Amid uncertainty about the plan’s prospects, US cash funds and banks stampeded to safety, buying short-term government debt, selling commercial paper and withdrawing funds from the interbank market. As a result, the rates that banks charge each other soared, while yields on short-term Treasury bills plunged.

Now it seems the plan is headed for approval with: it has to be signed off by the rest of the two parties’ representatives, US Treasury and other regulators.

Republicans are refusing to agree to the scope and direction of the legislation and this could defeat it as Democrats say they won’t pass it without substantial Republican support.

President Bush held a meeting with Barack Obama and John McCain and others at the White House.

The legislation will go to the US House of Representatives tonight, our time, and the US Senate will meet on Saturday to debate and approve it.

But it needs consensus, and if that’s not apparent, then trading will be fraught tonight.

Wall Street kicked higher in anticipation; up 300 points at one stage, then down sharply, before rising at the end to be up nearly 200 points on the Dow. It closed before signs of a lack of agreement emerged in Washington.

Financial stocks rose 2.6% and were among the biggest gainers on hopes that the plan would unlock frozen money markets.

GE rose 4.4% even after the world’s fourth-largest company cut its third-quarter and full-year earnings forecast and suspended a share buy-back. It was GE’s the second earnings downgrade this year.

Escaping the bullish momentum, Washington Mutual, America’s biggest savings and loan plunged 25% to just $US1.69 on reports that regulators were struggling to broker the takeover of the company.

Oil rose, the US dollar was stronger (and the Aussie was back around 83.60 US cents) and gold weakened. US Treasury bond yields rose on the news.

Figures were released showing another sharp slump in new US home sales and industrial production. It was a reminder that the real problems remain and won’t be touched by the bailout plan.

Stockmarkets in Asia fell, especially in Japan and Australia, thought China’s were higher. 

Stocks in Europe were up in early trading and finished higher, with gains in the UK, France and London as news spread of the broad agreement on the bailout.

Money market rates in Asia’s biggest financial centres jumped on concern that the US Congress might hold up or water down the Treasury Department’s plan to bail out the financial system (or at least try to).

A cash freeze has gripped world financial markets as fearful banks hoard billions and billions of dollars and prefer to leave it on deposit with central banks and earn less than they could get from lending it to normal business and personal customers.

Not even Australia is exempt: our well capitalised banks were following suit and sitting on billions of dollars.

Banks around the world are refusing to deal with each other, or anyone else, so they are leaving tens of billions of dollars on deposit with central banks.

The drought has worsened significantly since the collapse of Lehman Brothers 10 days ago and still rising losses taken by bond holders and other investors.

Bank nervousness seems to have picked up from earlier this week as the progress of the US bailout proposal slows in the Congress.

If that proposal was to fail, markets would dry up and if there was to be a reason why the global economies slumps into recession or worse, it would be this cash drought. The money’s there, tucked away in cash management accounts and at central banks, but no one is willing to lend. There is no shortage of borrowers.

Central banks in the UK and Australia moved this week to try and ease the drought by moving to mop up the cash.

The drought has seen short term interest rates around the world rise sharply as banks choose to leave their money with the central bank, or invest in short term US Government treasury notes as the ultimate short-term safe haven.

Short term US treasury note rates have again fallen under 1% while short term US dollar (and some other currency) LIBOR rates in London has jumped sharply to levels seen in the dark days of early January.

The three-month US Treasury bill traded at 0.49% in New York overnight, down from 0.79% at the close Tuesday and 0.88% on Monday.

The demand for short term, security can be seen from the results of a huge US Treasury auction of $US34 billion in two-year bonds: demand was about normal for the moment at 2.2 times the amount offered. Market yields for the notes traded down to 2.02%,

In Australia yields on 90 day bank kills, the key short term funding source in the country, have risen to where they are higher currently than 180 day bills. It is normally the other way around. Spikes like we are seeing are signs of a cash shortage.

A cash freeze has gripped world financial markets as fearful banks hoard billions and billions of dollars and prefer to leave it on deposit with central banks and earn less than they could get from lending it to normal business and personal customers.

Not even Australia is exempt: our well capitalised banks are following suit

Banks around the world are refusing to deal with each other, or anyone else, so they are leaving tens of billions of dollars on deposit with central banks around the world.

The drought has worsened significantly since the collapse of Lehman Brothers 10 days ago and still rising losses taken by bond holders and other investors.

Bank nervousness seems to have picked up from earlier this week as the progress of the US bailout proposal slows in the Congress.

If that proposal was to fail, markets would dry up and if there was to be a reason why the global economies slumps into recession or worse, it would be this cash drought. The money’s there, tucked away in cash management accounts and at central banks, but no one is willing to lend. There is no shortage of borrowers.

Central banks in the UK and Australia have moved within the past 24 hours to try and ease the drought by moving to mop up the cash.

The drought has seen short term interest rates around the world rise sharply as banks choose to leave their money with the central bank, or invest in short term US Government treasury notes as the ultimate short-term safe haven.

Short term US treasury note rates again fell under 1% while short term US dollar (and some other currency) LIBOR rates in London has jumped sharply to levels seen in the dark days of early January.

The three-month US Treasury bill traded at 0.49% in New York overnight, down from 0.79% at the close Tuesday and 0.88% on Monday.

The demand for short term, security can be seen from the results of a huge US Treasury auction of $US34 billion in two-year bonds: demand was about normal for the moment at 2.2 times the amount offered. Market yields for the notes traded down to 2.02%,

In Australia yields on 90 day bank kills, the key short term funding source in the country, have risen to where they are higher currently than 180 day bills. It is normally the other way around. Spikes like we are seeing are signs of a cash shortage.

Three-month interbank offered rates in Hong Kong and Singapore have risen sharply as well (Hong Kong has just had a run on the Bank of East Asia on Wednesday, which frightened the market there).

Dealers said the three month rates (90 days) jumped past the levels when Lehman Brothers filed for bankruptcy and the U.S. government nationalized American International Group last week.

Three-month rates on yen loans rose to a two-month high and bill swap rates in Australia soared to the highest since August.

In China however, shares rose to a three-week high yesterday as parent companies continued to buy back shares of their listed subsidiaries after the central government made that move easier as a way of helping stop the market slump.

In Australia, banks kept $6.9 billion in their exchange settlement accounts instead of using it to lend to one another. That was the highest amount kept in the ESA at the Reserve Bank since the credit crunch started and it’s a sign the banks are fearful of liquidity risk, even with one another.

Japan’s trade account dropped into a surprise deficit in August as high oil prices pushed up import costs, but more importantly, exports slowed to a trickle.

Apart from January, which usually sees low levels of exports because of factory closures, it was the first monthly deficit since 1982, when Japan was reeling from the aftermath of the second oil crisis.

But, more important was the bad news from the export account.

Shipments to the United States had their sharpest fall ever from the same month a year earlier.

Exports rose 0.3% in August from August 2007, compared to a forecast of a rise of 2.4%.

Japan’s exports to the United States fell a record 21.8% last month, marking the 12th straight month of annual declines, on sluggish shipments of automobiles and consumer electronics.

Exports to the European Union fell for the third month in four.

A 6.7% rise in shipments to Asia and an 8.8% rise in exports to Japan’s new number one destination, China (for the second month in a row), couldn’t offset the slump in exports to the US and Europe.

Japan’s economy contracted in the second quarter at its sharpest rate in seven years thanks to slowing demand from the US and Europe and there are growing fears that it will shrink this quarter to put the country into a proper recession.

And major car companies, Toyota and Honda chopped back car production and exports in Japan and in the US and Europe in response to the slow down. Toyota’s global output was cut by a substantial 17%.

Thus far in September the Fed has expanded its balance-sheet by some US$425 billion dollars. In just the past three weeks, the Fed has rescued Fannie and Freddie, AIG, spent tens of billions of dollars in efforts with other central banks and has extended a US$75 billion dollar lifeline guarantee to money-market fund investors.

But these figures pale in comparison to the estimated cost of Paulson’s new plan.

Clearly, the credit crisis requires desperate measures and only governments can help to alleviate or even quash systemic failure through unprecedented credit expansion. Like I’ve said all along, it’s Inflate or Die for Western capitalism.

The strains of deflation, however, will take time to extinguish. Markets are wrong to think we can all enjoy a sustained v-shaped recovery. This just won’t happen. Corporate profits will decline for at least the next two quarters.

But over the next 18-36 months, inflation is going to make a formidable comeback as the chickens come home to roost in the United States and Europe.

The cost to resuscitate the financial system is primarily an American problem and will result in a massive expansion of credit. So inflation is all but inevitable.

The best long-term short-sale in my book is Treasury debt. The dollar will eventually return to the basement but that might be delayed as the outlook in Europe grows more and more dim. Though I can’t make a long-term case for the dollar, the odds are high it can continue to rally over the next several months or more, especially if RTC II is passed.

Next on the chopping block for the bears is the Treasury market. The United States will have to pay its creditors higher interest rates in the future. U.S. funding costs will eventually rise significantly unless the United States cuts its bloated spending. And the odds of that happening are pretty much nil.

“Moral Hazard” is a pair of buzz words circling lunch tables, office cubicles and board rooms around the world. Why? Simply because the Fed and Treasury are taking matters into their own hands, trying to put an end to the losses wreaking havoc on the global financial system.

And in doing so, our government could be seen as endorsing the reckless lending that led us to this disaster in the first place.

However, what scares me most about these interventions is that some could create a humongous burden on the taxpayer.

The two-year US$85, billion loan from the Fed to AIG this week is an attempt to provide a controlled environment to deal with the pain, spare the financial system from the effects of extreme counterparty risk, protect the real economy and keep the bill off the taxpayer.

So what if the burden of this financial mess doesn’t end up in the taxpayers’ lap? Could there still be moral hazard?

Good question.

Because what kind of precedent are they setting? These are banks and institutions that took on toxic derivatives and securitized debt. They fattened up when times were good, but come crying for help now that the going has gotten tough. How many more will follow expecting the same treatment?

Perhaps this is the real issue.

So now we have the mega US government fund that will save the markets from imploding.

It has stopped the rot in sharemarkets, but credit markets remain wary and uncertain.

But for the time being, we have to assume that the bailout is going to work even if it could allow some of the folk who caused the current crisis to keep ducking reality and avoid taking their lumps.

So it’s no wonder there are mutterings about the fates of Lehman Bros, Merrill Lynch and AIG: the usual collection of opportunists and lurk merchants want to know why the bailout came Friday and not last Sunday when Lehman failed, and then AIG was taken over and Merrill Lynch sent hurrying into the embrace of Bank of America.

Lawyers are being assembled and loopholes looked for.

So the cynics and smarter investors are asking who gets to bear the cost in the long run.

The answer is the American taxpayer is the only one who will pay.

So the poor American taxpayer who have already lost their homes in three million cases; faces that prospect in millions more; are losing their jobs (an extra 610,000 so far this year), will now having to support stumping up $US700 billion, and well over a $US1trillion if the costs of early support moves are added in.

What about shareholders and managements of the institutions being supported by the Treasury plan?

The plan will be rightfully extended to foreign institutions which hold these dodgy securities (That includes the likes of Barclays in London and Deutsche Bank in Germany), so what also about their management and boards?

On all the evidence so far, it will do nothing to help end the root cause of the problem, the continuing decline in US home sales, new home starts and house prices.

Until that happens, the cost to the US Treasury and to US and other financial groups will continue to escalate.

It’s going to do nothing to stop that, or change the direction of the US economy which is sliding towards an increasingly nasty looking recession.

An announcement is due from the US government shortly, led by Treasury Secretary Hank Paulson, Federal Reserve chairman Ben Bernanke and US Congressional leaders, detailing the final agreement and the scope of the legislation for the fund.

The fund will be around $US700 billion, but that considerably underplays the true cost of the debacle so far.

Since March Mr Paulson and Mr Bernanke have spent $US29 billion guaranteeing the bailout of Bear Stearns, $200 billion at least on the bailout of Fannie Mae and Freddie Mac, $85 billion on the bailout of AIG (the big insurer which wrote credit default swaps on a range of debt that it had no idea about) and at least $US50 billion guaranteeing money market funds.

That’s $US364 billion.

Seeing financial institutions around the world have already written down or lost over $US500 billion (and have raised around $US360 billion in new capital), the cost so far of the debacle that started with dodgy subprime mortgages and associated credit derivatives is well over $US800 billion (including Fannie, Freddie IAG etc).

If the $US700 billion is for new purchases of bad securities (and it could be extended to non-US groups at the decision of the Treasury secretary), the cost will balloon. 

That will allow the likes of Deutsche Bank, UBS, Credit Swiss and French and UK banks to unload their dodgy securities in certain cases.

Assuming that the $700 billion is spent on new securities, the cost could be well over $US1.1 trillion, excluding already announced losses (and over $US1.6 trillion if they are included).

Remember that a lot of analysts and commentators, plus bankers and their mates laughed at the International Monetary Fund when it said earlier in the year that the losses could be $US1 trillion.

It was obviously very conservative.

We are yet to see whether the debt to be bought will include non-mortgage related debt, say CDSs (Credit Default Swaps) and other dodgy credit derivatives issued over the debt of groups like General Motors or healthy US or foreign corporations’ debt.

Will it include leverage buyout debt for the likes of private equity groups like Blackstone, KKR, CVC and the like?

And on top of all the spending so far on the likes of Bear Stearns and AIG, there’s the $US500 billion spent or being spent a day by the Fed funding the markets in the US, Europe, Japan, Canada, Switzerland and other areas.

There’s the $US180 billion swapped last week, there’s the monthly $US200 billion being lent to banks and other groups in the US each 28 days and there’s the daily $US33 billion being injected into US commercial banks each day and the $59 billion primary dealers last week (investment banks).

Even in a US economy that produces $US14.4 trillion worth of goods and services a year, that’s a lot of loot.

In fact a working paper from two IMF economists estimated that banking crises chew up an average of 16% of the GDP of an economy. That’s based on looking at 42 major banking crises around the world from 1970 to 2007 (and not including the current problem).

Spending all that money will intensify long-standing questions about America’s fiscal health, possibly at the expense of another drop in the value of the dollar.

No wonder the US dollar blew out on Friday, sliding to over $US1.44 on the euro (the Australian dollar rose by more than 1.5c in offshore trading on Friday night).

To mitigate the cost and make for a more brutal (to the selling groups) and equitable arrangement for US taxpayers, the purchases could be made by the US Treasury through a bidding process.

Companies that want to offload their dodgy assets would bid to sell to the government at a huge discount. The company willing to sell at the lowest price wins. That’s a reverse auction.

The government would then be able to sell the assets back into the market when it wanted: the government could give the banks a share of the upside if there are any profits.

The Fed lent that $US85 billion to AIG at a margin of 8.5% over the rate banks lend to each other internationally (so-called 3 month LIBOR). That’s around 11% or a bit more in normal times outside of last week.

Using that as a yardstick, the pricing by the Fed could be brutal indeed.

So far it seems like the purchases will be aimed at dodgy housing-related debt of varying kind, but you can bet there will be pressure to offload corporate and buyout loans that are going bad. The property related debt specified in the proposed bill is residential (AND) commercial.

That alone will limit the Fund’s ability to concentrate solely on residential debt.

And what about personal loans, credit card and car loan debt tied to foreclosures and home equity loans which is another disaster area?

The idea seems to be that the US government will buy at below-market rates and sell for a gain when the housing market recovers: when that will happen, no one is willing to say.

The problem is that the dodgy housing-related assets have proven extremely difficult to value as the demand for them has disappeared.

And there is a nasty message there: those banks and financial groups that stayed away from this sort of toxic debt are being punished. The incompetent and imprudent will be rewarded by being bailed out. This is what moral hazard is all about.

The strong stock-market rally late last week reflects the belief that companies have been saved from the cost of making dodgy decisions on these loans from incompetent and risky decisions to speculate and gear balance sheets to generate big earnings for the company and themselves.

The inevitable death of weaker firms will be delayed, and in turn that will delay the reckoning that must occur before a sustainable economic recovery can take shape.

The US government is seeking to eliminate legal challenges by making the Treasury the sole and final arbiter and not allowing any legal challenges, a move that has upset Americans in the legal field (naturally).

While the proposal calls for the purchase of as much as $US700 billion of bad loans, it’s unknown what taxpayers will ultimately pay for the bailout.

The Bush administration’s proposal requests that the US Congress authorises an increase to America’s debt ceiling.

That’s set to rise to $US10.6 trillion for fiscal year 2009 - which runs from October 2008 through September 2009, to accommodate a Federal Budget deficit already estimated at some $US580 billion.

But now the Administration wants to lift the ceiling to $US11.315 trillion to allow for the purchases of these dodgy mortgage-backed assets.

US commentators say that it’s unclear at this point if it will help homeowners.

If the Treasury buys an entire securitized loan, it could help struggling homeowners by modifying the terms. This could include reducing a loan’s interest rate or principal balance to help prevent foreclosure.

But if it doesn’t buy all the securities. It could be held to ransom by the other holders.

The bottom line remains: if the plan doesn’t stem the tide of foreclosures, home prices will not stabilize and the economy will not recover and banks and other financial groups will still be on death watch.

It will not help them lend more money for housing business, credit cards and the like.

Indeed, emerging markets continue to post strong growth rates while the industrialized economies continue to struggle. Markets from the U.S. to the Eurozone are drowning under debt deflation tied to a financial crisis, rising long-term unemployment and declining standards of living.

The emergence of China as a major financial power combined with rich commodity-producing nations of Brazil, Russia and the Gulf States all point to a bright long-term outlook for emerging market plays.

It’s worth noting that emerging nations hit a bear-market low in late 1998 following the Asian economic crisis and the Russian ruble collapse.

At the time, this marked the best market-timing purchase among select global indices. We may see the same opportunity emerging here in the U.S. in the S&P 500.

For now, the S&P 500 Index remains hostage to a credit squeeze, deflation in housing, and a decline in domestic consumption. But that may all change soon.

Amid a 13-month credit crisis affecting most of the developed world, the United States might be at the cusp of outpacing other markets over the next decade. What happened in the emerging markets 10 years ago suggests this might be possible, at least from a contrarian investor’s standpoint.

LONDON - European stocks closed higher on Friday, with investors betting that the US authorities will ensure that failing investment bank Lehman Brothers finds a saviour and ease the pressure on the banking sector.
In London, the FTSE 100 index was up 98.3 points, or 1.85 per cent, to 5,416.70 points.

FRANKFURT - Germany’s DAX 30 rose 55.99 points, or 0.91 per cent, to 6,234.89.

PARIS - France’s CAC 40 jumped 83.59 points, or 1.97 per cent, to 4,332.66 points.

TOKYO - The Tokyo Stock Exchange’s benchmark Nikkei-225 index closed up 112.26 points, or 0.93 per cent, to 12,214.76 ahead of a three-day weekend in Japan.

HONG KONG - Hong Kong share prices closed down 0.18 per cent on Friday, as weakness in Chinese banks offset earlier gains in property developers and energy firms.
The benchmark Hang Seng Index plunged 35.82 points to 19,352.90

WELLINGTON - The New Zealand share market rose to end the week, the benchmark NZSX-50 index closing up 28.15 points, or 0.844 per cent, at 3361.68.

SYDNEY - Australian markets have received a mixed lead from Wall Street, although the price of oil fell again in a special trading session overnight whilst gold and silver rose.
At 0722 AEST, the Sydney Futures Exchange’s September Share Price Index contract was 50 points higher, or 1.02 per cent, at 4,975.
In news today, the Australian Bureau of Statistics will release dwelling unit commencements data for June.
Reserve Bank of New Zealand assistant governor Dr John McDermott speaks at an Australian Business Economists lunch on “Monetary Policy Issues in New Zealand”.
Base metals and uranium explorer Aluminex Resources Ltd is to list on the Australian securities exchange.
On Friday, the benchmark S&P/ASX200 was up 89.5 points, or 1.86 per cent, to 4,903.8, while the broader All Ordinaries added 85.6 points, or 1.76 per cent to 4,957.1.

NYMEX

In energy trading on Friday, crude oil briefly fell below $100 a barrel despite threats to Gulf energy supplies from Hurricane Ike, suggesting traders still believe a soft economy will keep driving down demand.
Light, sweet crude for October delivery ended Friday 31 cents higher at $101.18 a barrel, after briefly sinking to $99.99.
That was the first time oil traded below $100 since April 2.
In a special trading session on the NYMEX last night Australian time, crude oil fell to a six-month low and gasoline tumbled amid signs that refineries along the Gulf of Mexico coast will soon resume operations after escaping major damage from Hurricane Ike.
More than 20 per cent of the US’s oil refining capacity was shut, limiting fuel deliveries and prompting the Department of Energy to release 309,000 barrels from its strategic reserves. New York Mercantile Exchange electronic trading opened early today to allow traders to respond to Ike.
Crude oil for October delivery fell $2.18, or 2.2 per cent, to $99 a barrel at 4.26 pm (0626 AEST) on the Nymex. Futures touched $98.46, the lowest since February 26.
Prices are up 25 per cent from a year ago.
Gasoline for October delivery fell 10.86 cents, or 3.9 per cent, to $2.661 a gallon in New York.
Oil in New York has fallen 33 per cent from a record $147.27 a barrel on July 11 as high prices and slowing global economic growth reduce demand for fuels. Sales at US retailers dropped in August for a second straight month and July inventories at American businesses increased the most in four years, Commerce Department reports showed last week.

COMEX

Gold for December delivery rose $19 to settle at $764.50 an ounce on the New York Mercantile Exchange on Friday, after earlier rising to $770.50. It was gold’s first positive close in 10 days.
Other precious metals also traded higher Friday. December silver rose 24 cents to settle at $10.795 an ounce, while December copper gained 7.2 cents to settle at $3.194 a pound.

First of all, to avoid pervasive U.S. financial surveillance, I highly recommend offshore investments and relationships:

• Place a portion of your assets outside the United States. Yes, you do have to report offshore bank accounts and trusts to the IRS, but you can purchase some regulated contracts, such as insurance policies, in relative privacy (see Marc Sola’s article above for more details on such a tax-deferred policy).
• Transfer funds outside the U.S. dollar. It’s still possible to legally transfer funds from the United States, into alternative currencies. The dollar has appreciated sharply in recent months, so it’s an ideal time to start diversifying your cash into greater currencies (you’ll get more “bang for buck,” because of the stronger dollar).
• Use attorney-client privilege. Many countries (including EU members) now require attorneys to report “suspicious transactions” to their domestic authorities. Keeping this requirement in mind, you can achieve considerable privacy by conducting business and financial transactions through an attorney. However, in virtually all jurisdictions, attorneys can’t provide advice that would result in or encourage the commission of a crime.
• Evaluate non-reportable offshore investments. Depending on where you live, certain offshore relationships or assets may not be legally reportable. U.S. persons need not report assets held in a non-U.S. safety deposit box, where no foreign financial institution has legal custody of those assets. Other non-reportable offshore investments for U.S. persons include real estate, vehicles and other assets not considered a “foreign bank, investment or other financial account.”
• Use cash. Despite the global crackdown on cash, you can still achieve significant privacy by using cash instead of debit/credit cards or checks. This is particularly true outside the United States. However, cash transactions (over US$10,000) are subject to substantial surveillance. An increasing number of countries also require that you declare substantial sums of cash when crossing domestic frontiers.

It’s known as a foreign variable annuity.

I know that “variable annuity” sounds boring, but it’s one of the most powerful investment tools used by wealthy individuals in their international portfolios.

An annuity allows you to invest freely, shield your assets and even allow your wealth to build up tax-deferred until you withdraw assets.

Plus, your foreign annuity will protect your wealth from the next bank failure in the United States. Not to mention, it gives you the leverage you need to have your money managed by some of the best asset managers and banks in the world.

Without an official guarantee from Washington, the odds of a full-scale mortgage-backed crash was imminent. So you could argue Paulson’s pre-emptive strike on Sunday was successful.

Spreads, or the difference between risk-free Treasury bonds and mortgage-backed debt, remained elevated all year until this past Monday. That rate was 2.74% last Friday or 6.40% - the highest spread versus T-bonds since the credit crisis began.

Meanwhile, the 30-year fixed rate mortgage plunged from over 6.40% on Friday to 6.04% on Monday. In other words, the bailout alleviated credit stress on that segment of the mortgage market. That’s the good news.

The bad news is that “jumbo” mortgage rates, or mortgages considered too large to be purchased by Fannie and Freddie climbed to 7.35% from 7.14%. How the jumbo market will react going forward is anyone’s guess. But the primary concern for the market is that lending giants Fannie and Freddie remain solvent and recapitalized by the federal government.

Paulson, a former Goldman Sachs chief, is no stranger to structuring deals. In some ways, the United States and its foreign creditors are lucky because anyone else holding this position would have no idea how to put together such a complex rescue package.

Here’s the plan: The Treasury will recapitalize the government-sponsored enterprises (GSEs) by gradually buying preferred stock. Of course, stock holders will get the short end of that stick. Fannie and Freddie shares collapsed about 85% on Monday.

I’ve already purchased intermediate and short-term Fannie and Freddie debt. Spreads should continue to narrow over the next several weeks as investors return to this market. These bonds, along with high quality corporate bonds are among the best values today in fixed-income markets. In stark contrast, treasury bonds offer you poor values adjusted for inflation. They’re also overbought.

Taxpayers, naturally, will fund this enormous bailout. The Savings & Loans crisis in the late 1980s cost taxpayers about US$300 billion adjusted for inflation since 1989. This bailout should easily match those figures. It might ultimately be twice that amount if housing values don’t stop falling soon.

The US government has in all but name nationalized both institutions. It effectively means that the US government owns nearly half of all outstanding mortgages in the United States and follows on the heels of news last week that the UK government was offering “free” mortgages to first home buyers.

As Moody’s chief economist points out “the federal government has now become the nation’s mortgage lender.”

How much money are we talking about here? It is, wait for it, USD$5 trillion, that’s USD$5,000,000,000,000 in home loans. That is one big exposure to the mortgage markets that the government is burdening its taxpayers with.

But sleep easily, because US Treasury Secretary Hank Paulson thinks that the government may only have to cough up a maximum of USD$200 billiion to cover any debt shortfalls. That’s USD$200,000,000,000 - which still looks like a whopping big number to us.

Let’s just put these numbers in perspective. Over the past few years you have all read about the massive debt hole that the US government is in, how it is unsustainable, how the country is living beyond its means. The current US national debt (although by the time you receive this email it will be higher) stands at USD$9,674,134,313,303 so in one fell swoop you could argue that the national debt has been increased by over 50% to just under USD$15 trillion.

And yet the buck has been getting a lot of love since early August – rallying nearly 8% against a basket of major currencies. What gives? Do global investors see positive factors we don’t? Hardly. Overseas investors are simply taking advantage of cheap dollar-based assets and 2009 growth prospects for the U.S. economy that are more compelling than for other major economies.

In short, almost certainly, what we’re looking at right now is not a new dollar bull market, but a cyclical bear market rally. That’s exactly what happened in 2005 as the dollar rallied 12.8% versus the euro and other currencies. But back then the Fed was raising short-term interest rates and the U.S. economy was still firing on all cylinders.

It’s quite a different story now.

In fact, the only thing that could keep the dollar rally going is a continued deterioration of other major economies while U.S. growth accelerates.

UBS May Have Hung Their American Clients Out to Dry… But Switzerland Isn’t Budging

This court order came about because the UBS private bankers may have been stupid enough to advise wealthy Americans on how to evade taxes (at least according to the IRS).

The UBS situation was the subject of a series of noisy, demagogic anti-tax haven hearings in the Democrat-controlled U.S. Senate last month.

At the time I wrote: “The big question now is whether UBS, the supposed giant of Swiss banking, will have the guts to take a strong stand based on the Swiss bank secrecy laws and fight for the principle of its clients’ financial privacy…”

“Even if UBS is willing to abandon its American customers to the IRS, I suspect that official Switzerland…[is] going to stand and fight for their basic bank secrecy laws — laws that have been revised and updated to accommodate reasonable law enforcement requirements.”

Well, UBS went beyond abandoning their American clients in one respect. They announced then and there that the Swiss-based UBS is abruptly ending its private banking services to Americans. In other words, if you’re an American banking in Switzerland at UBS, you’re out of luck.

In fact, thousands of Americans with UBS accounts were suddenly left high and dry. Our Swiss banking contacts tell us that other Swiss banks are refusing to accept UBS American clients seeking new banks there. They obviously don’t want to inherit alleged UBS tax evasion problems with the IRS.

U.S. clients are especially nervous because the UBS statement said it would work with the U.S. government to identify the names of its clients who may have engaged in “tax fraud.” (That phrase has special meaning in Swiss law because tax evasion per se is not a crime in Switzerland.)

You Can’t Shake the Swiss Government

But as I predicted, while the spineless UBS bends, the Swiss government is standing firm. That official firmness may be cloaked in the diplomatic Swiss language (that has made Switzerland so famous) but it’s still a firm stance nonetheless.

Example: This week the Swiss government informally asked the U.S. not to pressure UBS for client data located within the Alpine country.

Swiss State Secretary Michael Ambuehl told his U.S. counterparts that any request for client data must be decided by the Swiss government. It’s a government issue because UBS would be breaching Swiss bank secrecy law by voluntarily revealing bank account records.

“I reaffirmed the offer by the Swiss government to cooperate constructively with the U.S.,” Ambuehl said in his Bern office on Aug. 19.

“I underlined, however, that we expect them not to take unilateral steps against UBS to obtain information which is located in Switzerland as long as the agreed, bilateral legal cooperation is ongoing.”

This was undoubtedly a reference to the Swiss-U.S. mutual tax treaty and the mutual legal assistance treaty (MLAT) between the two countries.

Tax Evasion Isn’t a Crime in Switzerland

“UBS is seeking to address these requests with both Swiss and U.S. government authorities within the legal framework for intergovernmental cooperation and assistance established between Switzerland and the U.S.,” a UBS spokesman said in Zurich.

According to Swiss law, bank secrecy can only be lifted in connection with a criminal offense, such as tax fraud or money laundering.

But tax evasion isn’t a crime in Switzerland. Should the finance ministry agree that UBS release the account details, then account holders will be informed before their details are handed over. This gives them the option to go to court to oppose the release, a Swiss official said.

Ambuehl said pressure from the U.S. and the European Union for Switzerland to amend bank secrecy laws hasn’t increased. He also sees no need to revise them, because they include “strict internal rules and good external cooperation.”

No One Is Abandoning Swiss Policy Here

An alarmed Teodoro Cocca, formerly with Zurich University’s Swiss Banking Institute said at the time of the UBS revelations: “This is a direct and coordinated attack on the heart of the Swiss financial system. This is a long-term threat that will not go away, and there is not too much Switzerland can do.”

It appears that the professor was right about the gravity of the situation, but wrong to think that the Swiss government would supinely abandon the cornerstone of their banking success - strict bank secrecy.

There is a great deal the Swiss can do to defend their laws - and they are doing it.

By the way, it’s worth noting that The Sovereign Society has NEVER recommended UBS. We have always thought they were too cavalier with their client’s privacy.

Indeed for the last decade, we have advised U.S. depositors considering Swiss banks to avoid UBS AG and any other Swiss bank with U.S. based branches, affiliates or banking operations, other than a mere “representative office.”

However, that doesn’t mean you should abandon the country of Switzerland altogether. As you can see, Switzerland still has some of the strongest banking laws in the world - and the local Swiss government is even willing to take on American politicians to keep that bank secrecy their policy. ]]> http://www.raymondteo.com/2008/08/30/ubs-may-have-hung-their-american-clients-out-to-dry-but-switzerland-isnt-budging/feed/ http://www.raymondteo.com/2008/08/28/who-really-insures-the-fdic/ http://www.raymondteo.com/2008/08/28/who-really-insures-the-fdic/#comments Thu, 28 Aug 2008 02:28:19 +0000 Alex http://www.raymondteo.com/?p=905 Insurance is one of those things that’s supposed to help you sleep at night. It’s right up there with putting locks on your doors and installing airbags in your teenager’s new car. It should mean that you’ve got one less thing to worry about.

So when you find out that the insurance policy itself may be at risk, it’s basically like hearing all those precautions were just a huge waste of time.

All chances of a good night’s sleep are gone forever.

That brings me to FDIC insurance. Nine banks have already failed this year, so how “safe” is your FDIC insurance? When you pull back the covers on the FDIC insurance program, what exactly will you find backing up every dollar in your bank account?

Where Did the FDIC Come From?

The FDIC (Federal Deposit Insurance Corporation) is an independent agency of the federal government. So even though it’s technically independent of the federal government, it was the U.S. government’s brainchild. Congress first created the FDIC in 1933 in response to the thousands of bank failures in the 1920s and early 1930s.

For as long as the FDIC has existed, its primary goal has been to:

“…Preserve and promote public confidence in the U.S. financial system by insuring deposits in banks and thrift institutions for at least $100,000.”

And to give them their due…they’ve done a pretty good job of it.

Just a year after Congress created the FDIC it also created the Federal Savings and Loan Insurance Corporation, FSLIC…remember them? The savings and loan crisis of the 1980s bankrupted the agency, after thousands of Savings and Loan Banks had to close their doors forever.

It was just more than the insurance could handle - the safeguards failed and the FSLIC insurance program closed. As usual, the American taxpayers picked up the tab for this failed organization, paying US$160 billion.

President George H.W. Bush requested and Congress agreed to abolish FSLIC. They decided the healthier, better-staffed counterpart for the banking industry (aka the FDIC) should watch over these deposits from now on.

Poof! - the FSLIC simply disappeared.

Fast-Forward to FDIC Insurance in 2008

This year, the FDIC is celebrating its 75th Anniversary with its “Face Your Finances” coast-to-coast road show. They’re also celebrating with a new website and big full-page ads in papers like The Wall Street Journal.

Unfortunately, there’s really not a lot to be celebrating…

When banks fail, the FDIC steps in to (remember their motto) “Preserve and Protect public confidence…” They have to move fast to accomplish all this. A bank can close their doors on Friday and technically be wiped from memory by Monday.

If a bank goes insolvent on Friday, the FDIC bank regulators scramble over the weekend. They freeze every account and work diligently to sort out the bank’s balance sheets. Then by 9 a.m. Monday morning, you suddenly have a new bank with a different name on the door. Other than that, it’s business as usual.

The FDIC works diligently to give you back your insured funds. In other words, any account in your name up to US$100,000 (per holder on the account), and US$250,000 for any retirement account. (Concerned about the minimums? Our friends at EverBank may have a solution for you.

But where does all this insurance money come from?

A Vicious Banking Cycle

The FDIC levies a fee on all U.S. Banks. These are the reserves that insure your deposits. But here’s the problem: The reserves are running low this year. As of today, the FDIC’s reserves reported it had US$45.2 billion of reserves covering 1.01% of all deposits. This is considered historically low.

The failure of just one bank last month - IndyMac - is going to wipe out 10-15% of all reserves. That’s just one bank (let’s not forget that the S&L bailout cost us over US$160 billion). Consider that nine have already failed this year. In fact, I see on the FDIC website another bank failed on Friday.

When the reserves that insure your bank deposits drop 1.15%, then by mandate the FDIC must come up with an action plan. If you do the math on this, you’ll find we’re already there. But what “actions” can they take? They don’t have that many choices.

Remember they get their reserves by levying a fee on their member banks. That can be a vicious cycle. Let me explain…

Congress gave the FDIC the mandate to replenish their reserves by charging higher premiums on their members. The current fee that most banks pay is five cents for every US$100 of insured deposits. But high-risk banks now pay up to 43 cents to insure that same US$100. That high-priced insurance is killing them. Especially since FDIC-insured lenders reported a net income of $4.96 billion this quarter, down 87 percent from $36.8 billion in the same quarter of last year. If the banks are called to increase their cost for insurance the money has to come from somewhere.

So here’s the problem: The FDIC needs more cash, but it comes from the banks. Right now, the banks need all their funds so they can make loans and clean up their balance sheets so they can stay in business. But the FDIC has to appear rock-solid, which means they need more than enough cash to cover all the banks.

The FDIC can’t let their reserves fall much lower. FDIC Chairman Sheila Blair said yesterday that they may need to borrow money from the Treasury due to “short-term liquidity issues”, but this is just a temporary fix.

The value of assets belonging to lenders on the ‘problem list’ has tripled to US$78.3 billion in the last quarter alone. That’s roughly twice the amount that the FDIC could currently cover. They’re going to have to raise fees and the inevitable outcome will be more bank failures.