amzn

The SEC's ban on short selling ended Thursday. This creates the conditions to resume the cycle of value destruction that brought down Lehman Brothers Holdings. What happens is that a threat of a credit downgrade causes a spike in the premiums for credit default swaps (CDSs) that insure the bank's debt. That premium spike requires a collateral call which the bank lacks the cash to meet. This jeopardizes its effort to raise capital and sends the stock plunging -- to the profit of the short sellers.

Enter Morgan Stanley (NYSE: MS). A few weeks ago, it announced that it would raise $9 billion from an investment from Japanese bank Mitsubishi UFJ Financial Group, which is due to close on October 14th. However, the $25 a share purchase price is now about double Morgan Stanley's closing stock price Thursday. If the $9 billion capital commitment remains constant, MUFJ would own 65% of Morgan Stanley rather than the original 21%.

And this morning, a report emerges that Moody's (NYSE: MCO) will put $200 billion of Morgan Stanley's debt on downgrade watch -- helping drive its stock down 27% in pre-market. As happened at Bear Stearns and Lehman, hedge fund clients have pulled out their money and its CDS premiums are up so much that it can't issue new debt. Specifically, Morgan Stanley's 5-year CDSs rose to an upfront payment of 28% of the amount insured -- yesterday it was 19% -- plus 5% percent a year. So Morgan Stanley would pay $2.8 million to insure $10 million of debt plus $500,000 a year.

While you were sleeping, Asian markets followed the U.S. down. Japan's Nikkei lost 9.6% as a real estate investment trust and an insurance company -- Yamoto Life -- filed for bankruptcy. Markets in Hong Kong, Korea, Australia, Singapore and Thailand fell between 6.5% and 8%. In Europe, markets opened down 10%. Fear is rampant with the volatility index (VIX), a measure of fear, closing at an all time high of 63.92.

By chance, there is a meeting of G7 finance ministers in Washington this weekend, and there will be a push to do something by Sunday night. I think it would be a triumph if everyone in the meeting could agree on a common definition of the key problem: the freezing up of short-term lending markets (the TED Spread, a measure of short-term lending risk, hit a record 4.23%), the lack of capital in the global banking system, or investors fleeing the stock market.

Why would this help? Part of the reason that global efforts so far have failed is that there does not appear to be a common understanding of what is wrong and what it will take to fix it. This has been reflected in uncoordinated tactics -- flooding the markets with liquidity, cutting interest rates, guaranteeing money market funds, injecting capital into banks -- in the UK only -- and our DOA $700 billion reverse auction plan.

This afternoon, Citigroup (NYSE: C) chose to walk away from its discussions to acquire Wachovia (NYSE: WB) but Citi will revive its $60 billion lawsuit against Wells Fargo (NYSE: WFC). Meanwhile, with its $122 billion portfolio of toxic option ARM mortgages -- which add gaps in borrowers' monthly payments to the loan principal -- Wachovia may be too radioactive for Wells Fargo to buy.

How did we get here? On September 29th, Citi thought it had a deal to buy Wachovia's banking operations for $2.2 billion -- Citi would absorb the first $42 billion in losses and stick the FDIC with the rest. In exchange, the FDIC would get $12 billion worth of Citi preferred stock. Last Thursday, Wells Fargo announced a deal to buy all of Wachovia for $15 billion without costing the FDIC anything. Citi sued, the FDIC encouraged the three parties to split the baby, and this afternoon Citi decided to withdraw.

But now that the field is open for Wells Fargo, should it continue with the deal or has it learned that Wachovia's bad assets will make the deal too costly? Although Wachovia would give Wells $448 billion in deposits in 3,300 branches in 21 states, it also has $122 billion worth of option ARM mortgages. These mortgages are likely to default in huge numbers over the next few years. That's because the average option ARM holder will see a 63% rise in monthly payments -- for an additional $1,053 per month. With the economy likely to deteriorate, that could burn a big hole in Wells' $48 billion in capital.

In the wake of S&P's downgrade watch of General Motors (NYSE: GM), which sent its shares down 31% to a 58-year low, the Dow lost another 679 points today. Exactly a year ago, it was levitating at 14,164 -- now 5,585 of those points are gone. In the process, $9.3 trillion in market value has evaporated. And that loss of market value shows no signs of stopping.

A week ago, I suggested that investors who need their funds in the next six years should give some thought to cutting their losses. Since then, the Dow has lost 2,252 points. As a reminder, during the Great Depression, the Dow lost 89% of its value. If you end up losing 40% of your investment instead of 90%, you may look back and think that you were wise to have salvaged something.

Last Friday, the White House signed an $850 billion bailout bill. That bill was pushed as a way to stop a catastrophe. With $3.2 trillion in stock market value lost since then, some might argue that the bill's benefits were oversold. Meanwhile, the short-term cash market seems to have stopped working as the TED spread peaked at 4.14%. I've suggested that a cull and capitalize plan for the U.S. banking system is essential for restoring the functioning of the credit markets. Let's get this started.

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He has no financial interest in GM securities.

A digital clock in New York City counts up the U.S. National Debt. But the current administration broke the clock which only had enough digits to count up to $9,999,999,999,999. As Dick Cheney said, Ronald Reagan proved that deficits don't matter. I wonder whether this broken clock is proving Cheney wrong?

The clock has an interesting history. The now-deceased Manhattan real estate developer, Seymour Durst, built this sign in 1989 because he thought that the then $2.7 trillion debt was too high. The debt kept growing after he put up the sign but by the end of Bill Clinton's second term, it was down to around $5 trillion. Since January 2001, the national debt has grown to $11.3 trillion thanks to the $850 billion bailout bill.

The good news is that the clock, which currently counts the deficit by substituting a 1 for the $ sign that was there before, will be fixed next year -- adding two digits. Too bad fixing the clock won't make the U.S. economy any less perilous. At 81% of Gross Domestic Product (GDP), our national debt is way above the 60% that the IMF considers to be a risky borrower.

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter.

With its stock down 53% since it announced the first delay in the 787 Dreamliner, it would be an understatement to say that Boeing (NYSE: BA) is going through a rough patch. It has been a month since its 27,000 machinists went on strike and both sides are hurting. Now they are resuming negotiations.

How much pain is this strike creating? Boeing could lose $1.75 billion worth of revenue and take a 13% earnings hit if the strike ends up lasting seven weeks. Meanwhile, machinists -- who average $26 an hour -- are making $3.75 an hour worth of strike pay (assuming a 40 hour week for their $150 a week strike pay packet).

The dispute between Boeing and its machinists appears to be about several issues. But the most important one seems to be that Boeing wants to have the flexibility to outsource work and machinists want to limit that flexibility. I think they should agree to a compromise which would give the machinists a chance to make a proposal to keep work with them if they can do the work well at a competitive price.

The government takeover of American International Group (NYSE: AIG) is going swimmingly -- for AIG's top brass. They got an $85 billion bridge loan in exchange for an 80% equity stake last month. AIG has already spent $61 billion of that $85 billion and will now get another $37.8 billion.

But wait -- there's more. AIG executives spent $440,000 for a spa vacation at the St. Regis resort in Monarch Beach, CA after they got our $85 billion. If you clicked on the link to the St. Regis, you know that AIG goes in style. That's why it came as no surprise that it was planning another ritzy affair for its insurance brokers. That event, at the Ritz Carlton in California's Half Moon Bay, was going to "motivate and educate" 150 independent agents who sell AIG coverage. (Update: They planned a big sales conference at the Ritz-Carlton in Half Moon Bay, but just cancelled it after public complaints). See how well reverse-Robin-Hood economics works?

Is there any business reason for AIG to be burning through so much of our cash? It claims that it needs the money because of its securities lending business, which lent securities to hedge funds and got the value of the securities and a fee in exchange. AIG then used the cash to buy mortgage-backed securities (MBS).

It's looking like the White House is floating the idea of using tax dollars to increase bank capital -- as the UK did yesterday. If it does not get significant political objections to the idea, this will probably happen. I think it is a great plan if they do it in the right way.

In order for this idea -- about which I posted -- to work, the Feds should not apply a peanut butter approach to capital injection. Rather, they should cull the herd and put enormous amounts of capital into a smaller number of strong banks.

The White House's original plan -- to buy up toxic waste -- is a great WPA program for Wall Street, but it won't solve the problem. That's because the price that Washington will set for the toxic waste will either be so high that it puts taxpayer money at risk, or so low that it slashes the banks' capital accounts -- making them unable to lend.

The basic problem is that banks are not comfortable lending to each other because they don't know whether the borrower will be around when it comes time to pay back the loan.

That's where the cull and capitalize plan comes in. Washington needs to decide which banks will get the combination of private and public money injected into their capital accounts. But it also needs to decide which banks must merge or close. Here's the important thing: if the money gets spread evenly among survivors and the rest, it won't do any good. The money needs to go to a handful of extremely well-capitalized and profitable banks -- otherwise confidence will not be restored.

As the U.S. market wraps up a wild day in which central banks cut rates in unison, one sector has no doubt at all about where it wants to go -- down. Three leading insurance companies have lost as much as a 28% of their stock market value in today's trading alone. How so? As I posted, insurers are the next part of the financial foundation to crumble due to mortgage-backed securities (MBS) gone sour.

Here's the latest insurance industry carnage:

• XL Capital (NYSE: XL) -28%. The property-casualty insurer holds $29 billion in asset-backed securities such as MBSs and collateralized debt obligations (CDOs), 330% of its shareholders' equity.
• Met Life (NYSE: MET) -27%. This life insurer announced plans to sell 75 million shares and to fire an unspecified number of employees. It also expects to earn between 83 cents and 93 cents per share -- way below analysts' $1.44 forecast.
• The Allstate Corp. (NYSE: ALL) -21%. This property-casualty insurer holds $83 billion in fixed income securities such as MBSs, 421% of its shareholders' equity -- and the $22 billion in Level 3 -- difficult to value -- fixed income securities exceed its $19.7 billion in capital.

I expect this problem to affect every insurance company to some extent. Will the $810 billion rescue plan relieve these institutions of their bad investment decisions? We might know in a year. Until then, look out below.

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He has no financial interest in the securities mentioned.

The Federal Reserve couldn't wait until October 29th to cut rates. Instead, it slashed its Fed Funds rate 0.5% to 1.5% in a move that was coordinated with other central banks. Interestingly, Milton Friedman's acolyte, Anna Schwartz, recently observed that Fed Chair Ben Bernanke, who is reportedly a student of the Great Depression, is taking the wrong approach to this crisis.

Milton Friedman is widely regarded as the economist who figured out that a lack of liquidity is the reason that the economy took such a tailspin after the crash of 1929. Schwartz, 92, co-authored A Monetary History of the United States 1867-1960, with Friedman. And her assessment of Bernanke is brutal. She thinks he should be fired. The reason? She believes that he and Paulson made a huge mistake in bailing out failed companies. In her view, they underestimated the free market's ability to recover from such failures.

Scwhartz also faults them for issuing dire warnings about how capitalism would fail unless Congress passed their bailout bill. I guess Friedman and Schwartz have influenced my thinking as reflected in this post about letting free markets work and this one questioning the fear tactics used to sell their program. This morning's emergency rate cut suggests that for all the fear mongering used to sell their program, its effect has not helped the markets, which have lost $2.8 trillion since the day investors thought the bill would pass.

Milton would have let the failed institutions fail. But it's too late to know whether his ideas would have worked.

Peter Cohan is president of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter.

The global financial catastrophe continues. With the Dow having Jones industrial average having lost $2.8 trillion in value since the day before investors thought the U.S.'s $810 billion bailout plan to save the world would pass, Asian markets cratered today. And the U.K. announced a plan much closer to the one that the U.S. should have been pushing. Maybe it's not too late for us to get it right.

With talk this morning of a plan for the Fed to set up Special Purpose Vehicles -- remember Enron? -- to buy up Commercial Paper (CP), a shrinking $1.6 trillion market of month long loans used to pay employees and buy inventory, we are now getting to the point where the Fed and the Treasury are the only bank that's still making loans. And with the new SPVs it looks like the Fed is running out of money to sop up all the financial toxic waste. The other banks seem to be frozen by fear. They borrow money from the Fed and clutch it to their breast, unable to trust that it they lend it to others that it will get paid back with interest.

But the good news for the time being is that the world still thinks of U.S. treasury bills as the safest place to park money. As a result, the Treasury can sell an apparently unlimited quantity of them to investors around the world and pay virtually no interest in the bargain. As long as this continues, it creates an opportunity to put that money to some positive use -- instead of throwing it at the world markets and watching value evaporate -- e.g., $2 trillion has disappeared since the $810 billion bailout bill to save us from heaven's wrath was about to pass.

The Fed could charter, say, 100 new banks around the country. These banks would be capitalized by a combination of money from the Treasury and private investors. Their deposits would be insured up to $250,000 and they would be required to lend out no more than $10 for every dollar of capital. They would be run by experienced bank executives who had been carefully vetted for their lending prudence. And because of their pristine balance sheets, they would be comfortable lending to each other -- knowing that they could get more capital if needed.

The banking system has been crumbling for over a year, but last month's collapse of American International Group (NYSE: AIG) -- which prompted an $85 billion government takeover -- suggests that insurance is not immune from the problems. As a reminder, AIG got snared in the $62 trillion Credit Default Swap (CDS) market whose growth was spurred by McCain advisor, Phil "Americans are Whiners" Gramm.

And as insurance crumbles, banks keep suffering. Bank of America (NYSE: BAC) and National City Corp. (NYSE: NCC) are both hurting. How much?

• Bank of America's earnings plunged 68% to $1.18 billion, or $0.15/share -- missing by 60% analysts' forecast of 62 cents. Bank of America will raise capital by selling $10 billion of common stock and slashing its dividend in half from 64 cents to 32 cents. One analyst cut the bank's 2009 earnings estimate to $2.50 per share from $3 per share -- this is well below the $3.12 per share from a Thomson Reuters analyst poll -- and lowered his price target by $2 to $26.

• National City Corp. and its National City Bank both suffered debt downgrades from Fitch. For instance, Fitch slashed the bank subsidiary's long and short-term Issuer Default Ratings (IDR) to A- from A. And it lowered the bank and holding company's Individual rating to C from B.

On September 27th, investors thought the $700 bailout package was on the verge of passing the House. Hank Paulson and George W. Bush pushed that bill as the way to avoid financial calamity -- and "heaven help us" if it failed to pass. Last Monday, the bill was voted down -- and the Dow fell a record 778 points. Last Friday, an $810 billion version of the bill passed -- with added sweeteners.

So, did the clouds in the heavens part to reveal sunshine and rainbows? Not exactly. Since the market closed on the 27th -- the day before the bailout to save the world was expected to pass -- the Dow has lost 1,188 points, wiping out $2 trillion in stock market value. I wonder whether anyone actually believed the government when it said the bailout bill would fix things.

I didn't, because I did not expect the bailout to work. The good news is that with the market regularly tanking so much every day, our leaders are getting ever more desperate to try something that will work. This increases the odds that they will try what I think is a better plan. And if it would kindly supply a $25 billion guarantee to the $1.7 trillion Commercial Paper (CP) market. This would help companies finance payroll and buy inventory. (How hard would that be to do this after the government has already set aside $50 billion to guarantee the $3.4 trillion money market industry?)

One of the great things about a global financial collapse is that economic activity slows down so much that people use less oil. And one of the more interesting aspects of this collapse is that despite the terrible problems we face in the U.S., investors are flocking to the dollar as a symbol of permanence in a turbulent world. Since oil is traded in dollars, the combination of a stronger dollar and weaker demand leads to a lower price.

For example, today oil went as low as $86.36 -- which is 41% below its July peak of $147. Meanwhile, the dollar hit a 13-month high of $1.36 to the Euro -- that's 15% stronger than the $1.60 it traded at this summer. That may be because the U.S. passed its $810 billion bailout plan and Europe has not yet figured out what it will do to deal with its financial crisis. Not to worry, oil is still 260% higher than the $24 it traded at in January 2001 and the dollar has lost 48% of its value of $0.92 to the Euro at which it traded back then.

Where do we go from here? That depends on two variables: how much oil-producing nations cut back on production and how the dollar performs relative to other currencies as this global financial crisis unfolds. If oil-producing nations cut back on production, prices will rise as long as the supply contraction matches the decline in demand. And as long as the world perceives that the U.S. is the world's financial safe haven -- the dollar could strengthen. And that would push oil prices lower.

In a nutshell, oil prices will keep dropping unless oil producing nations drastically slash production and the dollar plunges.

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter.