To cure greed disease, apply more money

STOP the insanity. So pleaded leading banking analyst Glenn Schorr, of UBS, in an extraordinary email to clients on Wednesday.

The plea pretty well summed up the mood from Wall Street to Main Street in the most harrowing week for the US financial system in living memory.

Since Monday, a top investment bank had collapsed in the biggest bankruptcy in history, another had been taken over in case it followed and the remaining two had been placed on the endangered list.

The US Government had nationalised the world's largest insurer, the sharemarket had gone into free-fall and credit markets had been paralysed.

That was just until Wednesday.

By week's end the world's central banks, led by the US Federal Reserve, had put up $US180 billion ($A226 billion) to provide liquidity to the fing system, short-selling bans had been imposed on markets to avoid the collapse of other financial institutions, and the Bush Administration was establishing an entity to hold the hundreds of billions in risky assets it was acquiring in bail-outs.

Final losses were now being estimated in the trillions of dollars and the only consensus was that nobody had any real idea how it would end.

Talk of the worst crisis since the Great Depression was no exaggeration.

"A once-in-a-century type of financial crisis" was how former Federal Reserve chief Alan Greenspan described it on Sunday. And he would know, as it all started on his watch.

Events moved so swiftly and dramatically that it was difficult for even those at the epicentre to process what was happening.

"Like tectonic plates shifting," said an economist of this week's seismic event, which might also be called the seven days that shook the financial world.

The subprime mortgage lending tremors might have first been felt a year ago, and have worsened since, but it was not until the Fed decided against bailing out Lehman Brothers last weekend and Merrill Lynch sold itself for half price to Bank of America that the real earthquake hit.

On Monday the financial district of Manhattan looked like it was in the grip of its worst siege since the terrorist attacks. The New York Stock Exchange was ringed by police and media crews, only this time Wall Street had blown itself up.

(Indeed, venerable uber-investor Warren Buffett had warned in 2003 that derivatives were "financial weapons of mass destruction".)

Few could miss the irony: that the investment banks themselves had created the complex and risky financial instruments and then buried them so far off balance sheet they had no idea of their total exposure to subprime.

"Pick a figure and double it," said an insider earlier this year when asked to estimate losses. And all this to help inflate profits and justify stratospheric remuneration packages, usually reserved for top sports and Hollywood stars.

The prime example is pugnacious Lehman Brothers chief Dick Fuld, who pocketed $US466million between 1993 and 2007. He has not been seen since the company's collapse.

No surprise then that the blogosphere erupted with ordinary wage earners and former home owners viciously gloating over the crash of the business titans. The only problem was the titans were taking everyone else down with them.

By Tuesday it was the turn of American Insurance Group. AIG's heavy exposure to toxic subprime loans made its position so terminal the Fed had to ride to the rescue with a $US85 billion bail-out. Forty-eight hours after letting Lehman go under, the Fed action confirmed that some companies are just too big too fail.

Fund managers to traders behaved as if in shock and froze as the collapse of confidence almost brought the system to a standstill. Liquidity dried up as banks stopped lending to each other. Even the strongest financial stocks headed to oblivion as no one trusted the loan books or valuations anymore.

Like a modern plague, the contagion continued to spread rapidly, infecting other financial institutions and causing a worldwide crisis of confidence.

In London, the giant bank HBOS was in the firing line, prompting a shotgun marriage with the more stable Lloyds bank. The Bank of England was holding the gun after one radio station urged customers to withdraw their money from HBOS, sparking fears of another Northern Rock-type bank run and costly bail-out by the Government.

Meanwhile Andrew Lloyd Webber offered free theatre tickets to his musicals to comfort devastated financial employees who make up most of the city's workers.

And pity the poor KfW Bank of Germany, which sent euro 530 million ($A956million) to Lehman Brothers on Monday in what it called an "erroneous swap" and is still vainly trying to retrieve the funds.

Even emerging market Russia, flush with oil money and billionaire oligarchs, was not immune, with the local stock exchange forced to halt trading two days in a row. Having survived the collapse of communism, Russians were obviously finding it difficult to cope with the sudden strains on capitalism.

Australia, which had hoped it had some immunisation by "decoupling" from the US in favour of digging up our resources for Chinese funds, still found itself infected, although not quite as severely as elsewhere.

Reserve Bank governor Glenn Stevens gave a timely mid-week speech reminding Australians the country's economic fundamentals and financial system were still sound - and indeed things looked much stronger in Australia than in the US and Britain.

However, Stevens did warn of an end to the nation's debt binge, which has pushed personal debt to second highest in the world after the US and is cause for concern among many jittery foreign investors.

Shares of the Big Four banks were hit hard, but after revealing total exposure of a mere $US400million to the US crisis, they were spared the full savaging of short-sellers. That was reserved for Macquarie, which has a bank in its name but is more the Wall Street model than the big safe local retail version.

Upmarket city eateries were near empty as business people retreated to their bunkers glued to the modern equivalent of the ticker tape.

"For those of us looking at the screens this is Armageddon," a broker said.

For everyone else it was simply a catastrophe as they contemplated shrinking super funds. But it was not just Sydney cabbies who were asking what it all meant for them. Financial advisers the world over reported even the most sophisticated investors calling in a panic.

Illustrating the general concern was the fact that at one stage US treasuries were trading at a negative yield in other words people were paying the US Government to take their money in return for the security of government

paper.

The two most asked questions all week were: "Have you ever seen anything like it?" The answer was: "No."

The other question was: "Is the worst over?" which was met with: "I don't know because I've never seen anything like it."

Veterans of the last great sharemarket crash in 1987 distinguished between what was then a much-needed market "correction" and the total paradigm shift in the financial system being experienced now. "The October crash of '87 was a market event, not a financial crisis," according to Commonwealth Bank global economic adviser David Hale.

"We are in the midst of a sustained downturn caused by a credit crisis due to non-performing real estate loans, (which) has broad consequences for the entire US economy, and by extension, the global economy."

The biggest casualty in 1987 was junk bond company Drexal Burnham. This time, Wall Street has already lost three of its top five big brand names.

"Junk bonds on steroids," said a broker comparing the subprime crisis.

And whereas back then new computerised program trading was widely blamed for sending the market into free-fall, this time the culprit is the old practice of short-selling.

This time the cashed-up and powerful hedge funds are often the ones betting on a stock price falling rather than rising.

A chilling example of the problem came early in the week on one of the myriad financial news networks beaming out from the chaos of the NYSE floor.

Earlier, the remaining two investment banks, Morgan Stanley and Goldman Sachs, had reported better than expected earnings and the market marked up their stocks.

Suddenly bewildered anchors noted that the shares were plunging and crossed to a trader to make sense of it.

"If the market wants to take out Morgan Stanley it can," the trader said matter of factly.

It was a stark reminder of short-sellers' power in this market. While they had not created the problems felling the Wall Street giants - that was their own handiwork - the shorters were certainly using their power to exacerbate it.

On Thursday, Britain took decisive action against short-selling with a ban on pension funds lending the stock in the first place. It places pressure on Australian regulators to follow, particularly in light of Macquarie Group's vulnerability.

US authorities were talking tough, acting to tighten rules on "naked" short-selling by forcing traders to reveal their position publicly. This prompted one shorter to claim it was akin to forcing Coca-Cola to reveal its secret formula.

" If you squeeze a pig it squeals," was the reply of an unimpressed Wall Street broker, proving sentiment had certainly moved against unfettered markets.

Indeed, in the surreal atmosphere that swirled this week, free-market proponents were blaming government deregulation for their woes, attacking lack of transparency and calling for tighter controls.

The events on Wall Street were already spilling over into the fierce US presidential campaign, forcing John McCain to reverse course and support more regulation and government intervention. He even called for SEC chief Charles Cox to be sacked.

With the new strategy of Treasury bail-outs being dubbed "socialised capitalism", Democrat vice-presidential candidate Joe Biden was calling for job creation through government-funded projects reminiscent of the Democrats' "new deal" in the Great Depression. (Or perhaps Australia's own infrastructure Future Fund).

President George Bush finally emerged at week's end to try to restore calm by appearing to have a plan. It looked like being the formation of a Resolution Trust Corp (RTC)-type vehicle used to to clean up the savings and loan scandal in the early '90s.

"Every 20 years or so the banks come up with new ways to lose money," said Tom Schneider of Washington-based Restructuring Associates. "When will we learn?"

The week's events had made it clear the Fed had gone from lender of last resort to buyer of last resort. It had wracked up a hefty tab of hundreds of billions of dollars bailing out or nationalising everything from the Fannie Mae and Freddie Mac mortgage giants to insurer AIG.

While Wall Street welcomed the RTC with a record rally, most banks were just relieved the Government would be able to take "distressed" and "impaired" assets off their books.

Ailing vehicle makers in Detroit, who were rebuffed on their own efforts for a government handout this week, pointed out that white-collar jobs were being protected over blue-collar.

The other big question of the week, and presumably the subject of numerous future inquiries, was how the Government had been caught off guard.

In June at the Australian-American Dialogue summit, business figures heard from senior Treasury officials that things had been looking serious only a few weeks back but the officials were confident the worst was over.

Yet the Lehman problem was well known on Wall Street, where many insiders were warning that the subprime losses could still be catastrophic.

But for now most players approached the weekend with trepidation rather than relief.

What they fear is a Monday announcement of another hasty marriage after Morgan Stanley confirmed prenuptial talks with the ailing Wachovia Bank and Washington Mutual.

"It's like grabbing a partner in the dark," said an observer, who expressed hope the RTC would end up with the "bad" banks.

And while most analysts are not yet ready to call the bottom, resilient New Yorkers are trying to conjure the hardy spirit they showed in rebuilding after the 9/11 terrorist attacks.

The impact on the city cannot be underestimated as it faces job losses in the hundreds of thousands and billions of dollars in lost revenue.

While Wall Street provides only one in 20 jobs, it accounts for 25% of wages and salaries in the city because the average income on Wall Street is five times higher than that of the average worker.

More than half of all skyscrapers erected in Manhattan since 2000 were built to house the investment banks that soon could be extinct.

The entire financial meltdown might have started and ended with a giant subprime property bubble, but in Sydney at least there was one piece of apparent good news overwhelmed in the avalanche of negative news this week.

A waterfront home reportedly sold for a record $47 milllion, even if it was the home of David Coe, former chief of the dying Allco group.