Spain could indicate the direction America is taking

"The Economy"

Suddenly, Spain and Greece are being racked by strikes and huge demonstrations. The public in these countries is, in effect, saying that it has reached its limit: With unemployment at Great Depression levels and with erstwhile middle-class workers reduced to picking through garbage in search of food, austerity has already gone too far.  Paul Krugman - New York Times

What began as an economic storm has blown into a full-scale political crisis. Amid popular discontent and separatist protests, Spain has stumbled towards a crossroads: without decisive action by the government, the post-Franco democratic settlement is at risk. Financial Times

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It is said that every historical phase carries within it the embryo of the next phase to be born in the future. If this is so, then someday we may come to consider the mountain of debt that threatens to crush our present system as an explanatory, broken condom.

One of the paradoxes here is that the enormous robustness of the United States, its size, population, its natural resources, military power and perhaps most of all, its ability to create money out of thin air to pay its debts, probably means that it would not see the total systemic crisis arriving until it was too late to really do anything about it.  

If Americans wonder where the world economic crisis is taking them, a look at what Spain is going through right now might give them some serviceable hints.

Spain is one of the world's oldest nation-states, with a population of 40M and a large economy somewhere in the world's top ten. Thus, unlike Greece, it is large enough and complex enough to serve Americans as a guinea pig.

Spain is infinitely more fragile and vulnerable than the USA, but for that very reason it is able to provide a valuable early warning for Americans... in much the same way that coal miners used to take little canary birds down into the mine to detect odorless, poisonous gases. Long before the burly miners noticed anything, the tiny bird would keel over in a faint from gas inhalation. When the canary passed out, the miners would run for the exit. Spain has just keeled over...

The distress signals coming from the American system are much more subtle than those emanating from Spain.

Here, for example is some socially ominous data:

Lower-paying jobs, with median hourly wages from $7.69 to $13.83, accounted for just 21% of the job losses during the recession. But they've made up about 58% of the job growth from the end of the recession in late 2009 through early 2012. Los Angeles Times

Whether people are actually "entitled" to "to health care, to food, to housing, to you name it" is open for discussion. But, the fact is that if enough of them don't have any plausible way of getting health care, food or housing, finally they are going to turn against any system that denies them these things. And if the number of the disgruntled is sufficient then, to maintain some sort of order and domestic tranquility, the system will have to give them health care, food and housing, whether they want to do so or not.

Probably the reason the American right wing has become so grotesquely strange and wacky of late is that the extremely lucid money financing all the zany craziness is aware that somewhere down the road, if the trends of growing middle class impoverishment continue, some sort of serious redistribution, strongly reminiscent of socialism, is going rear its head.

To me it is clear that the people who are willing to pay $50K to hear Romney talk over rubber chicken are trying to deny the declining middle class and the growing mass of working poor any kind of clarity of thought, if possible. If the Spanish crisis is any harbinger of things to come, it will be the people's stomachs however that will finally do the talking. DS

Er, uh... it seems the world is coming to an end... whatever.

Chart from ClusterStock

We are witnessing (how) a peak in a parabolic finance/asset/stock bubble of world proportions, is going to pan out. I think the entire credit crisis can be looked at from that perspective. We are merely witnessing the relentless unwinding of the biggest financial bubble in history. And, ominously, this particular bubble has grown from the end of WW2 to the present. That is one HUGE economic bubble, and this one envelops the entire world. This is not just a bubble in one country's economy. We are talking about the deleveraging of the greatest economic/finance bubble in history. Once the level of leverage reached 60 to 1, it becomes impossible to stay ahead of the deleveraging, even for central banks. The implications are staggering. Every major economy in the world is involved. The outcomes of deleveraging this monster bubble, represented by the green oval, will be what I term Credit Crisis II. At 60 to 1 leverage, a loss of 1 to 2% wipes out the capital. Christopher Laird

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These days the zeitgeist is rich with "end of the world" scenarios. The one I have quoted above is one of the milder ones: in it the waters are not going to rise or oil peak, in it sentient life on our planet is not directly threatened, we simply have to "deleverage", that is to say, pay back all the money we owe... all of us... simultaneously.

If I understand even a tiny bit of its implications, it would seem that most, if not all, of the wealth of our world is fictitious and that right now we are, every man jack of us, everywhere in the world, more or less in the position of a holder of Confederate currency and bonds on the eve of Appomattox.

Here is another quote from "gold bug", Mr. Laird:

Cross linkages reveal that it is virtually impossible, even with bailouts, to purge the ever growing $500 billion and counting losses of capital from the banking/financial system. The latest numbers being speculated on are the losses will be over $1 trillion (IMF) and $2 trillion or more (Roubini).

Now, maybe $2 trillion doesn't sound like a lot compared to the entire world economy. The trouble is, that capital is leveraged anywhere from 10 to 50 times by the financial system. Fannie and Freddie have 60 to 1 leverage.

Losing $2 trillion of capital will totally wipe out the entire world financial system for a decade because of the leverage at 60 to 1. Basically, unless those losses can be purged in some way, it has to be earned back over a period of years/decades. That essentially cripples the entire world financial system.

If all this is so and it plays out as Laird prophesies, it will mean levels of universal, simultaneous social unrest such as has never been seen in all history and will require massive government intervention and the nationalization of practically everything to keep people eating and maintain the basic infrastructure of civilized life... socialism, you might call it.. the question will be, if it is going to be coordinated internationally by the G-20, the EU, IMF and the WTO or will it be "national socialism", with all the baggage those two words carry. Whatever the remedies employed, we would be looking at a situation every bit as game changing, more so probably, than the collapse of the Soviet Union.

Raptured or ruptured?

Experience tells us that it probably wont be as bad as Laird paints, although experience is an all too faulty guide to totally new situations.

But, until the sky finally falls, the sheer proliferation of "Chicken Little" wannabes like Christopher Laird seems significant in itself... The ice is melting, the cows are farting, the oil is peaking, Jesus is in the green room, Obama is a communist, take your pick.

Me, while waiting for civilization to collapse, for the trumpets to sound, I think I'm going to chill out with a Spanish summer classic called "tinto de verano", which is basically one to one chilled red wine with iced Seven-Up.

Very nice stuff on a sweltering summer night, taken in good company, watching the world go by, sitting in a sidewalk cafe. DS

September Song

9-11 - El Roto

The Obama administration has proposed regulatory changes, but even their backers say they face a difficult road in Congress. For now, banks still sell and trade unregulated derivatives, despite their role in last fall’s chaos. Radical changes like pay caps or restrictions on bank size face overwhelming resistance. Even minor changes, like requiring banks to disclose more about the derivatives they own, are far from certain. New York Times

(H)ealth care reform, while an overdue imperative, still is overshadowed in existential urgency by the legacies of the two devastating cataclysms of the Bush years, 9/11 and 9/15, both of whose anniversaries we now mark. The crucial matters left unresolved in the wake of New York’s two demolished capitalist icons, the World Trade Center and Lehman Brothers, are most likely to determine both this president’s and our country’s fate in the next few years. Both have been left to smolder in the silly summer of ’09. Frank Rich - New York Times

(T)here is still a mammoth, gaping hole at Ground Zero. Bureaucratic gridlock, partisan bickering, old-fashioned greed and failed leadership have all been blended together perfectly in one big pot to create a colossal, historic stew of inaction. Paul Rieckhoff - Huffington Post

President Obama made clear during last year's presidential campaign that Afghanistan would be his war if he was elected. Since being sworn in, true to his word, he has made the Afghan war a national security imperative because that's where al Qaeda is. At least, that's where Mr. Obama thinks it is. But nothing is less certain. Arnaud de Borchgrave - Washington Times

He has decided to expand the current system, not fix it. David Brooks - NYT

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I have have held off commenting on the president's health care speech to congress in order to read the opinions of better qualified analysts: the general opinion seems to be that it was a very fine speech, but that no one is really that sure what he said. By now it seems pretty clear that whatever comes out of it this process will resemble what other developed western countries consider universal health coverage to the degree that a spavined camel resembles a racehorse.

As important as health care is (and what in a "serious" country could be more important?) the real story today is paralysis and this paralysis is, if nothing else, bipartisan. And it is bipartisan because it is systemic, something that has been brewing since the end of the Second World War and which now is coming to a head. Neither party has either the ideas nor the power to fix it and I am of the opinion that even if they fell into each other's arms and took a blood oath of mutual fealty; that even together, they wouldn't have either the ideas nor the power to fix it.

That is the reason why I was quite lukewarm about a Democrat -- any Democrat -- taking the White House at this moment. I have a very strong feeling that this president -- any president -- is set to preside over what many will see as the collapse of America's "empire" and whichever party is in the White House when this happens will take the blame for it... I would have preferred -- call me sentimental -- that the Republicans had taken the historic hit... I was hoping (not really believing) that the Democrats would be the ones to try to put Humpty Dumpty together again... it was not to be.

What will this collapse of "America's empire" look like?

It will look very similar to the collapse of Spain's empire and will feature some of the same players.

South America is going south... again.

The United States is so deeply entangled in and obsessed by the Middle East and Af-Pak that it has taken its eyes and energies off its proverbial back yard, Latin America. Because of its dependence on oil and the power of the Israel lobby it will find it impossible to refocus in time. There are simply not enough resources to control the Middle East and Southwest Asia and project power in South America at the same time. As professor Andrew Bacevich puts it, "we haven't got the money and we haven't got the troops".

Latin America gained its "first" independence at the beginning of the 19th century, when a prostrate Spain, exhausted from the Napoleonic wars, relaxed its grip. And now with a distracted and overburdened America relaxing its grip, Latin America is poised to gain its "second" and perhaps definitive independence.

Latin America and the United States have much in common, it is the proportions of the components that differ the most. All of us are great producers of raw materials and commodities, where not too much is manufactured (anymore). To understand the political mix of most of Latin America excluding lily white Argentina, Uruguay and Chile, known as the "Southern Cone," the USA will serve as a good model.

Imagine that instead of 12% and 1.5% of the population respectively, African and Native- Americans represented in varying proportions, 70 to 80+ percentage of the US population. Imagine that the distribution of wealth was similar to what it is right now. Here is how the sociology department of the University of Southern California, Santa Cruz describes it:

In the United States, wealth is highly concentrated in a relatively few hands. As of 2004, the top 1% of households (the upper class) owned 34.3% of all privately held wealth, and the next 19% (the managerial, professional, and small business stratum) had 50.3%, which means that just 20% of the people owned a remarkable 85%, leaving only 15% of the wealth for the bottom 80% (wage and salary workers). In terms of financial wealth (total net worth minus the value of one's home), the top 1% of households had an even greater share: 42.2%.

Now imagine that all the people with the money were of European descent and all the people without money were of color (not too difficult, is it?) now imagine that a series of political figures that combined the qualities of Doctor Martin Luther King and Sitting Bull appeared... That is what is happening in Latin America right now, while the United States faces the wars of Iraq and Afghanistan and quite probably Iran and has no marines left over to send.

President Barack Obama -- it could have (sigh) been McCain -- will have the dubious privilege of sitting by helplessly while the United States of America gets ridden out of Latin America on a rail. DS

Change... you mean spare change?

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The USA has gone broke.

From personal experience, I know that one of the hardest realizations that people who have always had quite a lot of money can have, is to discover that they are flat broke.

I don't say "wake up" to discover, because waking up is instantaneous and the discovery that one's world no longer exists is a slow one. Sometimes it never fully sinks in.

Denial is a wide river that floods the valleys of the nouveau pauvre.

Martin Wolf, the chief economist of the Financial Times outlines the situation:

"The risks are indeed high and the ability of the authorities to deal with them more limited than most people hope. This is not to suggest that there are no ways out. Unfortunately, they are poisonous ones. In the last resort, governments resolve financial crises. This is an iron law. Rescues can occur via overt government assumption of bad debt, inflation, or both. Japan chose the first, much to the distaste of its ministry of finance. But Japan is a creditor country whose savers have complete confidence in the solvency of their government. The US, however, is a debtor. It must keep the trust of foreigners. Should it fail to do so, the inflationary solution becomes probable. This is quite enough to explain why gold costs $920 an ounce."

David Ignatius elaborates in the Washington Post

"The public, fortunately, doesn't understand how bad the situation is. If it did, we might have a real panic on our hands.(...) Do you want to know who is bailing out America's biggest banks and financial institutions from the consequences of their folly -- by acting as the lender of last resort and controller of the system? Why, it's the sovereign wealth funds, owned by such nations as China and the Persian Gulf oil producers. The new titans are coming to the rescue, if that's the right word for their mortgage on America's future."

I disagree with David Ignatius when he says, "The public, fortunately, doesn't understand how bad the situation is." I think that deep down, the public does understand only too well and a great many of them are in denial.

I believe this explains the Barack Obama phenomenon, where a hysterical, nationwide personality cult has grown up mushroom style around a person who has never really done anything: Jerzy Kosinski's fantasy made flesh, a blank sheet, who creates rhythmic ecstasy in his followers with words like "hope" and "change".

Nobody has much of an idea what he might stand for. When Obama supporter Susan Sarandon was asked about this she replied, “I can’t wait to see”.

We are speaking of denial: lets review the steps of the classic, Kübler-Ross "grief cycle".

1. Shock stage: Initial paralysis at hearing the bad news.
2. Denial stage: Trying to avoid the inevitable.
3. Anger stage: Frustrated outpouring of bottled-up emotion.
4. Bargaining stage: Seeking in vain for a way out.
5. Depression stage: Final realization of the inevitable.
6. Testing stage: Seeking realistic solutions.
7. Acceptance stage: Finally finding the way forward.

I think it is obvious that the eight long years of the Bush Restoration have been pure Kübler-Ross. Different parts of the American electorate are at different places on the cycle.

Some of us went directly from "shock" to "anger". Others, the Obamites, are stuck at step two with maybe a foot in four; those disposed to vote for either Hillary or McCain are either at step five or are dabbling in six or seven.

I think these months are going to go down in history as one of the most bizarre chapters of our amazing and original national experiment. DS

When backing Barack feels like joining a cult - Boston Herald
Abstract: I’m nervous because too many Obama-philes sound like Moonies, or Hare Krishnas, or the Hale-Bopp-Is-Coming-To-Get-Me nuts. These true believers “Obama-ize” everything. They speak Obama-ese. Knit for Obama. Run for Obama. Gamble - Hold ’Em Barack! - for Obama. They make Obama cakes, underwear, jewelry. They send Valentine cards reading, “I want to Barack your world!” At campaign rallies people scream, cry, even faint as Obama calmly calls for the EMTs. When supporters pant en masse, “I love you!” (like The Beatles, circa 1964), Barack says, “I love you back” with that deliciously charming, almost cocky smile. Oh - I’m nervous because it’s all gone to his head and he hasn’t even won yet. I’m nervous because it’s gone to a lot of other people’s heads as well. Maryland Congressman Elijah Cummings introduced Obama last week in Baltimore and said, “This is not a campaign for president of the United States, this is a movement to change the world.” “He walks into a room and you want to follow him somewhere, anywhere,” says George Clooney. “I’ll do whatever he says to do,” says actress Halle Berry. “I’ll collect paper cups off the ground to make his pathway clear.” I’m nervous because nobody’s quite sure what Obama stands for, even his supporters. (“I can’t wait to see,” said actress/activist Susan Sarandon, declaring full support nonetheless). I’m nervous because even his biggest fans can’t name Obama’s accomplishments, including Texas state Sen. Kirk Watson, an Obama-man who humiliated himself when MSNBC’s Chris Matthews asked him about five times to name something, anything, Obama’s done. Watson hemmed. Watson hawed. Watson gave up. I’m nervous because John McCain says Obama’s is “an eloquent but empty call for change” and in the wee, wee hours, a nagging voice whispers, suppose McCain’s right, too? Then what? READ IT ALL

What Marx called "contradictions" others call a belly laugh

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This is what it really is all about. The Chinese have all our debt and all our cash. They are about to spend the money they have earned and call in the loans they have made and either they can buy what they want and can get paid in full or the system will break.

I think future Chinese historians will call this "Capitalism-Leninism", and I think Vladimir Ilyich must be rolling in his mausoleum with laughter (when the tourists aren't looking of course). DS

Niall Ferguson: Small stakes for Bush-Brown-Sarko - Los Angeles Times
Abstract: In Kissinger's heyday, the president of the United States really was a potentate. Like his opposite number, the general secretary of the Communist Party of the Soviet Union, he had the power to kill tens of millions of people at the touch of a button. Even the British prime minister had real power in the 1980s: The power to send a fleet from Portsmouth to the other end of the Earth to expel invaders from the Falkland Islands. The leaders of the last generation had real economic power as well. Just over 25 years ago, the president of France had the power to nationalize the country's largest banks. It's not that today's politicians are inferior to their predecessors. It's their predicament that's changed. Not everyone sees this. Not everyone wants to see it. The news media, in particular, depend for their very existence on the notion that politicians are powerful. The politicians need the media to publicize their activities. No one understands this better than the new French president, Nicolas Sarkozy, whose whole life has become a performance for the benefit of Paris Match. We are told that Sarkozy is pondering a fundamental realignment of French foreign policy. Perhaps, after more than 40 years of semi-detachment, he will take France back into NATO's integrated command structure. Perhaps, after more than 50 years of attachment, he will loosen the ties between France and Germany.(...) From the mid-17th century until the mid-20th, relations between Britain and France truly were of vital importance to the stability of the world. Had it not been for Anglo-French conflict, the U.S. might have been suffocated at birth. Had it not been for Anglo-French cooperation, the German Reich might have conquered Europe. France, Britain, America: They each have had their era of hegemony. Now, however, they all belong to the club of developed debtors, with combined current account deficits of $970 billion last year. Other members of this club are Australia, Greece, Iceland, Ireland, Italy, New Zealand, Portugal and Spain. Apart from Iceland, it reads like a list of ex-empires, with the former members of the British Empire (energy-rich Canada excepted) in the lead. Collectively, the developed debtors had to borrow about $1.3 trillion last year. On the other side of this great global equation is the club of emerging exporters. According to the International Monetary Fund, more than 40% of the developed debtors' funding requirement last year was met by China, Russia and the Middle East. The problem for the deficit countries is essentially that their people think the world owes them a living. Their politicians pander to this assumption by making a series of more or less incompatible promises: that expenditure on healthcare and education will always go up; that direct taxation will never go up; and that the assets against which voters borrow will never go down. The only way to fulfill these promises is to pump out ever more printed paper: bank notes, bills, bonds, stocks and the rest. The emerging exporters buy these. The net result must be a creeping transfer of financial ownership from West to East. This process is about to enter a new phase as China establishes its own sovereign wealth fund to join those operated by the likes of Kuwait, Abu Dhabi and Singapore. According to Morgan Stanley, these funds manage about $2.6 trillion. In 15 years, their assets could reach $27 trillion, giving them control of nearly 10% of total global financial assets. So the big question is not whether Sarkozy or Brown will get along better with Bush, but what China's sovereign wealth fund will buy when it embarks on its first investment spree. READ IT ALL

The conundrum of America’s economy - Economist

"The market was so leveraged, and the instruments so complicated, that no one seemed understand what would happen if it all began to unwind." - Economist

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That is the key phrase, everything.... and I mean EVERYTHING, revolves around things that nobody understands. DS

The conundrum of America’s economy - Economist
Abstract: There are plenty of ominous signs. The housing market, long the mainstay of America’s economic boom, is sagging. Defaults in the subprime lending market grow ever more worrisome. The core inflation rate, which excludes food and energy, is not exactly subdued: consumer prices were up by 2.2% in May from a year ago. Add in the tepid GDP growth and the mix is making consumers nervous.(...) As vexing a concern is the effect that a slowing housing market will have on the mountain of debt and debt-related instruments that were issued to finance the boom. The most frightening aspect of the problems at two hedge funds run by Bear Stearns, both heavily exposed to the subprime-mortgage market, was not that a big bank had been plunging into risky assets; it was the revelation of how little anyone knew about the risks involved. The market was so leveraged, and the instruments so complicated, that no one seemed understand what would happen if it all began to unwind. READ IT ALL

Subprime crisis: from sushi to meatloaf

"The sub-prime carnage is now front page news on every possible media; soon enough it may be even become cover story on People magazine as even Britney Spears will soon be asking about it." Nouriel Roubini

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If you are too young to to have clear memories of the cold war it will be impossible for you to imagine how all embracing it was. Bush and Cheney have been trying to "recreate" the cold war's tension in their "Great War On Terrorism" (GWOT), but they don't even come close. It went from horizon to horizon. Like living in the same room with a dangerous animal... for both sides.

So, when the Soviet Union went down there was a huge sigh of relief. Instead of thinking that if such a huge and powerful system could collapse, any system could collapse, that collapse was in the nature of huge and powerful systems, there was a sense of "victory" accompanied by euphoria.

To give you an idea of the period, in 1992, sober and reputable Francis Fukuyama published, "The End of History and the Last Man", where he wrote, "What we may be witnessing is not just the end of the Cold War, or the passing of a particular period of post-war history, but the end of history as such: that is, the end point of mankind's ideological evolution and the universalization of Western liberal democracy as the final form of human government." In real life people only say things like that when they sniff cocaine.

Meanwhile in the United States, during the 80's, while the Soviet Union was preparing to collapse, amazing things were happening in the world of finance. The definitions of money and value were revolutionized. The symbol of this revolution was the "Junk Bond" and its Lenin was Michael Milken. A new way of looking at money and the ways to use it was born. The film that symbolized this revolution was Oliver Stone's, "Wall Street".

Simultaneously, the power of computers began its geometric increase that has become so familiar to us over twenty years later. This increase in computer power made it possible to calculate financial risk in a much more sophisticated way. So everything was in place: euphoria and new ways of creating value seemingly out of thin air.

The result was that huge amounts of money appeared in the newly deregulated world and began to move at a dizzying speed. It became easier and easier to borrow money, in increasing quantities, at lower rates and for longer times. People who had heretofore worked hard to make ends meet, to own their own home and to send their kids to school, began to feel "rich". In fact the only thing they really owned was the house they lived in, whose theoretical value was increasing daily and against whose "paper" value they contracted real debts. It looks as if the party may be over and as in the "Crash of 29" creditors may panic and call in their loans... with devastating and unpredictable knock on effects.

Politically this will mean that a lot of people, with a good education and brilliant prospects, who thought they were rich will suddenly feel that they are poor, they will make a lightning fast voyage from sushi to meatloaf. Normally people take too much credit for their successes and often blame themselves too much for their failures. It takes a very wise man or woman to look in the mirror and to see a fool and then to shrug this vision off.

Many will feel betrayed by the very system they thought they understood and knew how to game. This declassing and sudden insecurity is often the origin of much bitterness and political agitation... normally it offers opportunities for the far-right. The left must be prepared to offer solid analysis and strong support, both moral and material to the victims of what appears to be a severe fall to earth for the "nouveau pauvre"... or risk being swept away by their rage. DS

Leap of faith? How a fiasco of easy home loans has tripped up America - Financial Times
Abstract: Victoria Wagner, credit analyst at Standard & Poor's, the ratings agency, says some subprime mortgage lenders dramatically lowered their standards amid "the so-called democratisation of credit", granting loans that contained many levels of default risk. These included a lack of income documentation and no downpayment. Ms Wagner calls this kind of risky lending "unprecedented". Now buyers (...) are falling behind or defaulting, as interest rates that started relatively low go higher and home prices in some parts of the US stop rising. So far the problem has remained largely contained within the subprime sector. It may stay there but concern is growing that difficulties could spread throughout the housing market and then, perhaps, the wider US economy. The first way the subprime decline could impact on the housing market is if a flood of foreclosed homes came up for sale and pushed down prices in areas where the supply of homes is already high because demand has dropped off. "The big question is, how quickly will housing prices adjust lower as delinquency rates rise?" says Richard Gilhooly, senior fixed income strategist at BNP Paribas. Analysts at Lehman Brothers project that mortgage defaults could reach $225bn during 2007 and 2008 and perhaps go as high as $300bn. "The risk that they impact the broad housing market and begin to weigh upon prime borrowers is very real," they say. (...) Delinquency rates for subprime adjustable-rate mortgages, the riskiest kind, hit 14.4 per cent. The numbers could get much worse because many who bought homes face "resets" in their mortgage payments; the low rates that tempted them in will revert to higher, market-determined rates. Lehman estimates that more than $900bn of mortgages will hit a reset in the next two years.(...) Still, it is far from certain that the subprime ailments will infect the broader housing market. Steven Wieting, economist at Citigroup, suggests that the problems are likely to affect financial institutions and their investors - as indeed they already have - more than consumer sentiment and the economy at large. But if the marginal buyer - someone able to buy a house only if conditions are right - is knocked back, that could at best slow a recovery in the housing market. At worst, it could lead to recession. David Rosenberg, North American economist at Merrill Lynch and a perennial bear, says: "This housing downturn is far from over and the full impact across the economy has notbeen felt . . . As with most bubbles, this one started with loosening credit guidelines, excessive price appreciation, classic performance-chasing [and] speculative fervour, and nowends in lawsuits." Whatever the impact of the subprime fiasco on the wider economy, it is already deeply painful for many Americans.(...) One way the subprime shake-out could lead to systemic problems across the capital markets is if investors who had little idea they might own such mortgages suddenly discovered that they did. These holdings would probably be through complex structures called collateralised debt obligations - packages of asset-backed bonds. Investors in CDOs - say, pension funds in Europe or Japan - may be inclined to act more quickly when they detect subprime exposure than would a group that was already well aware of the risks in their CDOs. One problem is a lack of information. CDOs are rarely traded and difficult to value. As a result, buyers are often reliant on credit ratings to know when to sell. However, credit ratings regularly lag market prices, meaning that losses can be greater than necessary when the credit rating downgrade finally comes. Josh Rosner, managing director at Graham Fisher & Co, an investment research firm, says: "Because many buyers of CDOs can only hold investment-grade assets, they may continue to hold deteriorating and increasingly illiquid assets as long as credit ratings have not been downgraded." This means that when these investors eventually sell, they may also be forced to accept large losses in a fast-moving market. The heavier the losses, the less likely investors are to want to return, a classic case of "risk aversion". Such risk aversion is already clear among the commercial and investment banks that had provided funding to subprime mortgage lenders. Those banks cut off credit lines to New Century Financial and Accredited Home Lenders, pushing both close to bankruptcy filings. With equity investors in subprime (and even prime) mortgage lenders offloading their shares - "then asking questions later", according to David Hendler, an analyst at CreditSights - some industry executives say the selling appears irrational and panic-driven, another signal of growing risk aversion. Angelo Mozilo, chief executive of Countrywide Financial, a leading mortgage lender, said on television this week that investors were dumping shares of home loan groups with little regard for a lender's actual fiscal health. "This is now becoming a liquidity crisis," he declared, adding: "It's going to get uglier." The ugliness could spread if lending standards to companies, hedge funds, private equity groups and others come under review.A broad tightening of credit requirements by lenders could have ramifications throughout the markets.(...) As well as affecting US mortgage borrowers, a credit crunch could make hedge funds that use large amounts of borrowed money cut their debt, perhaps selling assets en masse in order to do so. If that led prices to fall, the effect could feed on itself as others scrambled to limit losses. Companies, particularly weak ones, could find it hard to refinance existing debt - potentially leading to a sharply higher incidence of failure, which would further rock credit markets. The worry is that such a wave of "deleveraging" could swell, with few investors both willing and able to start buying and halt the decline in asset prices. "There is an elevated risk of a financial market crisis during the next two months," says T.J. Marta, fixed-income strategist at RBC Capital Markets. "There is a concern that as liquidity tightens, the wheels could fall off." Signs exist that investors have adjusted leverage levels in recent weeks. The yen is tending to strengthen whenever other markets show weakness, an indication that "carry trade" investors - who borrow in yen at low interest rates to finance purchases elsewhere - are at best nervous about their exposure. Steven Wieting, economist at Citigroup, points out that banks have tightened lending standards, at least for mortgages, according to the latest quarterly survey by the Federal Reserve. But he notes that the shift followed a period of easy loan availability, which continued even after mortgage delinquencies began to rise. There seem few signs of investors leaving the debt markets. The huge quantities of capital looking for a home, which have powered the ability of private equity to announce ever larger leveraged buy-outs, have not dried up. Still, analysts worry that the subprime meltdown could be the catalyst that brings the era of easy access to cheap debt to a close.(...) One area where the impact of the subprime mortgage shake-out is already clear is the equity market. Each day on Wall Street seems to bring fresh news of specialist lenders collapsing and fears about possible problems elsewhere, such as at the investment banks that have big subprime holdings. The result is dizzying volatility. Financial stocks have been down since worries over the subprime sector began in earnest in mid-February. The big equity sell-off of February 27, though in part the result of concerns about a possible economic slowdown in China, also demonstrated subprime anxieties in the US. The financial sector took among the biggest tumbles that day, with some banks down by as much as 8 per cent. The power of fear has remained visible this week. Goldman Sachs shares failed to budge even after the bank reported another quarter of stunning earnings on Tuesday - and Goldman does not even have much of a subprime business. Lehman Brothers, which does, saw its shares initially plunge 5 per cent when it reported record results on Wednesday but suggested that it was seeing some impact from problems in the subprime market.(...) "The current battle involving Wall Street firms' subprime exposure and investor perception of contagion risk rages on without any end in sight," says Michael Hecht, a Bank of America analyst. "This is occurring in spite of positive commentary from both Lehman and Goldman Sachs that the sky is not falling." One fear surrounding the investment banks is that while subprime might not be that big a problem on its own, a flight from risk could mean that other profitable Wall Street businesses - such as the packaging of prime mortgages, credit card loans, student loans and other liabilities into securities - would dry up. David Viniar, Goldman's chief financial officer, says such securitisations have been a key part of Wall Street's profit growth. But he adds that he does not think the current subprime problems will derail that growth. "The concept of securitisation, which I think of as the ability to [divide] up credit risk so you can put it in the hands of people who want it as opposed to people taking parts of risk they don't want, has been an important development over the last several years," he says. "It has been good for all of the capital markets - and I still think it will be an important financial tool that will be used, although I think the subprime market will be smaller." The wild ride played out in the larger market as well on Wednesday, as the two main schools of thought (subprime is a disaster versus subprime is no big deal) fought it out, leading to big swings in the main indices. One of the biggest fears among market watchers now is that the worriers will win, whether based on fact or fear, and push stock prices beneath levels that have held even in the face of recent heavy selling pressure. For the Dow Jones industrial average the recent bottom being watched by the market is 12,050, which was hit on March 5. If that level is breached, the theory goes, the rout could quickly turn vicious, with selling begetting more selling and reason going by the wayside. READ IT ALL