After the price action seen lately, a decline of 162 points in the Dow hardly seems worth a mention. BUT the decline was lead by the industrials and basic materials sectors, NOT by financials. This suggests broader market concerns about the underlying weakness of the US economy. Money markets remain frozen despite the massive injections of cash by central banks around the world. Trading remains hazardous in these treacherous markets - one must be nimble, not get married to a position and become a news junkie.

Today’s Market Moving Stories

• Dow Futures are up this morning on news that Warren Buffet’s Berkshire Hathaway has decided to buy 9% of Goldman Sachs! They get a 10% dividend guaranteed and warrants to buy $5bn more of stock at $115 exercisable within 5 years. Looks a sweet deal, for Warren. What the world’s banking system needs is more capital NOT more liquidity.
• UK housing sales fell to 62K in August, the lowest rate since record began in 1959!
• French bank Societe Generale (who have been spot on in this crisis thus far courtesy of their equity guru Albert Edwards) are advising clients to dump shares of banks exposed to the Far East and warning of a major slowdown in China.
• The SEC and New York State are looking now to try and regulate the CDS (credit default swap) market. This is a $64 trillion unregulated iceberg at the moment!

Hank and Ben Go To Washington. Uncle Sam Picks Up the TAB

Ben Bernanke wants to throw a lot more of taxpayer’s money into the laps of Comrade Hank’s friends in Wall St. He said that there are two prices that the TAB (toxic assets bailout) fund can pay for all this junk that Wall St created. One is the fire sale price, i.e. what they’d probably get today in the market. The second is the “hold to maturity” price.

What’s a hold to maturity price? Well suppose a bank has one of these toxic bonds on their books. Originally they were valuing it at 100 cents in the dollar in their books. This may now be worth say 60 or 40 or even 5 cents in the dollar. The extent of the loss can only be gauged when you go to sell it, but there is NO market for this garbage. Ben’s proposal is that IF you hold this paper to maturity, IF the bank doesn’t go bust, IF the collateral (house prices) doesn’t deteriorate further and IF default rates don’t rise, then these bonds would be worth a lot closer to 100% of their face value than their current fire sale price. Who is going to pay for this premium? The taxpayer of course.

If you pay over the odds for this junk then it will sit on the books of the new bailout fund for years. Who will buy them if you have overpaid for them? How will the market find a clearing price if someone is artificially inflating the true market price? And maybe of course the true prices of these “assets” are below even the fire sale prices, maybe they are worthless. Ben’s proposal would only prolong the agony. We were led to believe he was a student and expert of the Japanese deflationary experience and that the Fed had studied the Nordic banking crisis. Well they may have studied but their final paper and conclusions gets an F from me. One just hopes some Democratic Senator can shoot this plan down.

Outlook for the Dollar

The USD has started to weaken. Investors fear how Washington’s bail-out plan will affect America’s fiscal position, whether foreign investors will continue to fund US deficits and whether the Fed will have to start printing more money, which is of course inflationary.

At $700bn the Treasury’s plan would cost 5% of GDP. The US fiscal deficit next year could hit $1trn plus (7% of GDP) if Congress approves the bail-out.

Historically, financial bail outs that cost more than 5% of GDP have been accompanied by sharp exchange rate weakness. But at least America’s debt to GDP ratios are currently at average levels within the G7 economies, and the greenback remains the world’s reserve currency.

The key things I’ll be watching going forward will be:

• the degree to which foreigners are willing to sponsor upcoming Treasury bond auctions,
• the monthly US TIC data (which shows overseas inflows / outflow into American equities & bonds),
• foreign central banks balance sheet data.

Data. As if it matters anymore!

The key German IFO sentiment survey was released this morning at 09.00. This is one of only a handful of indicators that the ECB actually takes any note of. A print of 94.1 was expected, but came out a much weaker 92.9.

From the US at 15.00 we get existing homes sales (consensus 4.9m units).

Equities.

• Hapless Bradford & Bingley received some good news overnight in that they have been partially let off the hook with regard a liability to buy £1.75bn of mortgages from GMAC. The compromise deal is STILL onerous and involves them having to buy about £500million. The question remains where will they get the money from? They were also downgraded again last night to levels which trigger expensive covenants on existing bonds.
• France’s EDF have finally made a bid for British Energy and this time it looks like it will succeed at 774p.
• Bank of Ireland has launched a series of cover bonds totalling €15bn, secured by pools of UK mortgage assets. These should be eligible for REPO for cash with the ECB, which will help their Balance Sheet.

And finally. The Nigerian spoof email scam comes to Washington

From: Minister of the Treasury Paulson
Subject: REQUEST FOR URGENT CONFIDENTIAL BUSINESS RELATIONSHIP

Dear American:

I need to ask you to support an urgent secret business relationship with a transfer of funds of great magnitude.

I am Ministry of the Treasury of the Republic of America. My country has had crisis that has caused the need for large transfer of funds of 800 billion dollars US. If you would assist me in this transfer, it would be most profitable to you.

I am working with Mr. Phil Gram, lobbyist for UBS, who will be my replacement as Ministry of the Treasury in January. As a Senator, you may know him as the leader of the American banking deregulation movement in the 1990s. This transaction is 100% safe.

This is a matter of great urgency. We need a blank check. We need the funds as quickly as possible. We cannot directly transfer these funds in the names of our close friends because we are constantly under surveillance. My family lawyer advised me that I should look for a reliable and trustworthy person who will act as a next of kin so the funds can be transferred.

Please reply with all of your bank account, IRA and college fund account numbers and those of your children and grandchildren to wallstreetbailout@treasury.gov so that we may transfer your commission for this transaction. After I receive that information, I will respond with detailed information about safeguards that will be used to protect the funds.

Yours Faithfully,
Minister of Treasury,
Hank Paulson