"I keep my savings in HSBC, which reflects the fact that I am a very cautious banker" - Paolo Comboni, head of treasury, London, Intesa Sanpaolo.

"Those responsible [for the crisis] should face, at the least, financial penalties" - Nicolas Sarkozy, president of France.

And read Felix Salmon on the kudos owed to Spain's central bank.

We've been running daily reports on interbank borrowing costs for some time now - here's the latest. (Get them sent straight to you via our RSS feed or sign up for the Risk News email newsletter - now running twice a week because there's, well, just so much news.)

Salmon comments:

Overnight Libor came down today, to Extremely High from Utterly Ridiculous. But three-month Libor went up: it's now 4.15%, which means that TED's at 334bp -- or as it's referred to these days, "frozen". (No interbank lending is actually going on at these, or any, levels.) ... frankly I'm not sure that even passage of a $700 billion bailout bill will be enough to unfreeze markets at this point.

This interesting paper from Daniel Gros looks at the scope of the bailout and asks: what, if anything, are subprime MBS worth?

Not a whole lot, is the answer. Because US mortgages are non-recourse, they effectively contain an embedded put - at any time, the holder can sell his house to the bank for the amount of the outstanding loan. Depending on your assumptions of future house price movements, this could mean that subprime MBS are collectively worth pretty much zero.

Alea and Yves Smith both have news of the proposed €300 billion European bailout.

I have stolen this WSJ story from Paul Krugman...

Inmates of America's vast prison system are not allowed to possess cash. Traditionally this meant that cigarettes were used as a medium of exchange - but then smoking was banned. The replacement is, for some reason, mackerel fillets.

Unlike more expensive delicacies, former prisoners say, the mack is a good stand-in for the greenback because each can (or pouch) costs about $1 and few -- other than weight-lifters craving protein -- want to eat it.

Question, though: surely the reason that cigarettes were used in the first place is that lots of people did want them? Why aren't the prisoners using some more desirable substitute for cigarettes? Stamps are mentioned, which seem ideal. After all, they're durable, compact, have an obvious face value, and easily convertible into cash outside the prison, unlike mackerel - the non-convertibility of the "mack" is mentioned as a problem. Why has mackerel outdone stamps - or the other alternatives such as PowerBars? The article suggests that it's because of mackerel's undesirability, but that just seems wrong.

Maybe what we have is a QWERTY situation; there were so many good alternatives springing up after the cigarette ban that none of them were able to dominate the market. Mackerel, purely by chance - perhaps some large criminal group decided to start accepting the mackerel as settlement for all debts public and private - became the leading contender, and after that network effects took over; mackerel became widely used because it was widely used, and everyone knew that other traders would accept the mackerel, despite its apparent disadvantages. A bit like the Maria Theresa Thaler.

The next step is to watch for the emergence of notes of hand backed by large reserves of mackerel held by a reliable (in prison terms) central authority...

We are indeed drifting into the arena of the unwell.

Yves Smith picks up on the FT warning about the potential for disaster in the upcoming CDS settlement auctions.
Is this why banks are hanging on to so much cash? It would explain the immense heights reached by the Ted spread and the virtual absence of interbank liquidity at the long end.

Meanwhile, Goldman Sachs insists it doesn't have any real exposure to AIG. Suspicious Greg is suspicious. But Salmon suspects that more information from GS wouldn't help a bit and adds: "My gut feeling is that we can trust Viniar on this one. He says that Goldman had hedged its AIG exposure, and I don't think he's the type of person to come out with a bald-faced lie."

...which saw the Fortis bank deal collapse and then recover, leaving BNP holding the reins - and creating a €10 billion toxic waste SPV...

... and saw the US bailout finally pass the House - and have apparently no impact at all...

...the Fed follows the Bank of England in opening its pockets still further, but with no effect on the panicked interbank market...

Any good news? ...Oil's well down...

Sunday: German chancellor Angela Merkel says "we want to tell savers that their money is safe - the government guarantees that".

Did she really mean it? The BBC has been investigating, and, apparently, she did not. It was just a political statement...

The government has been seeking to clarify her remarks amid concerns that Britain would have to follow suit to stop savings ebbing away from British banks.

But the BBC understands she was making a political commitment that savers would not lose money, rather than guaranteeing unlimited 100% protection.

The prime minister's spokesman said: "Our understanding of the situation is that the German government will not be bringing forward legislation for a legally-binding guarantee of bank deposits."

Presumably the full sentence would have been something like "we want to tell savers that their money is safe - the government guarantees that - but we can't because it isn't actually true."

The Fed's finally managed to pour more money into the markets than they can soak up - yesterday's vastly increased TAF auction was undersubscribed. (Undeterred, the Fed's planning an entirely new intervention - in the commercial paper and unsecured lending markets.)
There's no sign of an easing in interbank lending costs - Libor rocketed up again today.
And there are reports that RBS, Lloyds and Barclays - the UK's three biggest banks - are calling for a £15 billion bailout. That's £15 billion each.
Warren Buffett is still sanguine, buying into GE despite rumours (via Felix Salmon) that it's on the brink of bankruptcy.

The UK bailout is going ahead - £50 billion in two tranches will go into buying UK banks' preferred shares.
There's also £200 billion more in an expanded special liquidity scheme, and the prospect of a government guarantee for medium-term bank debt, details to be confirmed.
Paul Krugman approves:

Unlike the Paulson plan, this sounds as if it makes sense. However, given the strong financial linkages among the world’s economies, I wonder how much Britain can do on its own. Let’s see what the plan actually looks like; if it’s good, it can be a model for US emulation, and for the eurozone too if they can get their act together.

"So your vast financial conglomerate has just been saved from certain ruin by an $85 billion bailout from the US taxpayer. What are you going to do next?"

"We're going to Disney World!"

Or, rather, the St. Regis Resort, Monarch Beach, CA - try their Collapsing Financial Behemoth discount package at just $370,000. This one is all over the media...

Congress has understandably seized on this colossally bad piece of PR as a stick to beat AIG with in hearings this week. There's also this - apparently the SEC's own inspector general edited his report on the Bear Stearns collapse to make the commission look better.
To be honest, even the edited version was still pretty damning.

Eighteen months ago, Moody's announced that it was upgrading Icelandic banks like Kaupthing to Aaa, because it reckoned that they had an effective guarantee from the Icelandic govenrment. This made a lot of people very angry and was widely regarded as a bad move.
Well, everyone was right. Moody's was right in saying that if Kaupthing got into trouble the Icelandic government would step in to help. And everyone else was right when they worried that, maybe, a nation of only 300,000 people might not be able to do very much about it...

From our March 2007 article:

"We used to steer clear of putting more complex structures before Moody's for rating, as it tended to be more difficult to convince it to look at structures as we do," says one London-based structured credit desk head. "Now that we know we can include high-yielding credits in baskets without worrying about ratings, we'll probably be approaching it a lot more."

Oh, good.

Earlier this week, as you know, Bob, Citi and Wells Fargo were almost at daggers drawn over who would walk away with Wachovia.

“We saved Wachovia from collapsing,” Mr Pandit said, according to people who were present. “We have to be compensated for that. That is like somebody buying a $2 ticket, winning $10 . . . and somebody says, ‘I am going to come and steal it away from you for two-and-a-half bucks.’ ”

Now? The ardour seems to have cooled. Now that both suitors have had a chance to go through the books, they're starting to think twice, Yves Smith says.

Good and bad news on the effects of the crisis on the real economy - specifically, the shipping business.

Good news first, from Felix Salmon - the Baltic Dry Index, which measures the cost of shipping freight, has fallen 79% since May.

...a Panamax ship, the Dong Sheng Ocean, is rumored to be taking iron ore from the Persian Gulf to China for free.

I think this is good news, actually. Shipping costs have for the past couple of years been a serious constraint on international trade, and if they stay low, that's a helpful lubricant in terms of the real global economy. It's clearly the non-financial sector which is going to pull us out of this recession...

Attention is shifting to the influence that governments (UK and, probably, US as well) will have on executive pay. See here, for example:

One concern about the Treasury’s bailout plan is that it calls for limits on executive pay when capital is directly injected into a bank. The law directs Treasury officials to write compensation standards that would discourage executives from taking “unnecessary and excessive risks” and that would allow the government to recover any bonus pay that is based on stated earnings that turn out to be inaccurate. In addition, any bank in which the Treasury holds a stake would be barred from paying its chief executive a “golden parachute” package.

And in a startling report today, the NY Times reports that this could be a dealbreaker. US banks might refuse government assistance if it meant they couldn't pay their executives quite as much:

Britain’s plan also hinged on the willingness of several of the largest banks — Royal Bank of Scotland, Barclays and HSBC Holdings, among them — to sell preferred shares to the government. It is not clear, administration officials said, that the largest American banks would agree to this, particularly given the restrictions on executive pay.

Again, comment seems unnecessary.

"And so the system broke down, the empire collapsed, and a long, sullen silence settled over the galaxy, disturbed only by the pen-scratchings of scholars as they laboured into the night over smug little treatises on the value of a planned political economy." - The Hitch-Hiker's Guide to the Galaxy

The latest totals of subprime writedowns and capital raising provide food for thought: writedowns now total $592 billion and new capital raised (whether through shares, bonds or other means) $443 billion.

If some forecasts are right, that first figure has some distance still to climb. Funny - the Fed predicted that we'd only see mark-to-market losses of $475 billion...

Lars Toomre notes the head of BaFin, Jochen Sanio, saying that Lehmans' collapse caused $300 billion of damage outside the US. (No details on how that total was reached, unfortunately.)

And radical calls to ban off-balance sheet accounting, restrict bank investments, cut leverage to under 50%, level the CME and Nymex and ban derivative trading - from Felix Rohatyn and Charlie Munger.

according to this study (via Alea) from the Goethe University in Frankfurt: it wasn't inability but misconceived bonus schemes that drove the crisis in the securitisation market.

We believe that incentives in banks and in financial value chains are at the core of the problem. Incentive misalignments tend to lower the quality of financial products, thus destabilizing asset valuation. Moreover, incentives misalignments tend to raise the leverage of financial intermediaries. Both effects undermine transparency about asset quality and risk positions of financial intermediaries. This cocktail inevitably destabilizes financial markets...

Politics blogger Matthew Yglesias has been reading the textbook Macroeconomics by Krugman and Wells, and comes across this "check your understanding" question:

A con man has a great idea: he’ll open a bank without investing any capital and lend all the deposits at high interest rates to real estate developers. If the real estate market booms, the loans will be repaid and he’ll make high profits. If the real estate market goes bust, the loans won’t be repaid and the bank will fail—but he will not lose any of his own wealth. How would modern bank regulation frustrate his scheme?

Ah, how indeed...

Also, more on the American fair value war, and thoughts on German regulatory arbitrage.

There seems to be an unusual sort of story surfacing these days - good news. The equity markets are no longer plunging as steeply as they did a few weeks ago;
interbank borrowing rates are improving (the infamous Ted spread is falling, though it's still at levels that would have been unthinkable before last month);
and CDS spreads are coming in slowly but steadily.

Calculated Risk notes that the credit markets are looking healthy - or at least less catastrophically ill. Interbank rates and CDS spreads more or less echo that.
But all is not well - the corporate bond market is in freefall, John Jansen writes; so is the European government bond market, according to the FT today; and Yves Smith pulls up a suggestion that we might be about to enter an emerging-market currency crisis as well.

Remember back in July - "One analyst expressed concern that her firm's model did not capture half of the deal's risk, but that 'it could be structured by cows and we would rate it'"?

Yes, I thought so. Well, the rating agencies were getting slated by Congress yesterday, and among the bits of evidence cited by chairman Henry Waxman was this gem, from Moody's CEO Ray McDaniel at a meeting in September 2007:

The following day, a member of the Moody’s management team commented:
We heard 2 answers yesterday: 1. people lied, and 2. there was an unprecedented sequence of events in the mortgage markets. As for #1, it seems to me that we had blinders on and never questioned the information we were given. … As for #2, it is our job to think of the worst case scenarios and model them. … Combined, these errors make us look either incompetent at credit analysis, or like we sold our soul to the devil for revenue.

Of course, the essential point about all those stories of deals with the devil is that someone generally ends up getting cheated. Faust got a date with Helen of Troy, and Robert Johnson got the ability to play great blues guitar. What did Moody's get?

The UK is probably now in one, and the markets are reacting accordingly. Goldman Sachs hit the headlines with its promise to sack 10% of its employees - over 3000 people - even though it's about the only major bank still to be making profits, and even though its 'fast-burnout' approach to managing its staff means that all it needs to do is cut back hiring and wait for staff numbers to plummet.

But it does lead rather neatly on to this study from 2005 (via Chris Dillow) - people are not more likely to lose their jobs in recessions. (People in general, that is - people at major investment banks, yes.)

The rate of "separation" remains pretty much the same - between 3% and 4% a year in the US (unfortunately the study is US only). Instead, what happens is that the rate of formation of new jobs slows down - people are losing their jobs all the time, recession or not, but during recessions it takes longer to find a new one.

Our mental images of recessions consist of factories closing down and people being thrown out because those are what we remember from histories of the Great Depression, and because that's what makes it on to the news now. But you can't take a memorable picture of a manager in an office looking at a budget and deciding to get by with a team of nine, rather than hiring an extra person - yet, it turns out, that's what causes the unemployment.

It's a problem of generalisation: we tend to form an image of what is happening at a national level, and then assume that everyone's personal experience echoes that. So during the Sixties everyone was a hippie and loved the Beatles (or the Stones). During a war everyone is in the thick of the fighting. During a boom everyone prospers; and during a recession everyone has their job threatened.

But human experience is a lot lumpier than that. For a lot of people, the Sixties were pretty much like the Fifties - bad food, bedsits and skiffle bands. As seen in Band of Brothers, Capt. Richard Winters went through the close-quarter fighting of the Battle of the Bulge as an infantryman and never fired a single shot. During the long boom of 1997-2005, every year one in seven jobs in the UK private sector were destroyed. And, during a recession, your job is no less safe than at any other time.

Unless, as I say, you work for a major investment bank.

Poor macro figures, especially in the UK, and the equity markets are falling fast again.

Also: AIG wants more cash:

AIG may need more than the $122.8 billion now available to the New York-based insurer, Chief Executive Officer Edward Liddy said Oct. 22. The company, which agreed Sept. 16 to turn over majority control to the U.S. in exchange for an $85 billion loan, got access to an additional $37.8 billion this month. AIG's latest balance was revealed yesterday by the New York Federal Reserve, and is up from $82.9 billion a week ago...The financial-products unit that caused most of the firm's losses ``is a big black hole.''

Probably not the best time to start reading Nouriel Roubini. Oh well:

``We've reached a situation of sheer panic,'' Roubini, who predicted the financial crisis in 2006, told a conference of hedge-fund managers in London today. ``There will be massive dumping of assets'' and ``hundreds of hedge funds are going to go bust,'' he said.

...``Systemic risk has become bigger and bigger,'' Roubini said at the Hedge 2008 conference. ``We're seeing the beginning of a run on a big chunk of the hedge funds,'' and ``don't be surprised if policy makers need to close down markets for a week or two in coming days,'' he said.

Sounds disturbingly probable. See, for example, here: Hedge funds worldwide posted record monthly losses in September, according to Eurekahedge Pte., as short sale bans and client redemptions amid the credit crisis hurt funds including Citadel Investment Group Inc.
The Eurekahedge Hedge Fund Index, which tracks 2,431 funds that invest globally, declined 4.7 percent, preliminary figures from the data provider show. The drop is the biggest one-month loss since it began collecting data in 2000 and the index, down 7.9 percent through September, is set for its worst year on record...

Good news, on the other hand: oil is still falling - that means cheaper fuel and so cheaper food. So while we may see a lot more stories like this in the months ahead

Stocks plunge on recession fears

we might see slightly fewer stories like this

Why the price of 'peak oil' is famine.

In the FT today, the story of a startling merger approach: Lloyd Blankfein apparently rang Vikram Pandit last month to trail his coat for a takeover.

[sources] added that the conversation was brief as Mr Pandit rejected the proposal at once.

A deal would have been structured as a Citi takeover of Goldman. In spite of the slide in Citi’s shares, its market value around the time of Mr Blankfein’s call was $108bn, roughly double Goldman’s capitalisation...

If nothing else, it's an example of just how desperate things were getting before the US government announced TARP. But Goldman Sachs? The bank that came out best - or at any rate least worst - from the subprime fiasco, seeking to tie up with Citi and its eleven-figure writedowns? What exactly was Blankfein so worried about?

Barney Frank is incensed to discover that, if you give people a lot of money to spend on whatever they feel like, they will spend it on whatever they feel like:

"I am deeply disappointed that a number of financial institutions are distorting the legislation that Congress passed at the president's request to respond to the credit crisis by making funds available for increased lending," Rep. Barney Frank, a Massachusetts Democrat, said in a statement...

The banks are not exactly cowed into submission.

Take the Winston-Salem, N.C.-based BB&T Corp. (BBT). During a conference call that dealt with the bank’s third-quarter results, Chief Executive Officer John A. Allison IV said the bank “will probably participate” in the bailout program, accepting federal infusions. Allison didn’t say whether the federal money would induce BB&T to boost its lending. But he did say the bank would probably accept the money in order to finance its expansion plans, The Wall Street Journal said.
“We think that there are going to be some acquisition opportunities – either now or in the near future – and this is a relatively inexpensive way to raise capital [to pay the buyout bill],” Allison said during the conference call...Zions Bancorp will also use the money “to take advantage of what we would expect will be some acquisition opportunities, including some very low risk FDIC-assisted transactions in the next several quarters.”