Thursday, October 30, 2008

Debt Rattle, October 30 2008: Swamps and Swaps

Lewis Wickes Hine Ethel June 1911.
Ethel Shumate has rolled cigarettes in Danville, VA, factory for six months.
Says she's 13 years old, but looks much younger.

Ilargi: The US is now 'officially' on the edge of a recession, This looks very much like another way of saying the government gave up on trying the cook the books and massage the numbers. Five days before the election, why should they try any longer? From now on, it'll be someone else’s fault. And if, after November 4, the new messiah doth protest, just flip 'em the one-fingered W. bird.

I think we'll see a fierce competition between real and made-up accounting in the weeks and months to come. It'l be hilarious. Promise.

The EU, Japan, Canada and likely others have already passed acts to suspend or abolish mark-to-market valuations on tons of asset classes. The argumentation is that, today, a fair value cannot be assigned to these assets, and that once the economy rebounds they'll be soaring towards heaven.

There are several problems with this approach, the main one being that it makes it impossible for trust and confidence to return to the markets. And that, as everyone agrees, is the no.1 problem in those markets. There is therefore a conscious effort going on to not solve the no.1 problem. Think about that.

In the US, accountants are pushing very hard for the real thing: fair-value, mark-to-market valuation. The Financial Accounting Standards Board, FASB, is still on track to introduce stricter regulations.

The reason accountants want this so much is that recent legislation has made them personally responsible -at least far more than before- for the corporate balance sheets they sign off on. They risk being called to task for their clients’ lies.

Meanwhile, the banks and their main lobbyists, the American Bankers Association, are clamoring as loud as they can to have the US follow the other countries’ examples, and suspend any and all new and stronger rules.

However, as we see today, and this is where it gets hilarious, these same banks are at the same time looking for ways to impose the same sort of fair-value accounting on their corporate clients.

Now, we all know that the credit rating agencies have for years supplied extremely questionable and often manipulated valuations for both companies and their assets. But there is an alternative out there, one that is truly a product of the market, rather than of bribes and manipulation.

Credit default swaps are used to bet against -or in favor of- a company’s value. If traders think the numbers published don't add up, they'll say so with their money. In a world replete with moonlight-and-roses statements built in a swamp of slippery quicksand, they are a formidable instrument for truth-finding. Not perfect, but -much- better than the alternatives.

Still, we run face first into the next painful wailing wall, of course, if we, first, allow the banks not to tell us what their assets are worth, and, second, allow them to force their clients to do the opposite.

Pumping in a trillion dollars left and right makes bankers richer -and taxpayers poorer-. It does nothing to heal, repair or restore the most important issue: trust. And that means it's utter madness to hand out those trillions without simultaneously requiring that all assets are being laid out face up on the crap table.

There is an additional problem: the values of the collateral, like real estate, which the assets in question are based on, are falling rapidly. So the securities and derivatives, if they still had any value left, will be worth less tomorrow than they were today. Not more, as the owners are so desperate to pretend.

For the bankers' clients, the results can be disastrous: if traders drive up the spread of swaps on your firm, your interest payments can go through the roof overnight.

I look at this and think again: the center cannot hold. You cannot lie your way to the truth.

US economy contracts 0.3%, consumer spending down 3.1 %
The U.S. economy shrank at a 0.3 percent annual rate in the third quarter, its sharpest contraction in seven years as consumers cut spending and businesses reduced investment in the face of rising fears that recession was setting in.

The Commerce Department said the third-quarter contraction in gross domestic product was the steepest since the corresponding quarter in 2001 though it was slightly less than the 0.5 percent rate of reduction that Wall Street economists surveyed by Reuters had forecast.

The third-quarter contraction was a striking turnaround from the second quarter's relatively brisk 2.8 percent rate of growth. It occurred when financial market turmoil that has heightened concerns about a potentially lengthy U.S. recession. Consumer spending, which fuels two-thirds of U.S. economic growth, fell at a 3.1 percent rate in the third quarter - the first cut in quarterly spending since the closing quarter of 1991 and the biggest since the second quarter of 1980. Spending on nondurable goods - items like food and paper products - dropped at the sharpest rate since late 1950.

Continuing job losses coupled with declining gains from stocks and other investments have put consumers under severe stress. The GDP report showed that disposable personal income dropped at an 8.7 percent rate in the third quarter - the steepest since quarterly records on this component were started in 1947 -- after rising 11.9 percent in the second quarter when most of economic stimulus payments still were flowing.

Consumers cut spending on durable goods like cars and furniture at a 14.1 percent annual rate in the third quarter, the biggest cut in this category of spending since the beginning of 1987. Car dealers have said that sales have virtually stalled, in part because tight credit makes it hard for even creditworthy buyers to get loans.

Businesses also were clearly wary about the future, cutting investments at a 1 percent rate after boosting them 2.5 percent in the second quarter. It was the first reduction in business investment since the end of 2006. Inventories of unsold goods backed up at a $38.5-billion rate in the third quarter after rising $50.6 billion in the second quarter.

Bailout scope limited to ... virtually anything
Treasury acknowledges law is so vague almost any company could qualify

As the list of ailing companies seeking government help grows, it is anybody's guess where the Treasury Department's largesse will stop. The $700 billion bailout bill is so vague that virtually any U.S. company could be eligible for government help. While the capital infusions announced this month will be directed only to banks, Treasury spokeswoman Brookly McLaughlin confirmed the law allows the department to create other rescue programs "open to a broader set of financial institutions."

As the bill is written, "financial institutions" don't have to be banks or financial entities. In theory, any company could declare itself a financial institution and ask Treasury to grant it temporary aid if its rescue is deemed "necessary to promote financial market stability." Critics said Congress should have set a clearer definition for the kinds of companies that could be rescued.

"Talk about the barn doors being left open — it's like they left off the walls and roof, too," said Bert Ely, an independent banking consultant. He suggested that under the bill, an airline could transfer future revenue streams into a subsidiary and ask the government to buy shares in that new "financial institution." The only limit to what Treasury could do, Ely said, is the bill's $700 billion ceiling.

Representatives of the auto, insurance and other industries are already seeking government help, indicating they think they qualify because of their financing units. But McLaughlin's statement suggests that even companies without financing operations could qualify as well. No company outside of banking, insurance or auto manufacturing has yet said it will ask for aid from the bailout. But airlines and home builders are lobbying for government help to prop them up through the economic downturn — either under the bailout bill or some other legislation. And if insurance and auto lobbyists succeed in their efforts to tap the bailout money, experts said other industries would probably follow.

"Home builders employ a lot of people, and they're probably in crisis mode," said Tom Runiewicz, an industrial economist at consulting firm Global Insight. "If the auto sector is in line for funding, why not the home builders?" Dave Seiders, chief economist for the National Association of Home Builders, said his group is more likely to focus on a proposed new stimulus package that congressional Democrats are pushing. But he stressed that "the housing sector is still at the core of the economy's difficulty and the financial market's stability" and so might qualify for part of the $700 billion.

In fact, the modern economy is so interconnected that virtually any business could argue for its importance to the broader markets, agreed Daniel Meckstroth, chief economist with the Manufacturers Alliance, an industry group. "The trouble is, you're picking and choosing. You're deciding who's going to win and who's going to lose," Meckstroth said. "It's kind of like applying this 'too big to fail' doctrine to the private sector, and it's not fair." "Too big to fail" is how federal officials justified decisions earlier this year to bail out mortgage giants Fannie Mae and Freddie Mac and insurer American International Group Inc.

Treasury's McLaughlin would not rule out the possibility that nonfinancial companies could benefit from the law's ambiguity, and she would not say whether any such discussions have been held. A spokesman for the House Financial Services Committee, which helped draft the legislation, agreed that the loose definitions in the bill could open the door to nonfinancial companies lining up for aid. "The language is certainly broad," said spokesman Steven Adamske. "We did not set this up so we would have the opportunity to micromanage what they are doing. We need to provide broad policy oversight."

Scott Lilly, a longtime House staffer and senior fellow with the left-leaning Center for American Progress, said Treasury's broad reading makes congressional oversight even more important. "If they're going to assume that the language provides them with that kind of latitude, they need to go back and have that conversation with Congress and get consensus on that fact," Lilly said. Norman Ornstein, resident scholar at the American Enterprise Institute, said Treasury is not bound by "fixed rules" in implementing its bailout programs. He said the key will be whether companies can persuade Treasury officials that their failure would lead to "severe dislocation" in employment or other economic fundamentals.

If Treasury spurns overtures from bailout-thirsty industries, he said, many industries might seek government support as part of a future stimulus package. "Every one of those industries that gets rejected by the Treasury is going to come back to Congress unless things are booming for them, but I'm not sure every one of those industries is going to get the relief they want," Ornstein said.

Deutsche Bank kicks off funny accounting season
Welcome to the world of make-believe.

Deutsche Bank was supposed to report a loss in the third quarter. That would be no great shame or shock as banks across the globe have been hammered at a time of worldwide economic turmoil. And Deutsche Bank, alone of the firms with a major presence on Wall Street, hasn't needed a capital infusion from investors during the credit crisis. But the Frankfurt giant managed to turn a third-quarter profit of $575 million, and that's because it took advantage of a new European Union accounting change.

Deutsche Bank was able to shift 825 million euros, or roughly $1.1 billion, in assets before tax to its loan book from its trading book -- meaning that it doesn't have to take a write-off on the mark-to-market value of those securities, whatever they were. Certainly, Deutsche Bank shouldn't be criticized for doing so. They weren't just taking advantage of some loophole -- the rule change was actively designed for banks to shift assets around.

And lest the Europeans come in for a barrage of criticism, it's worth noting that many want the Financial Accounting Standards Board and the Securities and Exchange Commission to adopt a similar stance. The Europeans have already adopted the tougher, Basel 2 capital adequacy rules, which the U.S. regulators have batted away thus far. To its credit, Deutsche Bank made clear the amount of assets being shifted around -- it even included a slide in its presentation showing the difference between its assets under international and U.S. accounting standards.

As it's pointed out, Deutsche Bank has not used another accounting trick, of taking write-ups on the decline in value of its own debt, as much as peers have. But the "new" accounting from Deutsche Bank, and what its peers will likely copy, will further erode whatever little confidence is left in the accounting standards of financials. After all, others may not choose to go through the painful reconciliations between old and new rules that Deutsche Bank has done. The German lender itself is under no obligation to do so in the future.

The myopic world of bank accounting is getting even murkier.

Investors, accountants battle it out with bankers over mark-to-market accounting
Investors locked horns with the banking industry on Wednesday on whether U.S. regulators should suspend or change accounting rules used to value assets such as mortgage-backed securities. Fair value accounting has been blamed for billions of dollars in write-downs by some U.S. banks and policymakers. But investors and accountants say the approach gives investors a clearer window into banks’ balance sheets.

The U.S. Securities and Exchange Commission was charged by Congress to produce a study by early 2009 analyzing the effects of fair value accounting rules on financial firms’ balance sheets and examining alternative accounting standards. The SEC held a public meeting on Wednesday to gather information on mark-to-market accounting. Charles Maimbourg, senior vice president of KeyCorp, told the SEC that what management intends to do with an asset should help determine the fair value of the asset. “You have to include management intent. They have opinions, they are in the best position to do that,” Mr. Maimbourg said.

As Financial Week, reported yesterday, Mr. Maimbourg said that Key Bank passed on a possible acquisition earlier in the year due to FAS 157 and FAS 141R, which governs fair-value accounting in mergers and acquisitions. He said write-downs on some of the potential target’s loans would have hurt Key Bank’s balance sheet, forcing it to come up with more cash to meet capital adequacy requirements. “There are loans that banks hold and intend to hold,” said Mr. Maimbourg. “The fact that the market will only pay us 20 cents ... (is not) a reason to mark it down to 20 cents on the dollar.”

Patrick Finnegan, a director at CFA Institute, disagreed and said allowing management intent to influence the value of an asset was an “insidious” idea. “We should let all changes in net assets occur in the balance sheet,” he said. The SEC study was mandated under the government’s $700 financial services bailout law, which also lets the Treasury Department inject $250 billion into banks. Banks will exchange preferred stock and warrants for the government funds.

So far, Treasury has infused $125 billion of capital into the nine largest banks and allocated more than $33 billion to smaller banks, including KeyCorp. William Isaac, former Federal Deposit Insurance Corp chairman, said the mark to market accounting rules were negating the effect of the capital injections. “We have one hand of government handing out cash,” Mr. Isaac said. “And just as fast ... the SEC and (FASB) is destroying it.”

Scott Evans, executive vice president with pension fund TIAA-Cref, and Vincent Colman, partner at PricewaterhouseCoopers, defended fair value accounting rules as a way to provide transparency for investors. Separately, Rep. Barney Frank, the chairman of the House Financial Services Committee, said that he favors more flexibility in applying the way companies value assets. Frank and other lawmakers plan to propose broad financial services regulatory reforms in 2009.


Japan, Germany unveil plans to jumpstart their economies
Japan and Germany said on Thursday they would plow billions of dollars into their economies, hoping to provide a cushion against a deep recession and complement a series of expected interest rates cuts. Japan, the world’s second biggest economy, unveiled a 5 trillion yen ($51 billion) package of spending measures to support its economy and Germany planned a range of steps worth up to 25 billion euros ($32 billion) to boost business.

“A harsh storm seen only once in 100 years is raging,” Japanese Prime Minister Taro Aso told a news conference. “Under such circumstances, I am certain that what is most important is to remove uncertainties from the lives of people. A leading member of Germany’s ruling Social Democrats (SPD) told a newspaper that the government planned to introduce a range of steps to bolster the economy next week. “All together we are talking about a volume of perhaps 20 billion euros to 25 billion euros,” Peter Struck, parliamentary floor leader of the SPD, which shares power with Chancellor Angela Merkel’s conservatives, told the Berliner Zeitung.

The package will include support for car makers and building renovation as well as tax breaks enabling companies to write off a share of their investments, German newspapers reported. Governments are desperate to put measures in place to protect their economies against recession, which euro zone statistics suggested had hit much of Europe. Economic sentiment in the 15-nation currency bloc plunged to its lowest level since 1993 in October, official data showed.

“These are very bad. It’s a clear signal the euro area is in recession,” said Christoph Weil at Commerzbank. U.S. data later on Thursday is expected to show the world’s biggest economy shrank in the July-to-September quarter. Poor corporate earnings and forecasts for 2009 supported the view that the downturn would be long-lasting. Britain’s WPP Group, the world’s second-largest advertising firm, said 2009 would be very tough after reporting third-quarter figures in line with expectations.

In Asia, South Korea’s Hynix Semiconductor, the world’s No. 2 memory chip maker, reported its worst quarterly net loss in nearly 8 years, saying the future looks grim. And two of the largest U.S. auto parts makers, BorgWarner Inc and Tenneco Inc, said the economic crisis would mean more job cuts and plant closings. The International Monetary Fund said it was more worried by the slowdown than market volatility, adding it would propose a new regulatory strategy at next month’s meeting of the Group of 20 nations. “The IMF’s role as the coordinator of global regulation must be reaffirmed,” IMF chief Dominique Strauss-Kahn told French daily Le Monde.

He said the Fund’s resources were insufficient to meet requirements over the medium term. Countries have lined up to gain funds from the lender, with Turkey the latest to say it was continuing talks at a technical level on a possible precautionary stand-by agreement. Across the world, countries are using any means to make sure businesses do not fail. Russia’s state bank said it expected to pump around 5 billion rubles ($183.2 million) into the stock market, sending shares higher. The government disbursed around $3 billion to billionaire Mikhail Fridman’s Alfa Group and state oil major Rosneft to help finance their foreign debts, government and industry sources said.

On Wednesday, Russia’s richest man, Oleg Deripaska, became the first beneficiary of the rescue plan, when his flagship company secured a $4.5 billion loan needed to keep its stake in metals producer, Norilsk Nickel. Germany’s finance minister, Peer Steinbrueck, said he believed wage increases were both justifiable and right in the current economic climate. Four more of the world’s top central banks are forecast to have reduced interest rates by the end of next week.

Japan was expected, on Friday, to follow the United States and China and cut rates, with the European Central Bank, Britain and Australia doing the same next week. Hungary, Taiwan, Hong Kong, Norway and a number of Gulf states have already done so. The United States cut interest rates to 1% on Wednesday to try to kickstart its economy. The rate cuts and a U.S. move to offer funds to Brazil, Mexico, South Korea and Singapore via four new currency swap lines worth $30 billion spurred Asian markets. Japan’s benchmark Nikkei average index closed up 10%, a third straight day of gains. European shares gained 2%.

U.S. Treasury Program Shuns Banks That Need Cash Most
The U.S. government's $160 billion handout to banks from Niagara Falls to Beverly Hills is going mostly to lenders that need it least, putting weaker rivals at risk of being shut down or taken over, analysts say. "This has the unintended effect of making the strong stronger and the weak weaker," said Gray Medlin, founder of Carson Medlin Co., a Raleigh, North Carolina, investment bank focused on banking deals. "Banks that are getting bad exams and are under intense pressure from regulators won't be successful in applying."

The government buying spree has so far targeted two dozen regional lenders. One, PNC Financial Services Group Inc., immediately bought a competitor, National City Corp. Another, Saigon National Bank, had almost four times the minimum level of capital before selling a $1.2 million stake. Treasury Secretary Henry Paulson is doling out cash to recapitalize lenders and jump-start takeovers. Besides PNC and Saigon National, regional lenders that have accepted government stakes in exchange for cash include SunTrust Banks Inc., Capital One Financial Corp. and KeyCorp.

They also include City National Corp., in Beverly Hills, and First Niagara Financial Group Inc., in upstate New York. "The goal with this over time is to drive consolidation," said Ron Farnsworth, chief financial officer of Umpqua Holdings Corp. in Portland, Oregon, which expects to sell a $246 million stake to the government. Takeovers, either independently or helped by the Federal Deposit Insurance Corp., are "definitely one of the opportunities we have," Farnsworth said.

House Minority Leader John A. Boehner, an Ohio Republican, today questioned the program, saying in a letter to Paulson that "funds made available under the economic rescue package should not be used to pay for bank acquisitions, raises, and executive bonuses." His letter came as House Speaker Nancy Pelosi, a California Democrat, and Majority Leader Harry Reid, a Nevada Democrat, told Paulson to restrict pay at firms that get government money.

Banks that haven't yet joined the government's Troubled Asset Relief Program, or TARP, include Colonial Bancgroup Inc., a Montgomery, Alabama-based lender that lost $71 million in the third quarter and had its credit rating reduced Oct. 27 to BBB-by Fitch Ratings, the lowest investment-grade rating. Colonial has a Tier 1 capital ratio of 10 percent, compared with the 6 percent level deemed "well-capitalized" by regulators. "I'd view their approval in the TARP as unlikely," said Adam Barkstrom, an analyst at Sterne Agee & Leach Inc. in Baltimore. "They have a high exposure to Florida residential construction loans and there is a perception that they have been dragging their feet in addressing their problems."

Colonial Chief Financial Officer Sarah Moore said the lender was "interested" in the funding, and that it could be eligible for as much as $570 million. Banks have until Nov. 14 to apply to the Treasury's program. Some lenders, including International Bancshares Corp., Trustmark Corp. and Park National Corp., have said they intend to apply for Treasury funds. IBC and Park National both said shareholders must vote to permit issuing preferred shares.

Of 60 banks followed by Sterne Agee, five may not qualify for government help, the firm said in a report yesterday. Four of those are in Alabama or Florida, states hurt by the housing- market meltdown. The government money "amounts to a sort of `seal of approval' from the Treasury," CreditSights Inc. analysts led by David Hendler wrote in a note Oct. 27. "Those struggling the most probably aren't going to participate," said Karen Dorway, president of BauerFinancial, a Coral Gables, Florida-based research firm that studies the financial health of banks. She included as examples Downey Financial Corp., BankUnited Financial Corp. and Vineyard National Bancorp.

All three are operating under regulatory enforcement orders, and Downey earlier this month reported its fifth consecutive quarterly loss, bringing the total to $680 million. Downey said on Sept. 5 it had until Oct. 20 to submit a long-term plan to the Office of Thrift Supervision. Elizabeth Stover, Downey's spokeswoman, said on Oct. 22 that the company wouldn't discuss the plan publicly. The government isn't forthcoming on explaining the purchase program because of concern it may spark bank runs, said Randy Dennis, president of DD&F Consulting, a Little Rock, Arkansas, firm that advises banks. "Banks that are left out will have to deal with the PR effect of not being included," he said.

Some lenders say the deal was too good to refuse. The preferred shares that banks are selling to the U.S. Treasury yield 5 percent annually for the first five years before increasing to 9 percent. "The program is so attractive that even though we have a fairly strong capital ratio, we just felt that it was an opportunity to get capital at a very attractive rate," said Roy Painter, chief financial officer at Saigon National, based in the Orange County, California, community of Westminster. "We're a small organization, we expect to grow, and we'll need the additional capital down the road." Being early to attract Treasury's attention is an advantage, Farnsworth said in an interview Oct. 28. "In the next few weeks, smaller banks are going to be reaching out to the FDIC saying, `Hey, we'd like some."'

Hedge funds lose $40 billion on VW shorts, blame German government
Hedge funds nursing multi-billion-dollar losses from a wrong-way bet on Volkswagen shares have launched a furious attack on the German financial authorities, branding their handling of Porsche’s move to control its rival as a "fiasco’’ and "criminally irresponsible’’. The backlash comes as it emerged a raft of the world’s top hedge funds have been caught out by the swings in VW’s share price in the past two days that are estimated to have cost the global sector €30bn (£23.7bn).

Some of the funds affected include London-based Odey Asset Management and Marshall Wace, as well as US giants including GreenLight Capital, SAC Capital, Perry Capital and Glenview. One fund said: “In any other country in the world, taking control of a company in secret and still not launching a bid would be illegal. We believe the reactions of the German regulators to be criminally irresponsible but we are confident that this will be sorted out.” Another said: “We are stunned by the unregulated nature of the German market. This is a complete fiasco. Forget buying a Porsche, traders around the world will simply avoid Germany after this.”

Yesterday, Germany’s financial regulator Bafin opened a formal investigation into possible market manipulation in Volkswagen’s shares after they first quadrupled and then nearly halved. Yesterday, Porsche tried to appease the fury by saying it would sell 5pc of VW to try to avoid “further market distortions” that had threatened the survival of some hedge funds. But managers argued that far more would be needed to end the chaos in the market.

On Sunday, Porsche revealed it had bought 31.5pc of VW cash-settled options from a group of investment banks. Added to its known holding of 42.6pc, the options handed Porsche control of 75pc of its bigger rival. The news prompted a huge scramble to cover short positions in VW, which had been the most shorted stock in Germany’s benchmark DAX index. Traders are thought to have bet an estimated 13pc of VW’s market value that the stock would fall.

Crispin Odey, founder of Odey Asset management, said in his most recent quarterly report to investors in his $1.25bn European fund, that it had a short exposure to automotive companies amounting to about 2pc of its portfolio including VW. GreenLight, the US fund run by David Einhorn, has also taken a loss. He shot to fame by apparently making £1.7bn profit on the Lehman Brothers collapse. Marshall Wace, the fund run by Paul Marshall and Ian Wace, released a statement saying they “made an immaterial loss” as a result of short exposure to VW.

VW’s shares, which had quadrupled on Monday and Tuesday fell 44pc yesterday to €518. In a statement headlined: “Short sellers responsible for extreme price movements in Volkswagen” Porsche said yesterday that it “denies all responsibility for these market distortions and for the resulting risks to which the short sellers have exposed themselves.”

Citigroup, Credit Suisse Link Loans to Swaps in Shift
Citigroup Inc. and Credit Suisse Group AG are among banks tying corporate loan rates to credit- default swaps, raising borrowing costs and exposing companies to derivatives accused of crippling the financial system. Nestle SA, the biggest food producer, Nokia Oyj, the largest mobile-phone maker, FirstEnergy Corp., the Ohio-based owner of electric utilities, and at least three other companies bowed to banks' demands to link the interest rate on credit lines to the swaps, which are used to bet on borrowers' likelihood of default.

Banks are toughening terms following $678 billion in writedowns and losses, rising funding costs and a jump in companies drawing on lines they'd already negotiated. Before markets seized up this year, most rates on $6 trillion of revolving loans were based on a borrower's debt rating and priced at an amount over the London interbank offered rate. "We want banks to be able to provide credit and liquidity to a company like ourselves and they're only going to be willing to do that if they feel it has market pricing built into it," Randy Scilla, FirstEnergy's assistant treasurer, said in a phone interview from Akron, Ohio.

Companies such as FirstEnergy may have little choice but to accept the new terms. Banks arranged $603 billion of loans in the U.S. this year through yesterday, down from $1.73 trillion in 2007, according to data compiled by Bloomberg. Even a plan by U.S. Treasury Secretary Henry Paulson to buy $250 billion of shares in financial companies as part of a global injection of $3 trillion into capital markets may not be enough to stem the lending decline. The inclusion of the swaps shows that banks are shifting away from setting loan pricing by relying on debt ratings and Libor, a benchmark rate that is set each day in London by tallying the cost of 16 banks to borrow from each other. Three- month Libor, the typical benchmark for loans, rose to 4.82 percent on Oct. 10, the highest this year, as markets froze.

The rate was set at 3.42 percent today. The move to swap-based pricing may leave companies exposed to fluctuations in instruments that aren't listed on government- regulated exchanges. "That's crazy," said Lynn Tilton, chief executive officer of $6 billion private-equity firm Patriarch Partners in New York, which loans or lends money to more than 70 companies. "This will accelerate the downward spiral of market prices and raise borrowing costs to unsustainable levels."

The default swaps were created so bondholders and banks could buy protection against a borrower's inability to repay debts. The market ballooned to more than $60 trillion in the last decade as investors used the instruments to bet on companies. The Securities and Exchange Commission is probing allegations trading helped create a panic that caused the collapse of Lehman Brothers Holdings Inc. FirstEnergy, with utilities in Ohio, Pennsylvania and New Jersey, agreed this month to link interest rates on a $300 million credit line to the cost of Libor as well as the sum of the spread on its default swaps and those of Credit Suisse, according to a regulatory filing.

Loans from the Zurich-based bank would require total interest payments of about 6 percentage points over Libor if the power company draws on the bank line, according to regulatory filings and Bloomberg data. That's almost 14 times the spread on a $2.75 billion credit line the company negotiated in 2006. The utility would pay Libor plus 3 percentage points to draw on the line, according to company filings. Based on yesterday's levels, FirstEnergy would be charged an additional 1.70 percentage points, reflecting the levels of its credit- default swaps, and another 1.35 percent to account for the bank's own spread, according to Scilla.

Pricing on the loan will change as Libor and the swap spreads on Credit Suisse or FirstEnergy move. Spreads on FirstEnergy's default swaps reached a record high of 1.80 percentage points on Oct. 20, up from 0.48 percentage points a year ago and 0.12 percentage points in February 2007, according to CMA Datavision. Credit Suisse's have risen threefold since December. "We're in unprecedented times right now," Scilla said. FirstEnergy doesn't anticipate needing to borrow from the line, he said. Swings in credit-default swap prices can be more pronounced than a company's perceived nonpayment risk would suggest, said John Grout, policy and technical director at the U.K.'s Association of Corporate Treasurers in London.

Some companies, including Nestle and NiSource Inc., which owns Indiana's largest gas utility, convinced banks to include a cap on the level of its swaps. Vevey, Switzerland-based Nestle is seeking to refinance 6 billion euros ($7.7 billion) of debt, according to bankers familiar with the discussions. It wants to set up a backup for a commercial-paper program that's "not intended" to be drawn down, said Roddy Child-Villiers, head of investor relations. The debt being arranged by Citigroup will be linked to a percentage of the company's default swaps.

NiSource Finance Corp., the Merrillville, Indiana-based company's finance arm, agreed last month to a $500 million revolving credit line arranged by Barclays Plc. The line is priced at Libor plus 85 percent of the 30-day average of the company's credit-default swap rate, according to spokesman Tom Cuddy. The swap price has a ceiling of 1.75 percent and a floor of 1.25 percent, he said. Bank of America Corp. and JPMorgan Chase & Co. are among the six other banks that agreed to provide the line, according to a filing. Nokia is also paying a spread over Libor based on its derivatives, according to Arja Suominen, a Helsinki, Finland- based spokeswoman.

Credit lines were once seen mainly as emergency funds to be tapped as a last resort. Since markets tightened last year, at least 36 companies hurt by the slowing economy and an inability to tap commercial paper or bond markets have borrowed $30 billion on previously negotiated lines, according to Pacific Investment Management Co. in Newport Beach, California. "Historically there's been an illogical flaw in the price of revolving credit facilities and backstop loans in particular, they were priced very cheaply as they were never meant to be drawn down," said David Slade, head of European leveraged finance at Credit Suisse in London. "But now, in the current environment, these lines are being used and banks need to be properly recompensed."

Goodyear Tire & Rubber Co., the largest U.S. tiremaker, drew $600 million from its credit line last month after it couldn't gain access to $360 million of cash in a money market fund. The Akron, Ohio-based company, rated BB- by and Standard & Poor's, is paying 1.25 percentage points more than Libor, or 4.72 percentage points. It would pay about 12 percentage points if it were to negotiate a new loan today, based on the average of similarly rated companies in an S&P index. Spokesman Keith Price declined to comment.

Concerns that Libor may not truly reflect borrowing costs helped bring about the change. The rate came under scrutiny as the debt-market seizure deepened. Some lenders may have provided numbers to the British Bankers' Association that underestimated their cost of funds, the Bank for International Settlements in Basel, Switzerland, said in March. The BBA said on April 16 that any member deliberately understating rates would be banned. Banks are also seeking to shift from a reliance on credit ratings amid concern Moody's Investors Service and S&P have been too slow to act when credit quality deteriorates.

The push for the change is coming as the U.S. government and New York Attorney General Andrew Cuomo investigate whether the swaps were manipulated by short sellers to spread false rumors about financial companies. People who sell short hope to profit by repurchasing the securities later at a lower price and returning them to the holder. "We're going through a transformation right now with regard to pricing of credit," FirstEnergy's Scilla said. "It wasn't long ago that banks were basically giving away credit. That could be part of the reason we're in the problem we're in today. And those days are gone.

Key Bank acquisition squashed by fair-value accounting
Key Bank on Wednesday said it shied away from making an acquisition earlier this year because of the effect of fair-value accounting in conjunction with another accounting rule, on mergers and acquisitions, according to an executive at the bank. Key Bank isn’t completely opposed to fair-value accounting, since only about 12% of its assets are fair valued on a recurring basis, Chuck Maimbourg, senior vice president of accounting policy at Key, said during a Securities & Exchange Commission roundtable on fair value this morning.

“Our biggest challenge has been at the intersection of 141R and 157,” he said, referring to Financial Accounting Standard 157 on fair value when it’s used in concert with Financial Accounting Standard 141R, the revised standard on mergers and acquisitions. Mr. Maimbourg that in accordance with FAS 141R, Key Bank would have had to value the portfolio of loans of the bank it was hoping to acquire at fair value on the day of the acquisition. But that would have required taking into account market prices, which he said reflected “huge markdowns.”

That meant the deal would have negatively impacted Key’s balance sheet and forced it to increase its regulatory capital once the acquisition was complete. Mr. Maimbourg added that it doesn’t make sense to fair value assets if the acquiring company intends to keep and manage the assets, and not to trade or sell them. He said that even though the transaction would have made economic sense, “we just couldn’t make it work.” Mr. Maimbourg added that “there are more consequences of 157 that have not been felt by financial institutions at this time.”

FAS 141R is supposed to take effect for acquisitions that close after the end of 2008. Many companies entered into agreements to purchase other companies earlier this year and these deals may not close for months, which means that the new rule could apply to the transactions. “We’ll see the full impact after 141R comes fully into play,” Mr. Maimbourg said.

Government Said to Be Discussing Plan to Aid Homeowners
Senior Bush administration officials are completing a plan that could help up to three million homeowners struggling to pay their mortgages to stay in their homes, three people briefed on the proposal said Wednesday.

The initiative could be the most sweeping government effort directed at mortgage borrowers since the financial crisis began last year. Under the plan, the government would agree to shoulder half of the losses on home loans if mortgage companies agreed to lower borrowers’ monthly payments for at least five years, according to the people briefed on the plan who asked not to be named because details were still being negotiated.

Officials from the Treasury Department and the Federal Deposit Insurance Corporation are working on the proposal and an announcement may come soon. Sheila C. Bair, the chairwoman of the F.D.I.C., has been the leading proponent of the plan and first discussed the idea publicly a week ago. The plan could cost $40 billion to $50 billion and would be part of the $700 billion financial bailout package that Congress approved earlier this month. The money would go toward covering future losses on loans that are modified according to standards established by the government.

The program is intended to entice more mortgage servicing companies that handle billings and collections to reduce payments for homeowners by lowering interest rates, writing down loan balances or changing other loan terms. So far, many companies have been reluctant to aggressively reduce payments because they are afraid that borrowers might default again or that investors in mortgage securities might file suit.

By offering to shoulder half of any future losses, the government hopes to stabilize the housing market. At the end of June, nearly one in 10 mortgages was delinquent or in foreclosure. But the effort could prove to be expensive, especially if the economic slump is more prolonged and deeper than many are expecting. For instance, if $500 billion in loans are modified under the program, 25 percent of them redefault and losses on those loans total 45 percent, the government would spend $28.1 billion (half of $56.3 billion). If redefaults are 40 percent and losses 55 percent, the government would spend $55 billion.

A spokeswoman for the Treasury Department, Jennifer Zuccarelli, said it would be premature to discuss a plan that policy makers were still working on. “As we said last week, the administration is going through the White House policy process too look at ways to reduce foreclosures, and that process is ongoing,” she said. “We have not decided on a particular approach.”

A Rate of Zero Percent From the Fed? Some Analysts Say It Could Be Coming
Zero percent interest rates! It sounds like free money, or maybe a promotional deal from General Motors to get people to buy Hummers. Are zero rates coming to the Federal Reserve? As it happens, the Fed is surprisingly close to that point already. On Wednesday, the central bank lowered its target for the federal funds rate — the rate that banks charge each other on overnight loans — to 1 percent from 1.5 percent.

But in practice, the actual federal funds rate fluctuates slightly around its target as the Fed carries out its open-market operations in the money markets. And because banks and financial institutions have been so frightened about lending in the last month, the actual Fed funds rate has been below 1 percent for the last two weeks. On Tuesday, it averaged only 0.67 percent.

A growing number of analysts now predict that the economy is so weak that the Fed will have to reduce its official target to zero if it wants to jumpstart the stalled economy. Japan’s central bank reduced its benchmark interest rate to zero for five years, from 2001 to 2006. It did so mainly to combat a particularly persistent case of deflation, a broad-based decline in consumer prices, and to revive economic growth.

Some analysts see signs that the United States faces a similar threat. Like Japan’s, American banks have become so decimated by losses in real estate that they are either unable or unwilling to resume normal lending. And as prices for oil and many other commodities have crashed during the past two weeks, some analysts now warn that deflation might be a threat here as well. With the Fed funds rate already down to 1 percent, and below one percent on many days, the central bank is fast approaching what economists call the “zero bound.”

If the Fed funds rate did drop to zero, it would not mean free money for consumers or businesses. The zero rate would only apply to the reserves that banks are required to maintain and that they lend to one another. Customers would still have to pay some interest, but the rates could be extremely low for some business borrowers.

The real question for policy makers is what to do if they reach a zero rate and still want to rev up the economy. Fed officials have studied the question closely, and the Fed chairman, Ben S. Bernanke, gave a famous speech on the issue when he was a Fed governor in 2002.

In that speech, Mr. Bernanke described a series of options. The simplest option would be for the Fed to start buying Treasury securities with longer maturities. Buying up those longer-term securities would push up their prices and drive down longer-term interest rates. If that didn’t work, the Fed could start buying up privately-issued debt, like corporate bonds.

In effect, the Federal Reserve would be printing more money and injecting it into the economy — a strategy of “quantitative easing,” in Fed jargon. Too much money would provoke a new round of inflation and perhaps yet another asset bubble. But Japanese inflation never took off. After five years, the Bank of Japan cautiously raised its benchmark rate to .5 percent. This week, published reports have suggested that it might cut the rate in half once again.

Are analysts' forecasts now a lagging indicator?
Wall Street banks are behaving as if we are facing the mother of all recessions—while strangely, many of their securities analysts seem to be living in a parallel universe. The bankers have been in survival mode for some time, curbing lending and harboring cash while seeking money from the U.S. government’s bailout fund.

Meanwhile, dozens of companies across a wide spectrum of Corporate America have been slashing jobs and capital spending, and warning that the outlook for sales and earnings is deteriorating, in some cases rapidly. And yet the analysts expect aggregate earnings of companies in the Standard & Poor’s 500 index to grow by 32.2% in the fourth quarter of this year, according to a report from Thomson Reuters Research released on Wednesday. Within that figure are some startling expectations that defy the news flow coming out of key sectors.

For example, the analysts expect consumer discretionary companies—basically companies such as luxury apparel retailers who sell items that aren’t necessities of life—to post an earnings decline of just 1% in the final quarter. This is in the face of warnings from the retail industry of the worst holiday season in years and consumer confidence that has plunged to a record low.

The analysts have a similar rose-colored view of earnings in 2009. You think the downturn is going to be long and hard? Don’t believe a word of it. The research teams see earnings growth for the S&P 500 at 15.7% next year, with consumer discretionary earnings surging 32%, and financials climbing 149%, which includes a big assumption that the banks will be well on the road to recovery from the credit crisis.

“It’s hard to believe that they’re going to continue with that kind of estimate,” said Lawrence White, professor of economics at New York University’s Stern School of Business. “My guess is that come December for sure we would see much smaller increases being forecast and maybe even decreases being forecast.” The analysts do, of course, eventually catch up. But they lag so badly that the aggregate estimate figures are of little use to those wanting to know where earnings are heading.

For example, expectations for earnings growth for consumer discretionary stocks in the fourth quarter plummeted from 45% on April 1 to 25% on July 1 to 12% on October 1, before the latest forecast for a decline of 1%. Similarly, expected earnings growth for the aggregate of S&P 500 companies in the fourth quarter has dropped from 64% on April 1 to 59.3% on July 1 to 46.7% on October 1 and now to 32.2%. This is particularly important for investors trying to decide when the market has fallen so far that it has hit bargain-basement levels.

For example, the Thomson Reuters Research data shows that S&P 500 companies are expected to produce a collective $94.81 of earnings per share in 2009, which puts the market at a current price-to-earnings ratio of 9.91 at Tuesday’s close. That makes stocks look about 35% cheaper than their historical average of 15 times forecast earnings. But some investors and analysts expect the final figure for 2009 to plunge as low as $75.20, which means the market is now trading at a P/E of around 12.50, making buying now seem a lot less appealing.

And it wouldn’t be beyond possibility for it to head to $47.94 as it did in the last downturn after the dot-com bust, which would make a much uglier comparison and a P/E of 19.61. The key, of course, is how much of an earnings slowdown has already been baked into share prices. Indeed, according to Citigroup’s chief U.S. equity strategist Tobias Levkovich, the S&P 500 is discounting annual earnings of $50, suggesting that anything better than that kind of “appalling” result should be met with a positive market reaction.

“It is intriguing to us that nearly 80 percent of analysts’ estimate revisions are to the downside, which has historically marked turning points in equity market downward trading trends,” Mr. Levkovich said. However, this does not mean that earnings-per-share estimates cannot head lower, he added, reiterating a view that is now only too common among investors and analysts alike. Investors are continually looking at how long the current economic slowdown will last, and how badly this will affect earnings.

“There is a very real possibility that P/E ratios will continue to drop, that both prices and earnings will be falling,” said Bernard Baumohl, chief economist at the Economic Outlook Group. In the end, whether it’s earnings or valuations, it’s all a big guessing game in which analysts themselves don’t seem to have the answers. “We’re asking the same questions you are,” Mr. Baumohl said. “This is so unprecedented, so historic, and everybody’s sort of groping in the dark trying to make sense, trying to get a feel of what’s really going on.”

World According to TARP No Laughing Matter for U.S.
The financial crisis exacerbated by credit derivatives is costing so much to fix that speculators are now using those same instruments to bet on governments as the price tag for bailing out banks approaches $3 trillion. The cost to hedge against losses on $10 million of Treasuries is about $40,000 annually for 10 years, up from $1,000 in the first half of 2007, based on CMA Datavision prices. The equivalent for German bunds has risen to more than $36,000 from $2,000, while it has jumped to $64,000 from $3,000 for U.K. gilts.

Unlike John Irving's novel "The World According to Garp," which provokes laughter from readers, the devastation amplified by derivatives is proving unfunny as taxpayers finance the financial system's rescue through measures such as the $700 billion Troubled Asset Relief Program, or TARP. Pressure is rising on policy makers to regulate a market that's moved beyond its origins protecting banks from loan losses to $55 trillion, prompting Warren Buffett to call the contracts a "time bomb."

"There's a huge gap in our regulatory system," former U.S. Securities and Exchange Commission Chairman Harvey Pitt said at an industry conference yesterday, referring to legislation almost a decade ago that excluded the derivatives from government oversight. The regulatory system is "terribly broken," he said. The Federal Reserve has given futures exchanges until Oct. 31 to present written plans on how they'll make the market more transparent, said four people familiar with the request. The Fed called banks and exchanges into three meetings in two weeks, pressing them to agree on a clearinghouse that would require dealers to post collateral and pay into a fund that would absorb losses if one of them were to fail.

Turmoil triggered by credit-default swaps prompted calls from SEC Chairman Christopher Cox, Commodity Futures Trading Commissioner Bart Chilton and lawmakers including Senator Tom Harkin, a Democrat from Iowa, for Congress to authorize governing bodies to regulate the market. New York Governor David Paterson said in a Sept. 22 statement that "the absence of regulatory oversight is the principal cause of the Wall Street meltdown we are currently witnessing." New York officials proposed rules that would treat some of the contracts as insurance after the government was forced to bail out American International Group Inc.

"It's absolutely urgent that we bring disclosure to this corner of the market, that we let the market see where the risk is and price accordingly," the SEC's Cox told the House Committee on Oversight and Government Reform on Oct. 23. Derivatives are contracts whose value is derived from assets including stocks, bonds, currencies and commodities, or from events such as the weather or changes in interest rates. Credit-default swaps trade over-the-counter, leaving each party exposed to the risk the other won't fulfill the terms of the contract. The International Swaps and Derivatives Association, the industry group that has been setting the rules and acting as a self-regulator of the market, cited estimates that there were as much as $400 billion of contracts tied to Lehman Brothers Holdings Inc., even though the company only had $162.8 billion of debt, according to Bank of America Corp. analysts.

The Depository Trust & Clearing Corp., which runs a central registry for trades, placed the amount at about $72 billion. The contracts, which aren't issued by the companies they are linked to, pay the holder the face value of the amount protected in exchange for the underlying securities if a borrower fails to adhere to debt agreements. A basis point on a credit-default swap contract protecting $10 million of sovereign debt from default for 10 years is equivalent to $1,000 a year. New York-based AIG amassed bets of more than $440 billion on U.S. home loans, corporate bonds and other assets by selling protection against default via the derivatives.

After ratings firms downgraded the insurer in September because of potential losses from the trades, AIG had to accept an $85 billion loan from the government and turn over majority control because of more than $10 billion in collateral it was required to post on the trades. Lehman was one of the 10 biggest dealers in the credit- default swap market before it failed. New York-based Primus Guaranty Ltd. which managed $24.2 billion of credit-default swaps and sold guarantees on companies including Lehman and bankrupt Washington Mutual Inc. of Seattle, has tumbled 94 percent this year on the New York Stock Exchange to 40 cents a share.

Banks are now driving the cost of debt protection to records as they seek to guard against losses on contracts bought from money-losing hedge funds. The Markit CDX North America Investment Grade Index, linked to the bonds of 125 companies in the U.S. and Canada, reached a record 240 basis points on Oct. 24, before falling back to 207.5 today, according to Phoenix Partners Group. Europe's benchmark index reached a record 193 basis points before falling back to 159.5, according to JPMorgan Chase & Co. Buffett, called "the world's greatest investor" by biographer Robert Hagstrom, described derivatives in an annual report to shareholders of his Omaha, Nebraska-based Berkshire Hathaway Inc. as "financial weapons of mass destruction."

"The range of derivatives contracts is limited only by the imagination of man or sometimes, so it seems, madmen," Buffett said in the 2003 letter to shareholders. Credit-default swaps are just a tool available to investors to hedge against losses, said Robert Pickel, head of the International Swaps and Derivatives Association in New York. "To say that CDS were the cause, or even a large contributor, to that turmoil is inaccurate and reflects an understandable confusion of the various financial products that have been developed in recent years," Pickel told a House committee on Oct. 14.

Four groups are vying to operate clearing operations, including a partnership between Chicago-based CME Group Inc. and Citadel Investment Group LLC and a team consisting of dealer- owned Clearing Corp., Atlanta-based Intercontinental Exchange Inc. and credit-default swap index owner Markit Group Ltd. Eurex AG, the world's biggest futures exchange, and NYSE Euronext have also submitted proposals. The push to make the industry more transparent may finally let exchange-traded derivatives gain traction after years of failing to compete with banks. Eurex, the world's biggest futures exchange, opened the first market for exchange-traded credit derivatives in March 2007, beating Chicago Mercantile Holdings Inc. and Euronext, though dealers resisted moving to their platforms because it threatened their profits.

"The CDS market is going to go to exchanges," Emmanuel Roman, co-chief executive officer of GLG Partners Inc., which manages about $24 billion, said at the Hedge 2008 conference in London on Oct. 23. "That's a very good development. Not good for the banks but good for everyone else." Trading of credit-default swaps on government debt has increased since countries from the U.S. to Germany began pumping cash into their banks to prevent more failures, said Puneet Sharma, head of investment-grade credit strategy at Barclays Capital in London. The expenditures mean the "probability of downgrade has increased," he said.

Investors are buying protection on countries to speculate on a deterioration of their credit quality and ratings as governments take on risky assets, even if they don't think there is a chance of default. Gross issuance of Treasury coupon securities will rise to about $1.15 trillion in the 2009 fiscal year from $724 billion in fiscal 2008, according to Credit Suisse Securities USA LLC, one of the 17 primary dealers of U.S. government securities that are obligated to bid at the Treasury's auctions. "I do not think the U.S. market will blow up," said Pierre Naim, who bought default protection on Treasuries in January for his Rainbow Global High Yield hedge fund in the Bahamas. "But the quality of U.S. government assets is going down by the day."

Credit-default swaps on Treasuries have risen nearly 40 percent since TARP was signed into law Oct. 3, and are now about the same as Mexican and Thai government debt before the credit markets began to seize up in June 2007, CMA Datavision prices show. Contracts on bunds soared by 77 percent and gilts by 66 percent over the same period. The Treasury has allocated an initial $250 billion out of the $700 billion approved by Congress to shore up lenders, and is being pressured by the Financial Services Roundtable, a trade association of the 100 largest banks, securities firms and insurers, to broaden its guidelines so that insurance companies, broker-dealers, automobile companies and institutions controlled by foreign banks could also sell stakes to the government.

Credit 'Tsunami' Swamps Trade as Banks Curtail Loans
Richard Burnett's lumber company had started loading wood onto ships heading for China. More was en route to the docks. It was all part of an order that would fill 100 40-foot cargo containers. Then Burnett got a call from his buyer at Shanghai VIVA Wood Products Co. The deal was dead. He told Burnett, president of Cross Creek Sales LLC in Augusta, Georgia, he couldn't get a letter of credit to guarantee payment for at least six months.

"It was like a spigot got cut off," Burnett said, recounting the transaction that fell apart in July. The inability of buyers in China and Vietnam to get letters of credit has cost his company as much as $4 million this year, a third of projected revenue, forcing him to lay off 15 of 35 employees, he said. Suppliers of oil, coal, grains and consumer products from Chicago to Mumbai are losing sales as the credit crisis spreads beyond financial institutions, and banks refuse financing or increase the fees for buyers. Coupled with declining demand, the credit squeeze is threatening international trade, one of the lone bright spots in the global economy.

"It's like standing on a beach watching a tsunami, knowing that it's coming," said Scott Stevenson, manager of the International Finance Corp.'s Global Trade Finance Program. IFC is the World Bank's private lending arm. Emerging markets such as Brazil, Vietnam and South Africa are particularly vulnerable because buyers have more trouble proving their financial strength. The slowdown is also damaging the U.S., the world's largest economy, where exports accounted for almost two-thirds of the 2.1 percent growth in gross domestic product in the 12 months through June, according to the U.S. Trade Representative's office.

Another sign of trouble: The Baltic Dry Index, a measure of commodity shipping costs that banks watch as an economic indicator, fell below 1,000 yesterday for the first time in six years, dropping it 89 percent for the year. Global trade volumes may sink next year, their first decrease since 1982, according to Andrew Burns, a lead economist at the World Bank. While there is still uncertainty over future prospects, trade may contract by as much as 2 percent, after annual increases of 5 percent to 10 percent over the past decade.

"We only see this kind of shock when we have outbreaks of war, or maybe the oil shocks of the 1970s," said Kjetil Sjuve, a commodities shipbroker at Lorentzen & Stemoco AS in Oslo. "This lack of credit was a shock to the entire economy. We were hit second after the banks." Of the $13.6 trillion of goods traded worldwide, 90 percent rely on letters of credit or related forms of financing and guarantees such as trade credit insurance, according to the Geneva-based World Trade Organization.

Letters of credit are centuries-old instruments that allow far-flung partners to complete large transactions. An importing company gets its bank to issue the letter, guaranteeing payment for a delivery. That bank provides the letter to the exporter's bank, which then guarantees payment to the exporting company. The system breaks down when banks don't trust one another and are unwilling to accept a letter of credit as proof that payment is coming. From 2000 through last year, the use of letters of credit declined to about 10 percent of global trade transactions, the IFC's Stevenson said.

Over the past six months, they began "roaring back into fashion" as sellers sought to guarantee payments from buyers they no longer trusted, he said. At the same time, liquidity problems caused banks to increase charges. The cost of a letter of credit has tripled for buyers in China and Turkey and doubled for Pakistan, Argentina and Bangladesh, said Uwe Noll, director of country risk sales at Deutsche Bank AG. Banks are now charging 1.5 percent of the value of the transaction for credit guarantees for some Chinese transactions, bankers say.

"The whole global trade production line relies on letters of credit," Matt Robinson, an analyst at Moody's wrote in an Oct. 23 report. "No letters of credit, no transactions -- and no transactions mean no international trade." The evidence is piling up in the world's ports. An Iranian oil tanker able to carry enough crude oil to supply Ireland for five days arrived at the Turkish port of Ceyhan on Oct. 6. Then she waited eight days before the company that hired her was able to secure a letter of credit that was acceptable to Iraq, the country selling the cargo, according to two people involved in the loading and unloading of the oil.

Mumbai-based Essar Shipping Ports & Logistics Ltd. couldn't buy equipment used to handle bulk materials at ports when the Chinese supplier wasn't able get a letter of credit from an Indian state-owned bank accepted in China, said V. Ashok, Essar's executive director. "This is absolutely a crisis situation here," Ashok said. "If you don't discount LCs, how will you do business? Business around the world is done on LCs, not cash. It's all jammed." In Chicago, C1 Resources is holding up 1 million metric tons of cement valued at as much as $150 million, because an African customer can't secure a letter of credit, said Chief Operating Officer Rob Risner. The order was placed Sept. 10 for shipment to Nigeria, Cameroon and Angola and the customer is still seeking a line of credit, Risner said.

Burnett, of Cross Creek, said the demise of his deals with Asian buyers also reflects the weakness of the U.S. economy, including a slowdown in construction that has reduced demand for the wood products companies such as Shanghai VIVA make. Liu Jian Jun, manager of Shanghai VIVA, said weak demand in the U.S. and elsewhere killed the deal with Cross Creek, not access to credit.

James Morrison, president of the Small Business Exporters Association in Washington, polled 1,000 of his members this month on the impact tight credit is having on their ability to trade. By a margin of six to one, companies that had tried to get export financing recently said they faced "unusual difficulties." A few said their banks had told them the terms of existing credit facilities had to be reworked and the companies would have to provide more principal, Morrison said.

The same is true in Brazil. An Oct. 23 report from the country's Confederacao Nacional das Industrias, which represents 27 industry groups and 7,000 trade associations, found that Brazilian companies of all size are losing access to credit. "To make exports feasible, you need funding and this has virtually dried up in the last weeks," said Flavio Castelo Branco, chief economist for the group.

Policymakers are responding. Pascal Lamy, head of the WTO, has called a meeting of trade officials for Nov. 12 in Geneva to discuss how to get more credit to exporters in poor nations. The organization has invited heads of the largest development banks as well as representatives from Citigroup Inc., JPMorgan Chase & Co. and other commercial banks.
The World Bank has added $500 million to the $1 billion it was already using to guarantee export financing. The U.S. Export- Import Bank, a government-chartered entity that helps finance exports, is gearing up to provide more guarantees, said Jeffrey Abramson, vice president for trade finance.

Dominic Ng, chief executive officer of Pasadena, California- based East-West Bancorp Inc., the biggest lender serving the Chinese community in the U.S., said his bank this year has reduced the number of letters of credit issued for the first time. It is providing about 10 percent fewer letters, after annual increases of 10 percent to 20 percent in the past decade. "We've become more cautious," Ng said, blaming the retrenchment on a decline in the number of credit-worthy customers. Bank bailouts funded by the U.S. and other governments have begun to ease liquidity problems. "But we still have credit issues," he said. "And they are going to get worse, not better, because the economy is getting worse."

JPMorgan Swap With Alabama Drawn Into Criminal Probe
The U.S. Justice Department is investigating a derivative trade between the state of Alabama and JPMorgan Chase & Co. as part of a nationwide criminal probe. The Justice Department subpoenaed documents about a so- called swaption, or an option on an interest-rate swap, between JPMorgan and the state's school construction authority, according to a federal lawsuit filed by the state, which is trying to void the 2002 deal. The agency is investigating whether banks and advisers conspired to overcharge governments on the contracts.

"Although the authority does not seek by this action to avoid payment of any legitimate obligation, the pendency of at least two separate governmental inquiries implicating the validity of the transaction heightens the necessity for a judicial determination of the parties' rights," the complaint, filed yesterday in federal court in Montgomery, Alabama, said. U.S. prosecutors and the Securities and Exchange Commission have searched for almost two years for evidence of rigged bidding and price fixing by banks in the $2.7 trillion municipal bond market. They have focused on derivatives, such as interest-rate swaps tied to bonds, and contracts to invest bond-sale proceeds.

The SEC has also sought information from the Bethlehem Area School District in Pennsylvania about its swap transactions with JPMorgan, while two other school districts in that state have sued the bank for allegedly conspiring to shortchange them on swaption deals like the one in Alabama. Prosecutors have informed at least five former JPMorgan derivative bankers that they're targets of a grand jury investigation, according to the Financial Industry Regulatory Authority. Finra is the largest self-regulator for securities firms doing business in the U.S.

JPMorgan, in its annual report filed with the SEC on Feb. 29, said the inquiries focus on "possible antitrust and securities violations," mostly between 2001 and 2006. The federal subpoenas for documents regarding Alabama's swap deal with JPMorgan were reported earlier by the Birmingham News. JPMorgan spokesman Brian Marchiony didn't immediately return a call seeking comment. Alabama's finance director, James Main, who received the Justice Department subpoena, also didn't return a call.

Alabama's Public School and College Authority, which sells bonds for public schools, colleges and universities, alleges the deal doesn't comply with state law because it wasn't a "legitimate hedging transaction." In March 2002, the agency received $12.6 million upfront from JPMorgan in return for selling the swaption. That gave the bank the right to force the state into $710.2 million of interest-rate swaps on four series of bonds between 2008 and 2011. The swaps called for the state to pay a fixed rate and receive a percentage of the London interbank offered rate.

JPMorgan pitched the deal as a way to protect against the risk of rising interest rates and refinance old debt at a lower cost, the complaint said. In June, JPMorgan told the state it would exercise its option on Nov. 1 on a series of bonds issued in 1998. That would have required the state to issue floating-rate bonds, a type of security whose interest rates have jumped more than 10 percent because of the U.S. credit crisis. The state also could have terminated the deal at a cost that wasn't disclosed in the complaint.

Alabama alleges the swaption wasn't documented in accordance with state law, which requires a governmental body to certify the swap was entered into for the purpose of hedging. State law also says governments can issue refunding debt only at a lower cost than the old debt. The cost of issuing variable-rate bonds, including a fixed-rate payment to JPMorgan, would exceed the amount payable under the 1998 bonds, the complaint said. The $2.2 million Alabama received for the swaption on the 1998 bonds was less than 1 percent of the amount outstanding, the complaint said.

The deal was also structured so that JPMorgan would receive more than $66 million, 50 percent of the fixed-rate payments due from the state, within two years after the swaption was exercised. "By structuring APSCA's fixed-rate payments in this manner, JPMorgan's exercise of the swaption was for all intents and purposes a certainty, since by doing so it would receive what amounts to a $66 million loan from APSCA with effectively no rate of return or implied interest rate," the complaint said. The state authority can't legally make loans, the complaint said.

Swap Financial Group LLC of South Orange, New Jersey, advised Alabama on the swaption. Peter Shapiro, managing director at Swap Financial, didn't immediately return a call. Douglas MacFaddin, JPMorgan's former head of municipal derivatives sales, signed the swap documents with Alabama. MacFaddin, who worked at JPMorgan for 14 years, was fired by the New York-based bank in March after revealing he was a target of the municipal derivatives investigation. Alabama has agreed to repay JPMorgan the $12.6 million it received from the bank with interest, the complaint said.

Fed Opens Swaps With South Korea, Brazil, Mexico, Singapore
The Federal Reserve agreed to provide $30 billion each to the central banks of Brazil, Mexico, South Korea and Singapore to boost the liquidity of dollars in emerging markets. "The Federal Reserve has authorized the establishment of temporary liquidity swap facilities with the central banks of these four large systemically important economies," the U.S. central bank said in a statement. The swap lines will be in place through April 30, the Fed said.

The global credit crisis that began with the collapse of the U.S. mortgage-backed securities market has roiled developing nations, sending the premiums on their government bonds up and their currencies down. Today's decision comes as the International Monetary Fund works on a separate program to provide emergency credit to emerging markets. The Fed said it "welcomes" the announcement of the IMF's short-term liquidity facility.

The Fed also created this week a $15 billion swap line with its New Zealand counterpart and removed limits this month on four existing swap lines, including one with the European Central Bank. The Fed set up a $10 billion arrangement with Australia's central bank last month and then tripled it to $30 billion.

The Bank of Korea cut interest rates by a record amount on Oct. 27 and the government pledged to guarantee local banks' debts to help lenders struggling to access foreign funds. Stocks and the won tumbled last week, prompting concern the country may face a currency crisis a decade after the IMF organized a $57 billion bailout to help repay overseas debt.

Argentine Pension Seizure Spurs Brazil Stock Sale
Argentina's planned nationalization of its retirement system will trigger a fire sale of Brazilian stocks this week as private pension funds are forced to shed foreign holdings. The pensions must unload Brazilian assets within three days of "notification," according to a resolution dated yesterday and distributed by e-mail today. Amado Boudou, the head of Argentina's social security agency, told lawmakers yesterday that the funds shouldn't own foreign investments.

"That's not news we like, but I don't think it will cause problems," Carlos Kawall, chief financial officer of Brazil's securities exchange BM&FBovespa SA, said in an interview in New York yesterday. Pension funds in Argentina, known as AFJPs, owned 1.8 billion pesos ($536 million) of Brazilian stocks including Cia. Vale do Rio Doce, Petroleo Brasileiro SA and Banco Bradesco SA as of Oct. 15, according to the regulator's Web site. Although that's only about 0.1 percent of Brazil's total market value, it represents 21 percent of average daily trading in the past week.

The requirement to repatriate Brazilian funds will "take pressure off of the exchange rate," Sergio Chodos, the head of the AFJP regulator, said in an interview published in today's edition of Argentine newspaper Cronista. The peso fell to the weakest against the dollar since December 2002 yesterday. The AFJPs own Brazilian stock through so-called Mercosur common investment funds including those run by Schroder SASGFCI, Consultatio SA and Frances Administradora de Inversion, according to the regulator's Web site. Besides the Brazilian investments, the AFJPs owned 4.92 billion pesos of other foreign assets as of Oct. 15, the Web site shows.

"The funds shouldn't be invested abroad," Boudou said yesterday in a speech to lawmakers, who started debating President Cristina Fernandez de Kirchner's planned pension nationalization announced last week. Today's resolution was signed by Boudou; Eduardo Hecker, the chief securities regulator; and Martin Redrado, the central bank president. The government, grappling with a financial crisis that froze access to credit, is seeking control of about $26 billion in privately run retirement accounts. Nestor Kirchner, Fernandez's husband and predecessor as president, tightened restrictions on private pension funds last year, requiring them to keep more investments in the country to sustain economic growth.

Argentina's Merval stock index tumbled 27 percent last week and the yield on Argentina's 8.28 percent dollar bonds due in 2033 exceeded 29 percent as the nationalization spooked investors already shaken by slumping commodities and slower growth. The retirement system, set up in 1994 to help bolster capital markets, owns about 5 percent of companies listed on the Buenos Aires stock exchange and 27 percent of shares available for public trading, data compiled by pension funds show. Boudou said in yesterday's speech that authorities will "protect the value" of the AFJPs' local equity holdings since Argentina "doesn't need cash or funds," and will avoid any steps to exercise control over companies. "Don't think we are going to rush out and sell at any price," he said.

Argentina's Merval index rose 6.6 percent yesterday as Brazil's Bovespa rallied 13 percent, joining an advance in equities around the world after commodity prices rose. Authorities are probably buying domestic shares via state- owned Banco de la Nacion's brokerage unit to counter a sell-off spurred by last week's nationalization announcement as lawmakers debate the plan, according to Juan Diedrichs. "We've seen them in previous sessions actively buying and the speculation is that Anses is behind it," Diedrichs, a trader at Capital Markets Argentina, said by telephone from Buenos Aires yesterday. Nobody at the state bank's brokerage Nacion Busatil was available to comment, a management assistant said. A Nacion Busatil spokesman didn't return phone messages.

US Treasury to Need 'Unprecedented' Financing
The U.S. Treasury faces historic financing demands from a weakening economy and the added costs of a $700 billion Wall Street rescue program, the department's top domestic finance official said today. "This year's financing needs will be unprecedented," said Anthony Ryan, the Treasury's acting undersecretary for domestic finance, at a Securities Industry and Financial Markets Association conference in New York, where he was a last-minute substitute for Treasury Secretary Henry Paulson.

Ryan's borrowing outlook comes after Treasury officials spent much of the past month publicly praising the rescue plan's virtues. The Treasury needs to sell debt to raise money for the new initiatives and also cope with a weaker economy, two factors analysts say may push the country's budget deficit to more than $1 trillion for the current fiscal year. As part of the rescue effort, the Treasury aims to boost the economy by pushing $250 billion in new capital to U.S. banks. Half of that money has been set aside for large banks, which hold about half of all U.S. deposits, in hopes of stimulating more lending to businesses and consumers. The rest will go to regional banks and smaller institutions.

"What we're trying to do is get banks to do what they are supposed to do, which is support the system that we have in America," White House spokeswoman Dana Perino said at a news briefing today. "Banks exist to lend money, that's how they make money." Ryan said the Treasury will begin distributing $125 billion in capital injections to nine big banks "starting today." He reiterated that the Treasury's equity purchase program is aimed at healthy banks and has safeguards to protect taxpayer interests.

Wayne Abernathy, an executive vice president for the American Bankers Association in Washington, said his group met today with Treasury officials to discuss plans for making some of the aid available to the more than 6,600 financial institutions that aren't publicly traded. The Treasury told the association that private banks wouldn't be held to the same Nov. 14 application deadline in effect for public companies, Abernathy said. The message from the agency was that "other banks shouldn't feel that time is running out," he said.

Ryan also said the U.S. government now "effectively guarantees" debt issued by mortgage companies Fannie Mae and Freddie Mac, which were placed into conservatorship on Sept. 7. The preferred stock agreement included in the federal takeover means the U.S. now backs "both existing and to be issued" debt from the two companies. "The U.S. government stands behind these enterprises, their debt and the mortgage-backed securities they guarantee," Ryan said. The agencies have almost $6 trillion in outstanding debt and mortgage securities.

Yields above Treasuries on Fannie Mae and Freddie Mac's debt and mortgage securities were little changed after the speech. The spread on Fannie's five-year debt fell less than 0.01 percentage point to 1.52 percentage points at 5 p.m. in New York, according to data compiled by Bloomberg. Ryan said U.S. equity and credit markets remain under "considerable strain" and face ongoing challenges. Still, Federal Reserve efforts to backstop commercial paper are "helping" to stabilize markets, he said.

To raise the necessary funding for the bailout and other programs, the Treasury is looking at selling more long-term debt and possibly bringing back three-year note sales at the Nov. 5 refunding, Ryan said. The Treasury also is raising money to address "many different policy objectives" and reduce bond market disruptions and will try to keep its borrowing patterns as regular as possible, he said. "We firmly believe that investors value greatly and pay a premium for Treasury's predictable actions," Ryan said. "To the very best of our ability, we intend to stay the course."

Ryan said the Bush administration's July projection of a $482 billion deficit doesn't include new programs launched to attack the credit crisis. The bank rescue program, a separate mortgage-backed securities program, the Fannie-Freddie takeover and a student loan program all need funding, Ryan said. Also, the Treasury is borrowing money on behalf of the Federal Reserve and the Federal Deposit Insurance Corp., he said. "The potential for deterioration in economic conditions given the contraction in credit also may affect budget conditions this year," Ryan said. Analysts say the 2009 budget deficit could be more than double the White House projections. In fiscal year 2008, which ended Sept. 30, the deficit was a record $455 billion.

"The budget deficit for fiscal year 2009 might reach $1 trillion if Congress passes another stimulus package this winter," said Lou Crandall, chief economist of Wrightson ICAP, in a research note. "And that's just the beginning of the bad news -- financing needs arising from off-budget items might be nearly as large as the on-budget deficit." Crandall estimates 2009's total borrowing needs at $1.95 trillion. He says Treasury could raise this money with an "aggressive but sustainable" increase in regular borrowing, accompanied by one-time auctions as needed.

In response to a question after the speech, Ryan declined to comment on the dollar, which today rose to an 18-month high against the euro. The U.S. currency's gains could hurt exports, which has been one of the few bright spots of the weakening economy. "We don't have too many rules at the Treasury department, but one of the important rules is that only one person speaks on the dollar at the Treasury and he unfortunately couldn't join you here today," Ryan said.

UK pensions slump by 28% in a year
Private pensions have lost more than a quarter of their value in the last 12 months, a personal finance company has said. Employees' 'defined contributions' schemes have slumped by 28 per cent since October 2007 - wiping billions off their value, according to Aon Consulting. They dropped in value from £552 billion to just £395 billion, Aon found. Over the same period people paid in £6.7 billion.

'Defined contributions' schemes are those in which contributors buy investments, with no guarantee of the amount of money their pension pot will produce upon retirement. About four million people in the UK, mostly working in the private sector, have defined contributions pensions which their employers provide. Most are largely invested in shares, meaning they have been hit hard by the stock market crash. Most companies have stopped offering final salary schemes, which guarantee the amount paid out on retirement, meaning more and more people are reliant on the performance of volatile stocks and shares.

Helen Dowsey, of Aon Consulting, said: "It may appear a double blow to workers that not only are they facing more of a struggle to make ends meet, but the economic turmoil is also seemingly eating into the money they have been putting aside for retirement. "However, most workers will have the fortune of time on their side as their retirement will be many years away, enough time to weather the current storm."

Those that will be hardest hit are those approaching retirement who cannot wait for stockmarkets to recover before cashing in their pension pots. She warned that such people might have to consider postponing retirement and advised them to seek professional advice. Aon reached its conclusions after trawling a range of market information, research and data.

Its bleak assessment comes after the government-funded Pensions Advisory Service cautioned that millions of people are being encouraged to take too much risk with their pensions by investing mainly in shares. Over the long term shares tend to outperform other investment classes like cash and bonds but their value can also collapse very quickly.

Prices UK properties sold at auction fall 30%
The average price of a property sold at auction dropped nearly 30% over the past 12 months leading analysts to predict that house prices in the general market have a lot further to fall. The average price of the 4,796 homes sold at auction over the past quarter was £123,209, 29.6% below the average price of £172,470 in the same quarter last year, according to figures compiled by the property auction group EIG.

"House prices are falling much faster than the published house price indices suggest," said the Liberal Democrat Treasury spokesman, Lord Oakeshott. "Auctions are the real market where contracts are exchanged and a 10% deposit paid as soon as the hammer falls. "The Halifax and Nationwide indices are well behind the average fall in house prices, because they include houses approved for a mortgage. With mortgage lending down to a trickle, the 28.6% average price fall of homes sold at auction gives a true picture."

The futures market also predicted further falls. A properties derivative price report by Tradition Property showed that prices are likely to fall by a further 23.5% over the next year and 32.5% over the next two years, with 10 years to wait before prices get back to today's levels. Bank of England data out yesterday showed that mortgage approvals for September rose for the first time in a year. Several analysts believe that they may have hit bottom but could stay there for many months to come.

The Bank of England said that lenders approved 33,000 mortgages for new purchases last month, slightly up from 32,000 in August. They were still 67% lower than a year earlier and almost a quarter of their peak in late 2006. Remortgages accounted for half of all new loans and, at 72,000, were 30% lower than a year earlier.

"Approvals are likely to remain close to rock-bottom levels for many months yet," said Seema Shah at consultants Capital Economics. "The sharp rise in unemployment that we expect, the contraction in economic activity, as well as the continued tightening in lending criteria, will all curtail housing market activity. In turn, this will bear down further on house prices. We expect house prices to have fallen by 35% by the end of next year."

Net mortgage lending was £2.2bn in September, well below the £3.5bn monthly average for the previous six months. August's mortgage lending figure was revised to show a net repayment of £691m - the first repayment since the series started in April 1993. The Bank added that consumer lending through personal loans and credit cards increased by £0.3bn, the weakest rise since 1993.

Banks exploit legal loophole to seize homes
Banks and credit card companies are exploiting obscure legal powers to seize the homes of thousands of people who cannot pay their credit card bills. In some cases, people owing as little as £1,000 have been served with charging orders – the legal instrument enabling a creditor to order the sale of a property. The practice has emerged days after Yvette Cooper, chief secretary to the Treasury, called on banks to do more to allow people to keep their homes.

According to the Ministry of Justice, 97,026 charging orders were granted by courts in England and Wales last year, a tenfold increase since 2000. They allow financial institutions to order the sale of a property to pay off unsecured debts on credit cards, personal loans, store cards and car finance. Some will have been used only to threaten the debtor, or to levy a surcharge on the mortgage to recoup the debts.
Nationwide, the building society, and Northern Rock, which was nationalised earlier this year, are among the most aggressive in using the court orders.

Mark Sands, head of insolvency at KPMG, the accountancy firm, said: “The power of a charging order can come as a horrible shock to someone. When they took out the loan or the credit card, they were almost certainly not told that their home was at risk if they failed to keep up with repayments.” The rate at which the courts have granted charging orders has increased sharply in the past two months, according to Citizens Advice, National Debt-line and the Consumer Credit Counselling Service. Last week a homeowner posted a message on a website saying a credit card company had launched a charging order against him for a debt of £1,000.

From next year banks will be given further arbitrary powers because they will no longer need to secure a county court judgment against a defaulting debtor. They will be able to move directly to seek a charging order after two or three months of missed payments. Vince Cable, the Liberal Democrat Treasury spokesman, said: “No one should be allowed to lose their home simply because of a credit card debt. More needs to be done by the government to ensure that lenders simply do not act overzealously, and only take possession of properties as a last resort. The fact that banks can now kick people out of their homes for not keeping up with their unsecured debts is very worrying.”

Alex McDermott, social policy officer at Citizens Advice, said the government had presided over a hidden scandal, because homes repossessed in this way did not appear in the official statistics issued by the Council for Mortgage Lenders. The Consumer Credit Counselling Service said Northern Rock and Nationwide were particularly aggressive. Northern Rock confirmed it used charging orders where customers had missed payments on unsecured loans, saying: “Any application for a charging order on an unsecured loan is in strict accordance with the Consumer Credit Act.” Northern Rock and Nationwide declined to discuss how many homes they had forced to be sold.

Fears mount in Japan over complex yen products
Traders in Tokyo have given warning that about $90 billion (£55billion) of complex foreign exchange products, sold mainly to Japanese households and institutions, are on the brink of falling “like a house of cards”. A rescue effort by the product issuers - large Japanese, European and American investment banks - is expected to involve extensive hedging measures that will throw global currency markets into even deeper turmoil.

The products, which are known as power reverse dual currency notes (PRDC), were sold to Japanese households as simple products offering higher yields than regular savings but the bonds were in reality hugely complex structures “with 15 moving parts and multiple points of pain”, derivatives experts at RBS in Tokyo said. The products combine exposure to foreign exchange, interest rate differentials and domestic inflation and have formed a small but potent part of the so-called yen carry trade - the borrowing of yen to invest in currencies offering higher interest rates - a gambit thought to have financed huge amounts of global risk-taking in recent years.

The PRDC's complexity disguised from the buyers the fact that they were taking on the same big foreign exchange risks as the regular carry trade but with additional exposure to global interest rate volatility. The warning on PRDCs coincides with a phase of unprecedented volatility for the yen, which this week soared to levels against the dollar and euro that are likely to hurt the country's exporters. The yen traded at 97.65 to the dollar yesterday, close to levels not seen since 1995. Two months ago, the yen stood at 110 per dollar. Foreign exchange traders have blamed the unwinding of the yen- carry trade for much of the upward pressure on the Japanese currency.

Also fuelling yen volatility has been speculation that the Bank of Japan (BOJ) may be preparing to cut interest rates this week - rumours that provoked a sharp reversal for the yen over the past two days. The speculation suggests that the BOJ could be about to trim 25 basis points from rates and bring them down to only 0.25percent. At the same time, Japan's “Big Three” banks - Mitsubishi UFJ, Sumitomo and Mizuho - are tallying mounting losses from Tokyo's plunging stock market. Japanese banks have vast share portfolios that are bleeding red-ink.

When the Nikkei share index hit a 26-year low of 7,000 points this week, combined paper losses on the stocks held by the Big Three since March 2007 amounted to about $100billion. Industry figures said that if the savaging of the Japanese banks' huge stock portfolios continues, it could trigger a capital crisis among institutions recently viewed as among the safest and best capitalised in the world. The stock losses suffered by Mitsubishi UFJ alone - $41 billion - are greater than the total sub-prime writedowns of HSBC, JPMorgan or Bank of America.

Cost of Higher Education Heading For Sharp Increase
College students and their parents should brace for sharp tuition increases as the widening economic downturn begins to hit campuses across the country, an organization of higher education officials said yesterday.

The warning came in response to an annual national survey of tuition and fees that showed that college costs rose only modestly for the current academic year. But that report, released yesterday by the College Board, was based on data collected before June and did not reflect many of the economic trials embroiling the country.

The financial landscape has become far more grim, according to the American Council on Education, a coalition of more than 1,600 college and university presidents. "I am afraid this year's report may prove only to be a snapshot of a time in history that we might soon be referring to as 'the good old days,' " said ACE President Molly Corbett Broad. At least 17 states, struggling to balance budgets at a time of plummeting tax revenue, are beginning to slash appropriations for their public colleges.

Private schools are also being squeezed as their endowments wither in the stock market and donors grow more cautious. "I am concerned that we are entering a period -- as we did following the recession of the late 1980s and early 1990s -- when we will see a sharp spike in tuition prices at both public and private institutions," Broad said. "Presidents and boards of trustees will be reluctant to increase tuition, but they will likely have little choice."

Virginia and Maryland are among the states that have recently trimmed higher education budgets in the face of the downturn. In Richmond, Gov. Timothy M. Kaine (D) sliced higher education funding by about 6 percent three weeks ago to help close a projected $2.5 billion shortfall for Virginia's two-year, 2009-10 budget. Kaine said he didn't expect the cuts to cause a tuition increase. University of Virginia officials said they expected to cover the reduction by not filling open jobs and cutting administrative costs.

Maryland trimmed funding to state universities and community colleges by 1.5 percent this month as part of a $350 million emergency spending cut. University system officials, who have frozen tuitions at four-year state schools for three straight years, said they would absorb the cuts without a midyear price increase. But officials would not rule out an increase at community colleges.

"I can't predict what tuitions will be, but there is going to be a lot of pressure next year on universities," said John Childers, president of the Consortium of Universities of the Washington Metropolitan Area, which includes the University of Maryland College Park and 14 other area campuses. Yesterday's survey released by the College Board, a nonprofit association of educational institutions that provides assistance to college-bound students, showed relatively modest increases in tuition and fees for the 2008-2009 year, with costs rising 1 to 3 percent above inflation.

The report found that tuition for the year climbed 6.4 percent for in-state students at public four-year institutions, to an average of $6,585. Private colleges jumped 5.9 percent to an average of $25,143. The cost of attending community colleges declined, after adjusting for inflation, by 0.8 percent to $2,300 for the year. The report found that overall financial aid available to students, including grants and federal loans, increased for the year, particularly from public programs. Federal student loans jumped 6 percent, according to the most recent available data. But the number of private loans for higher education, which had been climbing, began to shrink even before the current credit crisis.

The report did not address the effects of the recent credit crunch on student lending. Rising college costs coupled with the economic downturn also have more students lining up for financial help. The popular federal Pell Grant Program, which serves low-income students, received almost 800,000 more applications in the first seven months of this year than during the same period last year -- the largest jump ever in that time period, according to the Department of Education. Officials are warning that Congress may need to budget an additional $6 billion next year for the program.

A Question for A.I.G.: Where Did the Cash Go?
The American International Group is rapidly running through $123 billion in emergency lending provided by the Federal Reserve, raising questions about how a company claiming to be solvent in September could have developed such a big hole by October. Some analysts say at least part of the shortfall must have been there all along, hidden by irregular accounting.

“You don’t just suddenly lose $120 billion overnight,” said Donn Vickrey of Gradient Analytics, an independent securities research firm in Scottsdale, Ariz. Mr. Vickrey says he believes A.I.G. must have already accumulated tens of billions of dollars worth of losses by mid-September, when it came close to collapse and received an $85 billion emergency line of credit by the Fed. That loan was later supplemented by a $38 billion lending facility.

But losses on that scale do not show up in the company’s financial filings. Instead, A.I.G. replenished its capital by issuing $20 billion in stock and debt in May and reassured investors that it had an ample cushion. It also said that it was making its accounting more precise. Mr. Vickery and other analysts are examining the company’s disclosures for clues that the cushion was threadbare and that company officials knew they had major losses months before the bailout.

Tantalizing support for this argument comes from what appears to have been a behind-the-scenes clash at the company over how to value some of its derivatives contracts. An accountant brought in by the company because of an earlier scandal was pushed to the sidelines on this issue, and the company’s outside auditor, PricewaterhouseCoopers, warned of a material weakness months before the government bailout. The internal auditor resigned and is now in seclusion, according to a former colleague. His account, from a prepared text, was read by Representative Henry A. Waxman, Democrat of California and chairman of the House Committee on Oversight and Government Reform, in a hearing this month.

These accounting questions are of interest not only because taxpayers are footing the bill at A.I.G. but also because the post-mortems may point to a fundamental flaw in the Fed bailout: the money is buoying an insurer — and its trading partners — whose cash needs could easily exceed the existing government backstop if the housing sector continues to deteriorate. Edward M. Liddy, the insurance executive brought in by the government to restructure A.I.G., has already said that although he does not want to seek more money from the Fed, he may have to do so.

Fear that the losses are bigger and that more surprises are in store is one of the factors beneath the turmoil in the credit markets, market participants say. “When investors don’t have full and honest information, they tend to sell everything, both the good and bad assets,” said Janet Tavakoli, president of Tavakoli Structured Finance, a consulting firm in Chicago. “It’s really bad for the markets. Things don’t heal until you take care of that.”

A.I.G. has declined to provide a detailed account of how it has used the Fed’s money. The company said it could not provide more information ahead of its quarterly report, expected next week, the first under new management. The Fed releases a weekly figure, most recently showing that $90 billion of the $123 billion available has been drawn down. A.I.G. has outlined only broad categories: some is being used to shore up its securities-lending program, some to make good on its guaranteed investment contracts, some to pay for day-to-day operations and — of perhaps greatest interest to watchdogs — tens of billions of dollars to post collateral with other financial institutions, as required by A.I.G.’s many derivatives contracts.

No information has been supplied yet about who these counterparties are, how much collateral they have received or what additional tripwires may require even more collateral if the housing market continues to slide. Ms. Tavakoli said she thought that instead of pouring in more and more money, the Fed should bring A.I.G. together with all its derivatives counterparties and put a moratorium on the collateral calls. “We did that with ACA,” she said, referring to ACA Capital Holdings, a bond insurance company that filed for bankruptcy in 2007.

Of the two big Fed loans, the smaller one, the $38 billion supplementary lending facility, was extended solely to prevent further losses in the securities-lending business. So far, $18 billion has been drawn down for that purpose. For securities lending, an institution with a long time horizon makes extra money by lending out securities to shorter-term borrowers. The borrowers are often hedge funds setting up short trades, betting a stock’s price will fall. They typically give A.I.G. cash or cashlike instruments in return. Then, while A.I.G. waits for the borrowers to bring back the securities, it invests the money.

In the last few months, borrowers came back for their money, and A.I.G. did not have enough to repay them because of market losses on its investments. Through the secondary lending facility, the insurer is now sending those investments to the Fed, and getting cash in turn to repay customers. A spokesman for the insurer, Nicholas J. Ashooh, said A.I.G. did not anticipate having to use the entire $38 billion facility. At midyear, A.I.G. had a shortfall of $15.6 billion in that program, which it says has grown to $18 billion. Another spokesman, Joe Norton, said the company was getting out of this business. Of the government’s original $85 billion line of credit, the company has drawn down about $72 billion. It must pay 8.5 percent interest on those funds.

An estimated $13 billion of the money was needed to make good on investment accounts that A.I.G. typically offered to municipalities, called guaranteed investment contracts, or G.I.C.’s. When a local government issues a construction bond, for example, it places the proceeds in a guaranteed investment contract, from which it can draw the funds to pay contractors. After the insurer’s credit rating was downgraded in September, its G.I.C. customers had the right to pull out their proceeds immediately. Regulators say that A.I.G. had to come up with $13 billion, more than half of its total G.I.C. business. Rather than liquidate some investments at losses, it used that much of the Fed loan.

For $59 billion of the $72 billion A.I.G. has used, the company has provided no breakdown. A block of it has been used for day-to-day operations, a broad category that raises eyebrows since the company has been tarnished by reports of expensive trips and bonuses for executives. The biggest portion of the Fed loan is apparently being used as collateral for A.I.G.’s derivatives contracts, including credit-default swaps.

The swap contracts are of great interest because they are at the heart of the insurer’s near collapse and even A.I.G. does not know how much could be needed to support them. They are essentially a type of insurance that protects investors against default of fixed-income securities. A.I.G. wrote this insurance on hundreds of billions of dollars’ worth of debt, much of it linked to mortgages. Through last year, senior executives said that there was nothing to fear, that its swaps were rock solid. The portfolio “is well structured” and is subjected to “monitoring, modeling and analysis,” Martin J. Sullivan, A.I.G.’s chief executive at the time, told securities analysts in the summer of 2007.

By fall, as the mortgage crisis began roiling financial institutions, internal and external auditors were questioning how A.I.G. was measuring its swaps. They suggested the portfolio was incurring losses. It was as if the company had insured beachfront property in a hurricane zone without charging high enough premiums. But A.I.G. executives, especially those in the swaps business, argued that any decline was theoretical because the hurricane had not hit. The underlying mortgage-related securities were still paying, they said, and there was no reason to think they would stop doing so.

A.I.G. had come under fire for accounting irregularities some years back and had brought in a former accounting expert from the Securities and Exchange Commission. He began to focus on the company’s accounting for its credit-default swaps and collided with Joseph Cassano, the head of the company’s financial products division, according to a letter read by Mr. Waxman at the recent Congressional hearing. When the expert tried to revise A.I.G.’s method for measuring its swaps, he said that Mr. Cassano told him, “I have deliberately excluded you from the valuation because I was concerned that you would pollute the process.”

Mr. Cassano did not attend the hearing and was unavailable for comment. The company’s independent auditor, PricewaterhouseCoopers, was the next to raise an alarm. It briefed Mr. Sullivan late in November, warning that it had found a “material weakness” because the unit that valued the swaps lacked sufficient oversight. About a week after the auditor’s briefing, Mr. Sullivan and other executives said nothing about the warning in a presentation to securities analysts, according to a transcript. They said that while disruptions in the markets were making it difficult to value its swaps, the company had made a “best estimate” and concluded that its swaps had lost about $1.6 billion in value by the end of November.

Still, PricewaterhouseCoopers appears to have pressed for more. In February, A.I.G. said in a regulatory filing that it needed to “clarify and expand” its disclosures about its credit-default swaps. They had declined not by $1.6 billion, as previously reported, but by $5.9 billion at the end of November, A.I.G. said. PricewaterhouseCoopers subsequently signed off on the company’s accounting while making reference to the material weakness. Investors shuddered over the revision, driving A.I.G.’s stock down 12 percent. Mr. Vickrey, whose firm grades companies on the credibility of their reported earnings, gave the company an F. Mr. Sullivan, his credibility waning, was forced out months later.

Through spring and summer, the company said it was still gathering information about the swaps and tucked references of widening losses into the footnotes of its financial statements: $11.4 billion at the end of 2007, $20.6 billion at the end of March, $26 billion at the end of June. The company stressed that the losses were theoretical: no cash had actually gone out the door. “If these aren’t cash losses, why are you having to put up collateral to the counterparties?” Mr. Vickrey asked in a recent interview. The fact that the insurer had to post collateral suggests that the counterparties thought A.I.G.’s swaps losses were greater than disclosed, he said. By midyear, the insurer had been forced to post collateral of $16.5 billion on the swaps.

Though the company has not disclosed how much collateral it has posted since then, its $447 billion portfolio of credit-default swaps could require far more if the economy continues to weaken. More federal assistance would then essentially flow through A.I.G. to counterparties. “We may be better off in the long run letting the losses be realized and letting the people who took the risk bear the loss,” said Bill Bergman, senior equity analyst at the market research company Morningstar.

Ron Paul : Spending the Economy into Oblivion
Statement from Congressman Ron Paul's texas straight talk for October 27, 2008. Congressman Ron Paul said:

With news this week that Congress is poised to consider a new stimulus package, I am forced to again ask a question that seems silly in Washington:  How will we pay for this? While a few Members of Congress have raised the issue, it certainly was not the primary concern of the House Budget Committee when they interviewed Ben Bernanke on Monday.  And, when they did direct this question to the Chairman of the Federal Reserve, his answer was the standard rhetoric about how Congress needed to make tough choices.  Needless to say, not many specifics were discussed.

One of the most liberal members of the House, Barney Frank, has at least volunteered something of a suggestion: “We can let Iraq take care of itself.”  This, of course, goes in the right direction, but hardly far enough. We need to declare the facts and their obvious consequences.  The deficit of the United States is now spiraling out of control, and the recent bailout package has only made it worse.  Our crushing federal debt is one key reason behind our current economic turbulence.

As Congress begins to consider the third “stimulus package” of the year, we need to realize it is time to start setting priorities.  Priority number one should be cutting spending in foreign countries. This does not simply mean Iraq, but everywhere. The next stimulus package is likely to include money for infrastructure.  While these investments are, constitutionally speaking, supposed to be made by state and local governments, it is not likely that Congress will suddenly begin to pay heed to the document we are all sworn to uphold.  Still, we need to acknowledge the fact that the current Congress and Administration are rushing the nation toward bankruptcy.

This being the case, we could hope they would at least come to their senses regarding our debt and foreign spending sprees.  Our nation’s foreign-held debt is at record highs and moving ever higher.  Continuing to borrow money from Red China and others in order to pay “dues” to the United Nations and run “Plan Colombia” makes no sense at all.

Our whole carrot-and-stick approach to foreign policy makes no sense.  The US government simultaneously gives money to Israel, and to Egypt.  We send AIDS money to Africa while AIDS clinics in America shut down.  “Millennium challenge” funding goes to countries which enact “market based reforms” as we push our own country further and further into a centrally planned economy.

Economic recovery will only come through financial prudence, savings and getting back to producing things of value again.  But it seems to be a foregone conclusion that we are about to enact another government initiative to “stimulate the economy.” Instead, there should be some serious talk about cutting all of these foreign giveaway programs.  But, alas and again, we should not hold our breath.  Congress is still not close to being serious about ending its addiction to debt and spending, and is again faced with the deadly temptation to attempt to spend us out of a recession.  We should not forget that in the 1930’s those types of efforts gave us the Great Depression. 

Environment Faces Its Own 'Credit Crunch'
With the world's press focusing on financial market turmoil, environmentalists are trying to tap the zeitgeist, using financial terminology to draw people's attention. The latest "Living Planet Report," issued by the WorldWide Fund for Nature (known as the World Wildlife Fund in North America) every two years, is replete with financial terms to describe the alarming conditions of the environment. From "environmental crunch" to "ecological capital," the report, released on Wednesday, said human beings are treating the environment "in the same way financial institutions have been behaving."

“We are acting ecologically in the same way as financial institutions have been behaving economically--seeking immediate gratification without due regard for the consequences,” said Jonathan Loh, co-editor of ZSL, which compiles the report's backbone, its Living Planet Index. “The consequences of a global ecological crisis are even graver than the current economic meltdown.”

The Living Planet Index showed a nearly 30.0% decline since 1970 in nearly 5,000 measured populations of 1,686 species. "These dramatic losses in our natural wealth are being driven by deforestation and land conversion in the tropics and the impact of dams, diversions and climate change on freshwater species," the WorldWide Fund for Nature declared. It blamed pollution, overfishing and destructive fishing in marine and coastal environments as partly responsible for the ecological deterioration that has led to species loss.

Still, WWF campaigners believed the figures by themselves were not enough to raise people's awareness of the urgency of the problem. "We need desperate attention on this issue because it is potentially more damaging. Hence the financial reference," Dax Lovegrove, head of business and industry relations at WWF-UK, told "We need to bring equal focus not only to the abuse of financial capital but also [to] the abuse of natural capital, which we are damaging pretty quickly."

So quickly, in fact, that the Fund issued a pointed warning about resource depletion. “Most of us are propping up our current lifestyles, and our economic growth, by drawing--and increasingly overdrawing--on the ecological capital of other parts of the world,” said James Leape, director general of WWF International. “If our demands on the planet continue to increase at the same rate, by the mid-2030s we would need the equivalent of two planets to maintain our lifestyles.”

Arctic ice thickness 'plummets'
The thickness of Arctic sea ice "plummeted" last winter, thinning by as much as one-fifth in some regions, satellite data has revealed. A study by UK researchers showed that the ice thickness had been fairly constant for the previous five winters. The team from University College London added that the results provided the first definitive proof that the overall volume of Arctic ice was decreasing. The findings have been published in the journal Geophysical Research Letters.

"The ice thickness was fairly constant for the five winters before this, but it plummeted in the winter after the 2007 minimum," lead author Katharine Giles told BBC News. Sea ice in the Arctic shrank to its smallest size on record in September 2007, when it extended across an area of just 4.13 million sq km (1.59 million sq miles), beating the previous record low of 5.32 million sq km, measured in 2005. The team from the university's Centre for Polar Observation and Modelling - part of the UK's National Centre for Earth Observation - found that last winter the ice had thinned by an average of 10% (26cm/0.9ft) below the 2002-2008 winter average.

Dr Giles added that the data also showed the western Arctic experienced the greatest impact, where the ice thinned by up to 19% (49cm/1.6ft). The recent record losses of ice cover in the Arctic has led to suggestions that the region could have reached a "tipping point" but some uncertainty over the causes had remained, explained co-author Seymour Laxon. "The extent can change because the ice can be redistributed, increasing the amount of open water," he told BBC News. "But this does not reduce the overall amount of ice."

"To determine whether the reduction in sea ice extent is the result of ice being piled up against the coast or whether it is the result of melting, you need to measure the thickness." "I think this is the first time that we can definitively say that the bulk overall volume of ice has decreased," observed Dr Laxon. "So this means melting; it doesn't mean that the ice has just been pushed up against the coastline."

Dr Giles explained that the measurements gathered by satellite provided a continuous data-set and had a number of advantages over other methods. "Drilling, submarines or aircraft; all of these techniques can be limited by time and space," she said. "You can only sample relatively small areas, and you cannot have a continuous time series - it's a very harsh environment, so field experiments in winter are logistically difficult." "We have been using satellite data, which means we get coverage all across the Arctic Ocean (apart from the very centre) and we get it continuously, so we have great coverage both in terms of time and area."

The measurements were recorded via a radar altimeter onboard the European Space Agency's (Esa) Envisat satellite.
The altimeter fires pulses of electromagnetic waves down on to the ice, which reflects them back up to a receiver on the satellite. The time taken for the waves to complete this journey is recorded, and it is a fairly straightforward calculation to work out the height of the ice above sea level. As one tenth of the ice sits above the water, it is then possible to work out the overall volume and thickness of ice in that location.

Dr Laxon said the project's findings are being used to help climate modellers refine their projections of what is going to happen in the future. "The time when Arctic sea ice is going to disappear is open to a lot of debate," he said. "About five years ago, the average projection for the sea ice disappearing was about 2080. "But the ice minimums, and this evidence of melting, suggests that we should favour the models that suggest the sea ice will disappear by 2030-2040, but there is still a lot of uncertainty." The researchers hope to keep the data series, funded by the EU and the Natural Environmental Research Council (Nerc), running for as long as satellite-based measurements are available.

I might have to rely on a vice-president that I select for expertise on economic issues


Unknown said...

>Credit default swaps are used to bet against -or in favor of- a company’s value. If traders think the numbers published don't add up, they'll say so with their money. In a world replete with moonlight-and-roses statements built in a swamp of slippery quicksand, they are a formidable instrument for truth-finding.

The trouble with relying on CDS to set a "true" value is that there is no requirement that I actually pay off. I form 100 shell corporations. Each sells CDS in a different company. One company goes bankrupt. That shell corp. declares bankruptcy and every one else keeps making money selling CDSs. The Madame Mombasa mud hut in Malaysia problem in other words.

Ilargi said...

There are plenty issues with CDS, but that's not the point. What is is that the alternatives for valuation are much worse. The system is rotten to the core.

Unknown said...


The Dow and particularly the TSX are booming up a storm the last few days. Rallies are not unexpected, of course, in the large downward trend, but have you any thoughts on what's driving this particular upswing? I can't put my finger on what happened this week that would've caused such a jump (I don't think the Fed rate cut accounts for it, really).

Anonymous said...

This was my rude wake-me-up today, courtesy of the inimitable Peter Schiff:
Reality Dawning...For Gold

In the third weekend of November, leaders of the G-20 nations will assemble in Washington for urgent economic talks. There may even be calls for a new Breton Woods... It is likely that a major debasement of all currencies will be undertaken to rescue the global economy and with it, the world’s politicians. As this proposal gathers momentum, gold is likely to explode in price.

However,... politicians the world over are likely to create international rules designed to preclude the holders of gold from making “windfall profits.”

Therefore, holders of gold should renew their efforts to ensure their holdings of gold are as isolated as possible from the long, greedy arm of the law.

Yeeowch! Right. No coffee: I'm awake now.

We'd heard rumors that a currency devaluation and/or default might be necessary in summer 2009, but this is a much faster schedule. A coordinated devaulation decision in late November -- true, false, odds-on bet? And are private gold holdings really at risk of confiscation if the devaluation goes through? Appreciate your thoughts on this!

Reluctant Poseidon Hamster

Ilargi said...


I have talked about that quite a bit.

A large part is due to to investors having to cover their shorts. A single rumor can now send stocks swinging all over, pun intended. People buy if and when they have to buy, far more than because they want to. That said, it'll drag in and down many suckers as well.

Unknown said...

I don't think we've yet reached the levels of public paranoia and destitution that would allow a forceful change of the monetary system... everything right now that can be done to feebly hold on the status quo is dutifully being done. Central bankers are still in the denial stage of trauma psychology.

Anonymous said...

BRILLIANT POST! I just wish you would write more, Ilargi, as I hang on and relish every word.

If this were a film, it would've been written and directed by Woody Allen. It's like a twisted global version of CRIMES AND MISDEMEANORS, with a touch of Renoir's THE RULES OF THE GAME. Men acting like children, but in this case destroying the world and not getting in trouble for doing it.

Unknown said...


Thanks. Yes, I noticed you talking about hedge funds covering their shorts on the VW stock event... I don't have a good idea of how much of that is going on and to what extent it can influence the overall index, I suppose.

bluebird said...

ilargi - you've mentioned about hedge funds covering their shorts, and the center cannot hold.

Seems to me that Goldman Sachs is in the middle of things, Paulson and Bernanke too. And most of the banks are hanging by a thread. It's all so fragile.

el gallinazo said...

Anon 2:59

The only thing inimitable about Peter Schiff is that even the Wall Street lemmings are having a hard time keeping up with his ability to lose his clients' money. I like to listen to his Wednesday night stream just to hear him whine that reality is not concurring with his flawless analysis. Maybe he was Dan W's Spock in a past life :-)

Anonymous said...


Who will buy the treasury notes?

The only way is the buyers must print more money. This creates more world wide debt. Which requires more financing, requiring more money to be printed, requiring more money to be printed.....AARRRGGG!!!

The coming meeting will be a discussion of the details for declaring a world wide bankruptcy!!

The mother of all CDS auctions is coming!!

DD (Dooms Day)

Anonymous said...

Just to add to the case it was missed from October 26th;

Lies and Audiotape: Morgan Chase Exec Brags Bailout Is for Takeovers, Restructuring, Not Lending (EIR)

Anonymous said...

It strikes me that we are currently involved in a multi-tiered crisis.

On the one hand, as Ilargi points out, there is a "crisis" of trust. Regardless of all of the moves by the FED, et al., everyone knows that everyone else could be lying about their "assets" because (a) those "assets" are hidden from view and (b) there is no objective 3rd party fair valuation.

There is also a crisis of DEBT in general, as basically ALL financial institutions are leveraged to the hilt.

There is ALSO a crisis of legitimacy, because now that Dictator Paulson has the power of life and death over not only banks but ALL institutions, the decision as to who lives and dies is no longer subject to any market forces.

And finally, there is the crisis of FRACTION RESERVE BANKING as a global economic system whose time has come. The world has finally come to the point where growth via debt is simply no longer sustainable. Additionally, there is a growing groundswell of vocal disgruntlement with a system that rewards usurious lenders, whilst punishing the rest of us.

The different layers of this crisis overlap in some places, but not in others. Fix one, and you exacerbate another. Open the vaults and show the people just how corrupt and dishonest the banks have been and are, and risk a true revolutionary movement to try and topple the system. DON'T open the vaults and continue to lie and know that eventually the economy and monetary system collapses completely.

Anonymous said...

For a good, in-depth discussion of how credit default swaps work, check out Specious Riches' explanation. There are some good tables showing that Detroit's Big 3 automakers have drunk deeply of the CDS Kool-Aid, which makes Ilargi's prediction of some automaker bankruptcies quite significant.

Anonymous said...
Cash was very much king. the first part is very relavent to the likes or rumor.

Deflation then was an affair of a collapse in more esoteric M3-style money, into the more concrete M2, M1, M0.

Regarding today's musings on the ironic use of CDS as mark-to-market, the situation will last until some innovative way of gaming these is found.

Unknown said...

With the exception of how much money a company has in the bank, every number on the balance sheet is an accounting convention. It's fair to say that CDSs provide the best alternative for valuation. I was objecting to any pretense that they provide "The Truth".

Anonymous said...

Ah, correction: the commentary Reality Dawning...For Gold was written by John Browne, not Peter Schiff as I first thought.

The only thing inimitable about Peter Schiff is that even the Wall Street lemmings are having a hard time keeping up with his ability to lose his clients' money.

Really? I don't invest with him, just noticed that he does some good interviews. Pollyannas fare badly against him. Makes me say, e.g., "Yeah, Peter, talk that leverage _smack_ at the buy-monkey!" :-)

But anyway, it was Browne's warning of a potential synchronized currency devaluation and gold confiscation that frazzled me this morning. Is anyone else hearing about such a move?

Reluctant Poseidon Hamster

Anonymous said...


Thanks for the shout-out. I have another article on CDS and AIG posting tomorrow morning.

Anyone notice Hartford Insurance Grp today? There will be other insurers that follow them into the abyss. And the hedgies? They wrote more CDS in 2006 than the insurers... since they are lightly regulated, they haven't been forced to show their hands, but you can bet there is more ugliness to come from the hedgefund space.



el gallinazo said...

Anon 6:30

Schiff has put must of his clients' money into Asian equities, particularly the Hong Kong and Shanghai exchanges. Also big on gold mining stocks and paper Australian gold. Anything to keep his clients' money out of USD. You crunch the numbers.

He does do a good interview because he is totally bearish on Wall Street, so he sounds on top of the game. His problem is that he is batshit bullish on everything else, especially Asia.

Anonymous said...

Can someone help me out on this one?
In the UK, when inflation went to 4% the gvnr of the BoE said that the 2% above target was largely/wholely the result of higher oil prices.
When/if? eventually, inexorably, falling supply of oil trumps falling demand, does this mean that oil prices will rise again and therefore inflation will rise?
I'm trying to evaluate the relative impact and gradient/timing of inflation due to resource constraints (i.e too much money chasing too few goods) vs the years of recession/depression discussed here.
If higher oil prices were, as has been suggested, the straw that broke the Ponzi's back, will they also trigger a hyperinflationary phase in the near future if the guys at the TOD are accurate in their remaining resource predictions?
If this is a naive question, apols, pls point me to a suitable econ 101 or the right end of the stick!

Anonymous said...


It's amazing how insidious the infection of CDS really is. It's like the Earth has a heartworm infection, and the only way to cure it is to untangle all of the parasitic tentacles, one by one. Meanwhile, OF COURSE, the last thing anyone wants to do is come clean...have their part in this crime-of-the-century exposed for all to see.

el gallinazo said...

Solution to the CDS quagmire

All the major government invalidate all CDS's except those actually covering their insured bonds and those bonds must be proven to be owned by the same party that owns the CDS at the time it was taken out. All premiums for invalidated CDS's must be returned.
Of course it won't happen.

Major mystery of the universe dept.

If Da Boyz set up this catastrophe a la Naomi Klein in order to buy up everything for pennies, why are all the central bankstas going batshit to try to stop deflation? ( One plausible answer to this which would cover all the bases is that they know their attempts to halt deflation will fail, but it's a plausible excuse for transferring private losses to the public.)

Stoneleigh said...

Anon @6:28,

When/if? eventually, inexorably, falling supply of oil trumps falling demand, does this mean that oil prices will rise again and therefore inflation will rise?

I'm trying to evaluate the relative impact and gradient/timing of inflation due to resource constraints (i.e too much money chasing too few goods) vs the years of recession/depression discussed here.

Rising prices do not constitute inflation. Inflation is an increase in the money supply relative to available goods and services, of which rising prices can be a lagging symptom.

Eventually, as you say, falling oil supply will trump falling demand, but we're nowhere near that point yet. Although IMO we have much further to go in the falling demand path, as purchasing power has vastly further to fall, we will soon start to see the impact on supply, as lower oil prices cause projects to be abandoned as uneconomic. That is the beginning of what will eventually become a supply collapse.

Many high cost projects will not proceed in a capital-scarce environment where oil prices are low. Exploration will grind to a halt for lack of viable financing, and infrastructure such as pipelines will not be built. The financial risks will simply be too high, meaning that we will not be developing the smaller fields that might have cushioned the downslope of Hubbert's curve. This is phase one, where falling demand would still be the dominant factor and developing energy scarcity would be largely masked.

Phase two would involve the impact of much more severe economic dislocation on supply. Here we would see the impact of increased physical risk in addition to financial risk. Among private individuals and small organizations, there will be many aggrieved parties with little to lose who may decide to wantonly destroy infrastructure, and many others bent on piracy for profit. at a state level, there is likely to be a resource grab that will see oil supplies either tied up in bilateral contracts or actively fought over.

IMO this will spell the end of oil as a fungible commodity available on a global market, as its strategic connection to hegemonic power will become much more evident. States will become much more involved in the energy sector, both as a result of private capital fleeing from risk and as a naked power grab.

Initially oil prices fall with demand, but as supply is hit and fungibility disappears, prices may well become very volatile - varying greatly in both space and time. Oil may simply not be available at any price in many places, while in others availability could be sporadic and prices would be very high. In luckier places availability may be maintained, but prices could still fluctuate wildly.

Energy affordability should be less everywhere than it is now though, even if prices are nominally lower in some areas, as purchasing power will be falling faster than price. The prices of essentials such as energy and food should fall less far than most other things however, as a much larger percentage of a much smaller money supply will be chasing them, and thereby lending a measure of price support even in the midst of a liquidity trap.

Ordinary people are destined to be priced out of the market almost entirely at some point, which will have a tremendous impact on societies structurally dependent on cheap energy. Unfortunately, adaptability, other than by pure deprivation, is very low where such dependencies have been created and entrenched.

Eventually, we will transition from a world where oil prices are simultaneously lower but less affordable (ie lower in nominal terms but higher in real terms where the change in the money supply is accounted for) to one where they are much higher (ie higher in nominal terms which would mean going through the roof in real terms). Trying to build economic recovery under such circumstances will be somewhere between extremely difficult and virtually impossible, and when some kind of recovery does eventually emerge - probably from the ashes of a great war - we won't be returning to our complex and energy-intensive societies of the present. Those days are gone permanently, along with the once-in-a-planet's-lifetime energy subsidy upon which they were built.

If higher oil prices were, as has been suggested, the straw that broke the Ponzi's back, will they also trigger a hyperinflationary phase in the near future if the guys at the TOD are accurate in their remaining resource predictions?

I disagree that oil prices were the trigger. Market manias and crashes, which have occurred repeatedly in the past before the age of oil, have their own internal dynamic. Credit hyper-expansions are inherently self-limiting as debt cannot continue to be created ad infinitum. The debt becomes unserviceable and the pyramid of IOUs collapses. The difference this time is that the whole world has been sucked into the largest such Ponzi scheme ever through globalized financial markets and the advent of derivatives (ie leveraged layers of 'financial innovation').

I do think hyperinflation is a distinct probability once the international debt financing model, and thus the power of the bond market, is well and truly broken. We're not there yet though, and even when we do reach that point, attempts to inflate will have to overcome the cash-hoarding mentality that has taken hold due to lack of trust.

Ilargi said...

anon 6.28

" When/if? eventually, inexorably, falling supply of oil trumps falling demand, does this mean that oil prices will rise again and therefore inflation will rise?"

There is no inflation in the west, only rising prices in selected fields. With $30 trillion gone from equity markets alone in the past year, there certainly isn't "too much money" either.

"If higher oil prices were, as has been suggested, the straw that broke the Ponzi's back..."

Whoever makes any such suggestion doesn't know what they're talking about. Peak oil has no influence whatsoever on the collapsing financial markets.

There are plenty in the peak oil field trying to fit square pegs in round holes, but that doesn't make it true. They simply refuse to see, and can't stand the fact that they have failed to understand.

Bev said...

Naomi Klein's explanation: The Bailout: Bush's Final Pillage

Unknown said...


Thanks again for the most recent commentary this morning. I know it must get tiresome repeating things from time to time, but on the other hand, that's really the only way to continue to spread awareness. There's another donation coming your way this month from me. Keep up the good work. I can't thank you two enough for opening my eyes over a year ago (boy, time really flies...) and ensuring that I'm already much better prepared for the debt crisis.

Anonymous said...

Many thanks for your gentle responses and clear explanations. From what I have read I don't think that TOD are suggesting that peak oil per se caused the financial collapse (banks are perfectly capable of doing that by themselves!) but rather that the high oil prices over the last year disproportionally hit the sub-primers as they spent more money on essentials, less on luxuries, and pushed them over the edge. It would have happened sooner or later though I agree and it's largely academic now, we are where we are.

On another tack - do you have any truck with predictive linguistics?

I don't know if it's a stopped clock telling the right time twice a day syndrome but some of the calls made on urban survival have been pretty accurate. Think he defers/refers to you two quite often.

Many thanks for taking the time out to unmuddy the waters, it's really appreciated.

I'll reciprocate (in a new age barter style) if you're ever stuck with your organic chemistry!

Cheers Countryslicker

Anonymous said...

Naomi Klein says:

"...What, then, is the real purpose of the bailout...Remember, the main concern among big market players, particularly banks, is not the lack of credit but their battered share prices. Investors have lost confidence in the honesty of the big financial players, and with good reason...By purchasing stakes in these financial institutions, Treasury is sending a signal to the market that they are a safe bet...If [these companies] get themselves into trouble, investors will now assume that the government will keep finding more cash to bail them out..."

This is interesting. I can't say that I disagree with her thesis, though I somehow feel uneasy about Klein's assertion that (a) the Treasury will continue to have access to UN-funny money that they can use to prop up the chosen few, and her leaving out a couple of pieces namely (1) that there is an incipient anti-US movement among the nations of the world who will do everything in their power to NOT let "democratic capitalism" continue to do that voodoo that is has done so...well..., and (2) that the FED's pumping TRILLIONS of dollars of DEBT into propping up certain corporations will only exacerbate the current leverage debacle.

Anonymous said...

from iTulip:

"...I run various websites for people in foreclosure and whatnot. Until just a month ago, it was lender policy not to grant a homeowner a modified loan unless the homeowner met certain criteria...Most loan mods fail. In that the homeowner fails to make the new payment also. So lenders were not eager to modify a loan and go through the expense and time, and have the borrower reneg. Well, as of about 3 weeks ago, this has all changed. Lenders are eager to modify any loan regardless of the probability that the homeowner will meet the new obligation. Most of the old loan mods failed. What chance do the new ones have, in this new "anything goes" climate? The US is dictating lender policy outright..."

Any thoughts?

Anonymous said...

"Volvo Truck Orders Decline 99.63 percent; Auto Industry Faces Crash in US,"

Mishe's Trend Analysis

Holy Batshit el pollo, that is one big egg to lay!

Anonymous said...

RE: my last post about loan mod.

Yves Smith | Oct 31, 2008
"...The problem is that banks are NOT making loan modifications as they did in the past. That is turn is due to securitization In the old days, including in the nasty (in the Southwest and Texas) housing bear market of the early 1990s, it was standard practice for banks to modify mortgages. That was not charity on the part of the bank but a cold-blooded economic calculation, that in the majority of cases, it would take a lower loss by changing mortgage terms than by foreclosing..."

I'm sorry. I'm lost here.

Anonymous said...

Gulf Citizens Beg for Bailout as Stock Rout Signals End of Boom

"Abdullah Hajeri led a march on the Emir's palace in Kuwait this week, demanding the oil-rich nation's ruler stop stocks from plunging. Adnan Mohammed Saleh, down the Persian Gulf coast in Dubai, said he wants more government protection from the global financial crisis."


Farmerod said...


Mish has updated his blog and the Volvo story is further down. The stuff on top was all about pensions, including those in Canada. That is spooky stuff. I'm guessing Canada will allow companies to extend their payment schedule on insolvent plans to the 10 years that they requested a few years ago. Right now companies have to at least get a letter of credit from a bank to guarantee the missing contributions but I suspect that the gov't will go the extra step and simply say that they don't even have to get that, as long as they pro-rate the shortfall over a longer period. This may keep these companies solvent (in not having to dip further into revenue to support the plan) but it won't help the stock market itself in further limiting buying.

For those who have defined-benefit pensions, it is instructive to study the management discussion of pensions in the financial statements.

And plan/act accordingly.

Anyone who happened to take a commuted value around July of this year in Canada chose very wisely as long term interest rates were their lowest then.

Anonymous said...

Ilargi said: "Peak Oil has no influence whatsoever on the collapsing financial markets."

Ilargi, would you elaborate a bit on this?

I know that the bulk of the blame for the collapsing financial markets goes to the Federal Reserve's policies. However, some Peak Oil people have said that no economic growth is possible after we have passed Peak Oil (supposedly reached in summer of 2008, although maybe in 2005) because the global economy is based on cheap energy. So are they correct regarding no growth is possible after Peak Oil, but fail to understand that the present financial collapse is not due to Peak Oil?

The way I understand this (with help from TAE, of course) is that the Federal Reserve -- Greenspan and his cronies, Bush neocon regime, etc. -- carefully orchestrated this financial collapse so that there could be a transfer of wealth from "the people" to their selected elites prior to the anticipated economic or financial collapse that would have been naturally induced by Peak Oil. In other words, they wanted to act prior to the actual crisis so they could manipulate the outcome to their benefit. Moreover, they once again succeeded in granting dictatorial powers to themselves, to the Executive branch.

Please correct me if I'm not interpreting this right.


Anonymous said...

dan w if you are lost try Fredat itulip.

He says " no deflation" and then goes on to describe what I can only think of as deflation:

"You see crowded stores and low prices–crowded because the equilibrium price between the cost of goods that stores pay and prices that customers can afford creates only enough demand to support a small number of stores for the local population. But the people who live there experience the same stores as crowded but with high prices. Why? Because while the new equilibrium price for goods is now the same as before or maybe higher, but the purchasing power of consumers has fallen due to lack of access to credit and falling incomes.

Correct me if I am wrong but I think that is what all he had to say.

Ilargi said...

"Volvo Truck Orders Decline 99.63 percent; Auto Industry Faces Crash in US,"

Holy Batshit el pollo, that is one big egg to lay!

Those numbers were in a Debt Rattle quite a few days ago.

Ilargi said...

"So are they correct regarding no growth is possible after Peak Oil, but fail to understand that the present financial collapse is not due to Peak Oil?

.... a transfer of wealth from "the people" to their selected elites prior to the anticipated economic or financial collapse that would have been naturally induced by Peak Oil. "

Pretty good.

Ilargi said...

" That was not charity on the part of the bank but a cold-blooded economic calculation, that in the majority of cases, it would take a lower loss by changing mortgage terms than by foreclosing..."

I'm sorry. I'm lost here."

Dan, this is because the loans are not on the banks' books anymore these days, they were packaged into securities and sold in separate tranches.

In other words, they no longer own the loans, which makes it very hard or even impossible to modify them. All the government shouting about modifications needs to be seen in this light.

el gallinazo said...


Holy Batshit el pollo, that is one big egg to lay!

Is that comment in reference to my modest proposal regarding how to fix CDS's?

Anonymous said...

Ilargi wrote:
If higher oil prices were, as has been suggested, the straw that broke the Ponzi's back...

Whoever makes any such suggestion doesn't know what they're talking about. Peak oil has no influence whatsoever on the collapsing financial markets."

Agree and disagree. Agree that high oil prices last year were not catalyst for market selloff, though the crowded energy trade, (ironically influenced and extended by Peak Oilers), exacerbated a normal downtrade while SEC was changing rules and losing participants/liquidity under a tighter regulatory margin regime.

But I disagree that peak oil itself had nothing to do with this. I believe net energy per capita in OECD peaked sometime in last decade. When energy surplus declines in a world of fiat currency, at first it isn't noticed as such, as politicians can make up for lost energy gain (less affordability and availability of energy to average person) by penstrokes - offering better terms to middle/lower class (FNM/FHLMC no doc/low income loans), changing rules to allow more leverage and easy credit (repealing Glass-Steagel), etc. All the easy money, based on nothing biophysical, was a political response to a peak in cheap energy. The unwinding, and deleveraging of such, took many years to first unfold, but will continue to have domino impacts over time. As Stoneleigh observes, for now demand is dropping more than supply, but this is cementing in Peak Oil, and quite soon, the 'market will always average 10% a year' adherents will find that energy supply limits will preclude any economic rebound in the bud, despite monetary printing. Then, I suspect some nasty wars start not too far down the road.

Stoneleigh said...


For now demand is dropping more than supply, but this is cementing in Peak Oil, and quite soon, the 'market will always average 10% a year' adherents will find that energy supply limits will preclude any economic rebound in the bud, despite monetary printing.

Agreed. I think oil, and probably gold as well, will bottom early in this deflationary episode, and at substantially higher percentages of their former prices than most other assets.

IMO cheap energy was definitely a driver on the way up (although bubbles also happened before the age of oil, they never reached these heights of socioeconomic complexity), but the way down is more complicated. I wouldn't say peak oil was a driver at the moment, as internal market dynamics can account for the what we are seeing, but agree that the market collapse is casting the effects of peak oil in stone - setting an upper limit on any potential recovery and determining what degree of socioeconomic complexity we could hope to achieve in the future. I expect it to be drastically (and permanently) lower than it is at present.

I think war is a given as the great powers play out the energy endgame. I expect that to have a significant effect on global population, and to put that in context, events such as the WWWI, the Spanish flu and WWII were not extreme enough to do so. I would expect a population reduction at least comparable to Europe during the era of the Black Death, and potentially considerably higher, as biological models of overshoot and collapse would suggest.

Anonymous said...

el pollo,

No, not a bit of it! Thanks for being forthright and asking. The remark, of course, referred to the Volvo bit.


Thanks OC for mentioning Mish's update.

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