Week in review: The contagion equation

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Bear Stearns was rushed into intensive care, Carlyle's hedge fund collapsed and Bernanke's medicine failed to rout the root of the disease.

Bear Stearns went into free fall as the week drew to a close (this was despite Monday's insistence by former CEO "Ace" Greenberg that rumours of a liquidity crisis were so totally and utterly unfounded as to be 'ridiculous, totally ridiculous').

Shares declined 50% on Friday following the admission that its liquidity position had 'significantly deteriorated.' JPMorgan and the Federal Reserve pumped in cash while markets took a nasty nose dive. Neither a sense of impending doom, nor a presentiment that by Friday afternoon he'd have lost $128m on his Bear stock in the past month alone, discouraged Bear chairman Jimmy Cayne from splashing out $26m on a super-deluxe New York condo sometime around Wednesday.

Carlyle Capital Corporation (CCC) finally crumbled mid week, prompting global stock markets to tumble. Shares in the Amsterdam-listed mortgage bond fund fell to $0.35, down 97% on the year, as it defaulted on $16.6bn of loans from banks (including some from Bear Stearns). David Rubenstein, co-founder of private equity firm the Carlyle Group, whose employees own 15% of its failed namesake, described the issue as a hiccup,

promised to compensate investors, and vowed that he didn't feel in the slightest bit antagonistic towards Wall Street.

Contagion became a real risk, despite Cayne's valiant attempts at circulating liquidity. On Monday there were fears for the stability of the financial system as rumours swirled that either Bear, Fannie Mae, or Freddie Mac were about to go under. When Bear emerged as the worst casualty, the Wall Street Journal suggested the Fed's 'unprecedented' rescue package might possibly reflect concerns about wider systemic meltdown.

'Haircuts' became the watchword as banks sought to reduce their exposure to further losses. Banks shaved bigger haircuts (ie, demanded more collateral) from hedge funds they'd lent money to for fear they might go the way of CCC (which coincidentally collapsed only after its haircut became more severe). The Times reported that various small credit hedge funds managing $10m-$200m in assets were facing a funding squeeze. Hedge funds' travails made it more likely that they'd be forced to sell some of their sounder assets to meet their obligations, thereby spreading the rot further.

The Federal Reserve under Ben Bernanke made a first valiant attempt to ride to the rescue of the US financial system on Tuesday (ie. before the Bear Stearns blowout), by announcing that it would be willing to exchange $200bn of ultra secure Treasury securities every month for increasingly shaky triple A mortgage securities. The Telegraph described it as the boldest action since the Great Depression. But the Economist said banks have already begun demanding haircuts on government bonds. Some commentators pointed out the Fed's policy was liable to have the perverse effect of making things worse by encouraging banks to seize mortgage assets at struggling funds in the hope of swapping them for Treasuries. Despite (or maybe because of) the Fed's endeavours, the dollar fell to a record low on Thursday, prompting Goldman to declare that the eurozone had temporarily displaced the US as the world's biggest economy.

Wall Street, nonetheless, scored a minor victory over London in the ongoing battle to become the most monumental financial centre as Barclays Capital moved some of its top brass to the US. Meanwhile, however, Lehman promoted its chief operating officer for Europe and the Middle East to its executive committee, suggesting EMEA will be of more importance to it in future.

The financial health of banking bosses was revealed as banks made their regulatory filings. Some were in fine fettle: presidents Gary Cohn and Jon Winkelried each made $67.5m at Goldman, or $185k a day. Citigroup's Vikram Pandit made a mere $3.2m in compensation (and no bonus), but received a $165.2m payment when Citi bought his hedge fund, Old Lane.

Redundancies, resignations and retirements were back in vogue. Goldman Sachs made 20 people redundant from its US quantitative investment team. Lehman announced plans to cut 5% of its workforce.

Neal Shear, former head of fixed income and commodities at Morgan Stanley (and once one of the bank's biggest earners), resigned. Michael Zaoui, chairman of European M&A at Morgan Stanley, unexpectedly rode into the twilight. In France, there were fears for the wellbeing of hundreds of staff at Natixis, as the bank announced plans to save €250m-€500m.

Credit Suisse, however, managed to prolong the life of several of its leveraged financiers by combining them with its investment grade financing arm.

Mining emerged as an unexpectedly alluring alternative career to banking for new MBAs. Bloomberg reported that geologists are now some of the top earning MBA graduates, with pay at mining companies up 44% in the past three years. With gold also at record levels, now could be an auspicious time to head for the pits.

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