Plenty More Bank Losses Expected Globally Additional $1.5 Trillion in Write-Downs Forecast by End of 2010 Despite Rising Securities Prices

Hat tip to C H Powell, who added....here you go, Kevin; everything I've been braying about for the last eight months:we're about 45% done (writedowns)....

ISTANBUL -- Rising global securities prices reduced the International Monetary Fund's estimate of bank losses, but banks around the world -- especially in Europe -- still are likely to face additional write-downs of $1.5 trillion by the end of next year, the IMF said.

Overall, the IMF calculates that the global financial crisis will produce $3.4 trillion in losses for financial institutions, between 2007 and 2010, a chunk of which already has been recognized. That estimate is $600 billion less than the IMF forecast in April, largely reflecting an increase in the prices of securities held by financial institutions since then.

AFP/Getty Images


The IMF projected total losses in the banking sector specifically will reach $2.8 trillion. That is the same as in April, but the figures aren't directly comparable because the IMF reworked its methodology, in part to track potential losses in European banks. Of that amount, the IMF said, banks globally have written down $1.3 trillion and have additional potential losses of $1.5 trillion facing them.

As in past estimates, the IMF said that banks in the U.S. are further ahead in dealing with potential losses than those in Europe. Banks in the U.S. have recognized about 60% of anticipated write-downs, the IMF calculated. Banks in the Britain and continental Europe have recognized only about 40% of their potential losses.

The IMF said that U.S. banks' portfolios rely more on securities, and thus have benefited from the recent gains in stock markets. Banks in Europe, however, are more dependent on loans to Eastern Europe and other beleaguered markets, whose economies remain vulnerable.

"Financial markets have rebounded, emerging-market risks have eased, banks have raised capital and wholesale funding markets have reopened," the IMF said. "Even so, credit channels are still impaired and the economic recovery is likely to be slow."
More
Full IMF Report


The IMF urged governments to continue pressing financial institutions to dispose of toxic assets and build capital cushions.

The fund estimated that bank losses in the U.S. and Europe over the coming year or so were likely to outpace the banks' retained earnings over that time, reducing their equity. By several measures of capital, banks in the U.S. and the U.K. were in better shape than their counterparts in continental Europe, the IMF found.

Private-sector demand for credit is likely to remain "anemic," the IMF said. But vastly increased public borrowing could put upward pressure on interest rates and undermine what is likely to be a tepid recovery.

Historical evidence suggests that a 1 percentage point increase in the fiscal deficit, if long lasting, helps produce an increase in long-term interest rates of between 0.1 and 0.6 percentage point. Picking the middle of that range, the IMF said increase in the budget deficits by sums equal to between 5 and 6 percentage points of gross domestic product -- well within the range of possibility in the U.S. and Europe -- could boost long-term interest rates by 1.5 to 2.0 percentage points. That, the IMF warned, would have "very adverse growth consequences."

The IMF urged global governments to start planning to reduce the extraordinary fiscal and monetary stimulus that has been used to fight the global recession, though it didn't urge that such a withdrawal begin yet.

The fund also counseled nations to adopt policies to reduce the threats posed by financial institutions deemed "too big to fail" -- meaning the government needs to bail them out or face a systemic meltdown. Among the possible policies the IMF suggested: requiring such institutions to carry additional capital and liquidity requirements to encourage them to reduce their size and complexity. Risk-based charges to "prefinance a bailout fund" are another possibility, the IMF said.

Write to Bob Davis at bob.davis@wsj.com

*****European Banks Desperate To Avoid Recognizing Losses On Their 8 Trillion Us Holding*****

Summary of key points:

European banks own 8 trillion US assets (treasuries, agencies, consumer loans, etc…) and they are losing access to their dollar funding. If European banks are forced to sell their US assets, it will crash the credit markets, and they will have to recognize enormous losses. Since the fed is desperate to prevent the collapse of the US financial system, it lent those European banks 600 billion dollars so that they wouldn’t be forced to sell. Meanwhile, European banks accepted this 600 billion because they don’t want to recognize losses on their toxic US securities.

What is going to happen? Well in my last entry, I highlighted how:

“When the American economy fell into depression, US banks recalled their loans, causing the German banking system to collapse”

The same thing will happen in 2009, except the roles will be reversed. As Europe falls into a depression, European banks will recalled their loans and sell off dollar assets, causing the US banking system to collapse. Once this foreign liquidation and deleveraging of US assets begins, the current need for dollar financing will be replaced by desperate panic to escape America’s collapsing currency. Finally, like with US banks back in the 1930s, European banks will have to recognize enormous losses on their foreign holdings, making many of them insolvent.

Full Article

The $700 trillion elephant

SANTA MONICA, Calif. (MarketWatch) -- There's a $700 trillion elephant in the room and it's time we found out how much it really weighs on the economy.
Derivative contracts total about three-quarters of a quadrillion dollars in "notional" amounts, according to the Bank for International Settlements. These contracts are tallied in notional values because no one really can say how much they are worth.
But valuing them correctly is exactly what we should be doing because these comprise the viral disease that has infected the financial markets and the economies of the world.
Try as we might to salvage the residential real estate market, it's at best worth $23 trillion in the U.S. We're struggling to save the stock market, but that's valued at less than $15 trillion. And we hope to keep the entire U.S. economy from collapsing, yet gross domestic product stands at $14.2 trillion.
Compare any of these to the derivatives market and you can easily see that we are just closing the windows as a tsunami crashes to shore. The total value of all the stock markets in the world amounts to less than $50 trillion, according to the World Federation of Exchanges.
To be sure, the derivatives market is international. But much of the trouble we're in began with contracts "derived" from the values associated with U.S. residential real estate market. These contracts were engineered based on the various assumptions tied to those values.
Few know what derivatives are worth. I spoke with one derivatives trader who manages billions of dollars and she said she couldn't even value her portfolio because "no one knows anymore who is on the other side of the trade."
Derivatives pricing, simply put, is determined by what someone else is willing to pay for the contract. The value is based on an artificial scenario that "X" will be worth "Y" if "Z" happens. Strip away the fantasy, however, and the reality of the situation is akin to a game of musical chairs -- without any chairs.
So now the music has finally stopped.
That's why stabilizing the housing market will do little to take the sting out of the snapback we are going through on Wall Street. Once people's mortgages were sold off to secondary buyers, and then all sorts of crazy types of derivative securities were devised based on those, and those securities were in turn traded on down the line, there is now little if any relevance to the real estate values on which they were pegged.
We need to identify and determine the real value of derivatives before we give banks and institutions a pass-go with more tax dollars. Otherwise, homeowners will suffer as banks patch up the holes left in their balance sheets by the derivatives gone poof; new credit won't be extended until the raff of the old credit is put behind.
It isn't the housing market devaluation, or the sub-prime mortgage market defaults that have us in real trouble. Those are nice fakes to sway attention away from the place where greed truly flourished -- trading phony instruments to the tune of $700 trillion.
Let's figure how to get out from under that. Then maybe the capital will begin to flow again through the markets. Right now, this elephant isn't just in the room, it's sitting on us.
Thomas M. Kostigen is the author of You Are Here: Exposing the Vital Link Between What We Do and What That Does to Our Planet (HarperOne). www.readyouarehere.com

“Bail us out, but leave us alone.”

This will appear in the next issue of Al-Ahram Weekly http://weekly.ahram.org.eg


Prison of nations


Sarkozy’s ‘incoherence’ is a sign of the euro-impasse, says Eric Walberg


Riots swept across Eastern Europe this winter. In Latvia 100 were arrested when they attacked the Finance Ministry with cobblestones from the quaintly restored tourist area protesting unemployment, budget and wage cuts. In Lithuania, riot police fired rubber-bullets and tear gas on a trade union march. A demonstration in the Bulgarian capital turned violent leading to the arrest of 150 protesters. These three states are all members of the Exchange Rate Mechanism (ERM2), the euro’s pre-detention cell. They must join.


The IMF calls for devaluation of the currencies of these “economies”, which are not really economies at all after their deindustrialisation over the past two decades, but the euro-agreements prevent this. And even if they could do the IMF number, their huge mortgage debts contracted in euros and Swiss francs over the past decade would still be unrepayable.


Latvia’s government was trying to comply with IMF-imposed measures to qualify for an emergency loan, much like Argentina in 2001, when brutal cuts to education and social programmes sparked a general strike and radicalised the entire nation (except, or course, those responsible for the crisis). The riots in Lativa brought the government down and its credit rating was just lowered to junk status.


It’s no better inside euroland. Q: What’s the difference between Ireland and Iceland ? A1: The letter “c”. A2: Six months.


We haven’t even mentioned Greece, which is already considered a failed state, virtually in a state of civil war since last September. And now the very pillars of the European Union are crumbling. In January, hundreds of thousands marched in French cities in the biggest protest in two decades. An ongoing month-long strike in France’s far-flung Guadeloupe is now full-scale urban warfare, with the dead including a trade union leader. The ruling white elite and tourists are at this very moment fleeing in panic. Martinique and Reunion have joined in.


In Britain demos are breaking out across the country protesting unemployment and the bank bailouts. The British National Party shocked the establishment by winning a council seat in Kent, “penetrating” the south of England, and are expecting major gains in the EU elections in June. Spain lost a million jobs in 2008 and the unemployment rate is expected to reach 25 per cent this year. Spain’s (and Ireland’s) so-called wage inflation now requires wage deflation, workers are told. With Spain’s high debt levels, this is impossible. Even if it were possible, wage deflation is a recipe for revolution.


Marches protesting the economic plight of the people are expected to grow and lead to further violence throughout Europe, with Greece as the prequel. Suddenly, the spectre of the end of the EU, certainly the end of the common currency, is being raised. Coined to convince the “free world” of the dangers of Communism, the domino effect is back with a vengeance.


The string pullers over the past two decades managed to transform the face of Europe, destroying the Soviet Union and expanding the EU and NATO rapidly eastward. But just as Napoleon and Hitler before them, the over-confident conquerors moved too far too fast, and now face the prospect of losing everything. The marvel of the euro zone is now derided as the Völker-Kerker (prison of nations) recalling the Austro-Hungarian Empire. Italian journalists have begun to talk of Europe’s “Tequila Crisis”, referring to the collapse of Mexico’s peso in 1993 when the elite took their money to the US. A similar capital flight from Club Med could set off an unstoppable process and even bring the euro down.


What is the euro, except a fixed exchange rate agreement among members? Sceptics have always dismissed it as a dangerous straight-jacket, since Europe is far from uniform. It means national governments are highly restricted in their monetary and fiscal policies to deal with crises. It also means that ripples in Europe become tidal waves, as all the countries’ economic successes or failures happen together.


This is fine if governments are united in pursuing a common agenda to promote stability and prosperity for the common Europeans, but neoliberalism allows for no such political will. The common economic space has merely allowed large companies and banks to take control of the whole market, supposedly to be equal competitors to their big brothers in the US, China and elsewhere. But riding the wave of privatisation and euro-expansion, they threw caution to the winds, with no strong national governments to clip their wings. The EU “government” is exposed as worse than useless, a rubber stamp for this Thatcherite mania, fooling Europeans into thinking there was someone controlling the private chaos.


As the euro begins to slide against the worthless dollar (that’s right), no one is seriously preparing for the possibility of its immanent collapse and what to do about it. Instead, incredibly, a Financial Times columnist calls on the EU to drop its euro-entry requirements for the “economies” of eastern Europe and quickly shepherd them into the “safe” euro-fold. Just as mad as this strategy may seem is the one presently being implemented: to pump endless cash into the banks that have recklessly moved into this economic wasteland.


It is vital to keep the edifice afloat, after all. Virtually all of Eastern Europe is in hock to Western banks and as they go bankrupt, or for the “lucky” ones, their exchange rates plummet with respect to the euro, they represent bargain-basement fire sales for the West. The Polish zloty plunged 50 per cent in the past six months, making it impossible to repay the countless euro-Swiss loans contracted by unwitting Poles, lured by low interest rates.


The banks have lent Eastern Europe about $1.7 trillion, since “independence” and this must be saved from disappearing at all costs. The currently proposed $31 billion to be pumped into the banks is peanuts -- as long as national governments (that is, the people) pay it, of course.


If the steely-nerved bankers can stay the course, the pay-off is potentially immense. Lured into euro-clutches, these orphan nations can now be squeezed. Integration with a vengeance, on a par with their WWII and post-WWII occupations. At least under post-WWII socialism (which many Eastern Europeans remember fondly), the common people were provided for and the ruling party’s privileges circumscribed. But if today’s unsupervised elites keeping sending their money abroad, the pit becomes bottomless. Riots turn into revolutions.


France will no doubt lead the way. Students occupied the Sorbonne recently in a long-running battle against President Nicolas Sarkozy’s education reforms, supported by 70 per cent of the population. French radical politicians Jose Bove and the popular New Anti-Capitalist Party leader Olivier Besancenot have already travelled to Guadeloupe in solidarity with the strikers. “Their fight is our fight — against captialism, exploitation, the big supermarkets,” exhorted a newly radicalised Bastille district activist.


Sarkozy’s popularity is at its lowest at 36 per cent, with a similar number of French saying they would welcome strikes “on a huge scale”. The pollster Dabi said, “There is a sense of incoherence and a sense that Sarkozy does not really know where he is taking France. But that’s largely because there is an incoherence and Sarkozy doesn’t know here he is taking France.”


The same can surely be said of all Western leaders these days. United States President Barack Obama has it easy. He at least has a clear agenda to tear up -- the Reagan-Bush one. But the only common policy of Western leaders so far is one dictated by the banking elite: “Bail us out, but leave us alone.” If anything, they are demanding coordinated bailing out and calling for a new international banking institution, which of course they will control, and which, we are supposed to believe, will avert any further unpleasantness. Such an institution may well act to avert capitalism’s collapse, but there will be lots of “unpleasantness”, evenly distributed among the common people.


The sunny euro-vistas of yesterday are no longer. Eastern Europe risks being eaten alive by Western banks. Western Europe risks mere stagnation and endless political unrest. All indications are that this is a deadend, that the only way forward is to break the hold that the economic system has on both East and West. The upheavals have begun and the real domino effect will spread throughout Europe this summer. That the European parliament elections in June will take place in a hostile atmosphere is an understatement.


Using a crisis to push through unpopular measures doesn’t work anymore, as Greek and Latvian politicians have discovered. The streets are already ringing with the cry: “We won’t pay for your crisis!”

***

Eric Walberg writes for Al-Ahram Weekly. You can reach him at www.geocities.com/walberg2002/

Switzerland threatened with bankruptcy

In an interview with Swiss daily Tagesanzeiger, a well-known economist has warned that Switzerland risks bankruptcy, if the recent market turmoil centering on Eastern Europe is not contained quickly. At issue are loans made in Swiss Francs to Eastern European debtors. With many countries in the region falling into depression, currencies and asset prices are plunging. Therefore, debtors domiciled in Eastern Europe are increasingly expected to have difficulty with mounting foreign debt loads — and that spells trouble for Switzerland.

Below is my translation of the Tagesanzeiger article.

Switzerland threatened with bankruptcy

Swiss banks have given billions of credit to Eastern Europe - now the customers cannot pay back the money. Switzerland is threatened with the fate of Iceland, says economist Arthur P. Schmidt.

In countries such as Poland, Hungary and Croatia, the Swiss franc has become an important currency. Thousands of households and small firms took out loans in Swiss francs, and not in the national currency zloty, forint, or kuna because of lower interest rates. In Hungary, 31 percent of all loans are in Swiss currency. Amongst household loans, they are almost 60 percent.

Borrowers in distress

Now, the financial crisis has ended the era of cheap credit. As a result, Eastern European currencies are falling. At the end of September, one had to pay 46 francs for 100 Polish zlotys. Today it is 30 francs. That means more and more borrowers are having problems with interest payments and repayment. So the question is what effect this has on the Swiss financial marketplace. One who sees a dark future for Switzerland is economic expert Artur P. Schmidt. He believes that the Swiss franc is in danger because of the loans in Eastern Europe.

In Poland, Hungary and Croatia, the Swiss franc has become an important foreign currency - the dollar, so to speak, of Eastern Europe. Thousands of households and businesses have franc loans. Why?

The rapid growth in many countries of Eastern Europe was stimulated through loans in Swiss francs. Swiss banks and offshore institutions loaned the local banks francs, which passed the francs onto their customers. The loans were attractive because borrowers pay interest rates much lower than required for loans in local currency.

Now, this system has been shaken?

Yes, the system has only worked as long as the exchange rate between the franc and the currencies were reasonably stable. But that is not currently the case. For example, the Hungarian forint and Polish zloty have lost over a third of their value against the Swiss franc in recent weeks. Because of the devaluations of the national currencies, the debt to Switzerland has increased by more than one-third. Many of the Eastern European countries have serious payment difficulties, and are virtually bankrupt.

What does this mean for Switzerland?

It is likely that a significant proportion of the total 200 billion U.S. dollars of Eastern European loans were issued in Swiss francs. According to a report by the Bank for International Settlements worldwide franc loans equivalent to around 675 billion U.S. dollars are in circulation - which was about 150 billion directly from Switzerland, 80 billion of Great Britain and about 430 billion U.S. dollars through offshore financial centres. How many of these loans have gone bad is not known. But even if the failure rate is 20 percent, the banks would lose a lot of money.

Is now the federal government intervene?

If the banks require a massive writedown of such loans, above a certain magnitude, the government must intervene. This is already happening via the Swiss National Bank. In Poland, it has made several billion francs available to the local central bank so that Polish banks can cover the loans. At the same time, the Swiss National Bank inquired by the European Central Bank whether it could borrow money in an emergency. This is a clear warning sign that the Swiss franc could be under huge devaluation pressures in the near future.

Swiss banks were too careless in their lending in Eastern Europe?

Yes, indeed. Many bankers wanted to earn a lot and neglected the risks. The National Bank is also at fault as it did not intervene. In addition, the regulator and the politicians completely failed.

What Switzerland must do now?
Now, the possible losses caused by these loans must be made transparent. Above all, all of the Eastern European risks must be fully disclosed. Together with the loan losses from UBS and Credit Suisse, the entire writedown for Switzerland could exceed the Swiss gross domestic product.

That is to say?
Switzerland, like Iceland, is threatened with a potential national bankruptcy. One consequence would be that the Swiss currency could fall massively in value — possibly even crash. Another would be that Switzerland’s credit rating would be massively downgraded. That would be a trauma for the country: Switzerland was always as a stronghold of stability. The franc could become an unstable soft currency. Then Switzerland would perhaps be forced to abandon the franc and take on the euro.

This article fills in a lot of gaps for me. Two weeks ago, I happened to catch another post in the Swiss press about the Swiss government issuing debt in U.S. Dollars. In my post “Why are the Swiss now issuing debt in U.S. Dollars? I asked an open question as to why the Swiss were issuing debt in dollars. No one knew and I had yet to hear a satisfactory answer to this question.

However, my post also pointed to central bank swap lines between Switzerland and a number of countries in Eastern Europe as a related event. The Tagesanzeiger article makes clear that these swap lines are needed due to Eastern European exposure to loans in Swiss Francs. I expect the U.S. dollar swap lines and dollar debt issuance are related - as are the Euro swap lines with the ECB - for liquidity in case of emergency.

These machinations are a testament to the continued fragility of the global financial system. The interconnectedness across currencies and countries is staggering. One domino falls and the whole global financial system is at risk.

Welcome to the dark side of globalisation.

credit writedowns

Citigroup Saw No Red Flags Even as It Made Bolder Bets ~ NYT

By ERIC DASH and JULIE CRESWELL

“Our job is to set a tone at the top to incent people to do the right thing and to set up safety nets to catch people who make mistakes or do the wrong thing and correct those as quickly as possible. And it is working. It is working.”

Charles O. Prince III, Citigroup’s chief executive, in 2006

In September 2007, with Wall Street confronting a crisis caused by too many souring mortgages, Citigroup executives gathered in a wood-paneled library to assess their own well-being.

There, Citigroup’s chief executive, Charles O. Prince III, learned for the first time that the bank owned about $43 billion in mortgage-related assets. He asked Thomas G. Maheras, who oversaw trading at the bank, whether everything was O.K.

Mr. Maheras told his boss that no big losses were looming, according to people briefed on the meeting who would speak only on the condition that they not be named.

For months, Mr. Maheras’s reassurances to others at Citigroup had quieted internal concerns about the bank’s vulnerabilities. But this time, a risk-management team was dispatched to more rigorously examine Citigroup’s huge mortgage-related holdings. They were too late, however: within several weeks, Citigroup would announce billions of dollars in losses.

Normally, a big bank would never allow the word of just one executive to carry so much weight. Instead, it would have its risk managers aggressively look over any shoulder and guard against trading or lending excesses.

But many Citigroup insiders say the bank’s risk managers never investigated deeply enough. Because of longstanding ties that clouded their judgment, the very people charged with overseeing deal makers eager to increase short-term earnings — and executives’ multimillion-dollar bonuses — failed to rein them in, these insiders say.

Today, Citigroup, once the nation’s largest and mightiest financial institution, has been brought to its knees by more than $65 billion in losses, write-downs for troubled assets and charges to account for future losses. More than half of that amount stems from mortgage-related securities created by Mr. Maheras’s team — the same products Mr. Prince was briefed on during that 2007 meeting.

Citigroup’s stock has plummeted to its lowest price in more than a decade, closing Friday at $3.77. At that price the company is worth just $20.5 billion, down from $244 billion two years ago. Waves of layoffs have accompanied that slide, with about 75,000 jobs already gone or set to disappear from a work force that numbered about 375,000 a year ago.

Burdened by the losses and a crisis of confidence, Citigroup’s future is so uncertain that regulators in New York and Washington held a series of emergency meetings late last week to discuss ways to help the bank right itself.

And as the credit crisis appears to be entering another treacherous phase despite a $700 billion federal bailout, Citigroup’s woes are emblematic of the haphazard management and rush to riches that enveloped all of Wall Street. All across the banking business, easy profits and a booming housing market led many prominent financiers to overlook the dangers they courted.

While much of the damage inflicted on Citigroup and the broader economy was caused by errant, high-octane trading and lax oversight, critics say, blame also reaches into the highest levels at the bank. Earlier this year, the Federal Reserve took the bank to task for poor oversight and risk controls in a report it sent to Citigroup.

The bank’s downfall was years in the making and involved many in its hierarchy, particularly Mr. Prince and Robert E. Rubin, an influential director and senior adviser.

Citigroup insiders and analysts say that Mr. Prince and Mr. Rubin played pivotal roles in the bank’s current woes, by drafting and blessing a strategy that involved taking greater trading risks to expand its business and reap higher profits. Mr. Prince and Mr. Rubin both declined to comment for this article.

When he was Treasury secretary during the Clinton administration, Mr. Rubin helped loosen Depression-era banking regulations that made the creation of Citigroup possible by allowing banks to expand far beyond their traditional role as lenders and permitting them to profit from a variety of financial activities. During the same period he helped beat back tighter oversight of exotic financial products, a development he had previously said he was helpless to prevent.

And since joining Citigroup in 1999 as a trusted adviser to the bank’s senior executives, Mr. Rubin, who is an economic adviser on the transition team of President-elect Barack Obama, has sat atop a bank that has been roiled by one financial miscue after another.

Citigroup was ensnared in murky financial dealings with the defunct energy company Enron, which drew the attention of federal investigators; it was criticized by law enforcement officials for the role one of its prominent research analysts played during the telecom bubble several years ago; and it found itself in the middle of regulatory violations in Britain and Japan.

For a time, Citigroup’s megabank model paid off handsomely, as it rang up billions in earnings each quarter from credit cards, mortgages, merger advice and trading.

But when Citigroup’s trading machine began churning out billions of dollars in mortgage-related securities, it courted disaster. As it built up that business, it used accounting maneuvers to move billions of dollars of the troubled assets off its books, freeing capital so the bank could grow even larger. Because of pending accounting changes, Citigroup and other banks have been bringing those assets back in-house, raising concerns about a new round of potential losses.

To some, the misery at Citigroup is no surprise. Lynn Turner, a former chief accountant with the Securities and Exchange Commission, said the bank’s balkanized culture and pell-mell management made problems inevitable.

“If you’re an entity of this size,” he said, “if you don’t have controls, if you don’t have the right culture and you don’t have people accountable for the risks that they are taking, you’re Citigroup.”

Questions on Oversight

Though they carry less prestige and are paid less than Wall Street traders and bankers, risk managers can wield significant clout. Their job is to monitor trading floors and inquire about how a bank’s money is being invested, so they can head off potential problems before blow-ups occur. Though risk managers and traders work side by side, they can have an uncomfortable coexistence because the monitors can put a brake on trading.

That is the way it works in theory. But at Citigroup, many say, it was a bit different.

David C. Bushnell was the senior risk officer who, with help from his staff, was supposed to keep an eye on the bank’s bond trading business and its multibillion-dollar portfolio of mortgage-backed securities. Those activities were part of what the bank called its fixed-income business, which Mr. Maheras supervised.

One of Mr. Maheras’s trusted deputies, Randolph H. Barker, helped oversee the huge build-up in mortgage-related securities at Citigroup. But Mr. Bushnell, Mr. Maheras and Mr. Barker were all old friends, having climbed the bank’s corporate ladder together.

It was common in the bank to see Mr. Bushnell waiting patiently — sometimes as long as 45 minutes — outside Mr. Barker’s office so he could drive him home to Short Hills, N.J., where both of their families lived. The two men took occasional fly-fishing trips together; one expedition left them stuck on a lake after their boat ran out of gas.

Because Mr. Bushnell had to monitor traders working for Mr. Barker’s bond desk, their friendship raised eyebrows inside the company among those concerned about its controls.

After all, traders’ livelihoods depended on finding new ways to make money, sometimes using methods that might not be in the bank’s long-term interests. But insufficient boundaries were established in the bank’s fixed-income unit to limit potential conflicts of interest involving Mr. Bushnell and Mr. Barker, people inside the bank say.

Indeed, some at Citigroup say that if traders or bankers wanted to complete a potentially profitable deal, they could sometimes rely on Mr. Barker to convince Mr. Bushnell that it was a risk worth taking.

Risk management “has to be independent, and it wasn’t independent at Citigroup, at least when it came to fixed income,” said one former executive in Mr. Barker’s group who, like many other people interviewed for this article, insisted on anonymity because of pending litigation against the bank or to retain close ties to their colleagues. “We used to say that if we wanted to get a deal done, we needed to convince Randy first because he could get it through.”

Others say that Mr. Bushnell’s friendship with Mr. Maheras may have presented a similar blind spot.

“Because he has such trust and faith in these guys he has worked with for years, he didn’t ask the right questions,” a former senior Citigroup executive said, referring to Mr. Bushnell.

Mr. Bushnell and Mr. Barker did not return repeated phone calls seeking comment. Mr. Maheras declined to comment.

For some time after Sanford I. Weill, an architect of the merger that created Citigroup a decade ago, took control of Citigroup, he toned down the bank’s bond trading. But in late 2002, Mr. Prince, who had been Mr. Weill’s longtime legal counsel, was put in charge of Citigroup’s corporate and investment bank.

According to a former Citigroup executive, Mr. Prince started putting pressure on Mr. Maheras and others to increase earnings in the bank’s trading operations, particularly in the creation of collateralized debt obligations, or C.D.O.’s — securities that packaged mortgages and other forms of debt into bundles for resale to investors.

Because C.D.O.’s included so many forms of bundled debt, gauging their risk was particularly tricky; some parts of the bundle could be sound, while others were vulnerable to default.

“Chuck Prince going down to the corporate investment bank in late 2002 was the start of that process,” a former Citigroup executive said of the bank’s big C.D.O. push. “Chuck was totally new to the job. He didn’t know a C.D.O. from a grocery list, so he looked for someone for advice and support. That person was Rubin. And Rubin had always been an advocate of being more aggressive in the capital markets arena. He would say, ‘You have to take more risk if you want to earn more.’ ”

It appeared to be a good time for building up Citigroup’s C.D.O. business. As the housing market around the country took flight, the C.D.O. market also grew apace as more and more mortgages were pooled together into newfangled securities.

From 2003 to 2005, Citigroup more than tripled its issuing of C.D.O.’s, to more than $20 billion from $6.28 billion, and Mr. Maheras, Mr. Barker and others on the C.D.O. team helped transform Citigroup into one of the industry’s biggest players. Firms issuing the C.D.O.’s generated fees of 0.4 percent to 2.5 percent of the amount sold — meaning Citigroup made up to $500 million in fees from the business in 2005 alone.

Even as Citigroup’s C.D.O. stake was expanding, its top executives wanted more profits from that business. Yet they were not running a bank that was up to all the challenges it faced, including properly overseeing billions of dollars’ worth of exotic products, according to Citigroup insiders and regulators who later criticized the bank.

When Mr. Prince was put in charge in 2003, he presided over a mess of warring business units and operational holes, particularly in critical areas like risk-management and controls.

“He inherited a gobbledygook of companies that were never integrated, and it was never a priority of the company to invest,” said Meredith A. Whitney, a banking analyst who was one of the company’s early critics. “The businesses didn’t communicate with each other. There were dozens of technology systems and dozens of financial ledgers.”

Problems with trading and banking oversight at Citigroup became so dire that the Federal Reserve took the unusual step of telling the bank it could make no more acquisitions until it put its house in order.

In 2005, stung by regulatory rebukes and unable to follow Mr. Weill’s penchant for expanding Citigroup’s holdings through rapid-fire takeovers, Mr. Prince and his board of directors decided to push even more aggressively into trading and other business that would allow Citigroup to continue expanding the bank internally.

One person who helped push Citigroup along this new path was Mr. Rubin.

Pushing Growth

Robert Rubin has moved seamlessly between Wall Street and Washington. After making his millions as a trader and an executive at Goldman Sachs, he joined the Clinton administration.

Mr. Weill, as Citigroup’s chief, wooed Mr. Rubin to join the bank after Mr. Rubin left Washington. Mr. Weill had been involved in the financial services industry’s lobbying to persuade Washington to loosen its regulatory hold on Wall Street.

As chairman of Citigroup’s executive committee, Mr. Rubin was the bank’s resident sage, advising top executives and serving on the board while, he insisted repeatedly, steering clear of daily management issues.

“By the time I finished at Treasury, I decided I never wanted operating responsibility again,” he said in an interview in April. Asked then whether he had made any mistakes during his tenure at Citigroup, he offered a tentative response.

“I’ve thought a lot about that,” he said. “I honestly don’t know. In hindsight, there are a lot of things we’d do differently. But in the context of the facts as I knew them and my role, I’m inclined to think probably not.”

Besides, he said, it was impossible to get a complete handle on Citigroup’s vulnerabilities unless you dealt with the trades daily.

“There is no way you would know what was going on with a risk book unless you’re directly involved with the trading arena,” he said. “We had highly experienced, highly qualified people running the operation.”

But while Mr. Rubin certainly did not have direct responsibility for a Citigroup unit, he was an architect of the bank’s strategy.

In 2005, as Citigroup began its effort to expand from within, Mr. Rubin peppered his colleagues with questions as they formulated the plan. According to current and former colleagues, he believed that Citigroup was falling behind rivals like Morgan Stanley and Goldman, and he pushed to bulk up the bank’s high-growth fixed-income trading, including the C.D.O. business.

Former colleagues said Mr. Rubin also encouraged Mr. Prince to broaden the bank’s appetite for risk, provided that it also upgraded oversight — though the Federal Reserve later would conclude that the bank’s oversight remained inadequate.

Once the strategy was outlined, Mr. Rubin helped Mr. Prince gain the board’s confidence that it would work.

After that, the bank moved even more aggressively into C.D.O.’s. It added to its trading operations and snagged crucial people from competitors. Bonuses doubled and tripled for C.D.O. traders. Mr. Barker drew pay totaling $15 million to $20 million a year, according to former colleagues, and Mr. Maheras became one of Citigroup’s most highly compensated employees, earning as much as $30 million at the peak — far more than top executives like Mr. Bushnell in the risk-management department.

In December 2005, with Citigroup diving into the C.D.O. business, Mr. Prince assured analysts that all was well at his bank.

“Anything based on human endeavor and certainly any business that involves risk-taking, you’re going to have problems from time to time,” he said. “We will run our business in a way where our credibility and our reputation as an institution with the public and with our regulators will be an asset of the company and not a liability.”

Yet as the bank’s C.D.O. machine accelerated, its risk controls fell further behind, according to former Citigroup traders, and risk managers lacked clear lines of reporting. At one point, for instance, risk managers in the fixed-income division reported to both Mr. Maheras and Mr. Bushnell — setting up a potential conflict because that gave Mr. Maheras influence over employees who were supposed to keep an eye on his traders.

C.D.O.’s were complex, and even experienced managers like Mr. Maheras and Mr. Barker underestimated the risks they posed, according to people with direct knowledge of Citigroup’s business. Because of that, they put blind faith in the passing grades that major credit-rating agencies bestowed on the debt.

While the sheer size of Citigroup’s C.D.O. position caused concern among some around the trading desk, most say they kept their concerns to themselves.

“I just think senior managers got addicted to the revenues and arrogant about the risks they were running,” said one person who worked in the C.D.O. group. “As long as you could grow revenues, you could keep your bonus growing.”

To make matters worse, Citigroup’s risk models never accounted for the possibility of a national housing downturn, this person said, and the prospect that millions of homeowners could default on their mortgages. Such a downturn did come, of course, with disastrous consequences for Citigroup and its rivals on Wall Street.

Even as the first shock waves of the subprime mortgage crisis hit Bear Stearns in June 2007, Citigroup’s top executives expressed few concerns about their bank’s exposure to mortgage-linked securities.

In fact, when examiners from the Securities and Exchange Commission began scrutinizing Citigroup’s subprime mortgage holdings after Bear Stearns’s problems surfaced, the bank told them that the probability of those mortgages defaulting was so tiny that they excluded them from their risk analysis, according to a person briefed on the discussion who would speak only without being named.

Later that summer, when the credit markets began seizing up and values of various C.D.O.’s began to plummet, Mr. Maheras, Mr. Barker and Mr. Bushnell participated in a meeting to review Citigroup’s exposure.

The slice of mortgage-related securities held by Citigroup was “viewed by the rating agencies to have an extremely low probability of default (less than .01%),” according to Citigroup slides used at the meeting and reviewed by The New York Times.

Around the same time, Mr. Maheras continued to assure his colleagues that the bank “would never lose a penny,” according to an executive who spoke to him.

In mid-September 2007, Mr. Prince convened the meeting in the small library outside his office to gauge Citigroup’s exposure.

Mr. Maheras assured the group, which included Mr. Rubin and Mr. Bushnell, that Citigroup’s C.D.O. position was safe. Mr. Prince had never questioned the ballooning portfolio before this because no one, including Mr. Maheras and Mr. Bushnell, had warned him.

But as the subprime market plunged further, Citigroup’s position became more dire — even though the firm held onto the belief that its C.D.O.’s were safe.

On Oct. 1, it warned investors that it would write off $1.3 billion in subprime mortgage-related assets. But of the $43 billion in C.D.O.’s it had on its books, it wrote off only about $95 million, according to a person briefed on the situation.

Soon, however, C.D.O. prices began to collapse. Credit-rating agencies downgraded C.D.O.’s, threatening Citigroup’s stockpile. A week later, Merrill Lynch aggressively marked down similar securities, forcing other banks to face reality.

By early November, Citigroup’s anticipated write-downs ballooned to $8 billion to $11 billion. Mr. Barker and Mr. Maheras lost their jobs, as Mr. Bushnell did later on. And on Nov. 4, Mr. Prince told the board that he, too, would resign.

Although Mr. Prince received no severance, he walked away with Citigroup stock valued then at $68 million — along with a cash bonus of about $12.5 million for 2007.

Putting Out Fires

Mr. Prince was replaced last December by Vikram S. Pandit, a former money manager and investment banker whom Mr. Rubin had earlier recruited in a senior role. Since becoming chief executive, Mr. Pandit has been scrambling to put out fires and repair Citigroup’s deficient risk-management systems.

Earlier this year, Federal Reserve examiners quietly presented the bank with a scathing review of its risk-management practices, according to people briefed on the situation.

Citigroup executives responded with a 25-page single-spaced memo outlining a sweeping overhaul of the bank’s risk management.

In May, Brian Leach, Citigroup’s new chief risk officer, told analysts that his bank had greatly improved oversight and installed several new risk managers. He said he wanted to ensure “that Citi takes the lessons learned from recent events and makes critical enhancements to its risk management frameworks. A change in culture is required at Citi.”

Meanwhile, regulators have criticized the banking industry as a whole for relying on outsiders — in particular the ratings agencies — to help them gauge the risk of their investments.

“There is really no excuse for institutions that specialize in credit risk assessment, like large commercial banks, to rely solely on credit ratings in assessing credit risk,” John C. Dugan, the head of the Office of the Comptroller of the Currency, the chief federal bank regulator, said in a speech earlier this year.

But he noted that what caused the largest problem for some banks was that they retained dangerously big positions in certain securities — like C.D.O.’s — rather than selling them off to other investors.

“What most differentiated the companies sustaining the biggest losses from the rest was their willingness to hold exceptionally large positions on their balance sheets which, in turn, led to exceptionally large losses,” he said.

Mr. Dugan did not mention any specific bank by name, but Citigroup is the largest player in the C.D.O. business of any bank the comptroller regulates.

For his part, Mr. Pandit faces the twin challenge of rebuilding investor confidence while trying to fix the company’s myriad problems.

Citigroup has suffered four consecutive quarters of multibillion-dollar losses as it has written down billions of dollars of the mortgage-related assets it held on its books.

But investors worry there is still more to come, and some board members have raised doubts about Mr. Pandit’s leadership, according to people briefed on the situation.

Citigroup still holds $20 billion of mortgage-linked securities on its books, the bulk of which have been marked down to between 21 cents and 41 cents on the dollar. It has billions of dollars of giant buyout and corporate loans. And it also faces a potential flood of losses on auto, mortgage and credit card loans as the global economy plunges into a recession.

Also, hundreds of billions of dollars in dubious assets that Citigroup held off its balance sheet is now starting to be moved back onto its books, setting off yet another potential problem.

The bank has already put more than $55 billion in assets back on its balance sheet. It now says an added $122 billion of assets related to credit cards and possibly billions of dollars of other assets will probably come back on the books.

Even though Citigroup executives insist that the bank can ride out its current difficulties, and that the repatriated assets pose no threat, investors have their doubts. Because analysts do not have a complete grip on the quality of those assets, they are warning that Citigroup may have to set aside billions of dollars to guard against losses.

In fact, some analysts say they believe that the $25 billion that the federal government invested in Citigroup this fall might not be enough to stabilize it.

Others say the fact that such huge amounts have yet to steady the bank is a reflection of the severe damage caused by Citigroup’s appetites.

“They pushed to get earnings, but in doing so, they took on more risk than they probably should have if they are going to be, in the end, a bank subject to regulatory controls,” said Roy Smith, a professor at the Stern School of Business at New York University. “Safe and soundness has to be no less important than growth and profits but that was subordinated by these guys.”

We had to burn the village to save it~ London Banker

The title of this diary is a quote from the Vietnam era that sums up for many the arrogance and pointlessness of American aggression in Asia two generations ago. It keeps coming to mind each time I read President Bush's (paraphrased) statement this week: We had to nationalise the banks “to preserve the free market.”

There is no free market when the government owns the actors and sets the terms of transactions. There is no village once it has been burned to the ground.

The collapse of the financial sector is unacceptable. It is unacceptable to bankers who have vested careers, status and equity wealth in the disproportionate expansion of the financial sector. It is unacceptable to politicians who have risen to high office doing the bidding of the financial sector in ceding progressively more generous taxpayer subsidy and regulatory forbearance to its chieftains.

And so in the US, UK and EU we have politicians appropriating more petrol to hand to the arsonists who started the conflagration which is consuming our economic and political fabric. The regulators whose forbearance is a root cause of the current conflagration are handing the arsonists fresh zippo lighters. The policies adopted in these debtor nations will fail, must fail, because they destroy what remained of market economies. In the meanwhile, however, the bankers and the politicians and the regulators cannot conceive of failure and so insist on more of the same – ordering hundreds of billions in more incendiaries to fuel the blaze. The same tax breaks. The same housing subsidies. The same regulatory forbearance. The same ill-transparent, off balance sheet, accounting sleight of hand. The same eradication of market incentives to productive, disciplined saving, investment and labour.

Those who would prudently save will be punished with negative real interest rates and asset deflation. Those who would prudently invest in productive industry will be starved of scarce capital and forced into liquidation. Those who would prudently labour for a decent wage will be slowly robbed by inflation and kept docile by the threat of unemployment.

There can be no more iniquitous alliance than to have the politicians at the service of the bankers, unless perhaps it is to have the military at the service of the bankers too. The US seems to have committed itself to this worst of all possible combinations, with Congressmen threatened by the imposition of martial law if they failed to acquiesce to the Paulson Plan. Thankfully the British and EU militaries are too small and ineffective to be leveraged into a similar threat to global or domestic peace and security.

Subsidised banking seems a faster method of going bust than military adventurism, but the two together will see the US bust even more certainly. The $700 billion appropriated for the Paulson Plan and the $840 billion extended in parallel by the Federal Reserve last month are together more than three times the expenditure on US wars for the past five years. The federal borrowing requirement for 2008 is now in excess of $1.02 trillion, and for 2009 is now estimated between $1.5 and $2 trillion.

Such hyperbolic growth in the fiscal deficit and debt is unsustainable, even with such very tolerant creditors as the Japanese, Gulf Arabs, Russians and Chinese. They can see that each dollar added to the Fed's balance sheet is tinder for burning those already held or denominated in their reserves. They can project the curve forward. At some point, they must react and restrain further debasement of their reserves and investments, either by collectively raising the prices charged for the resources and products they export, the interest charged on existing and future debt, or the forced exchange of debt for equity ownership of real economic assets.

Or all three.

The cycle of debt deflation is just getting rolling. The banks were only the first bailout and already the federal deficits are ballooning unsustainably. What will be the recourse when municipalities and states face default through catastrophic tax and revenue shortfalls? What will be the recourse when large commercial employers, industries and infrastructure confront failure from collapsing consumption expenditure? What will be the consequence when unemployment, homelessness, political disaffection and crime are resurgent and threaten the political fabric?

We are at the end of the beginning. Hank Paulson has played a clever game for the past decade of exporting dodgy paper to the US creditors abroad while forcing a middle class subsidy of the tax exempt corporatists at home. Now he plays a clever game of devaluing all currency and paper assets, exporting the pain to foreign taxpayers and investors. But this is not a game that America can win without the debasement of everything America once represented as holding value in its formerly prosperous market economy.

In my experience, there is nothing so permanent as a temporary expedient. It is hard to see how partially nationlised banks will ever be more than the means of political redistribution of wealth and power, and so corrupt both the economy and political system.

We had to burn the village to save it.

Perhaps someday we will hear a remorseful Mr Paulson or Mr Brown echo Robert McNamara, early architect and aggressive propagator of the Vietnam War: “We were wrong, terribly wrong.

Bailout will destroy US dollar

Government bailouts of the financial system will destroy the dollar, euro and sterling because of hyperinflation, Martin Hennecke, senior manager of private clients at Tyche told CNBC. But Todd Everts, president & CEO of Wall Street Global, disagreed.

"The privatization of the banks is the first step down the road to hyperinflation," Hennecke said Monday. "Maybe we are not seeing the Zimbabwe-style (hyperinflation), but inflation is a major major risk and investors should look at this very carefully."

Standard and Poor's projected in 2005, well before the current crisis hit, that all the major Western governments would be heading towards default on their sovereign bonds, Hennecke said.

But the dollar's value is set to decrease over time, argued Everts, after hearing Hennecke's case.

"The US consumer is not going to be able to drive the world economies as we've seen in the last several generations," Everts said, adding that a worsening trade deficit would help to ease inflation.

"I don't think we're going to get hyperinflation to the extent that we've seen in falling economies like we saw several years ago in Argentina, Brazil and what's happening right now in Iceland," Everts said.

Hennecke said the price of gold would continue to surge as investors swapped out of cash.

Everts agreed that cash was not necessarily the safest place to invest: "You can't just go to cash, What is cash? Cash is a several trillion dollar money-market mutual-fund industry in the US, which has seen several funds lose its one dollar NAV (Net Asset Value)."

global rush to dollar liquidity is not deflation

Confusion reigns: A crisis-driven global rush to dollar liquidity is not deflation

In the crisis stage of a debt deflation, defined by Fisher and Minsky as a reduction in debt financing, credit and money market panic causes banks to stop lending and borrowing from each other, pay off existing loans to shore up their balance sheets, and build reserves against expected future losses. This creates a short term spike in demand for the currency in which the debt is denominated, in the current case dollars. To the uninitiated, this looks like monetary deflation. A strengthening currency and falling interest rates also characterizes monetary deflation. That can in time produce commodity price deflation, so the confusion is understandable. But don't be fooled.

Today the Wall Street Journal explains the recent surge in the dollar in dollar demand:
Dollar Surges Amid Hustle For Supplies Overseas
Oct. 7, 2008 (WSJ)

The dollar is in demand because many foreign banks engaged in short-term borrowing in dollars to fund various activities in recent years. Now, one normal channel for getting those funds or rolling over such debt -- borrowing from U.S.-based banks -- is gummed up, as banks are leery of lending to one another.

At the same time, banks world-wide are also looking to reduce their overall borrowing as part of a race to clean up their balance sheets. Where that borrowing was in dollars, they need dollars in order to repay it.

"There is a pyramid of leverage" in the financial system built up over years, says Mark Astley, CEO of Millennium Global Investments, a U.K. currency manager with $15 billion in assets. "This isn't going to be over in a couple of weeks."

The global demand for dollars pushed the U.S. Federal Reserve to announce a major expansion of its "swap" lines with other central banks, which allow them to provide liquidity in dollars to their local commercial banks. The Fed now has arrangements with nine other central banks, which together provide access to a total of $620 billion.

Still, that hasn't been enough to ease the squeeze. Some of the demand for dollars has spilled over into the currency markets. There, participants can buy dollars outright, or use derivatives known as currency swaps to exchange one currency for another at two different points in time.

Some investors say the appetite for dollars is akin to the demand for the yen. The yen surged against the dollar and the euro Monday; late in New York one dollar bought 101.61 yen, down sharply from 105.14 Friday.

The yen's ability to thrive stems from the fact that in better times, investors borrow in yen to take advantage of Japan's ultralow interest rates. But when volatility rises or investors need to cover losses elsewhere, they undo these maneuvers -- known as carry trades -- and buy back yen, boosting Japan's currency.

Meanwhile, by borrowing so much in dollars, foreign banks may have created "the biggest carry trade of all time," says Hans-Guenter Redeker, a currency strategist at BNP Paribas in London.
What will happen when this temporary dollar carry trade reverses? When?

The dollar will weaken rapidly. When? The de-leveraging of the "pyramid of leverage" will take from two to six months but not likely more than that.

Terror as Iceland faces economic collapse

The Icelandic Government seized control of the country’s biggest banks last night in an attempt to fend off wholesale economic collapse.

Turmoil at the banks, whose shares were suspended by the Government yesterday afternoon, had sparked panic in the tiny state, which has a population of 300,000, about the size of Coventry.

Queues formed at petrol stations as Icelanders rushed to fill up before reported fuel shortages, while savers who tried to withdraw money from banks or sell bank shares on the internet found websites were not working.

Meanwhile, fears mounted in Britain that the deterioration of Iceland’s two biggest banks - Kaupthing and Landsbanki - could have disastrous consequences for savers, City staff and the high street.

Sources said that Landsbanki and the country’s third-biggest bank, Glitner, will soon be fully nationalised, while Kaupthing had been forced to take state loans.

In a late-night sitting, parliament approved a Bill giving the Government wideranging powers over the banks, including the ability to seize their assets, force them to merge or compel them to sell off their overseas subsidiaries, many of which are in London.

Icelandic banks have lent hundreds of billions of pounds overseas and their position in the world’s financial system far outweighs the size of the country’s tiny economy, the GDP of which was only $20 billion last year.

The country’s banks have been under pressure for most of the year, struggling with rampant inflation, the collapsing value of the currency and fallout from an overheated economy.

In Reykjavik, the capital, confusion reigned among a public unsure whether their savings and investments were safe, even after the Government moved to guarantee deposits. The country’s state surgeon even warned politicians and the media to ensure that they did not alarm old people.

Savers in Britain also face fallout from the collapse of the Icelandic banking system. Fears mounted yesterday among the 300,000 British savers holding bank accounts with Landsbanki that their deposits were at risk. In the event of a collapse, savers with Kaupthing are entitled to compensation of up to £50,000 from the British authorities - as much as depositors in any British bank - but British savers with Landsbanki are not.

British savers tempted into high-interest Icesave accounts would have to rely on a much smaller Icelandic government fund to guarantee their first £16,317 of savings should Icesave collapse, with Britain only picking up the remaining £33,483 under the government depositor guarantees.

Times readers reported yesterday morning that they could not withdraw their money from Icesave accounts over the internet. But a spokesman for the bank said that Icesave was now operating normally and depositors could withdraw money. He added that the Icelandic Government had ample foreign reserves to cover the £4bn of British deposits in the event of any collapse.

Icelandic banks have lent money to British retailing and pub groups, raising fears that their collapse could lead to a firesale of British assets. Baugur, the Icelandic investment group that owns stakes in House of Fraser, Debenhams, Woolworths, Moss Bros, French Connection and the supermarket chain Iceland, said that its British businesses were not affected. But well-placed City sources said that Baugur had held private discussions about selling some assets and persuading banks to lend fresh money against others. “There are covert conversations taking place,” one source said.

A spokesman for Baugur denied that there had been an increase in such conversations in the past week.

Hundreds of jobs in the City of London are also linked to the fate of Iceland’s banks. Market sources said yesterday that Singer & Friedlander, the asset manager owned by Kaupthing, was being informally offered for sale. Other sources said that Teather & Greenwood, the stockbroker recently sold by Landsbanki to Straumur, another Icelandic bank, could be put up for sale again. Straumur said that it had no plans to sell the broker, but this was before the Icelandic Government had announced its nationalisation plans.

Why US banks are failing

The reason why the banks are going bust in simple terms is:

The banks traded in complex derivatives products between themselves, in what is termed as the over the counter market. The exposure to the Securitized debt packages was further exaggerated by the use of leverage of in many cases more than 30X the banks assets against valuations based on complex models that inflated the packages values during the boom times which allowed huge profits and bonuses to be banked (Fraud?). However the critical point is in the final link in a long chain of sliced and diced debt packages was the US housing market.

As US house prices fell, the gap between the real value and the banks inflated model values to boost profits grew, until the crunch point of August 2007, when it dawned upon market participants that in actual fact they did not have a clue as to the real value of these mortgage backed securities and hence the credit markets froze as no one wanted to buy something they could not value and nor lend to financial institutions that may default on their obligations. The impact hit all banks, whether or not they had exposure to the US housing market, as those banks whose business model relied heavily on the short-term money markets to finance long-term mortgages were in deep trouble, i.e. Northern Rock and to a lesser extent ALL of the other UK mortgage banks.

Now many banks are left with assets that are worth LESS than 50% of their "mark to market" booked value. Now that does not mean a 50% loss for the banks on investments, remember the greedy banks deployed LEVERAGE of as much as 30 times of assets, so capital of say £100 million is controlling risk of as much as £3,000 million. Therefore a 50% loss results in a loss of value of £1,500 million, that's 15 TIMES the capital. Hence the banks have been reluctant to price their debt packages at the real market price as that would mean that the bank is effectively bankrupt with losses far greater than the banks capital base. So the market remains frozen until all of the illiquid mortgage backed debt has been transferred over to the tax payers in exchange for liquid cash, hence prompting the US Mother of All bailouts plan.

So Basically there are TWO related problems at work driving the Banks Bust:

1. One of collatorised debt that is not being valued at market prices, hence frozen money markets with banks sitting on over leveraged time bombs that have started to explode in recent weeks, as the credit markets tighten further.

2. Mortgage banks reliant on short-term money markets to finance long-term mortgages that threw caution to the wind and loaned far too much money to people who could not afford to repay the mortgages are now being hit by increasing defaults as the western housing markets crash from over inflated 'bubble' levels, as their losses mushroom but now find that they are unable to borrow money to cover day to day operations due to the increased risk of default and thus hoarding of cash (if they have any left) amongst investment banks in advance of further asset price mark downs. Therefore the only avenue available for short-term cash is from either the Bank of England or individual savers, hence high savings interest rates relative to the base interest rate of 5%.

And there's more .... mortgage backed securities are the tip of the credit crunch iceberg, the next inline are credit default swaps which are basically investor insurance to protect themselves against losses on the debt packages. However as we saw with collapse of and nationalisation of the worlds biggest insurer AIG, this is another huge part of the derivatives market that is imploding, perhaps in the region of $60 trillion. Its the reason why ordinary people are going to find problems with the credit card freeze next as defaults rise and retailers start to charge a premium on card transaction due to risk of default on the transactions, or even refuse to accept credit cards, but that has yet to happen..

United States Answer To Collapsing Banks is a $700 Billion Bailout Plan

Despite all of the noise of Congress's qualms that we will witness played out during the next 24 hours or so, the bailout plan will more or less pass . Despite the fact that it represents madness, an ultimate manifestation of the subprime contaigent spreading and infecting the US Treasury with all of the consequences of loss of confidence in ALL US paper as the value of US debt devalues in the eyes of all investors.

The US Treasury and Central Bank are eager to get the US Congress to pass a blank check bill so as much of the toxic mortgage backed bonds can be bought up to prevent a further collapse of the financial system. $700 billion is not enough, not in the face of the huge deleveraging of the $500 trillion dollar market, as I warned of 6 months ago. The $700 bailout plans two un-said objectives are -

a. To delay the potential of financial collapse until AFTER the November election.

b. That the real bailout cost will run to several trillion dollars as the US government seeks to prevent a chain reaction of collapsing banks in the wake of counter party failures amongst the huge $500 trillion global derivatives market.

The latest tactics is to suggest that the US Tax payer may even make a profit on these toxic securities. The fact of the matter is that the US will probably be looking at a loss of over 50% on maturity of the anticipated price paid as there is no way that market prices will be paid, as primary reason for the freeze of the interbank money markets is that the securities are NOT being priced by the market for if they were then the market valuations would imply that the financial institutions are bankrupt, hence the free market has been suspended. Taking an estimated eventual exposure of some $2 trillions, therefore implies an eventual US tax payer loss of at least $1 trillion. Which is more than enough to send the US bond market toppling as the US is heading for a budget deficit of more than $1 trillion.

The real question that the peoples representatives should be focusing themselves on is how do we bring those who benefited from the greatest fraud in history to account for their actions and the possible repatriation of wealth stolen in recent years to the tune of more than $1 trillion due to huge bonuses paid on the back of boosted fake asset valuations. That would probably increase confidence in US paper more than signing a blank check for $700 billion .

Is your Bank Safe ?
The US Fed's and other central back actions do not mean that banks will now be saved, as last weeks example of WaMu going bust, America's biggest bank failure illustrates that literally many hundreds if not a thousand plus banks will go bust during the course of the worsening credit crisis, with all of the consequences for depositors. The following report by EWI presents a list of the 100 safest US banks.

UK Toxic State Mortgage Bank

The ground work for the bank bailouts was laid earlier in March and April 08 on the announcements that the UK Government would loan £50 billion to the Banks in exchange for toxic illiquid mortgage backed securities in an attempt to unfreeze the interbank market , at the time I warned that this is just the first step and that eventual liability would extend to several hundred billions if pounds which would still be a drop in the ocean compared to the ongoing deleveraging of a 500 trillion derivatives market which has highly deflationary implications for the credit and asset markets as we have been observing in recent weeks.

First Northern Rock and now Bradford and Bingley mark Britain's own emergency government intervention of the bailout of toxic mortgage backed securities. The estimated UK tax payer exposure in terms of anticipated losses to date is about £40 billion, £20 billion for Northern Rock and £20 billion for B&B. This is in addition to the money loaned to the UK banks as a consequence of the freeze of the interbank money markets and represents a total tax payer exposure to of at least £150 billion, or some $280 billion which compares against the US tax payer exposure of approximately $1.2 trillion that takes into account the proposed $700 billion weekend bailout.

What can Savers do ?

The only thing that savers can do is to attempt to limit real terms losses as much as possible, this implies locking in fixed savings rates ahead of now increasingly anticipated interest rate cuts. The first port of call should be fixed rate cash ISA's which currently range between 6% and 7.3%. The next port of call should be Fixed rate bonds for at least 1year and preferably 2 years, in this case savers have a window of opportunity with rates ranging from between 6.3% to as high as 7.2%. The current market leader is ICICI Bank which pays 7.2% for terms of between 1 and 3 years. Remember to adhere to the limits mentioned above of £35k per banking group.

UK Housing Market

The implications for the UK housing market both as a consequence of the HBOS takeover and Bradford and Bingley bust are going to hit the mortgage market hard with both a reduction in supply of mortgages and an eagerness of the two banks to seek to reduce their mortgage books by trying to induce their customers to remortgage to other banks via higher mortgage interest rates and therefore reduce their risks of default in the wake of the ongoing housing bear market.

The Labour government has attempted to support the housing market by suspending the 1% stamp duty taxed on house purchases on properties up to a value of £175,000 for a period of 1 year and to support new house prices through Homebuy Direct Interest Free loans.

The Halifax's latest house price data shows that the housing market crash continued to accelerate into August, plunging by 1.7% that saw another £3000 wiped off house prices following the £3,300 write off for July to stand at down 12.8% on the year to August (on a non seasonally adjusted basis). UK house prices have now fallen by more than 8% since April. If a fall of 8% in 4 months cannot be considered a crash in UK house prices than I do not know what can. No wonder Chancellor Darling virtually threw in the towel recently in his famous "I give up, please let me spend more time with my family" speech.

Why President Bush Should Fire Ben Bernanke and Hank Paulson

A Workable, Private Bank Assistance Plan or Why President Bush Should Fire Ben Bernanke and Hank Paulson
September 26, 2008


"We got to start with some other plan, not the Paulson plan."

Senator Richard Shelby (R-AL)

"Most of the banks in the US are not broke, not in trouble, but they don't trust each other because they don't know which banks are bad. We've got to get the bad ones out."

William Seidman


First we want to start with an apology to our friends at Bloomberg News, the AP and anybody else with whom we have discussed the sufficiency of the FDIC's resources over the past several months. We were not clear enough in our description of the cost of resolving the 110 banks we expect to fail between June 30 of this year and July 1, 2009 and how this cost relates to the cash resources available to the FDIC. In fact, the cost of resolving insolvent banks, the visible amount in the Deposit Insurance Fund, and the actual monies available to the FDIC, are not connected at all.


As luck would have it, the takeover of Washington Mutual by JPMorgan Chase (NYSE:JPM) after the close yesterday, an action that will result in no loss to the FDIC or depositors, provides a road map for a workable assistance plan from Washington. Let's first walk through an inventory of the vast financial resources available to the FDIC as it ramps up to handle what is going to be an increasing number of bank resolutions and sales over the next few months, resolutions that will result in losses. Then we'll comment on the impending death of the Paulson plan and provide our view of a workable alternative financed largely by the banking industry and private investors.


Why the FDIC Will Not Run Out of Money


The first line of defense for the insured depositors of US banks is regulatory takeovers and sales such as the WaMu transaction, where the acquirer assumes all deposits and buys all of the assets after a resolution by the FDIC. The FDIC takes no loss and private investors bear whatever risk remains in the assets of the failed bank. The equity and bond holders of WaMu naturally remained with the failed, publicly listed holding company and will be wiped out in bankruptcy. See our previous comment in The IRA about the difference between a bank and a bank holding company from a public company creditor/shareholder perspective ("What is to be Done?: Interview with Bert Ely").


The next line of defense for depositors in US banks is the income of the banking industry. The FDIC has open-ended authority to tax the US banking industry through deposit premiums. While the visible income of the industry is shrinking rapidly due to the diversion of funds into loan loss provisions, in the first half of 2008, provisions ($81 billion) plus net operating income totaled over $100 billion.


Moreover, behind the income of the banking industry is $1.3 trillion in tangible equity capital, a base of support that alone should be sufficient to absorb any losses the industry may generate. While the FDIC may not be able to tax the industry in real time to absorb all of these losses as and when they occur, the fact is that this capital base is the first line of defense for all depositors of all US banks - insured or otherwise.


As the FDIC noted in an open letter to Bloomberg News posted yesterday: "The fund's current balance is $45 billion - but that figure is not static. The fund will continue to incur the cost of protecting insured depositors as more banks may fail, but we continually bring in more premium income. We will propose raising bank premiums in the coming weeks to ensure that the fund remains strong. And, at the same time, we will propose higher premiums on higher risk activity to create economic incentives for poorly managed banks to change their risk profiles. The fund is 100 percent industry-backed. Our ability to raise premiums essentially means that the capital of the entire banking industry - that's $1.3 trillion - is available for support."


A final note on the FDIC's "visible" reserves, the fiscal relationship with the Treasury, and what it means in terms of the safety and soundness of bank deposits from our statement to the media yesterday:


"The FDIC does not and will not run out of money. Like all federal trust funds, the FDIC's insurance 'trust fund' does not exist. The reserves shown in the fund simply evidence the amount of money contributed by the banking industry into the fund. Like all federal trust funds, the cash raised by FDIC insurance premiums goes into the Treasury's general fund. When the agency needs cash, then the Treasury makes the money available. When the positive balance shown in the FDIC insurance fund is depleted, the FDIC simply runs a negative balance with the Treasury, a loan that the banking industry will repay over time. Indeed, the FDIC is preparing to raise the industry's insurance premiums to generate even more cash to deal with the rising levels of bank failures. Also, in the remote chance that the FDIC ever reached the statutory borrowing limit from Treasury, the Congress will simply raise the limit."


Nuff said. And yes David Evans, we still love you.


A Private Sector Alternative to the Paulson Plan


We salute Senator Dick Shelby and the House Republicans for digging in their heels and saying no to the ridiculous proposal from Treasury Secretary Hank Paulson. The Paulson Plan, which was vigorously supported by Fed Chairman Ben Bernanke, never had a chance to work because it starts from a false premise, namely that by allowing banks to swap illiquid assets for Treasury bonds, banks will sell or finance this collateral to make room for new loans.


Anyone who works in the banking industry knows that most large banks have basically shut down new business origination. The managers of these institutions, especially those with solvency issues, are still trying to avoid writing off losses on illiquid assets because they know that to do so will result in a takeover by the FDIC and career death for all of the managers who made these bad decisions. And yet it is precisely a market-based resolution that is in the best interest of the US taxpayer, the economy and the well-managed banks in the US that did not slither into the subprime, derivative swamp.


We are glad to see that President George Bush finally took our advice and invited the two presidential candidates to the White House to discuss the financial crisis. But unfortunately, Bush still does not understand that Paulson, Bernanke and the other incompetent, conflicted former Goldman Sachs (NYSE:GS) banksters and academic economists who populate the US Treasury and Federal Reserve Board (excluding all bank supervision personnel, naturally) are the biggest obstacles to forging a workable plan to help re-liquefy the banking system.


We hear from several sources who were in the room that the meeting between Bush, John McCain (R-AZ) and Barrack Obama (D-IL) quickly devolved into a pissing contest between the two presidential candidates. Obama initially took control of the meeting, this while Nancy Pelosi (D-CA) and Harry Reid (D-NV) sat in silence. McCain then began to mumble something incomprehensible about "a plan" but we see no evidence that the AZ senator has formulated a serious proposal. So nasty and sharp was the exchange between McCain and Obama that President Bush had to get in between the two men. Who says the first debate is going to be delayed?


Just look at the accomplishments of the team of Paulson and Bernanke ("P&B"), the latter of whom has been the craven lap dog of the former GS CEO from day one. The Bear, Stearns fiasco was bad enough, but failing to find a smooth transition to the troubles at Lehman Brothers makes a complete mockery of Paulson's claims to be trying to restore liquidity to the US financial system. Indeed, with friends like Paulson, Bernanke and Barney "Napoleon" Frank (D-MA), why should the American people be afraid of Al-Qaida?


You see, when P&B let Lehman be forced into a bankruptcy filing last week, more was lost than just thousands of jobs and billions of dollars in losses to shareholders and creditors. These losses are, at the end of the day, attributable to SEC Chairman Christopher Cox and the happy squirrels at the FASB. As our friend Brian Wesbury from FT Advisors in Chicago wrote:


"It seems clear that much of the current crisis has been exacerbated by mark-to-market accounting, which has created massive, and unnecessary, losses for financial firms. These losses, caused because the current price of many illiquid securities are well below the true hold-to-maturity value, could have been avoided. The current crisis is actually smaller than the 1980s and 1990s bank and savings and loan crisis, but is being made dramatically worse by the current accounting rules." Amen brother Wesbury.


When Lehman failed, what was left of the CP market, mostly paper issued by prime borrowers, got flushed down the dumper as well. We hear from the channel that once Lehman filed, nearly every prime CP issuer in the US hit their standby lines of credit with various commercial banks. So much for recapitalizing the banking system. We expect that when the Q3 data from the FDIC is released, it will show a precipitous drop in unused credit lines at some of the major domestic and foreign banks domiciled in the US. You think P&B understand this? Dream on.


But there is more. We also hear from some very well-placed sources on Capitol Hill that when the Fed's Board of Governors was presented with an $80 billion price tag for supporting Lehman the day before the bankruptcy filing, there were not five votes at the big Fed table to support the loan. When the Board does not take action, there is no record of the meeting, no transcript, no tape. Several member of the House familiar with the details reportedly will be calling for a forensic investigation of the Fed's internal records, phone and email regarding this non-decision by the central bank. But they key fact is that Ben Bernake could not make the other governors take necessary action to forestall the uncontrolled collapse of Lehman. Recalling the "leadership" role played by every Fed chairman since Arthur Burns, what use is a Fed chairman who can't get five votes when absolutely required?


As a result, it is further suggested, when JPMorgan Chase (NYSE:JPM) presented an ultimatum to Lehman management that weekend, the only choice was bankruptcy. We hear that JPM told Lehman that if they did not file, then JPM was going to put them out of business by closing down their clearing account. To get a sense for the conversation which reportedly occurred between JPM and the doomed broker dealer, recall the scene from the film The Godfather when Robert Duval gives an imprisoned capo under federal protection the option of picking the manner of his own death. Unfortunately and unlike the movie, as JPM eliminated a major investment banking competitor by compelling the suicide of a long-time clearing customer, no surety was provided for the members of the Lehman family.


The tragedy of the failure of Lehman is that by failing to obtain Fed support for an expenditure of $80 billion needed to manage an orderly sale or bank holding company conversion of the still-solvent broker dealer, P&B have created the very crisis of confidence that they now seek to solve via a $700 billion bailout of truly insolvent financial institutions. If this very public act of grotesque incompetence is not sufficient reason for President Bush immediately to demand the resignation of both Hank Paulson and Ben Bernanke, then what actions would be sufficient? How much more damage must P&B commit before President Bush and the republicans in Congress demand their heads?


Fortunately, the takeover of Washington mutual by JPM last night provides the Congress and the other inhabitants of Washington a road map for a truly workable assistance package based on private capital rather than mountains of public debt and moral hazard. As Bill Seidman suggested on CNBC last night, the FDIC, backed by the Fed, OCC and Treasury, must aggressively begin to triage and close insolvent banks, large or small. Once these institutions pass through the cleansing process of an FDIC resolution and receivership, a process that cleans the assets of any legal or other liability, crowds of investors and solvent commercial banks will be waiting on the other side to finance the re-liquefaction of these assets.


We believe that the Congress should provide an initial $500 billion in authority for the new Treasury secretary to direct into capital assistance for solvent financial institutions. Institutions taking such assistance must agree to issue warrants to the Treasury, either against common equity or the upside potential of illiquid but still performing assets on the books of these banks. If these assets are sold, the warrants must convey with the assets so that the Treasury and the taxpayer benefit, at least to some degree from the upside gain as the markets recover.


Likewise, failed assets that are sold out of a resolution by the FDIC may also carry warrants for the Treasury, depending on whether the acquirers are willing to pay close to fair market value or fire sale prices for the assets and assume all insured deposits. In the case of JPM's purchase of WaMu, all depositors are fully protected and there will be no cost to the FDIC's Deposit Insurance Fund, thus no warrant cover is required. This transaction is the optimal model for cleaning up the other bad banks, to paraphrase Bill Seidman, but not all resolutions will work so smoothly and result in no loss to the FDIC.


The key principle we believe must be part of any assistance package approved by the Congress is to try, wherever possible, to keep the troubled assets of the banks in private hands. If the government must take ownership of bank assets, then the FDIC is the proper vehicle to play that role. Apart from the FDIC, which is an independent, self-funded agency, the US government has absolutely no competence when it comes to owning or managing financial assets. The GSE fiasco makes that clear. But by providing the authority for the Treasury to selectively support capital infusions into solvent banks, and the aggressive closure and sale of insolvent banks, we can quickly clean up this latest nightmare on Wall Street and get the US economy back on track.

Americans Should Worry About Bank Deposits

Top Economist: Americans Should Worry About Bank Deposits if Congress Doesn't Act
Posted Sep 15, 2008 12:58pm EDT by Aaron Task in Investing, Recession, Banking
Related: LEH, MER, BAC, AIG, WM, ^DJI, ^GSPC

Updated from 12:58 p.m. EDT

With the "financial storm of the century" hitting financial institutions, many Americans are worried about the safety of their bank deposits. While the FDIC insures individual accounts up to $100,000, the reaction to IndyMac's failure this summer -- lines outside retail branches -- shows Americans have limited faith in the Federal Deposit Insurance Corp., which guarantees individual accounts up to $100,000.

Update: "The banking system is safe and sound," Treasury Secretary Hank Paulson declared at a mid-afternoon press conference Monday, seeking to ameliorate such concerns.

"Nothing is more important than the stability and orderliness of our financial markets [and] regulators remain vigilant," Paulson continued. "We're working through a difficult period in our financial markets right now as we work of some of the past excesses, but the American people can remain confident in the soundness and resilience of our financial system."

But Americans are justified to be worried, says Nouriel Roubini, of NYU's Stern School and RGE Monitor, who notes there is already a "slow-motion run on retail banks" occurring nationwide.

That "run" could accelerate as people realize the FDIC fund has about $50 billion to "insure" about $1 trillion in assets at the nation's financial institutions, says Roubini. "They're going to run out of money" unless Congress acts soon to recapitalize the FDIC.

In addition, the recent spike in number of banks on the FDIC's "troubled list" is only through June, meaning even that inflated number understates the problem.

The intent here isn't to add to people's anxieties, but Roubini is one of the few market watchers to correctly predict the severity of this ongoing credit crisis. If nothing else, he says people with accounts exceeding $100,000 in value should spread their money - and the risk - among different firms.