• Companies from Russia and China are most likely to use bribes when conducting business abroad, says a report from Berlin-based corruption watchdog Transparency International (TI), Reuters reported. The least likely to bribe were Belgium and Canada, according to group’s 2008 Bribe Payers Index.

• Four days after rival J.M. Smucker Co. (SJM) cut its list price for Folgers coffee products, Kraft Foods Inc. (KFT) announced an immediate 10-cent price cut for its Maxwell House and Yuban ground and instant coffees. It marks the fifth price cut by major U.S. roasters this year, Reuters reported.

• Sales of existing homes fell again in October, says a report from the National Association of Realtors. Its index of pending home resales fell 0.7% to 88.9 from a revised 89.5 in September, Bloomberg reported.

• Smelters in China asked mining companies including BHP Billiton Ltd. (ADR: BHP) to pay 74% more to process copper next year, two sources told Bloomberg. Earlier this week, China – the world’s biggest iron and copper consumer – asked BHP and other mining companies to scale back prices of iron ore by 82%.

• Yahoo! Inc. (YHOO) directors are moving in on selecting a candidate for its vacant chief executive officer post, and have gone as far as checking references on a few candidates, sources told The Wall Street Journal. One of the names considered is Arun Sarin, former CEO of Vodafone plc (VOD).

• FedEx Corp. (FDX) warned that it would finish its fiscal year 26% below the low end of its projected earnings, Dow Jones reported. “Demand for our services weakened sequentially throughout the quarter and global economic trends continue to worsen, substantially reducing our second- half outlook,” Chief Financial Officer Alan B. Graf Jr. said in a prepared statement.

• Lehman Brothers Holdings Inc., the bank that filed the biggest U.S. bankruptcy, asked a judge to allow it sell its French unit to Nomura Holdings for $1, Bloomberg reported. According to its filing, Lehman was “unable to find an alternate solution or buyer.” And for the price (and liabilities that come along with it), Nomura would get employees, commercial records, information technology, furniture and other assets.

• The National Football League announced it will lay off 150 jobs in the next 60 days to cut costs in the face of recession. The job cuts are within the league offices, not the teams, Reuters reported.

Source: Global Investing Roundups Wednesday, December 10th, 2008

And that figure, incidentally, doesn’t include the additional losses from secondary-prime mortgage loans, auto loans, credit card balances, student loans and the other credit-related flotsam and jetsam floating around in the debt markets.

That suggests that the hundreds of billions of dollars in emergency capital infusions from the world’s central bankers we’ve seen to date may only be a fraction of what’s ultimately needed by the time fully leveraged figures are thrown into the mix.

Second, liquidity conditions now may actually be worse than when the entire credit-crisis mess began to unravel this time last year. For example, the benchmark London Interbank Offered Rate (LIBOR) remains higher than so-called “policy rates” and U.S. Treasuries of comparable maturities.

This suggests that banks still don’t trust each other and therefore are keeping so-called “Interbank” borrowing rates high in order to reflect what they perceive to be the added risk of doing business. We’ve been warning investors to watch out for this since as far back as April, and have generally been preaching caution since the credit crisis began last year.

In other words, the fact that Libor-Treasury spreads are wider today than they were a year ago suggests that the banks really don’t know who continues to hold the toxic debt instruments the entire world has come to fear – despite a recent earnings parade of CEOs making claims to the contrary.

The upshot: Many institutions are hoarding cash – something you’d hardly expect to see if the credit crisis were really on the mend.

Third, judging from recent reports, it’s beginning to dawn on financial regulators that this crisis was never about a lack of liquidity in the first place, which is something I suggested in an open letter to U.S. Federal Reserve Chairman Ben S. Bernanke some time ago.

Instead, this crisis is about three things:

• Too much liquidity.
• Fundamental structural problems in the credit industry, including the almost-total lack of regulation.
• And the lack of transparency of complex financial instruments for which there is no public market, making them tough to value and nearly impossible to trade.

It is becoming clearer by the day that – partly because of these three factors – a good deal of money has been made fraudulently, if not illegally.

Granted recent changes surrounding the “mark-to-market” accounting of so-called “Level 3″ assets are a step in the right direction. But what few people realize is that, in the short-term, these new requirements could involve the immediate recognition of even larger losses than we’ve seen to date.

The reason is that many of the firms involved – think Merrill Lynch & Co. Inc. (MER), Lehman Brothers Holdings Inc. (LEH) and Citigroup Inc. (C), for example – will no longer be able to hide their losses in Level 3 assets, as they have in the past.

As you might expect, there’s a counterargument to this, and it’s a highly popular one on Wall Street – especially inside the CEO set, whose members desperately want to stop the financial hemorrhaging their firms are enduring. They claim they’re “selling” risky assets and “de-leveraging” their balance sheets.

But here’s what they are not telling you.

Even though these folks are technically “selling” assets – particularly the distressed “Level 3″ assets I mentioned a bit earlier – what they are really doing is assigning the upside to hedge funds, private equity firms, and sovereign wealth funds in exchange for cash.

And here’s the kicker: The banks actually are holding onto the downside liability in the event the underlying securities go bad. That brings us back to the start of this commentary, when I said that I expect more securities to go bad.

No matter how you look at it, these financial institutions are playing a vicious shell game, hoping all the while that they’re not the loser who is taken to the cleaners when he picks up the wrong shell.

Where this goes from bad to worse is that at the same time they’re playing more fancy accounting tricks, these firms continue to pony up to the Fed’s private backdoor lending window for sweetheart financing. After all, they can’t get the financing anywhere else.

That means that every taxpayer in this country is involuntarily being put in the bailout business.

As for whether or not we’re near the end of the credit crisis as a whole, it depends on whom you ask.

When this crisis started a year ago, I was asked a similar question and answered it by saying that we would not even begin to approach the end of the line until the total losses exceeded $1 trillion.

My audience chuckled politely.

Fast-forward 12 months, and nobody’s laughing anymore – especially when I say that I’m now raising my industry loss estimate to nearly $2 trillion.

Increasingly, other analysts are embracing a similar viewpoint. UBS AG (UBS) raised its estimate of the total cost of the credit crisis to $600 billion, while noted hedge fund manager John Paulson suggested $1.3 trillion is not unthinkable. Meanwhile, in a report issued last May, the International Monetary Fund (IMF) projected the bailout costs at $1 trillion.

All of this leads us to a single conclusion: At least for now, this is a “recovery” in name only.

Source: Three Ways to Know When the Credit Crisis Hits Bottom

More from Bill:

Each country controls its own money (with the exception of the countries of Europe, who have decided…perhaps temporarily…to use a common currency). Since this paper money can be created at negligible cost to the creator, countries are tempted to create more of it than they should – especially in times of war or financial crisis.

Historically, what has kept this from happening was that the paper currency was tied to gold.

More recently, currencies are tied to the dollar. And since countries trade with one another, a sin by one country — printing too much money — is punished by the others.

They mark down its money.

But now, all the world’s major countries are conferring, colluding, and conspiring. They’re all going to do the same thing. They’re all going to take over their banking systems, support their financial industries, bail out important businesses and rescue their citizens from their own mistakes. Where will they get the money for all this? Will they borrow it from each other? Don’t be silly; they will print it.

“They are in trouble in New York,” said J.P. Morgan to Bishop Lawrence.

In October, 1907, J.P. Morgan was 70 years old…and attending a church meeting in Richmond when the importance of the sacred was disturbed by the urgency of the profane. Telegraphs kept arriving from New York; they warned of a disaster. According to Dun’s Review, 8,090 companies had failed in the first 9 months of 1907. Then, a failed takeover of the United Copper Company caused a panic.

“A correction is equal and opposite to the deception that preceded it,” Morgan would have said, if he’d thought of it. Since he didn’t, it falls to us.

Morgan had been around the block when it came to money.

He had taken over his father’s banking business decades ago. He’d seen panics, crashes, bankruptcies. And, now, it must have seemed that his whole life had been spent training for this one test. He returned to New York; crowds of investors looked to him to save the day.

And he did.

He put his own money on the line to help shore up troubled companies. He rallied friends, colleagues and competitors to do likewise. A trust was in trouble…then the New York Stock Exchange itself…then the City of New York…one after another, Morgan brought in the financiers…came up with the money…bullied and cajoled…until the storm had passed and they could all enjoy a good drink.

And when it was over, Senator Nelson W. Aldrich, realizing what Morgan had done said: “Something has got to be done. We may not always have Pierpont Morgan with us to meet a banking crisis. “

As it turned out, Pierpont Morgan was a ghost four years later. But in that same year — 1913 — the US Federal Reserve was set up to fill his big shoes.

This year, it’s the Fed that is being tested.

Armageddon seemed to arrive in Manhattan on Monday. And not just in New York, but in Moscow, Hong Kong, London and Frankfurt too. Germany hastened to succor bank account holders. In Rejkavik the pandemonium was so hot it seemed to melt the ice.

Then, on Tuesday, all the plagues and locusts we’ve been warning about here in The Daily Reckoning were loosed on the world: The US stock market fell hard again. Japan was sinking into the sea. Brazil’s market was down 51%, year to date. Central banks were cutting rates like pulpwood. Even so, unemployment was on still the rise. Consumer spending was falling. House prices were going down.

Of course, the world improvers were intervening in the usual clownish ways.

Short selling was blamed for more accidents than alcohol. And everywhere, the authorities were getting ready for show trials…perp walks…and public hangings.

Over on The Guardian’s front page, for example, was an extended whine about how much Richard Fuld earned at Lehman Brothers (NYSE:LEH) before he bankrupted the 158-year institution. $480 million was the number given for the 8 years of disservice. “Is that fair?” asked Congressman Henry Waxman.

Congressman Waxman seemed to think that something needed fixing. But that just goes to show how little he appreciates the free market. Investors handed Fuld that money of their own free will; they got exactly what they deserved. The system was fixing itself.

Politics always lists to the port side. But markets are more exquisitely balanced, between fear and greed.

When investors had the wind at the backs, they were ready to believe the most outrageous things — that the financial sector could get rich by lending money to people who couldn’t pay it back…and that a whole economy could flourish by luring consumers to spend more than they could afford.

These hallucinations created an immense worldwide bubble of debt and dollars.

But now, the wind has swung around. A huge anti-bubble is forming — equal and opposite, in true Newtonian form — a financial whirlpool marked by exaggerated thrift, debt destruction and sweaty-palmed investors.

And where is Morgan when we need him? Where is the Fed?

Ten years ago, the giant hedge fund LTCM had overdone it. As in 1907, according to Roger Lowenstein’s account, “Rushing for the exits…[traders] posed a danger not only to themselves, but to the entire world financial system.”

So, the Federal Reserve Bank of New York called in the big financial houses to help with the rescue. It worked. The crisis was averted. LTCM’s positions were liquidated in an orderly way, just the way Morgan would have wanted.

But this time, the fix doesn’t seem to stay fixed. Bad positions can’t be unwound in an orderly manner; there are too many of them.

And it’s not just a handful of speculators who are getting whacked — it’s half the population of the United States of America and Great Britain.

Trillions of new cash and credit are being pumped in. The Fed is buying ‘assets’ you would throw out of your refrigerator. Her majesty’s government is now proprietor of 50 billion pounds worth of banking shares; the government of George W. Bush is preparing to enter the banking business too.

But as trillions go in, trillions more leak out. So far this year, world equity markets have lost $20 trillion. US property markets alone have lost $6 trillion over the last two years.

It is not just a few investment decisions that are being corrected, in other words, it’s the delusions of an entire generation.

“These prices make no logical sense,” said a Wall Street trader, referring to mortgage backed derivatives at Wal-Mart Wal-Mart-style discounts, missing the point.

Markets are not scientific. They are poetic. After the liquidity comes the liquidation. After the outsized recklessness comes the appropriate regret.

Editor’s Note: Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of the national best sellers Financial Reckoning Day: Surviving the Soft Depression of the 21st Century and Empire of Debt: The Rise of an Epic Financial Crisis. Bill’s latest book, Mobs, Messiahs and Markets: Surviving the Public Spectacle in Finance and Politics, written with co-author Lila Rajiva, is available now by clicking here: Mobs, Messiahs and Markets

Source: Him That Hath Has Less Than He Thought

The crash in stock prices has most investors spooked. But it’s worth keeping you head while others lose theirs, says Strategic Investment editor Dan Amoss.

Right now, there are some very healthy resource stocks are shockingly cheap. What Dan calls “screaming bargains.”

This from Whiskey and Gunpowder:

It amazes me how long this environment of panic has lasted.

Last Thursday was one of the most violent days I’ve ever experienced in the markets, including the bursting of the tech bubble. Quality companies in the oil services, coal, steel, and agriculture sectors were liquidated in violent fashion — many of them down 20% in a day and 50% over the past month.

These are real companies performing vital functions necessary to keep the lights on and food on shelves, not speculative internet stocks.

The list of victims includes companies that are very likely to deliver good earnings over the next few years. The list includes several of the stocks I’ve recommended in past issues of Strategic Investment, and still follow closely.

If you’re a long investor, there are some screaming bargains out there — unless, of course, half of the world’s population stops using food, electricity, and oil. I doubt that will happen in a world of unfettered deficits and central banks, but anything’s possible. I’ll have more to say about this in an upcoming issue of Strategic Investment.

For immediate ideas, I strongly recommend considering the long list of bargains that my colleague Chris Mayer has recommended in Capital & Crisis and Mayer’s Special Situations.

It’s mind-boggling how cheap some of them have become. Chris is an excellent stock picker. He goes to great lengths to find safe, cheap investments.

The money managers that survive this environment will probably look to own some of the dirt-cheap stocks in the energy, commodity, and agriculture sectors, rather than expensive stocks that thrived on spending from home equity loans.

Once this credit market panic subsides, I expect we’ll see this shift in sector focus.

Fund managers will have to start distinguishing between earnings that resulted from fake, bubble-induced consumption, and earnings that resulted from real, sustainable demand.

I’m looking forward to earnings season, when analysts and fund managers can finally get some guidance about which companies’ earnings will hold up best during this recession.

Even the best fund managers and stock pickers in the world are down for the year. A few of these managers saw the credit crisis coming, and made nice profits shorting financial stocks. But the SEC’s totally arbitrary rule changes in recent weeks have created an environment that’s very difficult to navigate.

The SEC’s short selling ban has not changed much, other than taking efficiency and liquidity out of the market. For example, Allied Capital was on the “do not short” list. Yet it crashed earlier this week upon announcing the bankruptcy of Ciena Capital. That was a case of long investors all trying to squeeze out of a narrow door of liquidity. It was not a “short attack.”

Uncertainty about the banking system is causing this panic in the credit markets. Innocent bystanders are suffering from the fallout from this credit bubble.

For example, I’ve read several accounts of hedge funds whose assets are stuck in the black hole that is Lehman Brothers’ balance sheet.

I’m not referring to people who own Lehman bonds, I’m referring to funds that had custodial agreements with Lehman. Custodial agreements are supposed to ensure that Lehman could only execute trades for the pool of assets under its custody — not take actual possession of the assets.

It seems that in the days and hours before declaring bankruptcy, Lehman moved certain assets — many of which it did not own — to its subsidiaries all around the globe. Now, hedge funds with no perceived credit exposure to Lehman are joining the line of creditors, fighting to get their clients’ assets back in bankruptcy court.

This total destruction of confidence in counterparty risk is the reason why credit is drying up. So what has the Federal Reserve been doing as the lender of last resort?

It has nearly doubled the size of its balance sheet in the past few weeks. The Oct. 3 issue of Grant’s Interest Rate Observer describes:

“After a flat-footed start, [the Fed] had shown its ability to degrade its balance sheet by selling off its Treasuries and acquiring dubious mortgages. But it had not really put its back into dollar debasement. The sum total of its earning assets, i.e., Reserve Bank credit, was rising at year-over-year rates of just 3% to 4%. Where was the push to print up enough dollar bills to smother the debt crisis of 2007-8 — assuming the problem was susceptible to smothering through money printing?

“Mystery solved: Reserve Bank credit is suddenly flying. It surged by $203.6 billion, to $1.135 trillion, in the banking week ended Sept. 24. And if Merrill Lynch’s guess is on the mark, it has soared to $1.730 trillion in only the past few days, a near doubling since May 2007 [emphasis added], when the latent crisis became manifest.”

After the panic subsides, the Fed will rein in much of this new money.

Right now, banks are “stuffing it under the mattress,” so to speak. Banks and individuals are crowding into the perceived safety of Treasury bonds. That’s why consumer prices aren’t immediately rising; private market credit is contracting as fast as the Fed’s balance sheet is expanding.

The Fed will always lend when no one else is willing to do so. “The U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost,” said Fed Chairman Bernanke in November 2002. This means that there will always be paper money available to lend. However, the U.S. dollar is getting debased on an unprecedented scale.

~~~~~~~~~~~~~~~Special~~~~~~~~~~~~~~~

“Bailout” Ben Bernanke may be set on destroying the value of your savings, but you don’t have to stand for it.

A lot of Americans are already seeing their hopes dashed as the credit bubble deflates and the wealth they thought they had in stocks and real estate disappears.

It will get a lot worse for them when they find their dollars only buying half the food and fuel they used to.

Don’t be fooled by the dollar’s recent surge… the fix is in thanks to the Fed. Devaluation is inevitable. Make sure you protect your savings before it’s too late.

Read this special report for details…

~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

The printing press may be the only way to prevent a self-sustaining credit panic, but it doesn’t come without a price; it lowers the U.S. dollar’s stature even further in the eyes of our foreign creditors.

I’m betting that government inflation will defeat private market deflation.

However, when the dust settles, I expect the Treasury and Fed to have its own set of negotiations with foreign creditors. The obligations they are assuming and monetizing are simply too enormous without inciting a potential panic among our generous foreign creditors. Maybe we’ll see a Bretton Woods-type agreement in 2009 — one where the U.S. dollar is devalued by 50% against certain foreign currencies overnight.

Source: A Few Great Apples

This from Today’s Financial News

We have all heard about credit default swaps and their responsibility in the current market crisis. But what are these mysterious banking creations? In this piece, I take a different approach to explain them.

Major economic downturns are caused by a combination of many factors, but every recession in the nation’s history can be associated to one deadly flaw, greed.

Throughout this country’s history, greed has tempted investors to take on huge piles of leverage. Eventually, the levels of debt grow to such huge proportions, the system that created it comes crashing down under its own weight.

It was massive amounts of investing on margin that kicked off the Great Depression. It was the sudden impact of massive deregulation that allowed banks to lend huge amounts of cash to just about anyone that caused the savings and loan collapse.

Now, it is the deleveraging of the credit default swap (CDS) industry that has the entire planet wondering where all its money went. Tens of trillions of dollars have been wiped from investor bank accounts.

Where there is a will, there is a way

During each of the nation’s major financial crises, we learned our mistakes, governments created new laws, and the markets moved on. The lessons learned and the rules implemented have kept us from making the same mistakes over and over, but they have not prevented us from going around the rules and creating new types of excessive leverage.

This is exactly what has happened in the CDS industry. These so-called insurance policies became so popular and so profitable for banks, hedge funds, and other debt-industry investors they could not get their hands on enough of them.

Unfortunately, many investors have a tough time grasping the default swap concept. They are unique investments that can become quite complicated. I will do my best to explain them and show how they got us to where we are today.

A CDS is a bit like a blind date. At first, they sound like a fantastic idea. But we all know differently.

Your buddy’s wife calls you up and says, “I got this fantastic girl I want you to meet. If you don’t like her, I’ll pay for your dinner and you can go home.”

What’s the worst that could happen? You get a free dinner, right?

You wish.

When the big date comes around you get another phone call from your so-called friend, “Sorry bud, we can’t make it to dinner with you and your date tonight. But we are going to send our other friends along.”

That’s not what you agreed to. But it is too late to back out.

Next thing you know, you are at a cheesy Japanese restaurant with some guy in a goofy hat throwing shrimp in your mouth. Your date is a cross-eyed parolee that has been eyeing your wallet all night. And your buddy’s friends skipped out before the first round of drinks arrived.

Credit default swaps are a tad more technical but they offer a pretty similar risk/reward ratio.

A CDS is nothing more than an insurance policy on debt. If the person owing the debt fails to pay it back, the insurance kicks in and the policy seller pays you what is owed. All that you have to do to get the coverage is pay regular premium payments, just like nearly every other type of insurance.

A betting man’s insurance

For example, let’s say you bought a General Electric (NYSE:GE) bond. Its face value is $1,000 and it promises to pay 5% annually. You are not so sure the company will be able to pay you the money when it comes due, so you call up Lehman Brothers to buy insurance on the bond.

Lehman Brothers (NYSE:LEH) checks GE’s credit rating and default history and tells you it will insure the debt for a two percent premium. You lose a few percentage points on your annual yield but have a guaranteed payout. Lehman Brothers gets a nice stream of cash flow and has little default risk.

You purchased a CDS and effectively “swapped” the risk to Lehman Brothers.

Basically, both sides of the party just agreed to go on a blind date thinking they were being set up with the blonde cheerleader captain they remember from high school.

We all know blonde cheerleaders never need to be set up on blind dates.

The problem continues to get worse. As a bond holder, you can sell your bond at anytime. You can also sell your default insurance at anytime.

The insurance issuer can also sell the policy and its associated cash flows anytime it wants. This would be the equivalent of your friend exchanging your blind date during the middle of dinner.

The CDS market was entirely deregulated in 2000 (under the watchful eye of Slick Willy, mind you), so just about anything goes.

Let’s go back to our GE example. Imagine your thoughts of GE’s default woes go away and you no longer want to pay premiums on an insurance policy you will not need. You sell the insurance policy to a friend but kept the GE bond.

If the bond goes into default, you do not get the payout, your friend does. But he has to figure out who is now the insurer. After all, Lehman Brothers has the right to sell the policy as well. It could have sold the note and the associated cash flows the minute you signed the contract.

Who knows who owns the contract now? It could have changed hands over a dozen times. (The average CDS is sold over ten times.)

Imagine walking into a restaurant filled with women. One of them is your blind date. When you ask which one is Amy, if you are good-looking they will all raise their hands. If you are not-so-hot, you won’t see a single hand go up (ask me how I know).

It is the same in the CDS market right now. Nobody wants to claim ownership or fair values on their books. It is because the banks are all over-leveraged and cannot afford to pay as company after company defaults on their debt.

We need more regulation?

The lack of regulation in the market gets worse, though. Any bank, hedge fund, or other investor can create these insurance policies. Over the past two decades, they were extremely lucrative sources of premiums and cash flows. As long as the economy was soaring and defaults were low, everybody wanted in the market.

In other words, as long as curvy good-looking women were going on blind dates, every guy wanted to go. Unfortunately, we all know there are a lot of fish in the sea and not all of them are model material.

Back in the CDS world, it is the same deal. During the peak of the CDS industry in 2007, over $45 trillion worth of swaps were on the market. It is a ludicrously huge number that is nearly three times the value of the entire American equities market.

Suddenly, companies started to default and insurers suddenly had to pay on their debts. It drained them of huge amounts of cash. A company like GE could have $100 million of debt on its books, but banks were selling tens of billions of dollars worth of insurance on it. After all, the more they sold, the larger the bottom line.

Who knew the economy would slow, companies would default, and insurers would be forced to cough up billions of dollars they do not have? Don’t answer that.

The CDS market created incredible financial leverage. It was a great tool when the economy was trending upward, but now that growth has slowed and so-called insurers are forced to make good on their multi-trillion promises, swaps are not nearly as dreamy as they once appeared.

It is as if the market tried to go on too many blind dates at once. Eventually, the CDS market got caught and now all of its potential suitors are slapping it with their purses.

A serious matter

Obviously, credit default swaps are much more complicated then I make them out to be, with issues like transparency, pricing, liquidity, and regulation all playing a monumental role in their demise. History will show they were just one more mistake caused by greed and overleveraging.

Later today, the last of Lehman Brother’s credit default swaps will be auctioned off to the market. They will be sold for a fraction of their previous values.

Instead of a blind date, it will be a public date auction. The market will be able to see what it is getting before it opens its checkbook.

The CDS market has learned its lesson. Trading practices are being questioned. Valuations are created differently. And regulators have finally realized how deadly these huge leveraging creations can be to the free market.

It may have been a multi-trillion dollar date gone bad, but we learned our lesson and must move on. Once all this blows over, the equities market will be a safer place for your money than it was a year ago.

Source: Credit Default Swaps: A Blind Date Goes Wild

This from The Daily Reckoning:

I don’t particularly buy into the talk gurgling across the Internets that the whole worldwide banking system is going to freeze up this month, rendering your ATM card inoperable.  But if it were to go down, tomorrow’s as good a day as any.

Tomorrow is the settlement auction for $400 billion of credit default swaps connected to bonds issued by Lehman Bros (NYSE:LEH).

Actually, this whole month is a minefield of settlement days for toxic derivatives — Fannie (NYSE:FNM) and Freddie (NYSE:FRE) last Monday, Lehman tomorrow, Washington Mutual two weeks from today.

The Fannie and Freddie auction passed without incident, perhaps because the Treasury explicitly stands behind Fannie and Freddie’s debt.  Too, the Fannie and Freddie default claims totaled “only” about $50 billion.  But $400 billion of Lehman paper with no government guarantee?

There’s no telling what will happen, considering what the Financial Times reported last week in a story previewing these auctions:

Because of the opacity of this market, it is still not clear how many contracts have to be settled and whether payouts on the defaulted contracts, which could reach billions of dollars, are concentrated with any particular institutions.

According to dealers, insurance companies and investors such as sovereign wealth funds, which are widely believed to have written large amounts of credit protection through credit default swaps on financial institutions, could have to pay out huge amounts.

But the Lehman cards will be laid on the table tomorrow.  At least one reporter suspects the primary reason the credit markets have come to a near-standstill is that institutions are cashing up for tomorrow.  (Taken to its logical conclusion, you could even say it’s the reason gold is down today.)  If that’s the case, and the various and sundry counterparies have adequately cashed up, we’ll come out unscathed.

At least until the Washington Mutual auction in two weeks.  Whatever the outcome, it might be time to consider a “paddle strategy.”

PS. Last month Money Morning’s Shah Gilani called the $62 trillion CDS market a “ticking time bomb.” This is what he had to say:

“There are credit default swaps written on subprime mortgage securities. It’s bad enough that these subprime mortgage pools that banks, investment banks, insurance companies, hedge funds and others bought were over-rated and ended up falling precipitously in value as foreclosures mounted on the underlying mortgages in the pools.

What’s even worse, however, is that speculators sold and bought trillions of dollars of insurance that these pools would, or wouldn’t, default! The sellers of this insurance (AIG is one example) are getting killed as defaults continue to rise with no end in sight.”

Source: The $400 Billion Trigger?

The reader’s letter comes from a Mr. D.P. Marchessini. I suspect that Mr. Marchessini is correct and the present credit crisis is the natural consequence of high leverage, the repeal of the Glass-Steagall Act and the creation of excessive and complex derivatives. The letter traces the sequences of events:

“In 1933, the United States passed the Glass-Steagall Act, which prohibited commercial banks from dealing in investments, and prohibited investment banks from doing commercial banking activities. This was a very sensible measure, and kept the banks in reasonable order until 1990.

“Unfortunately, in 1990, this Act was repealed — for reasons best known to the psychiatrists of the legislators. The result was that all the big Wall Street brokers became banks, as well as brokers, and the big banks started trading and speculating. This was combined with an enormous increase in “leverage” — borrowed money — by all the banks. Leverage is the ratio of a bank’s capital to its total assets.

“This used to be between five and seven times, pre-1990. But post-1990, it immediately started ballooning and, although the banks tried to keep it quiet, it was known that Merrill Lynch (NYSE:MER) was more than 40 times. Goldman Sachs (NYSE:GS) was 28 times, and Lehman Brothers (NYSE:LEH) was 30 times when it failed. Regardless what one thinks of such hair-raising tactics, the one thing that is clear is that they only work when the market is going up. Apart from their Balance Sheet, all the banks also had an enormous amount of ‘derivatives,’ which were kept off the Balance Sheet. Derivatives are an enormous cocktail of very exotic Options, on almost anything. In 1995, I was talking to someone at a dinner party, who was rich and supposedly very well connected in the financial world. I asked him what he thought the total amount of nominal value in derivatives were at that time. He said he thought perhaps $100 billion. In fact, at that time, they were $1 trillion. Today, they are $1.3 quadrillion — all off the Balance Sheet. They are also not included in any bankruptcy. Of course, this is the nominal value, and the actual amount at risk is much less. But five percent of $1.3 quadrillion is $65 trillion — still a tidy sum.”

I do not understand derivatives, certainly not at a level of $1.3 quadrillion. I am not even sure what a quadrillion is, though I assume it is 1,000 trillion. I do not feel ashamed of my inability to understand the global derivatives market, since the Sage of Omaha, Warren Buffett, himself has said that he does not understand them. What is clear is that they have been created in very large numbers. If Mr. Marchessini’s figures are correct, the gross value of derivatives is far in excess of the capacity of all the world’s governments to bail them out. Even a net value of $65 trillion is beyond the bailout potential of the major powers.

The Secretary for the Treasury, Hank Paulson, has asked Congress to authorise $700 billion as a bailout for those banks that have invested in sub-prime mortgages and other toxic assets. This is a sum one can reasonably understand. In London there are a large number of houses worth £1,000,000 or more. A thousand such houses are worth £1 billion. That is a solid reality. The $700 billion, which Secretary Paulson is asking for, is worth about £400 billion. It is therefore equivalent to about 400,000 good town houses in London.

~~~~~~~~~~~~~Special~~~~~~~~~~~~~

Better Than Gold

With gold, your assets are safe. Your money should appreciate, and you can live independent from all the market troubles of today.

But if I told you that you could do that without gold, and even make more money with just as much security, would you be interested?

I hope so, because today I have something that’s better than gold. Read on…

~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

Plainly that would be a valuable estate, but it is conceivable. I can imagine the suburbs of London rolling out to Heathrow and the West. If one started at Canary Wharf and went on to Heathrow one could easily identify 400,000 houses worth £1 million each. If the U.S. Government chose to pledge itself for 400,000 such houses that seems reasonable. This may involve very large figures, but so does the Federal Budget.

It is the trillions that cease to be meaningful. I know several billionaires; I have certainly never met a trillionaire, let alone a quadrillionaire. If these derivatives hang over the whole banking system, then they should presumably be wound down and, over time paid off. They represent potential liabilities of the banking system, even if they are off the banks’ balance sheets. They cannot simply be consigned to a bad bank or simply be allowed to go into default. Even if Mr. Paulson gets his $700 billion, what will that do to settle the problems of quadrillions of derivatives?

Source: The Trouble with Trillions

This pairing is great for stability. Commercial banks take deposits and make loans. They have a capital base to offset the riskier stuff that goes on in investment banks that underwrite securities and engage in trading.

The pairing also brings these investment banks within commercial banks and insurance companies under Federal Reserve regulation. That’s very good. The Fed sets capital requirements that limit how much risk a bank can take. Had these rules, or even some slightly more generous version, applied to investment banks like Lehman Brothers (OTC:LEHMQ), they would not have taken on so much risk that they destroyed themselves in the process.

Don’t count me among the totally anti-regulation crowd. It’s true that sometimes government interference strikes me as particularly stupid. The current ban on short selling is a perfect case in point. But the day-to-day guidelines that keep rogue traders within bounds are useful.

It comes down to this: when a business is so big that the government needs to step in if it fails, then that business should be monitored and held to sensible standards before it takes itself to the destruction point.

Leaving a business alone to do anything it wants and get into as much trouble as it desires then standing ready to bail it out is about as wise as handing your 16-year-old hothead the keys to the Porsche and your credit card and telling him there’s no curfew, either.

Source: The Keys to the Porsche Should Come with Limits

Your assignment, if you accept it . . . Help me compile statements by every so-called expert on how the financial markets were safe, the stock market was going to rise, and “people should not panic and sell stocks.”

For months, high-level government officials assured us that America’s financial markets were safe. They continued to assure us right up until Treasury Secretary Henry Paulson on September 18 said a $700 billion bailout is required to save the economy from a collapse comparable to the Great Depression.

Our leaders, including Paulson, did not have a clue as to what was going on.

The World Wide Web has preserved their assurances. It is now time to collect them in one place. I propose to call this place The Gallery of the Clueless.

The assurances began in August 2007. They accelerated right through September 18.

It did not matter that Fannie Mae (NYSE:FNM) and Freddie Mac (NYSE:FRE) were nationalized without vote by Congress on a Sunday afternoon, September 7. The experts remained optimistic.

It did not matter that a week later, also on a Sunday, Merrill Lynch (NYSE:MER) sold itself without a vote by its Board of Directors to Bank of America (NYSE:BAC), which also did not ask for a vote by its Board of Directors.

It did not matter that on Monday, September 15, Lehman Brothers Holdings (NYSE:LEH) declared bankruptcy—the largest bankruptcy by far in American history, dwarfing Enron and WorldCom combined. We were assured on September 15 that everything was under control.

It was not just Paulson, Bernanke, and the President who assured us. It was also almost every talking head from the financial world who appeared on television. The main exception was Prof. Nouriel Roubini, whose grim forecasts have come true, one by one.

On Sunday, September 14, he said that no investment bank would survive. He said the model was fundamentally flawed. Two went bust within 24 hours: Merrill Lynch and Lehman. The other two were bailed out by a change in their legal structure on Friday, September 19. Both Goldman Sachs (NYSE:GS) and Morgan Stanley (NYSE:MS) surrendered their status as investment banks, switched to holding companies, thereby coming under Federal regulation, and immediately becoming eligible for bailout money.

We have seen a stream of ex-geniuses depart as multi-millionaires: Angelo Mozilo (Countywide Financial), Charles Prince (Citigroup), Stan O’Neal (Merrill Lunch), and Dick Fuld (Lehman). They join the legendary Franklin Raines (Fannie Mae), who had departed years earlier, and who today is an Obama advisor. Then there were the recent heads of Fannie and Freddie. The head of AIG will be replaced soon.

OH, YEAH?

In 1931, Viking books published a slim volume titled “Oh, Yeah?” It was a collection of quotations from the nation’s former experts of why the stock market was a great place for your money in 1928 and 1929. These quotations were identified as to who said what, when, and where.

I own a copy of this compilation. It ended with a 1931 quote from Calvin Coolidge, who was in retirement: “The country is not in good condition.” I intend to assemble a digital equivalent of “Oh, Yeah?” I will post it free of charge on the Web. I want to make it easy for journalists and historians to see just how blind the nation’s leaders were.

This collection will serve as a warning to future investors: ”Don’t trust the assurances of self-interested people whose careers and reputations are at stake.” The new Administration will return to Congress for more rounds of bailouts. Each will be presented as “the final request.” Each will be sold to Congress as last shoe to drop.

The result so far has been a gigantic increase in the nation’s debt. We have gone beyond the point of no return.

Voters know now that the national debt will never be paid off, at least not with dollars worth what they are worth today.
But they think they are helpless. They will let Congress get away with this.

WHAT I NEED FROM YOU

Do a Google search for such topics as these for 2007 and 2008:

“money is safe”, panic AND not “should not sell”, confidence AND banks, confidence AND FDIC, “economically sound” “fundamentally sound”, Paulson AND assurance, Bernanke AND assurance, Dodd AND assurance.

Maybe you can think of others. Look for links after page 1 on Google. Go as far as page 5. Look for juicy ones. Then extract the quotation using cut & paste (Ctrl-c, Ctrl- v). Paste it into an email letter (Ctrl-v). Then paste in the link to the Web source. Repeat the process using YouTube in the search box. If you find some choice videos, send them along with the links.

Put “clueless” in the subject box. Send it to garynorth@garynorth.com.

To Sign Up Click Here

This from The Daily Reckoning Australia:

Paulson and Bernanke argue that the fund (likely managed by either Goldman or Morgan, for a fee, of course) should not pay low, real-world prices for the bad debt. The market price of the bad assets is what Bernanke calls a “fire-sale” price. And that is bad, apparently (don’t ever try to go discount shopping with Ben Bernanke).

As we mentioned earlier this week, forcing the banks to sell at fire-sale prices doesn’t improve their capital position. So Paulson and Bernanke have advanced the theory that the tax-payer should pay the “hold-to-maturity” price for the securities. That price, as you might guess, is much higher than the “fire sale” (market) price.

Some people like paying higher prices simply because they can. It makes them feel rich, especially when they’re paying with other people’s money.

Hang on, though. What is the “hold-to-maturity” price? No one knows! Paulson and Bernanke argue that many of the mortgages will come good once the storm passes, and that the assets the taxpayer buys today at “hold-to-maturity” price might actually be a good investment in the proverbial “long term.”

Gag.

Wretch.

Here’s what we guess will happen. The Paulson plan is an attempt at price controls. Only here, the Plan is to value the impaired asset-backed securities much higher than the market values them at. This will not create a scarcity (as is the case with price controls in the stock market). It will create a surplus! How is that possible?

As Thomas Sowell explains, “A price set above the free market level tends to cause more to be supplied than demanded, creating a surplus…It is often lost sight of in the swirl of more complex events and more politically popular beliefs.”

Translation: if the Paulson plan offers a higher price for assets than the market price, the banks have every incentive to off-load as many assets as they can. They increase the supply of assets for sale that they consider the riskiest. And why not? If someone pays you to get rid of your biggest liabilities, wouldn’t take advantage of it too? If you could sell your garbage for gold, wouldn’t all of your possessions suddenly look like garbage?

A better plan might be to slap a multi-year freeze on the valuation of the suspect assets and leave them on bank balance sheets. Just let the banks carry them on the balance sheet, Japan style, without having to mark them to market. Let them unwind the bad debts over time, rather than going out of business, or transferring the whole mess to the Federal balance sheet.

Not that we like that solution. And it certainly doesn’t address the “root cause” of the problem. The assets the securities are tied to, American homes, are falling in value. As far as we can tell, there’s no way to slap a price control on those and keep them from falling.

But the Denning Plan – leaving the toxic waste on the balance sheets of the folks who created it – seems more just than the Paulson Plan.

Source: A Violation of Public Trust