS to return past bonuses. "We have received the demands and will look at them," UBS spokeswoman Rebecca Garcia said by phone.

UBS Chairman Peter Kurer, in an interview with Swiss radio DRS over the weekend, said while he has been in discussions about the return of former executives' bonuses, he doesn't see a legal basis for such a demand. "Given the current status of the bank and the environment we are in, I believe it is a question of ethics," Kurer, UBS's former general counsel, told DRS. UBS has received positive signals from some former senior managers, he said.

Ospel, 58, has received total compensation of almost 137 million francs ($117 million) as chief executive officer and later chairman of UBS since 2000. He hasn't disclosed how much he will be paid for this year after resigning from his position in April. Ospel didn't get a bonus for 2007. CEO Marcel Rohner declined variable pay he was entitled to for the part of the year he was in charge of wealth management business. UBS is paying former CEO Peter Wuffli, former finance chief Clive Standish and ex-investment banking head Huw Jenkins a combined 93.6 million francs in salary, deferred compensation and consulting fees from 2007 to 2009.

The Swiss Federal Banking Commission, which conducted an investigation into UBS's losses from the credit crisis, said in a report published last week it didn't find any evidence that managers intentionally damaged the bank to get a higher bonus. Ethos Foundation, a Swiss activist investor group, said in a report today that UBS has made "significant" progress in corporate governance. The bank is currently reviewing executive compensation and has said it plans to announce the results later this year. Kurer said last week he doesn't expect to get a bonus for 2008 because UBS will post a loss.

Greenspan Urges Tighter Regulation After 'Breakdown'
Former Federal Reserve Chairman Alan Greenspan called for tighter regulation of financial companies, distancing himself from the free-market culture that he helped to create. Firms that bundle loans into securities for sale should be required to keep part of those securities, Greenspan said in prepared testimony to the House Committee on Oversight and Government Reform. Other rules should address fraud and settlement of trades, he said.

Greenspan's office released the text ahead of the hearing scheduled for 10 a.m. in Washington. The comments contrast with Greenspan's aversion to increasing financial supervision as Fed chairman from August 1987 to January 2006. He said in a May 2005 speech that "private regulation generally has proved far better at constraining excessive risk-taking than has government regulation."

Today, the former chairman asked: "What went wrong with global economic policies that had worked so effectively for nearly four decades?" During his term at the Fed's helm, Greenspan repeatedly warned lawmakers against inhibiting markets, such as by tightening oversight of certain types of derivatives. Greenspan, reiterated his "shocked disbelief" that financial companies failed to execute sufficient "surveillance" on their trading counterparties to prevent surging losses. The "breakdown" was clearest in the market where securities firms packaged home mortgages into debt sold on to other investors, he said.

"As much as I would prefer it otherwise, in this financial environment I see no choice but to require that all securitizers retain a meaningful part of the securities they issue," Greenspan said. That would give the companies an incentive to ensure the assets are properly priced for their risk, advocates say. The rout sparked by the collapse of the U.S. subprime mortgage market has cost financial institutions worldwide $659 billion in writedowns and losses since the start of last year. Firms have raised $642 billion of capital in response.

"We are really going to have to rebuild this system from the ground up," Paul Volcker, who was Greenspan's predecessor, said at a conference late yesterday in New York. The creation of complex financial products, "instead of spreading the risk and creating transparency" wound up concentrating risk and "opaqueness," Volcker told the Columbia University's Women's Economic Round Table.

Volcker, 81, said the current crisis is more complex than any other in U.S. history. Greenspan, 82, called it a "once-in-a century credit tsunami." House Financial Services Committee Chairman Barney Frank called this week for a freeze on executive bonuses and other stronger regulation of Wall Street, following passage of a $700 billion rescue plan for financial institutions.

Frank said in a hearing in February that Greenspan "erred" in "his view that regulation was almost never required." Greenspan "often told us" that there were two options: "I can either deflate the entire economy or I can let the problems continue," Frank said. Securities and Exchange Commission Chairman Christopher Cox and former Treasury Secretary John Snow are also scheduled to appear at the House committee hearing today.

The credit crisis was rooted in a "surge in global demand" for U.S. subprime-mortgage debt, fed by "unrealistically positive rating designations by credit agencies," Greenspan said. "Whatever regulatory changes are made, they will pale in comparison to the change already evident in today's markets." Before the crisis intensified last month with the bankruptcy of Lehman Brothers Holdings Inc., Greenspan said markets should still be allowed to police themselves.

"I hope that one of the casualties will not be reliance on counterparty surveillance, and more generally financial self- regulation, as the fundamental balance mechanism for global finance," Greenspan wrote in the Financial Times in March. His successor, Ben S. Bernanke, has tried to revive credit during the past 15 months with an expansion of lending unprecedented since the Great Depression.

Bernanke has cut interest rates to 1.5 percent from 5.25 percent, made loans available to investment firms for the first time since the 1930s and arranged rescues of Bear Stearns Cos. and American International Group Inc. "Given the financial damage to date, I cannot see how we can avoid a significant rise in layoffs and unemployment," Greenspan said today. There will probably be a "marked retrenchment of consumer spending," he said, and a stabilization of home prices "is still many months in the future."

"To avoid severe retrenchment, banks and other financial intermediaries will need the support that only the substitution of sovereign credit for private credit can bestow," Greenspan said. The $700 billion rescue program, under which Treasury will inject capital into banks and buy distressed assets, is "adequate to serve that need," he said. Former Fed Governor Edward Gramlich, who died in 2007, had urged Greenspan to strengthen oversight of banks during the record U.S. mortgage boom from 2004 to 2006.

Greenspan said in a Bloomberg News interview in January that criticism of his record ignores the limits on what regulation and monetary policy can achieve. Since retiring, Greenspan has returned to his role as a private economic forecaster, speaking at conferences and to groups of bankers and investors, while consulting for clients such as Deutsche Bank AG.

U.S. Lawmakers Demand More Steps to Help Homeowners
U.S. lawmakers called on the Bush administration to step up aid to struggling homeowners, saying the Treasury's plans to buy stakes in banks won't fix the housing collapse that underlies the financial crisis. The Bush administration hasn't shown "the required dedication" to curb mortgage foreclosures, Senate Banking Committee Chairman Christopher Dodd said at a hearing with policy makers today. Richard Shelby, the panel's top Republican, said that unless the government deals with those fundamentals, "we're going to be wasting a lot of money."

Treasury Secretary Henry Paulson is under rising pressure to deploy part of the $700 billion rescue plan approved by Congress this month to help homeowners on the verge of losing their homes. Federal Deposit Insurance Corp. Chairman Sheila Bair urged using loan guarantees to influence mortgage servicers to modify loans. The Treasury plans to design and establish the program to insure troubled assets "immediately," Neel Kashkari, the interim Treasury assistant secretary who heads the office overseeing the bailout, said in testimony to the committee. Officials have submitted a proposal for public comment, with responses due by Oct. 28.

"We are behind the curve," Bair told the panel. "There has been some progress, but it has not been enough. We need to act quickly. We need to act dramatically."The FDIC is prepared to serve as a contractor on the loan guarantees, Bair added. "We are looking very hard at" the proposal to guarantee the loans, Kashkari said.

Paulson acknowledged this week that "there is clearly more that can be done -- needs to be done" on housing. He said after an Oct. 21 speech in New York that buying mortgages and related securities will give officials "more leverage" to modify loans. U.S. foreclosure filings increased 71 percent in the third quarter from a year earlier to the highest on record, RealtyTrac, an Irvine, California-based seller of default data, reported today. A total of 765,558 properties got a default notice, were warned of a pending auction or had foreclosure proceedings start. "The longer we allow foreclosures to erode family wealth, neighborhood stability, and financial market liquidity, the longer our economy will take to recover from this crisis," said Dodd, a Connecticut Democrat.

The first stage of the Treasury's plan is to inject $250 billion into the banking system by purchasing stakes in financial companies. Kashkari said officials are reviewing more than 100 applications from firms to become asset managers for the government's separate programs to buy home loans and related securities and will make selections "very soon." Bair called for a "carrot as well as a stick approach" to push mortgage servicers to rewrite loans.

Today's hearing is one in a series Congress is holding this month to consider ways to alleviate the U.S. financial crisis, restore confidence in the banking system and prevent foreclosures. Legislators also pushed Kashkari, a 35-year-old former Goldman Sachs Group Inc. banker, to ensure that banks use the new capital to lend, rather than hoard the cash. "We need more than just begging," Dodd said. Kashkari said the concern about hoarding capital "worries us" and the Treasury was "insisting" banks put the money to use, through a combination of requirements and recommendations. Banks won't be allowed to divert the new capital into dividends and share buybacks, he said.

Democratic Senator Charles Schumer of New York, who chairs the congressional Joint Economic Committee, urged the Treasury to tighten guidelines inhibiting banks that get government money from paying dividends. "There are far better uses of taxpayer dollars," he said. Shelby, an Alabama Republican, questioned why Paulson shifted tack and decided to use the first batch of the $700 billion plan for bank-stake purchases. The Treasury chief originally had asked Congress for authority to buy distressed assets from financial companies. "Treasury has deviated significantly from its original course," Shelby said. "We need to examine closely the reason for this change and understand how and why" nine banks were selected for the first $125 billion.

The Treasury last week agreed to purchase stakes with banks including JPMorgan Chase & Co., Morgan Stanley and Citigroup Inc. Kashkari said "my expectation is a few weeks" until the next equity purchases are agreed with banks and savings and loans. While the Treasury has no specific plan to push lenders to merge, Kashkari said that takeovers may be helpful and in some cases it would be a "good use" of taxpayer funds to aid them.

A small failing bank may not be able to make as many new loans on its own as it would after merging with a larger, healthier bank, Kashkari said. In that example, "that community is now better served" after consolidation, he said. Federal Reserve Governor Elizabeth Duke, Federal Housing Administration Commissioner Brian Montgomery and Federal Housing Finance Agency Director James Lockhart also are testifying before the panel.

British pound suffers biggest fall since Black Wednesday
The pound suffered its biggest fall since the aftermath of Black Wednesday in 1992 after the Prime Minister and Governor of the Bank of England warned that the UK is entering a recession. Sterling plummeted by almost 6? cents against the dollar as investors abandoned the UK currency after the warning, originally delivered by Mervyn King on Tuesday night. The pound ended the day worth just $1.6334, compared with almost $1.70 the previous close.

It also fell sharply against a host of other currencies, tumbling 2.3pc against a trade-weighted basket of other currencies. Both are the biggest one-day falls since sterling crashed in September 1992 after being ejected from the European Exchange Rate Mechanism, and it leaves the pound at a five-year low against the dollar.

Mr King warned in his speech that the pound could face a "larger and faster" adjustment in the coming months as the UK economy is forced to adapt to the new post-financial crisis landscape. He warned that the UK was facing a similar situation to the Asian economies in the late 1990s as foreign investors pull out their capital from the country.

Experts warned that the pound will fall still further in the coming months as the Bank of England slashes interest rates again. The majority of economists polled by Reuters predicted that the Bank will cut borrowing costs by a further half a percentage point to 4pc next month. Most now see rates falling to 3pc or below by next summer. Capital Economics analysts predicted that sterling would drop down to $1.50 against the dollar in the coming months.

Mr King's comments prompted JP Morgan economist Malcolm Barr to say: "With sterling falling sharply in recent days, it is tempting to see this as central banker who sees the possibility for a further marked fall, but is not inclined to do much about it."
Sterling's fall came on a volatile day for foreign exchange. The dollar rose sharply higher as investors returned to the greenback, and hedge funds sold assets in return for dollars.

In his speech in Leeds on Tuesday night, Mr King said: "It now seems likely that the UK economy is entering a recession."
He added: "It is surely probable that the drama of the banking crisis, which is unprecedented in the lifetime of almost all of us, will damage business and consumer confidence more generally." Since the Bank is currently in the middle of its quarterly forecasting round, analysts said the comments were doubly significant, shining a light on the tone of the Monetary Policy Committee's forthcoming Inflation Report, due early next month.

The pound sell-off continued after minutes from the Bank's emergency interest rate meeting earlier this month revealed that the MPC voted unanimously for a cut. The Bank's own survey also showed that consumer spending on a range of products had become "significantly negative" in September. The Agents' Survey showed that consumers are tending to switch to unbranded products and discounted outlets in an effort to save money

Foreclosure Filings Rose 71% in Third Quarter as Prices Fell
U.S. foreclosure filings increased 71 percent in the third quarter from a year earlier to the highest on record as home prices fell and stricter mortgage standards made it harder for homeowners to sell or refinance, RealtyTrac said.

A total of 765,558 U.S. properties got a default notice, were warned of a pending auction or were foreclosed on in the quarter, the most since records began in January 2005, the Irvine, California-based seller of default data said in a statement today. Filings rose 3 percent from the second quarter and fell 12 percent in September from August as state laws created to keep people in homes slowed the pace of defaults.

"I wouldn't be surprised to see foreclosures increase as the economy slows down," Rick Sharga, executive vice president for marketing at RealtyTrac, said in an interview. "The people living paycheck to paycheck are at risk if they lose their jobs. It will cause more people to lose their homes."

The worst U.S. housing slump since the 1930s is being compounded by a recession that began in the third quarter and may last a year or more, according to Jay Brinkmann, chief economist for the Mortgage Bankers Association. Home prices in 20 U.S. metropolitan areas fell in July at the fastest pace on record, and sales of previously owned homes in August were 32 percent below the peak reached in September 2005.

The government may buy home loans and related securities to help property owners struggling with monthly payments, even as "people are walking away from their mortgages," Treasury Secretary Henry Paulson said in an interview with PBS television's Charlie Rose on Oct. 21. Congress passed a $700 billion financial-rescue fund that may be used to modify loans and inject capital to banks and unfreeze credit markets.

A new law in California, which accounted for 27 percent of the foreclosure filings in the third quarter, helped slow the process in September as notices of default dropped 51 percent compared with the previous month, RealtyTrac said. In North Carolina, default notices fell 66 percent last month after lawmakers required lenders to give homeowners an additional 45- day notice.

In Massachusetts, filings rose 465 percent in September from August after a law was passed requiring a 90-day notice before foreclosures could proceed, RealtyTrac said. After a summer lull, defaults "jumped back up close to the level we were seeing earlier in the year," James Saccacio, chief executive officer of RealtyTrac, said in the statement.

Homeowners may be buffeted by a deepening recession as consumer spending contracts and job losses mount, especially in states such as Michigan and Ohio where manufacturing has declined, said Brinkmann of the mortgage bankers group. "The length of the recession will depend on how this bleeds over to employment," he said. The housing bust is the main reason more than 98,000 jobs in Florida and 77,700 in California were lost in the year through August, Brinkmann said.

Six states accounted for more than 60 percent of defaults in the third quarter, led by California with 210,845 foreclosure filings, more than double the amount from a year earlier, according to RealtyTrac. Florida more than doubled its total to 127,306 from the same period a year ago and Arizona almost tripled to 40,419. Ohio, Michigan and Nevada reported third- quarter filings of more than 30,000 each. New York had 14,477 filings, up 19 percent from a year earlier, and New Jersey had 17,893 filings, up 95 percent.

California had six of the 10 metropolitan areas with the highest foreclosure rates in the quarter, led by Stockton, where 3.69 of the housing units received a default filing in the quarter. Riverside-San Bernardino ranked third, Bakersfield was fourth, Sacramento was seventh and Fresno and Oakland ranked ninth and 10th, respectively, RealtyTrac said.

Las Vegas had the second-highest metro foreclosure rate with 3.48 of its housing units receiving a filing in the third quarter, more than double the amount from a year earlier. Fort Lauderdale and Orlando in Florida ranked fifth and eighth, respectively, said RealtyTrac, which has a database of more than 1.5 million properties. Nationwide in September, one in every 475 U.S. housing units received a foreclosure filing.

The state of the U.S. economy is emerging as a key issue in the presidential race between Democrat Barack Obama of Illinois and Arizona Senator John McCain, a Republican. Obama supports an economic stimulus plan to boost the economy, while McCain wants the government to purchase troubled mortgages.

Global bank lending declines to 30-year low
International bank lending shrank by 3 per cent between April and June, the sharpest decline in more than 30 years, revealing the depth of the credit squeeze between lenders before the recent series of government-led bailouts. Figures released today by the Bank for International Settlements (BIS), the Basel-based organisation, which acts as a lender for central banks, show that borrowers' total international claims declined by $1.1 trillion to $39.1 trillion.

Lending to the US, the UK, the Caribbean and European offshore centres shrank by 7 per cent. The BIS said this was due to declines of $564 billion in cross-border US dollar claims and $189 billion in sterling claims. Since then, governments have acted to increase lending between banks through a series of measures to strengthen lenders' balance sheets.

The US Federal Reserve has also pledged to make billions of dollars available for central banks to pump into their respective financial systems to help bring down the cost of borrowing the greenback. Today's figures represent the sharpest contraction in international banking activity since the BIS began its records in 1977.

Previously, the biggest declines were in the second quarter of 2001 after the dot-com bubble burst, when lending shrank 1 per cent or $125 billion of the total at the time, and in 1998, when it dropped 1.2 per cent following the failure of the American hedge fund Long-Term Capital Management.

Banks have been tightening their lending practices since August 2007. Co-ordinated action by central banks to improve liquidity in recent weeks has brought some relief to the taut money markets. Loans to banks in emerging markets continued to grow. Lending in emerging markets in Eastern Europe and Latin America rose $117 billion, or 4 per cent, in the second quarter.

Developing Nations' Borrowing Costs Soar on Bailouts
Developing nations' borrowing costs jumped to a six-year high as Belarus joined governments seeking International Monetary Fund support to weather the credit crisis and Standard & Poor's threatened to cut Russia's debt ratings.

The extra yield investors demand to own emerging-market government bonds instead of U.S. Treasuries rose 62 basis points to 8.64 percentage points, the highest spread since November 2002, according to JPMorgan Chase & Co.'s EMBI+ index. The annual cost to protect Russia's bonds from default soared to 10.5 percent of the debt insured, from 9.5 percent yesterday, according to credit-default swap prices from CMA Datavision.

"There is now no safe haven globally other than a deeply indebted U.S. government," said Jim Reid, head of fundamental credit strategy at Deutsche Bank AG in London. "The events of the last few days are categorical evidence of the globalization of the credit crunch and its subsequent problems."

Ex-Soviet republic Belarus added to requests from Iceland, Pakistan, Hungary and Ukraine for at least $20 billion of emergency loans as the financial crisis leaves nations unable to repay their debt. Russia has committed as much as 15 percent of its gross domestic product to propping up banks, including a $50 billion credit line to development bank Vnesheconombank, and further bailouts may trigger a downgrade, S&P said today.

Russia's international reserves, the world's third largest, declined by $14.9 billion last week after the central bank sold currency to support the ruble as investors pulled money out of the country. In Argentina, lawmakers are battling to block President Cristina Fernandez de Kirchner from seizing privately managed pension funds, as the government struggles to avert its second default this decade.

Emerging-market stocks, bonds and currencies are getting battered as the financial crisis that began with U.S. mortgages last year pushes the global economy toward a recession, crimping demand for the commodities that sustain most developing nations' finances. Emerging-market bonds have lost 22 percent so far this month, compared with a decline of 15.6 percent for U.S. high- yield debt, Merrill Lynch & Co. indexes show. Stocks in emerging markets have tumbled 59 percent this year, compared with 43 percent for developed countries, according to MSCI Indexes.

Mexico's peso, which has lost nearly a third of its value since August, fell as much as 3 percent to a record low against the U.S. dollar today. Brazil's real dropped by more than 5 percent for a third day after commodity prices slid to the lowest levels in four years. "It's becoming a mess in emerging markets," said New York University professor Nouriel Roubini. "There are about a dozen emerging markets that are now in severe financial trouble." The IMF forecast global growth will slow to 3 percent in 2009, from 3.9 percent this year, meaning a world recession under the fund's informal definition.

Belarus applied for a $2 billion loan and may also seek funds from central banks and commercial banks in other countries, news agency Interfax reported yesterday, citing the Belarusian central bank. Argentina's Fernandez roiled markets yesterday because the last time the government seized retirement savings was in 2001, before it reneged on $95 billion of debt and triggered a global selloff. Argentine stocks had their biggest two-day drop since 1990 and dollar bond yields topped 30 percent.

"If defaults were triggered, even more than the credit sector will get hurt," said Esther Law, an emerging-markets strategist in London at Royal Bank of Scotland Plc. "It would trigger unwinding in credit-default swaps and across currencies and stocks and the thin liquidity would mean extreme movements."

The cost to protect debt payments by 14 emerging-market governments from Argentina to Ukraine surged overnight by 3.2 percentage points to 9.9 percent, according to Deutsche Bank prices on the CDX Emerging Markets credit-default swap index. The cost of contracts on Hungary reached 5.8 percent and Croatia rose to 4 percent.

IMF bailout applicants Hungary and Ukraine led declines in Europe's emerging-market stocks to the lowest since 2005. The MSCI Emerging Markets Index of shares fell 4.2 percent to 512.07 at 12.34 a.m. in London, extending the worst monthly decline in at least two decades. The Budapest Stock Exchange index dropped for a sixth day, declining 3.43 percent to the lowest in five years. Ukraine's PFTS index fell 2.8 percent.

"The threat from the economic slowdown will be greatest in small open economies, those with sizeable external imbalances, and countries with large banking sectors," said Ivailo Vesselinov, a senior economist at Dresdner Kleinwort in London. South Korea and Europe's Baltic and Balkan nations are "particularly vulnerable," he said.

South Korea's won fell 3.4 percent to the lowest since 1998 on concern demand for the nation's exports is dwindling and the Kospi stock index slumped 7.5 percent. Romania's leu decreased 1.8 percent. The WIG20 Index in Poland was the worst performing European emerging market benchmark, declining as much as 7.61 percent. "It isn't necessary for a major economy like Russia or Brazil to fall for there to be severe pressure across the emerging-market universe," said Vesselinov.

Russia's Micex stock index dropped the most in a week, falling 5.49 percent. The yield on Russia's 30-year dollar notes increased 34 basis points to 11.32 percent, an all-time high. Moscow deployed as many as 7,000 soldiers in the separatist region of South Ossetia, leading neighboring Georgia to suspect "further provocations" following a five-day war in August, a Georgian Interior Ministry spokesman said today. Credit-default swaps on OAO Gazprom, Russia's biggest energy company, soared 188 basis points to 15.6 percent and contracts on Sberbank, the biggest bank, reached 13.4 percent.

Credit-default swaps protect bondholders against default by paying the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. An increase indicates deterioration in the perception of credit quality.

"There are legitimate reasons to be slightly worried about Russia, but the rise in credit-default swaps have very little to do with the credit risk of Russia and more to do with who holds emerging market debt," said Ronald Smith, chief strategist at Moscow-based Alfa Bank. "Funds are getting redemptions so are having to sell into a weak market, and if they can't sell the equity they may sell the debt as a proxy."

S&P Cuts Russia's Credit Rating Outlook to Negative
Standard & Poor's Ratings Services lowered Russia's long-term sovereign credit rating outlook to negative because the cost of the government's "bank rescue operation" may increase. The outlook was cut from stable, reflecting the increased probability for a downgrade, S&P said in an e-mailed statement today. Russia has committed as much as 15 percent of gross domestic product in budgetary and reserve funds to maintain banking liquidity, it said.

That may increase "amid rising capital outflows as confidence in the financial system and the monetary regime declines," S&P said. "It is difficult at present to determine the ultimate impact on the public sector balance sheet of the banking system bailout, not least due to the uncertain outlook on asset quality."

The government has pledged more than $200 billion to stem the worst financial crisis since 1998, including a banking liquidity boost worth $86 billion, following capital outflow. Slumping commodities prices, the war with Georgia and the seizing up of global capital markets prompted investors to pull at least $63 billion from Russia since Aug. 8, UniCredit SpA estimates. The central bank estimated net private capital outflow may reach $20 billion this year, compared with the previous forecast of net inflow of $40 billion.

"We are perhaps better prepared for the current situation than many other countries," President Dmitry Medvedev's economic aide, Arkady Dvorkovich, said yesterday. Russia can use its $515.7 billion reserves to boost the economy and ensure "stability" of the financial industry, he said. S&P affirmed Russia's BBB+ long-term foreign currency and the A- long-term local currency ratings and the short-term ratings of A-2.

"We expect Russian corporate and financial sector default rates to increase as debtors' access to official funds will vary," S&P said in the statement. "Other uncertainties remain regarding what the economic policy response will be to weakening growth, and whether the ongoing concentration of the financial system in state hands is permanent or temporary."

EU presses China to show leadership in crisis
The European Union on Thursday urged more say for Beijing in international financial bodies but said China in return had to play its part in helping to resolve the current global economic crisis.

The comments by European Commission President Jose Manuel Barroso set the stage for a two-day summit in Beijing of the 27 EU member states and 16 Asian countries covering the global downturn, climate change and international security. "We need a coordinated global response to reform the global financial system. We are living in unprecedented times, and we need unprecedented levels of global coordination," Barroso said. "It's very simple: we sink together or we swim together," he told reporters.

U.S. President George W. Bush has invited the Group of 20 nations, which includes major industrial states and big emerging economies such as China, India and Brazil, to meet in the United States on November 15 to discuss global financial reforms. Diplomats said the commission, the EU's executive arm, and France, which currently holds the EU's rotating presidency, hope to win a commitment from China in particular to use its clout to help shape the reforms and tackle the economic imbalances at the root of the current meltdown.

"I very much hope that China gives an important contribution to the solution of this financial crisis," Barroso said. "I think it's a great opportunity for China to show a sense of responsibility." Later, Barroso dangled the carrot of greater influence for Beijing on the world financial stage.

China this year won a modest increase in its voting power at the International Monetary Fund but argues that it is still not being allowed to punch its weight as the world's fourth-largest economy and the one that is growing fastest. "We think China could and should have a greater voice in international financial institutions," Barroso said in a speech at a school for civil servants.

The purpose of the biennial Asia-Europe Meeting (ASEM), launched 12 years ago, is to narrow the diplomatic distance between two continents accounting for 60 percent of global output and two thirds of world trade. But a decision on Thursday by the European Parliament to give its top human rights prize to Chinese activist Hu Jia risks straining ties with summit host Beijing.

"By awarding the Sakharov Prize to Hu Jia, the European Parliament is sending out a signal of clear support to all those who defend human rights in China," the assembly's president, Hans-Gert Poettering, told EU lawmakers in Strasbourg. The award to Hu, who was jailed for subversion after testifying to the EU parliament last year, seemed certain to enrage China. Foreign Ministry spokesman Qin Gang said beforehand that giving Hu the prize would be "an interference in both China's internal affairs and judicial sovereignty."

Barroso, who said human rights would be raised at the ASEM talks, was not alone in urging closer cooperation between the two blocs. German Chancellor Angela Merkel said after meeting Premier Wen Jiabao that working together was the key to overcoming the present financial crisis, the deepest in more than 70 years. Among a spate of other meetings on the sidelines of ASEM, Southeast Asian leaders were due later on Thursday to discuss a Thai proposal to develop an emergency financial fund for the region.

Thailand also wants countries around Asia to pool part of their vast holdings of foreign exchange reserves to facilitate trade, investment and tourism in the region. South Korea, Japan and China -- which will meet the leaders of ASEAN on Friday -- were likely to endorse the urgency of beefing up an existing web of central bank credit lines totaling $80 billion by the first half of 2009, diplomats said.

But they said the three North Asian neighbors, which have the biggest holdings of currency reserves in Asia, were opposed to putting part of their currency hoards into a common pot. ASEAN comprises Cambodia, Malaysia, Indonesia, Singapore, Vietnam, Philippines, Laos, Thailand, Myanmar and Brunei. Thailand currently chairs the group.

Small businesses cry out for help as failures mount
Forty small businesses go under every day because of dwindling orders and a lack of finance. As closures hit 280 a week, up from only 40 before the credit crunch hit, the Federation of Small Businesses (FSB) called yesterday for a £1 billion small-business survival fund that would be partly funded from Europe.

The FSB is also pressing HM Revenue & Customs (HMRC) to show forbearance to companies that have trouble paying VAT or corporation tax to avoid more closures. The calls come after a series of measures from the Government to try to bolster small businesses, which are finding it increasingly difficult to get money from banks, are suffering late payment from bigger customers and are facing reduced business from the economic slowdown.

Today Alistair Darling and Lord Mandelson, the Business Secretary, will meet the chief executives of the leading banks to press them to lend to smaller businesses on terms similar to those of last year. The banks that have been recapitalised by the Government have pledged to lend to small and medium-sized businesses. Ian Pearson, the Economics and Business Minister, told the Commons yesterday that he expected other banks to match the pledge of Royal Bank of Scotland, Halifax Bank of Scotland and Lloyds TSB.

The FSB laid out demands for a six-month £1billion fund to help to support Britain's 4.7million small companies. If collapses continue at their present rate, about 7,200 companies will have closed down in six months. The federation wants a survival fund to replace the existing small firms loan guarantee scheme and for it to be funded by the Government and by the European Investment Bank. John Wright, the FSB chairman, said: “A lot has been made of the rescue package for big banks, but small businesses are at the heart of our economy, employing just under 60 per cent of the private sector workforce. A rescue package for small businesses is crucial to shortening the economic downturn and saving jobs.”

The FSB is petitioning HMRC and Baroness Vadera, the Competitiveness Minister, to exercise lenience towards small businesses in recognition of the tough economic conditions. It is also pressing local authorities to relax the collection of some business rates for companies facing difficulties.

An HMRC spokeswoman said: “In the pursuit of Crown debt, HMRC staff are trained to be supportive of businesses that are viable but may be experiencing temporary financial difficulties. Our experience is that this approach provides a better longer-term return to the Exchequer. We do, of course, need to consider the balance between supporting businesses in temporary difficulties and fairness to our more compliant customers.”

Additionally, the Forum of Private Business (FPB) wrote to the British Bankers' Association to urge its members to support small businesses through the economic downturn. Phil Orford, the chief executive of the FPB, said that the conditions of the government bailout, in terms of the commitment to small business lending, was not being implemented on the ground. His letter read: “The Government is on the record as saying, following the very public bailout for many of your members, that lending would return to 2007 levels and at realistic rates. This is clearly not the case.

“As you are aware, real interest rates on overdrafts, in particular, are as high as 15 per cent, lending facilities are being reduced or withdrawn and charges for renegotiated agreements are excessive.” The FSB is also increasing the pressure for big companies that delay paying their bills to be named and shamed. The Government moved this week to speed up payments from public bodies to smaller suppliers and service providers. However, many big corporate names operate lengthy settlement periods.

It is estimated that small companies, on average, are owed £30,000 by large businesses. The FSB wants Companies House to be strengthened so that it could name late payers and fine companies that suddenly changed their payment arrangements. Small companies may charge interest on overdue bills; in practice, they rarely take such action because they fear that they will lose the business of larger clients.

Regional banks hit with losses
National City Corp. and Fifth Third Bancorp joined the list of banks that lost money in the third quarter. The two banks, which each have more than a dozen locations in the Lansing area, and several other banks reporting poor financial results Tuesday were hit by investment losses and higher credit costs - a stark indicator of more loan troubles ahead. Still, analysts noted several banks will likely benefit from the government's recent initiatives to aid ailing banks.

Cleveland-based National City said it will cut 4,000 jobs, or about 14 percent of its work force, after losing $5.15 billion, or $5.86 a share, during the quarter that ended in September. A year earlier, it lost $19 million, or 3 cents a share. Spokesman Bill Eiler said the cuts will be companywide and will be spread over the next three years. National City has banks in nine states.

National City recorded a one-time dividend of $4.42 billion on preferred shares issued in April related to its $7 billion capital raise. Excluding the preferred dividend, the quarterly loss was $729 million, or 85 cents a share. National City set aside $1.18 billion during the third quarter for loan loss provisions, compared with provisions of $368 million during the same quarter a year earlier. "National City's nonperforming assets were up only 13.1 percent from the prior quarter, which we consider fine in this environment," wrote Sandler O'Neill & Partners analyst R. Scott Siefers in a research note.

Cincinnati-based Fifth Third Bancorp lost $81 million, or 14 cents a share, during the third quarter. That includes $25 million in preferred dividends. That compared with a profit of $325 million, or 61 cents a share, one year earlier. Fifth Third set aside $941 million in the quarter to cover loan and lease losses.

KeyCorp also found itself in the red during the quarter, while U.S. Bancorp, Regions Financial Corp., BancorpSouth Inc. and M&T Bank Corp. reported steep profit declines. Gary Townsend, president and chief executive of private investment group Hill-Townsend Capital, said analysts were perhaps a bit too cheerful in their outlooks. At the same time, banks likely took advantage of the third quarter to "over" reserve, laying the foundation to rebuild their earnings and their balance sheets.

Goldman Sachs May Slash 3,200 Jobs as Turmoil Worsens
Goldman Sachs Group Inc., the only firm among Wall Street's five biggest to remain profitable through the credit crisis, will shed about 3,200 workers, or 10 percent of its staff, as the revenue outlook worsens, according to a person briefed on the plans who declined to be identified.

The cuts add to more than 130,000 jobs eliminated in the financial industry since mid-2007, eclipsing the cuts after the Internet bubble burst in 2001. Paul Kafka, a Goldman spokesman in London, wouldn't comment. Goldman had 32,569 employees at the end of August, up 3 percent from May and 9 percent for the year. Banks worldwide are shelving deals and cutting jobs as the unprecedented turmoil in credit markets spreads and spurs concern the global economy may fall into a recession. Goldman, which converted to a bank holding company last month and is receiving $10 billion from the U.S. Treasury, has dropped by almost 50 percent in New York trading this year.

"When a lean and mean firm starts trimming, they're cutting into muscle," said Shaun Springer, chief executive officer of Napier Scott Executive Search Ltd. in London. "The fact that they are cutting 10 percent is quite indicative of the fact that there are still a lot of problems ahead." The new job cuts signal a reversal in strategy at Goldman since Sept. 16, when Chief Financial Officer David Viniar told analysts he expected the number of Goldman employees to increase by a percentage "in the low single digits" this year, excluding the purchase of a mortgage servicing company.

The firm's revenue for nine months this year slid 32 percent from a year earlier, as investment banking fell 26 percent and trading and principal investment plunged 45 percent. Revenue may drop 38 percent in the quarter that ends in November, according to the average estimate of 12 analysts surveyed by Bloomberg. Mergers and acquisitions, in which Goldman is the top-ranked adviser for the eighth consecutive year, have declined by almost one third this year, and global equity offerings have tumbled 39 percent, data compiled by Bloomberg show.

The company has booked $4.9 billion of losses on devalued assets such as mortgage securities and leveraged loans, a fraction of the writedowns taken by rivals such as Citigroup Inc., Merrill Lynch & Co. and Morgan Stanley. Citigroup has cut 24,000 jobs in the past 18 months, more than any other bank in the world, according to Bloomberg data. Lehman Brothers Holdings Inc., which filed for bankruptcy last month, eliminated almost 14,000 jobs.

Other financial firms are planning further reductions. Merrill Lynch may cut more than 10,000 jobs after Bank of America Corp. completes its $50 billion acquisition of the firm, Ladenburg Thalmann Inc. analyst Richard Bove said this week. The Wall Street Journal reported Goldman Sachs's plan to cut jobs earlier today.

Banks may cut 62,000 jobs in London by the end of next year, reducing employment in the industry to the lowest level in more than a decade as the credit crisis worsens, the Centre for Economics and Business Research estimated this month.
In New York, state budget planners expect a loss of 40,000 financial jobs this year.

Investors Flee as Hedge Fund Woes Deepen
The gilded age of hedge funds is losing its luster. The funds, pools of fast money that defined the era of Wall Street hyper-wealth, are in the throes of an unprecedented shakeout. Even some industry stars are falling back to earth.

This unregulated, at times volatile corner of finance — which is supposed to make money in bull and bear markets — lost $180 billion during the last three months. Investors, particularly wealthy individuals, are heading for the exits.

As the stock market plunged again on Wednesday, with the Dow Jones industrial average sinking 514 points, or 5.7 percent, the travails of the $1.7 trillion hedge fund industry loomed large. Some funds dumped stocks in September as their investors fled, and other funds could follow suit, contributing to the market plummet. No one knows how much more hedge funds might have to sell to meet a rush of redemptions. But as the industry’s woes deepen, money managers fear hundreds or even thousands of funds could be driven out of business.

The implications stretch far beyond Manhattan and Greenwich, Conn., those moneyed redoubts of hedge-fund lords. That is because hedge funds are not just for the rich anymore. In recent years, public pension funds, foundations and endowments poured billions of dollars into these private partnerships. Now, in the midst of one of the deepest bear markets in generations, many of those investments are souring.

Granted, hedge funds are not going to disappear. In fact, some are still thriving. Even many of the ones that have stumbled this year are doing better than the mutual fund industry, which has also been hit with withdrawals that have forced their managers to sell. But the reversal for the hedge fund industry represents a sea change for Wall Street and its money culture.

Since hedge funds burst onto the scene in the 1990s, they have recast not only the rules of finance but also notions of wealth and status. Hedge-fund riches helped inflate the price of everything from modern art to Manhattan real estate. Top managers raked in billions of dollars a year, and managing a fund became the running dream on Wall Street. Now, for lesser lights, at least, that dream is fading.

“For the past five or six years, it seemed anybody could go to their computer and print up a business card and say they were in the hedge fund business, and raise a pot of money,” said Richard H. Moore, the treasurer of North Carolina, which invests workers’ pension money in hedge funds. “That’s going to be gone forever.” As are some hedge funds. For the first time, the industry is shrinking. Worldwide, the number of these funds dropped by 217 during the last three months, to 10,016, according to Hedge Fund Research.

Even some of the industry’s most well-regarded managers are starting to retrench. Richard Perry, who until now had not had a down year for his flagship fund in more than a decade, has laid off some employees. Mr. Perry, who began his career at Goldman Sachs, is moving away from stock-picking to focus on the troubled credit markets. Three other hedge fund highfliers — Kenneth C. Griffin, Daniel S. Loeb and Philip Falcone — have suffered double-digit losses through the end of September.

Steven A. Cohen, the secretive chief of a fund called SAC Capital, has put much of the money in his funds into cash, reducing trading by some of his workers. Many hedge fund investors, particularly the wealthy individuals, are flabbergasted by their losses this year. The average fund was down 17.6 percent through Tuesday, according to Hedge Fund Research. “You’re seeing a lot of shock, a lot of inaction, a lot of reassessment of where their allocations are and what to do going forward,” said Patrick Welton, chief executive of the Welton Investment Corporation, whose fund is up double-digits this year.

Many investors, Mr. Welton said, had hoped hedge funds would protect them from a steep decline in the broader market. But in many cases, that has not happened. Now Wall Street is buzzing about how much money could be pulled out of hedge funds — and which funds might bear the brunt of the redemptions. Funds have set aside billions of dollars in cash to prepare for withdrawals, and many prominent funds require their investors to leave their money in the funds for years. That could help relieve some of the pressure.

But because hedge funds are largely unregulated, they do not publicly disclose the identity of their investors or whether they have received requests for withdrawals. While it might make sense to pull money out of poorly performing funds, investors might also exit funds that are doing well to offset losses elsewhere. Institutions — pension funds, endowments and the like — pushed into hedge funds after the Nasdaq stock market bust at the turn of the century. Many hedge funds had prospered as technology stocks crashed, leading these investors to believe they would in the future.

In Massachusetts, for instance, Norfolk County broached the issue with the state’s pension oversight commission, said Robert A. Dennis, the investment director of the commission. Mr. Dennis was impressed that hedge funds had fared so much better than the broader stock market. Though Mr. Dennis says he recognizes the risks that come with selecting hedge funds, he thinks they remain a good investment. Next week, the state commission will vote on whether to allow some towns with pension funds below $250 million to invest in hedge funds, a move Mr. Dennis supports.

“Hedge funds are having a bad year, absolutely, but they’re still holding up better than stocks,” Mr. Dennis said. “Losing less money than another investment is, while not great, it’s still something to be at least satisfied with.” But now that the days of easy money are over, some fund managers are throwing in the towel.

One manager, Andrew Lahde, was blunt about his decision. “I was in this game for the money,” Mr. Lahde wrote to his investors recently. He made a fortune betting against the mortgage markets, calling those on the other side of his trades “idiots.” “I have enough of my own wealth to manage,” Mr. Lahde wrote. He did not return telephone calls seeking comment.

And what wealth there has been. More than anything else, hedge funds are vehicles for their managers to take a big cut of profits. The lucrative economics of the industry is known as “two and 20.” Managers typically collect annual management fees equal to 2 percent of the assets in their funds, and, on top of that, take a 20 percent cut of any profits. Last year, one manager, John Paulson, reportedly took home $3 billion.

But with the industry under pressure, those fat fees are being questioned. Mr. Moore and other investors are starting to ask whether hedge funds deserve all that money. Mr. Griffin, who runs Citadel Investment Group in Chicago, plans to offer funds with lower fees. More changes could be coming, including increased regulation. The House Committee on Oversight and Government Reform is scheduled to hold a hearing about regulation next month with five hedge fund managers who reportedly made more than $1 billion last year: Mr. Griffin, Mr. Falcone and Mr. Paulson, as well as George Soros and James Simons.

Credit Default Swaps Clearing House Deemed Too Risky
Electronic trading pioneer Thomas Peterffy says a plan by CME Group Inc. to guarantee credit- default swaps could put his entire $4 billion company at risk. CME Group's proposal to use its existing clearinghouse to clear swaps would require exchange members such as Peterffy's Interactive Brokers Group Inc. to bail out a failed trader. Those companies have put up $101 billion to guarantee the futures and options now cleared by CME.

"It would be a great mistake," said Peterffy, 64, a Hungarian immigrant whose company executes 14 percent of the world's equity options. "Mixing the two types of funds will jeopardize the entire financial system" set up to guarantee futures trades, he said. Peterffy, whose concern is shared by CME Group members including Penson GHCO Chief Executive Officer Chris Hehmeyer, is balking at a plan that CME developed amid pressure from the Federal Reserve to create a safety net for risky credit-default trades, now traded on an over-the-counter basis.

Failed investment bank Lehman Brothers Holdings Inc. was among the top 10 dealers in the $55 trillion CDS market. CME Group announced its CDS clearing plan Oct. 7, saying it would reduce counterparty risk and offer the market a "key turning point." A rival proposal by Intercontinental Exchange Inc. would avoid the issue raised by Peterffy by creating a separate clearinghouse to segregate its futures and credit-swaps business.

A clearinghouse, capitalized by its members, all but eliminates the risk of trading-partner default by being the buyer for every seller and the seller for every buyer. It employs daily mark-to-market pricing and liquidates positions of traders who can't pay their margin. In OTC markets, traders rely on their counterparty to make good on their agreements. A trader with a cleared OTC position could put other CME member firms at risk of making up a shortfall if the trader couldn't cover the losses. CME's clearinghouse hasn't ever suffered a default.

Kim Taylor, president of CME Group's clearinghouse, said she's taking steps to ensure solid pricing data for its CDS clearing. The plan to guarantee CDS indexes and contracts on individual companies is a partnership with hedge fund Citadel Investment Group LLC and includes a trading platform, which will create prices for the contracts, she said. "The trading in the index products will migrate very quickly to the trading platform," Taylor said. Prices can also be created from market data, she said. "This market already trades a significant amount," Taylor said. "It's just that none of the information is public."

Peterffy said he doubts that the exchange will be able to determine CDS pricing because they trade infrequently. "There is no assurance once the buyer or seller goes bust you can liquidate those positions near the price" that was settled upon the day before, Peterffy said. Interactive Brokers has as much as $1 billion pledged to equity and derivative exchanges, including CME Group, to fund trader shortfalls.

Credit-default swaps pay buyers face value for the underlying securities or cash equivalent should the company fail to keep to its debt agreements. "I can see why people would be concerned by the CME's model," Penson GHCO's Hehmeyer said. CDS pricing will still come from voice and electronically executed over-the-counter trades, said David Rutter, deputy CEO of ICAP Plc's electronic broking unit. Although most of these swaps trade daily, prices are not always available in all swaps, he said.

"The clearinghouse is potentially compromised if you don't have really good, independent and reliable mark-to-market information," Rutter said. The amount of money traders must have on deposit, known as margin, is the main way clearinghouses insure against losses. CME Group will require higher margin to trade CDS than futures, Taylor said. To set futures margins, CME Group tallies a trader's total potential portfolio loss in one day and uses that amount to derive the margin rate. For CDS contracts, CME Group will add up the potential portfolio losses over two to five days, and use that amount to set the margin rate, Taylor said.

Margin calls on CDS contracts could be a greater risk than with futures, said Howard Simons, a strategist at Bianco Research LLC in Glenview, Illinois. "You have highly correlated systemic risk," he said. "We have whole industries where if one's in trouble, all of them are in trouble." When Lehman went bankrupt last month, the cost of credit swaps on Morgan Stanley rose almost six-fold. The CME Group risk committee, composed of the banks and hedge funds that capitalize its clearinghouse, will have to approve any new contracts cleared by the exchange. Taylor declined to comment on the risk committee.

Gold's recent slump bewilders investors
'Investors worldwide are selling everything, including the kitchen sink, and gold is no exception.'
— Peter Grandich, Agoracom

Gold is often seen as an investment safe haven whose price tends to rise when the economy falls into troubles, but its recent slumps have defied conventional wisdom. Gold futures hit a historic high above $1,000 an ounce a few days after Bear Stearns was taken over by J.P. Morgan Chase & Co. on March 14. But in the recent round of crises triggered by the collapse of Lehman Brothers Holdings Inc., gold has fallen to below $700 for the first time in 13 months. The metal has so far lost more than $180 in October.

The reason, according to analysts at the World Gold Council, is that the latest bout of the credit crisis has been deeper and more far reaching. Funds were forced to sell desired assets such as gold to meet margin calls, while weakness in European economies lifted the U.S. dollar, which then pushed dollar-denominated gold prices lower. "The fact that gold did not head higher during the current leg of the crisis seems to reflect a combination of the rise in the dollar, deleveraging of commodity positions, sales to meet margin calls, and the unwinding of the long gold, short dollar trade," wrote Natalie Dempster, an analyst at the WGC, in a research report released Thursday.

Unlike in March, banks and investment funds were facing an increasingly tight credit market recently. The overnight dollar London interbank offered rate, the rate banks charge each other known as Libor, hit a record high of 6.88% earlier this month. The rate was at around 3% in March. Stocks also stood higher in March, with the Dow Jones Industrial Average trading around 12,000. The Dow has slumped to below 9,000 this month. "The current crisis has seen much more pressure on gold as an 'asset of last resort,' where it has been sold to meet margin calls when there have simply been so few other viable options available," Dempster said.

Trading in the over-the-counter gold market, where big institutions trade with each other directly in large orders, weakened in the third quarter due to the rise in counterparty risk and the lack of investment capitals, according to GFMS, a London-based precious metal consultancy. A wave of liquidations occurred in September as funds were forced to raise cash in the face of margin calls and massive investor redemptions, according to GFMS. The London gold-fixing price -- used as a benchmark for gold's OTC trading - has dropped $160 this month. It stood at $726 an ounce Thursday morning.

Gold trading in futures markets also went through a similar declining trend. In the two major global gold futures markets in New York and Tokyo, speculators' buy positions have been falling, while their sell positions have been rising. Some investment funds were forced to sell even their "most desired assets such as precious metals," said Peter Spina, president of There could be "more victims of the fund collapse and more forced liquidations."

Gold futures traded on the Comex division of the New York Mercantile Exchange have fallen in 10 of the past 11 sessions since Oct. 8 and have lost more than $200 an ounce. Futures slumped 5% Thursday to below $700 for the first time since September, 2007. "Investors worldwide are selling everything, including the kitchen sink, and gold is no exception," said Peter Grandich, chief commentator at Agoracom, an online marketplace for the small-cap investment community.

The U.S. dollar also played an important role in gold prices, as the greenback and the yellow metal often move in the opposite direction. During the Bear Stearns crisis, the dollar continued its long secular decline, with the euro trading above $1.50. The dollar, however, has seen a steep rise since late September, with the euro trading below $1.30 Wednesday for the first time since February 2007. The British pound fell to its weakest level against the dollar in five years. A stronger dollar reduced gold's appeal as an investment alternative. "Investors unwound leveraged short dollar, long gold positions, mindful of the long standing negative correlation between gold and the dollar," said the WGC's Dempster.

Some analysts, however, said that in the long term, the U.S. rescue plans to inject liquidity into banks will stir inflation and a devaluation of the dollar -- something that would be bullish for gold prices. "An extraordinary amount of liquidity has been pumped into the system this year," said Peter Grant, senior analyst at USAGOLD. "I anticipate further debasement of all currencies, including the dollar, which will ultimately drive gold prices higher."

Struggling to Keep Up as the Crisis Raced On
“I feel like Butch Cassidy and the Sundance Kid. Who are these guys that just keep coming?” — Treasury Secretary Henry Paulson Jr.

It was the weekend of Sept. 13, and the moment Treasury Secretary Henry M. Paulson Jr. had feared for months was finally upon him: Lehman Brothers was hurtling toward bankruptcy — fast. Knowing that Lehman had billions of dollars in bad investments on its books, Mr. Paulson had long urged Lehman’s chief executive, Richard S. Fuld Jr., to find a solution for his firm’s problems. “He was asked to aggressively look for a buyer,” Mr. Paulson recalled in an interview.

But Lehman could not — despite what Mr. Paulson described as personal pleas to other firms to buy some of Lehman’s toxic assets and efforts to persuade another bank to acquire Lehman. With all options closed, he said, the government’s hands were tied. Although the Federal Reserve had helped bail out Bear Stearns — and was within days of bailing out the giant insurer American International Group — it could not help Lehman, even as its default threatened to wreak havoc on financial markets.

“We didn’t have the powers,” Mr. Paulson insisted, explaining a decision that many have since criticized — to allow Lehman to go bankrupt. By law, he continued, the Federal Reserve could bail out Lehman with a loan only if the bank had enough good assets to serve as collateral, which it did not. “If someone thinks Hank Paulson could have made the Fed save Lehman Brothers, the answer is, ‘No way,’ ” he said.

But that is not the way that many who have scrutinized his actions see it. Bankers involved say they do not recall Mr. Paulson talking about Lehman’s impaired collateral. And they said that buyers walked away for one reason: because they could not get the same kind of government backing that facilitated the Bear Stearns deal. In retrospect, they added, it was emblematic of the miscalculations by the government in reacting to the crisis.

The day after Lehman collapsed, the Fed saved A.I.G. with an emergency $85 billion loan, but the credit markets around the world began freezing up anyway. It was at this point that Mr. Paulson — feeling outgunned by pursuers, like Butch and Sundance — decided he had to find a systemic solution and stop lurching from crisis to crisis, fixing one company’s problems only to find several more right behind. “Ben said, ‘Will you go to Congress with me?’ ” said Mr. Paulson, referring to the Federal Reserve chairman, Ben S. Bernanke. “I said: ‘Fine, I’m your partner. I’ll go to Congress.’ ”

In nearly a century, no Treasury secretary has faced a more difficult financial crisis than that Mr. Paulson is contending with. For months, he and his team have been working around the clock, often seven days a week, trying — in vain — to keep it from deepening. In an hourlong interview with The New York Times, Mr. Paulson defended Treasury’s actions, saying that he and his aides had done everything they could, given the deep-rooted problems of financial excess that had built up over the past decade. “I could have seen the subprime problem coming earlier,” he acknowledged in the interview, quickly adding in his own defense, “but I’m not saying I would have done anything differently.”

History will be the final judge. But in contrast with Mr. Paulson’s perspective, other government officials and financial executives suggest that Treasury’s epic rescue efforts have evolved as chaotically as the crisis itself. Especially in the past month, as the financial system teetered on the abyss, questions have been raised about the government’s — and Mr. Paulson’s — decisions. Executives on Wall Street and officials in European financial capitals have criticized Mr. Paulson and Mr. Bernanke for allowing Lehman to fail, an event that sent shock waves through the banking system, turning a financial tremor into a tsunami.

“For the equilibrium of the world financial system, this was a genuine error,” Christine Lagarde, France’s finance minister, said recently. Frederic Oudea, chief executive of Société Générale, one of France’s biggest banks, called the failure of Lehman “a trigger” for events leading to the global crash. Willem Sels, a credit strategist with Dresdner Kleinwort, said that “it is the clear that when Lehman defaulted, that is the date your money markets freaked out. It is difficult to not find a causal relationship.”

In addition, Mr. Paulson and Mr. Bernanke have been criticized for squandering precious time and political capital with their original $700 billion bailout plan, which they presented to Congressional leaders days after the Lehman bankruptcy. The two men sold the plan as a vehicle for purchasing toxic mortgage-backed securities from banks and others. But even after the House finally passed the bill on Oct. 3, markets remained in turmoil. It was not until Britain and other European countries moved to put capital directly into their banks, and the United States followed their lead, that some calm returned.

In the interview, Mr. Paulson said that even before the House acted, he had directed his staff to start drawing up a plan for using some of the $700 billion to recapitalize the banking system — something that Congress was never told and that he had publicly opposed. Why? Because in the week before the plan passed Congress, conditions deteriorated significantly, Mr. Paulson said.

But many complain the worst of the turmoil might have been avoided if it hadn’t been for Mr. Paulson sticking with an original bailout plan that they viewed as poorly conceived and unworkable. “They were asking the most basic questions,” said one Wall Street executive who spoke to Treasury officials after the bailout bill was passed. “It was clear they hadn’t thought it through.” Senator Charles E. Schumer, Democrat of New York, who had called for an infusion of capital into banks in mid-September, said, “They are so much more on top of this recapitalization plan than they were about the auction plan.”

Even as he defended his actions, Mr. Paulson said he was worried that some of the government’s moves could wind up haunting future Treasury secretaries. He pointed in particular to the decision to guarantee all bank deposits and interbank loans, something the United States did to keep pace with similar decisions in Europe. “We had to,” Mr. Paulson said. “Our banks would not have been able to compete.” But the federal guarantees could create “moral hazard” and simply encourage banks to take on dangerous risk, he acknowledged. “This is the last thing I wanted to do,” he said.

The subprime mortgage debacle began emerging in the summer of 2007, about a year after Mr. Paulson left his job as head of Goldman Sachs and joined the Bush administration. But the true depth and extent of the losses did not become clear until earlier this year, Mr. Paulson said. “We thought there was a reasonable chance of getting through this,” he recalled. Then came the near failure in March of Bear Stearns, which was rescued in a takeover by JPMorgan Chase only after the Fed agreed to cover $29 billion in losses. That briefly lulled the markets into thinking the worst might be over. But during the summer, conditions deteriorated, and in early September the government was forced to take over Fannie Mae and Freddie Mac, the mortgage finance giants.

With increasing speed, other problems emerged, most notably Lehman and A.I.G., which was also burdened with bad mortgage-related investments. Both became the focus of intense meetings the weekend of Sept. 13-14. Mr. Paulson, by then, had become frustrated with what he perceived as Mr. Fuld’s foot-dragging. “Lehman announced bad earnings around the middle of June, and we told Fuld that if he didn’t have a solution by the time he announced his third-quarter earnings, there would be a serious problem,” Mr. Paulson said. “We pressed him to get a buyer.”

Here the views of Mr. Paulson and his critics start to diverge, over what transpired in marathon meetings with Wall Street executives at the Federal Reserve Bank of New York that weekend. Lehman officials said they believed the firm had not one but two potential buyers: Bank of America and Barclays, the big British bank. But both had conditions. Bank of America wanted the Fed to make a $65 billion loan to cover any exposure to Lehman’s bad assets, according to one person privy to the discussions who did not want to be identified because of their sensitive nature.

Although this was more than double what the Fed had made available to facilitate the takeover of Bear Stearns by JPMorgan, Bank of America justified the request on the grounds that Lehman was larger. Barclays also wanted a guarantee to protect against losses should Lehman’s business worsen before Barclays could compete its takeover. The government initially was not clear in telling Bank of America and Barclays that no help would be forthcoming, participants said. The New York Fed president, Timothy F. Geithner, in particular, was uncomfortable about drawing a line in the sand against government support for a Lehman takeover.

Participants said they were left with the impression from Mr. Paulson and Mr. Geithner that the government might well provide help for a serious buyer, with Mr. Paulson also trying to get Wall Street firms to create a $10 billion fund to absorb some of Lehman’s bad assets. It remains unclear whether a more consistent message would have changed the outcome. But by Saturday, Bank of America, frustrated by the government’s unwillingness to commit to a deal, turned its attention to Merrill Lynch, which agreed to a takeover. Barclays, equally frustrated, walked away on Sunday, said the person with knowledge of the discussions.

Mr. Paulson said in the interview that Treasury was not at fault. The $10 billion industry fund had not worked because executives in the room realized that bailing out Lehman would not end the crisis. There were too many other firms that needed help. “I didn’t want to see Lehman go,” Mr. Paulson said. “I understood the consequences better than anybody.” At a White House briefing on Sept. 15, Mr. Paulson shed no tears over Lehman’s failure. “I never once considered it appropriate to put taxpayer money on the line in resolving Lehman Brothers,” he told reporters.

In the interview, however, Mr. Paulson said the main issue was whether it was legal. Under the law, the Fed has the authority to lend to any nonbank, but only if the loan is “secured to the satisfaction of the Federal Reserve bank.” When pressed about why it was legal for the Fed to lend billions of dollars to Bear Stearns and A.I.G. but not Lehman Brothers, Mr. Paulson emphasized that Lehman’s bad assets created “a huge hole” on its balance sheet. By contrast, he said, Bear Stearns and A.I.G. had more trustworthy collateral.

People close to Lehman, however, say it was never told this by the government. “The Fed and the S.E.C. had their people on site at Lehman during 2008,” said a person in the Lehman camp. “The government saw everything in real time involving Lehman’s liquidity, funding, capital, risk management and marks — and never expressed any concerns about collateral or a hole in the balance sheet.”

The aftermath of the Lehman bankruptcy was disastrous. “Lehman was one of the single largest issuers of commercial paper in the world,” said Joshua Rosner, a managing director at Graham Fisher & Company, referring to short-term debt issued by companies to finance day-to-day operations; this market locked up in the wake of Lehman’s failure. “How could you let it go bankrupt and not expect the commercial paper market to be completely crushed?” Why Bear Stearns but not Lehman, wonders Representative Barney Frank. Mr. Frank, Democrat of Massachusetts and chairman of the House Financial Services Committee, has generally been a supporter of Mr. Paulson during the crisis. “If it was the right thing to do, why did they do it only once?” he asked.

In response, Mr. Paulson said that only now that the bailout bill has been passed does the government have the authority to intervene in a nonbank failure in cases of firms that lack adequate collateral, like Lehman. Lehman’s failure was followed by another strategic misstep by Treasury, critics say. They assert that Mr. Paulson initially pushed the wrong systemic fix: a bailout plan that revolved around buying up toxic securities, rather than putting capital into the banking system, a far more direct way of providing assistance.

Mr. Paulson rejects this view. In the interview, he cited several reasons he and Mr. Bernanke concentrated initially on purchasing distressed assets. First, he said, this plan had been in the works for months and was much further developed. “If we had felt going in that the right way to deal with the problem was to put equity in, we would have taken some time and developed a program,” he said. He also worried that Congress would not be receptive to the idea of Treasury taking an ownership stake in banks: “This is a very complicated and difficult sell. We want to put equity in, but we don’t want to nationalize the banks. And I don’t know how to sell that.”

But he doesn’t dispute that he changed direction. Mr. Paulson said that by Oct. 2, as he was departing for a weekend getaway to an island with his family — his first weekend off in nearly two months — he told his staff, “We are going to put capital into banks first.” Although the bailout bill still had not passed, the financial markets had deteriorated. He did not, however, inform Congress of his change of heart, and the House debate revolved almost entirely around the asset-purchase plan.

Just 11 days later, Treasury had come up with a plan to inject capital into the banks — which Mr. Paulson sold to the nation’s nine largest financial institutions on Oct. 13. “I can imagine being dinged for some things,” he said, “but not for moving that quickly.” He also defended Treasury’s recapitalization plan against critics who say that he did not extract a high enough price from the banks getting taxpayers’ money. “I could not see the United States doing things like putting in capital on a punitive basis that hurts investors. And we don’t want to run banks.”

Asked what he might have done better, Mr. Paulson replied, “I could have made a better case to the public.” He added, “I never felt worse than when the House voted no” on the bailout plan Sept. 26, its initial rejection before ultimately passing the plan. As for Lehman, Mr. Paulson insisted that it was “a symptom and not a cause” of the financial meltdown that took place in recent weeks. The real problem, he contended, is that banks all over the world made wrong-headed loans that have now come back to haunt them.

After meeting recently with European central bankers, he said, “the thing that took your breath away was the extent of the problem. Look at country after country that said they didn’t have a problem, and it turned out they had a huge problem.” Mr. Paulson added, “Ten years from now no one is going to say that this crisis was brought about because Lehman Brothers went down.”

Citic Pacific Tied to Australian Dollar After Losses
Citic Pacific Ltd.'s attempt to manage currency risk means the Chinese steelmaker and property developer has four times more money riding on the Australian dollar than it earned last year. The unit of China's largest state-owned investment company has contracts committing it to buy as much as A$9.44 billion ($6.3 billion) of the currency, according to an Oct. 20 statement. That's more than quadruple Citic Pacific's market value yesterday and compares with 2007 net income of HK$10.8 billion ($1.4 billion).

Citic Pacific has plummeted 66 percent in Hong Kong trading since disclosing it has an unrealized loss of HK$14.4 billion on the contracts, which force it to purchase Australian dollars at an average price of 87 U.S. cents. The currency traded at 66.72 cents as of 7:54 p.m. in Sydney. "If you buy the stock, you're taking a view on Australian dollars," said Billy Ng, a Hong Kong-based analyst at JPMorgan Chase & Co. "I won't recommend buying, even at this price."

Shares of Hong Kong-based Citic Pacific tumbled 25 percent to HK$4.91 percent yesterday, after a 55 percent drop Oct. 21. They rose 2 percent to HK$5 today. Australia's dollar will appreciate to 72 U.S. cents next year, the median forecast of 25 analysts surveyed by Bloomberg shows. The Australian dollar may trade as low as 50.45 U.S. cents through March 31, according to Divyang Shah, chief strategist in London at CBA Europe, a unit of Commonwealth Bank of Australia.

Companies around the world are posting losses on foreign- exchange hedges amid record high volatility in currency markets. In Brazil, a pulp producer, a poultry company and a cement maker have reported $2.3 billion in losses on currency derivatives. Korean companies may lose as much as $2.2 billion on such contracts, according to Standard & Poor's.

Central banks and governments are pumping unprecedented amounts of cash into the financial system and banks that lost money on derivatives and asset-backed securities. Citic Group, the company's parent, is controlled by the State Council, China's cabinet. Citic Pacific's largest position was in so-called Australian dollar target redemption forwards, according to the company, which didn't elaborate. Such over-the-counter contracts aren't traded on an exchange. They differ from typical forwards, or agreements to buy and sell assets at current prices for delivery at a specified time and date, in that they are customized for clients.

The total notional value of outstanding foreign-exchange OTC derivatives in the world increased 78 percent in the two years ended 2007 to $56 trillion, according to the Bank for International Settlements in Basel, Switzerland. "They have gotten very popular in the last three years and a lot of people have been hurt already," said Joseph Ngai, a principal for the financial services sector in Hong Kong at McKinsey & Co., a New York-based consultancy. "When prices fall, you have to keep buying at a loss."

Citic Pacific didn't give details of the contracts, except to say that they would deliver a maximum of A$9.44 billion, while its U.S. dollar losses weren't limited. The company said it plans to take delivery of some of the currency, known as the Aussie, because it needs to finance an A$1.6 billion iron ore project in Australia.

"The contracts they're holding will track the Aussie dollar," said Jackson Wong, an investment manager at Hong Kong- based brokerage Tanrich Securities Co. Wong, who declined to say how much he manages, said he bought Citic Pacific shares yesterday. Deciding whether the stock is worth buying would be "a very sophisticated calculation," he added. The Australian dollar was trading close to its 25-year high of 98.49 U.S. cents when Financial Director Leslie Chang and Financial Controller Chau Chi Yin bought the forwards. The contracts have an average strike price of 87 U.S. cents.

Citic Pacific ousted Chang, 54, and Chau, 52, this week because the company said the trades weren't authorized. The contracts incurred losses as the Aussie tumbled 32 percent from its high in July. They "didn't understand the potential downside risks," Managing Director Henry Fan said in an Oct. 21 interview. Frances Yung, 36, daughter of Chairman Larry Yung and head of the finance department, will be demoted, Fan said.

HSBC Holdings Plc, BNP Paribas SA and Citigroup Inc. were among the banks who sold the derivatives, according to the company. Spokespeople for the banks declined to comment. Derivatives are financial instruments derived from stocks, bonds, loans, currencies and commodities, or linked to specific events, such as the weather or changes in interest rates. To limit losses, Citic Pacific has started to cancel some of the contracts, costing it $104 million, and is trying to renegotiate the remainder.

"Citic Pacific stands a good chance to restructure the contracts with the banks because of its State Council background," said Kenny Tang, a director of Tung Tai Securities Co. in Hong Kong. "Probably no banks dare to screw up their relationship with the government if they still want to do businesses with Chinese companies." The Securities and Futures Commission in Hong Kong said it started an investigation of Citic Pacific, without giving details. Hong Kong Exchanges & Clearing Ltd., which runs the city's bourse, is also "looking into" whether the company complied with listing rules, said Henry Law, a spokesman.

"I'm not quite sure how many understood what they bought, but when everything was going up in a straight line it looked very sensible," said Song Seng-Wun, an economist at CIMB-GK Securities Pte Ltd. in Singapore. "The great unwinding will see more casualties."

Allstate posts surprise $923M loss for 3Q
Property, casualty and auto insurer Allstate Corp. on Wednesday posted an unexpected loss in the third quarter, hit by hefty hurricane-related losses and the ongoing global financial crisis. For the July to September period, the company lost $923 million, or $1.71 per share, after a profit of $978 million, or $1.70 per share, a year earlier. Revenue fell to 7.3 billion from 9 billion.

Operating losses, which excludes investment gains and losses, totaled $190 million, or 35 cents a share — missing analysts' average profit estimate of 72 cents per share, according to Thomson Reuters. The company said catastrophe losses linked to Hurricanes Ike and Gustav cost it $1.8 billion for the quarter ended Sept. 30, more than five times than the same quarter a year ago.
The news marked the second quarter in a row that Allstate's results were hurt by higher-than-average disaster losses. During the second quarter, tornados and other severe weather cost the insurer $698 million in catastrophe losses. The declining value of investments amid "unprecedented declines in credit markets," also eroded third-quarter profit, Allstate said.

Net realized capital losses for the period totaled $1.3 billion, and primarily consisted of impairment write-downs of $666 million.
Allstate shares fell $3.72 to close at $28.23. Shares have traded between $23.39 and $55.50 in the past 12 months.

Credit Suisse Posts $1.1 Billion Quarterly Loss
Credit Suisse Group reported a 1.26 billion Swiss franc ($1.08 billion) loss during the third quarter Thursday, blaming bad investments and the global financial turmoil, and the bank said it was working to further cut its exposure to toxic assets.

Credit Suisse's second quarterly loss this year came as no surprise, following a warning by Switzerland's No. 2 bank last week that it expected to book writedowns of 2.4 billion francs ($2.06 billion) from its investment banking business during the quarter. Analysts at Zuercher Kantonalbank noted that those losses would have been higher if Credit Suisse had not revalued its own debt to reflect a book profit of 1.9 billion francs ($1.63 billion).

Last year Credit Suisse made an overall net profit of 1.3 billion francs during the July-September period. Revenues halved to 3.11 billion francs ($2.66 billion) compared with 6.02 billion during the period last year. "While understandable in the context of the market environment, this result is clearly disappointing," said chief executive Brady Dougan.

Institutional investors withdrew some 16.5 billion francs ($14.1 billion) from its asset management division during the quarter, but deposits in its private banking business saw a net increase of 14.5 billion francs ($12.4 billion), a sign Dougan said that the bank still enjoys considerable trust among individual customers. Overall, funds managed by Credit Suisse have declined almost 13 percent to 1.37 trillion francs ($1.17 trillion) since the third quarter 2007.

Rival UBS AG reported massive customer withdrawals in recent months as it struggled to turn around its business after losses and heavy writedowns since the start of the subprime crisis last year. Last week Switzerland's largest bank took up a government offer of almost $60 billion that will allow it to dispose of toxic assets -- the complex securities that have fallen in value and helped trigger the world financial crisis.

Credit Suisse passed up a similar offer, opting instead to seek a 10 billion franc ($8.6 billion) capital injection from foreign investors, including the government-controlled Qatar Investment Authority, to bolster its reserves. Banking analysts said earlier this week that they were looking for reassurances that Credit Suisse too is disposing of its troubled investments.

Dougan said Credit Suisse was working hard to reduce those liabilities, but Thursday's results show the bank is still sitting on leveraged loans, commercial mortgage-backed securities and subprime assets worth 31.5 billion francs (almost $27 billion), down from 35.8 billion francs last quarter.

"We expect the market environment to remain very challenging and we are cautious with regard to the outlook for the fourth quarter," Dougan said. Shares in Credit Suisse dropped 6.1 percent to 43.70 francs ($37.51) on the Zurich exchange.

Credit default swaps smartest guys in the Room may be not!
When the smartest guys in the room designed their credit default swaps, they forgot to ask one thing - what if the parties on the other side of the bet don’t have the money to pay up? Credit default swaps (CDS) are insurance-like contracts that are sold as protection against default on loans, but CDS are not ordinary insurance.

Insurance companies are regulated by the government, with reserve requirements, statutory limits, and examiners routinely showing up to check the books to make sure the money is there to cover potential claims. CDS are private bets, and the Federal Reserve from the time of Alan Greenspan has insisted that regulators keep hands off.

The sacrosanct free market would supposedly regulate itself. The problem with that approach is that regulations are just rules. If there are no rules, the players can cheat; and cheat they have, with a gambler’s addiction. In December 2007, the Bank for International Settlements reported derivative trades tallying in at $681 trillion - ten times the gross domestic product of all the countries in the world combined. Somebody is obviously bluffing about the money being brought to the game, and that realization has made for some very jittery markets.

“Derivatives” are complex bank creations that are very hard to understand, but the basic idea is that you can insure an investment you want to go up by betting it will go down. The simplest form of derivative is a short sale: you can place a bet that some asset you own will go down, so that you are covered whichever way the asset moves.

Credit default swaps are the most widely traded form of credit derivative. They are bets between two parties on whether or not a company will default on its bonds. In a typical default swap, the “protection buyer” gets a large payoff if the company defaults within a certain period of time, while the “protection seller” collects periodic payments for assuming the risk of default.

CDS thus resemble insurance policies, but there is no requirement to actually hold any asset or suffer any loss, so CDS are widely used just to speculate on market changes. In one blogger’s example, a hedge fund wanting to increase its profits could sit back and collect $320,000 a year in premiums just for selling “protection” on a risky BBB junk bond. The premiums are “free” money - free until the bond actually goes into default, when the hedge fund could be on the hook for $100 million in claims. And there’s the catch: what if the hedge fund doesn’t have the $100 million? The fund’s corporate shell or limited partnership is put into bankruptcy, but that hardly helps the “protection buyers” who thought they were covered.

To the extent that CDS are being sold as “insurance,” they are looking more like insurance fraud; and that fact has particularly hit home with the ratings downgrades of the “monoline” insurers and the recent collapse of Bear Stearns, a leading Wall Street investment brokerage. The monolines are so-called because they are allowed to insure only one industry, the bond industry. Monoline bond insurers are the biggest protection writers for CDS, and Bear Stearns was the twelfth largest counterparty to credit default swap trades in 2006.

These players have been major protection sellers in a massive web of credit default swaps, and when the “protection” goes, the whole fragile derivative pyramid will go with it. The collapse of the derivative monster thus appears to be both imminent and inevitable, but that fact need not be cause for despair. The $681 trillion derivatives trade is the last supersized bubble in a 300-year Ponzi scheme, one that has now taken over the entire monetary system. The nation’s wealth has been drained into private vaults, leaving scarcity in its wake. It is a corrupt system, and change is long overdue. Major crises are major opportunities for change.

The Ponzi scheme that has gone bad is not just another misguided investment strategy. It is at the very heart of the banking business, the thing that has propped it up over the course of three centuries. A Ponzi scheme is a form of pyramid scheme in which new investors must continually be sucked in at the bottom to support the investors at the top. In this case, new borrowers must continually be sucked in to support the creditors at the top. The Wall Street Ponzi scheme is built on “fractional reserve” lending, which allows banks to create “credit” (or “debt”) with accounting entries. Banks are now allowed to lend from 10 to 30 times their “reserves,” essentially counterfeiting the money they lend. Over 97 percent of the U.S. money supply (M3) has been created by banks in this way.

The problem is that banks create only the principal and not the interest necessary to pay back their loans, so new borrowers must continually be found to take out new loans just to create enough “money” (or “credit”) to service the old loans composing the money supply. The scramble to find new debtors has now gone on for over 300 years - ever since the founding of the Bank of England in 1694 - until the whole world has become mired in debt to the bankers’ private money monopoly. The Ponzi scheme has finally reached its mathematical limits: we are “all borrowed up.”

When the banks ran out of creditworthy borrowers, they had to turn to uncreditworthy “subprime” borrowers; and to avoid losses from default, they moved these risky mortgages off their books by bundling them into “securities” and selling them to investors. To induce investors to buy, these securities were then “insured” with credit default swaps. But the housing bubble itself was another Ponzi scheme, and eventually there were no more borrowers to be sucked in at the bottom who could afford the ever-inflating home prices. When the subprime borrowers quit paying, the investors quit buying mortgage-backed securities. 

The banks were then left holding their own suspect paper; and without triple-A ratings, there is little chance that buyers for this “junk” will be found. The crisis is not, however, in the economy itself, which is fundamentally sound - or would be with a proper credit system to oil the wheels of production. The crisis is in the banking system, which can no longer cover up the shell game it has played for three centuries with other people’s money.

The latest jolt to the massive derivatives edifice came with the collapse of Bear Stearns on March 16, 2008. Bear Stearns helped fuel the explosive growth in the credit derivative market, where banks, hedge funds and other investors have engaged in $45 trillion worth of bets on the credit-worthiness of companies and countries. Before it collapsed, Bear was the counterparty to $13 trillion in derivative trades. On March 14, 2008, Bear’s ratings were downgraded by Moody’s, a major rating agency; and on March 16, the brokerage was bought by JPMorgan for pennies on the dollar, a token buyout designed to avoid the legal complications of bankruptcy. 

The deal was backed by a $29 billion “non-recourse” loan from the Federal Reserve. “Non-recourse” meant that the Fed got only Bear’s shaky paper assets as collateral. If those proved to be worthless, JPM was off the hook. It was an unprecedented move, of questionable legality; but it was said to be justified because, as one headline put it, “Fed’s Rescue of Bear Halted Derivatives Chernobyl.” The notion either that Bear was “rescued” or that the Chernobyl was halted, however, was grossly misleading. The CEOs managed to salvage their enormous bonuses, but it was a “bailout” only for JPM and Bear’s creditors. For the shareholders, it was a wipeout. Their stock initially dropped from $156 to $2, and 30 percent of it was held by the employees. Another big chunk was held by the pension funds of teachers and other public servants. 

The share price was later raised to $10 a share in response to shareholder outrage, but the shareholders were still essentially wiped out; and the fact that one Wall Street bank had to be fed to the lions to rescue the others hardly inspires a feeling of confidence. Neutron bombs are not so easily contained.

The Bear Stearns hit from the derivatives iceberg followed an earlier one in January, when global markets took their worst tumble since September 11, 2001. Commentators were asking if this was “the big one” - a 1929-style crash; and it probably would have been if deft market manipulations had not swiftly covered over the approaching catastrophe. The precipitous drop was blamed on the threat of downgrades in the ratings of two major monoline insurers, Ambac and MBIA, followed by a $7.2 billion loss in derivative trades by Societe Generale, France’s second-largest bank. Like Bear Stearns, the monolines serve as counterparties in a web of credit default swaps, and a downgrade in their ratings would jeopardize the whole shaky derivatives edifice. 

Without the monoline insurers’ triple-A seal, billions of dollars worth of triple-A investments would revert to junk bonds. Many institutional investors (pension funds, municipal governments and the like) have a fiduciary duty to invest in only the “safest” triple-A bonds. Downgraded bonds therefore get dumped on the market, jeopardizing the banks that are still holding billions of dollars worth of these bonds. The downgrade of Ambac in January signaled a simultaneous downgrade of bonds from over 100,000 municipalities and institutions, totaling more than $500 billion.

Institutional investors have lost a good deal of money in all this, but the real calamity is to the banks. The institutional investors that formerly bought mortgage-backed bonds stopped buying them in 2007, when the housing market slumped. But the big investment houses that were selling them have billions’ worth left on their books, and it is these banks that particularly stand to lose as the derivative Chernobyl implodes.4

Now that some highly leveraged banks and hedge funds have had to lay their cards on the table and expose their worthless hands, these avid free marketers are crying out for government intervention to save them from monumental losses, while preserving the monumental gains raked in when their bluff was still good. In response to their pleas, the men behind the curtain have scrambled to devise various bailout schemes; but the schemes have been bandaids at best. To bail out a $681 trillion derivative scheme with taxpayer money is obviously impossible. 

As Michael Panzer observed on As the slow-motion train wreck in our financial system continues to unfold, there are going to be plenty of ill-conceived rescue attempts and dubious turnaround plans, as well as propagandizing, dissembling and scheming by banks, regulators and politicians. This is all happening in an effort to try and buy time or to figure out how the losses can be dumped onto the lap of some patsy (e.g., the taxpayer).

The idea seems to be to keep the violins playing while the Big Money Boys slip into the mist and man the lifeboats. As was pointed out in a blog called “Jesse’s Café Americain” concerning the bailout of Ambac:
It seems that the real heart of the problem is that AMBAC was being used as a “cover” by the banks which originated these bundles of mortgages to get their mispriced ratings. Now that the mortgages are failing and the banks are stuck with them, AMBAC cannot possibly pay, they cannot cover the debt. And the banks don’t wish to mark these CDOs [collateralized debt obligations] to market [downgrade them to their real market value] because they are probably at best worth 60 cents on the dollar, but are being held by the banks on balance at roughly par. That’s a 40 percent haircut on enough debt to sink every bank involved in this situation . . . . Indeed for all intents and purposes if marked to market banks are now insolvent. So, the banks will provide capital to AMBAC . . . [but] it’s just a game of passing money around. . . . So why are the banks engaging in this charade? This looks like an attempt to extend the payouts on a vast Ponzi scheme gone bad that is starting to collapse . . . .

The banks will therefore no doubt be looking for one bailout after another from the only pocket deeper than their own, the U.S. government’s. But if the federal government acquiesces, it too could be dragged into the voracious debt cyclone of the mortgage mess. The federal government’s triple A rating is already in jeopardy, due to its gargantuan $9 trillion debt. Before the government agrees to bail out the banks, it should insist on some adequate quid pro quo. In England, the government agreed to bail out bankrupt mortgage bank Northern Rock, but only in return for the bank’s stock. On March 31, 2008, The London Daily Telegraph reported that Federal Reserve strategists were eyeing the nationalizations that saved Norway, Sweden and Finland from a banking crisis from 1991 to 1993. In Norway, according to one Norwegian adviser, “The law was amended so that we could take 100 percent control of any bank where its equity had fallen below zero.”6 If their assets were “marked to market,” some major Wall Street banks could already be in that category.

Nationalization has traditionally had a bad name in the United States, but it could be an attractive alternative for the American people and our representative government as well. Turning bankrupt Wall Street banks into public institutions might allow the government to get out of the debt cyclone by undoing what got us into it. Instead of robbing Peter to pay Paul, flapping around in a sea of debt trying to stay afloat by creating more debt, the government could address the problem at its source: it could restore the right to create money to Congress, the public body to which that solemn duty was delegated under the Constitution.

The most brilliant banking model in our national history was established in the first half of the eighteenth century, in Benjamin Franklin’s home province of Pennsylvania. The local government created its own bank, which issued money and lent it to farmers at a modest interest. The provincial government created enough extra money to cover the interest not created in the original loans, spending it into the economy on public services. The bank was publicly owned, and the bankers it employed were public servants. The interest generated on its loans was sufficient to fund the government without taxes; and because the newly issued money came back to the government, the result was not inflationary.

The Pennsylvania banking scheme was a sensible and highly workable system that was a product of American ingenuity but that never got a chance to prove itself after the colonies became a nation. It was an ironic twist, since according to Benjamin Franklin and others, restoring the power to create their own currency was a chief reason the colonists fought for independence. The bankers’ money-creating machine has had two centuries of empirical testing and has proven to be a failure. It is time the sovereign right to create money is taken from a private banking elite and restored to the American people to whom it properly belongs.


Anonymous said...

Close to home - what's the situation in Canada?
It seems that we have $460B in debt, and $390B of it is foreign held. So that's something like $12,000 per person in Canada.
One would think (I is an engineer, not an economist) that if Canadians held their own debt that the whiplash that Argentina and Iceland faced could not happen.
Which makes me wonder. If $390B of our debt is held by foreigners, then how much foreign debt do Canadians, and their companies hold?

CIBC is rumored to be close to the edge. How does one determine which banks are fit? I use Citizens Bank (and TD) and Citizens back is west coast based where they are going to deal with bubbled home prices.

With the US Gov breaking so many rules and running roughshod over their constitution and the EU teetering; it makes one feel safe in Canada. Job losses, and bank collapses should be after the rest of the world. Perhaps distressed property sales (lots of Europeans have been buying up farm land in Ontario and sitting on it) will appear soon?

None are going quietly into this night. They're all driving by looking in the rearview mirror, trying to get back to where they were - not in the least considering long term sustainability (environmentally, energy-wise or financially).

Anonymous said...

Feed your inner doomer!

Taleb & Mandelbrot

Interesting! from Taiwan


Anonymous said...


Roubini:`Panic' May Force Market Shutdown

Consists of five parts, the last four are linked to in the "video responses".


Anonymous said...

Hello Stoneleigh,

Some questions following your comments on Denninger.

force GDP return on new debt below zero
Difficult concept. I understand that the new debt will no longer represent any benefit for GDP, that it will only worsen the debt situation. Yes/no?

I think we'll see yields spike and prices fall in the long end of the curve
Crucial point. Does it apply to Europe? How long would prices fall and stay down? What would be the sequence, i.e. telltale signs before prices fall? If the market survives, I assume the prices would rally sharply at some point.

For a holder of European long bonds, I see two possibilities.
1. Sell before prices fall, then buy back in if the market still exists.
2. Try to ride through the crisis if the low-price period is not too long (again assuming the market still exists).

Do these scenarii strike you as naïve?

Thanks so much,

Unknown said...

As long as Canada's debt is in their own currency, they can always print more. What gets countries in trouble is borrowing in a foreign currency.

el gallinazo said...

Right Robert,

Look ay Zimbabwe. Good thing that their debt is in their own currency. They are very good at printing but got cut off from their paper supplier in Germany.

Unknown said...

Zimbabwe does have debts in foreign currency. They stopped paying anything on their debt in 2004. Borrowing in a foreign currency isn't the only way a country can get into trouble.

The Lizard said...

Just a quick comment on Alan Greenspan:


Anonymous said...

"With the US Gov breaking so many rules and running roughshod over their constitution and the EU teetering; it makes one feel safe in Canada. "

Don't forget about that angry, emasculated population south of your nigh-on undefended land border, who are well-versed in the useage of things that go bang. ;) :(

Anonymous said...


Just a quick comment on Alan Greenspan:



What is it with the "who, me?" stuff. His wife is a big time newscaster too who can shape the way all this gets sold to the public. I am sure there are more power couples like that around, no?

. said...

Ilargi - are you sure about the OPEC cut? Have they even had time to adapt to the doubling in oil prices or where they just squirreling it away, knowing it would drop eventually?

el gallinazo said...

"With the US Gov breaking so many rules and running roughshod over their constitution and the EU teetering; it makes one feel safe in Canada. "

I wouldn't feel too safe. Harper is just another Bush, but with an IQ over 85 which makes him all the more dangerous. He put in for early elections because he knew he couldn't be elected dogcatcher of Moosejaw next year, and wanted to be around as BM so he could help his bankster buddies steal your treasury when the time was ripe.

scandia said...

thehangman...Waterboarding! Love it! surely tops washing out his lying mouth with soap!

el pollo, I share your analysis of the recent Cdn election. Most people's suspicions focused on the political integretion of the US and Canada. I was following the money as any automatic earthling would.

Aha-a..In the Reuter's China article, "...Baroso dangled the carrot of greater influence for Beijing on the world financial stage." I recall that some time ago Ilargi pointed out that China's agenda is long term and not primarily about the money, that China's interest is in acquiring power/influence.

Anonymous said...

Can you get delivery of gold?
John Embry has made good calls in the past. Check out his article.

Farmerod said...

The fear index almost broke 100 today. For comparison, it shot up to the high 30's after 9/11. For fun, click on "max". I don't think I've ever seen a graph go so close to vertical. And today's 96 isn't even depicted because it ended up closing below 70.

Anonymous said...

Jal, if you live in Canada you can buy gold and take immediate physical possession from ScotiaBank.

In Calgary you can go to the gold window at the ScotiaBank Main Branch downtown, taking a letter of introduction from your own Bank if you are not a ScotiaBank customer. The letter has to be in the exact format required by ScotiaBank, and should show the approximate value of gold you wish to purchase and be dated and signed by your bank's manager, or your account manager.

You will need to take a bank draft or certified cheque payable to Bank of Nova Scotia in the approximate amount (allow for a bit more in case the price changes). If you buy bars or mini-bars, you don't have to pay sales tax, but I think you may have to pay GST and/or sales tax.

Be prepared for significant swings in cost due to volatility in gold price and C$/US$ exchange rate. They will give you a quote at the window which is valid for 30 seconds only, so be prepared.

Make sure to bring one or two large friends with you if you are going to carry more than a few thousand dollars worth out of the Branch. Keep your sales receipt, or you won't be able to sell the gold back to ScotiaBank. You may wish to rent a safe deposit box within the same branch for storage.

A one kilogram bar isn't very large, and will cost you around C$30,000. One ounce mini-bars cost around C$900 each


bluebird said...

Stoneleigh or Ilargi: Can you comment on Karl Denninger's latest essays. Several essays are pointed to in this one link.

Here people discuss Naked Shorting of US Treasuries

Anonymous said...

Limit down S&P 500, Dow and Nasadaq Futures.

Bigelow said...

“Absent something extraordinary, we are going to crash this morning in the stock market.
For real.
No, what you saw earlier this month wasn't a crash.
This is a crash.
I expect some sort of intervention will be attempted. It won't work for long, if at all.
I need a drink, and its 5:30 in the morning.”
One Sentence This Morning Denninger

bluebird said...

What is Denninger trying to tell us?
That the government was 'borrowing' from our Treasuries to keep from crashing?

So whether we have Treasuries in a mutual fund, or have purchased Treasuries directly, we are screwed? So that would mean that a CD at a bank is screwed too as there is nothing left of the government to back the CDs? So that means everything is screwed...stocks, bonds, CDs, T-bills, bonds, notes? Nothing is safe?

Is that what Denninger is trying to tell us?

Anonymous said...

Pre-Market Trading Halted as Global Markets Slide

Maybe markets will have a bank holiday today?

el gallinazo said...

I couldn't understand a lot of the "technical" stuff Denniger was writing about Wednesday vis-a-vis bonds, but I think the gist of what he is saying is:

a) if the treasury tries to insure everything, it will result in the loss of AAA status of everything including treasuries.

b) when interest rates start to climb much higher, there may be doubt whether the treasury receipts in a dead economy will be able to pay the interest on the new, grossly inflated debt.

c) no brainer. Every progressive social program will be abandoned to preserve the solvency of the treasury and prevent a default. So the scumbags have in the end succeeded in privatizing Social Security by looting the treasury into the banks to the point that SS must collapse. Same result.

With the collapse of the economy and reduced payroll receipts, the start of the conversion of treasuries held by the SSA, projected to begin several years from now, will be necessary within a matter of months. I turned 62 last August and put in immediately for my 80% benefits. I was figuring on getting two years of checks to stuff in my mattress but I may be looking at a few months. Supposed to get my first check in November.

Anonymous said...

"... if you live in Canada you can buy gold and take immediate physical possession from ScotiaBank..."

I guess Canadians are better off than most.

"... c) no brainer. Every progressive social program will be abandoned to preserve the solvency of the treasury and prevent a default. So the scumbags have in the end succeeded in privatizing Social Security by looting the treasury into the banks to the point that SS must collapse. Same result. ..."

Before that happens, the gov. want to have "make work projects" to stimulate the economy.


Stoneleigh said...

Bigelow and OC,

I would call what we're heading for a fear-driven spike low - the culmination of the cascade that we've seen unfold over the last few weeks. As OC points out, watching fear develop is instructive, as such cathartic emotional peaks, or sentiment extremes, often mark the end of a move in one direction. We may well see a wash-out prior to a lasting rally, and my guess is that it will take out the October 2002 low (at least).

You could say that it's always darkest before the dawn, although in this case it will be very much a false dawn as the coming bottom isn't likely to last for long (my guess is perhaps a couple of months). There will be many false dawns on the long road down, and some are likely to be significantly larger affairs than this one. For instance, during the Great Depression there were large downward moves (interspersed with rallies) from 1929-1933 and 1937-1942 with an intervening larger partial recovery, but the whole period was one larger bear market (that lead to war, as Nouriel Roubini points out).

Bear markets, especially ones on this scale, are times of extreme volatility propelled in both directions by extreme emotions (and very little, if any, rationality). The important thing to remember is that we are still very much closer to a top than to a lasting bottom, and when we finally hit such a bottom, the market will be a pale shadow its former self (I would think DJIA less than 1000 by the end of 2010 and less than 500 by the middle of the next decade). Needless to say, this is not the time to hold equities - any equities at all.

el gallinazo said...


"Before that happens, the gov. want to have "make work projects" to stimulate the economy."

Is the government going to print the money or borrow the money to do this?

scandia said...

Whew! I feel the herd's fear, feeling my own fear....Crash as headline may enable a postponement of the US election?
Time to hold steady,check arrangements made, accelerate other plans...

Anonymous said...

@ Scandia

RE: election postponement

Y'know, at one time i thought the Bushies would try to orchestrate some something-or-other as a way to maintain 'power'...but with all that's been happening over the past 60-90 days, I am beginning to think more along the lines of the Bush/Cheney gang wanting OUT of D.C. ASAP. I mean...fighting the "war on terror" seems downright passe and pedestrian at this point.

Anonymous said...

Look, this is not a theory, its official, but somehow nobody noticed.

The United States, Canada and Mexico would be reorganized into the North American Union with a new currency called the Amero.

The Amero would then replace the USD, Canadian Dollar and Mexican Peso.

This would be completed by 2011,
according to the law signed in 2005 by the three presidents.

Someone please confirm this information, the fact that this agreement exists between the three nations to form such a North American Union with a new currency.

I believe Lou Dobbs was briefly reporting on this sometime in 2006

Can this now be implemented, if/when the US defaults on its debt?

Or perhaps this Amero plan is now no longer valid, and a new global currency will be created instead.

However, the North America Union will be created, as it provides strategic economic and military
benefits for the former US, its the only way it can survive.

Anonymous said...

This post was excellent and seemed to put some of the missing puzzle pieces together.
Roubini refers to the very real possibility of a war at the end of this bear market. I am understanding correctly that this is to again stimulate the economy as war creates new debt.

The Lizard said...

"This would be completed by 2011,
according to the law signed in 2005 by the three presidents."

Dear anon truthsayer:

Canada does not HAVE a "President".

Scram, dude.

Anonymous said...

So far the usual volatile day, but nothing huge - think it is going to swan dive this afternoon?

Anonymous said...

So whether we have Treasuries in a mutual fund, or have purchased Treasuries directly, we are screwed? So that would mean that a CD at a bank is screwed too as there is nothing left of the government to back the CDs? So that means everything is screwed...stocks, bonds, CDs, T-bills, bonds, notes? Nothing is safe?

This is what some of us have been saying for a while now.

Look, the present value of the dollar is mostly a sideshow. What we need to be paying attention to is the bond market/treasuries, which are beginning to unravel. They will take the dollar down with them. It happened in Argentina. It happened in Iceland. To think it can't happen here in America is foolish, particularly in light of the insane levels of debt that will never be paid back.

I'll repeat what I said earlier: Stoneleigh and Ilargi refuse to acknowledge that we can have, simultaneously, a deflationary spiral and the destruction of the dollar.

They have done a admirable job reporting the deflation, which is unimaginably massive. However, this appears to have blinded them to the imminent destruction of the dollar.

What a shame it will be, to those who foresaw this coming, when their wealth evaporates into ether. All because they naively believed that 'cash was king' and that 'short-term treasuries were practically infallible'.

Anonymous said...

@ Newbie re: 'crash'

all of the 30 components are down, but only BoA and GM are getting hammered. I don't think we'll see a DOW crash today, as most of the 30 are holding their own...somewhat. WHY is this? Probably a number of variable, including a smattering of fraud.

Ilargi said...

"However, this appears to have blinded them to the imminent destruction of the dollar."

Go fuck a duck, nitwitdrillbit.

Anonymous said...

Could somebody tell me how all three major index futures could be limited down hours before the start of the trading day, yet nothing is down more than 3% so far? Something really smells here... Anyone else think part of that $700B got dipped into this morning?

And if that happened, what do you think the changes are that we'll be told about it before the election?

Stoneleigh said...

Anon @1:27,

Markets are very volatile right now - strongly down , then up, then sideways etc. We could yet see a larger fall before the end of the day, or tomorrow. This is simply what people do when they have no real information are are looking for direction (ie a passing bandwagon to jump on). I still think we'll see new lows for this move by the end of the month. A rally is coming though.

Stoneleigh said...

Anon @12:56,

I'll repeat what I said earlier: Stoneleigh and Ilargi refuse to acknowledge that we can have, simultaneously, a deflationary spiral and the destruction of the dollar.

They have done a admirable job reporting the deflation, which is unimaginably massive. However, this appears to have blinded them to the imminent destruction of the dollar.

We've been round this loop with you before, and in great depth. We do think the dollar will eventually tank, but not now. For now it's upward move isn't over, although we may well see a counter-trend pullback coincident with a coming stock rally before the ascent resumes.

The main point, however, is that the value of the dollar against other currencies internationally is less important than its value domestically in comparison with available goods and services. The same is true of other currencies.

What a shame it will be, to those who foresaw this coming, when their wealth evaporates into ether. All because they naively believed that 'cash was king' and that 'short-term treasuries were practically infallible'.

Cash will be king for quite a while yet, and short-term treasuries are a far safer bet in an unsafe world than most options. Eventually people will need to move into hard assets, but that time is not now. For now you need liquidity.

Stoneleigh said...

So far the stock decline has lead to a flight to safety into US long bonds, which has increased prices and dropped yields. That move probably isn't quite over yet (for the time being), but should reverse with the coming stock rally. I'm not really with Karl Denninger, who thinks that it'll be a definitive move in that direction now (ie a break-the-back-of-the-treasury-bond-market kind of move), but I do think we'll see a trend reversal, and quite possibly a sharp one into the end of the year. I think the definitve move that could lead to debt default comes later though.

The ebb and flow of liquidity, as we see sharp falls and rises driven by sentiment swings, has tended to make groups of trends unfold in sync. Stock falls tend to go with higher demand for treasuries (ie rising bond prices and falling yields), a rising US dollar (ie flight to safety), falling Canadian dollar, and falling commodity prices (part of the reason for the falling Canadian dollar), among other things. Stock rallies should be accompanied by the opposite.

Next year may well see a bigger move in treasury yields - Karl's scenario where interest rates shoot up into double digits.