It is the same everywhere

It is funny how the headlines are the same all over the world; house prices down, inflation rising, growth slowing and central banks that don't know what to do. There is a sample from Australia.

HOME lending growth has suffered its biggest decline since the 1991 recession
while inflation continues to soar, confronting the Reserve Bank with the dilemma
of a slowing economy and simultaneously rising prices as it meets today to set
interest rates.

Inflation, according to the series, has been at or above 4 per cent for the past five months - and above the Reserve Bank's 2-3 per cent comfort band since September.

CEOs giving up bonuses

Seems unlikely; but this is what portfolio.com are reporting.

In the wake of losses sustained in the credit crunch, John Mack of Morgan Stanley gave up his 2007 bonus, as did top executives of Bear Stearns and Merrill Lynch. Lately, Lehman Brothers has been the Street's problem child, and Yalman Onaran of Bloomberg News reports that its C.E.O., Richard Fuld, and its president, Herbert (Bart) McDade, told the firm's managing directors this week that they will forgo 2008 bonuses.

The bonus is typically the majority of a Wall Street professional's annual compensation. But these are hard times, with credit markets mired and with deals and offerings chilled. "I'd be surprised if other C.E.O.'s didn't give up their bonuses this year," Jeanne Branthover, the New York-based head of the financial-services practice at Boyden Global Executive Search, told Bloomberg.

Bank against bank

What do Fleck, Fortis, RBS and Barclays have in common? An interesting obsversation from ML-implode; the banks are getting gloomy about banking sector prospects.

"What they have in common is all have recently predicted a massive unraveling of the US financial 'system' within a few weeks. It is not as if this prediction or being on the verge of a meltdown is something new. The financial system has come apart several times in the past year but the Fed has always stepped in with something that has caused the markets to calm down (on the surface) and stocks to rally. Bonds, however, have never responded quite in the manner of stock market participants ..."

Disappointment and understanding

I just loved this paragraph from last week's press release from the Council of Mortgage lenders:

“We understand the conflict between slowing economic growth and rising inflationary pressures, and the uncertainty over some of the data reflected in the split views of MPC members last month. However, the MPC had an opportunity to act to anticipate the worsening economic environment today, and it is disappointing that there has been no change. "

Despite feigning understanding about inflationary pressures, the CML remain disappointed that the Bank of England didn't cut rates. The worsening economic environment would be made much worse by a cut in interest rates. Inflation is rising extremely fast right now. A cut in interest rates would exacerbate price expectations and lead to further difficulties down the road.

Disappointed! Whatever!

Building societies begin to shrink

Today, the guardian reported:

Mortgage lending by the UK's building societies has slumped by more than £1bn, according to new home-loans data. Building societies advanced net loans of just £580m in March, down from £1.8bn in the same month last year.

The 68% decline means that building societies are scaling back lending as a result of the credit crunch even more severely than major mortgage bank rivals, such as Halifax and Cheltenham & Gloucester.

An unsurprising story; building societies were always more susceptible to the credit crunch since they had a smaller depositor base and a greater dependence on wholesale financing.

For the same reasons, building societies are the weakest link in the UK banking system. Although the BoE have never stated this publicly, the Special Liquidity Scheme was almost certainly designed with them in mind.

Unbelievable numbers

The numbers behind Carlyle capital - the hedge fund that is currently on the verge of insolvency - are just incredible.

The fund was started in 2006, but it attracted $670 million in equity.

It used that equity to build up assets amounting to $21.7 billion. It built up these assets by borrowing around $21 billion.

Most of its assets were mortgage-backed securities, primarily AAA-rated bonds guaranteed by Fannie Mae and Freddie Mac. As we have seen,these MBS haven't looked too good recently, what with all those foreclosures in the US.

It was leveraged 32 times, giving it an capital ratio of 3.2 percent of its assets.

According to the WSJ, it has defaulted on about $16.6 billion of its loans, and expects to default on the rest.

The stock has lost around 83% since the company first disclosed its funding problems last week. So the shareholders are pretty much wiped out.

How does this kind of hedge fund ever get past a financial regulator?

A quick primer on subprime

Here is a very funny link; check it out....

It is all about the banks.....

Over the last few weeks, a question has bugged me. Could the sub prime crisis bring down a major US investment bank? The crisis has already destroyed some 220 small financial institutions. It also forced Bank of America to bail out Countrywide, one of America's largest sub prime lenders. But what about a gorilla? Could it take down one of the big beasts roaming the financial jungle?

There are two badly wounded investment banks out there; Citigroup and Merrill Lynch. Out these two, Merrill looks the most vulnerable. In early January, the bank reported the worst quarter in its history, forcing the bank to write off $16 billion due to sub prime investments.

How much of a financial hit is $16 billion to a bank like Merrill? These days, balance sheets are available with a click of the mouse. Merrill started out in 2007 with assets amounting to $841 billion, and liabilities of $802 billion.

Subtracting assets from liabilities gives the bank's capital, which is the loss-making shock absorber. So long as the bank has a sufficiently large stock of capital, the bank can ride calamitous decisions like investing in sub prime assets. Simple arithmetic tells us that at the end of 2006, Merrill had capital amounting to around $39 billion.

The Merrill website has a couple of further, more interesting numbers for capital. During the first quarter, bank capital increased by around $2 billion, to around $41 billion. By the end of 2007, the bank had owned up to the losses. As a consequence, bank capital fell to $32 billion. In simple terms, sub prime investments burned up around 24 percent of Merrill's capital.

Looked from the perspective of bank capital, these losses are mighty. While subprime has not put the bank in any immediate danger of insolvency, neither is the bank in any shape to absorb any further shocks.

So when Bernanke met with the rest of the FOMC on Monday, he almost certainly had Merrill foremost in his mind. With the stock market crashing on monday, he had a vision of a further financial shock ripping through the banking system, zapping bank capital, much like the sub prime crisis did in 2007. He may be worried about a recession, but he is petrified of a major bank sinking into bankruptcy.

There is only one way he can help; reduce rates. This will allow banks like Merrill to increase their spreads between borrowing and lending money. Over time, bank profitability will improve and gradually bank capital will recover.

However, the rate cut comes at a time when inflationary pressure in the US is at a 17 year high. The CPI is now over 4 percent and will almost certainly rise further. After several years of relentless dollar weakness, import prices are rising.

However, when it comes to choice between Merrill or inflation, the Fed knows what to choose. It will be Merrill every time. This leads us to a profound conclusion. Whatever the Fed may say, monetary policy is there to serve Wall Street.