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**Sapiens** · August 10, 2007, 10:23 AM

Re: Banks are bankrupt, Lenders of last resort act!

Excellent piece by Mike Larson:

http://moneyandmarkets.com/press.asp...=889&cat_id=6&

Mortgage mayhem spreading! Markets plunging! (by Mike Larson)
If you think yesterday's 2.8% plunge in the Dow was severe, take a look at the shellacking of bank and brokerage stocks: Down 5%, 6%, even 7% across the board.

Why are things getting so hairy? Precisely because of the spreading mortgage market mayhem I've been warning about!

Virtually every day, another "tape bomb" � news of some unexpected loss in some part of the world � goes off.

Yesterday, it was France's turn. BNP Paribas, the largest bank in that country, froze three funds that invest in asset-backed securities (ABS). Those are bundles of loans (credit cards, auto loans, etc.) that are packaged together into bonds and sold to investors who want to generate income.

BNP said it will not allow investors to deposit or withdraw money out of its three funds. In fact, it won't even provide a value for the funds � Parvest Dynamic ABS, BNP Paribas ABS Euribor and BNP Paribas ABS Eonia, which recently had combined assets of about $2.76 billion.

BNP's reason for the freeze �

"The complete evaporation of liquidity in certain market segments of the U.S. securitization market has made it impossible to value certain assets fairly regardless of their quality or credit rating."

In plain English, they're saying that the subprime mortgage meltdown is causing pricing for all kinds of structured bonds to go haywire. Interestingly enough, BNP's move caused problems of its own. Namely �

The European Money Markets
Went Absolutely Haywire!

The overnight London Interbank Offered Rate (LIBOR) soared to 5.86% from 5.35%, according to the British Bankers Association. That put it at the highest level since the start of 2001.

Let me explain why this is so significant �

The overnight LIBOR is what banks charge each other when they lend money back and forth for 24-hour periods. These extremely short-term loans are generally risk-free. I mean, what bank is going to get into so much trouble in 24 hours that it can't pay you back?

Because of the low risk involved, LIBOR rates usually only move when central banks change their own rates. Since there were no major central bank changes made in the last day, the surge in LIBOR can only be tied to one thing: Abject fear of major bank losses!

This was so out of the ordinary, in fact, that the European Central Bank (ECB) responded by flooding the European money markets with a whopping $130 billion in instant liquidity. That was the single-biggest liquidity injection since the day after 9/11!

For months, we've had to listen to a bunch of government blather about how the housing and mortgage market problems are "well-contained." We've been told not to worry � that it'll all be over soon � or that the housing market "bottom" is in.

But if things are so contained, then why the heck are central bankers freaking out? Why are European policymakers throwing the most money at the markets since right after the biggest terrorist attack on U.S. soil in history?

It wasn't just the ECB, either. The U.S. Federal Reserve followed up the ECB's move by adding $24 billion in temporary money to our banking system. That was the most since April, according to Bloomberg. And the Bank of Canada felt it necessary to issue a statement saying that it will "provide liquidity" to "support the stability of the Canadian financial system and the continued functioning of financial markets."

This Is a Stunning Reversal of
Fortune in Just a Few Days

What makes this turn of events so amazing is that these emergency measures came just two days after the U.S. Fed met to talk policy.

What happened at that meeting? Well, in 1975, the New York Daily News ran a famous headline: "Ford to City: Drop Dead." The paper was referring to Then-President Gerald Ford's refusal to help the New York City government survive a financial crisis.

Ben Bernanke downplayed the risks of subprime mortgages just two days ago.
This week, Federal Reserve Board Chairman Ben Bernanke didn't quite go that far. But he clearly stated that the Fed wasn't going to come to the rescue of skittish hedge fund managers, private equity millionaires, and Wall Street head honchos.

Specifically, Bernanke kept interest rates unchanged on Tuesday. And while he acknowledged the credit problems in the market by saying,

"Financial markets have been volatile in recent weeks, credit conditions have become tighter for some households and businesses, and the housing correction is ongoing."

� He also added language reiterating the Fed's anti-inflation "bias,"

"Readings on core inflation have improved modestly in recent months. However, a sustained moderation in inflation pressures has yet to be convincingly demonstrated. Moreover, the high level of resource utilization has the potential to sustain those pressures.

"Although the downside risks to growth have increased somewhat, the Committee's predominant policy concern remains the risk that inflation will fail to moderate as expected."

In other words, there was no sign of panic � no hint that things were really coming unglued � and certainly no indication that within 48 hours, tens of billions of dollars of excess liquidity were going to be poured into the markets.

I think it must be becoming abundantly clear to policymakers that �

Mortgage Bombs Are
Going Off Everywhere

You know I've been chronicling the mortgage market's struggles for several months. I've told you many a financial horror story. But if you can believe it, things are getting even worse. I'm literally seeing mortgage companies and mortgage stocks implode almost every day now �

HomeBanc Corp. (HMB), a lender with operations around the Southeast U.S., just announced it will stop originating mortgages. The company said it can't borrow on its credit facilities and that it could no longer fund loans as of August 6.

Another lender, Aegis Mortgage out of Houston, suspended all of its mortgage originations as well. Said a company spokeswoman, "We're going to have to suspend lending until we get this figured out." Yikes!

Mortgage firm Delta Financial (DFC) tanked more than 40% on Wednesday. The company pushed back its scheduled earnings release, declining to say why or when it would release an update.

Mortgage REIT Luminent Mortgage Capital (LUM) just said it would suspend its dividend payments and push back an earnings conference call it had previously scheduled. Lenders are increasing margin calls and pulling back on funding for the company's operations. The stock plunged 30.8% on Monday alone, then kept on falling. It's now down a whopping 92% in 2007.
You know what Luminent's CEO recently said? "In my almost 30 years in the U.S. mortgage-backed securities market, I have never before seen the intensity of confusion, uncertainty and outright fear as right now."

In other words, things are ugly with a capital "U!"

Here's My Message to You �

These developments have been coming at traders fast and furious. That's why you're seeing such violent swings in the market, with the Dow down almost 300 points one day, then up 300 points the next.

My suggestion: Don't focus on the day-to-day swings. Focus on the big picture. And that big picture can be best described as follows:

1. The credit markets are in disarray �

2. The fundamentals in the housing and mortgage markets remain dismal �

3. And the likelihood of a 1998-style meltdown is still high.

Even if I'm wrong, and we don't get a broad U.S. market meltdown, certain sectors will likely continue to struggle.

Continue to avoid mortgage lenders, home builders, and most REITs like the plague. Keep those hedges we've discussed in Safe Money Report in place. And consider taking even more profits off the table.

Until next time,

Mike

--------------------------------------------------------------------------------

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**Rajiv** · August 10, 2007, 06:27 PM

Re: Banks are bankrupt, Lenders of last resort act!

Another good piece by Jerome a Paris titled "Credit markets: "Don't panic", they beg"

Is this the reason for the CBs pumping in liquidity -- to forestall a crash on a Friday?

Something is happening in the credit markets...

The above is the price of corporate loans in the secondary market - i.e. on the market where banks trade IOUs from corporations. If you have a contract that says that a company owes you 100, you can usually sell it (to other banks or financial investors) for 100 or thereabout - a bit more if the buyer thinks the interest rate on the loan is really good, or a bit less if it thinks the interest rate is not quite enough to cover the risk that the company might go bankrupt before paying its debt back.

As you can see above, the price of an IOU of 100 dropped brutally this month from 100 to 95 in the US (and to 97 in Europe). This is the lowest level ever for that market, and an unprecedented drop.

This is a credit crunch.

As gjohnsit chronicled in this recent diary, this means that banks no longer want to lend money to corporations. Almost no new debt was issued for the whole week. And banks that had underwitten loans (i.e. committed to lend) are now unable to sell these commitments down to other investors. Rumors puts such commitments at $300bn; at the 5% discount that such loans now carry, as per the graph above, that's a potential loss of $15bn for these banks if they want to dump that paper (they may decide to sit on it not to take any loss, as after all the borrowers have not defaulted, but that will weigh heavily on their balance sheets and at the very least will freeze a lot of capital and prevent them from doing new business).

Analysts everywhere (those that mocked the Cassandras that have said for a while that markets had gone crazy) have been forced to acknowledge that there is a brutal repricing of risk, and a new, sudden, unwilligness by banks to fuel the buy out craze - the debt-fuelled purchases of corporations by private equity funds at ever rising valuations. However, many are still calling this "healthy": a belated , but reasonable, return to normal after some excesses. (This is also what was said about the housing market before it claimed its first victims in the subprime lending sector this year).

**c1ue** · August 10, 2007, 11:01 PM

Re: Banks are bankrupt, Lenders of last resort act!

Originally posted by Rajiv

Is this the reason for the CBs pumping in liquidity -- to forestall a crash on a Friday?

Rajiv,

This is exactly what the CBs were looking to alleviate, although more than just corporate loans were involved.

**Rajiv** · August 11, 2007, 12:23 PM

Very Scary Things

Also see Krugman's article in the NYTimes - Text of the article from Common Dreams
- Very Scary Things

What�s been happening in financial markets over the past few days is something that truly scares monetary economists: liquidity has dried up. That is, markets in stuff that is normally traded all the time - in particular, financial instruments backed by home mortgages - have shut down because there are no buyers.

This could turn out to be nothing more than a brief scare. At worst, however, it could cause a chain reaction of debt defaults.

The origins of the current crunch lie in the financial follies of the last few years, which in retrospect were as irrational as the dot-com mania. The housing bubble was only part of it; across the board, people began acting as if risk had disappeared.

**Rajiv** · August 11, 2007, 01:23 PM

Re: Banks are bankrupt, Lenders of last resort act!

Another good article by Stoneleigh at the oil drum.

Yesterday's financial convulsion is arguably the beginning of the end for a credit expansion of epic proportions that has underlain the economic boom of the last 25 years. It had its roots in the corruption of fractional reserve banking, as directly overseen and facilitated by the Federal Reserve. For those who look to the Fed now for a solution, perhaps it would be advisable to look instead at how the Fed created the current mess.

Fractional reserve banking was designed to provide a controlled credit expansion. However, in the early 1990s, the Fed began to find its rules too restrictve and acted to lower reserve ratios on some deposits and eliminate them for others. In addition, creative accounting implicitly condoned by the Fed allowed banks to circumvent even the limited remaining need to hold reserves. According to the Fed itself (PDF warning, see page 44), by using overnight retail sweep accounts, banks can transfer a proportion of deposits out of the category for which they must hold funds at the Fed (checking deposits), and use them to invest in interest-earning assets.

The lowering of reserve ratios and the acceptance of sweeps by the Fed over a period of many years demonstrates its attitude towards the need for reserves in the first place. How can the Fed claim to be concerned about the unsustainable expansion of the money supply (ie inflation), via the creation of essentially limitless amounts of credit, when it has been fully aware of the corruption of US fractional reserve banking all along? And how can the Fed be unaware of the eventual consequence of uncontrolled credit expansion - a debt crunch - when it has played out many times before?

**Sapiens** · August 11, 2007, 01:51 PM

Re: Banks are bankrupt, Lenders of last resort act!

Rajiv, thanks for the links.

I have a few here:

Citigroup has $500 mln credit business loss - FT
http://today.reuters.com/news/articl...OUP-LOSSES.XML

NEW YORK, Aug 10 (Reuters) - Citigroup Inc (C.N: Quote, Profile , Research) has lost more than $500 million in "credit business" in recent weeks, the Financial Times said on its Web site on Friday, citing an unnamed person briefed on the situation.

The loss was largely in Citigroup's structured credit business, the newspaper said, and is in addition to potential losses from the bank's lending commitments related to leveraged buyouts.

Citigroup seen taking $700 million in credit losses
http://www.marketwatch.com/news/stor...31E9162DB28%7D

SAN FRANCISCO (MarketWatch) -- Citigroup Inc. has reportedly lost more than $700 million in credit business in recent weeks, placing the world's biggest financial services firm high on the list of casualties from the market-roiling credit crunch.
The losses are not a serious issue for a bank that pocketed more than $20 billion last year. The red ink, however, will be embarrassing for Citigroup's Chairman and CEO Chuck Prince, undermining his efforts to restore investor confidence, according to a report from the Financial Times on Saturday.
Prince told the FT last month that the lending party would end, but with so much liquidity that it wouldn't be disrupted by the U.S. subprime mortgage turmoil.
The losses, which are in addition to those Citi faces from lending commitments to leveraged buyouts, were incurred mostly in the structured credit business run by Michael Raynes, who came over from Deutsche Bank in London last summer, the report said.

Make no mistake, this is the big one.

This is the beginning of the end, the positive loop of expanding fractional reserve credit has halted, now we go into contraction.

-Sapiens

**Jim Nickerson** · August 11, 2007, 02:40 PM

Re: Banks are bankrupt, Lenders of last resort act!

Originally posted by Sapiens View Post

Rajiv, thanks for the links.

I have a few here:

Citigroup has $500 mln credit business loss - FT
http://today.reuters.com/news/articl...OUP-LOSSES.XML

Citigroup seen taking $700 million in credit losses
http://www.marketwatch.com/news/stor...31E9162DB28%7D

Make no mistake, this is the big one.

This is the beginning of the end, the positive loop of expanding fractional reserve credit has halted, now we go into contraction.

-Sapiens

Sapiens,

A lot of what you write strikes me as cryptic, or else makes me feel like no-sapiens; however, your remarks here leave nothing to one's imagination--at least not mine. Congratulations on your explicitness.

The looming question remains: Are you correct?

And I don't know.

**Sapiens** · August 11, 2007, 03:36 PM

Re: Banks are bankrupt, Lenders of last resort act!

Originally posted by Jim Nickerson View Post

Sapiens,

A lot of what you write strikes me as cryptic, or else makes me feel like no-sapiens; however, your remarks here leave nothing to one's imagination--at least not mine. Congratulations on your explicitness.

The looming question remains: Are you correct?

And I don't know.

You are correct Jim, I should have written "the positive feedback loop."

About being cryptic, I try not to be. I am succinct if anything, too bad for you I am not a verbose fellow.

As far as being correct, I can only judge by my personal returns, and all I can say about that is that I am very pleased with them.

All the best,

-Sapiens

**Sapiens** · August 15, 2007, 09:46 AM

Countrywide Cut by Merrill; Bankruptcy Seen Possible (Update2)

http://www.bloomberg.com/apps/news?p...f5k&refer=home

Aug. 15 (Bloomberg) -- Countrywide Financial Corp., the biggest U.S. mortgage lender, was downgraded to ``sell'' by Merrill Lynch & Co., which raised the possibility of bankruptcy if the company loses access to short-term financing.

``We cannot understate the importance of liquidity,'' Kenneth Bruce, a Merrill analyst in San Francisco, said in a research note today. ``Effective insolvency'' would result should creditors force Countrywide to sell assets at depressed prices or investors lose confidence in its ability to raise cash, he wrote.

``If liquidations occur in a weak market, then it is possible for CFC to go bankrupt,'' said Bruce, who had rated Countrywide a ``buy'' since April 2005, according to data compiled by Bloomberg. Countrywide trades under the ticker CFC.

If you have been reading this commentary you were prepared for the above.

-Sapiens

**Sapiens** · November 28, 2007, 10:01 AM

Re: Banks are bankrupt, Lenders of last resort act!

The New Savings and Loan Crisis by Mike Larson
http://www.moneyandmarkets.com/Issue...erEntryId=1213

The Next Big Bankruptcy by Martin D. Weiss Ph.D.
http://www.moneyandmarkets.com/Issue...erEntryId=1216

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Banks are bankrupt, Lenders of last resort act!

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