History > 2008 > USA > Economy (IXa)

Christopher Crotty

worked on the floor

of the New York Stock Exchange

on Wednesday.

Photograph:

Richard Drew        Associated Press        September 17, 2008

As Fears Grow, Wall St. Titans See Shares Fall

NYT

18.9.2008

http://www.nytimes.com/2008/09/18/business/18wall.html

Wesley Bedrosian

Editorial cartoon

 Present at the Crash        NYT        18.9.2008

http://www.nytimes.com/2008/09/19/opinion/19baris.html 

 

Op-Ed Contributor

Present at the Crash

September 19, 2008
The New York Times
By SAM G. BARIS

ON the subway, a stranger in a suit knowingly eyed my Lehman Brothers ID badge in its Bear Stearns holster. With a look of detached curiosity, he expressed his condolences. This is not the way I thought my Wall Street career would begin.

During college, I was an intern at Bear Stearns. There, I toiled at the lowest levels of Wall Street, fetching coffee, moving boxes, filing papers.

In my final summer at Bear, I was promoted to intern in the marketing department of the asset management division. There, I worked on some hedge funds that invested in stuff called “mortgage-backed securities.”

Several months later, the hedge funds went down the tubes, dragging Bear Stearns behind them.

After I graduated from college, Lehman Brothers hired me to help settle trades in complex derivatives, the very derivatives that led to the company’s demise. I helped resolve trading issues involving tens — hundreds — of millions of dollars.

And now? Now from my desk here in the trenches, my colleagues and I watch CNBC reports on the collapse of Wall Street. Over the months, we have watched our stock price plummet 99.8 percent, from $65 per share to 15 cents.

The news provides grist for the rumor mill. I trade notes with my colleagues here. Though some more senior people have lost their entire life savings, the steady stream of bad news and uncertainty are also difficult for those of us at the bottom of the Wall Street food chain. It is dizzying.

Most of the time, in the office and out, I feel like I am on display, an object of pity or fascination. Friends and family send frequent expressions of concern and empathy by phone, e-mail and text message.

Even though I had little — nothing, actually — to do with the real estate losses that led to Lehman’s problems, or the hedge funds that precipitated Bear’s demise, the only conclusion I can draw is that I’m a jinx. Prospective employers will take one look at my résumé and call security to escort me out the door lest my mere presence infect their otherwise healthy businesses.

Meanwhile, I sit at my desk. “Your password will expire in nine days,” my computer informs me. “Would you like to change it?” Each time, I click “No.”

Sam G. Baris is an analyst at Lehman Brothers.

Present at the Crash, NYT, 18.9.2008,
http://www.nytimes.com/2008/09/19/opinion/19baris.html

Eric Devericks

Editorial cartoon

Seattle, WA, The Seattle Times

Cagle

18.9.2008

Pain Spreads

as Credit Vise Grows Tighter

September 19, 2008
The New York Times
By LOUIS UCHITELLE

The latest outgrowth of the housing crisis, the breakdown on Wall Street, threatens to gradually corrode economic activity on Main Street, mainly by disabling the credit on which so many everyday transactions depend — but also by frightening people.

Lenders of all types had already been raising the bar for borrowers, turning away all but the best customers. This week, they became even less willing to part with their money, further crimping budgets and family spending.

An economy propelled by easy credit for more than a decade is fraying as credit disappears. American Express, to take one striking example, is reducing the maximum credit limit for half of its tens of millions of cardholders.

The credit shock is in some ways reminiscent of the 1973 oil embargo, which “came into people’s lives right away,” said Andrew Kohut, director of the Pew Research Center, the public opinion pollster. Then, Americans were forced to line up for gasoline and turn down their thermostats in winter. Though less visible, the credit squeeze, if it persists, will force businesses and consumers to cut spending more than they already have.

“We have moved into a decline in consumer spending, which normally happens only in a major recession,” said Ethan Harris, chief domestic economist at Lehman Brothers. He calls the experience “a slow-motion recession in which economic growth will be near zero for an extended period of time.”

Consumer spending accounts for two-thirds of American economic activity and has been slowing as the value of homes falls. Although the economy is not yet in a formal recession, consumer spending in June and July grew only because consumers paid more for the same goods. After factoring in higher prices, they actually bought less.

Borrowers are finding that the nation’s lenders are tightening up in numerous ways. American Express is hardly alone. After several banks said they would not lend the asking price, a tractor-trailer dealer in North Carolina had to cut the $20,000 he was seeking for a second-hand tractor to $14,000. And a commercial real estate agent, trying to raise $4 million by refinancing an apartment building, got only half that amount from the Bank of Smithtown on Long Island, even though the building was appraised for $10 million.

“With marginal lenders in trouble, we have more people than ever coming to us for loans,” said Brad Rock, chairman of the Smithtown bank. “So all of a sudden, we can be much pickier in deciding what loans to make and how much to lend.”

Being pickier means that an American Express cardholder whose maximum has been reduced to $1,000 from $1,200 has that much less to spend on clothing or meals out, purchases that lift the economy.

At $14,000 for a used tractor, a trucker, caught in the same squeeze as the dealer, would lack a sufficient down payment for a new tractor, which costs more than $100,000. Indeed, many truckers in this situation find themselves looking for other work, even as job seekers across the nation outnumber job openings by more than 2 to 1, the biggest mismatch since 2004, the Bureau of Labor Statistics reports.

And the commercial real estate agent is shy $2 million that would have been invested in a new venture to generate economic growth.

Mr. Rock, also chairman of the American Bankers Association, with 8,400 affiliates, does not see a problem in this turn of events.

“Now people are going to actually have to have a job to get a loan and they are going to have to make installment payments that are already higher per dollar borrowed than they used to be,” he said, arguing that the debt-fueled prosperity of the bubble years was unsustainable.

But there is not, for the moment, an adequate replacement.

Henry Kaufman, a Wall Street economist, ticks off the alternatives and discounts them. Exports could carry some of the load, but the surge in the first half of the year is fading as European and Asian economies weaken. Here at home, capital spending by business on new buildings and equipment could provide a lift, but that, too, is beginning to fade as corporate profits — and demand — weaken. Just Wednesday, FedEx announced that profits had shrunk in the latest quarter as freight traffic declined.

Home construction is off the table, of course, as a means of lifting the economy. That leaves government, which could inject money into the economy through aid to the states or infrastructure spending or another round of tax rebates. There is even talk of a bigger bailout for the housing market, akin to Resolution Trust Corporation’s role in the savings and loan crisis. But Congress seems unlikely to authorize any of these measures in its current, brief pre-election session.

“Sometime in 2009, after the new president takes office, we will address these issues,” Mr. Kaufman said, lamenting the delay.

Meanwhile, the barriers to borrowing go up. By late summer, a majority of the nation’s lenders had tightened standards for every type of credit, the Federal Reserve’s bank surveys show. Home equity lines of credit have been canceled or reduced as home prices have fallen. Credit card companies are imposing higher delinquency fees, stepping up collection efforts and checking on repayment histories.

“More and more, they don’t give the card if you don’t have a good credit record,” Mr. Harris, of Lehman Brothers, said.

Michael O’Neill, an American Express vice president, agrees. He adds that the company is offering fewer new cards than in the past in Florida, California and parts of the Southwest, all areas where home prices have fallen the most. And quietly, American Express is skinning back credit limits. The company is always reviewing its millions of accounts, normally increasing the limit on three out of four, and decreasing the fourth. Since July, “the tilt is 50-50,” Mr. O’Neill said.

The North Carolina truck dealer originally listed a 2001 Freightliner for $20,000 on truckertotrucker.com, an online marketplace for tractors and trailers, and this week, he dropped the price to $14,000 because of the growing resistance from bankers, said James McCormack, who operates the site.

“The banks were giving loans for the full value of these trucks and the value was falling, and the truckers found themselves owing more than the trucks were worth,” Mr. McCormack said. “They found themselves forced to keep driving or let the banks repossess, and many have elected repossession.”

Debt traps and loan famines, in one form or another, can prove costly to companies. Harley-Davidson, for example, which finances purchases of its motorcycles, is issuing bonds and notes at slightly higher rates to support its financing arm.

Restaurants in the casual-dining sector are in a severe slump, according to industry analysts, and will most likely come under further pressure. The pancake house IHOP bought Applebee’s last year with a strategy of selling off company-owned stores to franchisees. Now known as DineEquity, the company may have problems finding prospective franchisees who can obtain financing, industry analysts said.

The winners so far are the Brad Rocks of America, the bankers who have emerged unscathed, their capital intact and with enough retained earnings to support lending, on their terms. A residential mortgage from Bank of Smithtown requires 20 percent down and clear evidence of adequate income to repay the loan, as well as a good record of paying down debt.

Bank of Smithtown specializes in small businesses — the stationery stores, pizza parlors and pharmacies of eastern Long Island with annual revenue of $2 million or less, regularly in need of bridge loans, for example. During the credit boom, Mr. Rock said, many of these business owners went to lenders who required, as he put it, nothing more than a tax ID number to qualify for a loan.

“Now many of these lenders are gone,” Mr. Rock said, “and the small-business borrowers are coming to us, and we are doing good old-fashioned underwriting, and the result is that fewer people are getting loans.”

Pain Spreads as Credit Vise Grows Tighter, NYT, 19.9.2008, http://www.nytimes.com/2008/09/19/business/economy/19econ.html

Chris Britt

Editorial cartoon

Springfield, IL -- The State Journal-Register

Cagle

18.9.2008

Downturn Drives Up

New York’s Jobless Rates

September 19, 2008
The New York Times
By PATRICK McGEEHAN

The unemployment rates for New York City and State shot up in August as the rapidly spiraling economic downturn left more people without jobs, the state’s Department of Labor said on Thursday.

The city’s unemployment rate rose to 5.8 percent from 5 percent in July — the largest monthly increase in more than 30 years — as about 5,200 private-sector jobs were eliminated, the department reported. Many of the layoffs came in the tumbling financial sector, which is one of the city’s biggest employers and the provider of nearly one-fourth of its annual wages and salaries.

In the last 12 months, employment in the financial realm has declined by 5,300 jobs, according to James Brown, an analyst with the Labor Department. Some of those losses resulted from the collapse of the Bear Stearns investment bank in March. But many of the cutbacks at that firm and others on Wall Street still have not shown up in the official statistics.

For example, the August totals do not include the 1,500 layoffs that Lehman Brothers had planned to make before it was forced into a bankruptcy filing on Monday. Lehman, which employed more than 25,000 people, has sold its main trading operations to Barclays Capital, a London-based firm, but it is not known how many of the 10,000 employees of those operations will keep their jobs. American International Group, the Manhattan-based insurance giant, was on the brink of failure before receiving an $85 billion lifeline from the federal government this week.

“Although the crises at Lehman Brothers and A.I.G. appear to be working out so as to avoid immediate large-scale layoffs, the continued financial-sector turmoil guarantees that job losses on Wall Street will climb rapidly over the next few months,” Mr. Brown said.

Despite the current deterioration in the job market, the city still had about 31,000 more jobs last month than it had in August 2007, when the unemployment rate was 5.3 percent, according to the report. Most of that job growth has come in the fields of education, health care, trade and transportation, and leisure and hospitality.

“Most of the professional business industries such as law firms lost a small number of jobs in August, but all in all, New York City has still yet to see any significant impact from the turmoil on Wall Street,” said Barbara Denham, chief economist for Eastern Consolidated, a real estate investment firm.

“This will undoubtedly change in the next few months, but the job losses from Lehman Brothers’ bankruptcy and Bank of America’s purchase of Merrill Lynch may not hit the job numbers until November or later,” Ms. Denham said. “While New York City’s economy remains well diversified in health care and private education, the problems on Wall Street will likely spill over into the business travel industry, which would affect hotels, restaurants and entertainment.”

The jobless rates for the city and the state were lower than the national unemployment rate, which jumped to 6.1 percent last month, according to the Labor Department.

Statewide, the jobless rate also rose to 5.8 percent, from 5.2 percent in July. That was the largest monthly increase in the state’s rate since January 1991, said Peter A. Neenan, director of the department’s division of research. Still, the department reported that the state added 3,000 private-sector jobs in August.

“New York State’s labor market indicators reported mixed signals in August,” Mr. Neenan said.

Downturn Drives Up New York’s Jobless Rates, NYT, 19.9.2008, http://www.nytimes.com/2008/09/19/nyregion/19unemployed.html

Oil rises above $100 a barrel

September 19, 2008
Filed at 9:10 a.m. ET
The New York Times
By THE ASSOCIATED PRESS

LONDON (AP) -- Oil prices rose above $100 a barrel Friday as investors waited for details of a U.S. government plan that could help ease the credit crisis that has roiled global markets.

Light, sweet crude for October delivery rose $3.98 to $101.86 a barrel in electronic trading on the New York Mercantile Exchange after word of the plan eased concerns that demand for energy would fall sharply amid a weakening world economy.

After discussions Thursday night with congressional leaders, Treasury Secretary Henry Paulson said the goal was to come up with a ''comprehensive approach that will require legislation'' to deal with the bad debts on banks' balance sheets. He did not provide any details, but the plan taking shape called for Congress to give the Bush administration the power to buy distressed bank assets.

''The market is taking guidance from some mild restoration of confidence in the U.S., but the market still remains cautious,'' said Mark Pervan, senior commodity strategist with ANZ Bank in Melbourne. ''For the moment they have calmed some fears, but there will be a lot of fence-sitting before the plan comes out.''

Oil prices have fallen about $50 since reaching a record $147.27 a barrel on July 11 on concern that slowing economic growth in developed countries will undermine crude demand.

Those fears deepened this week as turmoil in the U.S. financial system led to the bankruptcy of investment bank Lehman Brothers Holding Inc. and an $85 billion government rescue of insurer American International Group Inc.

''Oil demand is coming off in the U.S. regardless of what Paulson does, but we may not see the sharp falloff that the market was increasingly worried about,'' Pervan said.

Nigeria's main militant group said Thursday it bombed another oil pipeline, marking a sixth straight day of stepped-up violence in Africa's oil giant.

The Movement for the Emancipation of the Niger Delta said in a statement it used high explosives to destroy the conduit run by a unit of Royal Dutch Shell PLC.

Shell officials could not immediately be reached for comment.

The militants have declared an ''oil war'' in the Niger Delta, where militants demanding more oil-industry funds from the federal government have increased attacks. About 40 percent of Nigeria's normal daily oil production is now offline, severely curtailing exports.

''The focus of the market right now has switched from supply to demand,'' Pervan said. ''So these stories will have some impact, but not as much as they had during the last six months when the market was supply-driven.''

In other Nymex trading, heating oil futures rose 2.31 cents to $2.806 a gallon, while gasoline prices gained 2.30 cents to $2.505 a gallon. Natural gas for October delivery fell 1.0 cent to $7.611 per 1,000 cubic feet.

In London, October Brent crude rose $2.23 to $97.42 a barrel on the ICE Futures exchange.

----

Associated Press writer Alex Kennedy contributed to this report from Singapore.

Oil rises above $100 a barrel, NYT, 19.9.2008,
http://www.nytimes.com/aponline/business/AP-Oil-Prices.html

Investors, Hungry for Hope,

Send Dow Up 410

September 19, 2008
The New York Times
By VIKAS BAJAJ
and MICHAEL M. GRYNBAUM

A seesaw day on Wall Street ended with a rush of euphoria Thursday as investors raced back into beaten-down banking shares, heartened by signs that the government is taking more drastic steps to tamp down problems plaguing the financial markets.

In a rally that came in the final hour of trading, the Dow Jones industrials surged to a 410-point gain, nearly erasing the 449-point loss sustained on Wednesday.

But it was by no means a sign that the crisis on Wall Street had turned a corner.

Fear and stress still abounded in the credit markets, where investors flocked to the safety of Treasury bills and banks charged each other higher loan rates, a reflection of lingering anxiety about the health of the financial industry.

As investors grapple with the once-unthinkable developments that have rocked the world of finance in the last week, lending to consumers and some businesses has tightened, drying up an important lubricant of the economy even as growth continues to contract.

“We are still in a flight-to-quality mode,” said Jane Caron, chief economic strategist at Dwight Asset Management, a bond investment firm in Burlington, Vt. “When I assess the mood on my trading desk, people are still very concerned that we have not seen the end of this crisis.”

The Standard & Poor’s 500-stock index closed up 4.33 percent, to 1,206.51, and the Dow Jones industrial average rose 3.86 percent, to 11,019.69 The Nasdaq composite jumped 4.78 percent.

Analysts attributed the stock market rally not to a fundamental improvement in the financial environment, but rather to reports that the government might be planning to quarantine some of the worst assets held by major banks.

Sentiment was also buoyed when regulators announced actions intended to blunt the impact of short sellers, investors who bet that a stock’s price will drop. Some banks and government officials have blamed short sellers for the precipitous drops in shares of big banks over the last few months, including the decline that played a role in the downfall of Lehman Brothers this week.

Shares of the last two independent investment banks standing, Morgan Stanley and Goldman Sachs, seesawed a day after suffering steep losses. Investors worried that the banks could face fates similar to those of Lehman and Merrill Lynch, which sold itself Sunday to Bank of America to avert a deepening financial crisis.

Morgan Stanley stock ended up 3.7 percent, but Goldman Sachs closed down, one of the few major financial companies to end the day in the red. Goldman shares lost 5.7 percent; earlier they were down as much as 25 percent, reflecting the uncertainty over the bank’s future.

Wachovia, the banking giant that is considering a possible merger with Morgan Stanley, jumped nearly 60 percent; Washington Mutual, the troubled savings and loan that has also been working on efforts to save itself, gained 49 percent.

For the first time since Lehman collapsed and the American International Group was rescued, President Bush made a brief statement in Washington, saying the government would “act to strengthen and stabilize our financial markets and improve investor confidence.”

Earlier, the Federal Reserve said it would extend an effort that allows central banks around the world to lend dollars in foreign economies. The Fed will provide an extra $180 billion under the program to grease the wheels of finance.

Despite the surge in stocks, investors remained wary about lending to businesses and to one another. The cost to insure companies’ debt, a measure of investors’ confidence in the firms, remained at historically high levels, analysts said, although the cost declined slightly from Wednesday.

Investors displayed a strong preference for safer and more tradable government securities than other short-term, private debt. The cost of several types of corporate and bank borrowing remained high and, in some cases, increased further. A gauge of fear — the Libor rate, which measures how much banks charge one another for overnight loans — remained elevated on Thursday.

Treasury notes and bonds sold off in the afternoon but the price of short-term government debt remained elevated. The yield on the three-month Treasury bill, which falls when the price rises, was 0.076 percent, little changed from 0.061 percent on Wednesday. A week ago, the yield was 1.644 percent.

The sharp move in the last few days suggests that some investors are willing to receive virtually no return to hold a Treasury bill, thought to be among the safest of all investments. By contrast, interest rates on three-month commercial paper, a competing form of private borrowing used by banks and corporations, jumped to 3.32 percent, from 3.17 percent on Wednesday and 2.86 percent a week earlier, according to Bloomberg data.

If the tight conditions in the money market persist, economists and analysts say it could severely limit the availability of credit to businesses and consumers. Federal Reserve data released on Thursday showed that consumer and business borrowing slowed significantly, though it continued to grow, in the second quarter.

Commercial paper outstanding fell by 2.87 percent for the seven days that ended Wednesday, according to the Federal Reserve, its biggest one-week decline since the summer of 2007. Back then, investors became concerned about certain kinds of commercial paper that was used to buy securities backed by mortgages and other consumer debts.

“This is a breakdown in the system of trading bonds and a breakdown of extending credit,” said James T. Swanson, chief investment officer at MFS Investments, a mutual fund company based in Boston.

Mr. Swanson said that so far, the stress had not affected most nonfinancial corporations, many of which have large holdings of cash and do not have a pressing need to borrow money. But he said companies that his analysts talk to have said the credit squeeze could start to hurt if the commercial paper market remains shut down and bank lending remains as tight as it is now.

Sectors like energy, pharmaceuticals and technology are more flush with cash and less vulnerable to troubles in the credit markets. But others, like retail stores, restaurants and airlines, could be hurt if tight conditions persist.

Kurt von Emster, portfolio manager of the MPM BioEquities Fund, said he had advised companies to draw down on their bridge loans from banks, because of the turmoil in the credit market. “Those will be not only hard to come by, but impossible to come by,” he said about bridge loans.

The benchmark 10-year Treasury note was down 1 3/32, at 103 25/32, and the yield, which moves in the opposite direction from the price, was at 3.54 percent, up from 3.41 percent late Wednesday.

Following are the results of Thursday’s Treasury auction of 20-day and 76-day cash management bills:
 

Matthew Saltmarsh and Heather Timmons contributed reporting.

Investors, Hungry for Hope, Send Dow Up 410, NYT, 19.9.2008, http://www.nytimes.com/2008/09/19/business/19markets.html

Kirk Walters

Editorial cartoon

Ohio -- The Toledo Blade        Cagle

18.9.2008

Paulson outlines

bold approach to end crisis

September 19, 2008
Filed at 10:52 a.m. ET
By THE ASSOCIATED PRESS
The New York Times

WASHINGTON (AP) -- Treasury Secretary Henry Paulson on Friday sketched out a multi-faceted effort to confront the worst U.S. financial crisis in decades, outlining a program that could cost taxpayers ''hundreds of billions'' of dollars to buy up bad mortgages and other toxic debt that has unhinged Wall Street.

''This needs to be big enough to make a real difference and get to the heart of the problem,'' he told reporters as the administration asked Congress to give it sweeping powers.

He gave few details but said he would work through the weekend with leaders of Congress from both parties to flesh out the program, the biggest proposed government intervention in financial markets since the Great Depression.

The government steps were clearly welcomed by financial markets. As Paulson spoke, the Dow Jones industrials were up over 300 points and at one point had soared by 450 points.

Before the markets opened, the government announced plans to temporarily insure money-market deposits and to block short-selling in financial securities. Short selling is a trading method that bets the stocks will go down.

Speaking to reporters at the Treasury Department, Paulson said that the new troubled-asset relief program that he wants Congress to enact must be large enough to have the necessary impact while protecting taxpayers as much as possible.

''I am convinced that this bold approach will cost American families far less than the alternative -- a continuing series of financial institution failures and frozen credit markets unable to fund economic expansion,'' Paulson said in a prepared statement.

''The financial security of all Americans ... depends on our ability to restore our financial institutions to a sound footing,'' Paulson said.

Paulson said mortgage giants Fannie Mae and Freddie Mac will step up their purchases of mortgage-backed securities to help provide support to the crippled housing market.

He also said Friday that the Treasury Department will expand a program, announced earlier this month, to buy mortgage-backed securities, which have been badly hurt by the housing and credit crisis.

''As we all know, lax lending practices earlier this decade led to irresponsible lending and irresponsible borrowing. This simply put too many families into mortgages they could not afford,'' Paulson said.

At a news conference in which he only took three questions, Paulson was asked the approximate dollar size of the government intervention. ''We're talking hundreds of billions,'' he said.

Paulson did not address specifics about the plan to buy back bad debt or whether the government would take a direct stake in troubled banks in exchange for its help.

''These illiquid assets are clogging up our financial system, and undermining the strength of our otherwise sound financial institutions. As a result, Americans' personal savings are threatened, and the ability of consumers and businesses to borrow and finance spending, investment, and job creation has been disrupted,'' Paulson said.

He said that the administration would present Congress with a proposed legislative package and then work with lawmakers ''to flesh out the details through the weekend. And we're going to be asking them to take action on legislation next week.''

''This is what we need to do. Because for some time we've been saying that the root cause of the problems in our economy and our financial system is housing, and until we get stability in the housing market we are not going to get stability in our financial markets,'' he said.

Earlier, President Bush authorized Treasury to tap up to $50 billion from a Depression-era fund to insure the holdings of eligible money market mutual funds. And the Federal Reserve announced it will expand its emergency lending program to help support the $2 trillion in assets of the funds.

Both moves are designed to bolster the huge money market mutual fund industry, which has come under stress in recent days.

The Fed said it is expanding its emergency lending efforts to allow commercial banks to finance purchases of asset-backed paper from money market funds. The central bank's move should help the funds meet demands for redemptions.

The Securities and Exchange Commission early Friday imposed a temporary emergency ban on short-selling of financial company stocks. As the financial crisis widened, entreaties had come from all quarters to stem a swarm of short-selling contributing to the collapse of stock values in investment and commercial banks.

Congressional leaders said they expected to get the rescue plan Friday and act on it before Congress recesses for the election.

The government's actions could help alleviate the uncertainty that has been sending the markets into tumult over the past week. Lending has grinded to a virtual standstill in the wake of the bankruptcy of Lehman Brothers Holdings Inc.

Global stock markets roared higher, too.

And European Central Bank, Swiss National Bank and Bank of England offered up more cash Friday. The three banks put a combined $90 billion into money markets in a lockstep move.

The chairman of the Senate Banking Committee, Chris Dodd, D-Conn., warned the United States could be ''days away from a complete meltdown of our financial system'' and said Congress is working quickly to prevent that.

Dodd told ABC's ''Good Morning America'' on Friday that the nation's credit is seizing up and people can't get loans.

The ranking Republican on the Banking Committee, Sen. Richard Shelby, said the U.S. has ''been lurching from one crisis to another'' and predicted the new bailout plan would cost at least half a trillion dollars.

''We hope to move very quickly. Time is of the essence,'' House Speaker Nancy Pelosi, D-Calif., said after Paulson and Bernanke briefed congressional leaders Thursday night.

The federal government already has pledged more than $600 billion in the past year to bail out, or help bail out, some of the biggest names in American finance.

------

Associated Press writers Martin Crutsinger, Andrew Taylor and Marcy Gordon in Washington and Joe Bel Bruno in New York contributed to this report.

Paulson outlines bold approach to end crisis, NYT, 19.9.2008, http://www.nytimes.com/aponline/business/AP-Financial-Meltdown.html

Martin Kozlowski

inxart.com        Cagle

18.9.2008

Bush says economy stable

despite financial crisis

September 19, 2008
Filed at 10:51 a.m. ET
By THE ASSOCIATED PRESS
The New York Times

WASHINGTON (AP) -- President Bush has told the nation his administration is taking ''unprecedented action'' to deal with the ailing financial markets.

Bush said he appreciates the willingness of Congress to work with the administration to address the crisis ''head on.''

The president spoke publicly for the third time this week about convulsive developments in the business world. He was joined on the White House steps outside the Oval Office by Federal Reserve Chairman Ben Bernanke, Treasury Secretary Henry Paulson and Securities and Exchange Commission Chairman Christopher Cox.

THIS IS A BREAKING NEWS UPDATE. Check back soon for further information. AP's earlier story is below.

WASHINGTON (AP) -- For the third time this week, President Bush will work to reassure nervous consumers and stabilize markets, delivering a short speech Friday about federal actions to halt the worst financial crisis in decades.

Bush will speak for about nine minutes in the Rose Garden alongside Treasury Secretary Henry Paulson and Christopher Cox, chairman of the Securities and Exchange Commission. White House press secretary Dana Perino said Bush will discuss the causes of the crisis and outline urgent actions being taken by the Federal Reserve, the Treasury Department and the SEC to stabilize markets and restore confidence.

The president will pledge to work in a bipartisan way with the Democratic-controlled Congress on a systemwide proposal to improve the health of U.S. financial institutions, Perino said.

The Bush administration said Friday it would safeguard assets in money market mutual funds and temporarily banned short-selling of financial company stocks. The Treasury Department has asked Congress to give it sweeping power to buy up toxic debt that has unhinged Wall Street.

Bush also has authorized Treasury to tap up to $50 billion from a Depression-era fund to insure the holdings of eligible money market mutual funds. And the Federal Reserve announced it will expand its emergency lending program to help support the $2 trillion in assets of the funds.

    Bush says economy stable despite financial crisis, NYT, 19.9.2008, http://www.nytimes.com/aponline/washington/AP-Bush-Markets.html

Mikhaela Reid        Cagle

18.9.2008

U.S. Drafts Sweeping Plan to Fight Crisis

Treasury Shores Up Money Markets in First Salvo;

Paulson Set to Hold Press Conference
 

SEPTEMBER 19, 2008
9:18 A.M. ET
The Wall Street Journal
By DEBORAH SOLOMON and DAMIAN PALETTA

WASHINGTON -- The federal government is working on a sweeping series of programs that would represent perhaps the biggest intervention in financial markets since the 1930s, embracing the need for a comprehensive approach to the financial crisis after a series of ad hoc rescues.

At the center of the potential plan is a mechanism that would take bad assets off the balance sheets of financial companies, said people familiar with the matter, a device that echoes similar moves taken in past financial crises. The size of the entity could reach hundreds of billions of dollars, one person said. U.S. Treasury Secretary Henry Paulson will hold a 10 a.m. EDT press conference Friday to discuss a "comprehensive approach to market developments."

Meanwhile, the Treasury announced a massive program Friday to shore up the nation's money-market mutual-fund sector, responding to concerns that the global financial crisis is starting to affect those historically safe assets. The move is designed to stem an outflow of funds as consumers start to worry about even the safest of investments, a sign of how the crisis is spreading to Main Street. There is $3.4 trillion in money-market funds outstanding.

In addition, the Federal Reserve is expanding its liquidity programs, which should help money funds meet redemption demand. The initiative includes purchasing certain short-term debt obligations issued by Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. The Fed said it will also extend so-called non-recourse loans at the primary credit rate to U.S. banks to finance their purchases of high-quality asset-backed commercial paper from money-market mutual funds.

Meanwhile, the Securities and Exchange Commission proposed a temporary ban on short-selling on 799 financial stocks. The ban, which is effective immediately, is set to last for 10 days, but could be extended for up to 30 days. (See related article.)

Under the Treasury program, the government will insure the holdings of any eligible publicly offered money-market fund. The funds must pay a fee to participate in the program.

"The program provides support to investors in funds that participate in the program and those funds will not 'break the buck,'" Treasury said in a statement, referring to the concern that arises when the net asset value of money-market funds falls below $1 per share.

The insurance program will be financed with up to $50 billion from the Treasury's Exchange Stabilization Fund, which was created in 1934. President George W. Bush had to sign off on Treasury's use of the fund.

"Concerns about the net asset value of money-market funds falling below $1 have exacerbated global financial market turmoil and caused severe liquidity strains in world markets," Treasury said in a statement.

The administration had been taking a patchwork approach to the financial crisis, putting out fires as they ignited. The new moves represent an effort to take a more systematic approach, after a spiral of bad debts, credit downgrades and tumbling stocks brought down venerable names from investment bank Lehman Brothers Holdings Inc. to insurance giant American International Group Inc. Banks have grown unwilling to lend to one another, a sign of extreme stress, because financial markets work only when institutions have faith in each other's ability to meet their obligations.

Word of a coordinated government plan came first came Thursday, a day when the Federal Reserve and other major central banks offered hundreds of billions of dollars in loans to commercial banks to alleviate a deepening freeze in the world's credit markets. That step appeared to have moderate impact on lending among banks. Meanwhile, a wave of redemptions continued hitting money-market funds, causing a second large fund to shut to investors.

In Russia, officials suspended stock-market trading for the second-straight day as the Russian government promised to inject $20 billion to halt a collapse in share prices. In China, government officials directed purchases of bank shares and encouraged companies to buy their own shares in efforts to prop up a falling market.

Stocks Rallied Thursday, Early Friday
 

Still, word of a possible U.S. plan to address the crisis sent the stock market soaring on Thursday, in one of its sharpest reversals in recent memory. The Dow Jones Industrial Average ended up 3.9%, the index's biggest percentage gain in nearly six years, on record New York Stock Exchange volume. The blue-chip index finished more than 560 points above its intraday low and reclaimed about 90% of its Wednesday losses. Nasdaq composite trading also saw trading volume set a new single-day high at 3.89 billion shares. All 30 Dow component stocks closed higher, but financial companies were the biggest winners, racking up double-digit percentage gains after weeks of selling off.

Early Friday, stock futures roared higher as investors welcomed government efforts to shore up markets and clamp down on short selling. Dow futures climbed more than 300 points before the opening bell.

The flurry of moves under discussion may bring the markets some breathing room, but it isn't clear whether they will amount to a long-term solution to the complex financial problems sweeping the market.

"The market wants to see a more systemic solution that doesn't leave us wondering day after day about the next institution that's the weakest link in the chain," said former Fed Board member Laurence Meyer, vice chairman of Macroeconomic Advisers, an economic research firm.

Treasury Department officials have studied a structure to buy up distressed assets for weeks, but have been reluctant to ask Congress for such authority unless they were certain it could get approved. The intensified market turmoil may have changed that political calculus, even with less than two months left until the November elections.

A big question still to be answered is how the government will value the assets it takes onto its books. One possible avenue could be some sort of auction facility, so that the government would not have to be involved in negotiating asset values with companies. Financial companies would likely take big losses.

President Bush met with Treasury Secretary Paulson, Securities and Exchange Commission Chairman Christopher Cox and Federal Reserve Chairman Ben Bernanke for 45 minutes Thursday to discuss "the serious conditions in our financial markets," said White House spokesman Tony Fratto.

Messrs. Paulson, Cox and Bernanke later addressed congressional leaders Thursday evening on their proposals. At the meeting, Mr. Bernanke began by laying out the severity of the crisis. Mr. Paulson "made the sale," said a top congressional aide.

House Financial Services Committee Chairman Barney Frank, the Massachusetts Democrat, said his panel could hold a vote on the package as soon as Wednesday.

"They said they would like legislation to do it, and there was virtually unanimous agreement that there would be legislation to do it," said Mr. Frank.

In a news conference after the meeting, Mr. Paulson described his effort as "an approach to deal with the systemic risk and the stresses in our capital markets." The "comprehensive" solution would deal with the souring real-estate and other illiquid assets at the heart of the financial crisis, he said.

Exactly how such an entity might be structured isn't yet clear. The possible plan isn't expected to mirror the Resolution Trust Corp., which was used from 1989 to 1995 during the savings and loan crisis to hold and sell off the assets of failed banks. Rather, a new entity might purchase assets at a steep discount from solvent financial institutions and eventually sell them back into the market.

The program may look more like the Reconstruction Finance Corporation, a Depression-era relief program formed in 1932 by President Hoover that tried to inject liquidity into the market by giving loans to banks and other businesses.

According to a top congressional aide, the Treasury department wants authority to either control the program or have it be a separate division of the government.

A series of veteran policy makers, including former Treasury Secretary Lawrence Summers and former Fed Chief Paul Volcker, has pushed in recent weeks for such a government agency that would attempt a comprehensive solution to the markets crisis.

The idea would be to steady the market so that investors regain confidence in financial institutions and resume conducting business normally with them.

"By stepping in here and getting the markets to function again, the government could deliver the Sunday punch to this financial turmoil," said former Comptroller of the Currency Eugene Ludwig, who is now chief executive of Promontory Financial Group, and a big proponent for the idea. "By taking the first step and making a market the new government entity could take fear out of marketplace," he added.

Thursday, Republican nominee Sen. John McCain sought a broad expansion of government regulation over financial institutions, including the formation of a body to both assume distressed mortgages and help failing investment banks.

Saying the government cannot "wait until the system fails," Sen. McCain called for the creation of an entity that would essentially help companies sell off bad loans and other impaired assets. It is unclear how the body, dubbed the Mortgage and Financial Institutions trust, would operate, including whether or not institutions would seek help or whether the government would intervene on its own behalf.

His rival, Democratic Sen. Barack Obama of Illinois was less specific about what steps he would take, offering broader outlines of policy proposals that included a "Homeowner and Financial Support Act." The measure, which would inject capital and liquidity in the financial system, is designed to provide a more coordinated response than "the daily improvisations that have characterized policy-making over the last year."

—Brian Blackstone, Maya Jackson Randall, Joellen Perry, Laura Meckler, Nick Timiraos, Elizabeth Holmes, Michael M. Phillips and Craig Karmin contributed to this article.

    U.S. Drafts Sweeping Plan to Fight Crisis, NYT, 19.9.2008, http://online.wsj.com/article/SB122182746619856569.html

Don Wright        Palm Beach , FL        Cagle

18.9.2008

Vast Bailout by U.S. Proposed

in Bid to Stem Financial Crisis

September 19, 2008
The New York Times
By EDMUND L. ANDREWS

WASHINGTON — The head of the Treasury and the Federal Reserve began discussions on Thursday with Congressional leaders on what could become the biggest bailout in United States history.

While details remain to be worked out, the plan is likely to authorize the government to buy distressed mortgages at deep discounts from banks and other institutions. The proposal could result in the most direct commitment of taxpayer funds so far in the financial crisis that Fed and Treasury officials say is the worst they have ever seen.

Senior aides and lawmakers said the goal was to complete the legislation by the end of next week, when Congress is scheduled to adjourn. The legislation would grant new authority to the administration and require what several officials said would be a substantial appropriation of federal dollars, though no figures were disclosed in the meeting.

Democrats, having their own desire for a second round of economic aid for struggling Americans, see the administration’s request as a way to win White House approval of new spending to help stimulate the economy in exchange for support for the Treasury request. Democrats also say they will push for relief for homeowners faced with foreclosure in return for supporting any broad bailout of struggling financial institutions.

“What we are working on now is an approach to deal with systemic risks and stresses in our capital markets,” said Henry M. Paulson Jr., the Treasury secretary. “And we talked about a comprehensive approach that would require legislation to deal with the illiquid assets on financial institutions’ balance sheets,” he added.

One model for the proposal could be the Resolution Trust Corporation, which bought up and eventually sold hundreds of billions of dollars’ worth of real estate in the 1990s from failed savings-and-loan companies. In this case, however, the government is expected to take over only distressed assets, not entire institutions. And it is not clear that a new agency would be created to manage and dispose of the assets, or whether the Federal Reserve or Treasury Department would do so.

The bailout discussions came on a day when the Federal Reserve poured almost $300 billion into global credit markets and barely put a dent in the level of alarm.

Hoping to shore up confidence with a show of financial shock and awe, the Federal Reserve stunned investors before dawn on Thursday by announcing a plan to provide $180 billion to financial markets through lending programs operated by the European Central Bank and the central banks of Canada, Japan, Britain and Switzerland.

But after an initial sense of relief swept markets in Asia and Europe, the fear quickly returned. Tensions remained so high that the Federal Reserve had to inject an extra $100 billion, in two waves of $50 billion each, just to keep the benchmark federal funds rate at the Fed’s target of 2 percent.

None of those actions, however, brought much catharsis or relief, with banks around the world remaining too frightened to lend to each other, much less to their customers. This forced Mr. Paulson and Ben S. Bernanke, the Fed chairman, to think the unthinkable: committing taxpayer money to buy hundreds of billions of dollars in distressed assets from struggling institutions.

Rumors about the Bush administration’s new stance swept through the stock markets Thursday afternoon. By the end of trading, the Dow Jones industrial average shot up 617 points from its low point in midafternoon, the biggest surge in six years, and ended the day with a gain of 410 points or 3.9 percent.

The rally continued in early trading in Asia. The Australian market was up 3.5 percent by mid-day there and the Nikkei 225 Index was up 2.9 percent in Tokyo.

“The markets voted, and they liked the proposal,” said Laurence H. Meyer, vice chairman of Macroeconomic Advisers.

The stock surge began after Senator Charles E. Schumer, Democrat of New York, announced his own proposal for a government rescue on the Senate floor and declared that both the Treasury and the Federal Reserve were open to all ideas.

“The Federal Reserve and the Treasury are realizing that we need a more comprehensive solution,” Mr. Schumer said. “I’ve been talking to them about it.”

Still, the evening discussions took most of Washington by surprise, especially since Congress had been trying to finish up its business and head home to campaign for re-election.

The scale and complexity of the project are almost certain to create huge philosophical differences among the parties, which could make negotiations difficult to say the least. Still, lawmakers said the goal was to work through the coming weekend and to have both the House and Senate vote on a measure by the end of next week.

As they exited the session, grim-faced lawmakers said they would await proposals from the Treasury Department. The Senate majority leader, Harry Reid, said he expected to see a proposal within hours, not days.

“What we agreed to do is sit down together on a bipartisan basis and work together to solve the problem,” said Senator Mitch McConnell of Kentucky, the Republican leader, who said no specific approach was advocated by the administration officials.

President Bush and his top advisers have adamantly opposed bailouts, but the mortgage crisis has already forced the Treasury and the Fed to bail out four of the country’s most prominent financial institutions — Bear Stearns in March; Fannie Mae and Freddie Mac earlier this month; and American International Group, the insurance conglomerate, just this week.

Created in 1989, the Resolution Trust Corporation disposed of bad assets held by hundreds of crippled savings institutions. The agency closed or reorganized 747 institutions holding assets of nearly $400 billion. It did so by seizing the assets of troubled savings and loans, then reselling them to bargain-seeking investors.

By 1995, the S.& L. crisis had abated and the agency was folded into the Federal Deposit Insurance Corporation, which Congress created during the Great Depression to regulate banks and protect the accounts of customers when they fail.

By any reckoning, Mr. Paulson and Mr. Bernanke were desperate for a way to stem the crisis once and for all by Thursday evening. Over the previous 10 days, they had allowed one Wall Street firm, Lehman Brothers, to collapse; and an even bigger Wall Street firm, Merrill Lynch, to be sold to Bank of America. Then, on Tuesday, the Federal Reserve abruptly took over the nation’s biggest insurance conglomerate, the American International Group, and began bailing it out with an $85 billion loan.

The meeting in the Capitol, which began around 7 p.m., came after Congressional leaders had initially appeared unclear about what role they would play in the rapid-fire decisions being made. Leaders of both parties had complained about a lack of hard information flowing from the administration. House Republicans even canceled a closed-door party session Thursday morning after the administration refused to provide an official to brief them on the administration’s emerging policies.

But as Thursday progressed, Congressional leaders sought to reassert themselves on the crisis, scheduling oversight hearings, calling for a legislative response to the market turmoil and offering to put off an adjournment scheduled to start at the end of next week if the administration and Congress could find common ground on a solution.

Nancy Pelosi, the House speaker, in a letter sent Thursday evening to President Bush, reiterated that view. “We stand ready beyond the targeted adjournment date of September 26 to permit Congress to consider legislative proposals and conduct necessary investigations,” Ms. Pelosi said in the letter, which said “the worsening crisis in our financial markets demands strong solutions and decisive leadership.”

But whether a legislative consensus could be found remained an open question, and members of Mr. Bush’s own party were among those who were most critical of the increasing federal intervention in private markets.

At the meeting Thursday night, where officials said the atmosphere was tense, Senator Richard Shelby of Alabama, the senior Republican on the banking committee, was notably skeptical.

A spokesman for the senator, Jonathan Graffeo, said later: “Senator Shelby believes it’s his responsibility to be skeptical on behalf of taxpayers. He believes our goal must be to minimize taxpayer exposure while maximizing the benefit to the economy. ”

Earlier in the day, Representative John A. Boehner of Ohio, the House Republican leader, had expressed similar wariness about the risk to taxpayers’ funds. And Representative Jeb Hensarling, a Texas Republican who heads a coalition of House conservatives, was circulating a letter to the administration demanding that it not engage in any further bailouts.

Even before the Thursday night session with Mr. Paulson — the second for top Congressional leaders this week — the House had scheduled new oversight hearings. The Financial Services Committee set a session for next week, with Mr. Paulson and Mr. Bernanke as witnesses. The Oversight and Government Reform Committee set hearings for early October to examine developments that led to the collapse of Lehman Brothers and the bailout of A.I.G., even though Congress is to be in recess.

Ms. Pelosi, suggesting the public was probably not of a mind to wait until 2009 for a Congressional fix, said lawmakers first had to explore the causes of the problems and potential solutions in hearings.

“Let’s hear from the Bernankes and the Paulsons and the rest what their view of it is,” she said. “Let’s hear from the private sector. How these captains of the financial world could make millions of dollars in salary, and yet their companies fail and then we have to step in to bail them out.”

Mr. Paulson and Mr. Bernanke have been studying an array of new and sometimes radical approaches to fight what current and former Fed officials describe as the worst financial crisis they have ever seen.

The Fed has already stretched itself very thin by introducing new emergency lending programs for banks, Wall Street firms and, this week, a giant insurance company.

With the Fed running short of unencumbered reserves, the Treasury Department had begun raising fresh cash for the central bank by selling new Treasury bills at an unprecedented pace — $200 billion this week alone — and parking it at the Fed for whatever use it wanted.

Carl Hulse and David M. Herszenhorn contributed reporting.

    Vast Bailout by U.S. Proposed in Bid to Stem Financial Crisis, NYT, 19.9.2008, http://www.nytimes.com/2008/09/19/business/19fed.html

Dan Wasserman

The Boston Globe        Cagle

18.9.2008

L: U.S. President George W. Bush.

Multiple quick fixes tried

for US financial crisis

September 19, 2008
Filed at 9:15 a.m. ET
By THE ASSOCIATED PRESS
The New York Times

WASHINGTON (AP) -- Urgently moving on multiple fronts to stem the worst financial crisis in decades, the government on Friday said it would safeguard assets in money market mutual funds and temporarily banned short-selling of financial company stocks. The Treasury Department has asked Congress to give it sweeping power to buy up toxic debt that has unhinged Wall Street.

President Bush authorized Treasury to tap up to $50 billion from a Depression-era fund to insure the holdings of eligible money market mutual funds. And the Federal Reserve announced it will expand its emergency lending program to help support the $2 trillion in assets of the funds.

Both moves are designed to bolster the huge money market mutual fund industry, which has come under stress in recent days.

The Fed said it expanding its emergency lending efforts to allow commercial banks to finance purchases of asset-backed paper from money market funds. The central bank should help the funds to meet demands for redemptions.

The Securities and Exchange Commission early Friday imposed a temporary emergency ban on short-selling of financial company stocks, a trading method that bets the stocks will go down.As the financial crisis widened, entreaties had come from all quarters to stem a swarm of short-selling contributing to the collapse of stock values in investment and commercial banks.

Bush planned to discuss the swirl of emergency actions in a Rose Garden statement later Friday.

Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke are crafting a massive rescue plan to buy up dodgy assets held by troubled banks and other financial institutions at the heart of the nation's financial crisis.

Congressional leaders said they expected to get the plan Friday and act on it before Congress recesses for the election.

Wall Street headed for a huge rally Friday. The government's moves could help alleviate the uncertainty that has been sending the markets into tumult over the past week. Lending has grinded to a virtual standstill in the wake of the bankruptcy of Lehman Brothers Holdings Inc.

Global stock markets roared higher, too.

And European Central Bank, Swiss National Bank and Bank of England offered up more cash Friday. The three banks put a combined $90 billion into money markets in a lockstep move.

The chairman of the Senate Banking Committee, Chris Dodd, D-Conn., warned the United States could be ''days away from a complete meltdown of our financial system'' and said Congress is working quickly to prevent that.

Dodd told ABC's ''Good Morning America'' on Friday that the nation's credit is seizing up and people can't get loans.

The ranking Republican on the Banking Committee, Sen. Richard Shelby, said the U.S. has ''been lurching from one crisis to another'' and predicted the new bailout plan would cost at least half a trillion dollars.

''We hope to move very quickly. Time is of the essence,'' House Speaker Nancy Pelosi, D-Calif., said after Paulson and Bernanke briefed congressional leaders Thursday night.

Stocks on Wall Street shot up more than 400 points late Thursday on word that a plan was in the works. Fallout from the housing and credit debacles have badly bruised the economy and pushed unemployment to a five-year high.

''I don't say any prudent money manager would say we're out of the woods, but right in this moment it all seems positive and leading toward an upward move for the market going into Friday session,'' said Scott Fullman, director of derivative investment strategy for New York-based institutional broker WJB Capital Group.

Fullman said the biggest bonus of any potential government plan is that it is being put together to help the banking industry as a whole. Until now, the Treasury and Fed have selectively bailed out institutions that were the most vulnerable.

''This staves off Judgment Day,'' said Anthony Sabino, professor of law and business at St. John's University. ''This is a detox for banks, and will help cleanse themselves of the bad mortgage securities, loans and everything else that has hurt them.''

The roots of the current crisis can be traced to lax lending for home mortgages -- especially subprime loans given to borrowers with tarnished credit -- during the housing boom. Lenders and borrowers were counting on home prices to keep zooming upward. But when the housing market went bust, home prices plummeted. Foreclosures spiked as people were left owing more on their mortgage than their home was worth. Rising mortgage rates also clobbered some homeowners.

As financial companies racked up multibillion-dollar losses on soured mortgage investments, and credit problems spread globally, firms hoarded cash and clamped down on lending. That crimped consumer and business spending, dragging down the national economy -- a vicious cycle policymakers have been trying to break.

''The root cause of the stress in the capital markets is the real estate correction,'' Paulson said, adding he hopes to have a solution ''aimed right at the heart of this problem.''

Bernanke said a resolution would help ''get our economy moving again.''

Rep. Barney Frank, D-Mass., chairman of the House Financial Services Committee, discounted the idea of setting up a new agency -- similar to the Resolution Trust Corp. -- established in 1989 to help resolve a savings and loan crisis at a cost to taxpayers of $125 billion.

''It will be the power -- it may not be a new entity. It will be the power to buy up illiquid assets,'' Frank said. ''There is this concern that if you had to wait to set up an entity, it could take too long.''

The federal government already has pledged more than $600 billion in the past year to bail out, or help bail out, some of the biggest names in American finance. There was no immediate word on how much the new rescue plan might cost.

The SEC on Friday said it was acting in concert with the U.K. Financial Services Authority in taking emergency action to prohibit short selling in financial companies to protect the integrity of the securities market and boost investor confidence.

''The commission is committed to using every weapon in its arsenal to combat market manipulation that threatens investors and capital markets,'' SEC Chairman Christopher Cox said in a statement. ''The emergency order temporarily banning short-selling of financial stocks will restore equilibrium to markets.''

------

Associated Press writers Martin Crutsinger, Andrew Taylor and Marcy Gordon in Washington and Joe Bel Bruno in New York contributed
to this report.

Multiple quick fixes tried for US financial crisis, NYT, 19.9.2008, http://www.nytimes.com/aponline/business/AP-Financial-Meltdown.html

Rob Rogers

cartoon

The Pittsburgh Post-Gazette, Pennsylvania

Cagle

18.9.2008

A Modest Proposal

to Help to Save the World

September 18, 2008
5:44 pm
The Wall Street Journal
Posted by Dennis K. Berman

It is about trust. Banks don’t trust one another to lend. Individuals are increasingly fearful of trusting, too, scared of putting their cash in money-market funds that lubricate the entire economy.

The root of all this panic lies, of course, in the deflating prices of mortgage assets and their gruesomely-twisted derivatives such as collateralized debt obligations, and synthetic-CDO-squareds.

The problem is that banks, hedge funds, and insurers aren’t too inclined to talk about the prices of these securities–what is known as their marks, in part because they don’t want anyone to know what they are. And that makes them just as suspicious about their own counterparties. If I’m fibbing, then everyone else must be fibbing.

The mistrust and misinformation feeds on itself, and before long the system grinds to a halt.

But what if there were a simple way to make everyone honest? And wouldn’t that honesty help clean up the markets, as everyone could see the prevailing market prices–for better or for worse–and get to the business of buying and selling?

That step would be to strongly ask (or perhaps even require) that banks, insurers and maybe even some hedge funds contribute their market prices to a fully transparent, searchable database of pricing data. This could be easily organized, because each security has a separate identifying number–called its CUSIP number–that makes for easy tracking.

In other words, everyone shows their hand, for better or for worse.

The markets rallied this afternoon on the expectation that the government would go one step further–and collect all these bad assets into a central clearinghouse. Taxpayers would, of course, pay a monumental price to absorb all the losses. And there could be lots of objections from market players who would be fearful of where their marks would stack up against competitors.

With the markets pleading for some sort of federal bailout, such a simple step may get trampled underfoot. But the interim step of price discovery may go a long way to establishing a market without immediately spending taxpayer money.

    A Modest Proposal to Help to Save the World, NYT, 18.9.2008, http://blogs.wsj.com/deals/2008/09/18/a-modest-proposal-to-help-to-save-the-world/

Scott Stantis

Alabama, The Birmingham News        Cagle

18.9.2008

As Fears Grow,

Wall St. Titans See Shares Fall

September 18, 2008
The New York Times
By BEN WHITE and ERIC DASH

Even Morgan Stanley and Goldman Sachs, the two last titans left standing on Wall Street, are no longer immune.

To the surprise of executives within those firms, and their rivals, the stocks of these powerful companies were drawn into the crisis of investor confidence on Wednesday. Morgan Stanley, whose stock fell almost 25 percent, was considering a merger with Wachovia or another bank to help shore up its finances. Goldman Sachs’s stock fell almost 14 percent, and it had to rebuff rumors that it was seeking a capital infusion.

The assault on these two companies underscored how quickly a sense of fear is spreading through Wall Street. Both firms just reported respectable profits on Tuesday, and were considered in a separate class from weaker banks like Bear Stearns and Lehman Brothers that saw the value of their businesses evaporate.

“Stop the Insanity,” wrote Glenn Schorr, a brokerage analyst at UBS, in an e-mail message to clients on Wednesday.

A tie-up with a bank would restore Morgan Stanley to its structure during the Depression, when the firm split from the Morgan banking empire. It would also leave Goldman Sachs as the last major American investment bank after a global financial crisis that has gripped markets for more than a year snowballed last week, forcing the most risk-taking industry in the world to get back to basics.

Only a day earlier, Morgan Stanley defended itself from growing doubts about its future, issuing a fairly positive earnings report to ward off concerns about its health. But the fear that gripped markets after Lehman Brothers failed also enveloped the firm.

Seeking to avoid the kind of fate that led Lehman and Bear Stearns to collapse, John J. Mack, Morgan Stanley’s chief executive, made an unsuccessful effort on Tuesday evening to persuade Citigroup’s chief executive, Vikram S. Pandit, to enter into a combination, according to people briefed on the talks.

“We need a merger partner or we’re not going to make it,” Mr. Mack told Mr. Pandit, according to two people briefed on the talks. Mr. Pandit, a former senior investment banker at Morgan Stanley, said Citigroup was not interested. It is thinking of deals it can strike with consumer banks, like buying the struggling Washington Mutual out of bankruptcy if its reported efforts to auction itself should fail, that would provide it with cheaper deposit funding. A Citigroup spokeswoman declined to comment.

Having failed at that, Mr. Mack entered into discussions on Wednesday with Wachovia and several other banks, people briefed on those discussions said. The talks with Wachovia are preliminary and a deal may not emerge. The banks declined to comment.

Goldman Sachs may be under less pressure given its recent history of outperforming its peers. The bank made $11.6 billion last year and has not posted a loss during the credit crisis. Morgan Stanley has also performed well, but has suffered more write-downs and had a loss of $3.6 billion in the fourth quarter of last year.

Still, many specialists say they believe that the monumental events of the last four days herald a new period of painful change for the American financial industry — one that speculators are rushing to pounce on. While Wall Street has gone through tough times before, only to emerge bigger and stronger, some financial specialists question whether the industry can rebound quickly after using high levels of leverage, or borrowed money, to binge on risky investments. Those investments have proved to be disastrous. Worldwide, financial companies have reported more than $500 billion in charges and losses stemming from the credit crisis — a figure some specialists say could eventually exceed $1 trillion.

Merrill Lynch rushed into the arms of Bank of America this week in a deal that in some ways harked back to the past. During the Depression, Congress separated commercial banks, which take deposits and make loans, from investment banks, which underwrite and trade securities. The investment banks were allowed to do business with less oversight, while commercial banks operated with tighter supervision.

But after Congress repealed those Depression-era laws in 1999, commercial banks began muscling in on Wall Street’s turf. As the new competition whittled down profit margins, investment banks used more of their capital to trade securities and also began developing financial derivatives to fuel profits.

Now, executives like John A. Thain, the chief executive of Merrill and a former Goldman executive, say investment banks will need large bases of deposits to shore up their capital.

Investors appeared to be questioning whether either Morgan Stanley or Goldman Sachs would be able to survive alone as panic spread through the markets. The cost of protecting against defaults on the debt of both have shot up, a signal that some investors believe one or both of the banks could be next in the growing list of financial companies to either go bust, get sold or require a government bailout. Any institution without a big, stable balance sheet is seen as vulnerable to the kind of rapid collapse in confidence that led to the demise of Bear Stearns and Lehman Brothers.

As Morgan Stanley considered its options on Wednesday, the struggling savings and loanWashington Mutual also put itself up for auction, people briefed on the matter said. Shares of Washington Mutual fell 31 cents, or 13.36 percent, to $2.01; Wachovia shares fell $2.39, or 20.76 percent, to $9.12.

Normally, a declining share price alone should not force a stalwart like Morgan Stanley into a sale. But those declines, which executives blamed on aggressive hedge funds that profit when stocks drop, can increase the firm’s cost of borrowing by forcing it to post more collateral to lenders when its credit default protection prices rise.

Such an event often leads credit rating agencies to downgrade a company’s debt. That, in turn, can quickly deplete even a well-financed bank’s capital and force into sale or bankruptcy. The real end for Lehman Brothers, for example, came when Moody’s, the ratings agency, downgraded the company’s debt last week, forcing it into a corner.

Indeed, with healthy earnings, Wednesday’s relentless downward spiral in shares of both Morgan Stanley and Goldman Sachs made little sense to some.

Mr. Schorr, the analyst at UBS, said the increase in the risk premiums investors are demanding on debt have become self-fulfilling prophecies that now operate almost entirely detached from underlying fact, a thought echoed by people inside both banks and by several investors.

“It’s all confidence, it’s not reality,” Mr. Schorr said.

Morgan and Goldman have some problems, including a parcel of troubled mortgage assets and trading and advisory businesses that are vulnerable to a slowing economy.

“But that is not what is going on here,” Mr. Schorr said. “It is just a flat-out squeeze that should not be able to happen. The negative feedback loop has to be somehow suspended,” he added, “but I don’t know exactly how you do that.” Goldman Sachs declined to comment.

On Wednesday, the Securities and Exchange Commission reinstated a rule curbing the ability of investors to drive the share price of firms down to make a profit. Nearly five days ago, Wall Street chieftans who were gathered for emergency meetings at the New York Federal Reserve bank pleaded for the agency to revive the rule, which expired in the summer.

Mr. Mack has been in contact with regulators about what he views as abusive short-selling of the company’s shares. On Wednesday, he sent a memo to employees assuring them of the bank’s strong capital position and blaming short-sellers for driving the stock down “in the midst of a market controlled by fear and rumors.” He plans to hold a town hall meeting with Morgan employees Thursday morning.

Andrew Ross Sorkin contributed reporting.

    As Fears Grow, Wall St. Titans See Shares Fall, NYT, 18.9.2008, http://www.nytimes.com/2008/09/18/business/18wall.html

Adam Zyglis

Buffalo, NY, The Buffalo News        Cagle

18.9.2008

Stocks Slump as Investors Run to Safety

September 18, 2008
The New York Times
By VIKAS BAJAJ

The financial crisis entered a potentially dangerous new phase on Wednesday when many credit markets stopped working normally as investors around the world frantically moved their money into the safest investments, like Treasury bills.

As a result, the cost of borrowing soared for many companies, while the stocks of Wall Street firms like Goldman Sachs and Morgan Stanley that only a couple of weeks ago were considered relatively strong came under assault by waves of selling. Investors were so worried that they snapped up three-month Treasury bills with virtually no yield and they pushed gold to its biggest one-day gain in nearly 10 years. Stocks fell by nearly 5 percent in New York.

The stunning flight to safety, away from other kinds of debt as well as stocks, could cause serious damage to an already weakened economy by making it more expensive for businesses to finance their daily operations.

Some economists worry that a psychology of fear has gripped investors, not only in the United States but also in Europe and Asia. While investors’ decision to protect themselves may be perfectly rational, the crowd behavior could cause a downward spiral with broader ramifications.

“It’s like having a fire in a cinema,” said Hyun Song Shin, an economics professor at Princeton. “Everybody is rushing to the door. You are rushing to the door because everyone is rushing to the door. Clearly, as a collective action, it is a disaster.”

Faltering confidence could have an infectious effect in Asia, whose savings has essentially bankrolled America for decades. “Asia, perhaps more than other markets, is a bit more volatile, a bit more based on sentiment,” said Dan Parr, the head of Asia-Pacific for brandRapport, a consulting firm with an office in Hong Kong. “It doesn’t take much for the man on the street to become very, very concerned.” In early trading in Japan, the Nikkei index fell 3 percent.

Despite government efforts to reassure investors over the last 10 days by rescuing some giant institutions — Fannie Mae, Freddie Mac and American International Group — many investors remain worried that the financial system has been badly battered and that more firms may fail as Lehman Brothers did.

The Federal Reserve has greatly expanded its lending to banks and securities firms this year and is continuing to relax rules that govern financial companies in hopes of alleviating the credit squeeze. Central banks globally are also injecting more money into their economies and lowering reserve requirements for their own institutions out of concern that the problems in the American financial system will inflict further damage.

If the problems in the financial system persist, businesses will have less money to put to work, job cuts will spread and consumers, already fearful, will have less money to spend, knocking the economy down another notch. High borrowing costs will further weaken the housing market, which is still struggling. The Commerce Department reported Wednesday that housing starts fell to their lowest level since early 1991.

Flashes of fear were evident Wednesday as investors clamored for government debt. When investors bid up the price, the yield falls, and it sank on three-month Treasury bills to 0.061 percent, from 1.644 percent a week ago. The yield was the lowest in more than 50 years.

In the stock market, the Standard & Poor’s 500-stock index fell 57.20 points, or 4.71 percent, to 1,156.39, the lowest close in more than three years. The Dow Jones industrial average fell 449.36 points, to 10,609.66.

Worries over financial investments hammered even the well-regarded Wall Street firms of Goldman Sachs, whose shares fell nearly 14 percent, to $114.50, and Morgan Stanley, whose shares dropped more than 24 percent, to $21.75. Now, both firms are reconsidering what their best strategies might be in such a fearful market.

In addition to shares of financial companies like Bank of America, those of other bellwethers like General Electric have also tumbled.

Responding to this pressure, the Securities and Exchange Commission proposed new rules on short selling, or betting on falling share prices, and even suggested that hedge funds and others might have to disclose short positions, a proposal that is likely to meet stiff resistance.

One key overnight lending rate was above 5 percent on Wednesday, more than double its level a week earlier. GMAC, the auto finance company owned in part by General Motors, had to pay interest of 5.25 percent on Wednesday for a form of short-term financing known as one-week commercial paper, up from 4 percent the previous day.

Businesses, stung by high interest rates, may be forced to trim expenses, an ominous turn in a slowing economy with unemployment rates on the rise.

“This is throwing sand in the gears of the economy,” said G. David MacEwen, chief investment officer for the bond department of American Century Investments. “The economy depends on credit to finance homes, automobiles, student loans, and inventories.”

Local governments and other enterprises will feel pressure, too. The city of Chicago and Lincoln Center in New York postponed debt offerings because they would have to pay such high interest rates to investors, said Daniel S. Solender, director of municipal bond management at Lord Abbett & Company.

Money market funds braced for possible fallout from the disclosure that one big fund’s net assets fell below $1 a share, because it had held securities issued by Lehman Brothers. It is so rare for money market funds to fall below that threshold that many investors consider them as safe as cash or a checking account.

Some mutual fund companies reported that customers were moving money from broader money market funds that have had higher yields to more conservative funds within the same company, Peter Rizzo, a senior director of Standard & Poor’s, said late Wednesday afternoon. The overall effect is to reduce the appetite for securities of companies with anything other than the most stellar reputations.

Governments around the world stepped up their efforts to ease the strain on the global financial system. The Bank of England extended a special bank lending program for three more months, while central banks in Japan and Australia injected more money into their banking systems. Russia injected money into its banks and lowered reserve requirements.

In New York, the Federal Reserve on Tuesday night said it would extend an $85 billion credit line to the insurer A.I.G. and receive the rights to a nearly 80 percent stake in the company. The deal came just after the government refused financial support to Lehman, leading it to file for bankruptcy on Monday.

The Treasury and Fed also said they would auction more Treasury bills. The Fed will use the securities to manage its balance sheet and inject more money into the financial system. Because the Fed has expanded its lending to banks and securities firm this year, some analysts had grown concerned that the central bank might run out of Treasury securities to conduct its operations. Mark Gertler, an economics professor at New York University, said the Fed was trying to balance two interests: protecting against a crisis but telling the market that it will not bail out every troubled institution. Despite the stress in the markets, he said, the Fed’s actions may have averted a worse outcome.

“Maybe this is being Pollyannaish, but they have been successful in signaling that the bailouts are no longer automatic, and thus far they have prevented a market meltdown,” Mr. Gertler said.

The dramatic events of the last year have called into question much of what policy makers, economists and investors once espoused about the financial system. As recently as the spring of 2007, many in Washington and New York continued to say housing prices could not fall across the board and that most of the bets made by Wall Street traders were inherently safe.

Now, there are signs that psychology is driving a reverse line of thinking. People are assuming that things will get worse and that any move by the Fed or the Treasury is a step down, not a step closer to improvement.

“There has been a tremendous amount of denial over the past two years, three years,” said Barry Ritholtz, chief executive of Fusion IQ, an investment firm, and author of The Big Picture blog.

The Treasury’s benchmark 10-year note rose 6/32, to 104 28/32, and the yield, which moves in the opposite direction from the price, fell to 3.41 percent from 3.44 percent late Tuesday. Following are the results of Wednesday’s auction of 35-day cash management bills:


Diana B. Henriques and Hilda Wang contributed reporting.

    Stocks Slump as Investors Run to Safety, NYT, 18.9.2008, http://www.nytimes.com/2008/09/18/business/18markets.html

David Fitzsimmons

Arizona Daily Star, Tucson AZ        Cagle

18.9.2008

L to R: FDR and George W. Bush.

Your Money

Money Market Funds

Enter a World of Risk

September 18, 2008
The New York Times
By TARA SIEGEL BERNARD

Money market funds have been among the few places that investors could put their cash and sleep peacefully.

At the moment, that is not necessarily true.

On Tuesday, the Reserve Primary Fund, a giant money market fund whose parent helped invent that investment, said its customers would lose money. Instead of each share being worth a dollar for every dollar invested, it said its customers’ shares were worth only 97 cents. In Wall Street parlance, it “broke the buck,” a rare occurrence.

So far, it appears that no other money market funds have fallen below a dollar a share. And other money market managers have hastened to reassure investors that their money is safe. But the Primary Fund’s announcement did raise this question: What, in today’s world, is truly safe?

After all, the Primary Fund’s troubles did not occur in isolation. They followed the disappearance of both Lehman Brothers and Merrill Lynch, not to mention the government bailouts of the mortgage finance giants Fannie Mae and Freddie Mac and the insurance company American International Group. And if you haven’t already forgotten, there was the failure of the California thrift IndyMac in July.

And that’s why, in this market, financial advisers agreed on Wednesday, consumers need to become their own chief investment officers, even when it comes to something as simple as finding a place to put their cash.

“One by one, all of my safe havens aren’t so safe anymore, and that’s a bad thing,” said Matthew Tuttle, a certified financial planner and president of Tuttle Wealth Management in Stamford, Conn.

“It used to be O.K. to have money in a CD, but now you have to worry, ‘Is my bank going to go under?’ ” he added. “You used to be able to buy a guaranteed annuity from an insurance company, but now you have to worry, ‘Is my insurance company going to go under?’ Or, you can have auction-rate preferred securities, but now there is no market.”

Before you pull your cash out of your money market fund, you need to understand what you own. There is a big difference between money market mutual funds and the money market deposit accounts at a bank (and banks sometimes sell both).

Money market funds are essentially mutual funds that invest in securities that, until this week, were deemed relatively low risk. Those include government securities, certificates of deposit, asset-backed commercial paper and other highly liquid securities.

The Primary Fund got in trouble because some of its investments were in Lehman Brothers’ debt. To stop what is in essence a run on the fund, the Primary Fund has stopped all redemptions for up to seven days.

A money market deposit account, on the other hand, is entirely different. It is an interest-bearing bank account that is insured — up to $100,000 per account and up to $250,000 for some retirement accounts — by the Federal Deposit Insurance Corporation. Joint accounts are insured for $100,000 per account holder.

If you had been putting your money into a money market account because you wanted to avoid all risk, then you should consider the money market deposit accounts and other accounts insured by the F.D.I.C., like certificates of deposit and regular checking and savings accounts.

There are also Treasuries. But because so many investors were rushing into them on Wednesday, the yields have been driven down. “There is no yield,” said Saxon Birdsong, chief investment officer of Baltimore-Washington Financial Advisors. “It’s just a safety play.”

If you decide to invest — or stay — in a money market fund, there are several things you should keep in mind.

When it comes to money market funds, bigger may be better, several financial advisers said. Many investors use the funds that happen to be with the brokerage firm they are doing business with because it’s convenient to sweep money between accounts. But you should make sure your money market account is with a large, diversified money management company that would have the resources to make you whole, even if its funds ran into trouble.

Mr. Tuttle said companies like Fidelity and Vanguard fit into this category.

“I would be less comfortable with a smaller money management fund that didn’t have a lot of assets and wasn’t making a lot of money,” he said. “From my standpoint, I have a very high comfort level that if a Fidelity money market fund had toxic whatever, they would step up with the money from somewhere else to keep the buck.”

Once you decide on a provider, read the prospectus carefully. If you don’t understand the investments, call the company and ask for more details.

“I would encourage investors to not stop asking questions until they have complete comfort and peace about what they own,” said Karin Maloney Stifler, a certified financial planner with True Wealth Advisors in Hudson, Ohio.

And if you are still nervous, ask your current mutual fund company or brokerage if it has a Treasury or government money market fund that invests only in Treasury securities, said Greg McBride, senior financial analyst at Bankrate.com, a personal finance Web site.

“You will have to settle for a lower yield,” he said, “but it takes risk off the table.”

Indeed, this is one of those times when you shouldn’t necessarily choose a fund because it has a high yield. That higher yield could indicate that the fund is investing in riskier securities.

“This is a painful but poignant reminder that anything that is paying you a higher yield, you have to assume is carrying a higher risk,” said Peter Crane, president of Crane Data, which tracks money market mutual funds.

Finally, investors should diversify cash holdings, just as they would with a stock and bond portfolio.

“If you have money market mutual funds with multiple providers, you are hedging against the risk that any one of them will encounter problems that they can’t survive,” Ms. Stifler said.

But if you don’t have a strong stomach for the slightest risk, stick with investments that are F.D.I.C. insured, even if you need to sacrifice a little yield.

After all, “this is a portion of your portfolio that should help you sleep at night, not keep you awake,” Mr. McBride said.

    Money Market Funds Enter a World of Risk, NYT, 18.9.2008, http://www.nytimes.com/2008/09/18/business/yourmoney/18money.html

Patrick O'Connor         the Los Angeles Daily News        Cagle

17.9.2008

Economic Scene

Perhaps, Time for Someone

to Play Offense

September 17, 2008
The New York Times
By DAVID LEONHARDT

WASHINGTON — Late last week, as Lehman Brothers was collapsing, an all-star group of economists was meeting here to ponder the lessons of the financial crisis. The group included Donald Kohn, the vice chairman of the Fed, and Edward Lazear, the top White House economist, as well as Lawrence Summers, the former Treasury secretary, and a few dozen others.

The discussion revolved around a handful of academic research papers, but it really boiled down to this: How do we get out of this mess?

At one point, Benjamin Friedman of Harvard raised his placard to inject a little sunshine into the room. If somebody had told the economists a year and a half ago what was about to befall Wall Street and then asked them to predict the economic impact, Mr. Friedman said, they almost certainly would have forecast a steeper downturn, with many more layoffs, than has occurred.

The fact that it hasn’t, so far, should be considered a victory for Ben Bernanke and Henry Paulson, the point men on the crisis. After some early missteps, they have acted aggressively to keep the financial system functioning — including Tuesday’s stunning takeover of A.I.G. — while still forcing Wall Street to suffer for its sins. The problem, unfortunately, is that neither man has done much to deal with the problems that caused the crisis in the first place.

For the past two and a half months, I’ve been on a break from column writing, and I’m struck by how much has changed during that time — and yet how little the big picture has changed. Lehman Brothers, Merrill Lynch, Fannie Mae and Freddie Mac have all essentially collapsed. But just as at the start of the summer, economists can’t even agree whether the country is in a recession.

The Bush administration, the Fed and Congress, meanwhile, continue to focus on the immediate crises, with little attention to the underlying reasons that the economy has gotten into this mess — a stagnation of incomes, an explosion of debt and a decidedly outdated, and limp, approach to government oversight. Remarkably, the presidential campaign has gotten less serious, while the economy’s problems have become more so.

So, yes, Mr. Bernanke and Mr. Paulson have done a nice job of playing defense. But when will someone start playing offense?

•

A good way to see the problems with a fingers-in-the-dikes strategy is to look back to the first big bailout of modern times. Before A.I.G., before Fannie and Freddie, before Bear Stearns, there was Chrysler.

In 1979, when it was still the 10th largest company in the country, Chrysler found itself on the verge of collapse, largely because high oil prices had made its gas guzzlers unappealing. Company executives and union leaders came to Washington, hat in hand, arguing that Chrysler’s demise would wreak unacceptable damage on the American economy. Congress and the Carter administration responded by arranging for $1.2 billion in subsidized loans. The Reagan administration helped further in 1981 by restricting Japanese imports.

On its face, the Chrysler rescue was a huge success. Under Lee Iacocca, the company came out with the K-car line of smaller vehicles, like the Dodge Aries, as well as the original minivan. By the mid-’80s, Chrysler had repaid the loans. Mr. Iacocca appeared on the cover of Time magazine as “Detroit’s comeback kid,” and his autobiography became a No. 1 best seller.

You can draw a clear line from the Chrysler bailout to the recent attempts to steady Wall Street. Back then, Washington insisted on a few pounds of flesh, like a wage freeze for Chrysler workers, in exchange for aid. Mr. Paulson has done something similar by insisting that shareholders of the Wall Street firms benefit little from any bailout.

In 1979, the government structured the Chrysler deal so that taxpayers might earn a profit from it (which they did). This year, the Fed effectively purchased securities from Bear Stearns that it hopes to sell for a gain when the financial markets calm down. While it’s way too early to know if the strategy will succeed as well as it did three decades ago, it’s certainly conceivable.

But if you take a moment to think through the full Chrysler story, you start to realize that it’s setting a really low bar. The Chrysler bailout may have saved the company, but it did nothing, after all, to stop Detroit’s long, sad decline.

Barry Ritholtz — who runs an equity research firm in New York and writes The Big Picture, one of the best-read economics blogs — is going to publish a book soon making the case that the bailout actually helped cause the decline. The book is called, “Bailout Nation.” In it, Mr. Ritholtz sketches out an intriguing alternative history of Chrysler and Detroit.

If Chrysler had collapsed, he argues, vulture investors might have swooped in and reconstituted the company as a smaller automaker less tied to the failed strategies of Detroit’s Big Three and their unions. “If Chrysler goes belly up,” he says, “it also might have forced some deep introspection at Ford and G.M. and might have changed their attitude toward fuel efficiency and manufacturing quality.” Some of the bailout’s opponents — from free-market conservatives to Senator Gary Hart, then a rising Democrat — were making similar arguments three decades ago.

Instead, the bailout and import quotas fooled the automakers into thinking they could keep doing business as usual. In 1980, Detroit sold about 80 percent of all new vehicles in this country, according to Autodata. Today, it sells just 45 percent.

There is a similar chance for us to be fooled about the extent of today’s problems. Some day, house prices will stop falling and the financial markets will calm down. But the underlying problems aren’t going away on their own.

At its core, the current crisis stems from two problems. Regulators, starting with Alan Greenspan, assumed that a real estate bubble couldn’t happen and that Wall Street could largely police itself. And households, struggling with incomes that haven’t kept up with inflation in recent years, said yes when those lightly regulated banks offered them wishful-thinking loans. No bailout can solve either problem.

The past week has offered a glimmer of hope that the policymakers want to get beyond short-term fixes. Mr. Paulson drew the line at Lehman Brothers last weekend, refusing to save it from bankruptcy. On Tuesday, the Fed kept its benchmark interest rate steady, rather than pretending that ever-cheaper borrowing was a cure-all.

Now should come the harder part: a much more serious attack on our economic problems. Earlier this week, I called Mr. Hart, who has written some thoughtful things about the economy lately, for his take on all this. “We’ve been consuming more than we’ve been producing. We’ve been spending more than we’ve been earning,” he told me. “It’s been a big holiday.”

His list of solutions is a pretty good one. The tax code, he said, should be changed to reward savings far more than consumption. The resulting savings would help families prepare for retirement — and also become a pool of money that companies could invest in productive ways. The federal government should lend a hand, by investing in areas like basic science and technology, which could, in turn, help create more good-paying jobs than the economy has been able to create recently. The government also needs to bring down Medicare costs, which is the key to solving its long-term budget deficit.

That’s one path. Another would be to add to the deficit by paying for one bailout after another.

Speaking of which, Detroit’s Big Three have come back to Capitol Hill lately, lobbying for billions of dollars in handouts. This time, their executives insist, they’ll use the money to solve their problems.

    Perhaps, Time for Someone to Play Offense, NYT, 17.9.2008, http://www.nytimes.com/2008/09/17/business/17leonhardt.html

Mike Lane

Baltimore, Maryland        Cagle

17.9.2008

M: U.S. President George W. Bush.

Pat Bagley

Salt Lake Tribune, Utah        Cagle

17.9.2008

Fed’s $85 Billion Loan Rescues Insurer

September 17, 2008
The New York Times
By EDMUND L. ANDREWS,
MICHAEL J. de la MERCED
and MARY WILLIAMS WALSH

This article was reported by Edmund L. Andrews, Michael J. de la Merced and Mary Williams Walsh and written by Mr. Andrews.

WASHINGTON — Fearing a financial crisis worldwide, the Federal Reserve reversed course on Tuesday and agreed to an $85 billion bailout that would give the government control of the troubled insurance giant American International Group.

The decision, only two weeks after the Treasury took over the federally chartered mortgage finance companies Fannie Mae and Freddie Mac, is the most radical intervention in private business in the central bank’s history.

With time running out after A.I.G. failed to get a bank loan to avoid bankruptcy, Treasury Secretary Henry M. Paulson Jr. and the Fed chairman, Ben S. Bernanke, convened a meeting with House and Senate leaders on Capitol Hill about 6:30 p.m. Tuesday to explain the rescue plan. They emerged just after 7:30 p.m. with Mr. Paulson and Mr. Bernanke looking grim, but with top lawmakers initially expressing support for the plan. But the bailout is likely to prove controversial, because it effectively puts taxpayer money at risk while protecting bad investments made by A.I.G. and other institutions it does business with.

What frightened Fed and Treasury officials was not simply the prospect of another giant corporate bankruptcy, but A.I.G.’s role as an enormous provider of esoteric financial insurance contracts to investors who bought complex debt securities. They effectively required A.I.G. to cover losses suffered by the buyers in the event the securities defaulted. It meant A.I.G. was potentially on the hook for billions of dollars’ worth of risky securities that were once considered safe.

If A.I.G. had collapsed — and been unable to pay all of its insurance claims — institutional investors around the world would have been instantly forced to reappraise the value of those securities, and that in turn would have reduced their own capital and the value of their own debt. Small investors, including anyone who owned money market funds with A.I.G. securities, could have been hurt, too. And some insurance policy holders were worried, even though they have some protections.

“It would have been a chain reaction,” said Uwe Reinhardt, a professor of economics at Princeton University. “The spillover effects could have been incredible.”

Financial markets, which on Monday had plunged over worries about A.I.G.’s possible collapse and the bankruptcy of Lehman Brothers, reacted with relief to the news of the bailout. In anticipation of a deal, stocks rose about 1 percent in the United States on Tuesday. Asian stock markets opened with strong gains on Wednesday morning, but the rally lost steam as worries returned about the extent of harm to the global financial system.

Still, the move will likely start an intense political debate during the presidential election campaign over who is to blame for the financial crisis that prompted the rescue.

Representative Barney Frank, Democrat of Massachusetts and chairman of the House Financial Services Committee, said Mr. Paulson and Mr. Bernanke had not requested any new legislative authority for the bailout at Tuesday night’s meeting. “The secretary and the chairman of the Fed, two Bush appointees, came down here and said, ‘We’re from the government, we’re here to help them,’ ” Mr. Frank said. “I mean this is one more affirmation that the lack of regulation has caused serious problems. That the private market screwed itself up and they need the government to come help them unscrew it.”

House Speaker Nancy Pelosi quickly criticized the rescue, calling the $85 billion a "staggering sum." Ms. Pelosi said the bailout was "just too enormous for the American people to guarantee." Her comments suggested that the Bush administration and the Fed would face sharp questioning in Congressional hearings. President Bush was briefed earlier in the afternoon.

A major concern is that the A.I.G. rescue won’t be the last. At Tuesday night’s meeting. lawmakers asked if there was any way of knowing if this would be the final major government intervention. Mr. Bernanke and Mr. Paulson said there was not. Indeed, the markets remain worried about the financial condition of major regional banks as well as that of Washington Mutual, the nation’s largest thrift.

The decision was a remarkable turnaround by the Bush administration and Mr. Paulson, who had flatly refused over the weekend to risk taxpayer money to prevent the collapse of Lehman Brothers or the distressed sale of Merrill Lynch to Bank of America. Earlier this year, the government bailed out another investment bank, Bear Stearns, by engineering a sale to JPMorgan Chase that left taxpayers on the hook for up to $29 billion of bad investments by Bear Stearns. The government hoped at the time that this unusual step would both calm markets and lead to a recovery by the financial system. But critics warned at the time that it would only encourage others to seek bailouts, and the eventual costs to the government would be staggering.

The decision to rescue A.I.G. came on the same day that the Fed decided to leave its benchmark interest rate unchanged at 2 percent, turning aside hopes by many on Wall Street that the Fed would try to shore up confidence by cutting rates once again.

Fed and Treasury officials initially turned a cold shoulder to A.I.G. when company executives pleaded on Sunday night for the Fed to provide a $40 billion bridge loan to stave off a crippling downgrade of its credit ratings as a result of investment losses that totalled tens of billions of dollars.

But government officials reluctantly backed away from their tough-minded approach after a failed attempt to line up private financing with help from JPMorgan Chase and Goldman Sachs, which told federal officials they simply could not raise the money given both the general turmoil in credit markets and the specific fears of problems with A.I.G. The complexity of A.I.G.’s business, and the fact that it does business with thousands of companies around the globe, make its survival crucial at a time when there is stress throughout the financial system worldwide.

“It’s the interconnectedness and the fear of the unknown,” said Roger Altman, a former Treasury official under President Bill Clinton. “The prospect of the world’s largest insurer failing, together with the interconnectedness and the uncertainty about the collateral damage — that’s why it’s scaring people so much.”

Under the plan, the Fed will make a two-year loan to A.I.G. of up to $85 billion and, in return, will receive warrants that can be converted into common stock giving the government nearly 80 percent ownership of the insurer, if the existing shareholders approve. All of the company’s assets are being pledged to secure the loan. Existing stockholders have already seen the value of their stock drop more than 90 percent in the last year. Now they will suffer even more, although they will not be totally wiped out. The Fed was advised by Morgan Stanley, and A.I.G. by the Blackstone Group.

Fed staffers said that they expected A.I.G. would repay the loan before it comes due in two years, either through the sales of assets or through operations.

Asked why Lehman was allowed to fail, but A.I.G. was not, a Fed staffer said the markets were more prepared for the failure of an investment bank. Robert B. Willumstad, who became A.I.G.’s chief executive in June, will be succeeded by Edward M. Liddy, the former chairman of the Allstate Corporation. Under the terms of his employment contract with A.I.G., Mr. Willumstad could receive an exit package worth as much as $8.7 million if his removal is determined to be “without cause,” according to an analysis by James F. Reda and Associates.

A.I.G. is a sprawling empire built by Maurice R. Greenberg, who acquired hundreds of businesses all over the world until he was ousted amid an accounting scandal in 2005. Many of A.I.G.’s subsidiaries wrote insurance of various types. Others made home loans and leased aircraft. The diverse array of companies were more valuable under a single corporate parent like A.I.G., because their business cycles offset each other, giving A.I.G. a relatively smooth stream of revenue and income.

After Mr. Greenberg’s departure, A.I.G. restated its books over a five-year period and instituted conservative new accounting policies. But before the company could really rebuild itself, it became embroiled in the mortgage crisis. Some of its insurance companies ended up with mortgage-backed securities on their books, but the real trouble involved the insurance that its financial products unit offered investors for complex debt securities.

Its stock tumbled faster this year as first the debt securities lost value, and then the insurance contracts, called credit default swaps, came under a cloud.

The Fed’s extraordinary rescue of A.I.G. underscores how much fear remains about the destructive potential of the complex financial instruments, like credit default swaps, that brought A.I.G. to its knees. The market for such instruments has exploded in recent years, but it is almost entirely unregulated. When A.I.G. began to teeter in the last few days, it became clear that if it defaulted on its commitments under the swaps, it could set off a devastating chain reaction through the financial system.

“We are witnessing a rather unique event in the history of the United States,” said Suresh Sundaresan, the Chase Manhattan Bank professor of economics and finance at Columbia University. He thought the near brush with catastrophe would bring about an acceleration of efforts within the Treasury and the Fed to put safety controls on the use of credit default swaps.

“They’re going to tighten the screws and say, ‘We want some safeguards on this market,’ ” he said of the Fed and the Treasury.

The swaps are not securities and are not regulated by the Securities and Exchange Commission. And while they perform the same function as an insurance policy, they are not insurance in the conventional sense, so insurance regulators do not monitor them either.

That situation set the stage for deep losses for all the countless investors and other entities that had entered into A.I.G.’s swap contracts. Of the $441 billion in credit default swaps that A.I.G. listed at midyear, more than three-quarters were held by European banks.

“Suddenly banks would be holding a lot of bondlike instruments that were no longer insured,” Mr. Sundaresan said. “They would have to mark them down. And when they marked them down, they would require more capital. And then they would have to go out and raise capital in these markets, which is very difficult.”

Mr. Sundaresan said that for a new market arrangement to succeed, it would have to create a clearinghouse to track swaps trading, and daily requirements to post collateral, so that a huge counterparty would not suddenly find itself having to come up with billions of dollars overnight, the way A.I.G. did.

Edmund L. Andrews reported from Washington. Michael J. de la Merced and Mary Williams Walsh reported from New York. David M. Herszenhorn contributed reporting from Washington and Eric Dash from New York..

    Fed’s $85 Billion Loan Rescues Insurer, NYT, 17.9.2008, http://www.nytimes.com/2008/09/17/business/17insure.html

John Deering

The Arkansas Democrat-Gazette        Cagle

17.9.2008

Wall Street in Worst Loss Since 2001

September 16, 2008
The New York Times
By STEPHEN LABATON

WASHINGTON — In another unnerving day for Wall Street, investors suffered their worst losses since the terrorist attacks of 2001, and government officials raced to prevent the financial crisis from spreading.

Trading opened sharply down Monday morning, and the mood later turned even gloomier, despite efforts by President Bush and Treasury Secretary Henry M. Paulson Jr., in separate appearances at the White House, to reassure markets that Wall Street’s deepening problems would not weaken an already anemic economy.

Amid worries that the bankruptcy of Lehman Brothers and the sale of Merrill Lynch over the weekend might not be enough to stop the downward spiral, stocks fell sharply in the last half hour of trading. By the end of the day, the Dow Jones industrial average had dropped 504.48 points, or 4.4 percent, as a record volume of more than 8 billion shares traded hands on the New York Stock Exchange. It was the biggest decline since Sept. 17, 2001 — the day the index reopened after the 9/11 terrorist attacks — when it fell 7 percent, or 684.81 points.

A concern hanging over the market is the fate of other financial companies, most notably the American International Group, one of the world’s largest insurers. After the Fed rebuffed a request by the company for a $40 billion temporary loan, federal and state officials worked on Monday to stabilize A.I.G., with the State of New York relaxing rules to allow the company to borrow as much as $20 billion in much-needed cash, while the New York Federal Reserve Bank was engaged in talks with JPMorgan Chase and Goldman Sachs on a $75 billion loan for the insurer.

Market participants fear that without a cash infusion for A.I.G., losses on its financial insurance contracts could cause a ripple effect that would damage other companies. Shares of A.I.G., already battered in recent weeks, plunged another 60 percent on Monday, closing at $4.76. Last year, the company had traded as high as $72.

The stock market’s descent in the closing minutes Monday could set the stage for more fallout on Tuesday, when Asian markets that were closed for a holiday the day before will reopen. In response to the market turmoil, officials at the Federal Reserve were considering lowering interest rates at the regularly scheduled meeting on Tuesday of the Open Market Committee, which sets monetary policy. Such a move would follow a pattern — the Fed lowered rates after the Sept. 11 attacks and after the crash of 1987 to help calm the markets — though a rate cut is far from a certainty.

The Fed also took steps to ease rules separating banks and investment banks, a move intended to make it easier for healthy companies on Wall Street, like Goldman Sachs, to buy up troubled institutions.

Wall Street was still reeling on Monday from a tumultuous weekend in which Treasury and Fed officials told top bank executives that they needed to work together to resolve the financial industry’s problems, because the government did not intend to bail out Lehman, a decision that led to Lehman’s bankruptcy filing.

Dispirited employees of Lehman arrived at work in Midtown Manhattan with little to do, with many spending their time polishing their résumés and sharing dark humor. Traders at other firms arrived at work before dawn to brace themselves for a heavy day and continued to limit their losses by unwinding their trading positions with Lehman. Nervous investors around the nation logged onto their investment accounts on the Internet to see what toll the financial tumult had taken on retirement and college-education funds.

Workers at Merrill Lynch, stunned by the respected institution’s demise as an independent brokerage firm, came to work after learning about the sale on Sunday of the company to Bank of America. While the acquisition may have saved Merrill from what some worried would be a fate similar to Lehman’s, it will come at a cost to Merrill workers. Bank of America said it planned to wring $7 billion in costs from Merrill over four years from the consolidation, a plan that could result in thousands of layoffs. At a news conference on Monday, Kenneth D. Lewis, Bank of America’s chairman, would not discuss job losses, but he repeatedly praised Merrill’s 16,000 financial advisers, calling them “the crown jewel of the company.”

Merrill employees who are laid off will have plenty of company, as many financial workers have lost jobs in the last year, leaving many without a paycheck. Appearing briefly in the morning before reporters in the Rose Garden, Mr. Bush characterized the recent events as short-term market adjustments that would have a limited effect on an otherwise sound economy.

“I know Americans are concerned about the adjustments that are taking place in our financial markets,” Mr. Bush said at a ceremony to welcome the president of Ghana.

He added: “In the short run, adjustments in the financial markets can be painful — both for the people concerned about their investments, and for the employees of the affected firms. In the long run, I’m confident that our capital markets are flexible and resilient, and can deal with these adjustments.”

But, seeking safer places for their money, investors drove down the yields of Treasury notes. Widening spreads in the credit market indicated deep skepticism about mortgage-backed securities. The price of crude oil dropped more than $5 a barrel to close to at $95.71, as investors seemed to conclude that an economic decline would cause a significant decrease in the demand for energy.

A senior administration official, recounting the fall of Lehman, said that for weeks Mr. Paulson had been pressing Richard S. Fuld Jr., the company’s chief executive, to sell the company, but that ultimately no one in the market wanted it because of billions of dollars in bad investments the company had made in subprime mortgages and real estate. They said that Mr. Paulson told Mr. Fuld after the company reported dreadful second-quarter earnings that Lehman had to be sold or it would not survive.

The official said that, several weeks ago, Mr. Paulson had a list in his mind of major institutions that might not be able to resolve their huge investments in troubled real estate and that the list consisted of Fannie Mae, Freddie Mac, Lehman Brothers, Merrill Lynch and Washington Mutual. The official said that Mr. Paulson also decided that it was paramount to first resolve the problems at Fannie Mae and Freddie Mac, the two huge mortgage finance companies, before turning to the others. In addition to A.I.G., the difficulties of Washington Mutual, the nation’s largest savings and loan, remain unresolved. On Monday, the shares of Washington Mutual closed down nearly 27 percent, to $2.

Mr. Paulson concluded that the financial system could survive the collapse of Lehman, which has shown signs of weakness for months.

The rapid deterioration of Bear Stearns, in contrast, took top officials by surprise last March. And Fannie and Freddie are government-created companies that are simply too large to fail — together they own or guarantee nearly half of the nation’s residential mortgages.

As throughout most of the year, Mr. Bush and the White House left most of the details about the crisis to Mr. Paulson, who told reporters at a White House briefing that the problems in the housing markets at the heart of the financial crisis would take months to resolve themselves.

“I believe that there is a reasonable chance that the biggest part of that housing correction can be behind us in a number of months,” Mr. Paulson said. “I’m not saying two or three months, but in months as opposed to years.”

Mr. Paulson sought to distinguish the government’s decision to provide financial assistance to Bear Stearns last March, as well as to rescue Fannie Mae and Freddie Mac last week, from its rejection of aid requests from Lehman Brothers and A.I.G.

“The situation in March and the situation and the facts around Bear Stearns were very, very different to the situation we are looking at here in September,” he said. “I never once considered that it was appropriate to put taxpayer money on the line in resolving Lehman Brothers.” He called the discussions on assisting A.I.G. “a private sector effort.”
 

Still, Mr. Paulson did not reject any future Washington bailouts.

    Wall Street in Worst Loss Since 2001, NYT, 16.9.2008, http://www.nytimes.com/2008/09/16/business/16paulson.html

Talking Business

On Wall St. as on Main St.,

a Problem of Denial

September 16, 2008
The New York Times
By JOE NOCERA

How can this be happening?

How can it even be possible that we wake up on a Monday morning to discover that Lehman Brothers, a firm founded in 1850, a firm that has survived the Great Depression and every market trauma before and since, is suddenly bankrupt? That Merrill Lynch, the “Thundering Herd,” is sold to Bank of America the same weekend?

Just months ago, Lehman assured investors that it had enough liquidity to weather the crisis, while Merrill raised some $15 billion over the last year to shore up its balance sheet. Now they’re both as good as gone.

Last week, it was Fannie Mae and Freddie Mac that needed a government bailout. This week, it looks as though American International Group and Washington Mutual will be on the hot seat. We have actually reached the point where there are now only two independent investment banks left: Goldman Sachs and Morgan Stanley. It boggles the mind.

But it really shouldn’t. Because after you get past the mind-numbing complexity of the derivatives that are at the heart of the current crisis, what’s going on is something we are all familiar with: denial.

Indeed, it is not all that different from what is going on in neighborhoods all over the country. Just as homeowners took out big loans and stretched themselves on the assumption that their chief asset — their home — could only go up, so did Wall Street firms borrow tens of billions of dollars to make subprime mortgage bets on the assumption that they were a sure thing.

But housing prices did drop eventually. And when people tried to sell their homes in this newly depressed market, many of them had a hard time admitting that their home wasn’t worth what they had thought it was. Their judgment has been naturally clouded by their love for their house, how much money they put into it and how much more it was worth a year ago. And even when they did drop their selling price, it never quite matched the reality of the marketplace. They’ve been in denial.

That is exactly what is happening on Wall Street. Ever since the crisis took hold last summer, most of the big firms have been a day late and dollar short in admitting that their once triple-A rated mortgage-backed securities just weren’t worth very much. And, one by one, it is killing them.

Take Richard Fuld, the chief executive of Lehman Brothers. Last summer, as the credit crisis first gripped Wall Street, Mr. Fuld’s firm, which was fundamentally a bond-trading firm, concluded that the problems would be short-lived — and that those firms willing to take big risks would be the ones that would reap the big rewards once things calmed down. So Lehman doubled down on mortgage-backed derivatives — not unlike a Florida condo owner buying a second one to flip 18 months ago.

Big mistake. Ever since then, Lehman has had a terrible time admitting the magnitude of its mistake — or properly pricing its securities. As mortgage derivatives became increasingly toxic, they also became increasingly illiquid. So firms were left to set their own “mark-to-market” price. And just like so many homeowners, they kept pricing their securities higher than they should have.

Earlier this year, for instance, when the hedge fund manager David Einhorn was making his public case against Lehman (he now refuses to talk about the firm), he stressed his belief that Lehman was valuing its securities too high. He turned out to be exactly right.

Every time the market was roiled — especially after the Bear Stearns collapse — every firm on Wall Street had to re-mark their securities to reflect the new reality. That’s why you saw firms taking billion-dollar write-off after billion-dollar write-off, long after they thought they had taken care of the problem. And it is also why the write-offs will continue now that Lehman is bankrupt.

“Selling begets more selling,” said Sean Egan of the independent bond-rating firm Egan-Jones. And yet, even as they lowered the value of their mortgage-backed securities, firms like Lehman had still priced them too high. Back when he was talking publicly about Lehman, Mr. Einhorn used to cast Lehman’s mark-to-market pricing as an act of dishonesty. I tend to think it was more like wishful thinking. Either way, the result was the same.

A week ago, even as the government was bailing out Fannie and Freddie, Mr. Fuld went off to seek new capital — something Lehman desperately needed to shore up its decimated balance sheet — from the Korea Development Bank. Why did those talks break down? Because Mr. Fuld wanted more for Lehman than the Koreans thought it was worth. He simply couldn’t face the reality that his firm wasn’t worth what he thought it was.

Now look at his next-door neighbor, John Thain at Merrill Lynch. To be sure, Mr. Thain owned a better house — although Merrill Lynch also had billions in toxic securities, its bread-and-butter is its brokerage arm. It is fundamentally a gatherer of assets, not a bond-trader.

But there is another big difference between the firms. Unlike Mr. Fuld, who had run Lehman since 1993 and is the architect of the modern Lehman, Mr. Thain had been at Merrill Lynch just since December, when he was brought in to stanch the bleeding. He didn’t have the same pride of ownership in Merrill that Mr. Fuld had in Lehman. That is why he was willing to sell $31 billion worth of mortgage-backed derivatives for 22 cents on the dollar in late July — far lower than many firms had been pricing those securities.

And that is also why, seeing what had happened to Bear Stearns, Fannie and Freddie, and Lehman Brothers, he took the pre-emptive step of selling Merrill Lynch to Bank of America. In the process, he got $50 billion for Merrill’s shareholders. True, that was half of what Merrill was worth a year ago, and a once-proud name is about to be swallowed up by a commercial bank. But he also got $50 billion more than Mr. Fuld got for his shareholders — and being sold is a lot better than being liquidated.

It is unlikely that the worst is over. The market Monday dropped more than 500 points, and the government is now trying to keep A.I.G. from going the way of Lehman Brothers, even asking Goldman Sachs and JPMorgan to make some $75 billion in loans available to the struggling insurance giant. And then there’s Washington Mutual. And then ... well, who knows where it will end?

Clearly the government is no longer willing to put the taxpayers’ money at risk to save firms that took on too much risk buying securities that they didn’t understand. As painful as it is to see Lehman employees lose their jobs, that is probably a good thing. That is the final parallel that exists between the housing market and Wall Street: the issue of moral hazard.

For over a year now, many Wall Streeters have complained about government efforts to forestall foreclosures, saying that it would create the expectation that everyone should be bailed out, and that consequently no one would learn important lessons about the dangers of taking more risk than they could handle. Besides, they added, the housing market was never going to improve until housing prices found their natural bottom. And that wouldn’t happen until the government stopped trying to prop up housing prices.

But in truth, you can say the same of Wall Street — it won’t learn any lessons, either, until firms that took foolhardy risks start to fail. One reason Lehman could not find a buyer over the weekend is because potential buyers were insisting on the same kind of taxpayer guarantees that the government had given JPMorgan when it bought Bear Stearns, or when it took over Fannie and Freddie. That’s the essence of moral hazard. When Treasury Secretary Henry Paulson refused to do so, the potential buyers went away.

With the government refusing to prop up Wall Street anymore, maybe now mortgage-backed derivatives will find their natural bottom. Something to look forward to, I guess.

    On Wall St. as on Main St., a Problem of Denial, NYT, 16.9.2008, http://www.nytimes.com/2008/09/16/business/16nocera.html?hp

In Candidates,

2 Approaches to Wall Street

September 16, 2008
The New York Times
By JACKIE CALMES

WASHINGTON — The crisis on Wall Street will leave the next president facing tough choices about how best to regulate the financial system, and although neither Senator Barack Obama nor Senator John McCain has yet offered a detailed plan, their records and the principles they have set out so far suggest they could come at the issue in very different ways.

On the campaign trail on Monday, Mr. McCain, the Republican presidential nominee, struck a populist tone. Speaking in Florida, he said that the economy’s underlying fundamentals remained strong but were being threatened “because of the greed by some based in Wall Street and we have got to fix it.”

But his record on the issue, and the views of those he has always cited as his most influential advisers, suggest that he has never departed in any major way from his party’s embrace of deregulation and relying more on market forces than on the government to exert discipline.

While Mr. McCain has cited the need for additional oversight when it comes to specific situations, like the mortgage problems behind the current shocks on Wall Street, he has consistently characterized himself as fundamentally a deregulator and he has no history prior to the presidential campaign of advocating steps to tighten standards on investment firms.

He has often taken his lead on financial issues from two outspoken advocates of free market approaches, former Senator Phil Gramm and Alan Greenspan, the former Federal Reserve chairman. Individuals associated with Merrill Lynch, which sold itself to Bank of America in the market upheaval of the past weekend, have given his presidential campaign nearly $300,000, making them Mr. McCain’s largest contributor, collectively.

Mr. Obama sought Monday to attribute the financial upheaval to lax regulation during the Bush years, and in turn to link Mr. McCain to that approach.

“I certainly don’t fault Senator McCain for these problems, but I do fault the economic philosophy he subscribes to,” Mr. Obama told several hundred people who gathered for an outdoor rally in Grand Junction, Colo.

Mr. Obama set out his general approach to financial regulation in March, calling for regulating investment banks, mortgage brokers and hedge funds much as commercial banks are. And he would streamline the overlapping regulatory agencies and create a commission to monitor threats to the financial system and report to the White House and Congress.

On Wall Street’s Republican-friendly turf, Mr. Obama has outraised Mr. McCain. He has received $9.9 million from individuals associated with the securities and investment industry, $3 million more than Mr. McCain, according to the Center for Responsive Politics, a watchdog group. His advisers include Wall Street heavyweights, including Robert E. Rubin, the former treasury secretary who is now a senior adviser at Citigroup, another firm being buffeted by the financial crisis.

If many voters are fuzzy on the events that over the weekend forced Lehman Brothers Holdings Inc. into bankruptcy and Merrill Lynch & Company to be swallowed by the Bank of America Corporation, the continuing chaos among the most venerable names in American finance — coming on top of the recent government seizure of mortgage giants Fannie Mae and Freddie Mac and the demise of the Bear Stearns Companies — has stoked their anxiety for the economy, the foremost issue on voters’ minds.

So it was that first Mr. Obama and then Mr. McCain rushed out their statements on Monday morning before most Americans had reached their workplaces.

To the extent that travails on Wall Street and Main Street have both corporations and homeowners looking to Washington for a hand, that helps Mr. Obama and his fellow Democrats who see government as a force for good and business regulation as essential. Yet Mr. McCain has sold himself to many voters as an agent for change, despite his party’s unpopularity after years of dominating in Washington, and despite his own antiregulation stances of past years.

Mr. McCain was quick on Monday to issue a statement calling for “major reform” to “replace the outdated and ineffective patchwork quilt of regulatory oversight in Washington and bring transparency and accountability to Wall Street.” Later his campaign unveiled a television advertisement called “Crisis,” that began: “Our economy in crisis. Only proven reformers John McCain and Sarah Palin can fix it. Tougher rules on Wall Street to protect your life savings.”

Mr. McCain’s reaction suggests how the pendulum has swung to cast government regulation in a more favorable political light as the economy has suffered additional blows and how he is scrambling to adjust. While he has few footprints on economic issues in more than a quarter century in Congress, Mr. McCain has always been in his party’s mainstream on the issue.

In early 1995, after Republicans had taken control of Congress, Mr. McCain promoted a moratorium on federal regulations of all kinds. He was quoted as saying that excessive regulations were “destroying the American family, the American dream” and voters “want these regulations stopped.” The moratorium measure was unsuccessful.

“I’m always for less regulation,” he told The Wall Street Journal last March, “but I am aware of the view that there is a need for government oversight” in situations like the subprime lending crisis, the problem that has cascaded through Wall Street this year. He concluded, “but I am fundamentally a deregulator.”

Later that month, he gave a speech on the housing crisis in which he called for less regulation, saying, “Our financial market approach should include encouraging increased capital in financial institutions by removing regulatory, accounting and tax impediments to raising capital.”

Yet Mr. McCain has at times in the presidential campaign exhibited a less ideological streak. As he did on Monday, he from time to time speaks in populist tones about big corporations and financial institutions and presents himself as a Theodore Roosevelt-style reformer. He supported the Bush administration’s decision to seize Fannie Mae and Freddie Mac, the mortgage giants, and he has backed as unavoidable the promise of taxpayer money to help contain the financial crisis.

Other than Mr. Gramm, who as chairman of the Senate Banking Committee before his leaving Congress in 2002 worked to block efforts to tighten financial regulation, Mr. McCain’s closest adviser on matters of Wall Street is John Thain, the chief executive of Merrill Lynch, who has raised about $500,000 for Mr. McCain. Unlike Mr. Gramm, Mr. Thain has a reputation as a pragmatic, nonideological, moderate Republican. That the men are Mr. McCain’s touchstones is typical of his small and eclectic mix of advisers, making it hard to generalize about how Mr. McCain would act as president.

A prominent McCain supporter, Gov. Tim Pawlenty of Minnesota, signaled how Mr. McCain would try to make his antiregulation record fit the proregulation times that the next president will inherit. Mr. Pawlenty suggested in an interview on Fox News that, given the danger that “any future administration” would go too far, Mr. McCain would be the safer bet to protect against “excessive government intervention or excessive government regulation.”

Mr. Obama also does not have much of a record on financial regulation. As a first-term senator, he has not been around for the major debates of recent years, and his eight years in the Illinois Senate afforded little opportunity to weigh in on the issues.

In March 2007, however, he warned of the coming housing crisis, and a year later in a speech in Manhattan he outlined six principles for overhauling financial regulation.

On Monday, he said the nation was facing “the most serious financial crisis since the Great Depression,” and attributed it on the hands-off policies of the Republican White House that, he says, Mr. McCain would continue. Seeking to showcase Mr. Obama’s concerns, his campaign said Mr. Obama led a conference call on the crisis early Monday that included Paul A. Volcker, the former chairman of the Federal Reserve; Mr. Rubin; and his successor as treasury secretary, Lawrence H. Summers.

Later, citing Mr. McCain’s remarks about the economy’s strong fundamentals, he told a Colorado crowd that Mr. McCain “doesn’t get what’s happening between the mountain in Sedona where he lives and the corridors of power where he works.”

One reason for both men’s sketchy records on financial issues is that neither has been a member of the Senate Banking Committee, which has oversight of the industry and its regulators. Under both parties’ leadership, the committee often has been a graveyard for proposals opposed by lobbyists for financial institutions, including Fannie Mae and Freddie Mac, which last week were forced into government conservatorships.

Industry lobbyists’ success in killing such regulations meant senators outside the banking panel did not have to take a stand on them.
 

Reporting was contributed by Kitty Bennett, Michael Luo, Adam Nagourney and Jeff Zeleny.

    In Candidates, 2 Approaches to Wall Street, NYT, 16.9.2008, http://www.nytimes.com/2008/09/16/us/politics/16record.html

Shares Fall in Europe;

U.S. Index Futures Slide

September 16, 2008
The New York Times
By MATTHEW SALTMARSH
and KEITH BRADSHER

PARIS — Markets sank in Europe and Asia on Monday after one of the most dramatic weekends on Wall Street saw the collapse of the bank Lehman Brothers and the takeover of Merrill Lynch.

Benchmark stock indexes in Europe and Asia tumbled, while on Wall Street, stock index futures were down sharply, suggesting that shares would drop when trading opened in New York. Crude oil was also down, trading at about $97 a barrel in electronic trading.

The dollar slid in reaction to the news that Merrill Lynch had agreed to sell itself to Bank of America for about $50 billion to avert a deepening financial crisis and that Lehman Brothers had filed for bankruptcy protection.

Pledges of support for the market from central banks failed to stem the selling, but analysts stressed that the atmosphere stopped short of panic.

“Investors are wandering around in a daze,” said Stephen Lewis, head of research at Monument Securities in London. “It’s not a panic by any means, but there is a sense that we’ll see a few more weekends like the last two and then we’re looking at a long, long convalescence.”

In the Lehman talks Sunday, the United States government was worried about the precedents that it had set in bailing out the investment bank Bear Stearns and the de facto takeover of the mortgage finance giants Fannie Mae and Freddie Mac the previous weekend. Washington wanted Wall Street to collectively take on the risk that Lehman’s assets were worth far less than the firm claimed.

The bankruptcy of Lehman, combined with the potential insolvency of the giant insurer AIG threatens to saddle financial institutions with new losses. Investors in Europe said it was still unclear exactly what Lehman held on its books over the weekend and how long the unwinding would take.

Mr. Lewis said the only parallel that he could remember was the banking crisis in Britain in the 1970s, which peaked around 1975, but was not fully resolved until about 1980.

On Monday, LCH.Clearnet, the largest European clearing house, declared Lehman Brothers’ European subsidiary a “defaulter” after the bankruptcy filing. Lehman shares dropped 81 percent in Frankfurt trading to 75 cents from their $3.65 close in New York on Friday.

In Europe, the broad Dow Jones Stoxx 600 Index declined 3.4 percent to 270.81 points, while the FTSE fell 3.8 percent in London and the CAC-40 in Paris lost 4.1 percent. U.S. stock index futures were down sharply, suggesting that shares would drop when trading opens in New York on later Monday.

Stock markets in Japan, South Korea, Hong Kong and China were closed for holidays, although other markets there slid. The benchmark Taiwan index shed 4.1 percent and the BSE lost 3.6 percent in Mumbai.

Markets were closed on Monday in Hong Kong, Tokyo, Seoul and Shanghai in observance of a holiday that the Chinese call Mid-Autumn Festival and the Japanese know as Respect for the Aged Day. Koreans were celebrating their Chusok, or Thanksgiving holiday. With roots in traditional harvest festivals, the holidays have a particular emphasis on family gatherings, similar to the U.S. Thanksgiving.

Peter Redwood, the director of Asian currency and economic research in the Singapore office of Barclays Capital, said in the longer term, the latest difficulties in the United States were likely to hurt Asian markets. “This is an increase in risk globally,” he said, adding that this was, “unambiguously negative for Asia and for capital outflows from Asia.”

The American dollar fell against the yen to an intra-day low of ¥107.95 as investors reduced so-called carry trades, where funds are borrowed in a country with low interest rates and used to buy assets where returns are higher. The dollar fell as low as 1.4480 to the euro before recovering some ground.

Bond prices, meanwhile, rallied as investors sought the safer waters of fixed income investments. Treasuries surged, sending two-year notes up the most since January. The yield on two-year notes dropped 37 basis points, to 1.8 percent. The 10-year German bund yield fell 19 basis points to 3.98 percent. Japanese government bonds did not trade.

To help Wall Street brace for Lehman’s bankruptcy, the Federal Reserve widened the collateral it accepts for emergency loans to securities firms. A group of 10 banks that includes JPMorgan Chase, Goldman Sachs and Citigroup separately formed a $70 billion fund to ensure market liquidity.

The European Central Bank said in a statement Monday that it was “ready to contribute to orderly conditions in the euro money market,” a formulation that indicated it was worried that the chaos in banking across the Atlantic would quickly spread to Europe.

The Bank of England said it would lend £5 billion or about $9 billion over the next three days at 5 percent. The loans will mature on Thursday, when the British central bank conducts its regular refinancing operation.

The bank said it would “be monitoring carefully the conditions in sterling money markets and will take appropriate actions if necessary to stabilize those markets.”

The Financial Services Agency of Japan, the main regulatory agency there, said late Monday that it was reviewing the exposure of Japanese banks, brokerages and other financial institutions to Lehman.

Some analysts expressed fears that the financial turmoil would dent already faltering economic growth, especially in Europe.

Ken Wattret, chief euro-zone economist at BNP Paribas said: “There is the possibility of intensifying financial problems that will impact the U.S. economy and then spill over into Europe and other markets.”

“We’ve seen business confidence collapse and the likelihood is that what happens will further enhance the downturn. The momentum downward is building.”

He added there was “increasing pressure on central banks to act” but that the Fed was more likely to cut interest rates than the central bank.

Macquarie Group, the biggest Australian investment bank, slumped 10.3 percent to 39.46 Australian dollars after The New York Times reported that American International Group was seeking a $40 billion bridge loan from the Federal Reserve.

Centro Properties, the shopping mall owner facing a deadline at the end of the month to repay some of its debt, plunged 31.4 percent to 72 cents after a planned asset sale fell through.

In European equity markets, the main focus was on banks and insurers amid fears that they will face more write-downs and the possible need for government support.

“Confidence has really collapsed,” said Yann Azuelos, fund manager at Meeschaert, an asset manager in Paris. “With the rescue of Fannie and Freddie, we thought the worst had passed. Now we know it hasn’t.”

Shares in UBS of Switzerland, the European bank hardest hit by mortgage-related losses, sank 7.2 percent.

Axa, the giant French insurer, fell 8.6 percent to 20.33 euros and Alllianz of Germany was off 5.3 percent at 104.62 euros.
 

Keith Bradsher reported from Hong Kong and Matthew Saltmarsh from Paris. Andrew Ross Sorkin in New York, Julia Werdigier in London and Carter Dougherty in Paris contributed reporting.

    Shares Fall in Europe; U.S. Index Futures Slide, NYT, 16.9.2008, http://www.nytimes.com/2008/09/16/business/worldbusiness/16markets.html?hp

5 Days of Pressure,

Fear and Ultimately, Failure

September 16, 2008
The New York Times
By ERIC DASH

A crisis of confidence in financial markets on Wall Street culminated in a weekend of brinksmanship and failed appeals that caused the demise of some of the nation’s most storied financial institutions.

It began on Tuesday, just two days after the Bush administration took control of Fannie Mae and Freddie Mac, the mortgage finance giants. Fears began to mount in earnest on Wall Street that Lehman might founder — and that the government might not ride to the rescue this time. As stock markets around the world tumbled, Lehman’s shares were hit by waves of selling that wiped out nearly half its value.

The next day, skittish employees inside Lehman’s Times Square headquarters held their breath as Richard S. Fuld Jr., Lehman’s chief executive, held an urgent conference call with investors and analysts to announce the biggest quarterly loss in the company’s 158-year history — as well as a master plan to pull the firm back from the brink. The blueprint centered on splitting Lehman into a “good” bank and a “bad” one that would get rid of troubled mortgages and real estate. Lehman would also sell most of its investment management division and cut its dividend to shareholders.

But there was little new in Mr. Fuld’s remarks, and by the end of the day, Lehman’s share price had fallen an additional 7 percent, leaving the shares down 55 percent over three days.

Employees who had clung to the belief that Lehman would never go under started polishing resumes in earnest, taking calls from headhunters and openly passing around job offers.

On Thursday, executives established a war room at the headquarters in Midtown Manhattan. As confidence in Lehman’s survival retreated, Mr. Fuld redoubled efforts to execute his plan to sell parts of the firm. The once unthinkable notion of selling Lehman in its entirety was also put on the table. Traders, meanwhile, were instructed to start pulling together data so that potential buyers could start examining Lehman’s positions.

When the shares plunged to a bargain-basement price below $4, potential suitors came out of hiding, including Barclays of Britain and the Bank of America, as well as several private equity firms. With fresh memories of the government-arranged fire sale of Bear Stearns to JPMorgan Chase, and the weekend bailout of Fannie Mae and Freddie Mac, each sought assurances from the Federal Reserve to help make an acquisition palatable. Meanwhile, as Wall Street surveyed the landscape for the next financial domino, it set its sights on Merrill Lynch and A.I.G., which were exposed to Lehman, and on Washington Mutual, the long-troubled giant savings and loan that was having problems raising capital.

On Friday , the uncertainty surrounding Lehman sent a new wave of fear rippling through the markets. Federal Reserve officials convened the heads of the major Wall Street banks for an emergency meeting at 6 p.m. in Lower Manhattan. The goal was to hash out a plan to rescue Lehman Brothers and stabilize the global markets. The group included the heads of 10 to 15 Wall Street banks, flanked by their top lieutenants and finance and risk chiefs. Among them: James Dimon of J.P. Morgan, Brady Dougan of Credit Suisse, Lloyd Blankfein of Goldman Sachs, John Thain of Merrill Lynch and John Mack of Morgan Stanley. Also participating were officials from Barclays, Deutsche Bank, Royal Bank of Canada. Kenneth D. Lewis of Bank of America phoned in from Charlotte, N.C. Vikram S. Pandit delayed his trip to a Citigroup board meeting in London to participate. Lehman Brothers was conspicuously absent.

The Treasury Department and Federal Reserve had been preparing for a failure of Fannie Mae and Freddie Mac for months. Some on Wall Street believe that Lehman Brothers caught the government flat-footed, and without a contingency plan.

“They thought that if they rescue Fannie and Freddie, there would be such support for the market that things would stabilize,” said one observer who was not authorized to speak because his institution was involved in the discussions. “They also thought Lehman management would have things under control.”

The clock, however, was ticking. Timothy F. Geithner, the president and chief executive of the Federal Reserve Bank of New York , appearing with Treasury Secretary Henry M. Paulson Jr. and Christopher Cox of the Securities and Exchange Commission, struck a serious tone. Over the next two hours, he and Mr. Paulson stressed that the government would not put taxpayer money on the line. They wanted an industry solution to prevent the crisis from worsening, according to two people who were briefed on the meeting but did not attend.

Mr. Geithner made an impassioned appeal to the group: We need an industry solution. We need an industry solution, no matter what, he said. His message was clear; it is not about any individual bank, it is about the industry. If you don’t create an industry solution, you will be next.

Most of the bankers quietly listened. But some questioned the need for them to play a role in a bailout. Lehman Brothers had overreached and brought its troubles upon itself, they argued. Why should they put up their own money in a rescue?

Both Bank of America and Barclays, a large British bank, expressed interest in making a bid. HSBC also suggested it might pursue Lehman, though it quickly faded.

With little time to inspect Lehman’s toxic assets, Barclays and Bank of America made it clear that any deal would be contingent on them receiving government agreeing to absorb a portion of the losses. The government had committed about $30 billion to supporting JPMorgan Chase’s emergency takeover of Bear Stearns and just last weekend put up $200 billion in its rescue of Fannie Mae and Freddie Mac.

But fearing they had created a moral hazard and already pushing its budget, Mr. Paulson and Mr. Geithner were adamant that the government would not participate in a bailout. With all sides digging in their heels, one thing was clear: Lehman was, as one participant at the meeting put it, a “Dead Bank Walking.”

Mr. Geithner told the Wall Street firms to start developing plans for an orderly liquidation. Lehman Brothers hired Weil, Ghotsal, Manages to start drafting bankruptcy plans.

The dramatic session was similar to one held a decade ago with the leaders of Wall Street to stave off the failure of Long-Term Capital Management, a hedge fund that plunged into esoteric derivatives and other complex investments. Its failure threatened to send shockwaves through the global markets.

But the fallout from Lehman Brothers threatened to be more severe. It is a vastly larger institution with trading partners around the world. There also was another problem. When Wall Street bailed out LTCM, its banks were healthy. This time around, they had already been weakened by heavy blows.

On Saturday, shortly before 9 a.m., black town cars carrying a Who’s Who of Wall Street arrived at the Federal Reserve Bank in New York for several hours of meetings. At an opening session, Mr. Geithner echoed his remarks from Friday evening: put aside your competitive interest in order to preserve the health of the markets. If you all do it together, nobody will point the finger at any of you, he said, according to a person briefed on the meeting but who did not participate in the talks.

Meanwhile, senior Wall Street executives at their corporate offices to examine their exposure to Lehman Brothers and other wobbly institutions, with an eye toward mapping out emergency plans for the next week. Senior traders began overseeing massive efforts to find banks that have offsetting trades with Lehman Brothers and take them out so that the troubled firm is no longer involved. Bankers with two or three decades experience used words “scary,” “terrifying,” and “horrible” to describe the situation.

The broad outline of two proposals began to take shape. One option was to have the major banks and brokerage firms agree to keep doing business with Lehman, while the bank unwound its positions over several months. Another was a daring rescue, in which Barclays or Bank of America would buy the good assets of the bank with a group of 10 to 15 Wall Street firms agreeing to absorb the losses.

At 3. p.m., Mr. Paulson called a meeting to brief the participants. Fears were swirling about troubles gripping financial companies. American Insurance Group, the global insurance giant, needed to raise between $30 billion and $40 billion to avoid severe ratings downgrade that would lead to its swift demise. And the financial health of Washington Mutual was quickly deteriorating. The prospect that Lehman and others could fail would send shockwaves through the global markets.

Some of the banks requested that the S.E.C. reinstate its temporary short-selling ban to try to limit the market impact, though it ultimately never agreed to such a move. Others feared that relatively healthier institutions might get swept up in the fallout. Merrill Lynch, and then Morgan Stanley — and then even Goldman Sachs — could be next.

By Saturday evening, Bank of America’s interest in a bid was fading. It dug in its heels, insisting that it would not buy the embattled bank without government support. Meanwhile, the proposal involving Barclays appeared to be gaining steam. But the negotiations still risked unraveling.

Unravel they did: On Sunday morning, as the group of banks reconvened at the Federal Reserve Bank, Barclays said it was pulling out from the deal. It could not obtain a shareholder vote to approve a transaction before Monday morning, something that was required under London Stock Exchange listing rules, one person close to the matter said. Other people involved in the talks said the British securities regulator, the Financial Services Authority, had discouraged Barclays from pursuing the transaction. Peter Truell, a Barclays spokesman, declined to comment.

By 2 p.m., Barclays was officially out of the deal. Bank of America, meanwhile, remained uninterested. Privately, its executives had been meeting with their counterparts at Merrill Lynch to settle the framework for a shot-gun merger.

That effectively put Lehman on the track for a bankruptcy filing. The goal, then became, figuring out the best possible way to unwind Lehman without adding to the turmoil.

Across Wall Street, traders rushed in to work to try to make sure they were out of the Lehman positions. “Every single person I know in New York is at work today,” one long-time banker said. “Everybody who isn’t blown up is figuring out their counterparty risk. Everybody who is, is cleaning out their desk.”

That sent the first indications that the markets were awry. Traders had to pay 80 cents on every dollar to buy protection against Lehman defaulting on its bonds. That meant to insure $10 million in bonds against default, you had to pay $8 million, a 15,000 percent jump from where that kind of protection traded on Thursday. Lehman traders, meanwhile, were called back to their desks as news seeped out about their pending bankruptcy. Most believed it would be their last time. .

They sent out goodbye messages to colleagues and gathered their belongings. Some huddled in a corner on the fourth floor eating pizza and drinking beer, according to a person who was there. They were dumbstruck that their firm could evaporate in days.

But uncertainty reigned. Lehman did not file for bankruptcy until early Monday morning. Its employees left their offices unsure if they should return to work. Some were planning to head in Monday around 9 a.m. as they normally do. Others were planning to head to the local unemployment office for the very first time.
 

Reporting was contributed by Jenny Anderson, Michael J. de la Merced, Andrew Ross Sorkin, Louise Story and Ben White.

    5 Days of Pressure, Fear and Ultimately, Failure, NYT, 16.9.2008, http://www.nytimes.com/2008/09/16/business/16reconstruct.html?hp

Obama blames Wall St. crisis

on Republican policy

September 15, 2008
Filed at 8:51 a.m. ET
By THE ASSOCIATED PRESS
The New York Times

CHICAGO (AP) -- Democratic presidential nominee Barack Obama said Monday the upheaval on Wall Street was ''the most serious financial crisis since the Great Depression'' and blamed it on policies that he said Republican rival John McCain supports.

''This country can't afford another four years of this failed philosophy,'' Obama said after the shock-wave announcements that financial giant Lehman Brothers was filing for Chapter 11 bankruptcy while titan Merrill Lynch was being bought by Bank of America for about $50 billion.

Obama's statement, issued as he prepared to fly to Colorado to begin a swing through contested Western states, was intended to serve two purposes: to link McCain with the unpopular presidency of George W. Bush and to express sympathy with the anxiety of most Americans who say the economy is issue No. 1 in the election.

''The challenges facing our financial system today are more evidence that too many folks in Washington and on Wall Street weren't minding the store,'' Obama said in a statement. ''Eight years of policies that have shredded consumer protections, loosened oversight and regulation, and encouraged outsized bonuses to CEOs while ignoring middle-class Americans have brought us to the most serious financial crisis since the Great Depression.''

''I certainly don't fault Sen. McCain for these problems,'' Obama said, ''but I do fault the economic philosophy he subscribes to.''

In a presidential race turning increasingly negative, Obama also drew on editorial comments from U.S. newspapers and magazines to accuse McCain of running a dishonest campaign with some of the ''sleaziest ads'' ever seen.

Obama's running mate, Sen. Joe Biden, said McCain was ''launching a low blow a day'' and went on to say the Republican candidate stands ''with George Bush firmly in the corner of the wealthy and well-connected.''

Obama's campaign launched a new television commercial that aggressively pushes back against charges by McCain, the GOP presidential nominee. Obama has been under increasing pressure from Democrats to strike back harder at McCain, who has taken a slight lead in national polls. Some leading Republicans faulted both presidential campaigns Sunday for the increasingly negative tone of their advertising.

Former Bush political adviser Karl Rove said McCain and Obama had both shaded the truth in campaign advertising.

''McCain has gone, in some of his ads, similarly gone one step too far in sort of attributing to Obama things that are, you know, beyond the 100-percent truth test,'' Rove told ''Fox News Sunday.''

The Obama campaign has complained especially about an ad that declares Obama supports sex education for kindergartners. He supported legislation that would teach age-appropriate sex education to kindergartners, including information on rejecting advances by sexual predators.

''Both campaigns are making a mistake, and that is they are taking whatever their attacks are and going one step too far,'' Rove said. ''They don't need to attack each other in this way.''

Obama's new commercial opens with a picture of McCain saying, ''I will not take the low road to the highest office in this land.'' The announcer then asks, ''What happened to John McCain?''

The ad uses brief phrases from editorials and commentators from The Washington Post, Time magazine, the Chicago Tribune, CBS and The New Republic: ''one of the sleaziest ads ever seen,'' ''truly vile,'' ''dishonest smears,'' ''exposed as a lie,'' ''a disgraceful, dishonest campaign.'' It concludes, ''It seems `deception' is all he's got left.''

The McCain campaign also has put out an Internet ad accusing Obama of calling Republican vice presidential nominee Sarah Palin a pig when he used the phrase putting ''lipstick on a pig'' to criticize the GOP ticket as trying to make a bad situation look better. McCain supporters said Obama was slyly alluding to Palin's description of herself as a pit bull in lipstick, but there was nothing in his remarks to support the claim.

Biden, in an appearance planned Monday in St. Clair Shores, Mich., tried to link McCain with President Bush.

''If you're ready for four more years of George Bush, John McCain is your man,'' Biden said in prepared remarks. ''Just as George Herbert Walker Bush was nicknamed `Bush 41' and his son is known as `Bush 43,' John McCain could easily become known as `Bush 44.'''

Excerpts of Biden's speech were released in advance by the Obama-Biden campaign.

With a passing reference to McCain's sacrifices as a Vietnam prisoner of war, Biden said: ''America needs more than a great solider, America needs a wise leader. Take a hard look at the positions John has taken for the past 26 years, on the economy, on health care, on foreign policy, and you'll see why I say that John McCain is just four more years of George Bush.''

    Obama blames Wall St. crisis on Republican policy, NYT, 15.9.2008, http://www.nytimes.com/aponline/washington/AP-Obama.html

Obama:

Financial crisis

a major threat to economy

Mon Sep 15, 2008
8:21am EDT
Reuters

CHICAGO (Reuters) - U.S. Democratic presidential candidate Barack Obama said on Monday the crisis sweeping Lehman Brothers and other Wall Street firms posed a major threat to the U.S. economy and underscored the need to modernize the financial system.

"The situation with Lehman Brothers and other financial institutions is the latest in a wave of crises that are generating enormous uncertainty about the future of our financial markets," Obama said in a statement.

"This turmoil is a major threat to our economy and its ability to create good-paying jobs and help working Americans pay their bills, save for their future, and make their mortgage payments," he added.

Obama, an Illinois senator running nearly dead even with Republican John McCain in the November 4 White House race, weighed in on the Wall Street turmoil as U.S. investment bank Lehman filed for bankruptcy protection and as concerns grew about the fate of other financial firms.

Rival Merrill Lynch agreed to be taken over by Bank of America. Insurer American International Group Inc asked the Federal Reserve for a lifeline, according to news reports.

Lehman's bankruptcy filing came after weekend talks brokered by U.S. officials failed to produce a sought-after solution that would involve a buyout of the troubled firm by other companies.

Obama and McCain both said they did not want a taxpayer-funded bailout of Lehman.

Obama has long called for an overhaul of Wall Street regulations, saying the subprime housing crisis and other problems stemmed in part from lack of transparency and accountability in the financial system.

"The challenges facing our financial system today are more evidence that too many folks in Washington and on Wall Street weren't minding the store," Obama said. "For years, I have consistently called for modernizing the rules of the road to suit a 21st century market -- rules that would protect American investors and consumers."

(Reporting by Caren Bohan, editing by Peter Cooney)

    Obama: Financial crisis a major threat to economy, R, 15.9.2008, http://www.reuters.com/article/newsOne/idUSN1551961320080915

News Analysis

Jittery Road Ahead

September 15, 2008
The New York Times
By FLOYD NORRIS and VIKAS BAJAJ

Wall Street and the federal government played a game of chicken over the weekend, and neither side backed down, pushing Lehman Brothers toward bankruptcy and setting off worries of a worldwide sell-off when markets open on Monday.

While some feared a precipitous decline in the markets, others hoped that Bank of America’s surprise announcement Sunday that it was buying Merrill Lynch might provide enough reassurance to calm investors.

“That would be seen as very good news,” Liz Ann Sonders, the chief investment strategist for Charles Schwab & Company, said of Bank of America’s $50 billion or $29 a share offer, a price far higher than Merrill’s close on Friday but less than a third of what the stock was worth early last year, before the mortgage crisis began to damage financial firms.

With major Asian markets closed for a holiday on Monday, the answer regarding investor response could wait until European markets open, and, after that, the American exchanges.

In the Lehman talks on Sunday, the government, worried about the precedents it had set in helping to rescue the investment bank Bear Stearns and the mortgage finance giants, Fannie Mae and Freddie Mac, wanted Wall Street to collectively take on the risk that Lehman’s assets were worth far less than the firm claimed. The firms, worried about their own capital, balked, though in the end they may take on some of the risk as Lehman’s investments are unwound.

Both the government and Wall Street announced steps to make a repeat less likely. The Federal Reserve said it would lend against more assets, including stocks, thus providing an additional cushion for a troubled firm. And the banks said they would set up a facility to buy assets from troubled firms in the future.

But none of that will help Lehman. Now, the risk for the financial firms is that investors will respond by trying to do exactly what they are trying to do — minimize their risk. If enough investors do that and choose to sell, stocks could plummet in markets worldwide, thus increasing the risks rather than easing them.

“We don’t want to be the first one in,” said Thomas Atteberry, a partner at First Pacific Advisors, an investment firm in Los Angeles specializing in fixed income. “I would rather wait and see that there are other participants in the marketplace.”

A bankruptcy filing could delay any immediate sell-off of some Lehman’s assets, although those pledged to secure loans might be quickly sold by lenders. The filing could also raise concerns that other firms will be badly damaged by their exposure to Lehman, which could lead to more selling pressure.

Ms. Sonders said that large-scale failures have not always led to more carnage. “In the past when you had a crisis that resulted in a big failure, that ended up being closer to the bottom than anything else,” she said. “The problem is that we have waves of these. Where does it stop is the question that is different than in the past.”

Among some market participants, the wait on Sunday was excruciating. There was trading in credit default swaps — contracts that allow traders to buy or sell protection against a company defaulting on its debts, and there were few willing to sell such protection.

Instead, traders said, the cost of buying protection against defaults soared, even for financial firms that are considered to be in good shape, like such as Morgan Stanley and Goldman Sachs.

Some even recalled the stock market crash in 1987, the biggest fall ever seen by the current generation of Wall Streeters. “This is an earth-shattering event, this is like a tectonic plate shifting event,” said Thomas Priore, chief executive of Institutional Credit Partners, a hedge fund active in credit markets. “This is welcome back to Black Monday.”

That day, Oct. 19, 1987, had the Dow Jones industrial average fall more than 22 percent. It came after a week in which the index fell 9.5 percent, for the worst week since 1940, when France fell to invading German armies.

Over the weekend in 1987 before Black Monday, there was no sign of an integrated approach to the crisis, and even public bickering between American and European officials, which some argued exacerbated investor fears.

To some, talk of 1987 was overdone. “The market has already leaped ahead to the end game here,” said Douglas Peta, a market strategist at J. &W. Seligman & Company, a brokerage firm, adding that if an unwinding of Lehman’s assets went well, things might not be so bad on Monday.

Long term, he was not as optimistic. “We are in the grip of a vicious circle,” Mr. Peta said, “and the only thing that to me will break that is for home prices to stop going down.”

Over the weekend, the Federal Reserve Bank of New York called together the leaders of most major financial firms in an effort to get them to act collectively to stem any possible panic, but could not force a deal.

In a way, that was similar to what happened a little more than a century ago, when the financier J.P. Morgan called the heads of all the trust companies in New York to a meeting in his library, and demanded that they agree to put up money to stop the bank run at another trust company.

The bankers did not want to do so, in part because they would need that money if the panic spread. Morgan locked the door, and kept the presidents in the library until morning, when they finally gave in. No such coercion exists this year.

The major financial firms are in agreement that prices in many markets are ridiculously low. But they have repeatedly underestimated how much further prices could fall, particularly for mortgage-backed securities and derivatives tied to mortgage markets, and they have been surprised by how much capital they have been forced to raise.

In recent years, there was a general increase in leverage, whether among the Wall Street firms or people who bought homes with no money down. Now that is reversing.

“This rarely observed systematic debt liquidation is what confronts the U.S. and perhaps even the global financial system at the current time,” Bill Gross of Pimco, a leading money manager, said in a newsletter on his Web site before the rescue of Fannie Mae and Freddie Mac. “Unchecked, it can turn a campfire into a forest fire, a mild asset bear market into a destructive financial tsunami.”

This year, every move by the government to shore up the financial system — from supporting the rescue of Bear Stearns to opening the Fed’s discount window to investment banks to last weekend’s move to rescue Fannie and Freddie — has produced rallies in hopes the problem was finally nearing an end. But new fears have soon arisen each time.

Now the government appears to have decided that it could not keep bailing out firm after firm, and to see how the markets will handle a bankruptcy, something it was unwilling to contemplate when it helped JPMorgan Chase take over Bear Stearns.

“After committing to JPMorgan and Bear and the involvement in Fannie Mae and Freddie Mac,” Mr. Peta said, “the government seems to have concluded: if you spare the rod, you spoil the investor.”
 

Louise Story contributed reporting.

    Jittery Road Ahead, NYT, 15.9.2008, http://www.nytimes.com/2008/09/15/business/15market.html

Banks Fear Next Move by Shorts

September 15, 2008
The New York Times
By LOUISE STORY

In May, David Einhorn, one of the most vocal short-sellers on Wall Street, made no secret he was betting against Lehman Brothers.

Now, some investors are afraid that fund managers like him will take advantage of the climate of fear stirred up by the troubles of Lehman to target other weak financial firms whose declining share price would bring them rich rewards.

At emergency meetings over the weekend, the heads of major financial institutions urged Timothy R. Geitner, the president of the New York Fed, and Treasury Secretary Henry M. Paulson Jr., to consider having the Securities and Exchange Commission reinstate a temporary rule to limit the risky but potentially lucrative practice of betting on a firm’s falling share price, according to two people who were briefed on, but did not attend, the meetings. They are concerned that short-sellers might fix their gaze on big financial institutions like Merrill Lynch and the insurance giant American International Group, which also need billions of dollars in capital to strengthen their businesses.

In July, the S.E.C. briefly halted a practice known as naked short selling after speculators placed large bets that shares of Fannie Mae and Freddie Mac, the troubled mortgage giants, would decline. That also made it harder to short the stocks of 19 financial institutions, including brokerage firms like Lehman Brothers and Morgan Stanley, although the curb wound up having little impact on the price of their shares.

The investment tactic of betting a stock will slide is not new, of course. But it has become particularly controversial in the last year, when Wall Street firms started to be targeted as the credit crisis turned the financial sector upside down. Short sellers and their free market supporters say they have done nothing wrong. If anything, they say, they have merely spotted problems at financial institutions ahead of everyone else, making them a useful early warning system for the rest of the market. Critics believe they have contributed to the speed of the decline of any number of financial shares.

Short-selling against financial institutions has proven particularly lucrative for hedge funds. Mr. Einhorn’s accusations that Lehman was failing to properly account for its marks on troublesome holdings, which appear to have presaged the bank’s early report of a $2.8 billion loss for its second quarter, has presumably netted him a handsome return.

Lehman’s shares were already under pressure when he took the microphone at a large industry gathering in May to lay out his case against the investment bank. The firm, he told the crowd, had used “accounting ingenuity” to avoid large write-downs and remained tainted by bad commercial real estate investments. Mr. Einhorn stood to profit by convincing people of his view: He had been betting against Lehman’s stock — it stood at around $40 when he spoke — since July 2007, when they traded for around $70 a share.

On Sunday, Lehman filed for bankruptcy protection.

While Lehman’s shares have declined as investors lost confidence in its ability to repair its balance sheet, in the four months after Mr. Einhorn’s remarks, short-selling played a role in the erosion. A rapid plunge in the shares to below $4 last week ultimately created the conditions that brought the 158-year old firm to its knees on Sunday.

For all his boldness, Mr. Einhorn is aware of the havoc that bank failures can create. “We would not win if Lehman went down and took the whole financial system with it,” Mr. Einhorn said in an interview in June. “An actual collapse of Lehman — that would not be a good thing.”

Other hedge fund managers recognize the dangers and the harm that is befalling bank employees who have been paid in their companies’ stocks . “My children, their playmates’ fathers work at Lehman,” said one manager who is short Lehman and asked to remain anonymous, citing the sensitivity of the situation. “Obviously I had nothing to do with what happened, and the idea that I profited, and they got clobbered, and I’ve got to see them on Monday is awkward. I feel badly for them.”

Mr. Einhorn was never shy with his criticism of Lehman. He pointed to the bank’s investments in two real estate companies, Archstone and Sun Cal, and said Lehman had not marked its mortgage assets down enough. “Lehman is one of the deniers,” he said in the June interview.

He first mentioned Lehman in a speech in October when he pointed out that the company had shifted $9 billion of mortgage securities into the “hard-to-value” category on its balance sheet. In April, he appeared unsure whether Lehman would suffer any time soon, saying “given that Lehman hasn’t reported a loss to date, there is little reason to expect that it will any time soon.” To many, Mr. Einhorn simply saw the writing on the wall early. And, hedge fund managers say, Lehman executives failed to realize how much credibility Mr. Einhorn has in the investor community. Lehman might have fared better if it raised capital or took write-offs far earlier, as Mr. Einhorn suggested.

But to some in the world of finance, Mr. Einhorn and investors like him are dangerous.

“It is really like taking a baseball bat to someone who is down,” said Jim Hardesty is president of Hardesty Capital Management in Baltimore. “A bunch of these guys with very large bats are circling around certain companies and banging them over and over again. It is unsportsmanlike conduct.”

Mr. Hardesty is among the investors who believe the S.E.C. made a mistake in allowing the temporary curb to slow the impact of short-selling to expire.

Hedge fund managers who focus on shorting companies stand out in the industry in an otherwise terrible trading year. Hedge funds are down more than 4 percent but short-focused hedge funds are up 9.76 percent, said Hedge Fund Research, a firm in Chicago.

Ironically, Mr. Einhorn’s fund, Greenlight Capital, is down 4.3 percent this year through Aug. 22, according to HSBC (he also invests in stocks, as well as shorting them). His is a so-called long-short fund, which means he invests $2 buying shares in companies for every $1 he places shorting other companies. One company he took a positive view on in recent years was New Century, one of the first subprime mortgage lenders to file for bankruptcy.

Mr. Einhorn declined to comment for this article and a spokesman would not say if he is still short Lehman’s stock or on what day he exited the position.

Eric Dash contributed reporting.

    Banks Fear Next Move by Shorts, NYT, 15.9.2008, http://www.nytimes.com/2008/09/15/business/15short.html

Nation’s Financial Industry

Gripped by Fear

September 15, 2008
The New York Times
By BEN WHITE
and JENNY ANDERSON

Fear and greed are the stuff that Wall Street is made of. But inside the great banking houses, those high temples of capitalism, fear came to the fore this weekend.

As Lehman Brothers, one of oldest names on Wall Street, filed for bankruptcy protection, anxiety over the bank’s fate — and over what might happen next — gripped the nation’s financial industry. By Sunday night, Merrill Lynch, under mounting pressure, had reached a deal to sell itself to Bank of America for $29 a share or about $50 billion, according to people with knowledge of the deal.

Dinner parties were canceled. Weekend getaways were postponed. All of Wall Street, it seemed, was on high alert.

In skyscrapers across Manhattan, banking executives were holed up inside their headquarters, within cocoons of soft rugs and wood-paneled walls, desperately trying to assess their company’s exposure to the stricken Lehman. It was, by all accounts, a day unlike anything Wall Street had ever seen.

In the financial district, bond traders, anxious about how the markets would react on Monday, sought refuge in ultrasafe Treasury bills. Greenwich, Conn., that leafy realm of hedge fund millionaires and corporate chieftains, felt like a ghost town. Greenwich Avenue, which usually bustles on Sundays, was eerily quiet.

A year into the financial crisis, few dreamed that the situation would spiral down so far, so fast. Only a week ago, the Bush administration took control of Fannie Mae and Freddie Mac, the nation’s two largest mortgage finance companies. Then, before anyone could sigh a breath of relief after that crisis, Lehman was on the brink.

As details of Lehman’s plight began to trickle out on Sunday, the worries deepened that big financial companies might topple like dominoes. Bank of America began discussions to buy Merrill Lynch, the nation’s largest brokerage.

“I spent last weekend watching Fannie and Freddie die. This weekend it was Lehman,” said one longtime Wall Street executive.

By late Sunday, a consortium of banks, working with government officials, announced a $70 billion pool of funds to lend to troubled financial companies.

The rat-a-tat-tat of bad news has frayed nerves up and down Wall Street. “People are just weary,” said another executive. And even more ill tidings loom. Thousands of employees at Lehman are likely to be laid off, casting them into one of the worst Wall Street job markets in years. Other banks are cutting back, too.

Even employees who manage to hold on are likely to make a lot less money this year. Bonuses are not only going to decrease; for many, they will evaporate completely.

While people were stunned by the near collapse of Bear Stearns in March, they were flabbergasted that Lehman, a respected firm with a 158-year history, could be brought to its knees. Many were equally shocked by the downfall of Richard S. Fuld Jr., Lehman’s chairman and chief executive.

“Everyone thought Bear Stearns was a bunch of cowboys; it made sense what happened,” said another executive. “But this is the great Dick Fuld. This is not supposed to happen to Lehman Brothers.”

Many Wall Street executives struggled to draw parallels to the current crisis. The collapse of the junk bond powerhouse Drexel Burnham Lambert in 1991 seems small by comparison, as does the 1998 failure of the big hedge fund Long Term Capital Management.

On Sunday, as the heads of major Wall Street banks huddled for a third day of emergency meetings at the Federal Reserve Bank of New York, many rank-and-file employees were at work in their offices.

“It’s all hands on deck,” said one senior banker.

At hedge funds, analysts worried that investors would rush to withdraw their money.

As a precaution, Wall Street banks have taken the extraordinary step of hiring advisers to assess the impact of the possible bankruptcies of other big financial institutions.

The mood could darken even further this week as several big Wall Street banks report what are expected to be grim quarterly results.

The problems the industry faces are myriad. Mortgage assets that both commercial and investment banks hold on their balance sheets continue to decline in value as potential buyers wait for prices to fall even further and sellers balk at prices being offered. At the same time, revenues from bread and butter Wall Street businesses like debt and equity underwriting and proprietary trading are sliding in a softening economy at home and abroad.

“I have not seen a quarter like this since 2001,” said Meredith Whitney, analyst at Oppenheimer. “And the expense bases at the banks are still built for 2006-style revenues. So the clash of these two things is going to produce the kind of quarter we have not seen in some time.”

Some thought that Merrill Lynch’s sale of $30.6 billion worth of mortgage-related securities in July to the private equity group Lone Star for $6.7 billion (75 percent of which was provided as a loan by Merrill) would unleash a torrent of similar sales. That has not happened.

Big investment groups like Pacific Investment Management Company have put together “vulture” funds worth at least $70 billion to buy distressed assets. So far, not many sales have happened amid a buyer’s strike.

Part of the fear gripping Wall Street is the “who’s next” game. After the collapse of Bear Stearns it was Lehman. After Lehman, many worry about who might be next.

Those who bet on a rebound in financials are getting clobbered. In March, O’Shaughnessy Asset Management, a $9 billion quantitative money management group, started investing in financials and the group continues to add to its portfolio. “We’re patient and we keep buying,” said Jim O’Shaughnessy, chairman and chief executive of the firm.

Mr. O’Shaughnessy created a proxy index of financials to test the performance of previous financial stock routs and recoveries dating back to 1964. The average return for the 20 worst 12 month periods was -34.96 percent. In the last year, through June 30, his proxy index was down 31 percent.

But Mr. O’Shaughnessy is betting on the rally.

In the subsequent one- and three-year periods after those drastic declines, his index rose an average 30.5 percent and an annualized 19.7 percent. “Financials falling out of bed has happened in the past,” he said. “I’m interested in what happens after they crash and burn.”

That strategy has not yet panned out this year. The O’Shaughnessy Dividend fund, which heavily invests in financials, is down 17.2 percent through July 30 compared with a 15.2 percent drop in the Russell 1000 value index. The three-year compounded return through July 30 is 6.5 percent, compared with 2.4 percent for the Russell 1000.

By contrast, hedge funds that continue to short financials (betting their prices will fall) are still performing well. Goshen Investments, a $200 million fund seeded by Tiger Management, is up 35 percent through the end of August, according to one investor. The fund has large short positions in American brokerage firms, European banks and American exchanges. Christopher Burn, founder of the fund, declined to comment.

    Nation’s Financial Industry Gripped by Fear, NYT, 15.9.2008, http://www.nytimes.com/2008/09/15/business/15street.html

Fed Loosens Standards

on Emergency Loans

September 15, 2008
The New York Times
By EDMUND L. ANDREWS

WASHINGTON — Even though the Federal Reserve refused to provide a financial backstop to potential buyers of Lehman Brothers, concerns over what may unfold in the market on Monday led it to dramatically loosen its standards on making emergency loans to major Wall Street investment banks.

At the same time, a group of 10 major banks agreed to contribute $7 billion each to an emergency borrowing facility that any of the banks can tap if they run into a crisis similar to the one faced by Lehman Brothers. The fund may grow in size as more banks agree to contribute.

Taken together, the Fed’s expanded lending facility and the banks’ emergency borrowing facility indicate that Washington officials and Wall Street have grave concerns about future losses at banks beyond Lehman.

In an obscure but highly important announcement late Sunday evening, the Fed said it would let Wall Street firms post as collateral much riskier assets — including equities, junk bonds, subprime mortgage-backed securities and even whole mortgages — in exchange for emergency loans through the Primary Dealer Credit Facility.

The Fed created the emergency loan program in March, at the same time that it engineered the shotgun marriage of Bear Stearns by JPMorgan. In itself, the program marked a historic expansion of the Fed’s lending to cover investment banks rather than only commercial banks.

Wall Street firms have used the emergency lending program very little in recent months, though Lehman Brothers and perhaps other companies are likely to use it this week.

Before the Fed’s announcement on Sunday, investment banks could pledge as collateral any kind of “investment grade” debt securities, which meant securities rated BBB or higher and included many securities backed by subprime mortgages.

But with the new announcement, the Fed will accept stocks and some debt that has junk-bond status and some securities that may have few real buyers.

It was unclear Sunday night just how much in the way of high-risk collateral the Fed would be willing to accept. The central bank said it would broaden its list of eligible collateral to “closely match” the practices of the “tri-party” overnight lending facilities run by two major clearing banks — JPMorgan Chase and Bank of New York.

Those programs allow about 15 percent of their collateral to be in equities or debt that is below investment-grade, and most of that is reserved for equities.

On Friday, Timothy F. Geithner, president of the New York Federal Reserve Bank, urged Wall Street chieftains to come up with a solution to stem the growing crisis of confidence. Echoing comments made earlier in the week by the Treasury secretary, Henry M. Paulson Jr., Mr. Geithner said the government would not rescue financial firms.

In the end, the government succeeded in getting Wall Street to create its own insurance policy. But at the same time, the Fed, in agreeing to loosen terms under which it lends money to firms, is potentially putting more taxpayer money at risk.

The events over a harrowing weekend indicate that top officials at the Federal Reserve and at the Treasury will take a harder line on providing government support to troubled institutions. But that does not mean they are unwilling to provide indirect help, or even relax regulatory requirements temporarily.

At first glance, the new strategy by Mr. Paulson and the chairman of the Federal Reserve, Ben S. Bernanke, represents a purer and tougher insistence that Wall Street work out its own problems without government help.

But before the weekend was over, it was also clear that they could stand by their principles — and be creative, too. For example, if Bank of America completes its acquisition of Merrill Lynch, its capital reserves would immediately fall below the minimum requirements for bank holding companies. Regulators, including the Federal Reserve, would have to show lenience for as long as it takes the capital markets to regain their confidence — which could be quite a while.

And the expansion of the Fed’s lending facilities adds another novel approach to help stabilize markets, but without supporting yet another bailout.

The Fed and the Treasury may be sticking to their guns for now, but Lehman and Merrill Lynch are hardly the only troubled financial institutions, and some experts wonder how long the government can stand by and watch more failures.

Administration officials acknowledged last week that more bank failures were inevitable, and the main protection for depositors — the Federal Deposit Insurance Corporation — is likely to exhaust its reserves.

That is similar to an approach urged by Alan Greenspan, Mr. Bernanke’s predecessor as chairman of the Federal Reserve. Mr. Greenspan, who has long been a staunch opponent of government interference in the economy, said on Sunday that the federal government might have to shore up some financial institutions.

“This is a once-in-a-half-century, probably once-in-a-century type of event,” Mr. Greenspan said in an interview on ABC. “I think the argument has got to be that there are certain types of institutions which are so fundamental to the functioning of the movement of savings into real investment in an economy that on very rare occasions — and this is one of them — it’s desirable to prevent them from liquidating in a sharply disruptive manner.”

Ben White contributed reporting from New York.

    Fed Loosens Standards on Emergency Loans, NYT, 15.9.2008, http://www.nytimes.com/2008/09/15/business/15fed.html

Purchase of Merrill

Fulfills Quest for a Bank

September 15, 2008
The New York Times
By ERIC DASH

Bank of America’s dream of dominating the brokerage business always seemed to elude it, even after it transformed itself from a regional bank into a consumer banking powerhouse through two decades of big acquisitions.

Now, that dream is on the verge of becoming reality. With its plan to buy Merrill Lynch, Bank of America is adding the most recognized name on Wall Street — and Merrill’s 17,000 brokers — to its empire.

Overnight, the shotgun merger will transform Bank of America into the nation’s largest player in wealth management. It already holds the biggest branch network and is the largest issuer of credit cards, home equity loans and auto loans. Its $4 billion takeover in January of Countrywide Financial, the troubled lender that became a symbol of the excesses of the subprime crisis, gave Bank of America the largest mortgage lending and payment collection operation.

Kenneth D. Lewis, Bank of America’s chairman, has burnished his reputation by gambling on bold acquisitions that turned what was once a regional institution into a national player. A decade ago, it was known as NationsBank when it bought a much larger institution, the Bank of America, and took its name. In 2003, it took over FleetBoston Financial, widening its branch base, and it snapped up MBNA two years later to create the largest American credit card business.

Mr. Lewis’s poker face and flare for the dramatic appear to have paid off with Merrill Lynch. On Friday night, Bank of America had emerged as one of the leading contenders to rescue Lehman Brothers. Just 24 hours later, its interest faded.

Merrill Lynch put itself up for sale as the danger deepened that it could be the next big firm to be crippled on Wall Street. After a series of side conversations with Merrill’s chief, John A. Thain, during emergency meetings over the weekend meant to try to salvage Lehman, Mr. Lewis swooped in as one of the few willing, and able, buyers for Merrill.

If Mr. Lewis has long clamored for the respect of the banking industry’s more established leaders, he appears to have emerged from the deal as one of Wall Street’s white knights.

“Ken Lewis with this transaction just got that much more powerful in the global financial structure,” said Meredith A. Whitney, a financial services analyst. “This is a deal that gets all the things he aspires to acquire — brand, scale and best-in-class businesses.”

Only a year ago, Bank of America appeared to have given up on investment banking after enduring a string of large losses. Mr. Lewis had spent more than $625 million to expand it only to see all of its trading businesses swamped by red ink.

He cut thousands of jobs in the investment banking operations, reined in its trading activities and ousted close lieutenants who had been in charge of the division. Asked by an analyst if he had a desire to pursue a deal with Bear Stearns, Mr. Lewis shot back: “I’ve had all the fun I can stand in investment banking.”

Whether he can make the Merrill Lynch deal work is still an open question. While Bank of America is financially strong, huge losses tied to credit cards, home equity loans and troubled mortgages from the Countrywide deal could erode its financial position. Many analysts say that it will need to shore up its balance sheet with additional capital.

Mr. Lewis, who already has his hands full with Countrywide, will also need to manage the absorption of one of Wall Street’s strongest cultures. Bank of America has traditionally been an acquisition machine, imposing its will and cost discipline on the companies it swallows. Merrill Lynch, with its thousands of brokers, has long prided itself on its tradition of being a standalone brokerage. Most analysts expect thousands of layoffs.

If it works, the deal could be a major coup for Mr. Lewis. Bank of America will get a stronger equities division and Merrill’s 45 percent stake in BlackRock, the global asset manager, along with the opportunity to offer Merrill’s products in its branches.

Merrill could be a crucial source of earnings for Bank of America as it brushes up against a cap on deposits. That has become increasingly important for Bank of America, which needs to find opportunities outside of traditional consumer banking.

    Purchase of Merrill Fulfills Quest for a Bank, NYT, 15.9.2008, http://www.nytimes.com/2008/09/15/business/15bofa.html

TIMELINE: History of Merrill Lynch

Mon Sep 15, 2008
1:29am EDT
Reuters

NEW YORK (Reuters) - The following is a brief history of Merrill Lynch & Co, which agreed to be acquired by Bank of America Corp in a $50 billion transaction. This history is taken from Merrill's website, published reports, and publicly available information.
 

1907: Charles Merrill arrives in New York to work for a textile company. He meets Edmund Lynch, who is looking for someone to share his boarding-house room at the 23rd Street YMCA. Both men were born in 1885.

1914: Charles E Merrill & Co opens its doors in January. Lynch joins him, and in May they open an office at 7 Wall Street in downtown Manhattan.
 

1915: The firm changes its name to Merrill, Lynch & Co. An associate notices a difference between the partners: "Merrill could imagine the possibilities; Lynch imagined what might go wrong in a malevolent world."

1938: Edmund Lynch dies. Merrill Lynch drops the comma from its name.
 

1956: Merrill helps take Ford Motor Co public, giving the firm its first billion-dollar year in underwriting. The same year, Charles Merrill dies.

1958: Firm changes its name to Merrill Lynch, Pierce, Fenner & Smith.
 

1960: Merrill opens its first London office. Four years later, it opens its first Tokyo office.

1964: Merrill buys C.J. Devine, becoming a dealer in fixed-income securities.

1971: Merrill goes public and lists on the New York Stock Exchange.

1976: Merrill creates Merrill Lynch Asset Management.

1999: Merrill is world's largest underwriter of stocks and bonds for the last time, a title it cedes the next year to Citigroup Inc.

2001: Most of Merrill's 9,000 Wall Street employees evacuate their offices opposite the World Trade Center during the 9/11 attacks. Three die.

Dec 2002: Merrill reaches $100 million settlement with New York Attorney General Eliot Spitzer over alleged conflicts of interest by research analysts. The same month, it names Stanley O'Neal chief executive. He becomes chairman in April 2003.
 

2006: Merrill adds billions of dollars of mortgages to its balance sheet. It acquires First Franklin Financial Corp, a subprime mortgage lender owned by National City Corp.

Oct 2007: Merrill ousts Stanley O'Neal as chairman and chief executive as mortgage losses begin to mount, and after O'Neal approaches Wachovia Corp about a merger without telling the board. John Thain, chief executive of NYSE Euronext, is named his replacement as of Dec 1.
 

2008: Losses top $19.2 billion in the year ended June 30, as credit losses $40 billion. Merrill scrambles to raise capital from sovereign wealth funds and other investors, and sell risky assets.

Sept 15, 2008: Merrill agrees to be acquired by Bank of America for $29 per share.

(Reporting by Jonathan Stempel; Editing by Quentin Bryar)

TIMELINE: History of Merrill Lynch, R, 15.9.2008, http://www.reuters.com/article/innovationNewsFinancialServicesAndRealEstate/idUSN1546989520080915

Stunning Fall

for Main Street’s Brokerage Firm

September 15, 2008
The New York Times
By LOUISE STORY

It’s the end of an era for Merrill Lynch, the brokerage firm that brought Wall Street to Main Street.

Merrill, which has lost more than $45 billion on its mortgage investments, agreed to sell itself to Bank of America for $50.3 billion in stock, according to people briefed on the negotiations.

It is a remarkable fall from grace for the 94-year-old Merrill, whose corporate logo — a bull — has long symbolized the fundamental optimism of Wall Street. After a frantic weekend of talks between Wall Street executives and federal officials over the fate of the teetering Lehman Brothers, fear spread on Sunday that Merrill, staggered by losses, might also falter. The merger would combine Bank of America’s banking and lending strength with Merrill Lynch’s wealth management expertise.

“It is an enormous shock,” said Steve Fraser, a Wall Street historian and author of “Wall Street: America’s Dream Palace.”

“Merrill was a kind of bedrock institution whose stability and longevity was taken for granted and was reassuring to people,” Mr. Fraser said. “Even in these very highly erratic and speculative marketplaces like we’ve been living through, you didn’t think Merrill would be vulnerable.”

The sale, if completed, would open a new chapter for Merrill, which was founded in 1914 and promoted the idea that anyone, not just the rich, should invest in markets. Merrill’s brokers would be combined with Bank of America’s smaller group of wealth advisers into an entity called Merrill Lynch Wealth Management, these people said. Customers with brokerage accounts at Merrill are unlikely to be financially affected.

Merrill, the nation’s largest brokerage firm, was one of the earliest Wall Street firms to go public, in 1971. Its executives, traditionally former stockbrokers, have long been viewed as spokespeople for the entire industry. After the crash of 1987, for instance, Merrill’s chief executive appeared on a television commercial and used one of the company’s long-time slogans, saying: “Merrill Lynch is still bullish on America.”

Last December, John A. Thain, Merrill’s chairman and chief executive, was brought in to try to salvage the troubled company. It remains unclear how many Merrill employees will be hired by Bank of America.

Since the credit crisis first flared more than a year ago, Merrill has been among the most wounded. Under its previous chief executive, E. Stanley O’Neal, Merrill moved aggressively into the mortgage market and became one of the top issuers of investment vehicles linked to subprime mortgages and other risky forms of debt. Mr. O’Neal was forced out last fall after the tumult in the mortgage market began.

Since then, the investment bank has taken more than $45 billion in write-downs, a figure that is two times more than all the profit Merrill made in the two and a half years before the credit crisis. The charges have pushed Merrill Lynch deep into the red and forced the company to lay off 4,000 workers. Merrill has raised more than $15 billion in additional capital to strengthen its financial position but has struggled to regain investors’ confidence.

Employees reached Sunday night reacted with dismay and said they would consider leaving after Bank of America took over. Many said they were saddened that Merrill, which has long prided itself on its independence, would now become part of a larger commercial bank.

“A hundred guys flew this firm into a mountain,” said a broker who works for Merrill in California and asked to remain anonymous because he did not have permission to speak with reporters. “It’s really sad. Now we’re going to be a bank like every one else.”

Many employees hoped that Mr. Thain would turn the company around. A former Goldman Sachs executive, Mr. Thain is known as Mr. Fix-It because he pushed the New York Stock Exchange into the modern era as its chief executive over the last two years.

Mr. Thain undertook seven major transactions this summer in hopes of bolstering Merrill. Among the transactions were a sale of Merrill’s $4.4 billion stake in Bloomberg, the financial news and data service. Merrill also raised $9.8 billion of common equity and shed $31 billion of its risky mortgage investments for pennies on the dollar.

Explaining his decisions in an interview in July, Mr. Thain pointed to employee morale and said Merrill needed to move beyond its past.

“We have over 60,000 people working every day,” Mr. Thain said. “All the efforts of these people were overwhelmed by the write-downs in the mortgage-related assets.”

Merrill Lynch has been through tough times before. As the stock market soared in the 1920s, Charles E. Merrill, one of the company’s founders, worried about speculation and advised his clients that they should “take advantage of present high prices and put your financial house in order.” After the stock market crash of 1929, Merrill survived in large part by spinning off its retail brokerage business and focusing on investment banking. The company later reunited.

Many Americans remained skeptical of Wall Street even into the 1950s, and Merrill Lynch used its marketing and local branches to try to build a better reputation for the industry. At the same time it began expanding into Europe. In the 1990s, Merrill was the first financial services company to surpass $1 trillion in client assets under management, according to the company’s Web site.

The new, combined group, Merrill Lynch Wealth Management, would be run by Robert J. McCann, the head of Merrill’s global wealth management business. Gregory J. Fleming, president of Merrill Lynch, will become president of the combined bank’s corporate and investment bank, while Thomas K. Montag, who started at Merrill Lynch in August, will be head of all risk, trading and institutional sales, the people briefed on the negotiations said.

Merrill’s top executives had long believed the company would survive the turmoil in the markets, but changed their minds this weekend. Some observers said they may have been wise to do so.

“Almost all of these institutions are worth a lot more while they’re still operating and before they get caught in a financial hurricane,” said James A. Wilcox, a professor at the Haas School of Business at University of California in Berkeley and a former chief economist at the Office of the Comptroller of the Currency.

As recently as last Wednesday, Mr. Thain was still out selling the Merrill story. He met with worried employees financial advisers in Minneapolis as part of a series of town halls he has been holding to answer employee questions. Mr. Thain reassured them about the company’s capital base, dwindling level of worrisome assets, and the value of Merrill Lynch’s businesses, according to someone who attended.

And he told them that the pain looked like it would end by 2009.

Jenny Anderson and Andrew Ross Sorkin contributed reporting.

    Stunning Fall for Main Street’s Brokerage Firm, NYT, 15.9.2008, http://www.nytimes.com/2008/09/15/business/15merrill.html

Bank of America

to buy Merrill for $50 billion

Mon Sep 15, 2008
7:57am EDT
Reuters
By John Poirier and Elinor Comlay

WASHINGTON/NEW YORK (Reuters) - Bank of America Corp said it agreed to buy Merrill Lynch & Co Inc in an all-stock deal worth $50 billion, snagging the world's largest retail brokerage after one of the worst-ever weekends on Wall Street.

The deal came after tense negotiations over the fate of Lehman Brothers Holdings Inc, which triggered concern that market participants would lose faith in other investment banks. Lehman said early on Monday that it would file for Chapter 11 bankruptcy protection.

"It catapults Bank of America into positions of strength in three businesses where they were weak," said James Ellman, portfolio manager at hedge fund Seacliff Capital.

"Now Bank of America has one of the best and largest retail brokerages in the country, one of the top investment banks in the world, and a large stake in one of the best investment managers in the world," Ellman said.

Bank of America agreed to pay 0.8595 shares of Bank of America common stock for each Merrill Lynch share. The price is 1.8 times stated tangible book value.

The bank is buying about $44 billion of Merrill's common shares, as well as $6 billion of options, convertibles, and restricted stock units.

Bank of America said it expects to achieve $7 billion in pretax expense savings, fully realized by 2012, and expects the deal to be accretive to earnings by 2010. The transaction is expected to close in the first quarter of next year.

The price, which comes to about $29 per share, represents a 70 percent premium to Merrill's share price on Friday, although Merrill's shares were trading at $50 in May and over $90 at the beginning of January 2007.

The deal has been approved by directors of both companies. Three Merrill directors will join the Bank of America board.

Stuck with some of the same toxic debt -- much of it mortgage-related -- that torpedoed Lehman's balance sheet, Merrill has been hit hard by the credit crisis and has written down more than $40 billion over the last year.

Last month, Thain arranged to sell over $30 billion in repackaged debt securities to Dallas-based private equity firm Lone Star Funds for 22 cents on the dollar.

In spite of its exposures to complex debt securities, the bank had seen by some as undervalued, in part because of its massive brokerage business, which analysts have said is worth more than $25 billion. The brokerage is the largest in the world by assets under management and number of brokers.

Merrill also has a stake of about 45 percent in the profitable asset manager BlackRock Inc, worth more than $10 billion.

"It could be a powerful fit," said Rick Meckler, chief investment officer at LibertyView Capital Management in New York, before news of the deal emerged.

DUE DILIGENCE

Still, there are risks for BofA, which had little time to complete due diligence of Merrill's books, a particular concern given the complexity of the company's exposure to mortgage-related securities and other complex debt.

"While we view this clearly as a long-term positive for (Bank of America), the stock will likely not respond accordingly as investors near term will focus on greater systemic risk," Oppenheimer & Co analyst Meredith Whitney said in a report on Sunday.

With the brokerage and the BlackRock shares worth more than $35 billion combined, and Merrill's market capitalization at around $26 billion on Friday, investors had been ascribing a negative value to the investment bank, implying huge potential embedded losses.

But this is not the first time Bank of America has done a quick acquisition. In 2005, the bank bought credit card company MBNA after less than a week of due diligence, with Lewis saying the company was comfortable with the acquisition because it knew the people and business well.

Bank of America under Lewis has in fact become renowned for large acquisitions and it has spent over $100 billion since 2004 buying other companies.

Most recently it acquired troubled mortgage lender Countrywide Financial Corp and -- although many were skeptical about this purchase -- veteran analyst Dick Bove said last week the takeover could prove to be a master stroke by Lewis, since the government takeover of mortgage agencies Fannie Mae and Freddie Mac could fuel business for other lenders.

Bank of America was advised by JC Flowers & Co, Fox-Pitt Kelton Cochran Caronia Waller and Bank of America Securities. It was represented by Wachtell, Lipton, Rosen & Katz. Merrill Lynch was represented by Shearman & Sterling.

(Additional reporting by Paritosh Bansal and Dan Wilchins;

Editing by Quentin Bryar)

    Bank of America to buy Merrill for $50 billion, R, 15.9.2008, http://www.reuters.com/article/newsOne/idUSN1445019920080915


 

 2 Wall St. Banks Falter; Markets Shaken        NYT        15.9.2008

http://www.nytimes.com/2008/09/15/business/15lehman.html

2 Wall St. Banks Falter;

Markets Shaken

September 15, 2008
The New York Times
By ANDREW ROSS SORKIN

This article was reported by Jenny Anderson, Eric Dash and Andrew Ross Sorkin and was written by Mr. Sorkin.

In one of the most dramatic days in Wall Street’s history, Merrill Lynch agreed to sell itself on Sunday to Bank of America for roughly $50 billion to avert a deepening financial crisis, while another prominent securities firm, Lehman Brothers, filed for bankruptcy protection and hurtled toward liquidation after it failed to find a buyer.

The humbling moves, which reshape the landscape of American finance, mark the latest chapter in a tumultuous year in which once-proud financial institutions have been brought to their knees as a result of hundreds of billions of dollars in losses because of bad mortgage finance and real estate investments.

But even as the fates of Lehman and Merrill hung in the balance, another crisis loomed as the insurance giant American International Group appeared to teeter. Staggered by losses stemming from the credit crisis, A.I.G. sought a $40 billion lifeline from the Federal Reserve, without which the company may have only days to survive.

The stunning series of events culminated a weekend of frantic around-the-clock negotiations, as Wall Street bankers huddled in meetings at the behest of Bush administration officials to try to avoid a downward spiral in the markets stemming from a crisis of confidence.

“My goodness. I’ve been in the business 35 years, and these are the most extraordinary events I’ve ever seen,” said Peter G. Peterson, co-founder of the private equity firm the Blackstone Group, who was head of Lehman in the 1970s and a secretary of commerce in the Nixon administration.

It remains to be seen whether the sale of Merrill, which was worth more than $100 billion during the last year, and the controlled demise of Lehman will be enough to finally turn the tide in the yearlong financial crisis that has crippled Wall Street and threatened the broader economy.

Early Monday morning, Lehman said it would file for Chapter 11 bankruptcy protection in New York for its holding company in what would be the largest failure of an investment bank since the collapse of Drexel Burnham Lambert 18 years ago, the Associated Press reported.

Questions remain about how the market will react Monday, particularly to Lehman’s plan to wind down its trading operations, and whether other companies, like A.I.G. and Washington Mutual, the nation’s largest savings and loan, might falter.

Indeed, in a move that echoed Wall Street’s rescue of a big hedge fund a decade ago this week, 10 major banks agreed to create an emergency fund of $70 billion to $100 billion that financial institutions can use to protect themselves from the fallout of Lehman’s failure.

The Fed, meantime, broadened the terms of its emergency loan program for Wall Street banks, a move that could ultimately put taxpayers’ money at risk.

Though the government took control of the troubled mortgage finance companies Fannie Mae and Freddie Mac only a week ago, investors have become increasingly nervous about whether major financial institutions can recover from their losses.

How things play out could affect the broader economy, which has been weakening steadily as the financial crisis has deepened over the last year, with unemployment increasing as the nation’s growth rate has slowed.

What will happen to Merrill’s 60,000 employees or Lehman’s 25,000 employees remains unclear. Worried about the unfolding crisis and its potential impact on New York City’s economy, Mayor Michael R. Bloomberg canceled a trip to California to meet with Gov. Arnold Schwarzenegger. Instead, aides said, Mr. Bloomberg spent much of the weekend working the phones, talking to federal officials and bank executives in an effort to gauge the severity of the crisis.

The weekend that humbled Lehman and Merrill Lynch and rewarded Bank of America, based in Charlotte, N.C., began at 6 p.m. Friday in the first of a series of emergency meetings at the Federal Reserve building in Lower Manhattan.

The meeting was called by Fed officials, with Treasury Secretary Henry M. Paulson Jr. in attendance, and it included top bankers. The Treasury and Federal Reserve had already stepped in on several occasions to rescue the financial system, forcing a shotgun marriage between Bear Stearns and JPMorgan Chase this year and backstopping $29 billion worth of troubled assets — and then agreeing to bail out Fannie Mae and Freddie Mac.

The bankers were told that the government would not bail out Lehman and that it was up to Wall Street to solve its problems. Lehman’s stock tumbled sharply last week as concerns about its financial condition grew and other firms started to pull back from doing business with it, threatening its viability.

Without government backing, Lehman began trying to find a buyer, focusing on Barclays, the big British bank, and Bank of America. At the same time, other Wall Street executives grew more concerned about their own precarious situation.

The fates of Merrill Lynch and Lehman Brothers would not seem to be linked; Merrill has the nation’s largest brokerage force and its name is known in towns across America, while Lehman’s main customers are big institutions. But during the credit boom both firms piled into risky real estate and ended up severely weakened, with inadequate capital and toxic assets.

Knowing that investors were worried about Merrill, John A. Thain, its chief executive and an alumnus of Goldman Sachs and the New York Stock Exchange, and Kenneth D. Lewis, Bank of America’s chief executive, began negotiations. One person briefed on the negotiations said Bank of America had approached Merrill earlier in the summer but Mr. Thain had rebuffed the offer. Now, prompted by the reality that a Lehman bankruptcy would ripple through Wall Street and further cripple Merrill Lynch, the two parties proceeded with discussions.

On Sunday morning, Mr. Thain and Mr. Lewis cemented the deal. It could not be determined if Mr. Thain would play a role in the new company, but two people briefed on the negotiations said they did not expect him to stay. Merrill’s “thundering herd” of 17,000 brokers will be combined with Bank of America’s smaller group of wealth advisers and called Merrill Lynch Wealth Management.

For Bank of America, which this year bought Countrywide Financial, the troubled mortgage lender, the purchase of Merrill puts it at the pinnacle of American finance, making it the biggest brokerage house and consumer banking franchise.

Bank of America eventually pulled out of its talks with Lehman after the government refused to take responsibility for losses on some of Lehman’s most troubled real-estate assets, something it agreed to do when JP Morgan Chase bought Bear Stearns to save it from a bankruptcy filing in March.

A leading proposal to rescue Lehman would have divided the bank into two entities, a “good bank” and a “bad bank.” Under that scenario, Barclays would have bought the parts of Lehman that have been performing well, while a group of 10 to 15 Wall Street companies would have agreed to absorb losses from the bank’s troubled assets, to two people briefed on the proposal said. Taxpayer money would not have been included in such a deal, they said.

Other Wall Street banks also balked at the deal, unhappy at facing potential losses while Bank of America or Barclays walked away with the potentially profitable part of Lehman at a cheap price.

For Lehman, the end essentially came Sunday morning when its last potential suitor, Barclays, pulled out from a deal, saying it could not obtain a shareholder vote to approve a transaction before Monday morning, something required under London Stock Exchange listing rules, one person close to the matter said. Other people involved in the talks said the Financial Services Authority, the British securities regulator, had discouraged Barclays from pursuing a deal. Peter Truell, a spokesman for Barclays, declined to comment. Lehman’s subsidiaries were expected to remain solvent while the firm liquidates its holdings, these people said. Herbert H. McDade III, Lehman’s president, was at the Federal Reserve Bank in New York late Sunday, discussing terms of Lehman’s fate with government officials.

Lehman’s filing is unlikely to resemble those of other companies that seek bankruptcy protection. Because of the harsher treatment that federal bankruptcy law applies to financial-services firms, Lehman cannot hope to reorganize and survive. It was not clear whether the government would appoint a trustee to supervise Lehman’s liquidation or how big the financial backstop would be.

Lehman has retained the law firm Weil, Gotshal & Manges as its bankruptcy counsel.

The collapse of Lehman is a devastating end for Richard S. Fuld Jr., the chief executive, who has led the bank since it emerged from American Express as a public company in 1994. Mr. Fuld, who steered Lehman through near-death experiences in the past, spent the last several days in his 31st floor office in Lehman’s midtown headquarters on the phone from 6 a.m. until well past midnight trying to find save the firm, a person close to the matter said.

A.I.G. will be the next test. Ratings agencies threatened to downgrade A.I.G.’s credit rating if it does not raise $40 billion by Monday morning, a step that would crippled the company. A.I.G. had hoped to shore itself up, in party by selling certain businesses, but potential bidders, including the private investment firms Kohlberg Kravis Roberts and TPG, withdrew at the last minute because the government refused to provide a financial guarantee for the purchase. A.I.G. rejected an offer by another investor, J. C. Flowers & Company.

The weekend’s events indicate that top officials at the Federal Reserve and the Treasury are taking a harder line on providing government support of troubled financial institutions.

While offering to help Wall Street organize a shotgun marriage for Lehman, both the Fed chairman, Ben S. Bernanke, and Mr. Paulson had warned that they would not put taxpayer money at risk simply to prevent a Lehman collapse.

The message marked a major change in strategy but it remained unclear until at least Friday what would happen. “They were faced after Bear Stearns with the problem of where to draw the line,” said Laurence H. Meyer, a former Fed governor who is now vice chairman of Macroeconomic Advisors, a forecasting firm. “It became clear that this piecemeal, patchwork, case-by-case approach might not get the job done.”

Both Mr. Paulson and Mr. Bernanke worried that they had already gone much further than they had ever wanted, first by underwriting the takeover of Bear Stearns in March and by the far bigger bailout of Fannie Mae and Freddie Mac.

Outside the public eye, Fed officials had acquired much more information since March about the interconnections and cross-exposure to risk among Wall Street investment banks, hedge funds and traders in the vast market for credit-default swaps and other derivatives. In the end, both Wall Street and the Fed blinked.

Reporting was contributed by Edmund L. Andrews,

Eric Dash, Michael Barbaro, Michael J. de la Merced, Louise Story and Ben White.

    2 Wall St. Banks Falter; Markets Shaken, NYT, 15.9.2008, http://www.nytimes.com/2008/09/15/business/15lehman.html

ANALYSTS' VIEW:

Lehman files for bankruptcy

Mon Sep 15, 2008
2:53am EDT
Reuters

SINGAPORE (Reuters) - Lehman Brothers Holdings filed for bankruptcy protection on Monday, while Bank of America announced it will buy Merrill Lynch, in latest developments in the troubled U.S. financial sector.

Meanwhile, the U.S. Federal Reserve and major banks announced steps to mitigate market volatility.

ANALYSTS' COMMENTS

MARCO ANNUZIATA, GLOBAL CHIEF ECONOMIST, UNICREDIT, LONDON

"There is now speculation that the Fed might decide an emergency rate cut to help the market absorb the stress this cannot be excluded if signs of meltdown materialise, but we think the Fed will try to avoid this step, which would be a reversal of the previous shift to more targeted measures.

"The US Treasury has decided it was time for shock therapy, and taken an extremely gutsy gamble by letting Lehman fail, against widespread expectations that a solution would be brokered over the weekend. The financial system now faces the unprecedented challenge of absorbing the unwinding of a major broker. If it works, it should boost considerably the hopes that the global financial system can work itself out of the year-long crisis. But the risk is enormous.

"As markets open in Europe today, we can expect equity markets to take a hammering, with major safe haven flight to government bonds and gold. The USD will likely be under pressure given the major question marks on the US financial system, to the benefit of safe haven currencies like CHF.

"We are witnessing a turning point in the modern history of the financial system, as three major brokers have now disappeared from the scene. The coming days and weeks will be truly crucial to the global economic outlook."

JUSTIN URQUHART STEWART, INVESTMENT DIRECTOR AT 7 INVESTMENT

MANAGEMENT

This is a perfect storm in a perfect storm. There are two ways of looking at it: one, as financial Armageddon, the other as a dose of realisation of the level of complexity of the problem people are dealing with.

It's a return to pure capitalism, the survival of the fittest -- the government can't and won't bail everybody out. Investors will now retreat to the trustworthy banks, though that's not a phrase that trips off the tongue easily nowadays.

There are three issues: the counterparties in derivative trades with Lehman, the people who hold Lehman stock and debt, and third and most important, market confidence.

The eye of cynicism now falls on European banks, highlighting the weaker ones.

ALAN RUSKIN AT RBS GREENWICH CAPITAL

"At the time of writing it seems the US Treasury has decided to teach us ALL a lesson, that they will not backstop every deal in the wave of financial sector consolidation that is upon us.

"Their motivation is part fiscal and part moral hazard. I suspect more the latter. Presumably the most important reason to teach Wall Street this lesson, is that they will change their behaviour, and not take the decisions that are reliant on a public bail-out. For many, but not all, this is an impossible lesson to learn in the middle of the worst financial storm since the Great Depression.

"Firstly, if institutions thought they were too big to fail and took unnecessary risks, those mistakes have long been made. The barn door was long left open (in part by the Fed), and this horse has long bolted. This would have been an invaluable lesson to have learned five years ago, but in the next year, it will encourage more defensive behaviour. Defensive behaviour from anyone with meaningful open exposure, whether they be financial counterparties; Joe Public scouring the FDIC rulebooks on deposit insurance; or, those exposed to particular fire sale asset classes.

"Teaching moral hazard in a crisis is inherently procyclical."

BROWN BROTHERS HARRIMAN FX STRATEGISTS

"We have argued that each major cathartic event (new lending facilities by the Fed, Bear Stearns, the Treasury announcement it would seek authority to take over Fannie and Freddie, and then when it actually did), the dollar rallied each time. This time is different.

"That may be infamous last words, but the reason it is different is that this is not a cathartic event. Lehman's demise will not make things more transparent or increase the appetite for risk. Quite on the contrary, its failure raises perceptions of risk. The fall of the house of Lehman means that others in the same situation, i.e., not posing significant systemic risk are increasingly vulnerable."

EARLIER COMMENTS

- PETER DOUGLAS, FOUNDER OF HEDGE FUND CONSULTANCY GFIA:

"The U.S. and the Fed in particular, appear to be drawing a line under public funding.

"In the near term, this will be very disturbing for markets, as the "Bernanke put" clearly applies to a finite number of entities, and not to any large institution merely by virtue of its size."

"Longer term this is very healthy as it accelerates the clearing process, and therefore the rehabilitation of the financial system."

- ROHAN WALSH, INVESTMENT MANAGER AT KARARA CAPITAL,

MELBOURNE:

"I suppose Merrill being bought might be a good thing, going to a stronger balance sheet. That's not necessarily a bad thing for the market.

"But Lehman is obviously creating uncertainty on how the counterparty risks work through, and how the derivatives exposures work through. It can't be a good thing and also the market is very worried about AIG.

"There is a number of implications and counterparties... obviously a big development and very concerning in terms of the broader impact on the financial system. It's hard to know what the implications are and what are the related exposures."

- MUHAMMAD AURANGZEB , MANAGING DIRECTOR RBS FOR

SOUTHEAST ASIA AND PAKISTAN (IN REMARKS TO REPORTERS):

"Unlike Bear Stearns, where literally things happened overnight, this has been in the news as it has been unravelling over the past few days.

"That has allowed time for the banks and for the markets to look at this risk situation, look at their respective positions which in turn gives me the hope and view that we will probably see a orderly resolution to this."

- V.ANANTHA NAGESWARAN, HEAD OF INVESTMENT RESEARCH,

ASIA-PACIFIC, BANK JULIUS BAER, SINGAPORE:

"To me the financial sector problems are a side-show. The real show is the U.S. economic slowdown and the consumer deleveraging, and that will play out for a couple of years if not longer.

"The retail sales number we saw on Friday was just the beginning."

- SEAN CALLOW, STRATEGIST, WESTPAC BANK, SYDNEY:

"The whole fresh wave of financial turmoil - Lehman, Washington Mutual, Merrill Lynch, AIG, etc - should play USD negative, especially as Feb 2009 Fed funds have rallied 20 basis points since Friday."

- CHRISTOFFER MOLTKE-LETH, HEAD OF SALES TRADING, SAXO

CAPITAL MARKETS, SINGAPORE:

"It's going to have a major effect on financials in particular, but it will spill over into all the sectors as well.

"This just confirms that we are nowhere near the end of the crisis. And it could get really ugly in the next 6 months or so cos there's a lot more to be uncovered."

KEY POINTS:

-- If Lehman and Merrill disappear or get taken over, then three of the top five U.S. investment banks would have dissolved or been bought inside six months. Bear Stearns was acquired in a fire sale by JPMorgan in March.

-- Expectations Lehman was heading into bankruptcy prompted a rare emergency trading session to allow Wall Street dealers in the $455 trillion (252.1 trillion pounds) derivatives market to reduce their exposure to the firm.

-- Bank of America said it is buying Merrill Lynch in a $50 billion all-stock transaction.

-- To help provide liquidity, the Federal Reserve said it would accept a wider array of securities as collateral at its key borrowing windows.
 

(Reporting by Vidya Ranganathan, Brenda Goh and Saeed Azhar in Singapore, Mette Fraende in Sydney; editing by Neil Fullick)

    ANALYSTS' VIEW: Lehman files for bankruptcy, R, 15.9.2008, http://www.reuters.com/article/idUKSP7519620080915

Markets in turmoil

by Lehman failure and Merrill sale

Mon Sep 15, 2008
8:34am EDT
Reuters
By Dan Wilchins and Jennifer Ablan

NEW YORK (Reuters) - Global markets plummeted on Monday after investment bank Lehman Brothers filed for bankruptcy protection, rival Merrill Lynch agreed to be taken over and the Federal Reserve threw a life line to the battered financial industry.

As a deepening crisis took new, bigger victims, The U.S. Federal Reserve said for the first time it would accept stocks in exchange for cash loans and 10 of the world's top banks agreed to establish a $70 billion emergency fund, with any one of them able to tap up to a third of that.

On a black Sunday for Wall Street, frantic attempts to find a rescuer for Lehman failed, and troubled insurer American International Group asked the Fed for a lifeline, according to news reports.

The events signal a seismic shift in Wall Street's power structure with big name investment banks biting the dust and major banks like Bank of America and JPMorgan Chase becoming the survivors.

"It's a return to pure capitalism, the survival of the fittest -- the government can't and won't bail everybody out," said Justin Urquhart Stewart, investment director at 7 Investment Management in London.

"Investors will now retreat to the trustworthy banks, though that's not a phrase that trips off the tongue easily nowadays."

Bank of America agreed to buy Merrill Lynch in an all-stock deal worth $50 billion, seeking a bargain as the world's largest retail brokerage sought refuge from fears it could be the next victim.

"It's just shockingly fast how it happened," an employee for Merrill in Asia said. "It's hard to believe there will be no more Merrill Lynch," he said of his firm, known as The Thundering Herd.

Asian and European stock markets tumbled as the worries about Lehman counterparty risk and further financial market turmoil sent investors scurrying for safe havens such as gold.

The FTSEurofirst 300 index of leading European shares fell 5 percent, led by falling bank stocks such as UBS, down 10 percent.

Shares in U.S. banks trading in Frankfurt tumbled, with Lehman plunging 80 percent and Morgan Stanley, Citigroup and others all in retreat. Frankfurt-listed shares in AIG fell almost 30 percent.

Merrill's shares offered a rare bright spot and its Frankfurt-based shares jumped 36 percent. Bank of America said it had agreed to buy Merrill in an all-share deal for the equivalent of $50 billion, or $29 a share, almost $12 a share above Friday's closing price.

Lehman said it filed for Chapter 11 bankruptcy protection and was attempting to sell assets, becoming Wall Street's highest-profile bankruptcy since junk bond specialist Drexel Burnham Lambert succumbed in 1990. Lehman's European arm appointed administrators, who said they would wind down the business in as orderly a manner as possible.

Lehman's petition followed three days of talks between bank CEOs and regulators at the Fed's fortress-like Manhattan building.

"This shows the U.S. government is saying 'enough' after saving other institutions and that they see Lehman as a private affair. I think today and tomorrow there will be a panic on the markets," said Marie-Pierre Pillon, head of equity and credit research at Groupama Asset Management in Paris.

S&P500 share futures fell more than 3 percent, signaling U.S. stocks will open sharply lower, and the dollar tumbled.

The euro jumped to as high as $1.4479, up 1.7 percent from Friday, while U.S. Treasury yields dropped to five-month lows on concern about the stability of the U.S. financial system and as investors increased bets the Fed will cut interest rates.

SHAKE-UP

With Lehman and Merrill out of the picture, three of the top five U.S. investment banks have effectively departed the scene inside six months. Bear Stearns was acquired in a fire sale by JPMorgan in March.

Britain's Barclays emerged as a front-runner to buy Lehman late on Sunday after Bank of America pulled back, but it was deterred by the U.S. government's unwillingness to provide a financial backstop to potential losses.

Lehman collapsed under the weight of toxic assets, mainly related to real estate, that are now worth only a fraction of their original prices.

In its bankruptcy filing, Lehman said Citigroup, Bank of New York Mellon, Japan's Aozora Bank and Mizuho Financial Group were among its top unsecured creditors.

The cost of insuring banks against default jumped and one credit analyst said without the positive Merrill takeover news the market could have seen "one of the most brutal days on record."

LINE IN SAND

Lehman employees streaming into its European headquarters in London's Canary Wharf financial district were met by television cameras, a swarm of reporters and a beefed-up security team.

"I guess times are tough and we've got to face the music ... Everyone is worried about their job, it's inevitable," said one banker entering the building, adding a company-wide meeting had been set for Monday morning.

Other employees said staff were clearing desks, packing personal belongings and saying farewells to colleagues.

Scores of Lehman employees began showing up at dawn at the company's New York headquarters, many dressed in casual clothes. Most were carrying duffel bags and suitcases, as if they were planning to pack up and leave.

The New York Times also reported that AIG, once the world's largest insurer, had made an approach to the Federal Reserve seeking $40 billion in short-term financing.

Authorities sought to prop up market confidence with announcements late on Sunday. The Fed said it would accept equities as collateral for emergency loans, and laid out a series of steps to calm markets and brace for Lehman's collapse.

In addition to broadening the collateral it will accept from investment banks for direct Fed loans, it said it would increase the amount of Treasury securities it auctions on a regular basis under one of its lending programs.

One of the catalysts for this weekend's events was the stance of U.S. Treasury Secretary Henry Paulson, who opposed using government money to resolve the Lehman crisis after a week earlier bailing out mortgage lenders Freddie Mac and Fannie Mae, wary of accusation of encouraging excessive risk-taking by bailing out the bank.

(Additional reporting by Steve Slater, Sitaraman Shankar, Brian Gorman, Jane Baird and Olesya Dmitracova in London; Editing by Andrew Callus and Maureen Bavdek)

        Markets in turmoil by Lehman failure and Merrill sale, R, 15.9.2008, http://www.reuters.com/article/ousiv/idUSN0927996520080915

    Crisis on Wall Street as Lehman Totters, Merrill Is Sold,

AIG Seeks to Raise Cash

WSJ        15.9.2008

http://online.wsj.com/article/SB122145492097035549.html

Crisis on Wall Street as Lehman Totters,

Merrill Is Sold, AIG Seeks to Raise Cash

Fed Will Expand Its Lending Arsenal in a Bid to Calm Markets;
Moves Cap a Momentous Weekend for American Finance

September 15, 2008
7:57 a.m.
The Wall Street Journal
By CARRICK MOLLENKAMP,
SUSANNE CRAIG, SERENA NG
and AARON LUCCHETTI


NEW YORK -- The American financial system was shaken to its core on Sunday. Lehman Brothers Holdings Inc. said it would file for bankruptcy protection, and Merrill Lynch & Co. agreed to be sold to Bank of America Corp.

The U.S. government, which bailed out Fannie Mae and Freddie Mac a week ago and orchestrated the sale of Bear Stearns Cos. to J.P. Morgan Chase & Co. in March, played much tougher with Lehman. It refused to provide a financial backstop to potential buyers. Without such support, Barclays PLC and Bank of America, the two most interested buyers, walked away. Barclays said Monday it pulled out of the potential deal after deciding it wasn't in the best interest of shareholders.

Early Monday morning, Lehman filed for protection under Chapter 11 of the U.S. Bankruptcy Code with the United States Bankruptcy Court for the Southern District of New York. Lehman said none of the broker-dealer subsidiaries or other subsidiaries of LBHI will be included in the Chapter 11 filing and all of the broker-dealers will continue to operate. Customers of Lehman Brothers, including customers of its wholly owned subsidiary, Neuberger Berman Holdings LLC, may continue to trade or take other actions with respect to their accounts, Lehman said.

On Sunday night, Bank of America struck an all-stock deal to buy Merrill Lynch for $29 a share, or $50 billion. (See related article.)

Though it steered clear of a bailout, the Federal Reserve is expected to take new steps to stabilize the broader financial system. These steps, expected to be temporary, would make it easier for banks and securities firms to borrow from the central bank by using a wider range of collateral. Bankers say these financial institutions might need short-term funds as they unwind their many trading positions with Lehman. (See related article.)

The Lehman board authorized the filing of the Chapter 11 petition in order to protect its assets and maximize value, the firm said. In conjunction with the filing, Lehman intends to file a variety of first-day motions that will allow it to continue to manage operations in the ordinary course. Those motions include requests to make wage and salary payments and continue other benefits to its employees.

Lehman said it is exploring the sale of its broker-dealer operations and, as previously announced, is in advanced discussions with a number of potential purchasers to sell its Investment Management Division. Lehman said it intends to pursue those discussions as well as a number of other strategic alternatives. Neuberger Berman LLC and Lehman Brothers Asset Management will continue to conduct business as usual and will not be subject to the bankruptcy case of the parent company, and its portfolio management, research and operating functions remain intact. In addition, fully paid securities of customers of Neuberger Berman are segregated from the assets of Lehman Brothers and aren't subject to the claims of Lehman Brothers Holdings' creditors, Lehman said.

The damage on Wall Street is the latest consequence of a storm that began last year with the sharp decline in American housing prices and losses on loans and other assets tied to home values. Massive capital infusions have failed to stem write-offs and losses, and financial firms are running out of options to escape the damage.

Regulators and others were preparing for a hectic Monday. The New York Stock Exchange prepared contingency plans over the weekend to reassign the approximately 200 blue-chip stocks that Lehman's specialist unit trades, according to people familiar with the matter. If Lehman is forced into liquidation, the exchange will likely transfer the stocks to one or more of the remaining specialist firms, most likely using the same technology and staff that currently trade the stocks.

Dozens of Wall Street desks have trades with Lehman. As word spread that the Barclays deal was falling apart, worries that the company could be thrown into bankruptcy mounted, and traders labored to get out of those contracts.

At approximately 2:30 p.m., government officials hosted a call, and a trading session was opened to ease fears. One trader said it was agreed that other brokers would pick up contracts that trading desks have with Lehman. If Lehman does open on Monday, the deals struck on Sunday, often at a worse price, would be void. "It is utter chaos here," the trader said.

At many Wall Street firms, traders of credit-default swaps -- contracts that act as insurance against debt defaults -- were told to come to work immediately. Concerned investors were rushing to buy swaps tied to other brokerages and corporations, sending the cost of protection on investment banks such as Goldman Sachs and others sharply higher.

In a statement Sunday, the International Swaps and Derivatives Association, a trade group whose members include many large dealers, said a "netting trading session" took place between 2 p.m. and 6 p.m. on Sunday. The idea was to allow firms to try to unwind their derivatives transactions with Lehman by finding other parties to step into Lehman's shoes.

"The purpose of this session is to reduce risk associated with a potential Lehman Brothers Holdings Inc. bankruptcy filing," it said. It added that trades conducted during this period "are contingent on a bankruptcy filing on or before 11:59 p.m. New York time" on Sunday. If no filing takes place, the trades will be canceled, ISDA said.


Some traders said it was difficult to find new counterparties for many of their outstanding trades with Lehman. The snags included different terms and maturity dates on derivatives contracts, and market prices changed rapidly Sunday afternoon. "People were screaming at each other over the phone, asking: How can this work?" one trader said.

William Gross, chief investment officer at bond-fund giant Pacific Investment Management Co., said very few Lehman trades were offset. "There's an immediate risk related to the unwind of these positions," he said.

Many Wall Street firms concluded that a liquidation of Lehman's assets likely would proceed in an orderly fashion, people familiar with the situation said. That means other firms could quickly buy real estate, securities and other investments, preventing the assets from flooding the market. Because of that, these people said, some participants in the New York Fed talks decided that liquidation was no worse an option than selling Lehman to a buyer such as Barclays.

"There will be an orderly wind down," said one banker involved in the matter. "This was the default option. It happens when you have no buyer."

The outside firms decided that instead of making guarantees for Barclays or some other purchaser of Lehman, they would prefer to pool their resources and buy the assets themselves, taking on the risks and carrying costs, along with the possibility of profiting down the road.

Those firms would likely then buy assets such as mortgage-backed securities, leveraged loans, private-equity positions and investments in real estate or hedge funds.

Roger Freeman, a nine-year Lehman employee who analyzes brokerage firms, spent the weekend gathering cellphone numbers and email addresses from colleagues who also are likely to lose their jobs. He plans to clean out his desk Monday morning. "We worked long hours here, we've made some of our best friends here. We're suddenly being ripped apart," he said. "It's just unbelievable."
 

--Jon Hilsenrath, Jeffrey McCracken and David Enrich contributed to this article.

    Crisis on Wall Street as Lehman Totters, Merrill Is Sold, AIG Seeks to Raise Cash, WSJ, 15.9.2008, http://online.wsj.com/article/SB122145492097035549.html

U.S. markets today:

Lehman, other worries may wreak havoc

15 September 2008
USA Today
By John Waggoner and Sue Kirchhoff,

Financial markets could be in for a wild ride Monday as they digest the meltdown of Lehman Bros., a merger of Merrill Lynch and Bank of America and efforts to bolster American International Group.

Early Monday, Lehman (LEH) announced plans to file for Chapter 11 bankruptcy protection.

"We are in a hysteria," said Richard Bove, banking analyst at Ladenburg Thalmann, prior to Lehman's announcement.

U.S. stock index futures tumbled Monday, suggesting that major Wall Street indexes were likely to slump 3% or more at the market's open. Dow Jones industrial average futures fell 372, or 3.3%, to 11,086. Standard & Poor's 500 index futures fell 48.00, or 3.81%, to 1,210.50. Nasdaq 100 index futures fell 49.25, or 2.8%, to 1,730.25.

Late Sunday night, 10 leading banks announced they had created a special $70 billion lending pool for troubled financial institutions. And the Federal Reserve announced it would make it easier for the firms to borrow from it.

Talks to find a buyer for Lehman apparently stalled Sunday as Bank of America and Barclays Bank walked away.

Early Monday, Bank of America (BAC) said it would acquire Merrill Lynch (MER) for around $50 billion. Merrill Lynch stock had fallen 12.3% to $17.05 Friday, as traders worried that Merrill could be the next firm caught in the vise of the credit crunch.

Rising mortgage defaults amid the collapse of the housing bubble left many financial firms holding billions in investments backed by bad loans. Merrill Lynch, AIG (AIG) and Lehman are just the latest victims of the credit crunch, which has also clobbered mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE), subprime lenders IndyMac Bank and Countrywide Financial, and investment bank Bear Stearns.

Lehman is an investment bank, so its bankruptcy could disrupt billions of dollars in financial transactions, spreading financial pain worldwide. Lehman account holders would be protected up to $500,000 by the Securities Investors Protection Corp.

"You don't know if the Dow will be up 300 points or down 300 points," says Richard Suttmeier, chief market strategist at ValueEngine.com. Futures on the Dow Jones industrial average fell 306 points Sunday. As Asian markets opened Monday, stocks and the dollar fell, and gold and U.S. Treasury bonds rose as investors sought safety.

Talks to buy Lehman apparently collapsed because the government refused to guarantee buyers against losses from Lehman's extensive holdings of mortgage-backed securities.

In recent months, the Fed and Treasury have taken measures aimed at buying time for the economy to recover and at reducing pressure on financial firms, including supporting an economic stimulus bill and legislation to calm the mortgage market.

A Lehman bankruptcy would be the largest financial collapse since 1990, when investment bank Drexel Burnham Lambert failed.

Government officials said the situation was not the same sort of crisis as the mid-March meltdown of Bear Stearns, when the Fed late on a Sunday evening agreed to make a $29 billion loan to facilitate the sale of that investment bank to JPMorgan Chase. (JPM)

The Wall Street Journal reported that AIG is trying to raise money to cushion its losses. The insurer is expected to announce a reorganization today and to sell some assets.

Contributing: Reuters

    U.S. markets today: Lehman, other worries may wreak havoc, UT, 15.9.2008, http://www.usatoday.com/money/markets/2008-09-15-markets-monday_N.htm

Lehman Brothers

files for Chapter 11 protection

September 15, 2008
Filed at 8:12 a.m. ET
By THE ASSOCIATED PRESS
The New York Times

NEW YORK (AP) -- Lehman Brothers has filed for bankruptcy protection under the weight of $60 billion in soured real estate holdings.

The company's filing for Chapter 11 protection will allow it to restructure while creditor claims are held at bay. The filing was made Monday in the U.S. Bankruptcy Court in the Southern Disctrict of New York.

Lehman's last hope of surviving outside of court protection faded Sunday after British bank Barclays PLC withdrew its bid to buy the investment bank.

The 158-year-old investment bank had said earlier that none of its broker-dealer subsidiaries or other units would be included in the Chapter 11 filing. It says it is exploring the sale of its broker-dealer operations and is in ''advanced discussions'' to sell its investment management unit.

    Lehman Brothers files for Chapter 11 protection, NYT, 15.9.2008, http://www.nytimes.com/aponline/business/AP-Lehman-Bankruptcy.html

http://i.usatoday.net/money/industries/banking/lehman-announcement.pdf
added 15.9.2008

Big Insurer Seeks Cash

as Portfolio Plummets

September 15, 2008
The New York Times
By MICHAEL J. de la MERCED
and GRETCHEN MORGENSON

The big insurance company, the American International Group, was seeking a $40 billion bridge loan Sunday night from the Federal Reserve, as it faces a potential downgrade from credit ratings agencies that could spell its doom, a person briefed on the matter said.

Ratings agencies threatened to downgrade the insurance giant’s credit rating by Monday morning, allowing counterparties to withdraw capital from their contracts with the company. One person close to the firm said that if such an event occurred, A.I.G. may survive for only 48 hours to 72 hours.

A.I.G.’s sickly financial health emerged late into one of the most tumultuous days in Wall Street history. The investment bank, Lehman Brothers, was expected to file for bankruptcy protection Sunday night, while Bank of America has agreed to buy Merrill Lynch for $50.03 billion.

A.I.G. has already raised $20 billion this year. But even that capital raise may not be enough.

Though this past weekend was convened to focus on Lehman, the Wall Street chieftains who gathered at the Federal Reserve Bank of New York also pondered a solution for A.I.G. The firm had become one of the biggest underwriters of complex debt securities known credit default swaps, used as insurance for a wide range of products, including the mortgage instruments that have been the bane of Wall Street for the past year and a half.

Eric Dinallo, the New York state insurance superintendent, has been deeply involved in discussions about A.I.G.’s survival, this person said.

J. C. Flowers & Company, a buyout firm focused on financial services firms, offered $8 billion for a stake in the business that would have given it an option to buy all of A.I.G. down the road. Kohlberg Kravis Roberts and TPG also said they would buy preferred shares in the insurer.

But J. C. Flowers's bid was rejected, and the other two firms withdrew at the last minute, citing anxiousness over the company's precarious financial health. K.K.R. and TPG had said they would invest only if the Fed provided a backstop to any investment they made.

A.I.G.’s extraordinary move of reaching out to the Fed for help may spur other non-investment banks to try a similar move. Companies ranging from General Electric to GMAC have been hurting badly and would desperately love the liquidity that the Fed would provide.

Yet it is not clear whether the Fed would acquiesce to A.I.G.’s request.

Before seeking a lifeline, the firm had earlier been reported to be interested in selling its aircraft leasing business, the International Lease Finance Corporation. Founded in 1973, the business has nearly 1,000 planes in its fleet. But people briefed on the matter said that unit bore special tax advantages that A.I.G. had decided would be lost on any other owner.

Investors, afraid that A.I.G. would have to absorb further write-downs in its already damaged mortgage securities and collateralized debt obligations, have driven down the company’s shares in recent days. The stock closed Friday at $12.14 a share, a decline of 46 percent for the week.

A.I.G.’s problems are not new. The company lost $13.2 billion in the first six months of 2008, largely owing to declining values in mortgage-related securities held in its investment portfolio and collateralized debt obligations it owns.

But the company’s outlook grew grimmer last week when Standard & Poor’s warned that it was considering downgrading the company’s debt as a result of further write-downs it might have to take.

As the credit storm has raged in recent months, insurance companies like A.I.G. have been better positioned than the nation’s banks and brokerage firms to weather it because accounting rules do not require insurers to mark the investments held in their long-term portfolios to market. Insurance companies like A.I.G. can hold their investments until they mature, riding out the ups and downs in the market for those assets.

But the moment it began trying to raise capital, A.I.G. had to open its books to potential investors who were likely to take a sharp pencil to the company’s portfolio values, analysts said. And with Lehman Brothers last week providing investors with a valuation for the same types of assets held by A.I.G., subprime and Alt-A mortgage securities, the investment bank’s marks can now be applied to the big insurer’s books.

As of the most recent quarter, for example, A.I.G. had $20 billion of subprime mortgages marked at 69 cents on the dollar and $24 billion in Alt-A securities valued at 67 cents on the dollar.

But Lehman officials on a conference call with investors last week said it was valuing similar subprime mortgage securities to those held by A.I.G. at 34 cents on the dollar; its mark on the Alt-A holdings was 39 cents. Those valuations suggest almost a $14 billion decline in A.I.G.’s holdings, after taxes, an amount representing 18 percent of the company’s book value.

Additional write-downs may also be required in A.I.G.’s collateralized debt obligations, which the company does mark to market because they are held in a short-term account known as available for sale. The company valued $42 billion in high-grade holdings at 75 cents on the dollar, while it marked another $16 billion in lower-rated obligations at 70 cents.

A spokesman for A.I.G., Nicholas J. Ashooh, said it was inappropriate to compare the markdowns of Lehman Brothers’ securities with those at A.I.G.

“We don’t think that’s valid, to look at somebody else’s portfolio markdowns and then infer what A.I.G.’s might be, because there’s so many variables,” Mr. Ashooh said, “what kind of risk is in the portfolio, what kind of collateral there is, and how the marks were calculated. We think we use a very thorough and conservative approach that includes third-party input and input from the rating services.”

A.I.G., which is based in New York, has also been under pressure from the derivatives contracts that its London-based financial products unit sold in connection with complex debt securities. Those contracts, called credit default swaps, acted as a type of insurance on the debt securities, making them more attractive to buyers. The swaps also gave speculators an opportunity to bet on the debt securities’ overall creditworthiness, which has declined in response to the turmoil in the housing markets.

When A.I.G.’s financial products unit sold the credit default swaps, it effectively promised to compensate buyers of the debt securities if the mortgages underlying them got into trouble. At the time, the securities were rated AAA, so it seemed at first that A.I.G. was not taking on inordinate risk.

But that picture changed as the housing crisis took hold and homeowners began to default. A.I.G. wrote down the value of its swap portfolio by $25 billion, telling investors that the markdowns did not represent a cash loss of that magnitude. It estimated possible cash payouts on the swaps of between $5 billion and $8 billion.

But because the debt securities covered by the swaps are so complex and opaque, it has been hard for investors to verify A.I.G.’s numbers on their own, and investors have grown impatient as A.I.G. reported big losses they did not expect in the last two quarters.

A.I.G. also said recently that it might have to post collateral to its swap counterparties, heightening concerns that the company would have to raise capital in tight markets. A.I.G. said in a filing with the Securities and Exchange Commission that if its own credit were downgraded one notch by Moody’s and Standard & Poor’s, its swap contracts would require it to post collateral of about $13 billion.

In addition, A.I.G. said some of the contracts gave counterparties the option to terminate their swaps, which would cost A.I.G. between $4 billion and $5 billion. A.I.G. said that it did not expect all of its counterparties to exercise that option, however.

As a result, when S.& P. announced a negative outlook for A.I.G.’s credit on Friday, investors understood the company might soon have to produce up to $18 billion

Mary Williams Walsh contributed reporting.

    Big Insurer Seeks Cash as Portfolio Plummets, NYT, 15.9.2008, http://www.nytimes.com/2008/09/15/business/15aig.html?hp

Lehman CEO Fuld's hubris

contributed to meltdown

Sun Sep 14, 2008
7:45pm EDT
Reuters
By Christian Plumb and Dan Wilchins - Analysis

NEW YORK (Reuters) - Not long ago, when Lehman Brothers CEO Richard Fuld talked about "everyone's worst nightmare" he was referring to a massive fraud at French bank Societe Generale.

Just a few months later Fuld, a 30-year-veteran of Lehman who had ably steered it through near-death experiences like the Asian debt crisis of 1998, is living his own worst nightmare as the venerable investment bank stands on the verge of collapse.

How the 158-year-year institution came to this is a tale of hubris and overreaching -- and a big dose of bad luck.

Lehman's fall from grace was brutally fast. Until June, it had never even reported a quarterly loss as a public company.

As recently as March, Fuld was awarded a $22 million bonus for 2007 -- a generous pay package to be sure, but one that also reflected a year in which the bank's net profit had risen 5 percent to a record $4.2 billion.

But Lehman soon emerged as Wall Street's next domino as real estate loans and other toxic assets increasingly weighed on its balance sheet, especially after the collapse of Bear Stearns Cos Inc in March.

Still, few were willing to second-guess its 62-year-old chief executive.

"Fuld went wrong in not taking seriously enough the impairment of his balance sheet," said Charles Peabody, analyst at independent research firm Portales Partners.

"He had the typical hubris that any long-term CEO has: 'I built this thing, and it's got more value than the marketplace understands.'"

As the credit crisis worsened, Fuld was Wall Street's one seemingly teflon chief executive, keeping his job unchallenged even as CEOs fell at rivals like Bear, Merrill Lynch Cos Inc and Citigroup and as Fuld's own underlings including Chief Financial Officer Erin Callan were pushed out.

Lehman's board, which includes retired CEOs like Vodafone's Christopher Gent and IBM's John Akers, may have been too slow to challenge Fuld -- a former competitive squash player -- as its share price spiraled lower.

GORILLA

As recently as June, rival CEOs like Lazard's Bruce Wasserstein were still professing confidence in Fuld, nicknamed "The Gorilla" for his intimidating presence.

Fuld had endured in-fighting that led to the firm's sale to Shearson/American Express in 1984 and was running the firm when it was spun off in 1994.

This time, though, he was no match for the implosion of the mortgage boom on which he had staked the firm's fortunes.

Lehman, until recently Wall Street's fourth-largest investment bank, for years did a big business in originating mortgages, re-packaging them and selling them onto other investors.

Lehman was the top U.S. underwriter of mortgage bonds in 2007 and 2006, grabbing about 10 percent of the market.

But as the U.S. housing market went from boom to bust, it ended up being unable to unload many of the most toxic loans.

"Dick went wrong three to four years ago when Lehman bought these assets, now he's paying the price," said Ralph Cole, portfolio manager at Ferguson Wellman Capital Management in Portland, Oregon.

"I don't think he knew when he was investing in mortgages where this could lead, and how important confidence is."

At key junctures Fuld seems to have played a game of brinksmanship, refusing to accept offers that could have rescued the firm because they didn't reflect the value he saw in the bank.

As recently as August, Fuld may have had a chance to sell a 25 percent stake in Lehman for $4 billion to $6 billion to state-run Korea Development Bank, but by some accounts he balked, saying the offer was too low, the Wall Street Journal has reported.

Differences over price also thwarted talks to sell up to half of Lehman shares to China's CITIC Securities in August, the Financial Times reported.

"Dick Fuld really blew it," said William Smith, chief executive officer of Smith Asset Management in New York. "How many opportunities did he have to sell Lehman?"

"There's a possibility this stock could zero out," Smith said. "It happened under his watch."

(Reporting by Christian Plumb and Dan Wilchins; Editing by Ted Kerr)

    Lehman CEO Fuld's hubris contributed to meltdown, R, 14.9.2008, http://www.reuters.com/article/wtMostRead/idUSN1341059120080914

TIMELINE:

U.S. financial rescues,

failures in last century

Sun Sep 14, 2008
6:30pm EDT
Reuters

(Reuters) - The Federal Reserve and Treasury Department once again led marathon weekend talks in an effort to resolve a crisis at a major financial institution, this time Wall Street investment bank Lehman Brothers, crippled by toxic real estate assets and a collapsing share price.

The federal government has a long history of involvement with financial institution rescues. Following is a chronology of key events over the last century.

PANIC OF 1907

In October 1907, a run on the Knickerbocker Trust Co after it failed in its effort to corner the market in shares of United Copper Co caused a panic on Wall Street. Banks called loans and stock prices plummeted, threatening several major banks with failure. The calming influence came not from the Fed, which did not exist, but from banker John Pierpont Morgan, who organized a consortium of bankers to provide funds to prop up banks and buy up stocks. They were joined by Treasury Secretary George Cortelyou, who brought in $35 million in federal funds. The episode led to creation of the Federal Reserve System in 1914 to add stability to the banking system.

GREAT DEPRESSION, 1930s

Some 9,000 U.S. banks failed during the Great Depression after a stock market collapse triggered a severe restriction of credit, massive loan failures and "runs" by depositors to withdraw their funds. President Franklin Delano Roosevelt's first act after his 1933 inauguration was to declare a three-day bank holiday to cool things off. He later signed into law the Glass-Steagall Act, creating the Federal Deposit Insurance Corp, to restore depositors' confidence in banks. The act also separated the operations of commercial banks and investment banks to reduce chances for another stock market bubble. Roosevelt also created the Federal Housing Administration and Fannie Mae to stabilize the housing sector and provide liquidity to the mortgage market.

COMMONWEALTH BANK OF DETROIT, 1972

Commonwealth Bank of Detroit was the first bank with more than $1 billion in assets to be bailed out. The bank was considered essential to Detroit's inner city, so the Federal Deposit Insurance Corp provided $35.5 million in loans. It was never paid back.

FIRST PENNSYLVANIA, 1980

Established in 1782 as one of the first U.S. private banks, First Penn was among many banks in the 1970s made insolvent by high deposit interest rates that outstripped earnings from lower-yielding assets. It was the first large-scale bailout by the FDIC, which provided a $325 million five-year subordinated note that allowed First Penn to sell off government securities and reduce its interest drain. The FDIC made its money back, without interest.

CONTINENTAL ILLINOIS, 1984

Once the seventh-largest U.S. bank, Chicago-based Continental Illinois National Bank and Trust Co. was deemed "too big to fail" and remains the largest commercial bank taken over by the Fed and FDIC. The $40 billion-asset bank became insolvent due largely to bad oil and gas exploration loans purchased from the failed Penn Square Bank of Oklahoma, some of which led to criminal fraud charges against lending officers.

The FDIC injected $4.5 billion to rescue the bank and buy bad loans. The federal government held an 80 percent stake in the bank until 1994, when it was sold to Bank of America.

SAVINGS AND LOAN CRISIS, 1980s-90s

From 1986 to 1989, the Federal Savings and Loan Insurance Corp closed or assisted 296 institutions hit by unsound real estate and commercial loans. More than 740 institutions were later closed or consolidated by the Resolution Trust Corp, a federal agency created to take over and liquidate their assets, often for pennies on the dollar.

The largest of these was the American Savings and Loan Association of Stockton, California, which had about $30 billion in assets and received a $250 million injection from the Federal Home Loan Bank Board in 1988.

The FDIC estimates that resolution of the S&L crisis cost a total of $153 billion, with taxpayers footing $124 billion of the bill. Other estimates of the cost, including those from lawmakers, have been as high as $300 billion.

LONG-TERM CAPITAL MANAGEMENT, 1998

Massive losses by U.S.-based hedge fund Long-Term Capital Management due to Russian government bond defaults in 1998 panicked markets around the world. U.S. Treasury Secretary Robert Rubin and the Federal Reserve organized a $3.625 billion bailout with funds provided by major creditors. Bear Stearns was among the creditors that declined to participate.

BEAR STEARNS, March 16, 2008

Hard-hit by its heavy exposure to the faltering U.S. mortgage market, Bear Stearns teetered close to collapse after an acute cash shortage caused its trading partners to lose confidence in the firm. But the Federal Reserve and Treasury brokered a weekend deal for JPMorgan Chase & Co. to buy Bear Stearns at a rock-bottom price, with the Fed agreeing to guarantee $29 billion in Bear Stearns assets taken on by JPMorgan. The first brokerage rescue since the Great Depression was done to avert a feared market meltdown and was accompanied by a new Fed lending facility for so-called primary dealers.

INDYMAC, JULY 11, 2008

Federal regulators seized control of Pasadena, California-based IndyMac Bank, the ninth-largest U.S. mortgage lender, after a massive run on deposits and mounting loan defaults. The bank, which had $32 billion in assets and once specialized in "Alt-A" home loans that often did not require borrowers to fully document income or assets, also faced losses on mortgages it could not sell into tight capital markets. The IndyMac failure, the largest this year and the third largest commercial bank failure ever, was expected to cost the FDIC about $8.9 billion from its $52.8 billion insurance fund.

FANNIE MAE, FREDDIE MAC, SEPT. 7, 2008

The government seized control of mortgage finance institutions Fannie Mae and Freddie Mac to stabilize them after massive falls in their share price made it impossible for them to raise needed capital to sustain mounting mortgage losses. The Treasury's move to put the government-sponsored enterprises into conservatorship and inject up to $100 billion into each gave their debt and mortgage-backed securities a full U.S. government guarantee. It was aimed at restoring investor confidence in the firms and keeping funds flowing into the mortgage market to help stem the collapse of the U.S. housing market.

(Reporting by David Lawder; Editing by Andrea Ricci)

    TIMELINE: U.S. financial rescues, failures in last century, R, 14.9.2008, http://www.reuters.com/article/idUSN1445176620080914

U.S. Arms Sales Climbing Rapidly

September 14, 2008
The New York Times
By ERIC LIPTON

WASHINGTON — The Bush administration is pushing through a broad array of foreign weapons deals as it seeks to rearm Iraq and Afghanistan, contain North Korea and Iran, and solidify ties with onetime Russian allies.

From tanks, helicopters and fighter jets to missiles, remotely piloted aircraft and even warships, the Department of Defense has agreed so far this fiscal year to sell or transfer more than $32 billion in weapons and other military equipment to foreign governments, compared with $12 billion in 2005.

The trend, which started in 2006, is most pronounced in the Middle East, but it reaches into northern Africa, Asia, Latin America, Europe and even Canada, through dozens of deals that senior Bush administration officials say they are confident will both tighten military alliances and combat terrorism.

“This is not about being gunrunners,” said Bruce S. Lemkin, the Air Force deputy under secretary who is helping to coordinate many of the biggest sales. “This is about building a more secure world.”

The surging American arms sales reflect the foreign policy tides, including the wars in Iraq and Afghanistan and the broader campaign against international terrorism, that have dominated the Bush administration. Deliveries on orders now being placed will continue for several years, perhaps as one of President Bush’s most lasting legacies.

The United States is far from the only country pushing sophisticated weapons systems: it is facing intense competition from Russia and elsewhere in Europe, including continuing contests for multibillion-dollar deals to sell fighter jets to India and Brazil.


In that booming market, American military contractors are working closely with the Pentagon, which acts as a broker and procures arms for foreign customers through its Foreign Military Sales program.

Less sophisticated weapons, and services to maintain these weapons systems, are often bought directly by foreign governments. That category of direct commercial sales has seen an enormous surge as well, as measured by export licenses issued this fiscal year covering an estimated $96 billion, up from $58 billion in 2005, according to the State Department, which must approve the licenses.

About 60 countries get annual military aid from the United States, $4.5 billion a year, to help them buy American weapons. Israel and Egypt receive more than 80 percent of that aid. The United States has also recently given Iraq and Afghanistan large amounts of weapons and other equipment and has begun to train fledgling military units at no charge; this assistance is included in the tally of foreign sales. But most arms exports are paid for by the purchasers without United States financing.

The growing tally of international weapon deals, which started to surge in 2006, is now provoking questions among some advocates of arms control and some members of Congress.

“Sure, this is a quick and easy way to cement alliances,” said William D. Hartung, an arms control specialist at the New America Foundation, a public policy institute. “But this is getting out of hand.”

Congress is notified before major arms sales deals are completed between foreign governments and the Pentagon. While lawmakers have the power to object formally and block any individual sale, they rarely use it.

Representative Howard L. Berman of California, chairman of the House Committee on Foreign Affairs, said he supported many of the individual weapons sales, like helping Iraq build the capacity to defend itself, but he worried that the sales blitz could have some negative effects. “This could turn into a spiraling arms race that in the end could decrease stability,” he said.

The United States has long been the top arms supplier to the world. In the past several years, however, the list of nations that rely on the United States as a primary source of major weapons systems has greatly expanded. Among the recent additions are Argentina, Azerbaijan, Brazil, Georgia, India, Iraq, Morocco and Pakistan, according to sales data through the end of last month provided by the Department of Defense. Cumulatively, these countries signed $870 million worth of arms deals with the United States from 2001 to 2004. For the past four fiscal years, that total has been $13.8 billion.

In many cases, these sales represent a cultural shift, as nations like Romania, Poland and Morocco, which have long relied on Russian-made MIG-17 fighter jets, are now buying new F-16s, built by Lockheed Martin.

At Lockheed Martin, one of the largest American military contractors, international sales last year brought in about $6.3 billion, or 15 percent of the company’s total sales, up from $4.8 billion in 2001. The foreign sales by Lockheed and other American military contractors are credited with helping keep alive some production lines, like those of the F-16 fighter jet and Boeing’s C-17 transport plane.

Fighter jets made in America will now be flying in other countries for years to come, meaning continued profits for American contractors that maintain them, and in many cases regular interaction between the United States military and foreign air forces, Mr. Lemkin, the Air Force official, said.

Sales are also being driven by the push by many foreign nations to join the once-exclusive club of countries whose arsenals include precise, laser-guided missiles, high-priced American technology that the United States displayed during its invasions of Iraq and Afghanistan.

In the Persian Gulf region, much of the rearmament is driven by fears of Iran.

The United Arab Emirates, for example, are considering spending as much as $16 billion on American-made missile defense systems, according to recent notifications sent to Congress by the Department of Defense.

The Emirates also have announced an intention to order offensive weapons, including up to 26 Black Hawk helicopters and 900 Longbow Hellfire II missiles, which can knock out enemy tanks.

Saudi Arabia, this fiscal year alone, has signed at least $6 billion worth of agreements to buy weapons from the United States government — the highest figure for that country since 1993, which was another peak year in American weapons sales, after the first Persian Gulf war.

Israel, long a major buyer of United States military equipment, is also increasing its orders, including planned purchases of perhaps as many as four American-made coastal warships, worth $1.9 billion.

In Asia, as North Korea has conducted tests of a long-range missile, American allies have been buying more United States equipment. One ally, South Korea, has signed sales agreements with the Pentagon this year worth $1.1 billion.

So far, the value of foreign arms deliveries completed by the United States has increased only modestly, reaching $13 billion last year compared with an average of $12 billion over the previous three years. Because complex weapons systems take a long time to produce, it is expected that the increase in sales agreements will result in much greater arms deliveries in the coming years. (All dollar amounts for previous years cited in this article have been adjusted to reflect the impact of inflation.)

The flood of sophisticated American military equipment pouring into the Middle East has evoked concern among some members of Congress, who fear that the Bush administration may be compromising the military edge Israel has long maintained in the region.

Not surprisingly, two of the biggest new American arms customers are Iraq and Afghanistan.

Just in the past two years, Iraq has signed more than $3 billion of sales agreements — and announced plans to buy perhaps as much as $7 billion more in American equipment, financed by its rising oil revenues.

Lt. Col. Almarah Belk, a Pentagon spokeswoman, said that making these sales served the interests of both Iraq and the United States because “it reduces the risk of corruption and assists the Iraqis in getting around bottlenecks in their acquisition processes.”

Over the past three years, the United States government, separately, has agreed to buy more than $10 billion in military equipment and weapons on behalf of Afghanistan, according to Defense Department records, including M-16 rifles and C-27 military transport aircraft.

Even tiny countries like Estonia and Latvia are getting into the mix, playing a part in a collaborative effort by 15 countries, mostly in Europe, to buy two C-17 Boeing transport planes, which are used in moving military supplies as well as conducting relief missions.

Boeing has delivered 176 of these $200 million planes to the United States. But until 2006, Britain was the only foreign country that flew them. Now, in addition to the European consortium, Canada, Australia and Qatar have put in orders, and Boeing is competing to sell the plane to six other countries, said Tommy Dunehew, Boeing’s C-17 international sales manager.

In the last year, foreign sales have made up nearly half of the production at the California plant where C-17s are made. “It has been filling up the factory in the last couple of years,” Mr. Dunehew said.

Even before this new round of sales got under way, the United States’ share of the world arms trade was rising, from 40 percent of arms deliveries in 2000 to nearly 52 percent in 2006, the latest year for which the Congressional Research Service has compiled data. The next-largest seller was Russia, which in 2006 accounted for 21 percent of global deliveries.

Representative Berman, who sponsored a bill passed in May to overhaul the arms export process, said American military sales, while often well intended, were sometimes misguided. He cited military sales to Pakistan, which he said he feared were doing more to stoke tensions with India than combat terrorism in the region.

Travis Sharp, a military policy analyst at the Center for Arms Control and Nonproliferation, a Washington research group, said one of his biggest worries was that if alliances shifted, the United States might eventually be in combat against an enemy equipped with American-made weapons. Arms sales have had unintended consequences before, as when the United States armed militants fighting the Soviets in Afghanistan, only to eventually confront hostile Taliban fighters armed with the same weapons there.

“Once you sell arms to another country, you lose control over how they are used,” Mr. Sharp said. “And the weapons, unfortunately, don’t have an expiration date.”

But Mr. Lemkin, of the Pentagon, said that with so many nations now willing to sell advanced weapons systems, the United States could not afford to be too restrictive in its own sales.

“Would you rather they bought the weapons and aircraft from other countries?” he said. “Because they will.”

    U.S. Arms Sales Climbing Rapidly, NYT, 14.9.2008, http://www.nytimes.com/2008/09/14/washington/14arms.html?hp

Wall St. Goliath Teeters

Amid Fear of Wider Crisis

September 14, 2008
The New York Times
By VIKAS BAJAJ

Fearing that Lehman Brothers is only days away from collapse, government officials and senior Wall Street executives met on Saturday to try to arrest a downward spiral that might imperil other financial institutions.

For a second day, the group convened at the Federal Reserve Bank of New York in Lower Manhattan, but the situation remained fluid, and the talks were set to resume on Sunday morning .

Adding urgency to the meeting were growing concerns that other big financial institutions like the insurance giant American International Group and the nation’s largest brokerage firm, Merrill Lynch, might face a similar crisis and also need billions of dollars in capital to strengthen their businesses. The group discussed the financial condition of other firms beyond Lehman and the overall state of the markets.

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 storied companies that were widely viewed as unassailable until recently.

In fact, Lehman and other companies have said for months that they had a handle on their troubled assets tied to real estate. But their share prices have continued to sink. As a result, many investors are no longer sure what these financial companies are worth, and they do not want to invest in them until they do. At the same time, many hedge fund managers and other traders have profited handsomely from bets that these stocks would fall in value.

Companies that took the biggest risks and used debt aggressively to build their businesses were the first to stumble as the credit market began to sink, and now healthier companies are coming under pressure. Loans that were considered far better than the subprime mortgages, which kicked off the panic, turned out to be only marginally safer.

“You have to think of this like there is an epidemic going on — an epidemic of capital destruction,” said James L. Melcher, president of the hedge fund Balestra Capital, who has been bearish on the stock market.

The federal government has taken an unusually activist role in the ongoing crisis. This spring, the Federal Reserve arranged a hasty rescue of Bear Stearns, the wobbly investment bank. Then last week, federal regulators took over the country’s two largest mortgage finance companies.

At every turn, officials hoped that they had done what was needed to restore confidence in the markets, only to be greeted with another crisis.

Policy makers have signaled that they are not willing to provide financial support for a takeover of Lehman, as they did with Bear Stearns. Unlike Bear Stearns, which lost many clients and its access to money markets in just a few days, Lehman has been able to finance its business, especially after investment banks were allowed to borrow directly from the Fed. But the quality of the securities it owns are still in question.

The Fed and Treasury continue to insist that Wall Street firms find a way to rescue Lehman because their own companies might be next. But the Lehman crisis comes at a time when many of them are also short on capital. Entities that do have cash ready to invest, namely private equity firms, are not at the table.

That is because regulators do not want those firms, which borrow money to buy companies, controlling major financial institutions that provide the financing for their acquisitions. Many foreign investors, for their part, are reluctant to buy now after having seen earlier investments drop sharply in value.

The decision by policy makers sets up a crucial test for the financial system: Can the market resolve the panic by pairing Lehman with a willing and strong suitor, or will the company be forced to liquidate?

Whatever the outcome, there is a growing consensus on Wall Street that the government may not be able to save every big firm whose failure would pose a risk to the system.

“The too-big-to-fail mantra or concept or government policy is, in my opinion, off the table and we have to deal with that,” said David H. Ellison, president and chief investment officer at FBR Funds, a mutual fund company. “They are not going to save these companies.”

Analysts say many financial companies, including the insurer A.I.G., need to raise capital. But every time their stock prices fall, raising capital becomes harder. And when that happens, bondholders and credit rating companies start worrying too. Stock prices fall even further — and the whole cycle repeats again.

On Friday afternoon, for example, Standard & Poor’s warned that it might lower A.I.G.’s credit rating because the drop in the company’s share price — 45.7 percent last week alone — could make it even harder for the company to raise capital.

That partly explains why markets in general, and financial shares in particular, are gyrating ever more wildly. Even after the Bush administration took control of the mortgage finance giants Fannie Mae and Freddie Mac last week, a step many thought might calm investors, trading remained volatile.

“Investors are like hyperactive first graders playing musical chairs,” said Sam Stovall, chief investment strategist at Standard & Poor’s Equity Research.

The government, for all its activism, has been unable to stabilize the markets for long — though policy makers would argue that their interventions have prevented failures from cascading through the financial system.

After the Federal Reserve arranged the emergency sale of Bear Stearns to JPMorgan Chase in March, the stock market rallied and many strategists and executives on Wall Street declared that the deal was a turning point.

Stocks also rallied on Monday after the Treasury Department and federal regulators took over Fannie Mae and Freddie Mac, only to sink the next day as investors grew more concerned about Lehman, A.I.G. and Washington Mutual, the nation’s biggest savings and loan.

Downturns are typically more volatile than the booms that precede them, strategists say. Investors try to anticipate the recovery, though the actual turning point is often visible only in hindsight. But after a lot of bad news, some investors usually dive in, believing that the markets have reached a cathartic, cleansing moment.

“There are lots of investors that don’t want to miss the absolute bottom,” said Allen Sinai, a former chief economist at Lehman Brothers who now has his own research firm, Decision Economics. “Unless you are a professional trader, and even then, it’s a very dangerous philosophy.”

Many of the fundamental forces in the economy remain worrying. Home prices are still falling, though their rate of decline appears to have slowed in recent months. Defaults on all kinds of loans are rising. In the broader economy, the unemployment rate is rising and consumer spending has been faltering.

The losses created by rising defaults have impaired the ability and confidence of banks to lend to one another and to consumers. As financial institutions rein in risk-taking to protect themselves and preserve their dwindling capital, interest rates go up, lending standards tighten and credit lines are capped or severed.

“Every time there is another problem, it causes lenders to become that much more conservative, which then puts the squeeze on someone else,” said David A. Levy, the chairman of the Jerome Levy Forecasting Center, a research firm in Mount Kisco, N.Y.

Many analysts believe that for the downward spiral to be broken, home prices must fall to a level that can be supported by factors like household income that have traditionally had a strong relationship to prices. Also, the government has to determine how it will restructure Fannie Mae and Freddie Mac, which own or guarantee half of the nation’s home loans, said Thomas F. Cooley dean of the Stern School of Business at New York University.

“We have to hit the bottom in housing prices,” he said, “and we have to just sort out how housing will be financed in future.”

Jenny Anderson contributed reporting.

    Wall St. Goliath Teeters Amid Fear of Wider Crisis, NYT, 14.9.2008, http://www.nytimes.com/2008/09/14/business/14spiral.html?hp

Sweet Dreams in Hard Times

Add to Lottery Sales

September 13, 2008
The New York Times
By KATIE ZEZIMA

When gasoline prices shot up this year, Peggy Seemann thought about saving the $10 she spends weekly on lottery tickets.

But the prospect that the $10 could become $100 million or more was too appealing. So rather than stop buying Mega Millions tickets, Ms. Seemann, 50, who lives in suburban Chicago and works in advertising sales for a financial Web site, saved money instead by packing her lunch a few days a week, keeping alive her dreams of hitting a jackpot and retiring as a multimillionaire.

“With companies tightening and not giving cost-of-living increases, you have to try to make money elsewhere,” she said, though conceding, “It might be convoluted logic.”

Many state lotteries across the country are experiencing record sales, driven in part by intense marketing but also by people like Ms. Seemann who are trying to turn a lottery ticket into a ticket out of hard times.

“When people view themselves as doing worse financially, then that motivates them to purchase lottery tickets,” said Emily Haisley, a postdoctoral associate at the Yale School of Management who in July published a research paper on lotteries in The Journal of Behavioral Decision Making. “People look to the lottery to get back to where they were financially.”

Of the 42 states with lotteries, at least 29 reported increased sales in their most recent fiscal year. And of those 29, at least 22, including New York, New Jersey and Connecticut, set sales records. Further, sales in some states are on a pace to finish higher still in the current year.

“I was surprised, because I thought with gas prices up and people not leaving the pump to go into the stores, we’d see a greater impact” on the downside, said Jodie Winnett, acting superintendent of the Illinois Lottery, whose sales increased 3 percent in the last fiscal year and are doing even better this year.

Others are not at all surprised.

Rebecca Hargrove, president of the Tennessee Lottery, said that in her 25 years working in lotteries, “I’ve noticed that if there’s a recession or a downturn in the economy, people cut back: it might be on the new car, the new house or the new fridge.”

“But the average player spends $3 to $5 a week on lottery tickets,” Ms. Hargrove said, “and it’s a pretty benign purchase.”

John Mikesell, a professor of public finance and policy analysis at Indiana University, published a study in 1994 showing that from 1983 to 1991, lottery sales tended to rise with unemployment rates.

“The findings were that in slump periods, lotteries historically have gotten a little bump upward,” said Professor Mikesell, who has not analyzed recent lottery data. “It’s taking a shot at getting some relief in hard times. It’s usually not a good gamble, but it’s a dollar, and if they happen to accidentally hit it, it may well change their lives.”

To be sure, other factors as well are pushing lottery sales. Lottery directors have spent the last few years heavily marketing their products through greater presence in stores, new games and partnerships with sports teams and television shows.

Among their new offerings are $20 and $50 scratch-off tickets that provide higher payouts, as well as additional fast-paced electronic games, part of the goal being to draw players who might otherwise head to a casino. Indeed, New York State’s 10 percent increase in lottery sales in the last fiscal year was due largely to the introduction of more video lottery terminals.

“We’re going after discretionary entertainment dollars,” said Anne M. Noble, president of the Connecticut Lottery, whose sales increase last year was 4.3 percent. “Let’s keep it fresh, keep it fun, encourage people to play in moderation and use the money they do have.”

In Massachusetts, where the per-capita sales volume last year was $707, the highest in the country, officials rolled out a $20 instant-win ticket in September, partly in hopes of appealing to gamblers who might be tempted to go to one of the two casinos in neighboring Connecticut.

It seems to have worked. Thanks in part to the introduction of the ticket, the Massachusetts Lottery achieved a record $4.7 billion in sales for the 12 months ended June 30, compared with $4.4 billion for the year before, and sales have continued to rise in the two months since the end of the fiscal year.

Drawing those casino players to the lotteries has been crucial. Though experts say casino gambling and lotteries have both been historically recession-proof, high gasoline and food prices have contributed to a revenue decline experienced this year by gambling destinations including Las Vegas and Atlantic City. (Atlantic City did record a slight rise in August.)

“The lotteries are on every street corner, and you do have to travel a bit to get to a casino as a general rule,” said John Kindt, a professor of business administration at the University of Illinois who has studied lotteries. “The accessibility of the lotteries is a plus for them. They’re in everybody’s backyard.”

The higher sales of the current economic downturn have generally drawn higher net revenue along with them, in continuation of a longer trend. A study issued in June by the Rockefeller Institute of Government, a research arm of the State University of New York, found that lottery revenue had grown steadily over the last 10 years, with the highest growth rates during the nation’s last recession, in 2001-2.

Increased lottery returns do little to offset declines in larger sources of revenue, like sales and income taxes, that have forced some states to impose hiring freezes, layoffs and wage reductions during the current downturn. “If your personal income tax is weak or sales tax is weak, the lottery isn’t enough to make up for that,” said Scott D. Pattison, executive director of the National Association of State Budget Officers. “But any revenue that is doing well, or at least not too bad, certainly helps.”

Somewhat incongruously, there is a thought that the hard times contributing to the lottery sales boom may well bring about its demise: if the economic slump continues, or even deepens, the thinking goes, many players may at last have had enough.

No one can know, of course, whether that reversal will be fully realized. But a survey of regular players by Independent Lottery Research, a consulting firm based in Chicago, found last month that 20 percent of them were already playing less or buying less expensive tickets.

So lottery directors are girding for the possibility of their own hard times, and that means staying innovative. To keep players buying, Buddy W. Roogow, director of the Maryland Lottery, is partnering with sports teams — a winning player may get tickets to a home-team game, for instance, rather than cash — and has introduced a simulated-racetrack game. “We have a challenge ahead of us,” Mr. Roogow said.

For now, anyway, Sheyda Belli, 38, a human resources director in Aliquippa, Pa., continues playing the lottery, though she and her husband tightened their belts by canceling their summer vacation and cutting back on all manner of other expenses, including cable television and eating out.

“I always joke with my husband that I’m a winner,” Ms Belli said, “until they tell me I’m not.”

The other day Lou Mott, who owns a convenience store in Aliquippa, a town that has struggled since its steel mills closed in the 1980s, sold tickets to about 40 people in the 45 minutes before the state lottery numbers were broadcast. Most spent $10 or more each.

Though Mr. Mott shakes his head in bewilderment at some of his repeat customers, including one retired woman who spends up to several hundred dollars a day on scratch-off tickets, he understands the motivation.

“I guess everyone is looking for a rainbow,” he said.

Catrin Einhorn contributed reporting from Chicago, and Sean D. Hamill from Pittsburgh.

    Sweet Dreams in Hard Times Add to Lottery Sales, NYT, 13.9.2008, http://www.nytimes.com/2008/09/13/us/13lottery.html?hp

U.S. Holds the Whip Hand

in Modifying Mortgages

September 13, 2008
The New York Times
By VIKAS BAJAJ

For much of the last year, Washington officials have been pressing the mortgage industry to modify home loans and avoid foreclosures. Now, the extraordinary government intervention in Fannie Mae, Freddie Mac and a growing number of banks puts federal agencies in the powerful, and awkward, position of deciding which borrowers will receive help and who will lose their home.

And while the Bush administration is leaving it to the next president to decide how the mortgage finance companies will operate further out, the actions taken by their conservators now will have an immediate influence on the cost to taxpayers — and to the economy — of stabilizing the nation’s fragile housing market.

Regulators are walking a fine line between protecting the government from losses and helping struggling homeowners and the broader economy, according to financial and political analysts. If officials modify too many home loans or the companies suffer high defaults on modified loans, taxpayers will be stuck with an inflated bill. But doing too little might prolong housing market problems.

“You are trying to strike the balance between the duty to protect the assets of the organization,” said Alex J. Pollock, a senior fellow at the American Enterprise Institute, “and the sensible policy of trying to control the downward momentum of the housing bust.”

Politics will also play a role as the November presidential election draws closer, not least because the rescue plan engineered by Treasury Secretary Henry M. Paulson Jr. defers important decisions about the companies’ missions for the next president and Congress. Both presidential campaigns have supported the takeover of the companies, but they differ significantly on what should be done with them in the future.

For now, the federal budget will not include Fannie’s and Freddie’s liabilities, the Office of Management and Budget said on Friday. Including the debts on the government’s books would have doubled the national debt.

On Thursday, four Democratic senators called on the Federal Housing Finance Agency, the regulator now in charge of Fannie Mae and Freddie Mac, to give some breathing room to defaulting borrowers by imposing a three-month moratorium on new foreclosures for loans owned by the companies. The Bush administration opposed calls for a similar moratorium by Senator Hillary Rodham Clinton earlier this year.

Mr. Paulson later persuaded some big lenders to give delinquent borrowers an extra month to negotiate modification or repayment plans before seeking foreclosure. As they prepare to go large-scale, regulators have been keeping an eye on how the Federal Deposit Insurance Corporation, which oversees failed banks, does things. The agency has taken several steps to make it easier for struggling borrowers to repay their mortgages and stay in their homes.

Last month, it began offering 25,000 customers of IndyMac Bank — which became one of the largest failed financial institutions in American history — lower-priced, fixed-rate loans if the borrower could afford to make payments. It offered to trim interest rates on loans to as little as 3 percent in some cases, and gave a number of borrowers up to 40 years for repayment.

Sheila C. Bair, the chairman, has been one of the most vocal proponents of wide-scale loan modifications since last year, when defaults on mortgages started rising sharply. A spokesman for Ms. Bair, Andrew Gray, said the efforts were still in the early stages, but the F.D.I.C. had been pleased with the results so far.

But the challenges for Fannie Mae, Freddie Mac and their regulators are on a different plane. How the Federal Housing Finance Agency decides to approach loan modification will have ripple effects through the economy, because the two companies together own or guarantee nearly half of all loans outstanding.

The director of the F.H.F.A., James B. Lockhart, has said he wants the two companies to be “creative and aggressive” in modifying loans, but he has not offered or endorsed any specific plans since he took their reins.

For the moment, only a small faction of loans controlled by the companies are delinquent or in foreclosure. But defaults have been rising fast, especially among a category of loans known as Alt-A, which are riskier than conventional prime loans. Many of these did not require borrowers to provide proof of their incomes and assets.

Before the government seized them, Fannie Mae and Freddie Mac had already advanced their efforts to modify loans. In July, the companies said they would pay the mortgage servicing companies that deal with borrowers on their behalf a double bonus to help arrange loan modifications. Fannie Mae has also been making personal loans to help borrowers with temporary financial problems catch up with past-due payments.

The government has, of course, overseen large programs for delinquent mortgages before. In the banking crisis that struck the economy in 1980, the F.D.I.C. and later the Resolution Trust Corporation took over many failed banks and savings and loans. But that is where the comparison ends: most of the problems then were concentrated among a relatively small number of commercial mortgages. It will be harder to deal with millions of home loans, said William M. Isaac, a former chairman of the F.D.I.C.

“When I make a judgment about commercial loans,” Mr. Isaac said, “it’s just a handful of commercial loans.” He says he believes the government will need to impose general rules and monitor how mortgage companies apply them to borrowers.

To make matters worse, a large number of mortgages made during the recent housing boom are unsalvageable because borrowers cannot afford even the terms of modified loans. Many of these will default yet again after they are altered, said Bert Ely, a financial consultant who has been critical of the F.D.I.C. modification plan.

“If you do a bunch of mass modifications with borrowers who still can’t handle the modified loans for any number of reasons, all you have done is rolled the foreclosure into the future,” Mr. Ely said.

    U.S. Holds the Whip Hand in Modifying Mortgages, NYT, 13.9.2008, http://www.nytimes.com/2008/09/13/business/13fannie.html

U.S. Gives Banks

Urgent Warning to Solve Crisis

September 13, 2008
The New York Times
By ERIC DASH

This article was reported by Jenny Anderson, Edmund L. Andrews, Vikas Bajaj and Eric Dash and written by Mr. Dash.

As Lehman Brothers teetered Friday evening, Federal Reserve officials summoned the heads of major Wall Street firms to a meeting in lower Manhattan and insisted they rescue of the stricken investment bank and develop plans to stabilize the financial markets.

Timothy F. Geithner, the president of the New York Federal Reserve, called a 6 p.m. meeting so that bank officials could review their financial exposures to Lehman Brothers and work out contingency plans over the possibility that the government would need to orchestrate an orderly liquidation of the firm on Monday, according to people briefed on the meeting.

Flanked by Treasury Secretary Henry M. Paulson Jr. and Christopher Cox, the chairman of the Securities and Exchange Commission, he gathered the executives in person to impress on them the need to work together to resolve the current crisis.

Mr. Geithner told the participants that an industry solution was needed, no matter what, and that it was not about any individual bank, according to two people briefed on the meeting but who did not attend. They said he told them that if the industry failed to solve the problem their individual banks might be next.

A spokesman for the New York Federal Reserve Bank in New York confirmed the meeting but declined to provide details on the discussions. The Wall Street executives included the following chief executives: Lloyd Blankfein of the Goldman Sachs Group, James Dimon of JPMorgan Chase, John Mack of Morgan Stanley, Vikram Pandit of Citigroup and John Thain of Merrill Lynch. Representatives from the Royal Bank of Scotland and the Bank of New York Mellon were also present. Lehman Brothers was noticeably absent from the talks.

The meeting was reminiscent of the circumstances that preceded the near-collapse 10 years go of Long Term Capital Management. At that time, William J. McDonough, then the president of the New York Fed, summoned the heads of big Wall Street banks to the Fed to stop the failure of L.T.C.M., a hedge fund firm that had made big bets on esoteric securities using borrowed money and which had already lost $4.5 billion.

The bankers ended up committing $3.65 billion to save L.T.C.M., though Bear Stearns, the hedge fund’s clearing broker, refused to contribute to the investment. Traders from the banks wound down the fund over time, averting what might have been big losses across the financial system. But the fallout from a failure of Lehman Brothers could be even more severe, given the firm’s much larger size and its entanglements with trading partners around the globe.

Policy makers fear its losses could ripple through the financial industry at a time when banks and securities firms are trying to overcome $500 billion in write-downs.

One observer briefed on the situation described the session as a “game of chicken” between the government and the heads of the major banks.

Bank of America and two British firms, Barclays and HSBC, have expressed interest in bidding for Lehman Brothers, according to people briefed on the situation. But they have indicated that their bids are contingent upon receiving support from the government, just as it did with the rescues of Bear Stearns, and the government-sponsored agencies, Fannie Mae and Freddie Mac.

But Mr. Paulson and Mr. Geithner made it clear to the company, its potential suitors and to the meeting participants on Friday that the government has no plans to put taxpayer money on the line. The government is deeply worried that its actions have created a moral hazard and the Federal Reserve does not want to reach deeper into its coffers. Instead, Mr. Paulson and Mr. Geithner insist that Wall Street needs to come up with an industry solution to try to stabilize Lehman Brothers and calm the markets.

Still, some of the other Wall Street banks, facing billions of dollars in losses themselves, have resisted this approach. They argue that Lehman Brothers overreached and brought its current troubles on itself. If there are no bidders for Lehman Brothers, these banks say they can collect their collateral and liquidate the troubled firm’s assets. In this high-stake game, they may also be trying to call the government’s bluff, knowing that if push came to shove, it would provide financial support.

Mr. Geithner, who led the session, firmly stood his ground. He told the banks that this was about fixing the system and preventing the crisis from worsening.

By the time Lehman’s shares went into a spiral this week, Fed and Treasury officials were convinced that Lehman posed far fewer real risks than Bear Stearns had back in March. The confidence by Washington officials stemmed from the fact that, after the Bear Stearns collapse, they obtained stronger regulatory powers that gave them the ability to peer into the activities and risk exposures of institutions on Wall Street.

Fed officials, for example, are now embedded at each of the big Wall Street investment banks and have at least some capacity gauge the firms’ exposure to hedge funds and other big players, as well as their positions in financial derivatives and other opaque markets. Fed and Treasury officials have also been taking the daily pulse of executives and traders on Wall Street for months, and much of that discussion has been about Lehman.

Officials detected a rising number of defections by Lehman’s institutional customers to other firms, but nothing near the panic that caused Wall Street executives to bombard Mr. Paulson with dire warnings about a Bear Stearns collapse in March.

Fed officials also saw few signs that fears about the future of the investment bank were spilling over to fears about its customers and trading partners.

And in practice, taxpayers could still end up on the hook for at least as much money as they were in the case of Bear Stearns. Lehman’s successor will still be able to borrow from the Fed’s new lending program for major investment banks, which the Fed created in response to the collapse of Bear Stearns in March. If Lehman were to borrow money and then default on its loans, the Fed’s losses would reduce the amount of money it turns over to the Treasury.

For political and economic reasons, both the Federal Reserve and the Treasury Department are loath to save financial institutions from their own folly.

But as the housing crisis has deepened, they have abandoned free-market orthodoxy, fearing that the collapse of institutions like Bear Stearns or either Fannie Mae or Freddie Mac could cripple the financial markets, and perhaps the economy itself.

One of the biggest differences between the challenge facing Lehman and the one that faced Bear Stearns is the availability of the Fed’s emergency lending program for investment banks.

When confidence evaporated in Bear, with major hedge funds pulling their prime brokerage accounts, Bear’s financing ran out almost overnight, creating a panic situation. Lehman has had the power to plug any cash shortfalls by borrowing from the Fed, though it has not actually borrowed any money from the program since March.

Edmund L. Andrews reported from Washington, and Jenny Anderson, Vikas Bajaj and Eric Dash reported from New York.

    U.S. Gives Banks Urgent Warning to Solve Crisis, NYT, 12.9.2008, http://www.nytimes.com/2008/09/13/business/13rescue.html?hp

Lehman Sees $3.9 Billion Loss

and Plans to Shed Assets

September 11, 2008
The New York Times
BY BEN WHITE

The investment bank, Lehman Brothers, in an all-out fight for its survival, said Wednesday morning that it expected a loss of $3.9 billion, or $5.92 a share, in the third quarter after $5.6 billion in write-downs.

The investment bank also said that it would spin off the majority of its remaining commercial real estate holdings into a new public company to be owned by Lehman shareholders. And it confirmed plans to sell a majority of its investment management division in a move that it expects to generate at least $3 billion and perhaps more. Lehman still hopes to receive a majority of the net income from the unit by retaining higher-margin businesses like its stakes in individual hedge fund groups.

After initially jumping on the news, Lehman shares fluctuated in morning trading and were up about 1.5 2 percent to $7.91 shortly after noon.

The new declines came after Lehman’s stock lost nearly half its value on Tuesday as investors feared it was running out of options to raise capital and shore up its ailing balance sheet. Shares in Lehman, a major underwriter of mortgage-related securities during the credit boom, are down over 90 percent since hitting their peak last year before the subprime mortgage crisis.

The tepid reaction to Lehman’s announcements suggested that investors were eager to hear fewer words from Lehman and see more action.

“To decrease investor uncertainty, Lehman must have a definitive agreement by Monday to either sell its profitable asset management business, Neuberger Berman, sell a large portion of its subprime real estate exposure, reduce its leverage ratios, or line up a deep-pocketed buyer to either buy the company outright or take a significant ownership stake — a lot to accomplish in three working days,” said Mark Williams, a management professor at Boston University.

Lehman said Wednesday that it hoped to complete the spinoff of around $32 billion in commercial mortgage assets by early next year.

Among other decisions, Lehman also said it would cut its annual dividend to 5 cents a share and that it remained committed to examining “all strategic alternatives to maximize shareholder value.”

“This is an extraordinary time for our industry, and one of the toughest periods in the firm’s history,” the chief executive, Richard S. Fuld Jr., said in a statement. “The strategic initiatives we have announced today reflect our determination to fundamentally reposition Lehman Brothers by dramatically reducing balance sheet risk, reinforcing our focus on our client-facing businesses and returning the firm to profitability.”

On a conference call, Mr. Fuld said Lehman has been tested many times in the past and survived.

“This firm has a history of facing adversity and delivering. We have a long track record of pulling together when times are tough and taking advantage of global opportunities,” he said on a conference call. “We are on the right track to put these last two quarters behind us.”

Analysts said the planned spinoff reflected the poor state of the commercial mortgage markets.

“It’s not a good sign,” said Brad Hintz, an analyst with Sanford C. Bernstein. “It’s really a sign of the illiquidity in the markets — that no one wants to buy these assets.”

And others warned that Lehman would face a plethora of questions about how it assigned assets to the new company.

“What’s a bad asset, and what’s a good asset, and what’s in the middle?” said Jonathan R. Macy, a professor at the Yale Law School who has studied the good/bad bank structure. “There have got to be judgment calls.”

Mr. Macy also expressed concern about what options the new company may have to put the bad assets back onto Lehman’s books.

Lehman’s announcement came a day after the bank’s shares plunged 45 percent following reports that its efforts to secure a strategic investment from Korea Development Bank had failed. Investors also feared that the federal government would not bail out Lehman as it has mortgage giants Fannie Mae and Freddie Mac and investment bank Bear Stearns.

The investment bank has been struggling amid growing losses on its commercial and residential real estate holdings. It has been shopping its prized investment management division, which includes Neuberger Berman. People with knowledge of the auction say Lehman has asked for final bids to be submitted by this weekend.

Lehman has been under heavy pressure since the collapse of Bear Stearns, as investors believe its heavy reliance on mortgage-related underwriting and trading could lead it to suffer the same fate that forced Bear into an emergency sale to JPMorgan Chase.

Lehman has steadfastly said that its balance sheet remained much stronger than Bear’s ever was and that it continued to have access to an emergency lending facility put in place by the Federal Reserve after Bear’s near collapse.

But Tuesday’s plunge of Lehman shares fanned worries about the troubles plaguing the broader financial industry and sent the Standard & Poor’s 500-stock index tumbling 3.4 percent. The decline more than wiped out the market’s rally on Monday, when stocks surged after the weekend rescue of Fannie Mae and Freddie Mac, the government-chartered mortgage finance giants.

There has been a growing sense on Wall Street that Lehman may have to solve its problems on its own. Since March, Lehman has been in a fight for its life, as some investors, including prominent short-sellers betting against the bank’s stock, questioned how the firm was valuing some of its assets. Lehman lost $2.8 billion in the second quarter and was forced to raise $6 billion in new capital. But investors were not placated, and the firm was compelled to explore more extreme measures.

Mr. Fuld has replaced virtually every major division head, including the firm’s president and chief financial officer.

During that time he has replaced the global head of fixed income — the division from which most of Lehman’s problems have arisen — twice.

But with every measure taken, Lehman’s stock price has fallen further.
 

Michael J. de la Merced and Louise Story contributed reporting.

    Lehman Sees $3.9 Billion Loss and Plans to Shed Assets, NYT, 11.9.2008, http://www.nytimes.com/2008/09/11/business/11lehman.html?hp

Pending Home Sales Declined in July

September 10, 2008
The New York Times
By THE ASSOCIATED PRESS

WASHINGTON — Pending home sales fell more than expected in July as the housing market’s struggles continued, an industry group said Tuesday.

The National Association of Realtors said its seasonally adjusted index of pending sales for existing homes fell 3.2 percent to a reading of 86.5 from an upwardly revised June reading of 89.4. The index was 6.8 percent below year-ago levels.

Home sales are considered pending when the seller has accepted an offer, but the deal has not closed. Typically there is a one- to two-month lag before a sale is completed.

Wall Street economists surveyed by Thomson/IFR had predicted the index would fall to 88.6. The index, which sunk to a record low of 83 in March, stood at 92.2 in July 2007.

Lawrence Yun, the trade group’s chief economist, forecasts that home sales are on a pace to fall 11 percent from last year to just over 5 million in 2008. Mr. Yun said stringent lending criteria by Fannie Mae and Freddie Mac — the mortgage finance companies taken over by the government this weekend — held back sales activity.

Many in the real estate industry are hopeful that these standards will be relaxed with Fannie and Freddie under government control, but the outlook remains uncertain.

Wholesale Inventories Increase

WASHINGTON (Reuters)_ — Inventories at wholesalers rose 1.4 percent in July, twice what analysts had forecast, while sales were down 0.3 percent, the Commerce Department reported on Tuesday.

Wall Street analysts polled by Reuters were expecting inventories to rise 0.7 percent, compared with a 0.9 percent gain in June, previously reported as 1.1 percent.

The inventory-to-sales ratio, a measure of how long it would take to sell stocks at the current sales pace, rose to 1.07 months’ worth in July from 1.06 months’ in June.

The ratio for automotives rose to 1.68 months’, the highest since 1.72 months’ in December 1997.

While sales declined in July, they rose 3 percent in June, up from the previously reported 2.8 percent gain. They also rose 16.5 percent from a year earlier, and inventories increased 10.6 percent from July 2007.

Petroleum wholesale sales in July fell a sharp 5.9 percent, compared to the 13.9 percent gain in June and the 55.1 percent rise from a year ago. Oil prices peaked at $147.27 a barrel on July 11.

Durable goods, which make up more than half of wholesale inventories, rose 1.6 percent in July to $270.84 billion, with the largest gains in the automotive, metals and machinery categories.

Nondurable goods inventories increased 1.1 percent to $170.42 billion, with drugs rising 6.1 percent and chemicals 6.3 percent over the month.

Inventories of farm products saw the largest drop of 4.7 percent to $26.64 billion from $27.96 billion.

    Pending Home Sales Declined in July, NYT, 10.9.2008, http://www.nytimes.com/2008/09/10/business/economy/10econ.html?hp

Editorial

The Bailout’s Big Lessons

September 9, 2008
The New York Times
 

As an act of crisis management, the government takeover of Fannie Mae and Freddie Mac, the mortgage-finance giants, was a reasonable and reassuring move. It ensures the flow of mortgage credit and is likely to reduce mortgage rates, which are important steps toward the eventual recovery of the ailing United States housing market.

And it does so while putting taxpayers first for future dividends or money that may be earned when the firms are reprivatized, holding out hope that the bailout costs may someday be recouped. Beyond the immediate crisis, however, the takeover raises disturbing issues that may get lost in the tumult of the moment.

¶ The need for an explicit bailout underlines the economic vulnerabilities of the United States. In July, Congress gave Treasury Secretary Henry Paulson unlimited authority to pay the debts of Fannie and Freddie and to shore up their capital, if need be. Yet investors the world over continued to doubt the companies’ viability, shunning their securities or demanding unusually high interest rates on loans. In effect, investors deemed the government’s commitment to Fannie and Freddie as either insufficient or not credible — an extraordinary vote of no confidence that, in the end, led to the bailout.

¶ There is no single reason for the lack of confidence. But investors have good cause to be concerned about the deep indebtedness of the United States, about the nation’s apparent political unwillingness to restore its fiscal health and about the ability of the government to responsibly make good on its commitments. A pledge of the full faith and credit of the United States still means something. That’s why the markets responded favorably to the takeover. But investors’ refusal to accept a promise to act is another sign of the need to reverse the fiscal mismanagement of the Bush years.

¶ The United States must acknowledge that its deep indebtedness is especially dangerous in times of economic crisis. The level and stability of American interest rates and of the dollar are now dependent on the willingness of foreign central banks and other overseas investors to continue lending to the United States. The bailout became inevitable when central banks in Asia and Russia began to curtail their purchases of the companies’ debt, pushing up mortgage rates and deepening the economic downturn.

¶ The bailout is new evidence of the need for better regulation of the American financial system. As the housing bubble inflated, the Bush administration often claimed that America’s unfettered markets were the envy of the world. But, in fact, they have sowed mistrust.

¶ The cost of the bailout needs to be carefully monitored. Fannie and Freddie own or back nearly $800 billion of generally junky mortgages, and some of those will inevitably go bad. So it is reasonable to assume that the cost could easily near $100 billion. There may be ways to make back some of that money later, but for a long time, the bailout will divert resources from other needs.

Senators John McCain and Barack Obama have both voiced support for the bailout, which shows good judgment. But what the next president will need to worry about, and both candidates need to talk about, is the depth of the country’s economic problems. It will take discipline and sacrifice to address them.

    The Bailout’s Big Lessons, NYT, 9.9.2008, http://www.nytimes.com/2008/09/09/opinion/09tue1.html

U.S. Takeover of Mortgage Giants

Lifts Global Markets

September 9, 2008
The New York Times
By KEITH BRADSHER
and DAVID JOLLY

Investors around the world breathed a sigh of relief Monday after the American government took over and backed Fannie Mae and Freddie Mac, assuring a continued flow of credit through America’s wounded mortgage system.

Stocks rallied in Europe and Asia, after the Treasury announced that it would transfer control of the mortgage finance giants, Fannie Mae and Freddie Mac, to a conservatorship. In Europe, the FTSE 100 index in London rose 3.8 percent before trading was halted by a technical glitch, while the DJ Euro Stoxx 50 index, a barometer of euro-zone blue chips, rose 4.3 percent. The Nikkei 225 stock average closed Tokyo trading 3.4 percent higher, and the Hang Seng index in Hong Kong rose 4.3 percent.

Futures contracts on the Dow Jones industrial average rose 2.2 percent as investors concluded that the Bush administration’s decision over the weekend had strengthened the prospects for American businesses, particularly banks, and for the American economy.

Shares of global banks soared. In Tokyo, Mitsubishi UFJ Financial rose 10 percent, and Sumitomo Mitsui Financial climbed more than 15 percent. In Europe, UBS gained 12 percent and Deutsche Bank rose 8 percent and HSBC Holdings added 5 percent.

The dollar and yen weakened in orderly trading against the euro and the British pound, as investors halted a recent flight to the safety of the dollar and yen and began to conclude that European economies might not be in as grave danger as they had seemed last week. The yield on 10-year Treasury notes rose 10 points, to 3.802, amid expectations that the American government will need to issue more debt.

German-listed shares of Fannie and Freddie plummeted in Frankfurt trading, losing about 50 percent of their value.

Investors said the provision in the bailout plan under which the Treasury will begin buying some of Fannie and Freddie’s securities in the open market would help to restore confidence.

“The fact that they’ll be able to buy mortgage-backed securities from other banks is really important,” William de Vijlder, chief investment officer at Fortis Investment Management in Brussels, said, “because it means the U.S. is serious about fixing the problems in the market.” The “doomsday scenario,” in which write-downs of those securities results in a continuing cycle of bank write-downs and losses, is over, he added.

“I expect a positive reaction in the market in the near term,” he said. “The problems have not gone away, but along with the decline in the oil price, this helps to put the machinery into place by which things will eventually return to normal.”

But the takeover of the companies also reinforced concerns about troubles of the American economy and highlighted its significant reliance on foreign investors, particularly in Asia.

Almost immediately, the move will protect central banks in Asia, which have amassed hundreds of billions of dollars of Fannie Mae and Freddie Mac bonds, from taking big losses. The move should also bode well for American financial institutions and, in the short term, the broader stock market.

Investors said they expected the spread between Treasury securities and comparable Fannie Mae and Freddie Mac debt to shrink drastically, reflecting renewed faith about the safety of the market.

In recent months that spread, or premium, had ballooned significantly, eroding confidence in the health of the companies. Before the housing crisis, Fannie and Freddie could borrow money at a small premium over the federal government’s rates. “If it becomes like U.S. Treasuries, that is a positive for Asia,” said Ifzal Ali, the chief economist of the Asian Development Bank in Manila.

Treasury’s purchase of mortgage securities may help lower interest rates on home loans, which this summer rose to their highest level in a year. That reduction in housing costs should help cushion the decline in home prices, which have already fallen more than 18 percent from their peak in the summer of 2006, said Bill Gross, the co-chief investment officer of Pimco, the large bond investment firm.

“It goes a long way to stopping this housing deflation which, I think and Pimco thinks, is at the heart of the problem,” he said.

But the plan also raises a host of questions about the fragility of the American economy, which will continue to figure into investor calculations. On Friday, for instance, the Labor Department reported that the unemployment rate climbed to a five-year high of 6.1 percent. And while dramatic, the rally in global share prices Monday only partially restores the losses suffered in the indexes last week, suggesting investors do not expect an end to the market misfortunes.

Perhaps most important, despite the government support for Fannie Mae and Freddie Mac, any stabilization in home prices is still a way off, and the waves of foreclosures battering the housing market are not likely to reverse right away. What is more, the plan will do little to stem losses in risky home loans, commercial mortgages and debt used by private equity firms to acquire companies. Financial institutions have already taken write-downs of $500 billion and the International Monetary Fund projects that losses could reach $1 trillion.

“It’s a good half a plan, but its still just half a plan,” said Joseph Mason, a finance professor at Louisiana State University, who cautioned that the government needed to outline its longer-range plan for the two companies and the credit markets to restore greater confidence to markets.

Yet for foreign investors, particularly in Asia, the takeover will do little to assuage mounting fears that the economic problems in the United States are not only far from over, but could also hurt growth in China, India and other emerging economies.

“People don’t know about the depth of the problem,” Mr. Ali said.

Asian central banks, particularly the People’s Bank of China, have emerged over the last several years as important buyers of bonds from Fannie Mae and Freddie Mac, the two American government-sponsored enterprises.

Standard & Poor’s estimates that the People’s Bank of China held $340 billion of these agency securities at the end of June, but has been unable to estimate Asian holdings over all because the data is too unclear.

The Treasury plan met Monday with a positive response from Asian monetary authorities.

“I think it will have a positive impact on the world economy as it eases worries over the U.S. economy through more stable financial markets in the United States,” the Japanese finance minister, Bunmei Ibuki, said in Tokyo. “Japan welcomes the steps as it removes one unstable factor in the United States, especially because the dollar is a key international currency.”

The Treasury secretary, Henry M. Paulson Jr., was to explain the details of the rescue to his Group of Seven counterparts Monday evening, he said.

“Different people may have different responses,” Zhou Xiaochuan, governor of the Chinese central bank, said in Basel, Switzerland. “From my point of view this is positive.”

While central banks around the world have historically accounted for a quarter of purchases of Freddie Mac debt, their share rose to 37 percent for debt issued since 2006, according to an analysis of the latest available data by CreditSights that was released on Wednesday. The bulk of those purchases appear to have been by Asian central banks, which have been buying dollar-denominated securities at a record pace to slow their currencies’ rise against the dollar and thus preserve the competitiveness of their exports.

Keith Bradsher reported from Hong Kong and David Jolly from Paris. Vikas Bajaj contributed reporting from New York.

U.S. Takeover of Mortgage Giants Lifts Global Markets, NYT, 9.9.2008, http://www.nytimes.com/2008/09/09/business/worldbusiness/09markets.html?hp

Editorial

Real Life Economy

September 8, 2008
The New York Times

During the boom years of the Bush presidency — remember them? — economic growth was an especially unreliable indicator of how most Americans were doing.

The numbers were impressive, but the gains were lopsided, benefiting executives and investors far more than hourly workers and salaried employees. Because the growth was fueled by reckless lending and borrowing, it created an illusion of wealth even as many Americans lost ground.

The strange and painful disconnect was evident again in recent weeks.

The government reported that the economy grew at a surprising 3.3 percent in the second quarter, while productivity (the measure of how much workers accomplish per hour) soared. Unfortunately, those bounces did not mean a rebound in the lives of most Americans.

Growth rose, but so did unemployment. Productivity surged, but wages fell. Fixing that disconnect is the central economic challenge for the next president.

Increased exports were responsible for last spring’s strong economic growth numbers. But selling more abroad has not led to more manufacturing jobs or working-class pay raises at home.

One reason, as The Times’s Louis Uchitelle reported, is that manufactured goods accounted for an unusually low share of export gains in the first half of 2008, while commodities like corn and scrap metal accounted for an unusually high share. Worse yet, exports are likely to fall as the economies of Europe and Japan slow.

American consumers also helped drive recent growth, spending nearly $100 billion in government-provided stimulus payments. That was only a temporary lift. A true rebound cannot occur until the economy stabilizes. For that, oil prices have to settle at or below their recent levels; housing prices have to bottom out; and emerging economies, like China, have to avoid recession, thus propping up global growth.

Washington has little influence over those factors. But the government can try to stop things from getting much worse, helping to set the stage for a rebound. Congress will likely have to provide another round of stimulus — which should center on bolstered food stamps and grants to state and local governments. It may also have to provide more foreclosure relief.

That’s the easy part. Once the economy stabilizes, the creative and controversial work must begin to build an economy in which all Americans have a shot at sharing in the growth.

Senator Barack Obama has addressed the issue conceptually, rejecting the “you’re on your own” ethos of the Bush years. He has put forth prescriptions, including specific plans to create jobs with public-works investments, and he supports legislation that would make it easier for employees to form unions.

It’s well established that public-works spending yields a big economic bang for every buck and that unions lead to better pay. The politics are difficult. First, Americans must agree that government has a useful role to play in the economy, a notion that has been disparaged for decades. Big employers with powerful friends on Capitol Hill — Wal-Mart comes immediately to mind — can be expected to fight any attempts to foster unions.

Senator John McCain has also pledged to address the struggles of working Americans. Both candidates say their energy plans will create jobs. But Mr. McCain emphasizes more high-end tax cuts as the main engine for new jobs. Tax cuts are always politically popular. As job generators, however, they are a loser strategy, especially now. The Bush era, with its huge tax cuts, has the worst job-creation record of any post-World War II economic cycle.

America needs more jobs and American workers need a raise. Mr. Obama should sharpen his promising ideas. Mr. McCain has yet to address the real economy’s real problems head on.

    Real Life Economy, NYT, 8.9.2008, http://www.nytimes.com/2008/09/08/opinion/08mon1.html

Your Money

Fannie, Freddie and You:

What It Means to the Public

September 8, 2008
The New York Times
By RON LIEBER

So what does the federal takeover of two mortgage finance giants mean to consumers?

Mortgage rates may fall a bit initially but probably not enough to halt the decline in home prices anytime soon. Some delinquent borrowers may have a better shot at modifying their loans and ending up with lower fixed payments. And the rules on new mortgages could slightly change.

Oh, and the federal government will help pay for it all, using your tax money.

These themes emerged over the weekend as mortgage specialists wrinkled their foreheads to determine what the federal bailout of the mortgage finance giants Fannie Mae and Freddie Mac will mean for consumers. They cautioned, however, that the unprecedented nature of the rescue makes it hard to know all of the ramifications immediately.

So first, what happened here, and why? In order to provide capital to banks that lend money to aspiring homeowners, Fannie and Freddie need to be able to sell the mortgages, packaged as securities, to investors around the world once the two companies have bought the loans from the banks.

All this worked fine until foreign investors got nervous about the housing market and the uncertainty over how a theoretical federal takeover might affect their holdings. When concerns emerged about the viability of Fannie and Freddie, the government thought it had no choice but to step in and take over.

Here’s what could happen next:

MORTGAGE RATES If you already have a fixed-rate mortgage, nothing will change, except perhaps for a rising feeling of righteous indignation that you as a taxpayer are footing the bill for the mistakes of borrowers who got in over their heads and the lenders who let them.

If you are thinking of buying a home or refinancing a mortgage, the emerging consensus is that the government takeover will help stabilize rates. They might even fall a quarter of a percentage point or so, now that the government has stepped in to make its backing of Fannie and Freddie more explicit, said Kevin Iverson, who has been in the mortgage business for 30 years and is president of Reed Mortgage Corporation, a loan brokerage firm in Denver.

John A. Courson, chief operating officer of the Mortgage Bankers Association, a trade group, also pointed with relief to the statement by the Treasury secretary, Henry M. Paulson Jr., on Sunday morning that Fannie and Freddie would examine the fees they charge banks for loan securitization services, “with an eye toward mortgage affordability.”

Any reduction in those fees, Mr. Courson said, could help bring mortgage rates down a bit if the banks pass on the lower costs to consumers.

HOME PRICES Rates certainly matter in persuading people on the sidelines to step in and start shopping for a home, so any stabilization there can only help.

The overall mood in the market is also a factor, but the front-page headlines noting the government’s move may not resonate with home buyers. “I would love it if people thought that way, but they don’t connect the dots like that,” said Steve Heideman, president of United Mortgage Financial Group, a mortgage brokerage firm in Tempe, Ariz.

The biggest factor weighing on home prices, aside from the overall jobs picture and the state of the economy, may now be the sheer number of homes for sale, as people try to get out from under bad mortgages or their lenders put homes on the market, having already foreclosed on them.

NEW DEALS ON OLD LOANS “The government doesn’t have a great deal of interest in foreclosing on a ton of homes,” said Kurt Eggert, a law professor at Chapman University in Orange, Calif., and a former member of the Federal Reserve Board’s Consumer Advisory Council. As an example, he pointed to IndyMac, which was seized in July. Soon after, the Federal Deposit Insurance Corporation began offering troubled borrowers the opportunity to move into cheaper fixed-rate loans.

Could a similar move happen here? Well, both Fannie and Freddie have already provided additional financial incentives to the companies that service the loans to modify some of the troubled ones. It remains to be seen how much further they can or will go to bail out homeowners, or what sort of political pressure may be put on them to do so.

NEW RULES ON NEW LOANS The interest rate you pay for a mortgage depends in part on the rules that Fannie and Freddie set for the kinds of loans they will buy. Now that they have new bosses in the federal government, the rules could change.

“How much authority will they have to make changes?” asked Mr. Iverson, the Denver mortgage broker. “Must they go to Congress? It’s a huge unknown for consumers.”

Mr. Courson, of the Mortgage Bankers Association, said that in theory at least, credit score requirements, loan-size-to-home-value ratios and down payment requirements could come up for review.

We may not know if the loan rules will change for a few months, given the potential desire to push off some of the tough decisions until after the November elections.

INVESTORS While it is not yet clear whether stockholders in Fannie Mae and Freddie Mac will be wiped out entirely, Mr. Paulson did say on Sunday that the entities “will no longer be managed with a strategy to maximize common shareholder returns.”

The drop in their share prices thus far offers another lesson in the importance of diversification. If you invest in mutual funds, those funds may have lost a bit of money on Fannie and Freddie. But that is the whole point; it was just a bit, because most funds hold many securities.

It is now clearer than ever that there is no such thing as a truly safe single investment — not a big savings account at IndyMac, not the auction-rate securities that have caused so many problems for scores of investors and not supposed blue-chip stocks like Fannie Mae or Freddie Mac that you might buy on your own, outside of a mutual fund.

Any big, focused bets are better left for hedge funds, not for you and me.

    Fannie, Freddie and You: What It Means to the Public, NYT, 8.9.2008, http://www.nytimes.com/2008/09/08/business/08consumer.html?hp

Few Stand to Gain on This Bailout,

and Many Lose

September 8, 2008
The New York Times
By ERIC DASH

Over the years, Fannie Mae and Freddie Mac showered riches on many winners: their executives, Wall Street bankers and Washington lobbyists. Now the foundering mortgage giants are leaving some losers in their wake, notably their shareholders, rank-and-file employees and, in the worst case, American taxpayers.

But even after the government seized the mortgage finance companies on Sunday and dismissed their chief executives, the companies’ outgoing leaders could see big paydays — a prospect that angers many investors, particularly because ordinary stockholders could be virtually wiped out.

Under the terms of his employment contract, Daniel H. Mudd, the departing head of Fannie Mae, stands to collect $9.3 million in severance pay, retirement benefits and deferred compensation, provided his dismissal is deemed to be “without cause,” according to an analysis by the consulting firm James F. Reda & Associates. Mr. Mudd has already taken home $12.4 million in cash compensation and stock option gains since becoming chief executive in 2004, according to an analysis by Equilar, an executive pay research firm.

Richard F. Syron, the departing chief executive of Freddie Mac, could receive an exit package of at least $14.1 million, largely because of a clause added to his employment contract in mid-July as his company’s troubles deepened. He has taken home $17.1 million in pay and stock option gains since becoming chief executive in 2003.

Both executives stood to make millions more from restricted stock grants and options, but those awards are now worthless because of the plunge in the companies’ share prices. Even so, their past pay — and the idea that they might receive more — irks some investors.

“This is completely outrageous,” said Richard C. Ferlauto, the director of corporate governance and investment for the American Federation of State, County and Municipal Employees, a large pension fund. “It is really a slap in the face to shareholders and homeowners whose loans are at risk and taxpayers footing the bill for a bailout.”

Whether Mr. Mudd and Mr. Syron will collect their severance package is unclear. A spokeswoman for the Federal Housing Finance Agency, the companies’ primary regulator, declined to provide details about their exit packages. F.H.F.A. officials said the compensation of their successors, Herbert M. Allison Jr. and David M. Moffett, both longtime financial industry executives, would be “significantly lower” than that of the departing chief executives.

Fannie Mae and Freddie Mac have enriched their top executives for years. Mr. Mudd’s predecessor at Fannie Mae, Franklin D. Raines, took home more than $52 million while he was chief executive from 1999 to 2004, according to Equilar data.

Mr. Raines later agreed to forfeit several million dollars’ worth of stock and options to resolve personal claims over allegations that Fannie Mae had inflated its earnings to raise executive bonuses. Even though Fannie Mae was forced to restate its earnings, Mr. Raines walked away with at least $25 million in pension benefits, as well as stock options he did not cash in — many of which are now worthless.

Mr. Syron’s predecessor at Freddie Mac, Leland C. Brendsel, took home more than $28.4 million from 1993 to 2003, the only part of his pay package that was publicly disclosed during his 13-year tenure as chief executive.

The shareholders of Fannie Mae and Freddie Mac, including many employees, will not be so lucky. The companies’ share prices have plunged about 90 percent this year, wiping out about $70 billion of shareholder value. The shares are likely to be worth little or nothing under the government’s rescue plan.

As a result, Wall Street money managers and everyday investors alike stand to lose big. Bill Miller, the star mutual fund manager at Legg Mason, increased his bet on Freddie Mac even as the company’s shares plummeted this year. Last week, when Freddie Mac stock was trading at about $5, Legg Mason disclosed that it had bought an additional 30 million shares. Other value-oriented investors, including Rich Pzena, David Dreman and Martin Whitman, also placed big bets that the mortgage companies would recover. None of these money managers returned calls for comment.

“I am just shocked how they missed this, and why, when it became completely clear that the problem was snowballing, guys like Bill Miller doubled down,” said Douglas A. Kass, head of Seabreeze Partners and an outspoken short-seller.

For years, the shares of Fannie Mae, the larger of the two companies, have ranked among the most widely held stocks in America. Many ordinary investors believed that the company’s quasi-governmental status would insulate shareholders from big losses.

“People perceived they had government support of some sort,” said Byron Wien, the chief investment strategist at Pequot Capital. “The perception was they were more secure investments than they turned out to be.”

Members of the Fannie Mae and Freddie Mac rank-and-file were big shareholders, too. Stock and options could make up a fifth of employees’ total pay.

While those who bought the companies’ shares lost, short-sellers who bet against Fannie Mae and Freddie Mac won. So-called short interest in Fannie Mae and Freddie Mac stock soared in recent months as the companies’ troubles deepened.

Among the most vocal short-sellers betting against the companies is William A. Ackman, who runs a hedge fund called Pershing Square Capital. Mr. Ackman was among the earliest to warn of the credit crisis, and he is believed to have landed a windfall after shorting both companies, according to a person with direct knowledge of a recent investment letter.

Wall Street investment banks, meanwhile, are breathing a sigh of relief. Fannie Mae and Freddie Mac pay hefty fees to big Wall Street debt underwriters, and that is unlikely to change. Fannie Mae and Freddie Mac’s business was worth $1.5 billion in fees in 2007, according to a Sanford C. Bernstein report. Through the first six months of this year, that figure sank to $600 million.

Washington lobbyists, however, may be hurting. Over the last decade, Freddie Mac paid more than $94.8 million for lobbying services, in part to fend off attempts to tighten oversight, according to the Center for Responsive Politics; Fannie Mae spent about $79.5 million. The government plan will immediately eliminate that spending.

Some commercial banks and insurance companies that hold the companies’ preferred stock could suffer, too. Auditors may force those investors to mark down the value of the holdings. Sovereign Bancorp, a regional lender near Philadelphia, holds about $588 million of the securities, about 13 percent of its tangible capital, according to a research report by Keefe, Bruyette & Woods, a securities broker.

Midwest Banc Holdings, a community bank in Illinois, and Gateway Financial Holdings, which operates in Virginia and North Carolina, each have tens of millions of dollars of the preferred stock, representing more than one-third of their tangible capital, the report said. And federal banking regulators said in a joint statement that a “limited number” of smaller banks could need new financing.

The Treasury secretary, Henry M. Paulson Jr., urged those institutions to contact their regulator, which said it was “prepared to work with those institutions to develop capital-restoration plans” and other corrective actions.

    Few Stand to Gain on This Bailout, and Many Lose, NYT, 8.9.2008, http://www.nytimes.com/2008/09/08/business/08scorecard.html

Clive Crook:

Nationalisation in all but name

Published: September 8 2008 03:00
Last updated: September 8 2008 03:00
The Financial Times
By Clive Crook


The "conservatorship" that Hank Paulson, Treasury secretary, has announced for Fannie Mae and Freddie Mac is nationalisation by another name. Give the man some credit for this. It is not an easy thing for a Republican administration to take two such colossal undertakings on to the public sector's balance sheet two months after promising not to.

Recall that Fannie and Freddie - hybrids that are privately owned but "government sponsored" - own or guarantee more than $5,000bn (€3,500bn, £2,825bn) of mortgage-backed securities. Britain's nationalisation of Northern Rock brought some £100bn of loans on to the public sector's balance sheet, and was the biggest in the nation's history. The nationalisation of Fannie and Freddie, in a country less well disposed to public ownership, is more than 25 times bigger.

Under the new plan the Treasury will directly support the housing market by buying mortgage-backed securities. That too requires an ideological flexibility not usually associated with this administration. Two months ago Mr Paulson emphasised the importance of supporting Fannie and Freddie so that they could carry on - as they must, he said - as privately owned entities. So much for that.

It would have been possible to muddle through a while longer. Recent suggestions of new accounting issues, indicating that the agencies' capital was even thinner than supposed, helped bring the announcement forward. The continuing deterioration in their ability to borrow - let alone raise new equity - pushed the same way.

Now that it has decided to move, the Treasury cannot plausibly be attacked for trying to patch and mend. The comprehensive character of the plan contrasts favourably with the evasions and hesitations of the British government's handling of Northern Rock.

The eventual cost to taxpayers is unknown. If the housing market rallies before long, it could be in the low tens of billions of dollars. If things keep getting worse, it could be in the hundreds of billions. But Fannie and Freddie have made themselves indispensable to any housing market recovery: the cost, whatever it is, will have to be paid.

Bearing in mind the staggering scale of this intervention, yesterday's move was surprisingly uncontroversial. Both presidential campaigns back it, recognising the need to keep mortgage finance flowing. Differences are likely to arise over the terms of the nationalisation, however.

Shareholders in the entities are expected to recover almost nothing: rightly so. Both boards (not just the chief executives) should be dismissed.

The plan calls for the agencies' portfolios to be downsized from 2010, but the next administration should aim beyond that to get the government as far as possible out of the housing market. This means breaking Fannie and Freddie into pieces small enough to fail, and privatising them. If the function they discharged - that of providing liquidity to the mortgage market - cannot be profitably undertaken without an implicit public subsidy, then it should not be undertaken at all.

    Clive Crook: Nationalisation in all but name, FT, 8.9.2008, http://www.ft.com/cms/s/0/4c6591be-7d3d-11dd-8d59-000077b07658.html

In Rescue to Stabilize Lending,

U.S. Takes Over Mortgage Finance Titans

September 8, 2008
The New York Times
By STEPHEN LABATON
and EDMUND L. ANDREWS

WASHINGTON — The Bush administration seized control of the nation’s two largest mortgage finance companies on Sunday, seeking to shrink drastically their outsize influence on Wall Street and on Capitol Hill while at the same time counting on them to pull the nation out of its worst housing crisis in decades.

The bailout plan for the companies, Fannie Mae and Freddie Mac, a seismic event in a year of repeated financial crises followed by aggressive federal intervention, places the companies in a government conservatorship, much like a bankruptcy reorganization. The plan also replaces the management of the companies.

The rescue package represents an extraordinary federal intervention in private enterprise. It could become one of the most expensive financial bailouts in American history, though it will not involve any immediate taxpayer loans or investments.

The Treasury secretary, Henry M. Paulson Jr., who engineered the plan, would not say how much capital the government might eventually have to provide, or what the ultimate cost to taxpayers might be. Two months ago, the Congressional Budget Office gave a rough estimate of $25 billion. One senior government official, speaking on the condition of anonymity, signaled on Sunday that even that figure was optimistic.

Mr. Paulson said Sunday that it was important to rescue the mortgage giants because a failure of either company would cause turmoil in financial markets in the United States and around the world.

“This turmoil would directly and negatively impact household wealth: from family budgets, to home values, to savings for college and retirement,” he said. “A failure would affect the ability of Americans to get home loans, auto loans and other consumer credit and business finance. And a failure would be harmful to economic growth and job creation.”

The plan received wide bipartisan support on Sunday, from Congressional lawmakers and both presidential campaigns.

As part of the plan, the chief executives of both companies were replaced. Herbert M. Allison Jr., the former chairman of TIAA-CREF, the huge pension fund for teachers that also offers mutual funds, will take over Fannie Mae and succeed Daniel H. Mudd. At Freddie Mac, David M. Moffett, currently a senior adviser at the Carlyle Group private equity firm, succeeds Richard F. Syron. Mr. Mudd and Mr. Syron, however, will stay on during a transition period.

The plan also commits the government to provide as much as $100 billion to each company to backstop any shortfalls in capital. It enables the Treasury to ultimately buy the companies outright at little cost. It bans them from lobbying the government, putting an end to their ability to use their political machine on Capitol Hill.

It also eliminates dividend payments to current shareholders while protecting the principal and interest payments on the debt, now held by foreign central banks, financial institutions, pensions funds and others.

The Treasury will force both companies to shrink their portfolios over the long term; they now hold or guarantee about half of the country’s mortgages. In addition, the government plans to buy significant amounts of their mortgage-backed securities on the open market, beginning with the purchase of $5 billion worth this month. This step, never before undertaken by the government, could begin to restore some confidence in the credit markets and lead to lower interest rates for home mortgages.

For the companies, the takeover caps an ignominious downfall. Fannie was created during the depths of the Great Depression, and Freddie in 1970, to help make mortgages more affordable for homeowners. The companies buy billions of dollars in mortgages each month from commercial lenders. Some are sold to investors as mortgage-backed securities; others are held by the companies in their own investment portfolios.

The plan represents a cease-fire in a decades-long ideological battle over the proper role of the companies. Free-market conservatives see the companies as extensions of “big government,” while Democrats have protected them as the main vehicle to promote affordable housing for middle- and lower-income people.

Alan Greenspan, the former Federal Reserve chairman, and Lawrence H. Summers, a Treasury secretary under President Bill Clinton, along with many other critics, have long maintained that the companies were too powerful politically and financially, and that their huge portfolios posed enormous risks to the financial system.

Moreover, these critics have complained, the companies have used their ability to borrow at low interest rates to dominate the mortgage-finance market, usurping the role of other financial institutions, which do not have the same subsidy.

Free-market adherents have warned of impending disaster as Fannie and Freddie used an implicit government backing to borrow at will, with only a tiny sliver of capital to protect them from nasty surprises like the recent sharp decline in housing prices and rise in foreclosures.

Mr. Paulson has sought to avoid taking sides in the debate, but in recent months came to the conclusion that the companies’ conflicting missions of providing federally backed financing for affordable housing while serving shareholders were untenable.

“Market discipline is best served when shareholders bear both the risk and the reward of their investment,” Mr. Paulson said on Sunday. “While conservatorship does not eliminate the common stock, it does place common shareholders last in terms of claims on the assets of the enterprise.”

Holders of the companies’ common stock will not fare well. The plan suspends their dividend payments and holds the potential to make their shares virtually worthless if the government chooses to exercise its right to buy the common stock. The stock of both companies, which traded above $60 a share last year, had fallen below $10 a share recently. Their shares will continue to trade and could fall further as a result of the government seizure.

Mr. Paulson made clear that the solution put forward on Sunday would only defer the most important decisions about the mission of the companies for the next president and Congress.

At a news conference on Sunday, Mr. Paulson said: “There is a consensus today that these enterprises pose a systemic risk and they cannot continue in their current form. Government support needs to be either explicit or nonexistent, and structured to resolve the conflict between public and private purposes.”

The plan requires the companies to shrink their portfolios long after the administration leaves, officials acknowledged, adding that they hoped to prod Congress into deciding what the role of the companies should be.

Hoping to limit potential taxpayer losses and gain any financial windfall if the companies are restored to profitability, the administration, in exchange for the investment commitment, will receive so-called stock warrants, or purchase rights, for up to 80 percent of the companies’ common shares at less than $1 a share. In after-hours trading on Sunday, Freddie Mac fell $1.06, or nearly 21 percent while Fannie Mae dropped $1.54, or 22 percent.

The companies agreed to provide the government with $1 billion of new preferred senior stock, which will pay the Treasury a dividend of at least 10 percent a year, as well as an unspecified quarterly payment to compensate the Treasury for any taxpayer money injected into the companies.

The companies will be allowed to “modestly increase” the size of their existing investment portfolios until the end of 2009, which means they can use some of their new taxpayer-supplied capital to buy and hold new mortgages in investment portfolios.

But in a strong indication of Mr. Paulson’s wish to wind down the companies’ portfolios, drastically shrink their role and perhaps eliminate their unique status altogether, the plan calls for the companies to start reducing their investment portfolios 10 percent a year, beginning in 2010.

In addition, the Treasury Department will create a so-called Secured Lending Credit Facility, a backup source of borrowing for the companies in the event that they cannot borrow enough money on the open market to finance their main business of buying mortgages and reselling them as pools of mortgage-backed securities.

While the government takeover seemed to catch some financial experts by surprise, Treasury officials appeared to have little choice, with the credit markets in a tailspin and investors reluctant to buy mortgages with even a hint of risk. Fannie and Freddie now guarantee about 70 percent of all new home loans, said Mr. Lockhart, the chief regulator of the companies.

The initial reaction to the plan was mostly positive. Senator John McCain, the Republican nominee for president, said on CBS’s “Face the Nation” on Sunday that he supported the Treasury move, but he also implicitly criticized the Bush administration’s oversight.

“It’s an example of cronyism, special interest, lobbyists,” he said, adding that the companies needed “more regulation, more oversight, more transparency, more of everything, and frankly, a dramatic reduction in what they do.”

Senator Joseph R. Biden Jr., the Democratic nominee for vice president, said on NBC’s “Meet the Press” Sunday that he had spoken to Mr. Paulson on Saturday night, and that he thought the plan had a good chance of succeeding. “It’s not an official reorganization. It will be left to the next administration and the Congress to make those judgments,” Mr. Biden said.

After being briefed by Mr. Paulson, the billionaire investor Warren E. Buffett said: “Secretary Paulson has made exactly the right decision for the country. He is minimizing the problem of moral hazard and maximizing the benefits for the housing market and for the smooth functioning of financial markets.”

Democratic and Republican lawmakers also spoke approvingly of the decision. They said that restoring stability to the financial markets was the top priority. But some longtime critics of the companies complained that their warnings had gone unheeded for too long.

“Fannie and Freddie were allowed to grow too quickly and for too long without the strong oversight required of such government chartered firms,” said Senator John E. Sununu, Republican of New Hampshire, who is facing a tough campaign for re-election.

Asian stock markets rallied at the opening on Monday after the Treasury’s announcement. The Tokyo market rose 2.8 percent and Australia’s market jumped 3.2 percent.

Futures contracts on the Standard & Poor’s 500-stock index jumped more than 2 percent in early Asian trading as investors concluded that the decision had strengthened the prospects for American businesses, particularly banks, and for the American economy.

The dollar and yen weakened against the euro and the British pound by late Monday morning in Asia as investors began to conclude that European economies might not be in as grave danger as they had seemed last week.

Treasury officials emphasized that the companies would open for business as usual on Monday and that, at least for now, almost nothing would change in their normal course of business.

Keith Bradsher contributed reporting from Hong Kong.

    In Rescue to Stabilize Lending, U.S. Takes Over Mortgage Finance Titans, NYT, 8.9.2008, http://www.nytimes.com/2008/09/08/business/08fannie.html

U.S. Seizes Mortgage Giants

Government Ousts CEOs of Fannie, Freddie;
Promises Up to $200 Billion in Capital

September 8, 2008
The Wall Street Journal
Page A1
By JAMES R. HAGERTY,
RUTH SIMON and DAMIAN PALETTA

In its most dramatic market intervention in years, the U.S. government seized two of the nation's largest financial companies, taking direct responsibility for firms that provide funding for around three-quarters of new home mortgages.

Treasury Secretary Henry Paulson announced plans Sunday to take control of troubled mortgage giants Fannie Mae and Freddie Mac and replace the companies' chief executives. The Treasury will acquire $1 billion of preferred shares in each company without providing immediate cash, and has pledged to provide as much as $200 billion to the companies as they cope with heavy losses on mortgage defaults. The Treasury's plan puts the two companies under a conservatorship, giving management control to their regulator, the Federal Housing Finance Agency, or FHFA.

With that, the U.S. mortgage crisis entered a new and uncharted phase, potentially saddling American taxpayers with billions of dollars in losses from home loans made by the private sector. Bush administration officials argued that the cost of doing nothing would be far greater because of the toll on the economy of falling home prices and defaults in the $11 trillion U.S. mortgage market.

Mr. Paulson noted that more than $5 trillion of debt and mortgage-backed securities issued by Fannie and Freddie is owned by central banks and other investors world-wide. "Failure of either of them would cause great turmoil in our financial markets here at home and around the globe," Mr. Paulson said.

By taking this action, the government has seized control of the vast bulk of the secondary market for home mortgages and will have a more direct responsibility than ever for solving the housing crisis. The intervention also marks the failure of the public-private experiment that was created to boost home ownership among Americans. Fannie and Freddie were created by Congress to help prop up the housing market, and investors have long believed the government would bail the companies out in a crisis. But the companies have long been owned by private shareholders seeking to maximize profits.

The federal takeover was initially welcomed by banks and market watchers outside the U.S. who saw it as a way to dispel some of the uncertainty roiling the world's financial markets. The intervention could eventually be a boon for Wall Street, by providing a boost to the moribund mortgage industry and by perhaps diminishing the influence of Wall Street's two largest competitors in the market of packaging and reselling mortgage-backed bonds.

Markets across Asia rallied early Monday morning on the news, with financial shares leading the way. Japan's Nikkei Stock Average of 225 companies soared more than 3%, and Hong Kong's Hang Seng Index opened 4.5% higher.

The move is also likely to nudge down mortgage rates for consumers, who are facing the worst housing bust since the 1930s. Despite steep interest-rate cuts by the Federal Reserve, the cost of a typical 30-year fixed-rate mortgage has remained well over 6% for most of the past year. To bolster the mortgage market, Treasury said it will buy, on the open market, at least $5 billion of new mortgage-backed securities issued by Fannie and Freddie.

The government rescue of Fannie and Freddie is likely to leave a trail of billions of dollars in losses for stockholders, including some major banks. But it protects the investments of bondholders, including mutual funds, foreign central banks and government investment funds that own huge amounts of debt issued by the two companies. Investors that have loaded up recently on mortgage-backed bonds -- such as Pacific Investment Management Co., the large Newport Beach, Calif., bond manager -- could benefit as Treasury purchases of such securities drive up their values.
 

It is unclear how much the government's intervention will ultimately cost taxpayers. In addition to its initial acquisition of preferred shares, the government receives warrants giving it the right to a stake of 79.9% of each company for a nominal sum. The Treasury's preferred shares, which carry an annual dividend yield of 10%, will be senior to those earlier issued, meaning the government will have the first right to receive dividends.

Existing shareholders won't fare so well. The new overseers will eliminate dividends on billions of dollars of common and preferred stock, moves that are expected to further drive down the price of those shares. If the government exercises its warrants, existing common shares will be drastically diluted. Common shareholders are expected to see the value of their investment, which has already fallen, shrivel further, say analysts. Even preferred stockholders are expected to see a significant decline.

That prospect is especially problematic for some of the commercial banks and thrifts that hold high concentrations of Fannie and Freddie preferred shares. The Office of Thrift Supervision, a government agency that supervises savings and loans, said that roughly 2% of the 829 companies it regulates -- or around 17 banks -- had a concentration in common or preferred shares of Fannie Mae and Freddie Mac that surpassed 10% of their Tier 1 capital. Regulators said Sunday they would work with banks that hold large exposures to Fannie and Freddie "to develop capital-restoration plans" if necessary.

The Shape of the Future

The Treasury's move doesn't answer the question of what ultimately happens to Fannie and Freddie. Under the conservatorship of their regulator, the companies will still have their shares listed on the New York Stock Exchange. But management control goes to the regulator until it deems the companies financially healthy. Congress ultimately will have to decide in what form Fannie and Freddie will be relaunched or whether they will be replaced by different types of entities.

Mr. Paulson signaled that he wants to remake the U.S. housing-finance system in the longer term, ditching the "flawed business model" of government-sponsored enterprises like Fannie and Freddie. The Treasury plan limits the size of each company's mortgage portfolios to a maximum of $850 billion as of the end of 2009. (Fannie currently owns about $758 billion of mortgages and related securities, while Freddie's total is about $798 billion.) After that, the Treasury intends for the mortgage holdings to shrink about 10% a year until they reach about $250 billion at each company.

Wrangling over the future shape of Freddie and Fannie will likely be kicked to the next Congress. Already the majority Democrats are pushing back on elements of Treasury's plan. "Good luck on that," said Massachusetts Rep. Barney Frank, chairman of the House Financial Services Committee, when asked about the Treasury's plan to start reducing the firms' portfolios beginning in 2010. Mr. Frank called it "more of a sop to the right" than a real policy prescription and said it wasn't going to happen.

Many economists and analysts believe the government had to wade deeper into the mortgage market because for now "private markets are just not willing to put up the capital" for home mortgages at prices U.S. consumers could afford, said Susan Wachter, a professor of real estate and finance at the University of Pennsylvania's Wharton School. Without government support for the mortgage market, home prices would fall much further, exposing the country as a whole to greater economic strain, Ms. Wachter says.

The turn of events for Fannie and Freddie is remarkable considering the two companies for so long shunned the riskiest type of mortgages, only to embrace those mortgages late in the game in an effort to regain market share from Wall Street rivals.

As early as 2005, Fannie executives publicly expressed concerns about growing risks in the mortgage market. In May of that year, Thomas Lund, a Fannie Mae executive vice president, said that lenders should be concerned if borrowers straining to afford homes were given loans allowing for low payments in the early years but storing up much higher ones for later. "In many cases the consumers may not understand all the risks," he said.

Yet both companies expanded their exposure to riskier loans. At both Fannie and Freddie, so-called Alt-A loans, a category between prime and subprime, accounted for roughly 50% of credit losses in the second quarter, even though such loans accounted for only about 10% of the companies' business. Alt-A mortgages include loans made with less than full documentation of borrowers' income or assets.

As these and other loans -- including many in areas such as California and Florida that are among the hardest hit by the housing crisis -- started to go bad, the companies failed to raise enough capital late last year, when investors were still fairly bullish on their prospects, to see them through the current storm. The companies have recorded combined losses totaling about $14 billion over the past four quarters, eating deeply into their meager capital holdings. Most analysts expect them to report sizable losses for at least another couple of years as the costs of foreclosures mount.
 

A Reflection of the Market

Fannie and Freddie's credit problems are largely a reflection of the overall weakness in the housing market. Some 9.2% of mortgages on one- to four-family homes were at least a month overdue or in the foreclosure process in the second quarter, according to the latest survey of the Mortgage Bankers Association. That is the highest percentage in the 39 years that the trade group has been doing the surveys.

"Make no mistake, anybody in the mortgage business is going to see much higher losses than they thought they would a year ago because we've had the worst housing market and the largest home price declines that anybody has seen," said Thomas Lawler, a housing economist in Leesburg, Va., who formerly worked for Fannie.

Both companies are also exposed to some of the mortgage industry's most troubled players. Countrywide Financial Corp., now part of Bank of America Corp., was the largest provider of loans purchased by Fannie Mae, accounting for 29% of its business in 2007, according to Inside Mortgage Finance, and was the second largest source of loans for Freddie Mac, with a 16% share. IndyMac Financial Corp., which previously had focused its business on Alt-A loans that didn't meet Fannie and Freddie guidelines, switched to a policy of making loans that could meet their standards in 2007. IndyMac was taken over by the Federal Deposit Insurance Corp. this summer.

At Fannie, Herb Allison, who formerly served as chairman of the investment company TIAA-CREF, succeeds Daniel Mudd. Freddie's chief executive, Richard Syron, was succeeded by David Moffett, who has been vice chairman and chief financial officer of U.S. Bancorp.

Potentially, Mr. Syron could walk away with an exit package totaling as much as $15 million, said David Schmidt, a senior consultant at James F. Reda & Associates LLC, a compensation consulting concern in New York. That includes a pension and deferred compensation, about $3.7 million in severance pay and a possible payment of $8.8 million to compensate for forfeiting recent equity grants. A Freddie spokesman said Mr. Syron had said he doesn't "anticipate receiving nearly that much."

Mr. Mudd's exit package, including stock he already owns, could total $14 million, Mr. Schmidt estimates. That includes $5 million in pension and deferred compensation, $4.2 million in severance pay and $3.4 million of restricted stock, based on Friday's closing price. The value of that stock could fall sharply, however.

--Aparajita Saha-Bubna and Michael R. Crittenden contributed to this article.

    U.S. Seizes Mortgage Giants, WSJ, 8.9.2008, http://online.wsj.com/article/SB122079276849707821.html?mod=hpp_us_whats_news

Taxpayers take on trillions in risk

in Fannie, Freddie takeover

USA Today
7 September 2008
By Stephanie Armour and James R. Healey

WASHINGTON — The unprecedented federal takeover of mortgage giants Freddie Mac and Fannie Mae announced on Sunday is a bold attempt to stabilize financial markets and restore the faltering housing market, but it thrusts trillions of dollars of risk directly onto taxpayers' shoulders.
"You can call it a bailout, you can call it a safety net or you can call it a rescue package, but the bottom line is the American taxpayer is left footing the bill," says Richard Yamarone, director of economic research at Argus Research.

At a Sunday morning news conference, Treasury Secretary Henry Paulson and James Lockhart, director of the newly formed Federal Housing Finance Agency (FHFA), announced that Fannie Mae (FNM), based in Washington, D.C., and Freddie Mac (FRE), based in McLean, Va., will begin operating immediately under a federal government conservatorship. Unlike a receivership, the arrangement leaves hope for shareholders that investments may regain some value. President Bush signed housing legislation in July that gives the government clear authority to intervene as it has.

If the plan settles the bond market as government officials hope, borrowers may find mortgages at slightly lower rates. In taking over the companies, the government ousted their CEOs; otherwise, work continues as normal.

Though the companies haven't been at imminent risk of collapse, deep losses from the housing meltdown have raised concerns from investors around the world about their ability to meet financial commitments.

"I have determined that the companies cannot continue to operate safely and soundly and fulfill their critical public missions without significant action to address our concerns," Lockhart said.

Freddie Mac and Fannie Mae combined own or guarantee $5.4 trillion in outstanding mortgage debt. The government's decision to place both agencies into a conservatorship — in essence, taking on responsibility for that debt by wresting control from the corporations — is an historic move.

It is still uncertain how much capital the companies may need from the government. What that means to taxpayers ultimately depends on what happens with the faltering housing market. To the extent homeowners continue to make timely mortgage payments, pressure on the government is lessened. Continued foreclosures and troubles in the mortgage market could run up an expensive tab.

The Mortgage Bankers Association reported Friday that more than 4 million homeowners, or 9% of those with mortgages, were delinquent by at least one payment or in foreclosure at the end of June. It's the highest rate ever, the MBA says.

Terms of the government takeover call for drastically reducing, over time, the roles that Freddie Mac and Fannie Mae play in the mortgage market. Government officials say the duration of the conservatorship is indefinite, and Paulson said policymakers need to use the time to decide whether the role of the companies is best played by private corporations, the government, or hybrids such as Fannie Mae or Freddie Mac.

Although Fannie and Freddie are public companies, owned by shareholders, their debt has had an implicit govnerment guarantee.

Paulson and Lockhart unveiled a four-part plan to come to the aid of the companies, which have sustained combined losses of $14 billion in the past four quarters.

Key elements of the plan:

•Government purchase of mortgage-backed securities. Initially, the government will spend $5 billion to buy the securities, to demonstrate Treasury support for continued mortgage availability.

•Gradual portfolio reduction. Starting in 2010, the companies' mortgage portfolios will be reduced at a rate of 10% per year.

This would dramatically reduce the role that Freddie and Fannie play in the mortgage market. Together, their market share of all new mortgages reached more than 80% earlier this year, but is now falling.

•A new lending program. The companies will have access to a new line of government credit if they run into serious trouble borrowing funds on the open market. Treasury officials say they consider it a symbolic step to provide confidence to investors in Fannie and Freddie debt.

•Purchase of preferred shares. The government would be allowed to buy new preferred shares that pay dividends that would be considered senior to the current common and preferred stock. The Treasury may purchase up to $100 billion of this new senior-preferred stock in each company to preserve the companies' positive net worth. Fannie Mae and Freddie Mac must give Treasury $1 billion in senior preferred stock today, as an upfront fee for agreeing to consider doing this in the future.

A closer look

The move to put Freddie and Fannie into conservatorship was triggered in part by closer government scrutiny of the agencies, prompted by the July housing legislation.

The Treasury Department recently signed a contract with Morgan Stanley to investigate the financial position of Fannie and Freddie, with help from the FHFA.

"Based on what we have learned about these institutions over the past four weeks, including what we learned about their capital requirements, and given the financial markets today, I concluded that it would not have been in the best interest of the taxpayers for the Treasury to simply make an equity investment in these enterprises in their current form," Paulson says.

Lack of confidence in the agencies has meant that to build capital, Fannie Mae and Freddie Mac have had to pay more for borrowing in the bond market and have had to tighten credit standards. The takeover is intended to boost confidence in the two companies. They could then find it easier to get funding, which could lead to lower mortgage interest rates. That could spur buyers and help rejuvenate the housing market.

"It'll bring (mortgage rates) down a little bit," says Bert Ely, a banking consultant in Alexandria, Va. "Freddie and Fannie now are piggybacking on the credit of the United Sates government, and that will allow them to borrow more cheaply" and, in turn, lend more cheaply. "It might not happen overnight. But it sure won't drive up interest rates."

"Effectively, this is nationalization," Paul Miller, an analyst at investment firm Friedman Billings Ramsey, said before the announcement. "Freddie and Fannie need help. This is the best way."

But Sung Won Sohn, an economist at California State University, warned that the government's financial standing could get shakier. "The U.S. government has trillions of dollars of debt outstanding. With the takeover of Fannie and Freddie, the government will add trillions more to the burden, because the Treasury will, in fact, guarantee all the Fannie and Freddie debt," he said.

Widespread backing

But many supported the move, since financial problems at Freddie and Fannie risk inflaming problems far beyond the U.S. housing market. Fannie Mae and Freddie Mac shares each are down about 90% from a year ago. Central banks around the world hold their securities.

Bond investors traditionally have believed that the U.S. government would backstop the companies, even in the absence of an explicit guarantee. The action Sunday removes any doubt.

In a statement Sunday, Bush supported Paulson's move, saying, "As we determine the appropriate role for the companies in the future, it is crucial that they not pose similar risks to our economy or the financial system again."

Republican presidential candidate John McCain told CBS television program Face the Nation that it was a necessary step. "We've got to keep people in their homes," he said. "There's got to be some confidence that we've stopped this downward spiral."

Democratic candidate Barack Obama told ABC News he's "inclined to support some form of intervention to prevent a long-term, much bigger crisis."

Federal Reserve Chairman Ben Bernanke said in a statement Sunday that "these necessary steps will help to strengthen the U.S. housing market and promote stability in our financial markets."

Spokesmen for Freddie and Fannie had no comment Sunday.

The takeover also means the ouster of current CEOs at Freddie and Fannie. At Fannie Mae, Herbert Allison, former CEO at mutual fund company TIAA-CREF, replaces Daniel Mudd. At Freddie Mac, David Moffett, who was vice chairman of U.S. Bancorp, replaces Richard Syron. Syron and Mudd will remain as consultants for an undetermined time.

Freddie and Fannie were chartered by the government in an effort to help stabilize the mortgage market by buying loans from lenders. Fannie Mae was first established in 1938, during the Great Depression, and Freddie followed in the 1970s.
 

Contributing: Barbara Hagenbaugh, Sue Kirchhoff, John Waggoner. Healey reported from McLean, Va.

    Taxpayers take on trillions in risk in Fannie, Freddie takeover, 7.9.2008, http://www.usatoday.com/money/economy/housing/2008-09-07-fannie-freddie-plan_N.htm

Fannie, Freddie takeover

a pre-emptive strike

Sun Sep 7, 2008 7:07pm EDT
Reuters

By David Lawder - Analysis

WASHINGTON (Reuters) - The U.S. Treasury has been worrying and wrangling over Fannie Mae's and Freddie Mac's capital levels and systemic risks for years. So why move now to seize control of the two troubled mortgage finance giants?

Mounting credit losses, waning foreign appetite for the institutions' mortgage-backed securities and a sobering review by Morgan Stanley prompted Treasury Secretary Henry Paulson to launch what may become the most costly bailout in U.S. history.

"Rather than waiting until a triggering event -- but seeing one on the horizon -- they decided to strike preemptively," said Bert Ely, a longtime banking industry consultant in Alexandria, Virginia.

"They lined up the evidence to present this to the Fannie and Freddie boards before their hand was forced like it was with Bear Stearns," he added.

At the crux of the matter is housing and the economy. With mortgage default rates rising, markets have been losing confidence in the viability of Fannie Mae and Freddie Mac, government-sponsored enterprises that buy mortgages from lenders and hold them or securitize and sell them on to investors.

As demand for their paper diminishes, the cost of mortgages rises, putting more pressure on the already battered housing market.

"He (Paulson) has got to fix housing. Fixing the GSEs is critical to fixing housing. He has to do it before he leaves office," said Michael Youngblood, principal of Five Bridges Capital LLC in Bethesda, Maryland.

FOREIGN APPETITE WANES

Foreign investors, in particular, have been shunning Fannie and Freddie securities, long viewed as nearly as safe as Treasury debt due to an implied government backing. They cut their holdings of U.S. agency securities by $9.75 billion in the week ended September 3, marking the seventh weekly drop in a row, according to Federal Reserve data.

The Bank of China recently said it cut its holdings of Fannie and Freddie securities to $12.67 billion as of August 25 from the end of June, and Russia has reduced its holdings of Fannie, Freddie and Federal Home Loan Bank securities by around $40 billion this year by not replacing maturing paper. A central bank official said last week further reductions were being made.

"There is little doubt that foreign central bank holdings of agency bonds were a major factor shaping Treasury thinking on how to deal with the Fannie/Freddie restructuring. The People's Bank of China, of course, is the largest foreign holder of agency paper," said Nicholas Lardy, senior fellow with the Peterson Institute for International Economics in Washington.

Domestic investors, too, have voiced concern. Bill Gross, the influential chief investment officer of Pacific Investment Management Co called upon the Treasury last week to open its balance sheet to halt a "financial tsunami" of debt and asset liquidation.

MORGAN STANLEY INFLUENCE

A month of consultations with Morgan Stanley, hired as an adviser to the Treasury on August 5 on its recently minted GSE backstop authority, appeared to be influential in making up Paulson's mind to grab the reins of Fannie and Freddie.

Senior government officials said the consultations with Morgan Stanley and the Federal Housing Finance Agency regulator revealed the GSEs capital base was inadequate for the mortgage losses they faced and their ability to raise new equity capital was impaired by the massive drop in their share prices in recent months.

"Based on what we have learned about these institutions over the last four weeks -- including what we learned about their capital requirements -- and given the condition of financial markets today, I concluded that it would not have been in the best interest of taxpayers for Treasury to simply make an equity investment in these enterprises in their current form," Paulson said in a statement.

The Treasury has said there would not be a final report on Morgan Stanley's conclusions about Fannie and Freddie.

Analysts also said the picture for Fannie and Freddie could worsen significantly with their third-quarter financial reports in coming weeks, which is likely to show increasing credit losses and delinquencies from subprime and near-prime "Alt-A" loans.

Also by the end of September, Fannie and Freddie are scheduled to roll over some $500 million in debt, which could go badly if markets lack confidence in the two institutions.

Although the move was bold and intricately structured to preserve equity and existing preferred shareholders while providing new capital on a quarterly basis as needed, some regarded the move as only a partial step, leaving a full takeover to the next president.

"They're kind of doing this in dribs and drabs, putting in enough capital to get us through to next year. It strikes me as a bit half-hearted," said Morris Goldstein, a senior fellow at the Peterson Institute.

(Additional reporting by Burton Frierson and Richard Leong in New York; Editing by James Dalgleish)

    Fannie, Freddie takeover a pre-emptive strike, R, 7.9.2008, http://www.reuters.com/article/idUKN0737388720080907

News Analysis

A History of Public Aid During Crises

September 7, 2008
The New York Times
By NELSON D. SCHWARTZ

Despite decades of free-market rhetoric from Republican and Democratic lawmakers, Washington has a long history of providing financial help to the private sector when the economic or political risk of a corporate collapse appeared too high.

The effort to save Fannie Mae and Freddie Mac is only the latest in a series of financial maneuvers by the government that stretch back to the rescue of the military contractor Lockheed Aircraft Corporation and the Penn Central Railroad under President Richard M. Nixon, the shoring up of Chrysler in the waning days of the Carter administration and the salvage of the savings and loan system in the late 1980s.

More recently, after airplanes were grounded because of the terrorist attacks of Sept. 11, 2001, Congress approved $15 billion in subsidies and loan guarantees to the faltering airlines.

Now, with the federal government preparing to save Fannie and Freddie only six months after the Federal Reserve orchestrated the rescue of Bear Stearns, it appears that the mortgage crisis has forced the government to once again shove ideology aside and get into the bailout business.

“If anybody thought we had a pure free-market financial system, they should think again,” said Robert F. Bruner, dean of the Darden School of Business at the University of Virginia.

The closest historical analogy to the Fannie-Freddie crisis is the rescue of the Farm Credit and savings and loan systems in the late 1980s, said Bert Ely, a banking consultant who has been a longtime critic of the mortgage finance companies.

The savings and loan bailout followed years of high interest rates and risky lending practices and ultimately cost taxpayers roughly $124 billion, with the banking industry kicking in another $30 billion, Mr. Ely said.

Even if the rescue of Fannie and Freddie ends up costing tens of billions of dollars, the savings and loan collapse is still likely to remain the costliest government bailout to date, said Lawrence J. White, a professor of economics at the Stern School of Business at New York University.

“The S.& L. debacle cost upwards of $100 billion, and the economy is more than twice the size today than it was in the late 1980s,” he said. “I don’t think this will turn out to be as serious as that, when over 2,000 banks and thrifts failed between the mid-1980s and mid-1990s.”

Most of those losses were caused by the shortfall between what the government paid depositors and what it received by selling the troubled real estate portfolios it acquired after taking over the failed thrifts.

In the Chrysler case, President Jimmy Carter and lawmakers in states with auto plants helped push through a package of $1.5 billion in loan guarantees for the troubled carmaker, while also demanding concessions from labor unions and lenders.

While Chrysler is remembered as a major bailout, Mr. White says it was minor compared with the savings and loan crisis or the current effort to shore up Fannie and Freddie.

In fact, the government did not have to give money directly to Chrysler, and it actually earned a profit on the deal because of stock warrants it received when the loan guarantees were provided. At the time, Chrysler had a work force of more than 100,000 people.

Still, Mr. Ely makes a distinction between the rescue of Fannie and Freddie and the thrifts versus the aid packages for Chrysler and other industrial companies. “They didn’t have a federal nexus,” he said. “They weren’t creatures of the federal government.”

This effort is also different from the others because of the potential fallout for the broader economy and especially the beleaguered housing sector if it does not succeed.

Unlike a particular auto company or even a major bank like Continental Illinois National Bank and Trust, which was bailed out in 1984, “we depend on Fannie and Freddie for funding almost half of our mortgage market,” said Thomas H. Stanton, an expert on the two companies who also teaches at Johns Hopkins University.

“The government,” he added, “has many less degrees of freedom in dealing with these companies than in the earlier bailouts.”

    A History of Public Aid During Crises, NYT, 7.9.2008, http://www.nytimes.com/2008/09/07/business/07bailout.html

Loan Giant Overstated

the Size of Its Capital Base

September 7, 2008
The New York Times
By GRETCHEN MORGENSON
and CHARLES DUHIGG

The government’s planned takeover of Fannie Mae and Freddie Mac, expected to be announced on Sunday, came together after advisers poring over the companies’ books for the Treasury Department concluded that Freddie’s accounting methods had overstated its capital cushion, according to regulatory officials briefed on the matter.

The proposal to place both companies, which own or back $5.3 trillion in mortgages, into a government-run conservatorship also grew out of deep concern among foreign investors that the companies’ debt might not be repaid. Falling home prices, which are expected to lead to more defaults among the mortgages held or guaranteed by Fannie and Freddie, contributed to the urgency, regulators said.

Investors who own the companies’ common and preferred stock will suffer. Holders of debt, including many foreign central banks, are expected to receive government backing. Top executives of both companies will be pushed out, according to those briefed on the plan.

The cost of the government’s intervention could rise into tens of billions of dollars and will probably be among the most expensive rescues ever financed by taxpayers.

Both presidential nominees expressed support for the government’s plans. Senator Barack Obama, Democrat of Illinois, said as he campaigned in Indiana that not acting could place the housing market in further distress.

Senator John McCain’s running mate, Gov. Sarah Palin, said at a rally in Colorado Springs that Fannie Mae and Freddie Mac have become too big and too expensive .

The takeover comes on the heels of a rescue of the investment bank Bear Stearns, which was sold to JPMorgan Chase in a deal backed by taxpayers. Already, the housing crisis has cost investors and consumers hundreds of billions of dollars.

The big question now is whether the federal government’s move to take over Fannie and Freddie will restore investor confidence in the nation’s credit markets, help stabilize the stock market and keep loans flowing to creditworthy borrowers.

Fannie and Freddie, by buying mortgages, provide banks and other financial institutions with fresh money to make new loans, a vital lubricant for the housing and credit markets.

Under the plan, the Treasury Department itself will begin buying mortgage securities, providing crucial market support.

As a result of the government’s intervention, the cost of borrowing for Fannie Mae and Freddie Mac should decline, because the government will be insuring their debts. Equally important, because the government is backing the companies, they will continue to buy and sell home loans.

But the plan will probably do little to stop home prices from falling further. And foreclosures are almost certain to rise.

Just a week ago, Treasury officials were still considering a wide variety of options for Fannie Mae and Freddie Mac, ranging from doing nothing to taking over the companies completely, according to people with knowledge of those discussions.

The Treasury secretary, Henry M. Paulson Jr., who won authority from Congress last month to use taxpayer money to bolster the companies, always maintained that he hoped never to use that power. But, as the companies’ stocks continued to languish and their borrowing costs rose, some within the Treasury Department began urging Mr. Paulson to intervene quickly.

Then, last week, advisers from Morgan Stanley hired by the Treasury Department to scrutinize the companies came to a troubling conclusion: Freddie Mac’s capital position was worse than initially imagined, according to people briefed on those findings. The company had made decisions that, while not necessarily in violation of accounting rules, had the effect of overstating the companies’ capital resources and financial stability.

Indeed, one person briefed on the company’s finances said Freddie Mac had made accounting decisions that pushed losses into the future and postponed a capital shortfall until the fourth quarter of this year, which would not need to be disclosed until early 2009. Fannie Mae has used similar methods, but to a lesser degree, according to other people who have been briefed.

Representatives of both companies did not return calls or declined to comment. But officials who have been briefed on the plans said late Saturday that the companies had agreed to the takeover.

On Friday, executives from Fannie Mae and Freddie Mac were ordered to appear in the offices of their regulator, James B. Lockhart, in separate meetings. They were told that regulators were exercising their authority to place Fannie Mae and Freddie Mac in conservatorship, which would allow for uninterrupted operation of the companies but would put them under the control of Mr. Lockhart.

The details of those plans continued to be worked out on Saturday, when the Federal Reserve chairman, Ben S. Bernanke, met with Mr. Paulson, Mr. Lockhart and key company executives in Washington.

While Freddie Mac’s accounting woes make it easier for regulators to force the company into conservatorship, there was more resistance from Fannie Mae, according to people familiar with the discussions. Once the government took action against Freddie Mac, however, confidence in Fannie Mae would certainly waver. Given Fannie Mae’s declining financial condition, the company has few options but to concede to the government’s demands.

Accusations of questionable accounting are not new for either company. Earlier this decade, both companies paid large fines and ousted their top executives after accounting scandals.

Freddie Mac’s current chief executive and chairman, Richard F. Syron, joined the company in 2003 after the former managers revealed that they had manipulated earnings by almost $5 billion. The next year, Fannie Mae’s chief executive, Daniel H. Mudd, was promoted to the top spot after that company was accused of accounting errors totaling $6.3 billion.

The accounting issues that brought so much urgency to the bailout appear to center on Freddie Mac’s capital cushion, the assets that regulators require them to keep on hand to cover losses.

The methods used to bolster that cushion have caused serious concerns among the companies’ regulator, outside auditors and some investors. For example, while Freddie Mac’s portfolio contains many securities backed by subprime loans, made to the riskiest borrowers, and alt-A loans, one step up on the risk ladder, the company has not written down the value of many of those loans to reflect current market prices.

Executives have said that they intend to hold the loans to maturity, meaning they will be worth more, and they need not write down their value. But other financial institutions have written down similar securities, to comply with “mark-to-market” accounting rules. Freddie Mac holds roughly twice as many of those securities as Fannie Mae.

Freddie Mac and Fannie Mae have also inflated their financial positions by relying on deferred-tax assets — credits accumulated over the years that can be used to offset future profits. Fannie maintains that its worth is increased by $36 billion through such credits, and Freddie argues that it has a $28 billion benefit.

But such credits have no value unless the companies generate profits. They have failed to do so over the last four quarters and seem increasingly unlikely to the next year. Moreover, even when the companies had soaring profits, such credits often could not be used. That is because the companies were already able to offset taxes with other credits for affordable housing.

Most financial institutions are not allowed to count such credits as assets. The credits cannot be sold and would disappear in a receivership. Removing those credits from assets would probably push both companies’ capital below the regulatory requirements.

Regulators are also said to be scrutinizing whether the companies were trying to manage earnings by waiting to add to their reserves. Both companies have gradually increased their reserves for loan losses — Fannie’s reserves today stand at $8.9 billion, and Freddie’s at $5.8 billion.

Other companies, like private mortgage insurers, have been quicker to identify large losses and have set aside much greater amounts. Fannie and Freddie have dribbled out bad news with each quarterly announcement, suggesting they may be trying to manage this process.

Finally, regulators are concerned that the companies may have mischaracterized their financial health by relaxing their accounting policies on losses, according to people familiar with the review. For years, both companies have effectively recognized losses whenever payments on a loan are 90 days past due. But, in recent months, the companies said they would wait until payments were two years late. As a result, tens of thousands of loans have not been marked down in value.

The companies have injected their own capital into pools of securities containing these loans, arguing that their new policies are helping more borrowers.

Under conservative accounting methods, changing these policies would not have any impact on the companies’ books. However, people briefed on the accounting inquiry said that Freddie Mac may have delayed losses with the change.

“We have just had to nationalize the two largest financial institutions in the world because of policy makers’ inaction,” said Josh Rosner, an analyst at Graham Fisher, an independent research firm in New York, and a longtime critic of the government-sponsored enterprises. “Since 2003, when these companies’ accounting came under question, policy makers have done nothing.”
 

Reporting was contributed by Stephen Labaton and Edmund L. Andrews in Washington; Jeff Zeleny from Terre Haute, Ind.; and Elisabeth Bumiller from Colorado Springs.

    Loan Giant Overstated the Size of Its Capital Base, NYT, 7.9.2008, http://www.nytimes.com/2008/09/07/business/07fannie.html?hp

US jobless rise

fuels fears on economy

Published: September 5 2008 14:09
Last updated: September 6 2008 00:16
The Financial Times
By James Politi in Washington,
Krishna Guha in St Paul,
and Michael Mackenzie in New York


The US unemployment rate unexpectedly jumped to a five-year high of 6.1 per cent, suggesting a bleaker picture of the world’s largest economy than thought.

Labor Department data released on Friday showed that employers shed 84,000 jobs in August – the eighth consecutive month of job losses – significantly worse than economists were expecting.

The news dented hopes for a stronger US economy that were stirred last week when the government announced an upward revision to its assessment of gross domestic product growth in the second quarter.

The August jobs report could have a substantial effect on thinking at the Federal Reserve. Hawkishness at the US central bank had already largely subsided after falls in commodity prices, and policymakers now have to worry that unemployment may be climbing faster than they anticipated.

An influential minority of Fed officials now think that further rate cuts cannot be ruled out. However, most policymakers still have what some call a “soft inflation bias”.

That means they still believe the next move in rates is more likely to be up than down, though they are increasingly prepared to keep rates on hold for an extended period.

The S&P 500 fell as much as 1.6 per cent after the report was released but closed 0.4 per cent higher as financials led a late rally.

That snapped a four-day losing streak and trimmed the S&P’s loss this week to 3.2 per cent. The main US markets remained in official bear market territory on Friday, after falling more than 20 per cent from their record 2007 peaks on Thursday.


Ahead of the announcement, shares across Asia-Pacific fell for the fifth consecutive day to hit their lowest levels in 27 months.

In Paris, the CAC 40 closed down 2.5 per cent while in London, the FTSE 100 index ended the session down 2.3 per cent.


Additional reporting by Andrew Wood in Hong Kong

    US jobless rise fuels fears on economy, FT, 5.9.2008, http://www.ft.com/cms/s/0/c0ab7fe6-7b4b-11dd-b839-000077b07658,dwp_uuid=b8efc2ae-d98d-11dc-bd4d-0000779fd2ac.html

A Market Decline in Search of a Reason

September 5, 2008
The New York Times
By MICHAEL M. GRYNBAUM

Stocks on Wall Street plunged on Thursday, but few investors seemed to know why.

A broad sell-off sent the Dow Jones industrial average down 260 points in afternoon trading, hours after the government reported that the number of Americans filing for unemployment benefits unexpectedly rose last week.

But the sharpest declines came nearly two hours after that report was released, a lag that rarely occurs in today’s overheated financial world. The other financial news of the day, including a $2.50 drop in the price of oil, would usually cheer investors. So what gives?

“I’m trying to answer the same question,” Steve Sachs, who directs trading at Rydex Investments, said. With no clear catalyst in sight, Mr. Sachs pointed out that trading was relatively light on Thursday, which means big trades by a handful of investors can cause swings in the major indexes.

“Volumes overall are very, very light,” he said. “If this was happening last week, before Labor Day, everyone would be saying, ‘Don’t read too much into it.’ Nobody’s around. There aren’t a lot of players.”

The confusion was shared by several analysts who were watching stocks fall. By midday, the Standard & Poor’s 500-stock index was off 2.2 percent. The Dow was also trading down 2.2 percent and the Nasdaq composite index had declined 2.3 percent.

Some investors may be looking ahead to the government’s report on unemployment in August, which will be released on Friday. Economists expect the economy to have shed another 70,000 jobs last month, which would be an ominous sign for growth in the fall.

Claims for new unemployment benefits rose 15,000 for the week ended Aug. 30. Claims are now near a seasonally adjusted five-year high of 444,000, the Labor Department said on Thursday, evidence that payrolls probably contracted in August.

“This morning’s employment numbers continue to indicate that the labor sector remains soft at best and looks to continue to shed jobs throughout the remainder of the year,” Joseph Brusuelas, chief economist at Merk Investments, wrote in a note.

But the other economic data released on Thursday was more positive. Productivity in the economy was revised up to 4.3 percent last quarter, far higher than economists had estimated.

A separate private report showed that activity in the services sector grew in August after contracting for months. The non-manufacturing index of the Institute for Supply Management rose to 50.6 from 49.5 in July, on a scale where readings above 50 indicate growth.

In the retail sector, Wal-Mart Stores, the world’s largest retailer, reported a 3 percent jump in sales in August, topping expectations, but many other retailers posted weaker results, citing sluggish back-to-school sales.

    A Market Decline in Search of a Reason, NYT, 5.9.2008, http://www.nytimes.com/2008/09/05/business/economy/05stox.html?hp

August Sales Sluggish for Many Retailers

September 5, 2008
The New York Times
By THE ASSOCIATED PRESS

Many retailers struggled with a sluggish back-to-school season, though Wal-Mart posted higher August sales on Thursday as shoppers focused on buying essentials amid persistent worries about high gas and food prices.

As merchants announced their August sales results, Wal-Mart Stores, the world’s largest retailer, reported a solid gain that beat Wall Street forecasts as consumers stick to low-price operators. But mall-based apparel stores, including merchants like Wet Seal and Abercrombie & Fitch, remained in the doldrums. And the high-end retailers Saks and Nordstrom posted weaker results as their affluent customers start to feel pinched.

“Consumers are spending on necessities and looking for value and the lowest price possible,” Ken Perkins, president of the research company RetailMetrics, said. “And it’s reflective again in the results that we are seeing.” `

A report from the Labor Department offered more evidence that the slowing economy was taking its toll on the job market, a bad sign for consumer spending. The number of workers seeking unemployment benefits jumped unexpectedly last week, reversing three weeks of declines. The number of new applications increased to a seasonally adjusted 444,000, up 15,000 from the previous week. Economists had expected claims to drop to 420,000.

The reports are not comforting to the retail industry as it prepares for the critical holiday season. Many merchants had entered the fall season with inventories well below a year ago, but such reductions may have not been enough as last month proved to be even weaker than planned. Dan Hess, founder and chief executive of the research firm Merchant Forecast, estimated that discounts were 10 percent deeper at mall-based apparel stores than a year ago, despite a drop of 10 percent to 15 percent in inventories.

One encouraging piece of news is that Hurricane Gustav, which hit the Gulf Coast on Monday, was not as bad as analysts feared. But retailers are now getting ready for the next series of tropical storms likes Hanna, which could be become a hurricane when it hits the United States land sometime Saturday.

Wal-Mart reported a solid 3 percent gain in same-store sales, helped by sales of groceries and back-to-school products. Analysts surveyed by Thomson Reuters had expected a 1.6 percent increase. Including fuel, the retailer’s total same-store sales rose 3.5 percent.

Same-store sales are sales at stores opened at least a year and are considered a crucial indicator of a retailer’s health.

“The underlying business performance for Wal-Mart U.S. continued to show strength and the improved relative performance has resulted in market share gains,” Eduardo Castro-Wright, the president and chief executive of Wal-Mart’s American stores, said in a statement.

Wal-Mart expects same-store sales to rise 2 percent to 3 percent in the current month.

At a Wal-Mart rival, the Target Corporation, same-store sales fell 2.1 percent, though that was better than the 2.6 percent decline that Wall Street expected. The discount retailer has not fared as well as Wal-Mart in the weak economy as Target heavily emphasizes nonessentials like home furnishings and trendy jeans.

Another bright spot is warehouse club operators as shoppers buy in bulk. The Costco Wholesale Corporation announced a 9 percent same-store sales increase in August on Wednesday as higher gas prices lifted sales. Analysts had expected a 9.6 percent gain. Excluding the effect of higher gas prices, Costco’s same-stores sales rose 6 percent.

Among luxury department stores, Saks recorded a 5.9 percent drop in same-store sales, steeper than the 4.7 percent decline that Wall Street expected. The weakest categories were women’s apparel, women’s shoes and intimate apparel, while the strongest categories were fashion jewelry, fragrances, men’s sportswear and men’s shoes.

Nordstrom recorded a 7.9 percent drop in sales, a bit worse than the 7.1 percent decline expected.

On Wednesday, J. C. Penney announced that same-store sales at its department store business dropped 4.9 percent, slightly better than the 6.3 percent drop that analysts had projected. Penney also predicted a mid- to high-single digit decrease in sales for the current month.

Kohl’s announced on Wednesday a 5.8 percent drop, though the decline was less steep than the 7.6 percent expected by analysts.

Gap Inc. recorded an 8 percent drop, though it was less steep than the 9.7 percent decline projected by Wall Street.

Limited Brands, the operator of Victoria’s Secret and Bath and Body Works, suffered a 7 percent drop, mostly in line with the 6.9 percent decline estimated from Wall Street.

Business at merchants focused on teenagers was disappointing. Abercrombie & Fitch suffered an 11 percent drop, worse than the 7.9 percent decline expected. Wet Seal recorded an 8.7 percent drop, as demand at its Arden B stores dropped. Analysts expected a decline of 7.5 percent.

Sales at Pacific Sunwear of Californiafell 6 percent, though it was smaller than the 8.8 percent decline projected by Wall Street.

    August Sales Sluggish for Many Retailers, NYT, 5.9.2008, http://www.nytimes.com/2008/09/05/business/05shop.html

Ford Sales Fall 26%,

and No Respite Is Seen

September 4, 2008
The New York Times
By NICK BUNKLEY

DETROIT — The Ford Motor Company said Wednesday that its United States sales dropped 26 percent in August and warned that it did not expect vehicle demand to rebound before the end of the year.

“We expect the second half of 2008 will be more challenging than the first half, as weak economic conditions and the consumer credit crunch continues,” Ford’s marketing chief, James D. Farley, said in a statement.

Sales of Ford’s sport utility vehicles fell 53 percent, while pickup trucks and vans were down 38.5 percent.

Results were expected to be even worse at General Motors and Chrysler, which will report sales later Wednesday afternoon. Chrysler stopped leasing vehicles through its financing arm as of Aug. 1 because it was losing money on many of those deals, a move that undoubtedly drove some potential customers to its rivals.

Toyota Motor also is expected to report lower sales, though it is likely to gain market share at the expense of the Detroit companies.

August is typically among the best months of the year for automakers as they clear out old models and begin introducing their new lineups. But a weak economy, high gasoline prices and slumping home prices are keeping many consumers away from dealerships, even as the car companies keep offering more discounts.

G.M. said Wednesday that it was extending its “employee pricing” sale through the end of September and expanding it to include many 2009 models. The sale was timed to coincide with the company’s 100th anniversary. Two years ago, Detroit automakers began trying to move away from such heavy discounting as they tried to get shoppers to focus more on the vehicles themselves instead of their price.

Before the sale started, analysts estimated that G.M.’s sales in August were on track to be as much as 50 percent lower than a year ago. G.M.’s chief executive, Rick Wagoner, maintained that the company was not slipping back into old habits but said that such deals were necessary right now to increase showroom traffic.

“We’re trying to convince consumers that it’s still a good time to buy a car,” Mr. Wagoner told reporters recently.

Sales of pickup trucks and sport utility vehicles, segments that have historically generated enormous profits, have been dismal for most of this year. Through July, sales of all vehicles were down 10.5 percent across the industry, with pickups and S.U.V.’s down 18.9 percent.

The automakers say demand for trucks increased slightly as gas prices began to recede from their peak earlier in the summer.

Meanwhile, tighter credit markets and scarce supplies of the smaller cars that have become popular this year have hurt sales of those vehicles, too.

Brian Johnson, an analyst with Lehman Brothers, estimated that sales last month were 19 percent lower than in August 2007.

“The very difficult environment for auto sales continues to take a much heavier toll on the Big Three, which are being hit disproportionately by the consumer’s dramatic shift away from traditional trucks towards more fuel-efficient vehicles,” Mr. Johnson wrote in a note to clients.

G.M., Ford and Chrysler are adding more small cars to their lineups and spending billions to retool truck factories so that they can start making more fuel-efficient vehicles, but most will not go on sale until at least 2010.

    Ford Sales Fall 26%, and No Respite Is Seen, NYT, 4.9.2008, http://www.nytimes.com/2008/09/04/business/04auto.html?hp

Op-Ed Contributor

How the Fed Can Fix the World

September 3, 2008
The New York Times
By ROGER C. ALTMAN

SMALL rallies notwithstanding, we are experiencing the most dangerous financial period since the 1930s. In the year since this crisis erupted, huge losses have threatened the solvency of our largest financial institutions. As a result, the Federal Reserve has been forced into increasingly difficult emergency actions, including the rescues of the investment firm Bear Stearns and the mortgage companies Fannie Mae and Freddie Mac, to prevent the entire system from collapsing. To the Fed’s credit, these efforts have worked so far. But financial market conditions may yet worsen and put too much pressure on the Fed.

Legally, the Fed can extend virtually unlimited support to our financial system. If forced, it could reduce short-term interest rates to zero and rescue 10 more financial giants. But there is a point beyond which confidence in the Fed could erode. The downside would be a rise in the inflation rate, a weaker dollar and higher long-term interest rates.

The Federal Reserve is not yet at the edge of that cliff. Let’s hope that further emergencies won’t drag it over. But we must prevent our financial system, and the Fed, from being stretched like this again.

This means addressing the weaknesses that allowed financial firms too much leverage and too little disclosure. Our entire regulatory system, conceived long ago for a different financial world, must be rebuilt. The next president will have no choice but to undertake this task next year.

Today, regulatory authority is divided among the Federal Reserve, the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Office of Thrift Supervision, the Office of Federal Housing Enterprise Oversight, the Securities and Exchange Commission, the Commodity Futures Trading Commission, state banking regulators and state insurance regulators. That’s too many players.

What’s more, this balkanized system supervises only half of the relevant financial universe. It neglects investment banks, hedge funds and institutions like mortgage companies that issue asset-backed securities. The assets of these unregulated entities total about $10 trillion — which is the same amount we see on the regulated side.

The unregulated institutions pose particular risks because they are highly leveraged and financed primarily through short-term money markets rather than customer deposits. And unlike big banks, many of them do not disclose their finances to the public.

The Bear Stearns case vividly illustrated the dangers that come with lack of regulation and transparency. Although Bear Stearns carried $300 billion in liabilities, it was not supervised by the Fed. When it began to fail, the Fed correctly judged that the system might not withstand the shock and arranged a rescue. But suddenly, the Fed was standing behind both the larger banks it regulates and the major investment banks it does not. This cannot continue.

The next president must first create a single framework for the major financial borrowers, administered by the Federal Reserve alone. This wider regulatory umbrella should be more conservative. In particular, the minimum levels of capital and liquidity that financial institutions are required to maintain should be higher than they have been in recent years. And the institutions should put in place better and more detailed systems for reporting — internally as well as to regulators and the public — on all the risks they are taking.

These steps, as they make institutions more stable, will also reduce their financial leverage and thus their ability to generate earnings. Their managements won’t like it, but the institutions — and, indeed, the entire financial system and the Fed itself — will be less exposed when severe turbulence hits the financial markets again.

For its part, the S.E.C. should require that publicly owned financial institutions provide more data in their quarterly reports. Any risks that the institutions retain, whether on or off their balance sheets, should be disclosed. And they should better explain the methods they use to determine the values of their own assets.

To fulfill its wider supervisory role, the Fed should also be given the authority to collect data from firms that are not publicly owned, including hedge funds and commodities trading firms.

Finally, much stronger restrictions should be imposed on the kinds of predatory mortgage-lending practices that preceded this crisis. The Fed recently proposed new rules for banks that would, for example, require better verification of borrowers’ income and reduce onerous prepayment penalties. These rules should be applied to all mortgage lenders. For those institutions not managed by the Fed, the rules should be enforced by other federal agencies or state banking regulators.

It usually takes a severe crisis to bring about systemic change. The upside to the punishing turmoil in our financial system is the growing probability that regulatory overhaul is at hand. And that’s good, because without it the Fed might be unable to save the system next time.
 

Roger C. Altman was the deputy secretary of the Treasury during the first Clinton administration.

    How the Fed Can Fix the World, NYT, 3.9.2008, http://www.nytimes.com/2008/09/03/opinion/03altman.html

Abu Dhabi Puts More Cash

on the Line in Hollywood

September 3, 2008
The New York Times
By TIM ARANGO

Last September, Abu Dhabi Media Company, an arm of the government in the city-state capitol of the United Arab Emirates, reached a $1 billion deal to make movies and video games with Warner Brothers, the big Hollywood studio owned by Time Warner.

A year later, the two partners have announced just one movie: “Shorts,” a family-friendly adventure film by the director Robert Rodriguez and starring William H. Macy.

But that has not stopped Abu Dhabi Media, flush with oil cash, from spreading even more money around the movie business.

The company, which was created last year by the government of Abu Dhabi, is starting a new subsidiary that will spend about $1 billion more over the next five years making feature-length films in partnership with three American producers, said Edward Borgerding, the chief executive of Abu Dhabi Media Company.

At the same time, the new company, called Imagenation Abu Dhabi, will manage Abu Dhabi Media’s side of the partnership with Warner Brothers. In addition to movies, Imagenation will also create shows and short films for the Internet.

“We certainly want to be in that business and see how it works and take advantage of how the media world is evolving,” said Mr. Borgerding, who added that the company would announce its American partners during the Toronto Film Festival, which will run Thursday through Sept. 13. “There’s a lot of creative destruction going on.”

The deal, to be announced Wednesday, comes amid a flurry of partnerships being created between Hollywood studios and outfits in Abu Dhabi and Dubai in the U.A.E. But many of those have been aimed at creating studios, theme parks and multiplexes in the U.A.E., and in supporting Arab filmmakers.

Direct investment in films is a little trickier: Abu Dhabi Media is controlled by the government, and media companies in the United States do not like to be seen making such deals. The new name, Imagenation Abu Dhabi, gives Warner and other film companies a more politically palatable name to put on promotional materials for jointly financed movies.

Each of the three American production partners will open offices in Abu Dhabi, Mr. Borgerding said. While the focus will be on producing Hollywood-type films for English-speaking audiences, Mr. Borgerding said the company also would like to cater to the Arabic-language audience by making movies with Arab stars and Middle Eastern filmmakers.

“We’re not just writing the checks,” Mr. Borgerding said of his partners. “These are people who will be matching us dollar for dollar.”

While Hollywood was awash in hedge fund and private equity money a few years ago — both MGM and the Weinstein Company, the film company started by the brothers Bob and Harvey Weinstein, were recipients of private money — that flow of Wall Street cash has since slowed, though it has not stopped.

Some hedge funds that invested in slates of films found themselves stung when movies flopped at the box office. Other funds have been hurt by the credit crisis.

But entertainment executives, by and large, do not consider money from the oil-rich Middle East as a replacement for slowing hedge fund dollars. Because of cultural and religious issues, financing from the Middle East, especially those from a government used to controlling the media, is unlikely to come without restrictions.

In a statement, Mohamed Khalaf al-Mazrouei, the chairman of the Abu Dhabi Media Company and director general of the Abu Dhabi Authority of Culture and Heritage, a government agency, said: “Abu Dhabi has established itself as a major player in the global economy, as evidenced through recent activity in the energy, real estate and transportation sectors. Media is no different, and Abu Dhabi Media Company is fulfilling its ambition to become a global player in the media industry.”

Abu Dhabi is also becoming a cultural and media center in the region. Last year, Abu Dhabi Media started The National, an English-language broadsheet newspaper in Abu Dhabi edited by a former editor of The Daily Telegraph in Britain. The government has also enticed the Louvre and Guggenheim museums to establish outposts there.

So why is now a good time to pump money into Hollywood?

“Primarily because you are kind of buying in at the bottom of the cycle,” Mr. Borgerding said. “The subprime thing hit a lot of those hedge funds. There was a glut of films because a lot of money was chasing a finite amount of creative talent and good stories.”

Mr. Borgerding, who grew up in Cleveland and now divides his time between Abu Dhabi, London and Los Angeles, said Imagenation would make six to eight movies a year, with budgets of $10 million to $50 million a film.

“We’re not going to be making the Hollywood blockbuster type,” he said, which typically can have budgets of more than $100 million.

    Abu Dhabi Puts More Cash on the Line in Hollywood, NYT, 3.9.2008, http://www.nytimes.com/2008/09/03/business/worldbusiness/03fund.html

Despite Lower Oil Prices,

Little Relief for Consumers

September 3, 2008
The New York Times
By LOUIS UCHITELLE
and MICHAEL M. GRYNBAUM

As oil prices surged this year, manufacturers raised the prices of a lot of products — not just gasoline but lotions, toothpaste, plastics and many more items that use oil as a raw material. But now that oil costs are plunging, other prices are not following them lower — not yet, anyway.

Even though oil prices have fallen closer to $100 a barrel, from $147 about two months ago, many companies that cited higher energy costs for increasing prices are resisting a rollback, saying they still need to recover money lost in the run-up.

Crude oil prices slid Tuesday by $5.75, to $109.71 a barrel, down 25 percent from the high on July 11, as Hurricane Gustav passed near New Orleans without damaging oil production facilities. The Dow Jones industrial average jumped more than 220 points before falling as energy company shares lost ground.

As oil tumbles, prices at the gas pump come down. But the costs of many other products have not. Procter & Gamble, for example, has raised by 7 percent to 10 percent the prices it charges retailers for items made with ingredients derived from oil. The company is planning to maintain the increase “to recover costs already incurred,” Paul Fox, a spokesman, said.

Such decisions will come as little relief for thousands of retailers and wholesalers that have been forced to squeeze margins instead of passing their elevated costs to consumers, who have cut back on consumption of finished goods as their bills for groceries and gas jumped.

P.& G., Dow Chemical, Goodyear Tire and Rubber Company, as well as other big users of oil-based raw materials, are waiting to see if oil prices will stay down or continue to fall before they commit to price cuts.

“Everybody still feels there is too much uncertainty to be clear about what action they should take,” said Ali Dibadj, an analyst at Sanford C. Bernstein, who specializes in companies that use oil-based raw materials in making a variety of consumer products. “They won’t immediately drop their prices.”

Until recently, robust growth in Europe and a seemingly endless thirst for petroleum in China and developing nations lifted global demand for oil, and the price with it. But now some economies, especially in Europe, are weakening almost more rapidly than America’s, lifting the dollar. That should help relieve price pressures over all by making imports — as well as oil prices — cheaper.

This uncertainty helps to explain why Dow Chemical, for example, which had raised prices this year by nearly 50 percent for the oil-based raw materials that go into the manufacture of products like diapers and polystyrene, does not want to give up those increases until the company recovers its old profit margins. “Our prices continue to lag our cost increases,” the spokesman, David Winder, said.

And Goodyear Tire and Rubber, which has raised tire prices by 15 percent this year, said it was still making synthetic rubber tires from oil-based feed stocks bought at relatively high prices more than three months ago.

Keith Price, a Goodyear spokesman, said Goodyear could not consider canceling the price increase until it knew whether oil prices were going to stay down.

The decline in oil prices has also dragged the cost of other commodities sharply lower since early summer. Corn, in particular, has slumped: it settled on Tuesday at $5.69 a bushel, down 29 percent since June 27. Soybean prices are down 21 percent in the same period.

Despite the steep declines in the cost of raw ingredients, prices for packaged foods sold at supermarkets are likely to remain higher than they were last year, said Ephraim Leibtag, an economist who studies food markets for the Agriculture Department.

With oil prices in sharp decline, the nation’s millions of car owners are a little better off. The average price of a gallon of gas settled at $3.68 on Tuesday, down from a record $4.11 in mid-July. “That’s a 43-cent decline,” said Ellen Hughes-Cromwick, chief economist for the Ford Motor Company. “It’s almost like a tax cut for consumers.”

Just the opposite holds for commuters who travel on the nation’s airlines. The major carriers have pushed through 15 price increases since the beginning of the year, with 11 of them depicted as fuel surcharges. None of the domestic airlines has stated how or when the surcharges might be removed, making them the equivalent of price increases, said Rick Seaney, who runs FareCompare.com, a Web site offering information on plane fares.

Like Procter & Gamble, Dow Chemical and Goodyear, the airlines suggest that what they do with fares depends on what happens to the price of oil over the long run.

“We would love to see it come down and stay down,” said Betsy E. Talton, a Delta spokeswoman.

Interest rates were slightly lower with the rate on the 10-year Treasury note at 3.73 percent, down from 3.81 percent late Friday. The price, which moves in the opposite direction from the yield, rose 21/32, to 102 6/32.

Despite Lower Oil Prices, Little Relief for Consumers, NYT, 3.9.2008, http://www.nytimes.com/2008/09/03/business/03commodities.html