For a while it looked as though the Warren Buffett had pulled it off: markets around the world rallied on his $US5 billion move into Goldman Sachs, but then the debate restarted in Washington over the $US 700 billion bailout plan and confidence evaporated.

But that puncturing of the up-swell of confidence after the Buffett move is understandable. Fed chief Ben Bernanke was even gloomier overnight in his warnings about what failure to approve the bill would mean for the economy.

His comments on the US economy have been equally arresting. US home prices and house sales slumped again in August, with a seemingly bullish reduction in the number of unsold houses a mirage. As analysis showed, most of the houses which remained unsold and those coming onto the market are foreclosures. The demand, therefore, is not genuine.

Short term interest rates in the US fell sharply as banks and others parked their money in US Government notes and paper and wouldn’t lend it to markets. That produced another sharp rise in short term US dollar bank borrowing rates in Europe as the supply of US dollars dried up, something the $US240 billion in fed swaps is trying to solve.

The Fed did a $US10 billion swap with the Reserve Bank (the first auction of US dollars will happen tomorrow) and $US20 billion with a trio of Scandinavian central banks for the sale reason: to try and fix a shortage of US dollars in specific regions.

US Treasury Secretary Henry Paulson seemed to finally heed the message that there would be victims of the bailout plan. It is, after all, an election year and Congress, which is complicit in creating the situation by forcing banks to lend more to subprime type borrowers, wants to divert attention. So his former banking executives mates (maybe they are still his mates from Goldman Sachs days) are in the gun and Mr Paulson changed his mind in testimony to a House of Reps Committee when he said:

The American people are angry about executive compensation and rightfully so. We must find a way to address this in the legislation, but without undermining the effectiveness of this program.

The remarks were a significant change from Tuesday when he claimed introducing limits on pay would impede getting the fund started. Democratic and Republican legislators have called for restrictions on executive compensation in return for the government buying devalued assets from financial companies (such as no bonuses paid on any profit improvement flowing from such a sale).

The Fed chairman told the Joint Economic Committee of both houses of the US Congress overnight that the US is facing “grave threats” to financial stability and warned that the credit crisis has started damaging household and business spending.

“Economic activity appears to have decelerated broadly,” Bernanke said, a statement which US commentators said downgraded the assessment of the economy given eight days ago when the Fed met and decided to keep rates steady.

He said that without the bailout, “credit will be restricted further for home ownership, for small business, for individual consumers and so on, but that is not just an inconvenience. What that is going to do is affect spending and economic activity and it will cause the economy as a whole to decline and be much weaker than it otherwise would be.”

He has affectively confirmed feelings that the US economy is slowing rapidly this quarter from the export-driven annual growth rate of 3.3% in the second quarter.

Sales of existing homes fell 2.2% last month, worse than expected by the market. The median existing home price fell 9.5% to $US203,100, the sharpest drop on record. A ray of hope was the fall in the inventory of unsold houses to 10.4 months worth from 10.9 months, a noticeable reduction.

But that was a false hope as agents report that many of the sales at the moment are of properties that have been foreclosed on or being sold by homeowners whose properties have fallen below the value of their mortgages.

That means there has been no upsurge in new demand from real buyers, not bottom fishers. An estimated 35% to 40% of all sales are of distressed properties, so real demand is actually much lower than it seems and many real homes are being taken off the market.

In Hong Kong a bank run materialised out of nowhere late yesterday, stunning local regulators and the Government and setting off alarm bells. The only other runs reported were on IndyMac bank in California two months ago and more vividly on Northern Rock mortgage bank in the US a year ago. A run on a bank in a Chinese Administrative region is a big surprise. Thousands of people queued outside Bank of East Asia’s branches across Hong Kong to withdraw their life-savings on rumours that the lender was in financial trouble.

The territory has seen only one other bank run since its return to mainland China in 1997, when the International Bank of Asia saw large withdrawals in November of that year. Regulators appealed for calm, the bank remained open past normal closing time and plans to open today and stand ready to meet any rush.

Peter Fray

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