Tuesday, September 30, 2008

Oil Drops Most in 17 Years in Quarter on Economy Woes (Update2)

By Margot Habiby

Sept. 30 (Bloomberg) -- Crude oil futures plunged 28 percent in the third quarter, their biggest decline since 1991, amid concern that slowing economic growth will curtail global demand and as the dollar advanced.

Oil traded within a $56 range in the quarter, reaching a record $147.27 a barrel on July 11 and retreating to as low as $90.51 a barrel on Sept. 16, as long-term supply concerns gave way to forecasts a recession would cause fuel use to drop. The dollar is having its best quarterly gain against the euro.

``It's been one of the wildest quarters I've ever seen,'' said Peter Beutel, president of Cameron Hanover Inc. in Stamford, Connecticut, who has been watching the oil market for 25 years.

Crude oil for November delivery fell $39.36 in the three months ended today to settle at $100.64 a barrel at 2:51 p.m. in New York Mercantile Exchange trading. It was the first decline in seven quarters. Futures moved 5 percent or more on a quarter of the trading days. Oil rose $4.27, or 4.4 percent, today.

Crude posted the biggest single-day gain ever on Sept. 22, as traders rushed to unwind positions on the October contract's last day of trading. Prices rose as much as $25.45 a barrel before closing up $16.37, or 16 percent, to $120.92 a barrel.

``It's certainly been a tremendously volatile quarter, and you can throw the way the October contract expiration occurred in as a part of that,'' said Tim Evans, an energy analyst with Citi Futures Perspective in New York. ``Volatility has just bloomed here and hasn't settled down.''

Volatility Index

The Chicago Board Options Exchange Crude Oil Volatility Index, or OVX, rose to a record 64.21 yesterday, then retreated to 59.84 at 3:07 p.m. New York time today, which would be the second-highest closing level. The gauge, introduced by the largest U.S. options exchange on July 15, extends back to May 2007 and measures expected price swings for the United States Oil Fund, an exchange-traded fund tracking crude futures.

The dollar's advance in the quarter reduced oil's appeal among investors who purchased energy and metals as a hedge against the currency's drop earlier in the year. The euro declined the most versus the dollar today since its introduction in 1999.

The International Energy Agency, adviser to 27 nations, on Sept. 10 lowered its 2008 demand forecast as high prices and slowing economic growth trimmed demand for diesel, gasoline and jet fuel. The agency cut its 2008 forecast by 100,000 barrels to 86.8 million barrels a day and the 2009 forecast by 140,000 barrels to 87.6 million barrels a day.


The Organization of Petroleum Exporting Countries, which supplies more than 40 percent of the world's oil, cut its forecast for 2009 oil demand on Sept. 16. The 13-member group said oil consumption will average 87.66 million barrels a day next year, compared with 87.80 million barrels a day in its previous outlook. It also cut its 2008 forecast by 120,000 barrels a day.

U.S. stocks plunged yesterday after U.S. lawmakers rejected a $700 billion plan to rescue the financial system. The move caused the Standard & Poor's 500 Index to tumble the most since the 1987 crash and the Dow Jones Industrial Average to post its biggest point drop ever. The indexes rallied today on speculation Congress will salvage the package.

``Our most pressing concern is to what extent the U.S. virus spreads globally and specifically to China,'' Adam Sieminski, a Deutsche Bank AG analyst in Washington, said in a report yesterday. ``We believe recessions are under way in both Europe and Japan, and that U.S. growth over the next few quarters looks to be very flat at best.''

Forecast for 2009

Deutsche Bank yesterday slashed its 2009 New York oil price forecast by 23 percent to $92.50 a barrel because of the economic crisis.

U.S. petroleum demand is about 4 percent below year-ago levels, amid rising U.S. economic growth, according to Citi's Evans.

``That's a pretty clear indication that consumers were making efforts to become more efficient in their petroleum use as a response to all-time high prices,'' he said, adding that ``the economic pressures that high prices for crude oil brought'' have a lot to do with the quarterly slide in prices.

Oil averaged $118.22 a barrel in the quarter, down 4.5 percent from a second-quarter average of $123.80, a record. It was the first time the average price dropped in six quarters.

No Impact

Futures couldn't sustain a rally even when faced with factors which under other conditions would have driven the market higher, Beutel said. They include Hurricanes Ike and Gustav, which shut in all of U.S. Gulf of Mexico production and much of the region's refining capacity, the Russian incursion into Georgia, an OPEC production cut, pipeline fires and Nigerian unrest.

``Had you told me July 11 that we've got two hurricanes coming, one that will hit Louisiana and one that will hit Texas, we've got an OPEC cut coming, we've got Russia going into Georgia and a number of attacks into Nigeria, I would have said without a second's hesitation that we would have been over $200, no question,'' he said.

U.S. gasoline stockpiles fell to an 18-year low in the week ended Sept. 12 after the hurricanes struck Texas and Louisiana, according to the U.S. Energy Department. U.S. refiners operated at 66.7 percent of capacity in the week ended Sept. 19, the lowest since at least 1989, because of storm damage.

Gasoline prices have dropped the most since the third quarter of 2006. Futures for October delivery fell $1.0168, or 29 percent, in the three months ended today to settle at $2.4847 a gallon. Today, gasoline added 8.77 cents, or 3.7 percent.

Regular gasoline, averaged nationwide, dropped 11 percent in the quarter to $3.633 a gallon, according to AAA, the nation's largest motorist organization. It was the first quarterly decline in a year. The price peaked at $4.114 a gallon on July 16.

Euro Falls Most Since 2001 Against Dollar as Bailouts Spread

By Daniel Kruger and Ye Xie

Sept. 30 (Bloomberg) -- The euro fell the most against the dollar since 2001 after France and Belgium led a state-backed rescue of Dexia SA, as the widening financial crisis forces governments to prop up financial institutions across Europe.

The cost of borrowing in dollars and euros reached record highs today as banks' reluctance to lend at the end of the third quarter exacerbated the freeze in global credit markets. The dollar rose against the yen on speculation the U.S. Senate will salvage a $700 billion bank-bailout plan as early as tomorrow after Congress rejected it yesterday.

``The consensus is the U.S. banking system is a little bit further along in its exposure of its toxic assets,'' said Firas Askari, head currency trader at BMO Nesbitt Burns in Toronto. ``It's a case of which is relatively worse. The dollar's going to benefit against the euro because Europe has more to expose.''

The euro tumbled 2.4 percent to $1.4092 at 5 p.m. in New York, from $1.4434 yesterday, the most since a 2.5 percent slide in January 2001. The currency dropped as much as 3 percent, the biggest intraday decline since its 1999 debut. The euro slid to 149.56 yen from 150.38. The yen weakened to 106.11 per dollar from 104.18, after reaching 103.54, the most since Sept. 16.

Implied volatility on one-month euro-dollar options rose to 16.9575 percent, or the highest in almost eight years. On Sept. 18, it reached 15.55 percent, the same level that triggered the Group of Seven nations to buy euros in 2000 to halt the 27 percent slide from its 1999 debut. The dollar had its biggest drop ever against the euro Sept. 22, falling 2.1 percent.

The euro also fell against the British pound after Belgium and France said they would lend Dexia, the world's biggest lender to local governments, $9.2 billion to shore up capital.

Bank Borrowing

The capital infusion for Dexia comes two days after Belgium, the Netherlands and Luxembourg rescued Fortis, the largest Belgian financial-services company, Britain took control of Bradford & Bingley Plc, the country's biggest lender to landlords, and Germany bailed out Hypo Real Estate Holding AG.

Banks are being squeezed amid a surge in borrowing costs as lenders hoard cash on concern more financial institutions will fail. The euro interbank offered rate, or Euribor, for one-month loans jumped to a record 5.05 percent, the European Banking Federation said. The London interbank offered rate, or Libor, that banks charge each other for overnight loans climbed 431 basis points to an all-time high of 6.88 percent today, the British Bankers' Association said.

`Fundamentals Are Irrelevant'

``There's a dollar shortage globally,'' said Alan Ruskin, head of international currency strategy in North America at RBS Greenwich Capital Markets Inc. in Greenwich, Connecticut. ``Demand for liquidity trumps the fundamentals. Fundamentally, the U.S. is awful, and Europe is awful. Fundamentals are irrelevant today.''

Foreign banks are paying the highest premiums in at least a decade to borrow in dollars in the swaps market even after the Federal Reserve more than doubled the amount of funds available to other central banks yesterday by expanding swap lines.

The Fed's actions included increasing existing currency swaps with foreign central banks by $330 billion to $620 billion to make more dollars available worldwide. The European Central Bank, the Bank of England and the Bank of Japan are among the participating authorities.

The price on one-year cross-currency basis swaps between yen and dollars reached minus 70 basis points, the biggest effective premium for dollar funding since Bloomberg began tracking the data in 1997. The highest reached in 1998, during the Asian banking crisis was minus 38.5 basis points in October 1998, according to Bloomberg data.

`Mad Scramble'

``There is a mad scramble for U.S. dollar funding demand from a global U.S. dollar-based financial system,'' said Claudio Piron, Singapore-based head of Asian currency research at JPMorgan Chase & Co, the second-biggest U.S. bank by market value. ``Central banks have been extending swap lines as lenders of the last resort. The banks access this liquidity, but they hoard it for themselves as they believe it too risky to lend to anyone else.''

The U.S. Senate will try to revive a $700 billion financial-rescue package after yesterday's defeat in the House of Representatives. The bill would have allowed the government to buy troubled assets from banks. Institutions posted $590 billion of losses and writedowns since the start of last year following the collapse of the U.S. subprime-mortgage market.

``The U.S. problem has been public for a while, we're dealing with it,'' said Russell LaScala, the New York-based head of foreign exchange trading at Deutsche Bank AG, the world's biggest foreign-exchange trader. ``Traders are very confident something's going to be passed in the next seven days. That's definitely a sentiment that's being priced in the market.''

Rising Yen

Higher-yielding currencies recouped losses against the Japanese yen as Europe's benchmark Dow Jones Stoxx 600 Index gained 1 percent. The New Zealand dollar gained 1.5 percent to 71.07 yen after dropping 3.7 percent yesterday. The Australian dollar was little changed at 84.08 yen, after rising as much as 1.6 percent to 85.18 yen after falling 4.9 percent yesterday.

``I would be very cautious in betting on further near-term dollar-yen losses,'' said Michael Klawitter, a currency strategist at Dresdner Kleinwort in Frankfurt. ``Any positive news on the political front would have quite an impact.''

The yen typically declines when demand for high-yielding currencies rises, as traders put on so-called carry trades. In such transactions, investors get funds in countries with low borrowing costs and buy assets where returns are higher. Japan's 0.5 percent target lending rate compares with 7 percent in Australia and 7.5 percent in New Zealand.

Quarter End

The yen rose the most of all 16 most-actively traded currencies yesterday after the Standard & Poor's 500 Index plunged the most since the 1987 crash.

The Japanese currency rose 12 percent against the euro this quarter. The dollar fell 0.9 percent against the yen, paring a 7 percent gain in the previous three months. The euro is down 11 percent against the dollar.

``It is the last day of the quarter,'' said Daragh Maher, deputy head of global currency strategy in London at Calyon, the investment-banking arm of France's Credit Agricole SA. ``You can get more unusual volatility, and I think we will get back to a more real market toward the end of the week and we can reassess what is happening then.''

Monday, September 29, 2008

Fed Would Gain More Power Over Short-Term Rates in Rescue Bill

By Craig Torres and Scott Lanman

Sept. 29 (Bloomberg) -- The Federal Reserve would gain more power over short-term interest rates as part of Congress's $700 billion legislation to revive credit markets, making it easier for the Fed to pump funds into the banking system.

The draft bill, released yesterday, gives the Fed authority as of Oct. 1 to pay interest on reserves held at the central bank by financial institutions. That would encourage banks to deposit excess funds with the Fed rather than dumping them into the money markets and distorting its overnight federal funds rate.

The flood of liquidity pumped into the financial system by the Fed to encourage interbank lending over the past year has made it harder for the central bank to gauge market conditions and keep fed funds at its 2 percent target. The rate has traded between zero and 7 percent since Sept. 15.

``It's probably a good thing,'' said Marvin Goodfriend, a former senior policy adviser at the Richmond Fed who is now professor of economics at Carnegie Mellon University in Pittsburgh. Allowing payment of interest on reserves will ``enable the Fed to have credit policy that's independent of its monetary policy,'' he said.

While containing the interest provision sought by Fed Chairman Ben S. Bernanke since May, the draft legislation increases congressional scrutiny of the Fed's emergency loans in connection with the collapses of Bear Stearns Cos. and American International Group Inc.

Report to Congress

The bill requires the central bank to submit reports to Congress on loans to nonbanks since March 1 as well as updates at least every two months while the loans are outstanding.

The Federal Open Market Committee sets a target for the federal funds rate, which the New York Fed is obligated to achieve on a daily basis through temporary and permanent purchases or sales of bonds in the open market. Banks are required to hold a proportion of their customers' deposits in an account at the central bank.

Paying interest on reserves puts a ``floor'' under the traded overnight rate, which would allow a central bank ``to provide liquidity during times of stress'' without affecting the rate, New York Fed economists said in a paper last month. New Zealand's central bank has adopted such an approach.

The Fed had already received authority in 2006 to start paying interest on reserves in October 2011. Bernanke asked House Speaker Nancy Pelosi in May to expedite the authority. U.S. lawmakers are reviewing the $700 billion plan to buy troubled assets from financial institutions, and the House and Senate may vote tomorrow.

New Date

The draft legislation doesn't mention the Fed in the three- line section that would provide the interest-payment authority. The bill says that the part of the 2006 law giving the Fed the power ``is amended by striking `October 1, 2011' and inserting `October 1, 2008'.''

In 2006, the Congressional Budget Office estimated that Fed interest payments would cost the government $1.4 billion in the first five years.

``I expect them to use it to manage the funds rate more efficiently,'' said Lou Crandall, chief economist at Wrightson ICAP LLC, in Jersey City, New Jersey.

A measure of availability of cash among banks, known as the Libor-OIS spread, widened to 2.08 percentage points, the most on record, on Sept. 26. In the year before the credit crisis started in August last year, the spread averaged 8 basis points.

Commercial banks borrowed $39.4 billion from the Fed's discount window for the week ending Sept. 24, almost double the previous period, as the financial crisis deepened and funding from other banks dried up.

Counterparty fears also increased in the wake of Lehman Brothers Holdings Inc.'s bankruptcy filing on Sept. 15.

Dollar Intervention Risk `Meaningful' on Volatility (Update3)

By Ye Xie

Sept. 29 (Bloomberg) -- A growing number of currency traders and strategists are starting to speculate that finance ministers from the world's biggest economies will join to support the dollar.

Volatility in currencies is the highest since 2000, when the so-called Group of Seven nations last intervened in the foreign-exchange market. The dollar weakened 2.5 percent on a trade-weighted basis in the past two weeks as the turmoil on Wall Street intensified. It had the biggest one-day drop against the euro since 2001 a week ago.

While the dollar strengthened 9 percent from its record low against the euro on July 15, wider price swings threaten to undermine confidence in the U.S. currency just as government borrowing rises and U.S. lawmakers prepare to vote on Treasury Secretary Henry Paulson's plan to bail out the nation's banks. The greenback is still down 23 percent since 2005.

``We're getting closer to the right conditions for authorities to step in and prop up the dollar,'' said Maxime Tessier, who manages $151 billion as head of foreign exchange in Montreal at Caisse de Depot et Placement. ``The nightmare scenario will be a wholesale loss of confidence in the dollar.''

The dollar rose to $1.4337 per euro at 8:26 a.m. in London from $1.4614 on Sept. 26 after weakening 2.7 percent in the previous two weeks. The broader U.S. Dollar Index was at 78.202.

Even a hint that finance ministers might influence exchange rates may be enough to set a floor under the currency after efforts by the Federal Reserve, European Central Bank and Bank of Japan failed to revive investor confidence by injecting more than $1 trillion into the world financial system.

`Extraordinary Interventions'

``The central banks of the world have embarked on all sorts of extraordinary interventions,'' said Stephen Jen, the global head of currency research at Morgan Stanley in London. ``Currency joint intervention would be the least surprising. And it would probably be the cheapest.''

Morgan Stanley's intervention watch index suggests an 18 percent chance that policy makers will step into the market to influence exchange rates. Any reading above 10 percent suggests the risk is ``meaningful,'' or elevated, according to the New York-based firm.

The index, based on interest rates, trading patterns and investor positions, is accurate 78 percent of the time. The index is at the same level as when the G-7 intervened in 2000.

Finance ministers from the G-7 are more concerned about rapid swings in exchange rates than the absolute level of currencies because volatility complicates the assessment of economies, interferes with monetary policy and gives companies little time to adjust by cutting costs.

`Sharp Fluctuations'

Sadia SA, Brazil's second-biggest food company, posted a 760 million-real ($410 million) loss last week related to foreign-exchange hedges after the nation's currency tumbled 26 percent from a nine-year high on Aug. 1.

The G-7, which includes the U.S., Japan, Germany, Britain, France, Italy and Canada, warned in April against the implications of ``sharp fluctuations in major currencies,'' the first time since 2004 that the group used such language. Shoichi Nakagawa, Japan's new finance minister, reiterated that view on Sept. 26, saying ``sharp fluctuations in the foreign exchange market aren't good.''

Implied volatility on one-month euro-dollar options rose to an eight-year high of 15.55 percent on Sept. 18, the same level that triggered the G-7 to buy euros in 2000 to halt the 27 percent slide from its 1999 debut. Volatility gained to 14.93 percent from 14.51 percent last week, up from this year's low of 8.02 percent on Aug. 1.

U.S. Growth

Weakness in the dollar hasn't become so disruptive to suggest imminent intervention, said Ken Jakubzak, who manages the KML Currency Program in Chicago for KMJ Capital LLC, which has $100 million under management.

The currency is 3 percent stronger than its record low in March on a trade-weighted basis. Some investors say the currency may rally as the economies outside the U.S. slow.

Growth in the euro-zone will decelerate to 1.35 percent this year from 2.63 percent in 2007, according the median estimate of economists surveyed by Bloomberg. Japan's economy may expand 1 percent, compared with 2.08 percent, while the U.S. economy will likely grow 1.7 percent, the surveys showed.

The dollar will rally to $1.43 by year-end and to $1.40 by the end of the first quarter, according to the median estimate of more than 40 economists and strategists surveyed by Bloomberg.

``Should the bailout plan succeed in stabilizing the markets, the sentiment will shift to be more constructive for the dollar,'' said Jakubzak, who expects the dollar to rise to $1.30 by year-end. ``What happens in the U.S. will also happen in the other places in the world.''

Paulson Plan

U.S. lawmakers are reviewing a tentative agreement to revive credit markets by authorizing a $700 billion plan to buy troubled assets from financial institutions. ``The deal is done,'' said Senator Judd Gregg, a New Hampshire Republican, a ranking member of the Budget Committee. The House and Senate may vote Sept. 29 on it, he said.

Dollar bears say the U.S. budget and trade deficits and negative real interest rates make a sustained dollar rally unlikely. Paulson's plan to buy devalued securities from banks would drive U.S. government debt above 70 percent of gross domestic product, the most since 1954, based on economist estimates and details of the bailout.

Barclays, TD

If the Treasury spends the entire amount next year, it would drive next year's budget deficit to $1 trillion or more from about $500 billion now. Michael Feroli, an economist at JPMorgan Chase & Co. in New York, estimated the combination of the Paulson plan, additional government expenditures, and a slower economy, may swell the deficit to $1.5 trillion, or 10 percent of GDP.

The currency will drop to $1.57 per euro by year-end, according to London-based Barclays Plc, the world's third- largest foreign exchange trader. Toronto-based TD Securities, a unit of Canada's second-biggest bank by assets, said it will weaken below $1.60 in the next few months.

``Authorities don't want excessive dollar weakness to feed the sell-America mentality,'' said Chris Turner, head of foreign exchange strategies in London at ING Groep NV, the largest Dutch financial-services company. ``We are not there yet, but the risk is there. People I speak to are worried about a budget explosion.''

The government depends on foreign money to finance the budget deficit because investors outside the U.S. own 56 percent of the $4.8 trillion in marketable Treasuries outstanding, up from 42 percent five years ago, according to data compiled by the government.

`Been Crushed'

While the G-7 decided against intervening in April when the dollar fell below $1.60 per euro for the first time, tolerance for a weaker currency may be limited because of the turmoil sweeping the financial system. The next meeting is scheduled for Oct. 10 in Washington.

In the past month, the government took over Washington- based Fannie Mae and McLean, Virginia-based Freddie Mac, the two biggest mortgage finance companies, as well as New York-based American International Group Inc., the largest U.S. insurer. New York-based Lehman Brothers Holdings Inc. went bankrupt and Washington Mutual Inc. of Seattle was seized by regulators in the biggest bank failure in U.S. history.

``At the end of the day, the financial sector is our flagship,'' Kenneth Rogoff, a professor of economics at Harvard University, and a former chief economist at the International Monetary Fund, said in an interview on Bloomberg Radio Sept. 19. ``It has been crushed, and that's going to have a big impact on international capital flows. That's going to affect the positions of the dollar in the global financial system.''

Wednesday, September 24, 2008

Bernanke Sees `Grave Threats' to Financial Stability (Update5)

By Craig Torres

Sept. 24 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke said the U.S. is facing ``grave threats'' to financial stability and warned that the credit crisis has started to damage household and business spending.

``Economic activity appears to have decelerated broadly,'' Bernanke said today to a congressional Joint Economic Committee hearing, downgrading the assessment of Fed officials when they met on Sept. 16. ``Stabilization of our financial system is an essential precondition for economic recovery.''

Bernanke's comments, his most dire about the economy since he became central bank chief in 2006, may stoke investors' expectations the Fed will lower interest rates by year-end to alleviate the credit crisis. He reiterated his call for Congress to pass Treasury Secretary Henry Paulson's plan for a $700 billion fund to remove devalued assets from the banking system.

Without the bailout, ``credit will be restricted further for homeownership, for small business, for individual consumers and so on, but that is not just an inconvenience,'' Bernanke said. ``What that is going to do is affect spending and economic activity and it will cause the economy as a whole to decline and be much weaker than it otherwise would be.''

The Federal Open Market Committee left its benchmark rate unchanged at 2 percent this month for a third straight meeting after seven cuts since September 2007. Policy makers next gather Oct. 28-29, when traders see a 78 percent chance of a reduction, futures prices show.

`Downside Risks'

``The downside risks'' to economic growth ``remain a significant concern,'' Bernanke said.

Lawmakers including Representative Paul Kanjorski, the second highest-ranking Democrat on the House Financial Services Committee, said taxpayers don't want to rescue mortgage lenders and other financial institutions viewed as responsible for the credit crisis.

Taxpayer interests ``must trump those of corporate fat cats and cowboy capitalists,'' Kanjorski of Pennsylvania told Bernanke at an afternoon hearing by the House panel. ``Americans are tired of enabling corporate excess.''

The Fed chairman's testimony today signaled that restrictive credit has now slowed the economy from its 3.3 percent annualized pace in the second quarter to a pace ``appreciably below its potential rate.'

Bernanke is ``very much leaning to seeing downside risks to growth as much greater,'' said James O'Sullivan, senior economist at UBS Securities LLC in Stamford, Connecticut. ``If we don't get credit market relief, the risks tilt overwhelmingly to growth rather than inflation.''

Waning Credit

Tumbling housing prices and waning mortgage credit have pushed up borrowing costs for both banks and consumers, and will probably slow the expansion to a 1.7 percent annual rate in 2008, according to the median forecast of 80 economists in a Bloomberg News survey.

Unemployment rose in August to a five-year high of 6.1 percent and payrolls have fallen for eight straight months.

``The weakness in fundamentals underlying consumer spending suggest that household expenditures will be sluggish, at best, in the near term,'' the Fed chairman said. ``The continuing decline in house prices reduces homeowners' equity and puts continuing pressure on balance sheets of financial institutions.''

Bernanke said construction of commercial office buildings and business spending on equipment and software are likely to slow. Declining growth abroad could reduce the lift the U.S. economy received from exports in the first half, he said.

`Quite Adverse'

``If financial conditions fail to improve for a protracted period, the implications for the broader economy could be quite adverse,'' Bernanke said.

Bernanke also said slowing growth should help moderate inflation pressures. The consumer price index rose 5.4 percent for the year ending in August.

``The inflation outlook remains highly uncertain,'' he said. ``The upside risks to inflation remain a significant concern.''

Responding to questions from lawmakers, Bernanke said that should the rescue succeed and spur an economic recovery, the Fed may raise interest rates sooner than it otherwise would. For the plan itself, ``I don't expect any effect on inflation,'' he said.

Bernanke yesterday told the Senate Banking Committee in a joint appearance with Paulson that lawmakers should pass the rescue plan quickly.

Worsening Crisis

In a worsening credit crisis, ``people cannot borrow to buy a car, to send a student to college, to buy a house,'' Bernanke told the House committee today. Scant lending harms ``people at the lunch bucket level.''

Fed officials have so far failed to stem the credit crisis even after the steepest rate cuts in two decades and interventions in Bear Stearns Cos. and American International Group Inc. this year.

The Fed has also pumped billions of dollars into banks to try to restore liquidity, while invoking extraordinary powers to loan to securities firms.

The Treasury this month took over Fannie Mae and Freddie Mac as the turmoil engulfed the two largest mortgage finance companies.

Lawmakers have balked at approving the Treasury's proposal to buy illiquid assets from financial institutions without changes. Republicans resisted the plan's size and scope and Democrats demanded support for homeowners and limits on executive pay.

Tuesday, September 23, 2008

Dollar Falls Versus Euro Amid Delay in U.S. Bailout Proposal

Dollar Falls Versus Euro Amid Delay in U.S. Bailout Proposal

By Stanley White and Ye Xie
Enlarge Image/Details

Sept. 24 (Bloomberg) -- The dollar fell against the euro on bets U.S. congressional scrutiny will delay passage of the government's $700 billion rescue plan for financial institutions.

The dollar also declined against the British pound after Federal Reserve Chairman Ben S. Bernanke and Treasury Secretary Henry Paulson said yesterday failure to pass the bailout would threaten the U.S. economy as lawmakers balked at rubber-stamping the plan. The Australian and New Zealand dollars slumped as prices dropped for commodities the two countries export.

``The dollar will face a lot of pressure to go lower,'' said Tsutomu Soma, a bond and currency dealer at Okasan Securities Co. in Tokyo. ``Uncertainty about when the U.S. rescue package will pass and how much of a burden it will place on future generations is damaging confidence in the dollar.''

The dollar slid to $1.4683 per euro at 7:54 a.m. in Tokyo from $1.4648 late yesterday in New York. It was at 105.76 yen from 105.56 yen. Against the pound, the dollar traded at $1.8552 from $1.8522. The euro bought 155.31 yen from 154.63 yen. The dollar may decline to $1.4710 per euro today, Soma forecast.

The Australian dollar fell to 83.07 U.S. cents from 84.40 cents late in Asia yesterday. New Zealand's dollar weakened 1.5 percent to 67.97 U.S. cents.

Gold, Australia's third most-valuable raw material export, fell below $900 an ounce in New York yesterday. Crude oil, its fourth most-valuable export, also slipped. Raw materials account for 60 percent of Australia's exports and sales of commodities such as lumber make up 70 percent of New Zealand's overseas shipments.

Government Plan

Paulson and Bernanke appeared before the Senate Banking Committee to provide details on the proposed bailout. Under the plan, the government would buy devalued securities from financial institutions that economists estimate would drive government debt above 70 percent of gross domestic product and push the annual budget gap to an all-time high next year.

``The sooner we get a plan in place -- we can worry about the details later -- the sooner we can reduce uncertainty,'' said Michael Woolfolk, senior currency strategist in New York at Bank of New York Mellon, the world's largest custodial bank, with more than $23 trillion in assets under administration.

European Contraction

Gains in the euro may be limited by speculation weakening German business confidence will point to slower growth in the 15 countries that share the currency.

The Ifo institute's business climate index declined to 94.3 from 94.8 in August, according to the median of 41 forecasts in a Bloomberg News survey. That would be the weakest reading since June 2005. Ifo will release the report, based on a survey of 7,000 executives, at 10 a.m. in Munich today.

``Economic data in Europe reminds people there's more weakness coming,'' said Brian Kim, a currency strategist at UBS AG in Stamford, Connecticut. ``It's going to provide longer-term support for the dollar, but right now all focus is on the bailout plan.''

The U.S. currency has lost almost 6 percent versus the euro since touching a one-year high of $1.3882 on Sept. 11. The dollar reached $1.6038 on July 15, the weakest level since the European currency made its 1999 debut.

Sunday, September 21, 2008

Crude Oil Falls After Nigerian Militants Call End to Attacks

By Gavin Evans

Sept. 22 (Bloomberg) -- Crude oil fell for the first time in four days as Nigerian militants stopped attacks on oil facilities and investors awaited the U.S. government's proposed $700 billion rescue package for the finance industry.

The rally in oil, up 15 percent the past three days, stalled as the Movement for the Emancipation of the Niger Delta ended attacks that cut production by 280,000 barrels a day the past week. U.S. lawmakers are pledging fast consideration of the Treasury's plan to buy devalued mortgage-related securities from investment firms to keep the financial system from stalling.

Crude oil for October delivery fell 86 cents, or 0.8 percent, to $103.69 a barrel at 8:24 a.m. in Sydney. The contract, which expires at the close of trading today, jumped as much as 7.4 percent on Sept. 19 as investors bought oil to cancel out earlier bets on falling prices.

The more widely held November contract traded at $102.52 a barrel, down 0.2 percent. It gained 5.3 percent on Sept. 19.

Oil fell more than $10 a barrel early last week as the bankruptcy of Lehman Brothers Holdings Inc. shocked world equity markets. Prices gained 3.3 percent over the five trading days, the first weekly increase since August, as the dollar slumped on the prospect of the biggest U.S. financial bailout since the Great Depression.

The U.S. dollar fell to $1.4483 against the euro in early Asian trading today. The currency dropped 1.7 percent last week, its biggest decline since March 28, to $1.4466 per euro in late New York trading on Sept. 19.

Brent crude oil for November settlement rose $4.42, or 4.6 percent, to $99.61 a barrel on London's ICE Futures Europe exchange on Sept. 19.

Australian Regulator Extends Ban to 'Covered' Short Selling

By Stuart Kelly

Sept. 22 (Bloomberg) -- Australia's corporate regulator extended its ban on short selling to include so-called ``covered'' transactions, following similar moves by U.S. and U.K. regulators in an attempt to alleviate volatility in the stock market.

Traders won't be allowed to transact covered short sales, in which stock is borrowed for the purposes of betting on share price declines, from the start of trading today, the Australian Securities and Investments Commission said on its Web site yesterday. It abolished so-called ``naked'' short sales, in which traders never borrow the shares, last week.

The move comes after the U.S. Securities and Exchange Commission halted short selling of financial companies in a bid to stymie speculators seeking to benefit from the credit crisis that led to the collapse of Lehman Brothers Holdings Inc. and American International Group Inc.

``In the current climate and, in light of the actions taken by other regulators, we need a circuit breaker to assist in maintaining and restoring confidence,'' ASIC Chairman Tony D'Aloisio said in the statement. ``These measures are necessary to maintain fair and orderly markets. Because of the relatively small size and the structure of the Australian market, it is necessary to extend the prohibition to all stocks.''

Short sellers try to profit by betting stock prices will fall. In a short sale, traders borrow shares from their broker that they then sell. If the price drops, they buy back the stock, return it to their broker and pocket the difference.

ASIC and the Australian Securities Exchange on Sept. 19 abolished ``naked'' short selling, in which traders never borrow the shares, raising concerns that investors are flooding markets with sell orders to drive down prices.

The changes will be reviewed in 30 days, ASIC said yesterday.

Friday, September 19, 2008

Paulson, Bernanke Expand U.S. Power to Rescue Markets (Update4)

By Rebecca Christie and John Brinsley

Sept. 19 (Bloomberg) -- The U.S. government moved to cleanse banks of troubled assets and halt an exodus of investors from money markets in the biggest expansion of federal power over the financial system since the Great Depression.

``We're talking hundreds of billions,'' Treasury Secretary Henry Paulson said in a press conference. ``This needs to be big enough to make a real difference and get to the heart of the problem.''

The Treasury is likely to run the program, which would involve auctions where the government buys devalued assets, said House Financial Services Committee Chairman Barney Frank. The plan, which will apply to U.S.-based financial institutions seeking to sell mortgage assets, is designed as a comprehensive approach after a series of individual rescues failed to stem the crisis.

Paulson and Fed Chairman Ben S. Bernanke's plans, which include the removal of illiquid mortgage securities from companies' balance sheets, sent stocks from the U.K. to China soaring. The dollar gained, while two-year Treasury notes tumbled, sending the yield up the most in 23 years.

The Treasury tapped all $50 billion in the country's Exchange Stabilization Fund to insure money-market mutual fund holdings, and the Federal Reserve expanded lending to commercial banks. The measures were aimed at credit markets teetering on the edge of collapse, as investors pulled a record $89.2 billion from money-market funds Sept. 17.

`Giant Step'

``This is taking a giant step toward a cure and a giant step toward creating some clarity in the market,'' said Alan Blinder, a professor at Princeton University and a former Fed vice chairman. ``This needs to be drafted very carefully. What's needed is something large and systemic.''

The effort is a recognition that Paulson and Bernanke's earlier efforts failed to revive financial and housing markets. The government took over American International Group Inc., Fannie Mae and Freddie Mac in the past 12 days, a period when Lehman Brothers Holdings Inc. filed for bankruptcy and Americans pulled a record $89 billion from money-market funds.

Congressional leaders who met with Paulson and Bernanke late yesterday in Washington said they aim to pass legislation soon. The initiative is aimed at removing the devalued mortgage-linked assets at the root of the worst credit crisis since the 1930s.

Paulson and Bernanke told lawmakers late yesterday that the consequence of inaction would be ``disaster,'' Frank said in an interview with Bloomberg Television.

Short-Selling Ban

Securities and Exchange Commission Chairman Christopher Cox, who attended the gathering with lawmakers, said the SEC planned to consider more rules to guarantee market liquidity. Today, the SEC temporarily banned short-selling of financial companies' shares until Oct. 2 after Morgan Stanley fell 39 percent earlier this week. The U.K. took a similar step yesterday.

Stocks surged around the world after a three-day slide earlier this week wiped about $1.9 trillion in market value from the MSCI World Index. The U.K.'s benchmark FTSE 100 index rose almost 9 percent. The Standard & Poor's 500 Index climbed as much as 4.9 percent and Japan's Nikkei 225 Stock Average climbed 3.8 percent.

Two-year note yields climbed 44 basis points, or 0.44 percentage point, the most since February 1985, to 2.14 percent at 1:39 p.m. in New York, according to BGCantor Market Data. It had dropped to 1.36 percent yesterday.

Options that U.S. officials are considering include establishing an $800 billion fund to purchase so-called failed assets and a separate $400 billion pool at the Federal Deposit Insurance Corp. to insure investors in money-market funds, said two people briefed by congressional staff. They spoke on condition of anonymity because the plans may change.

Previous Rescues

The likelihood of the government taking on yet more devalued assets, after the seizures of Fannie, Freddie and AIG and the earlier assumption by the Fed of $29 billion of Bear Stearns Cos. investments, may spur concern about its own balance sheet.

The Treasury has pledged to buy up to $200 billion of Fannie and Freddie stock to keep them solvent, while the Fed agreed Sept. 16 to an $85 billion bridge loan to AIG. The Treasury also plans to buy $5 billion of mortgage-backed debt this month under an emergency program.

``It sounds like there's going to be a giant dumpster for illiquid assets,'' said Mirko Mikelic, senior portfolio manager at Fifth Third Asset Management in Grand Rapids, Michigan, which oversees $22 billion in assets. ``It brings up the more troubling question of whether the U.S. government is big enough to take on this whole problem, relative'' to the size of the American economy, he said.


Senator Richard Shelby of Alabama and some other Republicans have criticized the takeovers of AIG, Fannie and Freddie for imposing a potentially high cost on taxpayers.

``This could be the biggest bailout in the history of the country and could ultimately cost $500 billion to $1 trillion,'' Shelby, the top Republican on the Senate Banking Committee, said in a Bloomberg Television interview today. ``Congress is not going to rubber stamp something.''

Still, Representative John Boehner, the head of the Republicans in the House, told reporters after the meeting with Paulson and Bernanke that he was ``hopeful that in the coming days we'll have a proposal that will pass this Congress.''

Senator Charles Schumer of New York, a Democrat who chairs the congressional Joint Economic Committee, warned yesterday against leaving the Fed with an expanding role for addressing the credit crisis.

Liquidity Measures

``It's hard for them to do monetary policy, which is their primary task, and then run all these businesses,'' Schumer said yesterday in Washington.

The Treasury the past two days announced $200 billion in special bill sales to help the Fed expand its balance sheet. The U.S. central bank extended a record $59.8 billion in loans to investment banks and $33.4 billion to commercial banks as of Sept. 17. The Fed yesterday also joined its counterparts from around the world to pump $180 billion into global money markets.

An increasing number of lawmakers are advocating a stronger response to the crisis sparked by record homeowner defaults.

Schumer proposed an agency to inject capital into troubled financial companies in exchange for rewriting mortgages to make them more affordable. It would be modeled on the Great Depression-era Reconstruction Finance Corp., he said. Others have floated a type of Resolution Trust Corp., which was a 1990s fund to manage devalued assets from failed savings and loans.

Citigroup Inc., JPMorgan, Bank of America Corp., Goldman Sachs Group Inc., Merrill Lynch & Co. and Lehman Brothers alone had more than $500 billion of so-called Level 3 assets as of June 30, according to data in a Sept. 15 report from New York-based bond research firm CreditSights Inc. The holders of these assets say their values can only be determined through internal models because of illiquid markets.

Senator Christopher Dodd, who chairs the Senate Banking Committee, said it was a ``sober'' gathering. The plan would likely come from the Treasury and Fed this weekend and ``nothing is more important than this,'' Dodd said.

Thursday, September 18, 2008

Paulson, Bernanke Consider Plan to Stem Deepening Credit Crisis

By Alison Vekshin

Sept. 18 (Bloomberg) -- Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben S. Bernanke are considering immediate steps to address the deepening credit crisis in advance of possible legislation that would inject new capital into troubled financial institutions.

Paulson and Bernanke will speak with congressional leaders this evening on current market conditions, Treasury spokeswoman Michele Davis said. Lawmakers warned this week the legislative calendar makes it difficult for Congress to act quickly enough to address a plunge in confidence in U.S. financial markets.

Democratic Senators Christopher Dodd and Charles Schumer have said the Federal Reserve, which is getting $200 billion in special funding from the Treasury this month, has the authority to take on a broader role.

``The Federal Reserve and the Treasury are realizing that we need a more comprehensive solution,'' said Schumer, who today proposed an agency to pump capital into troubled banks. ``I've been talking to them about it,'' Schumer, a Democrat who chairs the congressional Joint Economic Committee, told reporters in Washington today.

Schumer urged forming an agency to inject funds into financial companies in exchange for equity stakes and pledges to rewrite mortgages and make them more affordable.

Schumer advocated a Great Depression-era Reconstruction Finance Corp. model, different from the Resolution Trust Corp.- type plan others have floated. Another RTC, which was a 1990s agency that sold devalued assets in the Savings and Loan Crisis, would ``simply transfer excessive risk to the U.S. government without addressing the plight of homeowners,'' he said.

Stronger Response

An increasing number of lawmakers are advocating a stronger response to the crisis sparked by record homeowner defaults. The turmoil swept Lehman Brothers Holdings Inc. into bankruptcy three days ago and prompted government takeovers of Fannie Mae, Freddie Mac and American International Group Inc. this month.

The Fed's role expanded further when the central bank agreed on Sept. 14 to accept a broader range of collateral, including equity, in exchange for loans to investment banks. The central bank today said loans to securities firms soared to a record $59.8 billion yesterday.

At the Fed's request, the Treasury yesterday instituted a supplemental funding program for the central bank allowing it to expand its balance sheet. The Treasury has announced a total of $200 billion of bill auctions so far under the program.

``Right now, we're working with the tools we have,'' Paulson said in remarks at the White House Sept. 15. Treasury and regulatory officials are ``all working together and we're going to do what's necessary to protect this system with the tools we have,'' he said.

Congressional Calendar

Setting up an RTC-type of fund would require an act of Congress. House Majority Leader Steny Hoyer said Sept. 16 a proposal to have the U.S. create an agency to buy distressed debt won't be considered before Congress adjourns ahead of the Nov. 4 elections.

Fed spokeswoman Michelle Smith declined to comment.

Discussions with the Treasury and Fed focus on ``trying to do something more permanent'' after the series of government interventions, the New York senator said. For the Fed, ``it's hard for them to do monetary policy, which is their primary task, and then run all these businesses,'' he said.

Fed officials announced an $85 billion takeover of AIG two days ago, hours after leaving their benchmark interest rate unchanged in a decision that rebuffed some investors' calls for a cut.

``There is some preliminary discussions about how to sort of encapsulate and separate the two -- both to keep focus on monetary policy by the main Fed leaders, but also to prevent any conflicts of interest,'' Schumer said.

Ad Hoc Actions

Lawmakers are weighing responses to a crisis that prompted Paulson to seize Fannie and Freddie and caused the bankruptcy of Lehman Brothers Holdings Inc. in the past two weeks. The Fed's takeover of AIG followed its March agreement to take on $29 billion of Bear Stearns Cos. assets to secure the company's takeover by JPMorgan Chase & Co.

``The series of ad-hoc interventions in the market over the past 10 days were important to avoid a systemic disaster,'' Schumer said. ``But we cannot continue to act in such an uncoordinated and ad-hoc fashion.''

Under Schumer's RFC plan, ``the government would come first,'' he said. ``The government would get repaid before the others in the financial chain.''

House Financial Services Committee Chairman Barney Frank, a Massachusetts Democrat, this week proposed Congress create a federal entity to buy bad loans. Senator Hillary Clinton of New York, a former candidate for the Democratic nomination for president, proposed resurrecting a 1930s-era agency to stem foreclosures.

`Quarantining' Needed

``We need a modern day Home Owners' Loan Corporation,'' Clinton said in remarks at the Senate today. ``There will not be any semblance of a normal or orderly market'' without ``quarantining'' the devalued loans outstanding, she said.

The HOLC bought up outstanding mortgage and issued new, more affordable loans that helped people stay in their homes, Clinton said.

White House spokeswoman Dana Perino yesterday indicated the White House is open to options.

Senate Democrats huddled at the U.S. Capitol today with former Treasury Secretary Lawrence Summers, who urged Congress to consider legislation to provide a short-term stimulus to the economy, said North Dakota Democrat Kent Conrad, who attended the meeting.

Summers, a Harvard University economist who served as President Bill Clinton's last Treasury secretary, recommended such a stimulus because ``now there is a loss of confidence and there is a significant decline in borrowing and spending, therefore a reduction in demand,'' Conrad said.

Wednesday, September 17, 2008

Deutsche Bank Limits Credit Swaps Adding to Bank Risk (Update2)

By Jody Shenn

Sept. 17 (Bloomberg) -- Deutsche Bank AG is taking steps to slow credit-default swap trades that expose it to the risk of failure among Wall Street firms, according to three investors told of the policy.

Germany's largest bank is requiring risk managers to approve trades where the company takes over an investor's contract with another dealer, said the people, who declined to be identified because they do business with Deutsche Bank. Signing off on so- called novations can take an hour, deterring investors from the trades with the Frankfurt-based institution, they said.

Financial companies are seeking to limit exposure to competitors after Lehman Brothers Holdings Inc. went bankrupt and the government rescued American International Group Inc., sparking concern that other dealers may fail. Credit-default swaps on Goldman Sachs Group Inc. and Morgan Stanley surged to a record today, as their shares fell the most in at least a decade.

``Counterparties are being judicious in their actions at this point, given what's happened,'' said J.J. McKoan, who oversees about $65 billion as director of global credit at AllianceBernstein Holding LP in New York. ``Few are willing to take on new risk positions.''

Credit-default swaps are financial instruments that are used to speculate on a company's ability to repay debt. The agreements between so-called counterparties trade over-the-counter, leaving each side exposed to the risk that their partner will fail to pay its obligations. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements.

`Heightened Sensitivity'

If a holder is concerned about the dealer on the other end of the trade, he can find a second dealer to take over the contract, known as a novation. Ted Meyer, a spokesman in New York for Deutsche Bank, declined to comment.

Several financial companies have made similar changes since last week, said Thomas Priore, the chief executive officer of Institutional Credit Partners LLC, a New York-based fixed-income advisory and investment firm that manages $13 billion. He declined to name the other firms.

``There's heightened sensitivity around novations and that's pretty consistent across the Street,'' said Priore. ``There's so much fear about the systemic issues engulfing the market that you can't really blame your counterparts for dotting every `I' and crossing every `T'.''

The price of insuring against defaults by securities firms and banks jumped today as investors retreated from all but the safest government debt. Yields on three-month Treasury bills dropped as much as 67 basis points to 0.0203 percent, the lowest since World War II.

Costs Surge

Sellers of credit-default swaps on Morgan Stanley demanded as much as 21 percentage points upfront and 5 percentage points a year today to protect the company's bonds for five years, according to broker Phoenix Partners Group. That means it would cost $2.1 million initially and $500,000 a year to protect $10 million in bonds. Contracts on Goldman climbed as much as 265 basis points to 685 basis points.

Greater difficulty and costs in doing novations may be driving investors to try to hedge against counterparty defaults with swaps on securities firms and banks, helping push their debt protection costs wider, Brian Yelvington, a strategist at New York-based bond research firm CreditSights Inc., said.

``It probably is exacerbating the situation,'' Yelvington said in a telephone interview. ``It's kind of a house of cards, though: Who do you hedge with, with respect to counterparty exposure?''

Bigger Losses

At the beginning of 2007, before the losses on securities created from subprime mortgages contaminated financial markets, contracts on Goldman and Morgan Stanley traded below 20 basis points. The companies are based in New York. Goldman fell $18.51, or 14 percent, to $114.50 in New York Stock Exchange composite trading. Morgan Stanley dropped $6.95, or 24 percent, to $21.75.

``As we reported yesterday, Morgan Stanley has a strong capital and liquidity position, as evidenced by nearly $180 billion in liquidity,'' Morgan Stanley spokesman Mark Lake said. Michael DuVally, a spokesman for Goldman, declined to comment.

Money-market rates jumped this week as lending between banks seized up. The London interbank offered rate, or Libor, that banks charge each for three-month loans rose the most since 1999, to 3.06 percent, the British Bankers' Association said.

Hedge funds are assessing their exposure to banks after the collapse of New York-based Lehman, one of the 10 largest providers of credit-default swaps, ICP's Priore said.

``There's now been bigger losses in the fund community from the dealers than there has been among the dealers from the funds,'' said Doug Dachille, chief executive officer of First Principles Capital Management in New York, which oversees $7 billion in fixed-income investments.

Monday, September 15, 2008

U.S. Stocks Drop, S&P 500 Sinks Most Since 2001 Terror Attacks

By Lynn Thomasson and Elizabeth Stanton

Sept. 15 (Bloomberg) -- U.S. stocks tumbled, pushing the Standard & Poor's 500 Index to the steepest drop since the September 2001 terrorist attacks, as Lehman Brothers Holdings Inc.'s bankruptcy and declining commodities increased speculation that credit-market losses and the economic slowdown will worsen.

Stocks erased more than $600 billion in value as financial shares in the S&P 500 decreased the most since at least 1989, according to data compiled by Bloomberg. American International Group Inc. sank 61 percent and Washington Mutual Inc. decreased 27 percent. Concern the U.S. is heading for a recession pushed oil lower, prompting a drop in energy stocks, and sent General Electric Co. down 8 percent.

``Fear is in charge,'' said Henry Herrmann, president and chief executive officer of Waddell & Reed Financial Inc. in Overland Park, Kansas, which manages $70 billion. ``This blows another hole in the banking system's ability to extend credit.''

The S&P 500 declined 59 points, or 4.7 percent, to 1,192.70, the lowest level since October 2005. The Dow Jones Industrial Average tumbled 504.48, or 4.4 percent, to 10,917.51. The MSCI World Index of developed-market equities slumped the most in six years while the 7.6 percent drop in Brazil's Bovespa was the steepest since Sept. 11, 2001. The dollar weakened the most against the yen in a decade and two-year Treasury notes surged.

More than 24 stocks slipped for each that rose on the New York Stock Exchange on concern financial shares will continue their slump. The S&P 500 has fallen 23 percent since an October record as bank losses from the first nationwide decline in U.S. home values since the Great Depression reached $514.6 billion.

`Remember Where You Were?'

``It really goes to the heart of the financial system,'' said Stephen Wood, who helps oversee $213 billion as senior portfolio strategist at Russell Investment Group in New York. ``It'll be one of those days where people say in 10 years, `Do you remember where you were?'''

The Dow average pared its decline by half at midday in New York after plunging more than 330 points in the first 30 minutes of trading. Losses accelerated at 2 p.m. when Treasury Secretary Henry Paulson said the U.S. wasn't considering a ``bridge loan'' to bail out AIG.

GE, which makes power-plant turbines and jet engines and offers commercial loans, retreated $2.15 to a five-year low of $24.60. The company may miss profit estimates because of credit- market turmoil, according to Citigroup Inc.

Caterpillar Inc., the world's largest maker of construction equipment, fell 3.4 percent to $63.21. AK Steel Holding Corp. slumped 19 percent to $31.82.

Loss Insurance

Investors paid up for protection from further losses. The Chicago Board Options Exchange Volatility Index jumped 24 percent to 31.70, the highest since the March bailout of Bear Stearns Cos. The VIX measures the cost of using options as insurance against declines in the S&P 500.

``We need to get to the bottom of the credit crisis before financials are the sort of place that we want to put a lot of money,'' said Bruce McCain, the Cleveland-based chief investment strategist at Key Private Bank, which oversees about $30 billion.

Lehman was forced into bankruptcy after Barclays Plc and Bank of America Corp. abandoned takeover talks yesterday and the company lost 94 percent of its market value this year. Lehman sank 94 percent to 21 cents.

Citigroup Inc., the largest U.S. bank by assets, declined 15 percent to $15.24 for the steepest drop since July 2002. Bank of America retreated 21 percent, the most since at least July 1982, to $26.55 after agreeing to purchase Lehman rival Merrill Lynch & Co. for $50 billion. American Express Co., the biggest U.S. credit card company by purchases, fell 8.9 percent to $35.48.

`Down The Drain'

``It's all basically going down the drain,'' said Franz Wenzel, who helps oversee about $830 billion as deputy director for investment strategy at Axa Investment Managers in Paris. ``The rhythm of the shoes that drop has accelerated. That's what we follow with caution.''

AIG lost $7.38 to $4.76, the lowest price since June 1988. The biggest U.S. insurer fell after failing to present a plan to raise capital and stave off credit downgrades. AIG may need to raise $20 billion in capital and sell $20 billion of assets to ease a cash crunch brought on by the collapse of U.S. mortgage markets, people familiar with insurer's plans said.

Goldman Sachs Group Inc. fell 12 percent, the most since April 2000, to $135.50. JPMorgan Chase & Co. retreated 10 percent to $37. Their shares were downgraded by Merrill Lynch.

Goldman Sachs was cut to ``neutral'' on the likelihood Lehman's bankruptcy will reduce profitability for the biggest U.S. securities firm. The analysts cut their recommendation on JPMorgan to ``underperform'' and predicted the lender will report a third-quarter loss.

Morgan Stanley, the biggest U.S. securities firm other than Goldman Sachs, fell 14 percent to $32.19.

Betting Against Financials

The Financial Select Sector SPDR Fund, an exchange-traded fund linked to financial companies, had 42.6 million shares on loan on Sept. 11, or 87 percent more than a week earlier, according to Alexander Hofmann, an analyst at Data Explorers in London. Shares on loan can be an indication of short positions.

Former Fed Chairman Alan Greenspan said the financial crisis that began with the collapse of the subprime-mortgage market last year ``is probably a once in a century event'' that will lead to the failure of more firms.

``There's no question that this is in the process of outstripping anything I've seen, and it is still not resolved,'' Greenspan said in an interview yesterday on ABC's ``This Week with George Stephanopoulos.'' Greenspan, 82, retired from the Fed in January 2006 after serving for 18 years as chairman.

Junk Status

Washington Mutual retreated 27 percent to $2, the lowest price since October 1990. The company may cost taxpayers as much as $24 billion in the event of a U.S. government bailout, said Richard Bove, an analyst at Ladenburg Thalmann & Co. After the close of exchanges, Standard & Poor's lowered the bank's credit rating to junk because of the deteriorating housing market.

``You may get an assisted merger with a limit on how much the private buyer would pay for the bank with the government giving a guarantee for the rest,'' Bove said in an interview with Bloomberg Radio.

Some investors said Lehman's failure may allow financial markets to rebound.

``The air will be clean within the next one month and we can get a fairly good rebound starting from the middle of October until the spring of next year,'' Gloom, Boom & Doom Report publisher Marc Faber said in a Bloomberg Television interview from Thailand.

Merrill climbed 0.1 percent to $17.06, almost fully erasing a 33 percent surge. Bank of America, the biggest U.S. consumer bank, agreed to buy the company in a stock transaction now valued at $22.82 a share as the credit crisis claimed another of America's oldest financial institutions.

Short-Sale Restrictions

The U.S. Securities and Exchange Commission will likely stiffen rules targeting manipulative short selling, a person familiar with the matter said.

The SEC may strengthen rules this week by requiring brokers to deliver shares that have been sold short, according to the person, who declined to be identified because the plans aren't complete. The SEC also will consider it securities fraud when short sellers deceive brokers about their intention to deliver shares to buyers, the person said.

The S&P 500 Energy Index lost 6.9 percent. Chevron Corp. fell 4.9 percent to $80.09, and Valero Energy Corp. decreased 13 percent to $31.19.

Crude oil plunged 5.4 percent to $95.71 a barrel in New York as refineries along the Gulf of Mexico escaped major damage from Hurricane Ike.

Rate-Cut Odds

Stocks pared their losses during the first 1 1/2 hours of trading, led by gains in consumer companies including Procter & Gamble Co. and McDonald's Corp., on speculation the Federal Reserve will reduce rates tomorrow. Traders in futures contracts gave 60 percent odds the Fed will shift its target for overnight loans between banks to 1.75 percent from 2 percent.

European and Asian stocks slumped on concern turmoil in the U.S. banking industry will infect financial institutions and economies abroad. The MSCI World Index lost 3.6 percent to 1,236.90, a three-year low, as of 4:33 p.m. in New York.

Europe's Dow Jones Stoxx 600 Index retreated 3.5 percent to 270.68 for the biggest decline since March 17. The MSCI Asia Pacific excluding Japan Index slipped 1.9 percent to 347.26, the lowest since October 2006. Markets in Japan, South Korea, Hong Kong and China were closed for holidays.

Dollar Trades Near 2-Month Low Versus Yen on Fed Rate Cut Bets

By Stanley White and Ye Xie

Sept. 16 (Bloomberg) -- The dollar traded near a two-month low against the yen on speculation the Federal Reserve will cut the target lending rate today after Lehman Brothers Holdings Inc. filed for bankruptcy.

Japan's yen and the Swiss franc may extend gains against major currencies as the Wall Street firm's collapse encourages investors to sell higher-yielding assets and pay back low-cost loans in Japan and Switzerland. The dollar rose against the Brazilian real and the Mexican peso yesterday as widening credit market losses prompted investors to seek the relative safety of U.S. Treasuries.

``Dollar selling is all but unavoidable,'' said Tsutomu Soma, a bond and currency dealer at Okasan Securities Co. in Tokyo. ``A rate cut is likely because the Fed needs to do something to stabilize the financial system. Risk aversion will also help the yen rise.''

The dollar traded at 104.35 yen at 7:56 a.m. in Tokyo from 104.66 yesterday. It earlier touched 104.19 yen, the lowest level since July 16. The dollar fell to $1.4268 per euro from $1.4243. The pound declined to $1.7970 from $1.8007. The dollar may weaken to 103.90 yen today, Soma forecast.

Japan's currency rose 0.2 to 148.76 per euro and 1.8 percent to 83.31 versus the Australian dollar as Lehman's bankruptcy prompted investors to reduce carry trades in which they borrow in countries with low borrowing costs and buy higher-yielding assets elsewhere.

Lehman's Bankruptcy

``Carry trades had a double-whammy as concern about financial firms fed into risk aversion and concern about global growth compounded the hit,'' said Paresh Upadhyaya, who helps manage $50 billion in currency assets as a senior vice president at Putnam Investments in Boston. ``It's a perfect storm.''

Lehman filed for the biggest bankruptcy filing in history after Bank of America Corp. and Barclays Plc pulled out of talks to buy the New York-based bank. Bank of America, the biggest U.S. consumer bank, instead agreed to acquire Merrill Lynch & Co. for about $50 billion, as the credit crisis claimed another of America's oldest financial companies.

``It's hard to imagine anything more cataclysmic than this,'' said Alan Ruskin, head of international currency strategy at RBS Greenwich Capital Markets in Greenwich, Connecticut. ``It will be hard to top that kind of news flow. The yen hasn't looked so good for quite a while.''

American International Group Inc., the largest U.S. insurer by assets, was given permission to access $20 billion of capital in its subsidiaries to free up liquidity, New York Governor David Paterson said yesterday.

Franc's Gains

The Swiss franc increased 1.3 percent to 1.5869 per euro yesterday and 2 percent to 1.1079 per dollar, the biggest gain since June 6. Japan's 0.5 percent target lending rate and Switzerland's 2.75 percent benchmark compare with 4.25 percent in Europe and 12 percent in South Africa.

Futures on the Chicago Board of Trade showed yesterday a 74 percent chance the central bank will lower its 2 percent target rate for overnight lending between banks by a quarter-percentage point today, compared with no chance a week ago.

Policy markers are scheduled to announce their decision at 2:15 p.m. in Washington. One hundred of 105 economists surveyed by Bloomberg News expected the Fed to keep the rate on hold, while the rest forecast a cut.

Implied volatility on one-month euro-dollar options surged to 14.34 percent yesterday, the highest level since the aftermath of the Sept. 11, 2001, terrorists attacks, indicating traders see more price fluctuation in the next month.

Dollar's Gains

The dollar rose 1.9 percent to 1.8149 Brazilian real yesterday and 1.4 percent to 10.7437 Mexican pesos as U.S. investors repatriated capital and bought Treasuries.

``The vicious cycle of the credit crunch causing a slowdown in the U.S. economy will continue,'' said Toru Umemoto, chief currency analyst in Tokyo at Barclays Capital, Britain's third- biggest lender. ``For the dollar, there will be a flight to quality into Treasuries.''

A rally in Treasuries pushed the yield on the two-year note down 0.42 percentage point to 1.78 percent yesterday, the most since the Sept. 11 attacks. It was the first time the yield fell below 2 percent since April. The 10-year note's yield dropped 0.20 percentage point to 3.52 percent.

The yield advantage of the benchmark 10-year note over comparable-maturity Japanese government securities decreased to 1.90 percentage points yesterday, the narrowest since 1993, making the U.S. securities less attractive.

Stocks tumbled yesterday, with the Standard & Poor's 500 Index dropping 4.7 percent. The Dow Jones Stoxx 600 Index retreated 3.5 percent.

The dollar has gained about 12 percent since touching an all-time low of $1.6038 per euro on July 15 as the European economy slowed and crude oil dropped 35 percent from its peak of $147.27 a barrel.

`` The appetite for the U.S. dollar has not reversed,'' said Jack Spitz, a managing director of foreign exchange at National Bank of Canada in Toronto. ``Risk reduction provides support.''

Sunday, September 14, 2008

Bernanke May Be Wrong: Next Rate Move Might Be Down (Update1)

By Rich Miller

Sept. 12 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke and his fellow policy makers agreed at their August meeting that their next move on interest rates would probably be up. They may turn out to be wrong.

Inflation looks likely to ebb, thanks to falling commodity prices and contained labor costs. The U.S. economy, meanwhile, may be set to take another lurch down as consumer spending gives way and the credit crunch intensifies with the plunge in Lehman Brothers Holdings Inc.'s shares.

``If the consumer balance sheet starts to unwind quickly, you'd get another disinflationary force and then the Fed would be brought back into play with lower rates,'' says Mohammed El- Erian, co-chief executive officer of Pacific Investment Management Co. in Newport Beach, California.

Bernanke and his colleagues are likely to hold their benchmark rate at 2 percent when they meet Sept. 16 and may keep it there until 2009, trading in federal funds futures indicates. Still, the odds of a rate cut by year-end have been growing. Futures trading shows more than a 40 percent chance of a December reduction, up from zero odds at the beginning of September.

Traders increased their bets after government figures today showed sales at U.S. retailers unexpectedly dropped in August and a bigger-than-forecast decline in wholesale prices signaled inflationary pressures may ease.

San Francisco Fed President Janet Yellen left open the possibility of a rate cut in comments to reporters after a Sept. 4 speech in Salt Lake City. ``There is some chance'' of easing credit ``if things start going seriously wrong,'' she said.

Policy Decision

She made clear, though, that she agreed with her fellow policy makers, who ``generally anticipated that the next policy move would be a tightening,'' according to the minutes of the Fed's last meeting on Aug. 5.

If the Fed instead ends up lowering borrowing costs, it wouldn't be the first time Bernanke and his colleagues have been forced to shift their stance from fighting inflation to supporting growth. When the credit crisis first struck in August 2007, the Fed cut its discount rate on loans to banks just 10 days after declaring that inflation was its overriding concern.

Investors have remained on edge since then, even after the Fed-assisted takeover of Bear Stearns Cos. in March and the rescue of Fannie Mae and Freddie Mac this month. Shares in Lehman Brothers dropped more than 70 percent this week as the firm reported a record $3.9 billion loss for the third quarter and concern mounted about its capital levels.

`Feedback Loop'

The big risk is what some at the Fed have called an ``adverse feedback loop'' as the credit crisis and the weak economy aggravate each other. Now, officials also fear that another spiral could take hold as the U.S. housing collapse and credit crunch weaken economies overseas, in turn curbing U.S. exports.

``The balance of risks in the American economy is now towards contraction and a vicious cycle in which declining economic performance exacerbates financial strains, which feeds back to hurt the economy,'' Harvard University professor and former Treasury Secretary Lawrence Summers said in congressional testimony Sept. 9.

Jan Hatzius, chief U.S. economist at Goldman, Sachs & Co. in New York, reckons that the credit squeeze will bring the economy to a halt in the fourth quarter of this year and the first quarter of next, after growth of 2 percent this quarter.

``The headwinds pushing against the economy look to be a good bit stronger than those experienced in the early 1990s,'' when the country last faced a credit crunch, Boston Fed President Eric Rosengren said in a speech Sept. 3.

`Tapping the Brakes'

Wachovia Corp. of Charlotte, North Carolina, the fourth- largest U.S. bank, is ``tapping the brakes'' on lending as credit losses mount, Chief Executive Officer Robert Steel told investors Sept. 9.

Debt-laden consumers appear particularly vulnerable as house prices continue to fall and unemployment rises. Credit- card payments 30 or more days overdue rose to 4.7 percent of total card debt in the second quarter, the highest level in 4 1/2 years, according to the Federal Deposit Insurance Corp.

The Fed reported in its latest regional economic survey, released Sept. 3, that consumer spending was slow in most of the country, ``with purchasing concentrated on necessary items.'' Nondiscretionary outlays -- including rent, taxes, food and fuel -- accounted for a record 57.8 percent of expenditures in July, up from 56.3 percent a year earlier.

Even some well-off consumers are feeling the pinch. Cie. Financiere Richemont SA, the Geneva-based maker of Cartier necklaces and Piaget watches, said Sept. 10 that the lower and middle range of the luxury-goods market in the U.S. is facing ``difficult'' market conditions.

Threat to Exports

The spread of the weakness abroad is threatening to undercut one of the U.S. economy's few strengths: exports, which accounted for virtually all of the growth in second-quarter gross domestic product. On Sept. 10, the Japanese government said the world's second-largest economy is ``deteriorating,'' and the European Commission forecast a recession for Germany.

``Not only is the U.S. in a recession, but the rest of the world is slowing down,'' Ford Motor Co. Chief Executive Officer Alan Mulally said in a Sept. 8 speech. ``I've never seen anything quite like it.''

The global slowdown does have one silver lining: It's sapping demand for everything from oil to soybeans, dragging down their prices and taking the edge off inflation. The Reuters/Jefferies CRB Index of 19 raw materials has tumbled 25 percent since hitting a record in July. Crude-oil prices dropped close to $100 a barrel this week from a high of $147.27 just two months ago.

`Very Hopeful'

``I am very hopeful that inflation will come down quite substantially,'' Yellen said in a Sept. 5 speech, pointing in particular to the drop in commodity prices.

Consumers' troubles will also help to temper inflation -- which ran at a year-over-year rate of 5.6 percent in July, the fastest pace in 17 years -- by making it tougher for companies to raise prices. Some may even be forced into reducing them.

Medford, Oregon-based Harry & David Holdings Inc., which markets gift baskets and other products, said Sept. 7 that it is cutting shipping charges to its customers by as much as one- third from last year as it prepares for what analysts expect will be a tough holiday-selling season.

``With the risk of inflation steadily disappearing and the economic risk rising, the Fed will cut rates,'' says Ethan Harris, chief U.S. economist at Lehman Brothers in New York.

Tuesday, September 9, 2008

New Zealand May Cut Benchmark Rate a Second Time Amid Recession

By Tracy Withers

Sept. 10 (Bloomberg) -- New Zealand central bank Governor Alan Bollard will cut interest rates for the second time in seven weeks tomorrow as spending slows amid a recession, easing pressure on inflation.

The Reserve Bank will cut the official cash rate a quarter point to 7.75 percent, according to 13 of 14 economists surveyed by Bloomberg. One expects Bollard will lower the rate a half point when he announces his decision at 9 a.m. in Wellington.

Bollard cut borrowing costs in July for the first time in five years, and said further reductions are likely as the economy slows. The Treasury Department said this week the economy was in a recession in the first half of 2008 and may also contract in the third quarter amid a slump in housing investment and rising unemployment.

``The slowdown in the economy is well and truly entrenched and the inflation outlook has improved,'' said Nick Tuffley, chief economist at ASB Bank Ltd. in Auckland. ``We continue to expect a cautious easing cycle.''

Bollard, 57, will cut the rate twice more this year, according to the economists surveyed by Bloomberg. The rate will be 6.75 percent by March, the lowest level since September 2005, they forecast.

The central bank will probably revise its forecast for the economy to show gross domestic product contracted in the second quarter, putting New Zealand in its first recession since 1998, said Tuffley. The economy shrank 0.3 percent in the first three months of the year.

Construction Slows

Construction fell 5.8 percent in the second quarter, according to a Sept. 8 government report. Retail spending dropped 1.4 percent, the most in 13 years. The government publishes second-quarter GDP figures on Sept. 26.

The Treasury Department this week reiterated it expects the economy shrank in the three months ended June, and said it couldn't rule out a further contraction in the three months through September.

The decline in domestic demand was led by record-high credit costs and soaring food and fuel prices, which curbed consumer spending and stalled the housing market.

The jobless rate rose to a two-year high in the second quarter and hiring intentions have declined.

``The New Zealand economy stalled in the first half, reducing company profits, so employers became more hesitant in their hiring plans,'' Catherine Lo-Giacco, general manager of Manpower New Zealand, said in a report yesterday.

House Sales

House prices fell 4.5 percent in August from a year earlier, according to the government valuation agency. That followed a 2.2 percent drop in July, the first decline since the series began in February 2005.

House sales fell to a 16-year low in June, before gaining in July as sellers lowered prices to complete deals, according to the Real Estate Institute.

While the economy stalls, high fuel and food prices have driven faster inflation. Consumer prices rose at the fastest pace in 18 years in the second quarter and the central bank forecasts the inflation rate will be close to 5 percent in the year to September.

``The Reserve Bank has no headroom and needs to limit the scope for flow-on into inflation expectations,'' said Robin Clements, chief New Zealand economist at UBS AG. ``There doesn't look to be a sense of urgency that would demand aggressive easing at this time.''

Bollard expects the inflation rate will slow to 3 percent by mid-2010. The central bank is required to keep average inflation between 1 percent and 3 percent.

Gasoline Prices

Gasoline prices have slumped 8 percent since Bollard's July 24 rate cut, adding to signs inflation may have peaked.

Central bankers around the world are grappling with slowing economic growth while surging fuel and food prices fan inflation.

The Reserve Bank of Australia this month lowered its benchmark for the first time in seven years as economic growth weakens. Governor Glenn Stevens said this week it may be six months before inflation eases.

The European Central Bank last week kept interest rates unchanged at a seven-year high, citing inflation concerns even as the euro-region economy contracted in the second quarter. The Bank of England kept its rate steady after economic growth stalled in the three months ended June 30.

Following is a table of forecasts for New Zealand's cash rate at the next three reviews, and the target at the end of the first and second quarters next year.

2008 2009
Sept. Oct. Dec. March June
Median 7.75% 7.5% 7.25% 6.75% 6.75%
4Cast 7.75% 7.75% 7.5% 7.25% 6.75%
ANZ National 7.75% 7.5% 7.25% 7.25% 7.0%
ASB Bank 7.75% 7.5% 7.25% 6.75% 6.75%
BNZ 7.75% 7.5% 7.25% 6.75% 6.25%
Barclays 7.75% 7.75% 7.5% 7.25% 7.0%
Citigroup 7.75% 7.5% 7.25% 6.75% 6.5%
Deutsche 7.75% 7.5% 7.25% 6.75% 6.25%
First NZ 7.75% 7.5% 7.25% 7.25% 7.0%
Goldman Sachs 7.75% 7.5% 7.25% 6.75% 6.0%
JPMorgan 7.75% 7.5% 7.25% 6.75% 6.25%
Macquarie 7.75% 7.5% 7.25% 6.75% 6.5%
RBC 7.5% 7.25% 7.0% 6.5% 6.25%
UBS 7.75% 7.5% 7.25% 6.75% 6.75%
Westpac 7.75% 7.5% 7.25% 7.0% 7.0%

Monday, September 8, 2008

Fannie, Freddie Seizure Triggers Credit-Default Swaps (Update1)

By Shannon D. Harrington and Oliver Biggadike

Sept. 8 (Bloomberg) -- The government seizure of Fannie Mae and Freddie Mac triggered what may be the biggest settlement of credit-default swaps in the market's decade-long history.

The International Swaps and Derivatives Association will set rules by which parties to credit-default swap trades can demand payment on the net amount covered by the contracts, according to a statement today. According to an ISDA memo yesterday obtained by Bloomberg News, 13 Wall Street firms agreed unanimously that the government takeover of the biggest U.S. mortgage-finance companies qualified as a so-called credit event on contracts covering more than $1.4 trillion in Fannie and Freddie debt.

``The market is not experienced at settling a credit event for a name of this size, so it is a bit of an unknown,'' said Sarah Percy-Dove, the head of credit research at Colonial First State Global Asset Management in Sydney.

Because the government stands behind the companies' debt, which rallied on the news, the actual money exchanged between sellers and buyers of protection may be limited, analysts at CreditSights Inc. said. Buyers of the contracts are paid face value in exchange for the underlying securities or the cash equivalent.

``If bonds rally and trade close to par, recovery could be close to 100 percent, with protection sellers having little to pay out despite a technical default,'' CreditSights analysts Richard Hofmann and Adam Steer wrote in a note to clients.

`Potential Significant Losses'

The settlement, however, may wipe out any market-value gains that investors or Wall Street firms were counting on, Bank of America Corp. strategists led by Jeffrey Rosenberg wrote in a note to clients yesterday.

That may spell ``potential significant losses at dealers from this event,'' the strategists wrote, though they said it will be relatively small compared with the more than $500 billion in credit losses and asset writedowns reported by the world's largest banks and securities firms since the start of last year.

Treasury Secretary Henry Paulson and Federal Housing Finance Agency Director James Lockhart yesterday placed Freddie and Fannie in conservatorship, ousting their chief executives and eliminating their dividends. The Treasury may purchase up to $200 billion of preferred stock in the firms to keep them solvent.

Credit-default swaps on Fannie and Freddie debt have been among the most actively traded individual contracts the past few months, according to reports from broker GFI Group Inc. Dealers don't disclose the amount outstanding.

Fannie and Freddie also are among 125 companies in the benchmark Markit CDX North America Investment Grade Index, the most actively traded contract in credit markets.

Money Exchange

Dealers today were quoting the CDX index contracts both with and without Fannie and Freddie. Contracts with the companies dropped 7 basis points to 138 basis points as of 3:45 p.m. in New York, according to broker Phoenix Partners Group. Contracts without the companies were trading 1.5 basis points to 2 basis points tighter, according to Credit Derivatives Research LLC.

That would imply the market has priced in a recovery rate, as a percentage of total value, ``in the mid-to-high 90s,'' said Tim Backshall, chief strategist at Credit Derivatives Research in Walnut Creek, California, meaning investors who bought protection would get five cents on the dollar or less to settle.

Five-year contracts on the senior debt of Fannie and Freddie had been trading at about 38 basis points on Sept. 5, according to CMA Datavision. That's down from 81 basis points on July 10. Contracts on Fannie subordinated debt fell from a record high of 364 basis points on Aug. 20 and closed on Sept. 5 at 233 basis points, CMA prices show. The cost is equivalent to $233,000 annually to protect $10 million in notes from default.

A `Unique Situation'

Under the process being created by ISDA, investors will have the option to settle without an actual exchange of the underlying bonds. Wall Street firms including JPMorgan Chase & Co., Goldman Sachs Group Inc. and other market makers will hold an auction to determine a recovery value for the securities. Investors who agree to a cash settlement would exchange the difference between the recovery value set at auction and the face value on a contract.

Because investors have the option to settle contracts using the cheapest qualifying bond, and because bonds with longer maturities can continue to trade at a discount because of interest rate risks, it's too early to assume that the recovery level will be at or almost at par value, said Morgan Stanley strategist Sivan Mahadevan.

``It is a unique situation,'' Mahadevan said on a conference call with clients today.

Friday, September 5, 2008

U.S. Stocks Advance as Rally in Banks Overshadows Drop in Jobs

By Lynn Thomasson

Sept. 5 (Bloomberg) -- U.S. stocks gained, paring the worst weekly loss for the Standard & Poor's 500 Index since May, on speculation Lehman Brothers Holdings Inc. will raise capital and investor Barton Biggs' prediction the market is near a bottom.

Lehman rallied 6.8 percent on a Reuters report the securities firm may sell assets to Blackstone Group LP and Kohlberg Kravis Roberts & Co. Bank of America Corp., Citigroup Inc. and JPMorgan Chase & Co. climbed more than 4 percent as banks also benefited from growing expectations the Federal Reserve will hold off raising interest rates.

``We're probably somewhere pretty close to a bottom, at least an intermediate-term bottom, from which we can mount a fairly powerful rally,'' Biggs, who runs the hedge fund Traxis Partners LLC, told Bloomberg Television.

Bank gains overpowered earlier declines of more than 1 percent in the S&P 500 and Dow Jones Industrial Average following a jump in the unemployment rate to a five-year high. The S&P 500 added 5.48 points, or 0.4 percent, to 1,242.31. The Dow rose 32.73, or 0.3 percent, to 11,220.96. The Nasdaq Composite Index slipped 3.16 to 2,255.88. About six stocks rose for every five that fell on the New York Stock Exchange.

Stocks tumbled in the morning after the government report showing an unemployment rate of 6.1 percent added to concern that the worst housing slump since the Great Depression and more than $500 billion in credit losses and writedowns at global banks are dragging the nation into a recession.

The S&P 500 pared its weekly loss to 3.2 percent and the Dow reduced its weekly retreat to 2.8 percent. The MSCI World Index tumbled 5.8 percent in the week, its steepest drop since the first week of trading after the September 2001 terrorist attacks.

Bank of America gained 5.3 percent to $32.23. Citigroup added 4.2 percent to $19.07. JPMorgan increased 4.5 percent to $39.60.

Lehman Rally

Lehman rose for the seventh time in eight trading session, adding 6.8 percent to $16.20. Blackstone Kohlberg Kravis Roberts may buy some of the company's assets, including real-estate holdings and part of the asset-management unit, Reuters reported, citing unidentified sources familiar with the situation. Lehman's real-estate unit may be worth about $5 billion, the news agency said. Randy Whitestone, a Lehman spokesman, declined to comment.

Lehman rose to its highest level of the day after financial commentator James Cramer said on CNBC that the stock is a ``screaming buy'' whose business is unlikely to worsen.

Financial shares climbed 3.2 percent, the most among 10 S&P 500 industries. Fannie Mae, the largest U.S. mortgage-finance company, added 9.7 percent to $7.04. Wachovia Corp., the fourth- largest U.S. bank, increased 7.9 percent to $16.75.

The gain in banks came even as foreclosures rose above 1 percent in the second-quarter for the first time since the Mortgage Bankers Association began its loan survey 29 years ago, as people walked away from homes they couldn't refinance or sell.

`Real Opportunity'

``The headlines are screaming adversity, but if you look below it all you'll see real opportunity,'' said Hans Olsen, who helps oversee $120 billion as chief investment officer of JPMorgan Private Wealth Management in New York.

Mining companies and chemical producers in the S&P 500 added 1.1 percent. Morgan Stanley analysts called recent declines in fertilizer stocks ``unfounded'' and predicted the group would see the highest earnings in 2011.

Monsanto Co. increased 3.4 percent to $107.19. Credit Suisse Group AG told investors to buy shares of the world's biggest seed producer. CF Industries Holdings Inc., the maker of nitrogen and phosphate fertilizers, rose the most among raw-material producers in the S&P 500 with a 6.3 percent gain to $131.20.

M&A Speculation

SanDisk Corp. had the biggest gain in more than eight years, soaring 31 percent to $17.64. Samsung Electronics Co. said it may buy the memory-card maker in what would be the South Korean company's biggest acquisition. Samsung, the world's second- largest chipmaker after Intel Corp., said it's considering various options, including an acquisition.

UST Inc. added 25 percent to $67.55. Altria Group Inc., the largest U.S. cigarette maker, is in talks to buy the nation's biggest snuff producer for more than $10 billion, the New York Times reported, citing people with knowledge of the discussions who weren't identified.

Exxon Mobil Corp., Chevron Corp. and ConocoPhillips fell as oil futures sank to a five-month low of $106.23 a barrel in New York. Energy producers in the benchmark index slumped 0.5 percent for a sixth straight retreat, the longest period of declines since 2002.

Utility stocks dropped the most among 10 S&P industries after Sanford C. Bernstein and Atlantic Equities analysts cut profit estimates for Exelon Corp., the largest U.S. owner of nuclear-power plants. The company, which lowered its forecast yesterday, lost 8 percent to $64.97 for the steepest retreat since 2001.

Europe, Asia

Stocks in Europe and Asia fell today on concern weakening economic growth will curb earnings at semiconductor makers while credit-related losses at banks increase.

``We're clearly in a bear market,'' Simon Moss, who manages the equivalent of $4.1 billion as investment director of U.S. equities at Scottish Widows Investment Partnership in Edinburgh, said in a Bloomberg Television interview. ``There is no doubt the economy is slowing.''

The employment report spurred investors to increase bets the Federal Reserve will hold interest rates steady for the rest of the year. Odds policy makers will leave the target rate for overnight loans between banks unchanged through January rose to 79 percent from 63 percent yesterday, futures trading shows.

The average price-earnings multiple of the S&P 500 has declined more than 5 percent from a five-year high of 26.2 on Aug. 15. The index is trading for 24.98 times profits in the last 12 months, or 14.8 times analysts' earnings estimates.

Companies in the S&P 500 are forecast to report profits in the fourth quarter that are 42 percent higher than a year ago, the biggest increase ever. Financial company earnings are projected to rise more almost five-fold, while income at mining and chemical companies may increase 35 percent.

Thursday, September 4, 2008

U.S. Must Buy Assets to Prevent `Tsunami,' Gross Says (Update3)

By Jody Shenn

Sept. 4 (Bloomberg) -- The U.S. government needs to start using more of its money to support markets to stem a burgeoning ``financial tsunami,'' according to Bill Gross, manager of the world's biggest bond fund.

Banks, securities firms and hedge funds are dumping assets, driving down prices of bonds, real estate, stocks and commodities, Gross, co-chief investment officer of Newport Beach, California-based Pacific Investment Management Co., said in commentary posted on the firm's Web site today.

``Unchecked, it can turn a campfire into a forest fire, a mild asset bear market into a destructive financial tsunami,'' Gross said. ``If we are to prevent a continuing asset and debt liquidation of near historic proportions, we will require policies that open up the balance sheet of the U.S. Treasury.''

The government needs to replace private investors who either don't have the money to buy new assets or have been burned by losses, Gross said. Pimco, sovereign wealth funds and central banks are reluctant to fund financial firms after losses on investments they made to support the companies, Gross said. The world's biggest banks and brokers have raised $364.4 billion in new capital after more than $500 billion in writedowns and credit losses since the beginning of last year.

Since financial markets seized up a year ago as the subprime-mortgage market collapsed, the Standard & Poor's 500 Index has fallen 13 percent and home prices are down more than 15 percent. Yields on investment-grade corporate bonds, debt backed by commercial mortgages as well as credit cards reached record highs last month relative to benchmark rates.

`Mom and Pop'

Gross cast a bleaker view for the prospects of the world's financial markets than in previous notes to clients. The fund manager has previously called on lawmakers to support housing with legislation passed in July that allows lenders to forgive some of homeowners' debt and then refinance them into government-insured loans.

Pimco, a unit of Munich-based Allianz SE, is seeking to take advantage of declines in home-loan bonds. The firm is raising as much as $5 billion to buy mortgage-backed debt that has plunged in value, according to two investors with knowledge of the matter. The Distressed Senior Credit Opportunities Fund will invest in securities backed by commercial and residential mortgages, said the people, who asked not to be identified because the fund is private.

Paulson Rescue

Treasury should support not only mortgage finance providers Fannie Mae and Freddie Mac, but also ``Mom and Pop on Main Street U.S.A.,'' by subsidizing rates on home loans guaranteed by the Federal Housing Administration and other government institutions, Gross said. A new version of the Resolution Trust Corp., which bought assets from failing institutions during the savings-and-loan crisis of the 1980s, may also work, he said.

U.S. Treasury Secretary Henry Paulson arranged a rescue package for Washington-based Fannie and Freddie of McLean, Virginia as concern escalated the government-chartered companies didn't have capital to withstand the housing slump. Treasury pledged to pump unlimited debt or equity into the companies should they need it.

As Fannie and Freddie, banks, securities firms and hedge funds shrink, yields on all debt assets will rise compared with benchmark rates and volatility will increase, Gross said. The declines will end once sellers have depleted their assets and sufficient capital has been raised, Gross said. Unless ``new balance sheets'' emerge, prices of almost all assets will drop, even those of ``impeccable'' quality, he said.

`Anorexic' Appetite

The extra yield demanded on Ginnie Mae's 30-year, current- coupon mortgage-backed securities over 10-year Treasuries has climbed to 1.75 percentage points, from 0.87 percentage points at the start of last year, according to data compiled by Bloomberg. Bonds guaranteed by the U.S. agency are backed by the U.S. government. Spreads on 2-year AAA rated bonds composed of federally backed student loans have climbed to 0.95 percentage points over benchmark rates, from 0.01 percentage points below, Deutsche Bank AG data show.

``There is an increasing reluctance on the part of the private market to risk any more of its own capital,'' Gross said. ``Liquidity is drying up; risk appetites are anorexic; asset prices, despite a temporarily resurgent stock market, are mainly going down; now even oil and commodity prices are drowning.''

Home Prices

The decline in home prices hasn't been seen since the Great Depression, Gross said. That drop translates to an even bigger decline in overall wealth as the effects ripple through markets, Gross said. Home prices in 20 of the largest U.S. metropolitan areas fell 15.9 percent in June from a year earlier, according to an S&P/Case-Shiller index.

Fannie and Freddie 30-year fixed-rate mortgage bond yields, which influence the rates on most new home loans, have probably risen 75 basis points because of the waning demand, Gross said. A basis point is 0.01 percentage point.

The Pimco Total Return Fund returned 9.8 percent in the past 12 months, beating 97 percent of its peers in the government and corporate bond fund category as of Sept. 3, according to Bloomberg data. The returns are 5.76 percent annually over five years. Pimco has about $830 billion of assets under management.

About 61 percent of Gross's holdings were mortgage-backed securities as of June 30, mostly debt guaranteed by Fannie, Freddie or Ginnie Mae, according to data on Pimco's Web site.

``In a global financial marketplace in the process of delevering, assets that go up in price are rare diamonds as opposed to grains of sand,'' Gross said.