NightBlogger

Elizabeth MacDonald
Why not declare to the Federal Reserve that you and your family now face “unusual and exigent circumstances” and that you would now like to register with the government as “Home Sweet Home Bank”? Why not do it now, since the government’s escape hatch is going to splinter into smithereens soon, as the Treasury is now inviting congestion with an expansion of its rescue to include other nonbank financial institutions, such as insurers and specialty-finance companies. They, too, could get a bailout under the watery terms of the government’s $250 bn capital purchase program.

Sure, you’d be running through a very crowded door here, joining in a fellowship of juvenilia with the likes of GE Capital, GMAC, Chrysler Finance, Morgan Stanley, Goldman Sachs and American Express, now hanging out a bank shingle to put an extra snap in their wilted yellow suspenders with taxpayer money. And that means private banks and insurers like Allstate and MetLife, which own thrifts, could be joining you in line. So far, 52 financial institutions have reportedly received preliminary or final approval for about $172 bn of the $250 bn available under the government’s capital-infusion program, according to Keefe, Bruyette & Woods, with another 23 companies that have submitted applications for an additional $4.6 bn. More

SPIEGEL Staff
The world financial crisis has reached a new level. No longer limited to banks and companies, it is now spreading like wildfire and engulfing entire economies. It has reached Asia and Latin America, Eastern Europe, Iceland the Seychelles, the Balkan nation of Serbia and Africa’s southernmost country, South Africa. It is a development that has investors and speculators alike holding their breath. Some are pulling their money out of troubled countries, while others are betting on a continued decline — and in doing so are only accelerating the downturn. Central banks are desperately trying to halt the downward trend, but in many cases the plunge seems unstoppable.

At first, it seemed as if the crash could be limited to Iceland. But now countries like Ukraine, Pakistan and Argentina are proving to be almost as vulnerable as the small island nation in the North Atlantic. It seems as though another country is added to the growing list of nations on the verge of collapse almost daily. A national bankruptcy isn’t just some theoretical construct. Argentina experienced it in 2001 and Russia three years earlier. Germany has gone bankrupt twice in its more recent history, once in 1923 and the second time after 1945. A country has reached this final stage if, as a result of war or blatant mismanagement, it has gambled away all trust, can no longer service its debt or convince anyone to lend it any money, no matter how high an interest rate it promises to pay.

This is what is currently happening to Iceland. The central bank in the capital Reykjavik increased its prime rate by six points to 18 percent last week. Venezuela, where inflation is also high, is now offering 20 percent to stimulate interest in its government bonds. At the moment, however, investors are shying away from all risk. In the end, the rating agencies will have no choice but to downgrade the problem countries to their lowest level of creditworthiness. When that happens, lenders will have no choice but to write off much of their money. For citizens, national bankruptcy would probably lead to massive inflation.

The threshold countries, described until recently as “emerging” economies, are in for an especially rough ride. “The dream that they would be spared seems to have come to an end,” says Rolf Langhammer, vice-president of the Kiel Institute for the World Economy. Countries like Russia and Brazil owe their recent success in large part to the boom in commodities the world has experienced in recent years. But now prices for oil, copper, wheat and corn have plunged and a giant spiral of debt has begun to turn. The companies and banks that borrowed vast amounts of money abroad for their investments can no longer service their debt, and investors are pulling out their capital. As foreign currency becomes scarce and imports unaffordable, the currencies of these countries are losing value, which only increases the mountain of debt.

According to Stephen Jen, a currency specialist with the US bank Morgan Stanley, the flow of capital to threshold countries could drop by more than half — from the current level of €575 billion ($730 billion) to €230-270 billion ($292-343 billion) — if world economic growth drops to only 1 percent in 2009. The demise of these countries, says Jen, represents the new “epicenter of the global crisis.” The looming crisis has the countries in most dire need lining up for emergency loans from the International Monetary Fund (IMF). But all they are doing is buying time — a few weeks, or perhaps even months — and hoping that the general situation will soon improve.

The Ghost of Buenos Aires
Once the Argentine businessmen had transferred their dollars abroad, the second phase of the collapse began. The Argentine government froze all bank accounts, capping the maximum amount an accountholder could withdraw at only $250 (€198) a week. Small investors, those who had left their money in the banks, were the hardest hit. Tens of thousands of desperate citizens stormed the banks, and many spent nights sleeping in front of the automated teller machines. The last phase of the downturn began in the Buenos Aires suburbs. After consumption had dropped by 60 percent, young men began looting supermarkets. In December 2001, 40,000 people gathered on Plaza de Mayo in front of the Casa Rosada, the presidential palace. There, they banged pots and pans together day and night, until an unnerved President Fernando de la Rúa fled by helicopter.

The image of the fleeing president has burned itself into the collective memory of Argentineans. It marks the worst financial crisis of the last 100 years. De la Rúa’s successor allowed the peso to float free on the world currency-exchange markets after it had been pegged to the US dollar at a ratio of 1:1. Tens of thousands of small business owners, who had incurred debt when the peso was still pegged to the dollar, filed for bankruptcy. Unemployment quickly ballooned to 25 percent. Five presidents passed through the Casa Rosada in the space of two weeks, until Nestor Kirchner, a provincial governor until then, assumed the presidency in 2003. Kirchner informed the country’s international creditors that Argentina would not be able to repay its $145 billion (€115 billion) in foreign debt.

Is history repeating itself today?
Economic experts have been warning for months that Argentina is again heading toward national bankruptcy. Men are traveling to Uruguay once again with suitcases filled with cash. In the space of only three weeks, more than $700 million (€553 million) was withdrawn from Argentine bank accounts. Government bonds have lost more than half of their value. ATMs are no longer giving out more than 300 pesos, and inflation is running rampant.

The signs of looming national bankruptcy are plentiful, and bankers in the Uruguayan capital of Montevideo know them well. In late 2001, they were the first to see the coming crash in Argentina. Men traveled across the Rio de la Plata, from Buenos Aires to Montevideo, carrying suitcases filled with US dollars. They stood in long lines at the city’s banks, depositing the contents of their suitcases into accounts and safe deposit boxes there. Uruguay is South America’s Switzerland, a safe haven for money in times of crisis. No one asks about where the millions come from. More

John Sakowicz
Bohemian.com
How prime brokers paved the way for the biggest bank heist in history
Movies by Werner Herzog, Rainer Werner Fassbinder, Margarethe von Trotta, Volker Schlöndorff, Wim Wenders–you know the genre. Their movies are difficult and dense. Mostly, they are horrid. I hate these movies, but have never forgotten one. I make the comparison because Wall Street, like German New Wave cinema, has always featured heroes with impossible dreams or people with unique talents in obscure fields. And like German New Wave, the obsessiveness of Wall Street’s main characters has also always taken the place of plot. The plan of Wall Street’s hot shots has always been that there is no plan. People are on their own. God is absent. Truth is elastic. The important thing is to keep on pushing.

In the lives of these characters, whether from German New Wave or Wall Street, a lot is improvised. For both groups, life is lived in the theater of the ridiculous. In the Wall Street version, that materializes in statements such as “I am ridiculously rich” or “I am ridiculously lucky.” It’s generally the opposite for characters in German New Wave. In German New Wave movies, chickens often stand in for people. It’s too painful to watch a German New Wave movie without a little existential comic relief every now and then, and the directors know it. There are long shots of chickens on the beach, buried up to their necks in sand, as the tide comes in. Shots of dancing chickens. Hypnotized chickens. Cannibalistic chickens. Dwarves throwing chickens. Chickens talking to themselves. Chickens jumping off of cliffs.

Lately, the chickens have come home to roost on Wall Street. And like German New Wave cinema, the stories coming out of Wall Street this year are touched by the ridiculous, but more fundamentally Wagnerian in scope, influenced by operatic themes. Themes like character, ambition, greed, scandal, disgrace, bankruptcy, ignominy, shame and even justice. Yes, justice.

Bear Stearns Bust

On Thursday, June 19, the FBI made its first big bust since last summer’s subprime mess, the first big bust since the housing and credit crises that followed the subprime mess pushed our country into a recession. Hooray for the FBI. They busted hundreds of housing developers, mortgage lenders and brokers, lawyers, real estate agents and appraisers across the country, while two hedge fund managers on Wall Street were arrested in a separate but related case. (Incidentally, those two guys were referred to, but not named, in our May 28 article, “Secrets and Lies,” about Bear Stearns.)

FBI director Robert Mueller was quick to congratulate himself. “This dragnet operation is an example of our unified commitment to address a significant crime problem,” he told reporters. “The FBI will continue to direct its investigative and analytic resources toward the mortgage fraud and corporate securities fraud that threaten our nation’s economy.” Nice start, Bob.

The fact that the investigation is ongoing underscores that the problems on Wall Street are not isolated to even a few hundred bad apples. “These arrests make it clear that the causes of our credit problems are very broad-based and can’t be put at the feet of any one player,” Mark Zandi of Moody’s said at the same press conference. “It makes it clear that everyone was involved to one degree or another–from lender to investment banker to hedge fund manager–all the way from the bottom to the top.” You forgot to mention someone, Mr. Zandi. You too, director Mueller.

Prime brokers. The new masters of the universe. Among all their colleagues on Wall Street, it is the prime brokers who dream the most impossible dreams and who have the most unique talents in the most obscure fields. If Werner Herzog were to make a movie about Wall Street today, he would be looking into the face of the prime broker. I’m reading from a possible movie review: “The face of the prime broker has the quality of a dream–at once vivid, but vague; easy to touch, but beyond reach; at once scary like science fiction and ethereally lovely like a fantasy. It is a beautiful face, reflected in the eerie blue of a computer screen, but in the end, it is the last face you will see before the market crashes.”

So who are they, these prime brokers? These guys who print the new money in the shadow banking system? These guys who live for all that is unregulated and opaque? First of all, they are not regular people. “They are professional madmen,” said Warren Buffet in his famous 2005 speech to shareholders at Berkshire Hathaway. Except for Warren Buffet, nobody spoke up. Since Buffet’s speech, billions and billions of dollars, perhaps a trillion, were stashed in offshore accounts, as Wall Street managed its own fortune. (It’s a myth that Wall Street manages the fortunes of its clients. It does not. It serves itself the cake. We’re lucky if a few crumbs fall off the plate.) Let’s now break this silence, and with it the omerta of prime brokerage.

‘Unspoken Terror’

It all started innocently enough, generically enough. In the beginning, through the 1980s and ’90s, prime brokers were the guys at big investment banks like UBS, Morgan Stanley, Merrill Lynch, Goldman Sachs, Bear Stearns, Lehman Brothers, etc., who supported the nascent hedge fund industry with basic services. A hedge fund start-up–and there were thousands of them back in the ’80s and ’90s, as many as 8,000 at one time–usually bought a basic package from a prime broker. The core services in the package included global custody (clearing, custody and asset servicing; no problem, all plain vanilla); securities lending (especially for what’s called “naked short sales,” which is illegal); financing (facilitating the crazy extreme leverage at hedge funds, sometimes as high as 40-to-1); customized technology (providing hedge funds with reporting necessary to value positions and risk; this is where things started to get funky); and operational support (prime brokers became the hedge fund’s primary operations contact with all other members of the broker-dealer community, and oh, did this invite abuse).

It is easy to see how young hedge funds became so dependent on prime brokers. Prime brokers served as incubators for hedge fund hatchlings that were proliferating like so many baby chicks at a Tyson chicken farm. In addition to all the above services, prime brokers also provided what is quaintly called “value-added” services in the hedge fund industry, including capital introduction (introductions to the prime broker’s institutional clients and other possible investors, a blatant conflict of interest but nobody in Congress cared); office space leasing and services (read: free or discounted office space, replete with staff and support–a bribe for business? you bet); risk management advisory services (prime brokers advising hedge funds on the very same junk bonds they secretly wanted to dump on them); and something ambiguously called “consulting services” (often focused on how hedge funds could circumvent established regulatory requirements, usually by domiciling operations beyond the jurisdiction of U.S. law).

It got worse after 2000.

Introduce swaps and derivatives into the mix. Yeah, baby. Things suddenly got really interesting. Preserving the integrity of the balance sheet at hedge funds got thrown out the window as swaps and derivatives grew, including the exponential growth of something called “synthetic positions.”

“Synthetic” means fake, bogus, fixed, fraudulent. It’s that simple. Add to synthetic positions the liquidity of the first years of our decade as Alan Greenspan brought interest rates down to almost nothing, and you get the picture. In one year alone, from 2005 to 2006, the market for credit default swaps, just one product, grew from $12.4 trillion to $26 trillion.

Most markets are a zero-sum game, meaning there are an equal number of winners and losers. For every dollar someone makes, someone else loses a dollar. Prime brokers changed all that. Because prime brokers never lost. Prime brokers acting as the hedge fund industry’s only interface with the world (see “operational support,” above) were able to create a shadow banking system where the counterparties to any hedge fund’s trades were unknown, even to the hedge fund. Add to that opaqueness a lack of infrastructure where a lot of trades are unconfirmed or delayed, and there are the makings for greatest bank heist in history.

While the Federal Reserve Bank has since 1996 published reports on these obvious problems, it wasn’t until September 2005 that the Fed addressed what was termed the “unspoken terror” of settlement issues among prime brokers. Funny that it took two more years before Congress noticed. All it took to get their attention were last summer’s subprime mess, the blow-up at Bear Stearns and a country plunged into a recession.

Shadow Masters

Dreamers and those with unique talents in obscure fields are the folks who built the shadow banking system. They are the prime brokers. Like actors in a Werner Herzog movie, they inhabit a strange new world, one as big as the traditional banking system or bigger, but where there are no federally insured deposits and where shadow banks neither have nor want–or even need–access to short-term borrowing from the Fed or any other central bank during times of crisis. It’s a world where no risk is too great, where collateral isn’t necessary, where there are no capital requirements and where counterparties are never identified. Shadow banks are beyond the reach of law, are almost always found offshore and redefine the term “international crime organization.” Indeed, because shadow banks always make money, they would even profit from the collapse of the global financial system. They might even cause it to happen.

Prime brokers have been the new masters, no question about it. But their primacy may finally be threatened. “This bright new financial system–for all its talented participants, for all its rich rewards–has failed the test of the market place,” said Paul Volker, former president of the Federal Reserve, during a speech I attended in April. “It adds up to a clarion call for reform.” Two months later, at a press conference where I was also present, Timothy Geithner, president of the Federal Reserve Bank of New York, answered that call.

“The structure of the financial system changed radically during the boom, with dramatic growth outside the traditional banking system,” Geithner warned in his speech, adding that unregulated growth in opaque assets made the last crisis difficult to manage and could make a future crisis impossible to manage. And two weeks before the FBI busted those two guys at Bear Stearns, U.S. Treasury Secretary Henry Paulson said the Federal Reserve should “be allowed to collect information from large complex financial institutions.” He said, “Regulators should have a clear path toward figuring out how to intervene in a crisis and how to close a failed brokerage firm.”

Sounds like Paulson is expecting more trouble. If this were a New Wave German film instead of the banal horror of real life, someone would figure out that it must be time to pull out the chickens.
___________________________________________________________________________________
John Sakowicz is a Sonoma County investor who was a cofounder of a multibillion-dollar offshore hedge fund, Battle Mountain Research Group. Arianna Carisella contributed research to this article.

Naomi Klein
In the final days of the election, many Republicans seem to have given up the fight for power. But don’t be fooled: that doesn’t mean they are relaxing. If you want to see real Republican elbow grease, check out the energy going into chucking great chunks of the $700 billion bailout out the door. At a recent Senate Banking Committee hearing, Republican Senator Bob Corker was fixated on this task, and with a clear deadline in mind: inauguration. “How much of it do you think may be actually spent by January 20 or so?” Corker asked Neel Kashkari, the 35-year-old former banker in charge of the bailout.

When European colonialists realized that they had no choice but to hand over power to the indigenous citizens, they would often turn their attention to stripping the local treasury of its gold and grabbing valuable livestock. If they were really nasty, like the Portuguese in Mozambique in the mid-1970s, they poured concrete down the elevator shafts. Nothing so barbaric for the Bush gang. Rather than open plunder, it prefers bureaucratic instruments, such as “distressed asset” auctions and the “equity purchase program.” But make no mistake: the goal is the same as it was for the defeated Portuguese—a final frantic looting of the public wealth before they hand over the keys to the safe.

How else to make sense of the bizarre decisions that have governed the allocation of the bailout money? When the Bush administration announced it would be injecting $250 billion into America’s banks in exchange for equity, the plan was widely referred to as “partial nationalization”—a radical measure required to get the banks lending again. Treasury Secretary Henry Paulson had seen the light, we were told, and was now following the lead of British Prime Minister Gordon Brown.

In fact, there has been no nationalization, partial or otherwise. American taxpayers have gained no meaningful control over the banks, which is why the banks are free to spend the new money as they wish. At Morgan Stanley, it looks like much of the windfall will cover this year’s bonus pool. Citigroup has been hinting it will use its newfound $25 billion buying other banks, while John Thain, the chief executive of Merrill Lynch, told analysts that “At least for the next quarter, it’s just going to be a cushion.” The U.S. government, meanwhile, is reduced to pleading with the banks that they at least spend a portion of the taxpayer windfall for loans – officially, the reason for the entire program.

What, then, is the real purpose of the bailout? My fear is this rush of deal making is something much more ambitious than a one-off gift to big business; that the Bush version of “partial nationalization” is rigged to turn the U.S. Treasury into a bottomless cash machine for the banks for years to come. 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.

This is where Treasury’s equity pays off big time. By purchasing stakes in these financial institutions, Treasury is sending a signal to the market that they are a safe bet. Why safe? Not because their level of risk has been accurately assessed at last. Not because they have renounced the kind of exotic financial instruments and outrageous leverage rates that created the crisis. Rather, because the market will now be banking on the fact that the U.S. government won’t let these particular companies fail. If they get themselves into trouble, investors will now assume that the government will keep finding more cash to bail them out, since allowing them to go down would mean losing the initial equity investments, many of them in the billions. (Just look at the insurance giant AIG, which had already gone back to taxpayers for a top-up and seems set to ask for a third.)

This tethering of the public interest to private companies is the real purpose of the bailout plan: Paulson is handing all the companies that are admitted to the program—a number potentially in the thousands—an implicit Treasury Department guarantee. To skittish investors looking for safe places to park their money, these equity deals will be even more comforting than a Triple-A rating from Moody’s.

Insurance like that is priceless. But for the banks, the best part is that the government is paying them to accept its seal of approval. For taxpayers, on the other hand, this entire plan is extremely risky, and may well cost significantly more than Paulson’s original idea of buying up $700 billion in toxic debts. Now taxpayers aren’t just on the hook for the debts but, arguably, for the fate of every corporation that sells them equity.

Interestingly, Fannie Mae and Freddie Mac both enjoyed this kind of unspoken guarantee before the mortgage giants were nationalized at the start of this crisis. For decades the market understood that, since these private players were enmeshed with the government, Uncle Sam could be counted on to always save the day. It was, as many have pointed out, the worst of all worlds. Not only were profits privatized while risks were socialized but the implicit government backing created powerful incentives for reckless business practices.

Now, with the new equity purchase program, Paulson has taken the discredited Fannie and Freddie model and applied it to a huge swath of the private banking industry. And once again, there is no reason to shy away from risky bets—especially since Treasury has made no such demands of the banks. (Treasury, apparently, does not want to “micromanage.”)

To further boost market confidence, the federal government has also unveiled unlimited public guarantees for many bank deposit accounts. Oh, and as if this wasn’t enough, Treasury has been encouraging the banks to manically merge with one another, ensuring that the only institutions left standing will be “too big to fail,” thereby guaranteed of a bailout. In three different ways, the market is being told loud and clear that Washington will not allow the country’s financial institutions to bear the consequences of their behavior, no matter how reckless. This may well be Bush’s most creative innovation: no-risk capitalism.

There is a glimmer of hope. In answer to Senator Corker’s question, Treasury is indeed having trouble dispersing the bailout funds. So far it has requested about $350 billion of the $700 billion, but most of this hasn’t yet made it out the door. Meanwhile, every day it becomes clearer that the bailout was sold to the public on false pretenses. Clearly, it was never really about getting loans flowing. It was always about doing what it is doing: turning the state into a giant insurance agency for Wall Street—a safety net for the people who need it least, subsidized by the people who will most need state protections in the economic storms ahead.

This duplicity is a political opportunity. Whoever wins the election on November 4 will have enormous moral authority. It should be used to call for a freeze on the dispersal of bailout funds—not after the inauguration, but right away. All deals should be renegotiated immediately, this time with the public getting the guarantees.

It is risky, of course, to interrupt the bailout process. The market won’t like it. Nothing could be riskier, however, than allowing the Bush gang their parting gift to big business—the gift that will keep on taking.

Ilargi
The Automatic Earth
Wherever I look this morning, Asia, Europe, Wall Street, I see journalists and analysts claim that bargain hunters are causing the rising stock prices. They’re not. There is something different going on. Prices these days fall when and because large investors need to sell assets in order to get cash. Prices rise when large investors need to cover their shorts.

The investors involved in both cases are largely identical, though not entirely. It’s important to understand that while, obviously, price drops cause loss of capital, price rises are now the result of the same. Everybody still tries to hide their losses, but it’s getting much harder. That’s what happens in casino’s: there comes a point where you have to show your hand. And when things get bad, sometimes you have to show both.

After Porsche said it wanted 75% of Volkswagen, VW went up 150% yesterday, and 93% more today, to become the biggest company in the world. Not because it’s doing great; in fact, it’s rumored to be drowning. Which is why parties like Morgan Stanley, Goldman Sachs and major hedge funds were shorting the stock. Porsche’s announcement forced them to cover their shorts and buy VW like mad men. And so you get to be the global no.1 because gamblers are paying off their losses.

The Bank of England reports today that the total cost of taxpayer funded bail-outs has surpassed $7 trillion. As insane as that is, it’s just the start. Now even Roubini wants to add another $500 billion plan in the US. That’s his second whopping no-no in a week. His first was a claim that the worst in the credit markets was over, and the real problems would from now on in be in the real economy.

Yes, Libor and other spreads are down a bit, and yes, the real economy now hits the real trouble. But the credit markets are still getting worse by the minute. That is because the underlying reason for the crash, the casino toilet paper is still being hidden, protected and even bailed out. A plan like Roubini’s, half a trillion dollars more for ‘infrastructure’, is a dead in the water duck -or worse- as long as it’s kept away from daylight. And Roubini should know that.

Turns out, the banks that got the bail-out billions are not using it to lend out, and they don’t give a hoot about Congress threatening to give them a grilling. They’ll use the taxpayers’ cash to buy other banks. Small fish gets eaten by bigger fish gets eaten by biggest fish, with Hank Paulson deciding who gets to be big.

And even that’s just a humble beginning. The IMF is running out of money to put thumbscrews on the world’s poor. But that won’t deter the fund, it can simply start issuing AAA rated bonds, which are rated by the …. IMF, and in real life are simply more casino bathroom paper. And if you don’t like that one, they’ll move to the most perverted financial instrument in centuries, the Special Drawing Rights, also called paper gold, introduced in 1969, in anticipation of Nixon’s 1971 decision to not honor US gold liabilities.

Who do you think determines the value of an SDR? Yup, you’re right, it’s the IMF. They can buy the world. That may seem far-fetched, but don’t forget that for a few billion dollars in loans that have to be paid back at high interest, they’ve bought themselves financial control of the likes of Hungary, Iceland, the Ukraine and soon Pakistan, Serbia, Croatia, Latvia and Turkey. And their eye is on Russia.

I was wondering last night how much money it would have taken me to drive up oil prices to $147 a barrel, go short oil all out, drive prices back down to $40, make a killer of a profit, and kill off OPEC control, Putin and Venezuela in the process. I concluded that $1 trillion would have been enough, when carefully utilized.

I’ve long since realized that it’s no use to fear for the future of mankind, since there’s nothing kind about man. But I still am surprised at how little people focus on the symbiosis of crisis and opportunity. There are people out there busy bankrupting the entire planet, and buying it back for pennies. Just like in the 1930’s, but this time on a global scale. More

Jonathan Weil
(Bloomberg)
Why would a smart guy like Hank Paulson…advance such a dumb, shady plan? Let us count the reasons:

No. 1: It delays our national reckoning until after the presidential election.

Paulson first floated a bailout Sept. 18, at the very hour when shares of Goldman Sachs Group Inc. and Morgan Stanley looked like they might go into a death spiral. It’s not so much a bailout, as it is a timeout. He had to follow up with something, anything, to stop the freefall from resuming. It didn’t have to make sense.

So it doesn’t. The plan is about creating the illusion of stronger financial institutions, not strengthening them.

The banks know this. Otherwise, they would have stopped charging each other near-record rates for three-month loans by now. The reason they haven’t is because they’re still afraid their customers — other banks — might go broke.

No. 2: The reckoning will be worse than you can imagine.

If Paulson were serious about recapitalizing rickety U.S. banks, he would infuse them with hundreds of billions of dollars of fresh government money, in exchange for ownership stakes. And if he wanted to create market liquidity for all those troubled assets on their books, he would be ordering banks to disclose everything there is to know about them, so Mr. Market could figure out their present value.

He can’t let that happen. Not now. If everyone could see how much the toxic waste is worth, the writedowns would be so huge that many banks would have to be declared insolvent.

Better to let the next administration deal with the clean- up. The trouble is, the longer the government waits to address the banks’ lack of capital, the worse it gets, barring a miracle.

No. 3: He’s helping his friends.

Is there any doubt? Let’s see.

…Morgan Stanley Chief Executive John Mack owned 2.75 million shares of his company’s stock, valued at about $67 million. If Mack can get Morgan Stanley to trade reams of sketchy paper for billions of dollars of our Treasury’s cash, without diluting any of his stake in the company, who benefits? Paulson would have us believe it’s you. More

The International Forecaster
Let’s now take a look at the new financial landscape in the aftermath of the initial carnage of the derivative debacle and credit-crunch. We are left with the Fed as overseer of the Big Four. Who are The Big Four? First, there is JP Morgan Chase, which bagged and tagged Bear Stearns with help from the Fed and Treasury and which just rescued Washington Mutual, preventing the FDIC from being wiped out in by far the biggest bank failure in US history. Next is Bank of America, which went bonzai for toxic waste dumps Merrill Lynch and Countrywide in buyouts that are certain to come back to haunt them. Rounding out the pack are Goldman Sachs and Morgan Stanley, who just became bank holding companies, abandoning their investment bank status for the stability of a commercial bank, but with far less leverage. You can rest assured that Goldie and Morgan will now dump their toxic waste on the Fed through the Term Securities Lending Facilities and will borrow from the Fed like fiends under the other plans of taxpayer largesse provided courtesy of the Fed. More

New York Times
Goldman Sachs and Morgan Stanley, the last big independent investment banks on Wall Street, will transform themselves into bank holding companies subject to far greater regulation, the Federal Reserve said Sunday night, a move that fundamentally reshapes an era of high finance that defined the modern Gilded Age. More

Martin D. Weiss, Ph.D.
In the wake of Lehman’s demise, Fed Chairman Bernanke and Treasury Secretary Paulson will try to put out the word that it’s no great trauma. But it’s a lie and they know it. If they openly admitted that the Lehman collapse will paralyze Wall Street, torpedo the stock market and sink the economy, they’d have to pony up $100 billion or more to support it. Instead, their agenda was to push big banks to put up the money. And they failed to do so. No matter what, there’s no denying that the Lehman debacle is a massive and immediate threat to U.S. and global markets. At the latest reckoning, Lehman had $691 billion in assets. That makes it bigger than Wachovia, twice as big as Washington Mutual, and over sixteen times larger than Schwab.

Lehman’s debts — at $668.6 billion — are also enormous. Even if you added together all the debts of TD Ameritrade, E-Trade and Schwab, you’d still have only $108.5 billion, or less than one-sixth the total debts which Lehman reports. In fact, among brokers, there are only two other U.S. firms that beat Lehman in the debt category: Morgan Stanley, with $1 trillion, and Merrill Lynch, with $988 billion. Can you imagine anyone in his right mind making the argument that a Merrill Lynch downfall would be “no great trauma to investors and financial markets”? Of course not. The reality: The collapse of America’s third-largest brokerage operation is very serious business with equally serious consequences. The primary concern …

Defaults on Derivatives

We’ve lost count of how many times the authorities have virtually sworn on a stack of Bibles that “our financial system is fundamentally sound.” But no one could possibly lose count of their recent desperate efforts to prevent the system’s collapse — actions which directly belie their words: One — the coordinated efforts by central banks to flood the global economy with liquidity in the summer of 2007. Two — the hasty bailout of Bear Stearns in March of this year. Three — the giant Fannie and Freddie rescue announced just eight days ago. Each time they intervene, they say “we must not reward CEOs who deceive the public and walk off with multibillion dollar bonus checks.” And each time they say it’s the “last time we’ll make an exception to that rule.”

But then they go ahead and do it anyhow, not only breaking their own word … but also trashing the long tradition of restraint established by their predecessors since the Great Depression. Why? Because they had neither the courage nor the audacity to confront Wall Street’s ultimate nightmare: A collapse in the giant mountain of derivatives. Derivatives are essentially bets on interest rates, foreign currencies, stocks or specific events like the bankruptcy of a particular company. The interest rate-related bets are by far the biggest. But the bets on bankruptcies — called credit default swaps — are the fastest growing and the most volatile. These derivatives were originally designed to help hedge investments reduce risk — like insurance policies. But in practice, they’ve been increasingly used to leverage investments, increasing the risks of participants.

Here are some essential facts that illustrate the enormity of the problem …

* The amounts are absurdly large. The total “notional,” or face value, of derivatives held by U.S. banks is $180 trillion, and it’s three times that much globally. This figure is said to overstate the actual market risk. But it does not overstate the risk of defaults such as those that could be triggered by the failure of a company the size of Lehman Brothers.

* Over 90% of all derivatives are traded outside of regulated exchanges. Consequently, other than very general information, the authorities have no mechanism for keeping track — let alone efficiently cleaning up the mess in the wake of a giant failure.

* Off the balance sheets. Some companies report nothing more than the total value of their derivatives in footnotes to their financial statements. Others don’t report at all. Consequently, the actual risk, amounts and even the very existence of derivatives is often poorly disclosed to investors.

* Disclosure in the brokerage industry is especially bad. Many brokerages are private and do not disclose more than their rank and serial number. The SEC collects sparse data and does not publish it. So if you want to figure out how much derivates risk your broker is exposed to, good luck! Getting the information can be like pulling teeth. More

Ilargi
The Automatic Earth
The US government and the Federal Reserve pulled out all the stops last night, laid all their weapons on the table, and stripped naked. As noted yesterday, all the politicians that matter in Congress and Senate were present at the meeting that resulted in the AIG bail-out. They were there to make sure any illegal steps could be made legal in the wink of an eye. Paulson and Bernanke have played havoc with the law lately, most recently when deciding stocks could be dumped at the Fed credit windows, and when allowing BoA to use its client deposits to go play in the casino. So everybody was there, and the deal got done. Big sigh of relief, right? Well, no. The Dow is falling off a cliff, and the next group of financial institutions are lined up to be the fastest to fall. Do note, please, that today can be pinned down as the first day that the financial crisis spills over into corporate America for real.

Allow me to quote myself from last night:

“What this means is the start of what you might call finance anarchy. The US government has lost control, that much is clear to everyone now, or at least those who’ve been paying attention. As I’ve said, the companies will now be picked off one by one through shorting and swapping. The free market reaches its self-chosen and inevitable climax.

AIG has liabilities that run into the hundreds of billions of dollars, if not thousands. The vultures know this, make no mistake about it. So an $85 billion rescue is but a joke. It won’t lift nothing for more than a few hours, probably not even long enough to last till the Dow opens tomorrow. There is blood in the water, and it’s feeding time.”

There are two converging problems at play here. One: the AIG deal doesn’t solve any of the issues that have built the crisis. Two: the US government is now out of ammunition, and it’s plain for everyone to see (not that everyone does see it). The emperor has nothing left to wear. That means we can now conclude that the financial crisis has become a corporate and overall economic crisis. But there is more. We are witnessing the beginning of a political crisis as well. There is no way that the financial downfall can be stopped, even temporarily, before the US elections. The government can now only try to negotiate mergers and private buy-outs. Its power and authority as a force in the markets is gone.

And as people see the world around them crumble, with mass-lay-offs, disappearing pension benefits and bank-runs, they will want to know who’s responsible. And that, of course, is the government: White House, Congress and Senate. Hence, when Americans go to the polls in November, they can only vote for candidates that are directly, as senators, responsible for the crisis. They try hard to distance themselves from it, but that is mere posturing.

This is the sort of responsibilty that in a functioning democracy forces politicians to step down. This goes right to the heart of issues such as trust and legitimacy: people need to be able to call their elected representatives on their mistakes, whether they are honest ones or not. I’ve long said that before the cascading failures start, we will see a round of consolidations. We have today arrived at that point. Wachovia and Morgan Stanley are in merger talks, the US government seeks a buyer for WaMu, Lloyds buys UK mortgage lender HBOS (HSBC wants in, but refuses to pay a single penny for HBOS shares).

Not all these talks will presumably be concluded in time to avoid bankruptcies, events are accelerating too fast. There is no trust whatsoever left in the system. For every successful deal, three more problems will emerge. It has to wind down till all the funny money has gone. I said yesterday that Morgan Stanley looked to be under siege. It’s down over 40% this morning. It has entered the emergency room. And when Goldman gets under attack (down 25%), the picture is complete: Wall Street as a whole is crumbling. There were bank runs at AIG affiliates yesterday in SIngapore. They won’t be the last, and they will hit closer to home. I wouldn’t be surprised if the Fed and Treasury will, in a sort of last gasp, bail out the FDIC as early as this weekend.

CNNMoney.com
…shares of most big banks plunge again as investors brace for a bigger financial shakeout. As the government reportedly tries to broker a buyer for Washington Mutual, shares of WaMu and other banking and finance firms continued to spiral downward Wednesday. WaMu fell 11% in midday trading on reports that federal regulators were trying to organize a buyout for the battered bank. Shares of other big commercial banks, including Citigroup and Wachovia, all tumbled more than 10% as well. And the nation’s top two investment banks were hit particularly hard: Morgan Stanley plunged 38% and Goldman Sachs plummeted 23%. More

(Reuters) - Shares of Goldman Sachs dropped below $100 for the first time in more than three years on Wednesday as concerns over the outlook for the remaining U.S. investment banks swelled. Goldman shares fell more than 20 percent, taking the stock as low as $97.78 on the New York Stock Exchange. Goldman last traded below $100 in June 2005. Shares of rival investment bank Morgan Stanley slid more than 30 percent to $19.91.

brad setser: follow the money
I am guilty of instinctively comparing large defaults to the Argentina’s default. That is the largest default that I know well.

And Lehman qualifies as a large default.

John Jansen reports one of Lehman’s bonds now trades at 35 cents of on the dollar. That a bit above the levels that Argentina’s bonds traded at after Argentina’s default in late 2001. But Argentina’s bonds also eventually proved to be worth something like fifty cents on the dollar, at least to investors who participated in Argentina’s exchange and got the GDP warrant.*

Lehman’s bankruptcy filing indicates that Citi is a trustee for $138b of Lehman bonds, and the Bank of New York is a trustee for another $17b. The resulting $155b in outstanding bonds significantly exceeds Argentina’s outstanding stock of bonds at the time of its default.

And investors had far longer to adjust their portfolios in anticipation of Argentina’s default than in anticipation of Lehman’s default.

I continue to believe that the credit markets’ reaction to Lehman will ultimately matter more than the reaction of the equity markets. John Jansen reports that the spreads on Morgan Stanley and Goldman have widened significantly. Evans-Pritchard reports (hat tip naked capitalism):

The interest rate on Tier 1 debt for typical banks has jumped by 125 basis points since Friday. “This is a violent effect,” said Willem Sels, credit strategist at Dresdner Kleinwort.

Michael Lewis seems to be thinking along similar lines.

As important as it seems right now on Wall Street, this isn’t a day that most Americans will remember as all that big of a deal. When Lehman Brothers Holdings Inc. goes out of business, the reaction of the average citizen is either “Lehman who?” or, “I heard of them! What do they do?”

It is a big deal, however, but not because some bond traders are out of work, or that puff pieces in business sections about Dick Fuld’s survival skills turned out to be wrong. It’s a big deal because this is the day that American financiers, from the point of view of the Asians who sit on top of the world’s biggest pile of mobile capital, became a bad risk.

And yes, the Bank of China seems to have a bit of exposure to Lehman. It also presumably has additional exposure to other US financial institutions (The BoC has by far the largest external portfolio of the Chinese state banks). Widening spreads though only really bite when debt actually has to be refinanced. AIG seems to be facing some rather more immediate pressure from its swap counterparties. More

(Reuters) - Insurer American International Group Inc struggled for survival a day after a financial tsunami swept away investment bank Lehman Brothers and forced the sale of rival Merrill Lynch in the biggest financial industry shake-up since the Great Depression. AIG scrambled for a financial lifeline on Monday after investment bank Lehman Brothers Holdings Inc failed to find a rescuer and Merrill Lynch & Co Inc agreed to be taken over by Bank of America Corp. The U.S. Federal Reserve has hired investment bank Morgan Stanley to review options for AIG — which has lost some 92 percent of its value so far this year — a person familiar with the situation said Monday.

AIG’s precipitous stock decline has led ratings agencies to threaten downgrades that could force it to post more collateral and nullify insurance contracts, possibly setting in motion a chain reaction that could threaten its survival. In an ominous sign, two ratings agencies went ahead with downgrades after the market closed on Monday. “AIG seems to be the next guy on the chopping block,” said Tom Sowanick, chief investment officer at Clearbrook Financial LLC in Princeton, New Jersey.

Again seeking a private solution to Wall Street’s woes, the Fed had asked JPMorgan Chase & Co and Goldman Sachs Group Inc to explore arranging $70 billion to $75 billion in loans to support AIG, among other financing options, another person familiar with the situation said. Fearing a financial meltdown, the U.S. presidential candidates sparred Monday over who could best restore the system’s health, with Republican John McCain pledging reform and Democrat Barack Obama saying hands-off Republican policies were the problem. More

Source: The Angry Bear
Nouriel Roubini
It is now clear that we are again – as we were in mid- March at the time of the Bear Stearns collapse – an epsilon away from a generalized run on most of the shadow banking system, especially the other major independent broker dealers (Lehman, Merrill Lynch, Morgan Stanley, Goldman Sachs). If Lehman does not find a buyer over the weekend and the counterparties of Lehman withdraw their credit lines on Monday (as they all will in the absence of a deal) you will have not only a collapse of Lehman but also the beginning of a run on the other independent broker dealers (Merrill Lynch first but also in sequence Goldman Sachs and Morgan Stanley and possibly even those broker dealers that are part of a larger commercial bank, I.e. JP Morgan and Citigroup). Then this run would lead to a massive systemic meltdown of the financial system. That is the reason why the Fed has convened in emergency meetings the heads of all major Wall Street firms on Friday and again today to convince them not to pull the plug on Lehman and maintain their exposure to this distressed broker dealer.

Let me elaborate in much detail on these issues…

This bail-in of investors is the opposite of a bailout of investors like the one that was done in the case of Bear Stearns and Fannie and Freddie. It is thus akin to the bail-in of investors that was done in the case of LTCM in the summer of 1998 and the bail-in of the interbank creditors of Korean banks in the winter of 1997. I wrote in 2004 with Brad Setser an entire book titled “Bailouts versus Bailins: Responding to Financial Crises in Emerging Markets” that discusses these policy tradeoffs in financial crises where you have runs on the liquid liabilities of either illiquid and/or insolvent countries. Those were the international equivalent of the banks runs and financial crises that we are now seeing in the cases of Bear Stearns, Lehman and Fannie and Freddie.

Since government bailouts put at risk public money and create moral hazard Treasury and the Fed decided that they need to draw a line somewhere after the bailouts of Bear Stearns creditors, of Fannie and Freddie and all the other actions aimed at backstopping the financial system. These actions have included the creation of the TAF, TSLF, PDCF, the use of the FHLBs to provide liquidity to distressed mortgage lenders, the provision of Treasury liquidity to the FHLBs, the outright purchase of agency MBS by the Treasury, the swapping of two thirds of the safe Treasuries of the Fed for toxic illiquid securities of banks and non banks, etc. So after having created the mother of all moral hazard with their actions (including the biggest bailout of all, i.e. the rescue of Fannie and Freddie) the Fed and Treasury are playing a chicken game with the financial system. Tim Geithner told clearly to the heads of all the major Wall Street firms that if they pull the plug on Lehman and Lehman collapses they are next in line for a run on their institutions. So if a buyer for Lehman is not found (or even if it is found and the counterparty lines are still pulled) not only Lehman will collapse but the run will extend to all of the other major broker dealers and banks that are the counterparties of Lehman.

The Fed may delude itself in thinking – as its stress models suggest – that the systemic risk of a collapse of Lehman are less serious than those of Bear Stearns: afterall Lehman is less involved into CDSs than Bear was and now both Lehman and the other major broker dealers have access to the discount window with the PDCF. A collapse of Lehman instead will have as much of a systemic effect as the collapse of Bear for many reasons: Lehman is larger than Bear was; Lehman is a major player in a variety of key financial markets; all the other major Wall Street institutions are interconnected with Lehman in dozens of different types of counterparty activities; the PDCF support of the Fed is neither unlimited nor unconditional, i.e. investors cannot assume that Lehman or any other broker dealer can borrow unlimited amounts with no conditions from the discount window. Thus, a collapse of Lehman would trigger a panic and a potential run on all sort of other broker dealers and also on other distressed financial institutions like banks (WaMu) and insurance companies (AIG) and smaller member of the shadow financial system (distressed and highly leveraged hedge funds, etc.).

The reason why Lehman is having a hard time to find a buyer is that it is most likely insolvent. If you had to mark to market the value of it illiquid and toxic assets (the $40 billion of commercial real estate assets, its remaining residential MBS and CDOs, its holdings of real estate private equity funds) Lehman is most likely insolvent (i.e. has negative net worth with liabilities well above its impaired assets). So leaving aside the potential and now dubious value of its franchise (an option to the value of a much slimmed down financial institution) no financial institution should be paying even a single penny to buy an insolvent firm. That is why all the potential suitors of Lehman (such as Bank of America and others) are waiting for the government to provide another sleazy Bear Stearns deal where the government would buy at higher than market value the toxic assets of Lehman (the commercial real estate assets for example) so as to make the net worth of the remaining institution positive and worth buying. But such action – borderline illegal in the case of Bear as pointed out by Paul Volcker – would be a scandal in the case of Lehman and severely exacerbate the moral hazard problem.

But here lies the conundrum of this Lehman crisis: no one seems to want to buy for a positive price Lehman unless there is a public subsidy (taking off their toxic assets off the firms’ balance sheet). The government cannot afford to provide the subsidy as the moral hazard problems are becoming severe. But then if on Monday no deal is done Lehman collapses and goes into Chapter 11 court and you have the beginning of a systemic financial meltdown as the run on the other broker dealers will start. Thus, what Fed and Treasury are trying to do this weekend is another 1998 LTCM bailin or Korea 1997 bailin, i.e. trying to convince all the major institutions to either support a purchase of Lehman or maintain their exposure to Lehman if no buyers is found. Can this bail-in work? It is not clear as there is a major collective action problem: you can’t only convince half a dozen major Wall Street firms to maintain their exposure to Lehman. You need also to convince all the other counterparties of Lehman (including the hedge funds and the other broker dealers and banks) not to roll off their claims and credit to Lehman. This is a much more messy collective action problem and coordination game than in the case of LTCM and Korea where the number of involved counterparties was more limited (less than 20 in each case).

Paulson and Bernanke and Geithner (the troika managing this financial crisis) have all made public statements in the last few month to the necessity of finding an orderly way to close down – rather than bailout – a major and systemically important non bank financial institutions: the embarrassment and losses for the Fed that the bailout of the creditors of Bear led made it paramount to avoid another Bear like bailout. That is why they are now playing tough with Lehman and its creditors. But in this game of chicken the Fed and the Treasury may end up being the ones to blink. Faced with the risk of a generalized run on the other broker dealers they may decide that greasing again a deal for the purchase of Lehman may be less costly and less risky than testing whether the system can orderly work out a collapse of Lehman (something that is highly uncertain). Even in the case of the Bank of America purchase of Countrywide such public subsidy was significant (the FHLB of Atlanta lent to Countrywide over $50 billion and Bank of America has most likely received plenty of tacit forbearance from the Fed to support its takeover of an insolvent Countrywide). So implicitly or explicitly the Fed and the Treasury may decide – however reckless and moral hazard laden that choice may be – to provide some explicit or implicit subsidy to a private purchase of Lehman.

The trouble is that, in spite of all public statements regarding the need to provide an orderly demise of large broker dealers, the Fed and the Treasury have done nothing to create such insolvency regime for such broker dealers. So the only option for Lehman – if a buyer is not found - will be the one of ending up in Chapter 11 and trigger massive losses on its counterparties that will in turn trigger a run on such counterparties.

In February of 2008 I predicted – in my “12 Steps to a Financial Disaster” – that one or two major broker dealers would go bankrupt. A month later Bear Stearns went bust and the collapse of the other ones was avoided for a time by the most radical change in monetary policy since the Great Depression, i.e. the creation of the PDCF that extended the lender of last resort (LOLR) role of the Fed to non-bank systemically important broker dealers (i.e. all of the bank and non bank primary dealers of the Fed).

I next argued in June that such action would not prevent a run on other broker dealers such Lehman as to avoid a run you need both deposit insurance and unlimited and unconditional access to the Fed LOLR support. I also discussed why Lehman was next in line for a collapse and why the PDCF would not prevent a run on Lehman.

I also argued in follow-up pieces that, in a matter of two years, no one of the remaining independent broker dealers (Lehman, Merrill Lynch, Morgan Stanley and Goldman Sachs) would survive as: 1. their business model is now impaired (securitization is semi-dead); 2. they will need to be regulated like banks given the PDCF support and thus have lower leverage, higher liquidity and more capital that will erode their profitability; 3. Their severe maturity mismatch – borrowing very short term and liquid, leveraging a lot and lending and investing in more long term and illiquid ways – makes them very fragile – in the absence of deposit insurance and in the presence of only limited LOLR support by a central bank – to bank like run that are destructive even of illiquid but otherwise solvent institutions. Thus all such broker dealers need to merge with larger financial institutions that have a commercial banking arm and thus access to stable and insured deposits and to true LOLR Fed support. That process of unraveling of independent broker dealers started with Bear Stearns; now it is moved to Lehman; tomorrow Merrill Lynch will be on line; and Morgan Stanley and Goldman Sachs will be next. No one of them can and will survive as independent entities. So, the Fed and Treasury should advise them all to start finding a large international partner (international as almost no domestic partner is now sound to take them over) and merge with such partner before we get another Bear or Lehman disaster.

The step by step, ad hoc and non-holistic approach of Fed and Treasury to crisis management has been a failure so far as plugging and filling one hole at the time is useless when the entire system of levies is collapsing in the perfect financial storm of the century. A much more radical, holistic and systemic approach to crisis management is now necessary.

What we are facing now if the beginning of the unraveling and collapse of the entire shadow financial system, a system of institutions (broker dealers, hedge funds, private equity funds, SIVs, conduits, etc.) that look like banks (as they borrow short, are highly leveraged and lend and invest long and in illiquid ways) and thus are highly vulnerable to bank like runs; but unlike banks they are not properly regulated and supervised, they don’t have access to deposit insurance and don’t have access to the lender of last resort support of the central bank (with now only a small group of them having access to the limited and conditional and thus fragile support of the Fed). So no wonder that this shadow banking system is now collapsing. The entire conduits/SIV system has already collapsed with the roll-off of their ABCP financing; next is the collapse of the broker dealers (Bear, Lehman and soon enough the other ones) that rely mostly on unstable overnight repos and other very short term funding for their financing; next will be hundreds of poorly managed hedge funds that will face a tsunami of redemptions; and finally runs on money market funds that are not supported by a large financial institutions or other smaller member of the shadow banking system as well as highly leveraged and distressed private equity funds cannot be ruled out either.

This is indeed the most severe financial crisis since the Great Depression and occurring at a time when the US is falling in a now severe consumer led recession. The vicious interaction between a systemic financial and banking crisis and a severe economic contraction will get much worse before there is any bottom to it. We are only in the third inning of a nine innings economic and financial crisis. And the only light at the end of the tunnel is the one of the incoming train wreck.

New York Times
Several possibilities began to emerge as top Wall Street executives met under the guidance of the Federal Reserve and Treasury Department. One would involve major banks and securities firms providing a financial backstop to facilitate a sale of Lehman. Another option would involve an agreement among Wall Street players to keep trading with Lehman as the bank seeks an orderly liquidation. Those briefed on the talks said the situation was still fluid and other options could emerge.

Adding urgency to the discussions were growing concerns that other big financial institutions like the insurance giant American International Group and Merrill Lynch might face a similar crisis and also need billions of dollars in capital to strengthen their businesses. The spreading troubles were the latest sign that even the government’s extraordinary interventions into private enterprise during the last year have not been enough to halt the unraveling of the financial system.

As the trading week ended, top officials from the Federal Reserve and the Treasury Department called an emergency meeting in Lower Manhattan with the heads of major Wall Street firms to insist that they find a way to rescue Lehman because their own companies might be next. The meetings, which involved top executives from Goldman Sachs, Morgan Stanley, JPMorgan Chase, Citigroup and other financial companies, continued on Saturday. More

FRANKFURT (Reuters) - The financial crisis will probably not end until next year or even 2010, Germany’s Handelsblatt newspaper quoted Morgan Stanley co-President Walid Chammah as saying in a preview of its Monday edition. Chammah also expected more banks to fall victim to the crisis, the paper said. “We will likely see more insolvencies among small U.S. regional banks that have focused on mortgage business,” the paper quoted him as saying. Chammah also said return-on-equity rates of 25 percent were a thing of the past for the investment banking industry, the paper reported. “I estimate returns in the industry will be more like 15 to 20 percent as a rule,” the paper quoted him as saying.

Morgan Stanley told thousands of clients this week that they will not be allowed to withdraw money on their home-equity credit lines, Bloomberg News reported Wednesday, citing a person familiar with the situation. Most of the clients had properties that have lost value, the agency reported, citing a person who declined to be identified. The second largest U.S. investment bank will review home-equity lines of credit, or HELOCs, monthly from now on, the agency said, citing the person familiar with the matter. More

Morgan Stanley, the investment bank, has issued a major alert on the health of Spanish banks, warning that a replay of the ERM crisis in the early 1990s could wipe out the capital base of weak lenders exposed to the property crash.” A momentous economic slowdown is now under way. We believe the deterioration in Spain is just in the beginning stages. The bulk of the pain will be suffered in 2009,” said the report, by Eva Hernandez and Carlos Caceres. “The probability of a crisis scenario similar to the early 1990s is increasing. If the ERM (Exchange Rate Mechanism) scenario were to become reality the main concern would not be earnings, but capital,” it said. More

Gawker
Look, it’s Ron Paul! But what is he doing in New York, the fancy magazine for elites, alongside establishment finance types like a former Morgan Stanley economist and a famous investor? Isn’t he sort of “kooky?” Everyone (who didn’t live in a basement or wasn’t a furry) laughed at Paul’s quest for the 2008 Republican presidential nomination, especially since Paul wanted to get rid of the Federal Reserve and take America back to the gold standard, in which money is backed by something other than the worthless promises of filthy bankers and shiftless bureaucrats. But now it looks like the Fed’s board of governors may be leading us into depression, and even that capitalist bible the Wall Street Journal ran an article this weekend speculating that the thinking behind the gold standard, if not the standard itself, “will have its day again.” So Paul’s stock is rising! Let’s hear what terrible things he has to say about our future:

“I think we are maybe 10 percent into this crisis. The economic distortions have been building for longer than we’ve seen in the history of the world. Never have we had such confidence falsely placed in a reserve currency.”

Ha ha, you know what’s funny about that Ron Paul quote? It’s probably the least disturbing one in the entire New York article. The people from inside the financial system sound far more depressing. Here’s the former Morgan Stanley chief economist:

“The American consumer is toast. We’re talking a multiyear adjustment, at least two or three years, maybe more. Does that mean America is over? Does that mean we have a whole new world order? The jury’s out on that.”

If you really want to ruin your Monday, go ahead and click through and read the other two quotes. The short version is that you’ll soon be starving in the street, but in the meantime don’t stop reading, because there’s this new tapas place New York would like to tell you about! More

CHICAGO (MarketWatch) — A former managing director at Morgan Stanley Asia was arrested and charged with nine counts of insider trading for his dealings in the shares of a public company prior to the announcement of an acquisition. Du Jun was arrested at the Hong Kong airport Friday after arriving from Beijing. He was arraigned in front of a magistrate but offered no plea. Du was freed after posting bail but had to surrender his passport and was ordered not to leave Hong Kong and report to the police twice a month. More

DailyReckoning.com
Not one but three different banks are warning investors of major crisis ahead. Note to the banks: where have you been for the last year? A thousand martini lunch? The slow-motion credit crisis is nearly twelve months old. The question today is whether the competing interest rate policies of the European Central Bank and the U.S. Federal Reserve will lead to more selling in global stock markets and higher commodity prices. Inflation is winning the war.

“A very nasty period is soon to be upon us - be prepared,” says Royal Bank of Scotland’s chief credit strategist Bob Junjuah. In Wednesday’s U.K. Telegraph Junjuah says, “The Fed is in panic mode… The massive credibility chasms down which the Fed and maybe even the European Central Bank will plummet when they fail to hike rates in the face of higher inflation will combine to give us a big sell-off in risky assets.” Aussie stocks are caught in the thematic cross fire. Higher commodity prices are good for commodity producers. But global inflation sows the seeds of global recession, which is not bullish for resources.

Morgan Stanley’s European research team says an European Central Bank rate hike next month (the one Jean Claude Trichet has threatened to deliver) could lead to a “catastrophic event.” Morgan’s report concluded that, “We see striking similarities between the transatlantic tensions that built up in the early 1990s and those that are accumulating again today. The outcome of the 1992 deadlock was a major currency crisis and a recession in Europe.” More

Financial Times
Morgan Stanley on Wednesday became the latest financial group to be hit by the actions of a suspected rogue trader after revealing that a London-based credit derivatives trader had incorrectly valued his positions, forcing the company to take a $120m revenue hit. Morgan Stanley said it had discovered the error in May, immediately alerted the Financial Services Authority and suspended the individual pending an internal probe. Morgan Stanley declined to comment further. More

By Ambrose Evans-Pritchard, International Business Editor
The clash between the European Central Bank and the US Federal Reserve over monetary strategy is causing serious strains in the global financial system and could lead to a replay of Europe’s exchange rate crisis in the 1990s, a team of bankers has warned. “We see striking similarities between the transatlantic tensions that built up in the early 1990s and those that are accumulating again today. The outcome of the 1992 deadlock was a major currency crisis and a recession in Europe,” said a report by Morgan Stanley’s European experts.

Just as then, Washington has slashed rates to bail out the banks and prevent an economic hard-landing, while Frankfurt has stuck to its hawkish line - ignoring angry protests from politicians and squeals of pain from Europe’s export industry. Indeed, the ECB has let the de facto interest rate - Euribor - rise by over 100 basis points since the credit crisis began. More