In this week’s essay, Ape Man makes a prediction that seemed more daring last week when it was supposed to run then it does this week. Such are the fortunes of life.

As I go through this story you will get a sense of the drama that has contributed to my silence here. When the stakes get high I get a little more cautious about publishing what I know, even in the semi-anonymous form that I follow.
Early in August, the plant manager’s boss scheduled a visit. In Click Here to continue reading.

From Politico….

Congressional leaders said after meeting Thursday evening with Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke that as much as $1 trillion could be needed to avoid an imminent meltdown of the U.S. financial system.

Paulson announced plans Friday morning for a “bold approach” that will cost hundreds of billions of dollars. At a news conference at Treasury headquarters, he called for a “temporary asset relief program” to take bad mortgages off the books of the nation’s financial institutions. Congressional leaders had left Washington on Friday, but Paulson planned to confer with them over the weekend.

“We’re talking hundreds of billions,” Paulson told reporters. “This needs to be big enough to make a real difference and get to the heart of the problem.”

Computer models have been getting a bad rap. It is often claimed that risk mangers and CFO’s at major banks made the mistake of relying to heavily on their models. But likes so many other things that are often said, this is self serving. It makes it seem as if all these smart people were just naive little boys who didn’t know any better.

The truth of the matter is that financial executives deliberately gamed their own models. As this New York Times blog post explains….

In other words, the computer is supposed to monitor the temperature of the party and drain the punch bowl as things get hot. And just as drunken revelers may want to put the thermostat in the freezer, Wall Street executives had lots of incentives to make sure their risk systems didn’t see much risk.

“There was a willful designing of the systems to measure the risks in a certain way that would not necessarily pick up all the right risks,” said Gregg Berman, the co-head of the risk-management group at RiskMetrics, a software company spun out of JPMorgan. “They wanted to keep their capital base as stable as possible so that the limits they imposed on their trading desks and portfolio managers would be stable.”

One way they did this, Mr. Berman said, was to make sure the computer models looked at several years of trading history instead of just the last few months. The most important models calculate a measure known as Value at Risk — the amount of money you might lose in the worst plausible situation. They try to figure out what that worst case is by looking at how volatile markets have been in the past.

But since the markets were placid for several years (as mortgage bankers busily lent money to anyone with a pulse), the computers were slow to say that risk had increased as defaults started to rise.

It was like a weather forecaster in Houston last weekend talking about the onset of Hurricane Ike by giving the average wind speed for the previous month.

The first comment on this blog post claims that Goldman Sachs superior performance relative to their peers stemmed from the fact that they did not mess with their models. I don’t find this hard to believe. While I think that Goldman Sachs will not escape in the long run, computer models do have advantages. The biggest one being that they take emotion out of a lot of decisions.

From Spiegel….

Two managers and one division head of the German state lending bank KfW were suspended Thursday after an emergency meeting of the administrative board in Berlin, amid uproar over a suspicious €300 million ($426 million) transfer made by the bank to Lehman Brothers on Monday — just as the New York financial institution collapsed.

From the Financial Times….

Were the financial crisis to end today, the costs would be painful but manageable, roughly equivalent to the cost of another year in Iraq. Unfortunately, however, the financial crisis is far from over, and it is hard to imagine how the US government is going to succeed in creating a firewall against further contagion without spending five to 10 times more than it has already, that is, an amount closer to $1,000bn to $2,000bn.

From the New York Times…

Before you pull your cash out of your money market fund, you need to understand what you own. There is a big difference between money market mutual funds and the money market deposit accounts at a bank (and banks sometimes sell both).

Money market funds are essentially mutual funds that invest in securities that, until this week, were deemed relatively low risk. Those include government securities, certificates of deposit, asset-backed commercial paper and other highly liquid securities.

The Primary Fund got in trouble because some of its investments were in Lehman Brothers’ debt. To stop what is in essence a run on the fund, the Primary Fund has stopped all redemptions for up to seven days.

A money market deposit account, on the other hand, is entirely different. It is an interest-bearing bank account that is insured — up to $100,000 per account and up to $250,000 for some retirement accounts — by the Federal Deposit Insurance Corporation. Joint accounts are insured for $100,000 per account holder.

If you had been putting your money into a money market account because you wanted to avoid all risk, then you should consider the money market deposit accounts and other accounts insured by the F.D.I.C., like certificates of deposit and regular checking and savings accounts.

From Financial Times….

Earlier, the Federal Reserve gave central banks in Japan, the eurozone, the UK, Switzerland and Canada $180bn to lend on to local banks that cannot access its onshore dollar lending facilities.

The central banks said they were taking “co-ordinated measures designed to address the continued elevated pressures in US dollar short-term funding markets”. They promised to “continue to work together closely” and to take “appropriate steps to address the ongoing problems”.

Brad Setser has more.