Paul Kedrosky has dug this quote out of a Center for European Policy Studies report.

The K-10 annex of AIG’s last annual report reveals that AIG had written coverage for over US$ 300 billion of credit insurance for European banks. The comment by AIG itself on these positions is: “…. for the purpose of providing them with regulatory capital relief rather than risk mitigation in exchange for a minimum guaranteed fee”. AIG thus helped to organise regulatory arbitrage on a gigantic scale. A formal default of AIG would have had a devastating impact on banks in Europe. This explains why AIG’s problems had sent shock waves through the share prices of European banks. For the time being the US Treasury has saved, inter alia, the European banking system, but given that AIG is to be liquidated European banks now have to scramble to find other ways of obtaining the ‘regulatory capital relief’ they appear to need urgently.

If you remember the interview with Germany’s finance minister that we quoted yesterday, you will remember that he said…

In the case of Lehman, the US government wanted to send a signal to the market that they are not prepared to offer a bailout under any circumstances. In the case of AIG, we had direct talks at the G7 level and implored them to stabilize the situation. An AIG bankruptcy would have triggered shock waves around the world. We were all staring into the abyss at that point.

I think Mr. Kedrosky has helped illuminate what the abyss looked like.

I can’t tell you how many times I have seen people use the unrevised TIC data to argue that the US is not all that dependent on foreign central banks. Always remember that they don’t know what they are talking about. From Brad Setser….

The scale of these revisions raises questions about a lot analysis that suggested that official inflows weren’t a major reason why Treasury yields remained low in 2005 and 2006. That analysis was based on the observation that yields didn’t rise after official flows – as reported in the TIC data — fell. Alas, it turns out that official flows didn’t actually fall. The TIC data just didn’t capture most of the flow — as China and the Gulf tend to buy through London. After the survey revisions, the US now thinks official flows for 2006 topped official flows in 2004.

What of the last four quarters? The US data indicates that official creditors provided the US with about $400b in financing — less than in 2006. It also indicates that “private” investors abroad bought about $250b of Treasury bonds (including short-term bills). If you believe that private investors abroad bought that many Treasuries, I have a lot of formerly triple AAA CDOs stuffed with subprime debt that I want to sell you at par.

The US Treasury made the direction of the likely revisions to the data totally clear in the last survey. It noted that the survey indicated that ALL of the increase in foreign holdings of Treasuries and most of the increase in foreign holdings of Agencies between June 2006 and June 2007 had come from the official sector (see p. 16 of the .pdf/ p. 14 of the udnerlying document). There isn’t good reason to think this has changed dramatically. If I add “private” purchases of Treasuries to the official flow data, the total is roughly equal to the current account deficit.

This post from Calculated Risk has this chart. Give it a good look. That line can’t go straight up for long without consequences.

You probably already know that the bail out failed to pass and why it failed. But if you have been living under a rock, read this post by Naked Capitalism. Read the comments. They will make you sick. Take this one for example…

There is simply a segment of the population that does not know better or does not care about the economic well-being of their families or other families. Whether for reasons for morality (what is caused by “debt” cannot be saved by “debt”) or schedenfreude or ignorance or indifference,…The house republicans are the voice for this segment…somehow they have to be bribed or cajoled or coerced into going along…otherwise, in the words of one of America’s greatest leaders, “this suckers going down…”.

The real divide over this issue is not between Republicans or Democrats. Rather it it is between the coastal elites who have had it good for many years and the poor blue collar suckers who have been watching their living standards stagnate for those same years. I have seen blue collar folk who never cared much for politics getting in touch with their representatives over this bail out. They simply can’t understand why none of the industries that they depended on were worth a bail out, but people who earned a hundred times what they make are being bailed out right and left.

But the white collar people with big money tied up in the markets are frothing at the mouth. They would shoot their own grandma to get this thing passed. The only reason they can see for people to oppose this bill is stupidity and ignorance. And that is a shooting offense when their money is at stake.

As usual, those with money are going to win in the end, but it is going leave a bad taste for a long time.

From Spiegel comes this interview with Germany’s finance minister…

SPIEGEL: And is the United States completely to blame?

Steinbrück: The source and focus of the problems are clearly in the United States. There are many causes. After 9/11, a great deal of cheap money was tossed into the market. Apparently some of that money went to people with poor creditworthiness. This led to the growth of the real estate bubble. The banks embarked on a race over profit margins. Then speculation spun completely out of control…

SPIEGEL: …which also benefited German banks for a while.

Steinbrück: But they didn’t invent these transactions. The stokers on the financial markets were responsible for that.

SPIEGEL: And how is the US patient doing now?

Steinbrück: It’s in the ICU with pneumonia. This means that here in Europe, we can at least expect to get a bad cold. The US patient lacked legislation, a regulatory framework that could have helped avoid this development. That’s the key issue for me. The financial products became more and more complex, but the rules and safeguards didn’t change. I don’t know anyone in New York or London who would have asked for a stronger regulatory framework 18 months ago. They were always saying: The market regulates everything. What a historic mistake!

SPIEGEL: Your US counterpart, Treasury Secretary Henry Paulson, began by essentially nationalizing the two US mortgage giants, Fannie Mae and Freddie Mac. But then he allowed investment bank Lehman Brothers to plunge in bankruptcy before saving the insurance giant AIG with an $85 billion (€58 billion) bailout. This doesn’t exactly look like a clear course of action.

Steinbrück: In the case of Lehman, the US government wanted to send a signal to the market that they are not prepared to offer a bailout under any circumstances. In the case of AIG, we had direct talks at the G7 level and implored them to stabilize the situation. An AIG bankruptcy would have triggered shock waves around the world. We were all staring into the abyss at that point.

I have to laugh when I read stuff like this. It is like the people in the US blaming Saudi Arabia for all the evils in the world. Granted, Saudi Arabian money funds a lot of Islamic extremists, but it is the western (and in particular the US’s) addiction to oil that makes them rich.

If it was so obvious that stronger regulation was needed why didn’t German regulators stop German banks from buying the crap? Most of the biggest buyers of US crap were banks owned by the German government. Furthermore, any government that allows a mere 6 billion euros of equity to support a 400 billion euro balance sheet does not have alot of room to talk trash.

I doubt I will find this as funny when a billion plus Chinese decide that their economic problems are all America’s fault.

A British Bank called Bradford & Bingley has gone down. From The Telegraph…

B&B’s £24 billion of savings and its 200 branches is likely be sold to a rival or rivals. Spain’s Santander, which owns Abbey and is in the process of buying Alliance & Leicester, was in talks about possibly taking over deposits and branches, an industry source said.

But rivals are reluctant to take ownership of B&B’s book of £41 billion pounds of mortgages – representing 3.4 percent of UK mortgages – as many of them are higher risk buy-to-let and self-certified, which have a far higher chance of defaulting. More than eight out of ten of B&B’s mortgages are either buy-to-let or self-certified.

Hypo bank in Germany has big problems. From Naked Capitalism….

The prospect of an almost-as-big-as-Lehman bankruptcy evidently focused the mind of the officialdom. The providers are private firms, but one imagines, a la the LTCM rescue, that they were given a big prod by regulators It appears the amount of the facility is sufficient to refund maturing paper, but likely falls short of the end of troubles for this highly geared bank (a mere 6 billion euros of equity supporting a 400 billion euro balance sheet).

Fortis Bank (which is based in Belgium) has big problems. As Spiegel Reports….

The news came one day after the Dutch, Belgian and Luxembourg governments announced an €11.2 billion bailout of troubled Fortis bank, which saw a partial nationalization of the company. Fortis is Belgium’s largest bank, and the government in Brussels is providing €4.7 billion for a 49 percent stake in the company’s Belgian operations. Luxembourg is providing €2.5 billion for 49 percent of Fortis Bank Luxembourg, and the Dutch are investing €4 billion for 49 percent of Fortis Holding Netherlands.