Things aren't looking good for them, with S&P's president out of work as of today. Bloomberg columnist Mark Gilbert adds:

Moody's... called structured investment vehicles ``an oasis of calm in the subprime maelstrom'' in a July 23 report. ``The vehicles are not structured to forcibly liquidate assets in times of crisis,'' Moody's said. Their ability to access several sources of finance ``obviates the need to liquidate large buckets of assets at potentially the worst period in the life of the vehicle.''

Tell that to Cheyne Capital Management Ltd., which said yesterday it may be forced to dump the securities owned by its $6 billion Cheyne Finance LLC fund because the asset-backed commercial paper market is freezing up and the SIV is struggling to fund itself beyond November... How's that for missing something the first time?

before waxing apocalyptic on the issue of dodgy valuation methods:

Suppose regulators decide to play hardball on how the financial community marks to market, imposing rules that outlaw the existing freewheeling approach to how over-the-counter derivatives are assayed.
Moreover, suppose those new decrees come just as much of the underlying collateral is so tarnished as to be almost worthless compared with its initial valuation.
The ensuing carnage in the balance sheets of every financial-services company in the world would dwarf the damage wrought in the securities industry by the subprime crisis so far.

All due respect, but I think this is unlikely - regulators aren't going to overturn the entire financial system out of a fanatical desire for probity. It's like Americans worrying that the Chinese government might sell off all its T-bills at once - yes, it could theoretically happen, but it would be utterly insane.
Nevertheless, the main point is a good one. We are not, actually, in the middle of a credit crisis or a subprime crisis or a liquidity crisis. All these things are going on, but they're just symptoms. The root problem is a valuation crisis - a sudden drop in confidence in currently-used valuation methods. Who's going to arrest it? Not, it seems, the rating agencies...

Risk has been keeping an eye on the Islamic finance market from its inception - see the Special Report in the last issue, for example. But trying to come in on the middle of the story can be tricky.

Risk Books, the publishing arm of Risk, has just produced a Guide to Islamic Finance, written by Munawar Iqbal, dean of the school of Islamic Banking and Finance at the International Islamic University in Pakistan, which aims to help. It includes an extensive glossary - vital for anyone who gets confused at times between mudarabah, murabahah and musharakah - and a conclusion which looks at some of the most important questions about the market's future. It's flourishing, he says, but much of this is due to the rise in oil prices - and a sudden change in regime in a key state could alter everything.

Rumour, in this case, centres on layoffs among US CDO specialists. See here on Risk News - Lars Toomre also comments on the news. The speculation is that the layoffs at RBS are going to be followed by a lot more at other CDO divisions in the US.

How are the titans of the fund world making out? Renaissance Technologies is not planning to sell a stake, despite what the FT said this morning. Subprime hedge fund manager Martin Finegold is having serious problems, with his Caliber Global Investment fund down 85% on US subprime, the Times reports.

It's no surprise that the credit crisis is now officially worse than terrorism...

the National Association of Business Economics... a Washington-based association, said 32 percent of its surveyed members cited loan defaults and excessive debt as their biggest near-term concern.

Only 20 percent of members cited defense and terrorism as their biggest immediate worry, down from 35 percent when the survey was last conducted in March.

Editorial comment: let's hope this doesn't mean a Global War on Credit...

Commercial paper has fallen further than at any time in the last seven years

Credit crunch continues - Nouriel Roubini musters the evidence

Robert Merton is starting a hedge fund

A comment piece in the FT today raises the question again:

Ratings agencies do more than opine; they play an active role in structuring RMBS and CDOs. They also serve as important sources of information about securitisation performance and often enumerate measures that issuers must take to maintain ratings in troubled securitisations. More importantly, unlike typical market actors, ratings agencies are more likely to be insulated from the standard market penalty for being wrong...It is no use blaming the ratings agencies, which are simply responding to the incentives inherent in the regulatory use of ratings. The solution is for regulators to reclaim the power that has been transferred to ratings agencies to award ratings and determine the meanings attached to them.

I can't help thinking that the atmosphere is similar to 2000-2001, when the news began to sink in that many equity analysts had basically been leading investors astray, in the hope of getting more IPO business for their banks. Now the rating agencies are reacting badly to the crisis - witness the sixteen- and seventeen-point downgrades yesterday - and attracting criticism from all sorts of people.
Jayne Jung reported on an earlier reform effort in the US in January this year, and raised the possibility of many more agencies getting government recognition. That was well before the current crisis - which way will the regulators go now?

According to this (fortuitously topical) paper, liquidity is hugely valuable: "a liquid asset can be worth up to 25% more than an illiquid asset, even though both have identical cash flow dynamics". Or, to put it another way, a sudden absence of liquidity could in effect mean a 20% drop in portfolio value, even if the assets - and their market prices - remain constant. Nasty.

Hold that thought while Rick Bookstaber speculates:

Lower volatility can mean higher risk. Here is how I think we get to this paradoxical result.

With the growth of hedge funds over the past few years, more and more capital has been scavenging for alpha opportunities... That is, there is more liquidity. And this is great for the liquidity demanders – for example a pension fund that has to invest a recent inflow – because they don’t have to move prices very far to elicit the other side of the trade. And that means lower price volatility. The lower volatility in turn leads to higher leverage...

More subprime and related news than anyone can handle today, but here are a few interesting sidelights:

Is the situation worse than 1998? Menzie Chinn at Econbrowser believes so:

The spread between the 3 months cash rate and the policy rate in the US, Eurozone and UK has jumped during this period of financial turbulence more than it did on the occasion of the Russian default/LTCM debacle in 1998.

A new (or rather old) measure of market unease - the T-bill/Libor spread, or TED - from Macro Man:

Expressed as a ratio (i.e., the current 3 month LIBOR rate is 1.71 times the 3m T-bill yield), the spread is the widest that Macro Man can find in his data set. So quite clearly, there is indeed panic on the streets of London....and Frankfurt...and New York...and Tokyo.

And Mark Thoma posts Four Views on What the Fed Should Do: go wild, go slightly wild, overhaul regulations or simply let them sink.

Dismal news from the world of commodities - when peace came to Angola, companies with mines there saw their stock fall significantly. The reason? While it's expensive to operate in a war zone, there's less competitive threat... read the full paper from the St Louis Fed.

An entertaining story for the weekend...

"There's no law west of Dodge City, and no God west of the Pecos," John Wayne is told at the end of the classic Western Chisum. "Wrong," he replies. "No matter where people go, sooner or later, there's the law."
In Second Life, the increasingly successful online universe, another milestone of sorts has been passed: the first bank rush.

Last Thursday, the bank posted a note on its website acknowledging that its coffers of Linden dollars were empty. A wave of withdrawals led to a "full-blown panic depleting even our last line of cash reserves," wrote Andre Sanchez, the real-world individual whose avatar is Ginko's CEO. Now the bank is handing out cheap bonds and asking customers to hold tight until it recovers. Ginko owes upwards of $750,000 (yes, real dollars), and some customers who invested heavily - hoping to reap whopping 48-percent annual returns - lost as much as $10,000.

But now a collection of "almost impossibly strapping men and buxom women, along with various furry creatures with wagging tails" are taking action:

A virtual counterpart to America's securities regulator appears to be evolving among a group of avatars. The Second Life Exchange Commission is currently in the process of crafting the Second Life Securities Exchange Act of 2007, which, according to its website, will closely resemble real securities law... but according to its online mission statement, the supervisory body will be dedicated to "assisting in providing market stability and investor confidence."

UPDATE: a colleague points to the news of the appointment of Eyjolfur Gudmundsson as central banker to the Eve Online science fiction world...

As new players join, CCP adds new planets and asteroids that can be exploited, one of several "faucets" that serve to inject funds into the universe and keep the economy ticking.
"After we opened up an area where there was more zydrine (an in-game mineral), we saw that price dropped. We did not announce that there was more explicitly, but in a matter of days the price had adjusted," Guodmundsson said.
He is tasked with figuring out whether the game has enough "sinks" that can soak up excess money if it looks like an inflationary bubble is emerging.
CCP pricked such a bubble when it overhauled the system for producing player-created items. The 425mm railgun—a powerful gun for the large ships that are a stalwart of any serious battle fleet—dropped to a fifth of its previous price.

Moody's has warned that the credit crisis could lead to a hedge fund collapse with the same disruptive effects as the 1998 LTCM failure. (Via Market Makers). Infuriated investor replies: and whose blasted fault will that be, then?

``To see Moody's make forward-looking negative statements about hedge funds, who may well be suffering in large part as a result of their reliance on Moody's now evidently worthless ratings, is to witness the height of chutzpah.''

What with that and the continuing flapping of central banks (Fed, RBA and BOJ all went in again in the last 24 hours), this weekend isn't getting here a moment too soon. And for those tempted to just stay at home until it all blows over - we've just heard that Deutsche Bank has cancelled all its traders' holidays. No doubt other banks will follow suit if they haven't already.

(Update: this post originally credited Felix Salmon with the linked article - it was in fact by Yves Smith. My apologies.)

"It's not our fault," the cry goes up as hedge funds start reporting their losses. Chief among them David Viniar, CFO of Goldman Sachs, who says “We were seeing things that were 25-standard deviation moves, several days in a row".

No, you weren't. You were seeing things that your model told you were 25 standard deviations away from the norm. And then, the next day, it told you that you were seeing them again.
Now, from my dimly-remembered statistics lectures, something 7 standard deviations away from the mean of a normal distribution will occur on the order of one in a hundred billion times. Something 25 standard deviations away... well, it's meaninglessly unlikely. If you wrote an asset price on every atom in the solar system, one of them might be that far off the mean.

Or, alternatively, the model might be wrong, and be vastly underestimating the probability of improbable events. The Fat Tail strikes again. But it's depressing Viniar didn't say "well, obviously, our models were wrong" rather than bringing in Infinite Improbability...

... have led to this communiqué (chapter on subprime starts on page 37). In its analysis, headlined "Money for Nothing and Checks for Free" (subheads: Twisting By The Pool: The Mechanics of Mortgage Securitisation, and Brothers in ARMs: Hybrids, Options, IOs, Neg-Ams and Teasers), it draws some fairly pointed conclusions about the alchemy involved in the financial industry's latest trick:

the viability of the riskiest mortgages and mortgage-related securities became reliant on continuing house price appreciation, and lending standards were relaxed to generate high-yielding loans to
meet securitization demand... fee-remunerated intermediaries within the securitization process had insufficient incentive to
monitor and maintain long-term loan quality. Less sophisticated investors were content to
outsource the risk management of their positions to the credit rating agencies, who have
appeared slow to respond...

The regulators have fallen behind as the mortgage market developed into an originate to securitize system, the authors conclude; while this is not in itself a bad thing - it made mortgage financing available to buyers on every street, even those previously excluded - it has left consumers inadequately protected from "predatory lending".

Meanwhile, Knopfler et al. remain regrettably silent on the crisis: the authors write in a footnote

2. Although some might describe the subprime market as in dire straits, none of the views in this paper should
necessarily be ascribed to the rock band of that name.

The August issue of Risk is now available online - including another look at the question of calculating downturn loss given default (LGD). Though the Basel II process depends on reliable calculations, this is far from a settled issue - Michael Barco of ANZ presents his approach in the Cutting Edge section. In Risk South Africa in March, three Regensburg economists looked at avoiding overestimates of capital by allowing for bias in LGD estimations.
Barco's work doesn't settle the issue - but he suggests that the next necessity is more clarity from the regulators. We can hope...

Bear Stearns has cut loose its hapless co-COO Warren Spector, as the bank continues to suffer from the failure of two of its hedge funds. Coverage and details everywhere, especially at the New York Times, which repays its inside source with a very positive writeup for Spector's replacement, Alan Schwartz; rather more balanced from the FT, which also points out that Bear itself is by no means out of the woods, with shares down and an S&P downgrade a possibility.
Meanwhile, a worthwhile case for a systemic crisis from Nouriel Roubini: this crisis may spread faster than previous upsets such as 9/11, Enron and the US auto downgrades, he reckons, for several reasons.

First, most of previous transitory episodes occurred at the time when US and other G7 monetary policy conditions were much looser than today... Second, following the brief US recession between March and November 2001, economic growth – first in the US, then in other G7 economies and emerging markets – recovered rapidly and has remained high for a number of years. But starting with the fall of 2006 the US has experienced a serious economic growth deceleration...Third, between 2001 and 2006 the debt, credit and financial excesses of important sectors of the economy were contained; today they are not...Fourth, the housing bubble has already popped in the US and is at risk of popping in other bubbly housing markets ...Fifth, we are now reaching a point where the distress of many and different economic agents may lead to a systemic effect.

Banca Italease has taken a serious hit from its derivatives business - see the linked Risk News article for details. Ironically, it looks as though the bank has been selling the products to widows and orphans - relatively unsophisticated small businesses - but it's the bank, not the widows, which is suffering now. Not only that, but there may have been dirty work - the bank was raided by the police earlier this week, reportedly as part of an investigation into hindering supervision. I wonder, too, if there's been any compulsion involved - as there was in the case of SMBC last year?