From Felix Salmon….

This is not how triple-A sovereigns behave. It’s as though the analysts at Moody’s were only able to see one step ahead, and not two: they could anticipate that Iceland would bail out its banks, but they couldn’t anticipate that when a tiny country bails out a bank whose assets vastly exceed the country’s own GDP, then the sovereign itself loses much creditworthiness. One scary datapoint: the assets of Kaupthing Bank amount to 623% of Iceland’s GDP, which is possibly why its own credit default swaps are trading somewhere over 2500bp.

There was is so much bad stuff in the Bloomberg article that I don’t know where to start. For starters there is this….

California, the most populous U.S. state, will run out of money by the end of this month and needs $7 billion in funding.

Naturally, the feds are being asked to cough up.

But that is not the worst of it. There is also this….

One California lawmaker said the state should consider borrowing the money from its public employee pension system, the largest such pension fund in the U.S., with $214 billion in assets.

Senator Dean Florez, a Democrat, said the California Public Employees’ Retirement System could buy all the state’s cash flow notes, earning more in interest than the system would by investing that same amount of money in U.S. Treasury notes.

From the New York Times (h/t Naked Capitalism)…….

In a move suggesting how the credit crisis could disrupt American higher education, Wachovia Bank has limited the access of nearly 1,000 colleges to $9.3 billion the bank has held for them in a short-term investment fund, raising worries on some campuses about meeting payrolls and other obligations.

Wachovia, the North Carolina bank that agreed this week to sell its banking operations to Citigroup, has held the money in its role as trustee for a fund used by colleges and universities and managed by a Connecticut nonprofit, Commonfund.

On Monday, Wachovia announced that it would resign its role as trustee of the fund, and would limit access to the fund to 10 percent of each college’s account value. On Tuesday, Commonfund said that by selling some government bonds and other assets held in the fund, it had succeeded in raising its liquidity to 26 percent.

Still, Wachovia’s announcement sent shock waves through higher education, sending hundreds of college presidents rushing to check their financial vulnerability on every front.

Some smaller colleges that had not previously arranged lines of credit were feverishly seeking to negotiate those on Wednesday. And some large institutions said they were facing, at the least, a major financial inconvenience as a result of Wachovia’s action.

If you are interested in the health of manufacturing you should read this and this.

From Bloomberg….

Pennsylvania must now find another source of revenue to bridge a transportation funding shortfall estimated at $1.7 billion in November 2006.

The state has about 8,500 miles of roadway rated in “poor condition,” said Rich Kirkpatrick, a state Transportation Department spokesman. The state has 6,034 bridges rated as structurally deficient as of June 30, the most of any state in the U.S., Kirkpatrick said.

(h/t Felix Salmon)

Worth watching if you can get past the first few minutes.

Words fail me. (h/t Calculated Risk)

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.