The financial crisis
Wall Street's bad dream
A nightmare that seems like it will never end
THE carnage of the past fortnight may have an unreal air to it, but the damage is all too tangible—whether the seizure of Fannie Mae and Freddie Mac by their regulator, the record-breaking bankruptcy of Lehman Brothers (and the sale of its capital-markets arm to Barclays), Merrill Lynch’s shotgun marriage to Bank of America or, most shocking of all, the government takeover of a desperately illiquid American International Group (AIG).
Contagion has spread far and wide, on Thursday September 18th central banks launched a co-ordinated attempt to pump $180 billion of short-term liquidity into the markets. HBOS, Britain’s biggest mortgage lender, also sold itself to Lloyds TSB, one of the grandfathers of British banking, for £12.2 billion ($21.9 billion) after its share price plunged. The government was so anxious to broker a deal that it was expected to waive a competition inquiry.
The rescue of AIG was justified on the grounds that letting it fail would have been catastrophic for financial markets. As it happened, even AIG’s rescue did not stop the bloodletting. On Wednesday shares in Morgan Stanley and the other remaining big investment bank, Goldman Sachs, took a hammering. Even though both had posted better-than-expected results a day earlier, confidence ebbed in their stand-alone model, with its reliance on flighty wholesale funding. An index that reflects the risk of failure among large Wall Street dealers has climbed far above its previous high, during Bear Stearns’s collapse in March (see chart).
It is a measure of the scale of the crisis that, by the evening of Wednesday, all eyes were on Morgan Stanley, and no longer on AIG, which only 24 hours before had thrust Lehman out of the limelight. After its share price slumped by 24% that day, and fearing a total evaporation of confidence, Morgan attempted to sell itself. Its boss, John Mack, reportedly held talks with several possible partners, including Wachovia, a commercial bank, and Citic of China.
Though officials are putting on a brave face, they could be forgiven for feeling at a loss as one great name buckles after another and investors flee any financial asset with the merest whiff of risk. Even the politicians have been stunned into inactivity. Congress probably will not pass new financial legislation this year, admitted Harry Reid, the Senate majority leader, because “no one knows what to do.”
At times, the responses appear alarmingly piecemeal. Amid a fresh clamour against short-sellers—Morgan Stanley’s Mr Mack accused them of trying to wrestle his stock to the ground—the Securities and Exchange Commission, America’s main markets regulator, brought back curbs on “naked”, or potentially abusive, shorts. It also rushed out a proposal forcing large investors, including hedge funds, to disclose their short positions. Calstrs, America’s second-largest pension fund, said it would stop lending shares to “piranhas”.
As in August 2007, when the crisis began in earnest, money markets were this week seizing up. The price at which banks lend each other short-term funds surged, leaving the spread over government bonds at a 21-year high. A scramble for safety pushed the yield on three-month Treasury bills to its lowest since daily records began in 1954—the year President Eisenhower introduced the world to domino theory.
Aptly enough, the crisis is spreading from one region to the next. Asian and European stockmarkets suffered steep falls. Another weak spot is the $62 trillion market for credit-default swaps, which has given regulators nightmares since the loss of Bear Stearns. It did not fall apart after the demise of Lehman, another big dealer. But it remains fragile; or, as one banker puts it, in a state of “orderly chaos”.
Consumers are already twitchy in America, where bank failures are rising and the nation’s deposit-insurance fund faces a potential shortfall. The failure of Washington Mutual (WaMu), a troubled thrift, could at the worst wipe out as much as half of what remains in the fund, reckons Dick Bove of Ladenburg Thalmann, a boutique investment bank. WaMu was said this week to be seeking a buyer.
No less worrying are the cracks appearing in money-market funds. Seen by small investors as utterly safe, these have seen their assets swell to more than $3.5 trillion in the crisis. But this week Reserve Primary became the first money fund in 14 years to “break the buck”—that is, to expose investors to losses through a reduction of its net asset value to under $1—after writing off almost $800m in debt issued by Lehman.
Any lasting loss of confidence in money funds would be hugely damaging. They are one of the last bastions for the ultra-cautious. And they are big buyers of short-term corporate debt. If they were to pull back, banks and large corporations would find funds even harder to come by.
At some point the Panic of 2008 will subside, but there are several reasons to expect further strain. Banks and households have started to cut their borrowing, which reached epic proportions in the housing boom, but they still have a long way to go. Furthermore, it is far from clear, even now, that banks are marking their illiquid assets conservatively enough.
The pain is only now beginning in other lending. “We may be moving from the mark-to-market phase to the more traditional phase of credit losses,” says a banker. This next stage will be less spectacular, thanks to accrual accounting, in which loan losses are realised gradually and offset by reserves. But the numbers could be just as big. Some analysts see a wave of corporate defaults coming. Moody’s, a rating agency, expects the junk-bond default rate, now 2.7%, will rise to 7.4% a year from now. Like many nightmares, this one feels as if it will never end.
Sept. 18 (Bloomberg) -- The Democratic-controlled Congress, acknowledging that it isn't equipped to lead the way to a solution for the financial crisis and can't agree on a path to follow, is likely to just get out of the way.
Lawmakers say they are unlikely to take action before, or to delay, their planned adjournments -- Sept. 26 for the House of Representatives, a week later for the Senate. While they haven't ruled out returning after the Nov. 4 elections, they would rather wait until next year unless Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben S. Bernanke, who are leading efforts to contain the crisis, call for help.
One reason, Senate Majority Leader Harry Reid said yesterday, is that ``no one knows what to do'' at the moment.
``When you rush to judgment, you usually make mistakes,'' said Sherwood Boehlert, a former Republican congressman from New York. ``This is something you can't go on forever without addressing, but Congress in a short span of time is best served by going home.''
In 2002, after accounting scandals forced Enron Corp. and WorldCom Inc. into bankruptcy, Congress passed the Sarbanes-Oxley law, setting new corporate-governance rules. While the measure passed unanimously in the Senate and overwhelmingly in the House, it has since become a target of criticism from some Republicans, including presidential candidate John McCain, and from many in the business and financial worlds.
``There's a huge danger that needs to be guarded against -- that we'll have a tremendous overreaction in regulations,'' former Treasury Secretary John Snow said in an interview.
Reid's `Despair'
Still, the Democrats opened themselves up for attack with Reid's comments. The Republican National Committee pounced on the Nevada lawmaker for his ``despair,'' and Senator Mel Martinez, a Florida Republican, said his remarks are ``not a way to inspire confidence or begin to turn the tide.''
And there were some calls for at least a bipartisan show of leadership during the crisis, which has resulted in the collapse of mortgage giants Fannie Mae and Freddie Mac, investment banks Lehman Brothers Holdings Inc. and Bear Stearns Cos., and insurer American International Group Inc., among other companies.
Unless party leaders on both sides of the aisle join with President George W. Bush to endorse a solution, there's little Congress and the president can do in the near term to restore market confidence, said Chuck Gabriel, managing director of Capital Alpha Partners LLC, which advises investors on politics and Washington.
White House Lawn
Wall Street would respond positively ``if the president and Treasury Secretary Paulson and a couple of Cabinet members and the Republican and Democratic leadership all went on the White House lawn and said that we are resolved to taking additional measures in the coming weeks despite the elections to ensure that confidence is restored,'' Gabriel said.
``But the odds of that seem very, very low.''
Some committee chairmen have scheduled hearings and promised better oversight.
Representative Henry Waxman, chairman of the House Oversight and Government Reform Committee, will hold two days of hearings on Oct. 6 and 7 ``to examine what went wrong and who should be held to account'' at AIG and Lehman Brothers, which filed for bankruptcy on Sept. 15.
Waxman's committee summoned Lehman Chief Executive Officer Richard Fuld, AIG CEO Robert Willumstad and former AIG chiefs Maurice ``Hank'' Greenberg and Martin Sullivan to speak.
`Work Will Continue'
House Speaker Nancy Pelosi defended the decision of Congress to adjourn. Lawmakers can always be recalled to Washington ``if there is a need to do so,'' she told reporters yesterday. In the meantime, House and Senate committees will hold hearings and the financial crisis will be studied by Congress, she said. ``Our work will continue even if we are not still on the floor,'' she said.
House Financial Services Committee Chairman Barney Frank said Congress could give the Federal Reserve authority to pay interest on bank reserves sooner than originally scheduled.
``They already have the authority; it's just a question of moving it up a couple of years,'' Frank, of Massachusetts, told reporters yesterday. ``We're trying to work that out.''
Senate Banking Committee Chairman Christopher Dodd said the Fed also has the power to buy and dispose of bad debt stemming from the subprime-mortgage crisis.
``The Fed has the authority to move in this area,'' Dodd told reporters in Washington.
No `Quick Fixes'
Creating a separate agency to take on bad debt, akin to the Resolution Trust Corp. set up in 1989 to absorb losses from savings-and-loan associations, would take about a year, he said. Instead, the Fed should use its own authority to act.
Senator Johnny Isakson, a Georgia Republican active on housing issues, scoffed at suggestions that lawmakers postpone adjournment to rewrite laws governing the financial markets.
``The last thing you need,'' he said, ``are 535 people, not many of whom are that well-versed in financial markets, trying to do quick fixes to a market correction that's one of the more significant that we've ever seen.''
Sept. 18 (Bloomberg) -- The rapid-fire rescues of financial firms may end up tarnishing America's free-market reputation as the moves expose defects in the U.S. economy, undermining its standing with foreign buyers of the dollar and U.S. Treasury securities.
The government's actions might add hundreds of billions to a budget deficit already expected to hit a record next year. The salvage operations, which include Tuesday's takeover of American International Group Inc., also raise questions about the U.S. commitment to a free-market economy that, until recently, was the envy of the world.
America's credit ``profile is now weaker because contingent risks have become actual risks to the U.S. government,'' said John Chambers, managing director of sovereign ratings at Standard & Poor's in New York.
The result: Foreign investors may demand higher compensation for providing the money the U.S. government and economy depend on. That, in turn, could translate into lower living standards for Americans as borrowing costs are pushed higher and the dollar is pulled lower.
There's not much evidence that any of this is happening yet. The yield on the 10-year Treasury note fell to 3.4 percent yesterday from 3.9 percent two months earlier as investors sought refuge from the recent turmoil in financial markets. The U.S. currency, meanwhile, has strengthened to $1.43 per euro from $1.59 on July 17.
Hedge Against Losses
Yet in what may be a sign that the complacency won't last, the cost to hedge against losses on U.S. government debt rose to a record yesterday after the Federal Reserve's rescue of insurance giant AIG. Benchmark 10-year credit-default swaps on Treasuries increased 4 basis points to 30, more than double those on government debt sold by Austria, Finland or Sweden, according to BNP Paribas SA.
Until now, the U.S. has enjoyed a special status among investors, thanks to the size of its economy, the power of its military and the depth of its financial markets. The dollar supplanted the British pound as the world's reserve currency after World War II, enabling America to borrow freely from abroad and run up big trade deficits. All this fed the country's sense that the U.S. was exceptional, destined to be the global political and economic leader.
America can no longer take its privileged position for granted. It has already lost some of its diplomatic luster because of President George W. Bush's go-it-alone foreign policy and the invasion of Iraq.
Dollar's Rival
The successful introduction of the euro a decade ago has created a rival for the dollar as the world's main currency for trade and investment. The rapid growth of emerging markets, particularly China, has also undercut America's attractiveness to the world's financiers.
That's why the ongoing financial turmoil is so dangerous. The meltdown has created ``a crisis of confidence in the U.S. government,'' said Jim Leach, a former Republican U.S. congressman from Iowa who is now a professor at Princeton University in New Jersey. ``The twin pinions of American strength -- our politics and our finance -- are under the gun today.''
Estimates of the eventual price the U.S. government will have to pay to end the credit crisis vary widely, ranging as high as $2 trillion. Many are lower than that, at roughly a half-trillion dollars -- equal to about 4 percent of gross domestic product. Kenneth Rogoff, an economics professor at Harvard, wrote in the Financial Times today that the U.S. may have to spend between $1 trillion and $2 trillion.
Facing Liabilities
While such a bill would be more than twice what the U.S. paid in today's dollars to resolve the savings-and-loan crisis in the early 1990s, budget experts said it would be manageable to finance on its own. The trouble is, the federal government already faces liabilities in the tens of trillions of dollars as baby boomers retire and begin collecting Social Security and medical benefits.
Joshua Rosner, an analyst with research firm Graham Fisher & Co. in New York, said the costs are unclear partly because the Treasury is effectively keeping some of them off the government's balance sheet by parking them at the Fed. That's the same sort of practice that got Citigroup Inc. and other banks in trouble during the now year-old credit crisis.
Fed Chairman Ben S. Bernanke and his colleagues committed $29 billion to back the takeover of Bear Stearns Group by JPMorgan Chase & Co. in March. Treasury Secretary Henry Paulson followed with a pledge this month of as much as $100 billion each for Fannie Mae and Freddie Mac to ensure that the two mortgage companies continue supporting the battered housing market. The Fed then kicked in an additional $85 billion this week for AIG.
Reassure Investors
Harvey Pitt, chief executive officer of Kalorama Partners in Washington and former chairman of the Securities & Exchange Commission, argued the rescues would help reassure foreign investors that the U.S. isn't prepared to accept a free-fall in financial markets. The bailouts, unfortunately, also do something else: They highlight the fragility of the U.S. financial system.
``The foreigners are torn right now,'' said Mohammed El- Erian, co-chief executive officer of Pacific Investment Management Co. in Newport Beach, California. ``On the one hand, they are stunned by what is happening to the U.S. financial system. On the other, they are impressed that we are getting a policy response that is relatively fast.''
Sovereign-wealth funds invested just $900 million in new capital in U.S. and European financial institutions so far this quarter. That's down from $6.43 billion in the second quarter, $19.7 billion in the first and $28.5 billion in the final quarter of last year, according to data compiled by Bloomberg News.
Increasing Uncertainty
Nobel Prize-winning economist Joseph Stiglitz said that the haphazard nature of the bailouts may discourage investors from putting money in the U.S. because it increases uncertainty about who will survive and who will fail.
``We used to believe that America was a country or a government that was based on the rule of law,'' the Columbia University professor said in a Sept. 16 interview on Bloomberg Radio. ``Today, we appear to be a law of discretion. Who gets bailed out seems to be totally up to the discretion of Paulson, of Bernanke.''
William Poole, a senior economic adviser at Merk Investments LLC and former St. Louis Fed president, said in a Bloomberg Television interview yesterday that the market system would be hurt by increased regulation in the wake of the rescues.
`Heavier Regulatory Hand'
``It is likely that we will see a much heavier regulatory hand that, in the end, is going to saddle lots of companies with unnecessary costs and damage our market system,'' said Poole, a Bloomberg News contributor.
Foreigners' appetite for investing in the U.S. may also be tempered by the impact of the crisis on the economy. Allen Sinai, chief economist at Decision Economics in New York, said the U.S. is in for an extended recession as the financial- services industry -- a major source of increased productivity growth in the past -- consolidates.
``The federal government assumes that it can borrow whatever it wants from foreign lenders at low interest rates for as long as it wants,'' said David Walker, former comptroller of the U.S. Government Accountability Office who's now head of the Peter G. Peterson Foundation in New York. ``That's an imprudent assumption.''
Sept. 18 (Bloomberg) -- President George H.W. Bush once introduced Condoleezza Rice to his Soviet counterpart as the aide ``who tells me everything I know about the Soviet Union.''
``I hope she knows a lot,'' Mikhail Gorbachev replied during the 1989 encounter, according to Rice biographer Elisabeth Bumiller.
Now, after seven years of focusing mostly on terrorism and the Middle East, Secretary of State Rice's original specialty confronts her with one of her toughest challenges: How to restrain a resurgent Russia while keeping lines open to the world's biggest energy exporter and second-largest nuclear power as the U.S. seeks its help on various fronts, including Iran and North Korea.
``We and our partners will need to push back hard and systematically against Russian behavior,'' Undersecretary of State William Burns told the Senate Foreign Relations Committee yesterday. But ``it is very important, in a tough-minded way, to stay engaged with them.''
Rice, who joined current President George W. Bush's administration as national security adviser in 2001, will spell out her views on Russia today in Washington. Her speech to the German Marshall Fund of the United States, a transatlantic public-policy organization, will be her first on Russia since last month's war in Georgia.
Since that fight, over Georgia's pro-Moscow breakaway region of South Ossetia, Rice and other U.S. officials have branded Russia as the aggressor and rallied allies around that view. The Americans have been less successful in persuading Prime Minister Vladimir Putin and President Dmitri Medvedev to ease their pressure on Georgia and other former Soviet republics.
Call to Lavrov
In an indication that she considers continued engagement crucial, Rice on Sept. 11 telephoned her Russian counterpart, Sergei Lavrov. In their first contact since mid-August, the conversation went beyond Georgia, covering Iran, North Korea and India, State Department spokesman Sean McCormack said.
Rice's condemnations of Russia's behavior have stressed the disparity between its gains and losses.
She told reporters Aug. 20 that Russia's war with Georgia had proven merely ``that it can use its overwhelming regional and military power against a small neighbor'' -- at the price of showing that ``its president doesn't keep its word.''
The U.S. has countered Russia's Georgia incursion by suspending a civilian nuclear deal and military cooperation, while sending humanitarian aid to Georgia on military planes and vessels and promising it $1 billion in long-term economic help.
Russian leaders have warned the U.S. that any attempt to impose economic penalties would be futile and counter-productive.
No `Banana Republic'
``It makes no sense to put pressure on the Russian Federation with the help of sanctions,'' Medvedev told business leaders on Sept. 15. ``It is no doubt possible to cut off a couple of channels to some banana republic and the situation there would turn dramatic, but this would not be the case here.''
Wayne Merry, a former U.S. diplomat in Moscow, says Russian leaders are comforted by their country's oil and gas windfall and give little thought to consequences. He compares them to a habitually losing gambler in a Fyodor Dostoyevsky novel whose luck has finally turned.
``He's euphoric and thinks he's on top of the world,'' said Merry, an analyst at the American Foreign Policy Council in Washington.
Pushing Russia too hard runs the risk of losing its cooperation in checking Iranian and North Korean nuclear ambitions and combating terrorism. Another constraint is the reluctance of its European allies to confront the country that supplies most of their gas. It will be at least four years before the completion of two U.S.-backed pipeline projects bringing gas from the Caspian region to Europe via Turkey, bypassing Russia.
Need for Capital
Russia has much to lose if its relations with the West deteriorate, because its economy remains underdeveloped and dependent on Western capital and technology.
``The Russians have to decide whether Gazprom or South Ossetia is more important to them,'' said Michael McFaul, a Russia expert at Stanford University in California and former Rice colleague, referring to the Moscow-based energy giant.
Since the conflict, the ruble has fallen to its lowest level in almost a year, investors have pulled about $35 billion out of Russia and the country's RTS stock index has had its worst slump since the 1998 government debt default. Russia put $44 billion into its three biggest banks yesterday as the crisis grew. Medvedev adviser Igor Yurgens said fallout from the Georgia conflict was worsening the stock market decline.
Anders Aslund, an adviser to the Russian government from 1991 to 1994, said the market is exacting its own punishment. ``It's the credit market that's really hit them,'' he said.
Gates, Leverage
That may give Rice and Defense Secretary Robert Gates, another Kremlinologist, leverage as they seek to influence Russia before they turn the problem over to successors in four months, when Bush's term ends.
Gates, 64, worked as a Soviet specialist at the Central Intelligence Agency. Rice, 53, made her reputation by helping the first President Bush bring the Soviet-bloc collapse and German unification to peaceful conclusions. Both now find their careers coming full circle.
Years after the German negotiations, Rice told Bumiller that the key to their success was the first President Bush's ability to manage them ``in a way that the Soviets believed there were no losers.''
``That's the value of diplomacy,'' Rice said. ``Letting the other guy have the face-saving way out.''
Sept. 18 (Bloomberg) -- European stocks and U.S. index futures climbed and Asian shares pared declines after the world's largest central banks said they will pump $247 billion into the financial system.
HBOS Plc rallied 45 percent as Lloyds TSB Group Plc agreed to acquire the U.K.'s biggest mortgage lender. UBS AG and Barclays Plc advanced more than 4 percent. Washington Mutual Inc. soared 18 percent in German trading on speculation of a sale for parts of the largest U.S. savings and loan. Volkswagen AG increased 13 percent as investors speculated that Porsche SE will make a full takeover.
Europe's Dow Jones Stoxx 600 Index added 0.9 percent to 260.34 at 1:34 p.m. in London, rebounding from its steepest three-day slide since 2002. Futures on the Standard & Poor's 500 Index climbed 1 percent. The MSCI Asia Pacific Index declined 2 percent, paring an earlier drop of as much as 4.3 percent.
``The central banks are aware of the problems, which is good, and they are being as proactive as they possibly can,'' Julian Chillingworth, who oversees about $2.5 billion as chief investment officer at Rathbone Unit Trust Management, said in an interview on Bloomberg Television. ``You could see the market have a knee-jerk reaction. It is positive, but it also underlines the level of the problem.''
More than $19 trillion has been wiped off global stock- market value since Oct. 31 as the worst U.S. housing recession since the Great Depression and more than $500 billion in credit losses and writedowns at banks slowed the world economy.
Dollar Funds
The S&P 500's slump from its October record has now reached 26 percent after Lehman Brothers Holdings Inc. filed for bankruptcy this week and the government had to take over American International Group Inc. The benchmark for U.S. equities has erased half its advance from the five-year bull market that ended last year.
Stocks in Europe extended gains after a report showed retail sales in the U.K. rose 1.2 percent in August. Economists had forecast a 0.5 percent drop, according to the median in a Bloomberg News survey. Kingfisher Plc led retailers higher, climbing 9 percent.
The Fed said today it authorized other central banks to auction $247 billion in dollar funds to financial institutions in a coordinated bid to ease the worst crisis facing financial markets since the 1920s. The Bank of Canada and the Swiss National Bank also participated.
HBOS Takeover
HBOS soared 45 percent to 214 pence. Lloyds, the bank that considered buying Northern Rock Plc, agreed to acquire HBOS for 232 pence a share, or about 12.2 billion pounds ($22.2 billion), to create a company that controls more than a quarter of the U.K. mortgage market. Lloyds shares rose 0.6 percent to 281.5 pence.
``We are finally getting to see the unraveling of the casualties,'' said Mike Lenhoff, who helps oversee about $36.4 billion as chief strategist at Brewin Dolphin Securities Ltd. in London. ``We have reached the point which could hopefully be the final phase of this,'' he said in a Bloomberg Television interview.
UBS, Switzerland's biggest bank, added 5.7 percent to 16.6 francs. Barclays Plc, the U.K.'s third-largest bank, climbed 4.6 percent to 332.25 pence.
The cost of borrowing in dollars overnight declined. The London interbank offered rate, or Libor, fell 1.19 percentage points to 3.84 percent today, according to the British Bankers' Association. It was at 2.15 percent last week.
Credit-Default Swaps
The cost of protecting European corporate bonds from default dropped today, according to traders of credit-default swaps.
Washington Mutual rallied 18 percent to $2.37 in Germany. JPMorgan Chase & Co., Citigroup Inc., Bank of America Corp. and Wells Fargo & Co. may bid for the company, three people with knowledge of the discussion said. Buyers may be interested only in pieces of Seattle-based WaMu, said the people, who asked not to be identified because the talks are private.
Brad Russell, a spokesman for Washington Mutual, declined to comment yesterday, as did JPMorgan spokesman Joseph Evangelisti and Wells Fargo spokeswoman Julia Tunis Bernard. Officials at Citigroup and Bank of America in London also declined to comment.
Volkswagen advanced 15 percent to 275.87 euros, climbing for a third straight day.
``The current share-price development shows that the market believes in a full takeover,'' Frankfurt-based Commerzbank AG analyst Gregor Claussen wrote to investors today. ``A further increase to above 50 percent is likely to happen around October/November.'' Claussen recommends selling the stock.
Kingfisher, Hays
Kingfisher rose 8.3 percent to 129.7 pence. Less discounts helped first-half profit at Europe's biggest home-improvement retailer to top analysts' estimates even as U.K., Irish and Spanish house prices declined.
Hays Plc, Britain's largest recruitment company, gained 10 percent to 84.75 pence after Royal Bank of Scotland Group Plc upgraded the shares to ``buy'' from ``hold,'' saying the current price is already discounting a global recession.
Ryanair Holdings Plc rallied 6.3 percent to 2.72 euros. Europe's biggest discount carrier said it will break even this fiscal year following the recent decline in oil prices.
Pernod-Ricard SA, the world's second-largest liquor maker, declined 5.1 percent to 58.87 euros after reporting the smallest profit increase in three years and saying weaker economies will hamper growth.
Sept. 18 (Bloomberg) -- The Federal Reserve almost quadrupled the amount of dollars central banks can auction around the world to $247 billion in a coordinated bid to ease the worst crisis facing financial markets since the 1920s.
The Fed increased the amount of dollars that the European Central Bank, the Bank of Japan and other counterparts can offer from $67 billion ``to address the continued elevated pressures in U.S. dollar short-term funding markets.'' The Bank of England, the Bank of Canada and the Swiss National Bank also participated.
Policy makers have struggled to revive confidence in markets this week as investors stockpiled money on concern more financial institutions would fail after the bankruptcy of Lehman Brothers Holdings Inc. and the U.S. government bailout of American International Group Inc. The cost to hedge against losses on U.S. government debt climbed to a record yesterday.
``There's a complete lack of faith in the markets,'' said Jim O'Neill, chief economist at Goldman Sachs Group Inc. in London. ``There's a lot of cash hoarding and people losing trust in banks, so the central banks are acting to relieve that. This might not be the last time they have to act.''
Markets welcomed the announcement, which was made in statements from each central bank at 9 a.m. Frankfurt time at the start of European trading. The cost of borrowing dollars overnight slid to 3.84 percent from 5.03 percent yesterday. It was 2.15 percent last week and reached the highest since 2001 on Sept. 15.
Limit Doubled
The Fed, which is adding $50 billion into its own banking system today, will spray dollars around the world via swap lines with other central banks. They can then auction them in their own markets. The ECB, Bank of England and Swiss National Bank allotted a total of $64 billion for one day today.
``The timing, so early in the trading day, shows both the severity of the strains in the interbank market and as well the authorities' determination to resuscitate orderly functioning of the money markets,'' said Julian Callow, head of European economics at Barclays Capital in London.
Under the new arrangements, the ECB doubled the limit of dollars it can get from the Fed to $110 billion and Switzerland's central bank can offer $27 billion, an extra $15 billion. New swap facilities with the Bank of Japan, the Bank of England and the Bank of Canada amount to $60 billion, $40 billion and $10 billion, respectively. The arrangements are authorized until Jan. 30.
Use as Necessary
The ECB said it would offer $40 billion ``for as long as needed'' in overnight funds to the region's banks. It will also increase by $5 billion the amount it lends for 28 days and 84 days to $25 billion and $15 billion. The Swiss National Bank will boost its 28-day auctions to $8 billion and the 84-day offering to $9 billion. Both were previously $6 billion.
The Bank of Canada said it has decided not to draw on its $10 billion swap facility at this time. The Bank of Japan, whose policy board held an emergency meeting today, said it will use its $60 billion as required by market conditions.
In auctions of their own currencies, the ECB today lent 25 billion euros in one-day money and the Bank of England 66.2 billion pounds in one-week loans.
The joint action is the latest attempt by central bankers to avert the financial crisis which deepened this week after Lehman and AIG tumbled and Merrill Lynch & Co. was sold. The crisis began over a year ago after the U.S. housing market imploded and has pushed the world economy to the brink of recession.
Asian Action
As markets seized up this week, central bankers pushed more than $200 billion into markets with those in Japan, Hong Kong, South Korea and Australia doing so again today.
Wall Street's woes have gone global, forcing the U.K. government to sponsor a rescue of mortgage lender HBOS Plc and Russia to pour money into its banks. Russia's government said today it would invest in the country's stock market when it reopens tomorrow. The official Xinhua News Agency said China will buy equity stakes in state-owned banks to stabilize its market.
Swap lines were first established in December when officials joined forces to boost dollar liquidity around the world after interest-rate reductions in the U.S., the U.K. and Canada failed to ease concerns about bank lending. The Fed increased its link with the ECB in July.
The announcement today boosted European shares and U.S. futures, which have been pummeled this week as contagion spread through financial markets. The Standard & Poor's 500 Index futures expiring in December added 15, or 1.3 percent, to 1,177.9 as of 11:22 a.m. in London. More than $19 trillion has been wiped off the value of global stock markets since Oct. 31.
More May Be Needed
Failure to calm markets will see central banks inject even more cash, said Robert Barrie, an economist at Credit Suisse Group in London. Other options central banks could take include accepting greater collateral denominated in foreign currencies and increasing lending to banks abroad.
``The lack of dollars has been making the financial crisis worse around the world, which is why we now have this coordinated response,'' Barrie said.
Since the credit squeeze began in August 2007, central banks have sought to keep apart the need to soothe markets and to combat inflation. They argue that interest rates are a blunt tool for helping markets and that price pressures prevent them from cutting rates. While the Fed slashed its key lending rate to 2 percent, the central bank has left it there since April. The Bank of Japan kept its key rate at 0.5 percent this week and the European Central Bank increased its benchmark to a seven-year high in July.
If the spasms in the markets continue and threaten to derail growth central bankers may shift, although for now they will want to wait, said Kevin Gaynor, head of economics at Royal Bank of Scotland Group Plc in London.
``Partly this is to keep powder dry and partly because cutting interest rates won't make much difference,'' he said.
Stocks fall amid new rescue moves
 Asian share prices have continued to fall as confidence remains low |
The Bank of Japan has injected another 1.5 trillion yen ($14.4bn) into money markets, as Asian shares continued the global trend downwards.
Tokyo's Nikkei average dropped 3.2% and South Korea's main stock index fell 3% in early trading on Thursday.
Analysts say brokers are not convinced by US efforts to stabilise markets with the $85bn bailout of insurers AIG.
US stocks plunged more than 4% to a three-year low on Wednesday, while European markets also ended down.
The Japanese central bank's injection was the third consecutive day it had tried to shore up cash markets since the Nikkei hit a three-year low on Tuesday.
Across Asia, central banks have already pumped $33bn into money markets this week in an attempt to allay investors' concerns and ensure the supply of funds does not dry up.
The financial markets continue to be hardest hit by the share slide, says the BBC's Chris Hogg in Tokyo, and it looks like traders are in for a white-knuckle ride over the next few hours.
 Traders saw plummeting shares on Wall St on Wednesday |
By 0400GMT, Hong Kong's Hang Seng had dipped below the 17,000 mark - a fall of 5% - Taiwan was down 4.5% and Australia had dropped 3.5%.
Brokers in Japan say the markets are in freefall because investors fear the US government's efforts to stop the financial system's turmoil are not working.
Consequently they are searching for safer places to put their money than stocks and shares, our correspondent says.
The flight of investors from shares has taken the price of gold to a 10-year high.
Many Japanese institutions have assets insured by AIG.
And in Singapore, for the second day running, hundreds of AIG policyholders queued up outside its offices trying to surrender or cancel policies they now fear could turn out to be worthless.
Banking chaos
The Federal Reserve's AIG rescue package followed the collapse earlier this week of 158-year-old US investment bank Lehman Brothers, which sent shockwaves through the world's financial community and sparked a global share price plummet.
Another investment bank, Merrill Lynch, has since been sold off to Bank of America.
 |  The global financial crisis  |
In picturesAnd there has been feverish speculation about the future of two other leading US banks - Morgan Stanley and Washington Mutual.
The New York Times quoted unnamed sources as saying an auction for Washington Mutual was under way. The Wall Street Journal reported that both banking giant Citigroup and Wells Fargo had expressed an interest in a takeover.
Meanwhile Reuters reported that Morgan Stanley, the second largest bank in the US which on Wednesday saw a quarter of its value wiped off its share price, had held preliminary takeover talks with Wachovia.
None of the companies involved has made any comment on the speculation and no negotiations can be confirmed.
The share-price of Goldman Sachs, the other surviving US investment giant, also fell on Wednesday, by 14%.
The US Securities and Exchange Commission, meanwhile, said hedge funds and large investors would be required to disclose their short-trade positions, Reuters reported.
Rocky road
The White House said the US Treasury was working to see if it could stem other losses, and defended the $85bn (£48bn) emergency loan for AIG.
White House spokeswoman Dana Perino said the US economy "has the strength to be able to deal with these shocks". But she added the government was still concerned about the stability of other big financial companies.
Despite the assurance, shares in AIG fell a further 45% to $2.05 on Wednesday.
Analysts say trading in general is likely to remain rocky amid concern that financial instability will continue.
Top UK mortgage lender HBOS had a rollercoaster ride on Wednesday before the news broke that it was to be taken over by Lloyds TSB in a £12bn merger.
In Russia, stock exchange trading was suspended on Wednesday following steep falls in shares.
Bad Accounting Rules
Helped Sink AIG
ZACHARY KARABELL
The decision by the Federal Reserve to loan insurance giant AIG $85 billion in return for as much as 80% ownership of the company is by any measure dramatic. The takeover early last week of Fannie Mae and Freddie Mac represented the culmination of years of intermingling of public and private interests. But the AIG move is de facto a government nationalization of an ailing private company, which, if not unprecedented, has rarely happened in the United States. Even if the intervention was imperative, its scope is startling.
![[Karabell]](http://s.wsj.net/public/resources/images/ED-AI246_karabe_D_20080917181828.jpg)
CorbisThe crisis on Wall Street has, of course, become a political football. Cries of "moral hazard" and "socialism" on one side are drowned out by charges that the current mess is the result of deregulation, and too cozy a relationship between "Wall Street fat cats" and the current administration in Washington. If only reality were that simple. The blame game will continue, but it won't do much to fix what's broken.
Let's get a few canards out of the way: First, yes, stupidity and cupidity and complacency and hubris are involved, and yes, there is gambling in Casablanca. Second, the idea that there is this thing called "the free market" that governments tame or muck up with regulation is a fiction. Governments create the legal conditions for markets; markets shape what governments can do or are willing to do. Regulation versus free-market is a false dichotomy. Maybe in some theoretical universe, if we could start with a blank slate and construct society anew, it wouldn't be. But we exist in a web of markets and regulations, and the challenge is to respond to problems in such a way so that we decrease the odds of future crises.
And that is where AIG becomes instructive. Even good regulations can't prevent all future crises, especially ones that are the result of new technologies and changes that result from them. The capital flows, derivatives contracts and nearly frictionless interlinking of global markets today are the direct result of the information technologies of the 1990s. The implications weren't known until very recently, so it would have been nearly impossible for regulations to have prevented what is happening. But if good regulation can't prevent crises, bad regulations can cause them.
The current meltdown isn't the result of too much regulation or too little. The root cause is bad regulation.
Call it the revenge of Enron. The collapse of Enron in 2002 triggered a wave of regulations, most notably Sarbanes-Oxley. Less noticed but ultimately more consequential for today were accounting rules that forced financial service companies to change the way they report the value of their assets (or liabilities). Enron valued future contracts in such a way as to vastly inflate its reported profits. In response, accounting standards were shifted by the Financial Accounting Standards Board and validated by the SEC. The new standards force companies to value or "mark" their assets according to a different set of standards and levels.
The rules are complicated and arcane; the result isn't. Beginning last year, financial companies exposed to the mortgage market began to mark down their assets, quickly and steeply. That created a chain reaction, as losses that were reported on balance sheets led to declining stock prices and lower credit ratings, forcing these companies to put aside ever larger reserves (also dictated by banking regulations) to cover those losses.
In the case of AIG, the issues are even more arcane. In February, as its balance sheet continued to sharply decline, the company issued a statement saying that it "believes that its mark-to-market unrealized losses on the super senior credit default swap portfolio . . . are not indicative of the losses it may realize over time." Unless one is steeped in these issues, that statement is completely incomprehensible. Yet the inside baseball of accounting rules, regulation and markets adds up to the very comprehensible $85 billion of taxpayer money.
What AIG was saying then, and what others from Lehman to Bear Stearns to the world at large have been saying since, is that the losses showing up aren't "real." Yes, the layer upon layer of derivatives built on the foundation of mortgages is mind-boggling. One reason that AIG had floated beneath the radar screen of the business media (relative to Wall Street investment firms) is that its business model is so complex and opaque that it is impossible to describe simply. It was briefly in the news in 2005, after it was accused of improper accounting by the SEC and the New York attorney general. Then it faded from view, until now.
Among its many products, AIG offered insurance on derivatives built on other derivatives built on mortgages. It priced those according to computer models that no one person could have generated, not even the quantitative magicians who programmed them. And when default rates and home prices moved in ways that no model had predicted, the whole pricing structure was thrown out of whack.
The value of the underlying assets -- homes and mortgages -- declined, sometimes 10%, sometimes 20%, rarely more. That is a hit to the system, but on its own should never have led to the implosion of Wall Street. What has leveled Wall Street is that the value of the derivatives has declined to zero in some cases, at least according to what these companies are reporting.
There's something wrong with that picture: Down 20% doesn't equal down 100%. In a paralyzed environment, where few are buying and everyone is selling, a market price could well be near zero. But that is hardly the "real" price. If someone had to sell a home in Galveston, Texas, last week before Hurricane Ike, it might have sold for pennies on the dollar. Who would buy a home in the path of a hurricane? But only for those few days was that value "real."
The regulations were passed to prevent a repeat of Enron, but regulations are always a work of hindsight. Good regulatory regimes can mitigate future crises, and over the past hundred years, economic crises world-wide have become less disruptive. The panics of the late 1800s, the bank runs, the Great Depression in Europe and the United States, were all far more severe than what is unfolding today in terms of business failures and jobs, homes and savings lost.
But bad regulation is something to be feared, especially as industries become more complicated. Legislators and agencies would be wary of passing rules regulating how a semiconductor chip is programmed; they would recognize that while the outcomes those chips produce might be simple, the way they produce them is not. Yet financial service regulations sometimes act as if we still live in a time when deposits consisted of sacks of money in a vault.
A few years from now, there will be a magazine cover with someone we've never heard of who bought all of those mortgages and derivatives for next to nothing on the correct assumption that they were indeed worth quite a bit. In the interim, there will almost certainly be a wave of regulations designed to prevent the flood that has already occurred, some of which are likely to trigger another crisis down the line. Until we can have a more rational, measured public discussion about what government and regulations can and should do vis-Ã -vis financial markets, we are unlikely to break the cycle.
There is one final irony: AIG was founded in Shanghai in 1919, when China was emerging from millennia of imperial rule. Over the next century, China turned away from capitalism. Almost 90 years later, AIG is now being taken over by the U.S. government just as the Chinese government is moving as quickly as possible to divest itself of control of major companies. One of those countries is growing fast; one isn't. Perhaps that is a coincidence; perhaps not.
Mr. Karabell is president of River Twice Research. His "Chimerica: How the United States and China Became One," will be published next year by Simon & Schuster.
Obama Needs to Sell Himself, Not Attack McCain
KARL ROVE
Be careful not to assign too much scientific precision to polls. They aren't as accurate as portrayed. But several different surveys at roughly the same time that show similar results are useful guides. So three trends in recent polls must worry Sen. Barack Obama and encourage Sen. John McCain.
First, an average of seven national polls the week before the Democratic convention showed Mr. Obama leading Mr. McCain by two points. By the middle of the next week, Mr. Obama's lead had climbed to almost eight points. Now, nearly two weeks later, Mr. McCain has a lead of roughly two points. Since the middle of the GOP convention, one out of every 10 voters has changed their preference -- a significant movement this late in the campaign.
That movement comes, in part, from gains Mr. McCain has made on personal leadership attributes. In the latest Washington Post/ABC poll, for example, he lengthened his lead on the question of who would be a better commander in chief (he's now ahead by 45 points). He is also seen as the stronger leader, and as the more honest and trustworthy candidate. Meanwhile, Mr. Obama saw his lead on who would "bring needed change" drop by 20 points.
The same survey found that 48% of Americans consider Mr. Obama unqualified for the presidency, virtually unchanged from 46% in March and June. When Fox News asked voters whom they would ask for advice for the toughest decision in their life, voters favored Mr. McCain by a 50% to 34% margin.
There is a similar pattern on issues. Both the Fox News and Washington Post/ABC polls showed Mr. McCain's advantages grew on terror, Iraq and an "unexpected major crisis," while he erased Mr. Obama's edge on energy, and cut the Democrat's lead on both the economy and the deficit to acceptable levels.
Perhaps most surprising of all, five recent national polls have shown a significant tightening in party identification, eroding a big lead Democrats have enjoyed since 2006.
How durable are these changes? We don't know. But opinions solidify as an election approaches, and this one is now only 47 days away.
There are a number of reasons for these changes. The Democrats had a less successful convention. Sen. Joe Biden doesn't reinforce, but instead conflicts with, Mr. Obama's change message. And the Republicans had a good convention and a great introduction of Gov. Sarah Palin as Mr. McCain's running mate. She has a rare visceral connection with both swing and base voters.
It's also possible that the do-nothing Congress is dragging down the Democrats' brand.
Events have intruded, often to Mr. McCain's benefit. He turned rising oil prices to his advantage by embracing offshore drilling. Russia's invasion of Georgia highlighted Mr. McCain's foreign policy credentials (and may have compelled Mr. Obama to add Mr. Biden, the Senate Foreign Relations Committee chairman, to his ticket).
The idealism and discipline that led to Mr. Obama's early primary victories has been replaced by unattractive attacks on Mr. McCain. Both campaigns have engaged in a tit-for-tat, but because Mr. Obama ran on "turning the page" on "old politics," he suffers more than Mr. McCain, especially since his attacks are more fundamentally unfair.
It is a mistake for Mr. Obama to spend a lot of time attacking Mr. McCain. In the past week, he, his surrogates or his ads have mocked Mr. McCain's inability to use a keyboard (an activity, like combing his hair or tying his tie, that Mr. McCain has difficulty with because of war wounds), claimed his administration would be riddled with lobbyists, tried to make an issue of his age and successful cancer treatment, missed no chance to suggest he'd be President George W. Bush's third term, and called him "dishonorable." This last charge is particularly foolish. It's one of the last things voters will believe about John McCain.
The people who can be won over by shouting "McCain is Bush" long ago sided with Mr. Obama. That message does not resonate with undecided voters. The Democrat should instead spend every moment spelling out what he would do to address the country's challenges.
This election is not fundamentally about Mr. McCain. It is much more about people's persistent doubts concerning Mr. Obama. The only way to reassure them is to provide a compelling, forward-looking agenda. That sounds obvious, but the Obama campaign seems to be betting on making Mr. McCain an unacceptable choice by striking at his character. Mr. McCain has absorbed many harder blows than anything the Obama campaign can throw his way.
In a revealing slip in an interview with ABC recently, Mr. Obama said, "If we're going to ask questions about who has been promulgating negative ads that are completely unrelated to the issues at hand, I think I win that contest pretty handily." That he is in fact winning the contest for the most negative campaign could well spell his defeat.
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