Financial and Credit Markets Seizure

By: Mike_Shedlock

Distrust between banks is growing. They are all wondering "who's next". Fear of an AIG implosion is on everyone's mind. But what to do about it? See The Crime In Buying AIG Time for some non-solutions that will put Life insurance policies, retirement annuities, and the like at risk just so AIG can make good on a bunch of derivative bets gone bad.

LIBOR Soars Amid Global Credit Seizure

Bloomberg is reporting Money-Market Rates Double Amid Global Credit Seizure .
The cost of borrowing in dollars overnight more than doubled to the highest since 2001 as the collapse of Lehman Brothers Holdings Inc. and credit downgrades of American International Group Inc. led banks to hoard cash.

The London interbank offered rate, or Libor, that financial institutions charge each other to borrow soared 3.33 percentage points to 6.44 percent today, its biggest jump in at least seven years, according to the British Bankers' Association. The rate was as low as 2.07 percent in June.

Banks are driving up short-term lending rates on concern that AIG, the biggest U.S. insurer, will follow Lehman into bankruptcy and leave financial institutions with losses on $441 billion of credit derivatives. Central banks around the world pumped more than $210 billion into the financial system as they sought to alleviate the credit-market seizure.

The yield on the 10-year Treasury note fell to the lowest level in five years as investors sought the safety of government debt. The cost of buying protection against default by Wall Street banks soared, as credit-default swaps on Morgan Stanley, Goldman Sachs Group Inc. and Citigroup Inc. all traded at records. Average yields on overnight U.S. commercial paper backed by assets such as credit cards and car loans jumped 54 basis points to 3.45 percent, the highest since March.

"I have never seen anything remotely like this. The money market was typically the one thing that always worked," said Luca Jellinek, head of interest-rate strategy in London at Royal Bank of Scotland Group Plc. "It's the cardiovascular system of the financial body. When this happens, it's like a heart attack."

Commercial Mortgage Bond Yields Soar to Record

Default risk is rising across the board. Inquiring minds are considering Commercial Mortgage Bond Yields Over Benchmarks Soar to Record .
Yields on commercial mortgage bonds relative to benchmark rates rose to record highs on concern that Lehman Brothers Holdings Inc. may dump its real estate on the market after filing for bankruptcy.

Spreads on AAA rated commercial mortgage-backed debt rose 41.25 basis points to 318.81 basis points more than benchmark swap rates as of yesterday's close, Bank of America Corp. data show. The previous record of 312.35 basis points was set March 10, the week before the Federal Reserve arranged JPMorgan Chase & Co.'s purchase of Bear Stearns Cos. A basis point is 0.01 percentage point.

The cost to insure against default on BBB- commercial mortgage-backed securities, the lowest investment-grade rating, soared 131 basis points to 2,437 basis points. That means it costs about $2.44 million to insure $10 million of the underlying securities.

New York-based Lehman was forced into bankruptcy after Bank of America and Barclays Plc backed away from bidding for the investment bank when the U.S. Treasury wouldn't provide a backstop on losses.

AIG Private Bailout Options Dim

Private equity and banks are afraid to provide capital to AIG for two reasons.

1) They are so preoccupied with their own risks they do not want to take on anyone else's risk.
2) They would not take on more risk even if they could for fear of getting stuck with "The Old Maid".

CNBC is reporting US Mulls AIG Bailout as Options Grow Dim

With a private sector solution looking increasingly unlikely, the government is once again considering providing American International Group with some sort of financial support, according to investment banking sources involved in the meeting.

The New York Federal Reserve is currently meeting to discuss the fate of the troubled insurance giant, these people say.

Sources close to the situation said a private sector solution to AIG's situation is definitively dead.

The Fed declined to comment Tuesday on report that the government is in discussions on the situation of troubled insurer AIG.

However, an unnamed Treasury official told CNBC that the comments of Treasury Sectary Hank Paulson on Monday still stand.

Six Sigma Events Happening Daily

That gold is down in the face of this mess is probably a good indication of the massive leverage still in play. Fundamentally gold should be soaring. However, the unwinding of leverage is forcing good assets to be sold with the bad.

Silver, an industrial commodity is in worse shape than gold. If silver does not hold the 10+- area look for another sharp drop down to support at 8+-.

Six sigma events are happening daily now (or appear to be). The reality is there was an upfront huge mispricing of the risk that such events could occur. This is what happens when fractional reserve lending allows financial institutions to leverage 30-1 or greater, the Fed fuels the fire with low interest rates, and the Fed praises derivatives even though derivatives usage is many multiple times greater than the entire world's economy.

It is increasingly clear that Greenspan's legacy will be that he aided and abetted this global financial collapse. The only solution is to abolish the Fed and fractional reserve lending, and let the market, not Fed bureaucrats or politicians set interest rates.

By Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

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Mike Shedlock / Mish is a registered investment advisor representative for SitkaPacific Capital Management . Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction.

Visit Sitka Pacific's Account Management Page to learn more about wealth management and capital preservation strategies of Sitka Pacific.

I do weekly podcasts every Thursday on HoweStreet and a brief 7 minute segment on Saturday on CKNW AM 980 in Vancouver.

When not writing about stocks or the economy I spends a great deal of time on photography and in the garden. I have over 80 magazine and book cover credits. Some of my Wisconsin and gardening images can be seen at MichaelShedlock.com .

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