Falling public equity markets make SPACs look compelling

SPAC Attack
Posted on March 20, 2008

(The Deal) The IPO window is all but closed, while the SPAC door looks wide open.

SPACs, or blank-check public offerings, are here to stay, having represented 21% of cash raised in the IPO market in 2007, notes Deal contributor Joseph Bartlett. "The SPACs phenomenon is based on fundamental shifts in the U.S. financial markets, the first being the extended closure (since 2001) of the IPO window in the U.S. for small- and midcap companies."

So what are they, exactly? The Deal's Vyvyan Tenorio offers a primer:

As blind pools, SPACs don't have an operating business when they raise money in public markets. But they have 18 months from an IPO to complete a deal using about 80% of net assets. Up to 95% of the money raised is held in a third-party trust. Once a SPAC has identified a target, it has to notify shareholders and submit documentation to the SEC. Shareholders can approve it and sell or redeem their shares. If the SPAC fails to successfully make an acquisition, the trust is liquidated and the cash returned.

SPACs are an investment favorite of hedge funds (Amaranth Advisors LLC loved 'em before its spectacular implosion) and, of late, large institutional investors like mutual funds. She writes:

Clearly there's an appetite for SPACs among sponsors whose access to capital may be limited, and among hedge funds that hope to profit from arbitrage opportunities. SPACs have also opened avenues for well-heeled financiers such as Texas private equity pioneer Tom Hicks. In June, Hicks filed to raise $400 million through an IPO for a SPAC. [He wound up raising $552 million in October.] Hedge funds, too, are exploiting these vehicles to take themselves public. GLG Partners LP, one of Europe's largest hedge funds, went public in 2006 through a reverse $3.4 billion takeover of Freedom Acquisitions Holdings Inc., which raised $528 million late in the year.

And they're also a popular exit route for private equity firms, notes The Deal's John Morris. (For other ways PE firms can capitalize, see below.) Eleven SPACs have bought private equity-controlled U.S. companies since mid-2006, he says, citing a SPAC tracker.

THE GOOD, THE BAD AND THE FIXES

More generally, SPACs seek to overcome some of the problems involved in the back-door route -- reverse merger into a public shell. It's a two-step process, Sonnenschein Nath & Rosenthal LLP's Bartlett notes: An underwritten IPO followed by an acquisition, effectively a back-door IPO but with built-in safeguards, promising shareholders get a say in choosing the target. He lays out the plusses, particularly when compared to shells, and the minuses:

• It affords retail investors access to many advantages of private equity. While hedge funds typically buy the stock, any average investor can too.
• Investors buy what the SPAC has set out to do; whereas investors in a shell are bystanders.
• And shareholders can vote for a deal or against it and recoup much of their investment, which is far less common with shells.
• All told, a SPAC deal is still a reverse IPO, so if a company is to float successfully, why not use the traditional avenue? The road is shorter, cheaper and less risky. But the window, for now, is closed.
• Further, many deals involve proceeds that fall short of the amount deemed advisable to escape orphanage, a problem that can be countered with rollups.

The remaining issues are tougher, he notes:

• How attractive is a company willing to hang around an average of 218 days for a yes vote that may or may not come? "If it is any good, it should be snapped up quickly by financial and/or strategic investors."
• And a no vote can be catastropic. "Take a look at the stock price nosedive of targets left at the altar by LBO funds reneging at the last minute." (For more on buyouts gone bust, see a related Dealwatch.)
• Further, once proxy materials go out, anyone can take a peek: competitors as well as customers.
• The 18-month deadline imposes tremendous pressure to cut a deal.

So what are the fixes?

• For SPACs themselves, a team-up with a PE fund may be the best model. (See below.) Potential conflicts of interest surrounding the role of private equity investors in SPACs can also arise, but the shareholders always have the cash-out option.
• Meanwhile the SEC needs to regulate to prevent market manipulation (one SEC rule is that SPACs can't predetermine acquisition targets, a contested point because they're often industry-specific) and the average 218-day delay (also aimed at preventing abuse) from sign to close needs to be shortened.
• Finally, reliable data on post-closing stock performance is essential, he notes, to help investors decide which SPACs and targets will withstand the after market.

GAME PLAN

SPACs are trying to differentiate from the checkered past of blind pools, note William F. Griffin Jr. and Andrew D. Myers, shareholders with Davis, Malm & D'Agostine PC. There are investor protections: the aforementioned shareholder vote on acquisitions and cash-out option; management and frequently underwriters have skin in the game via stock and warrant purchase agreements and deferred fees, respectively; a relatively small amount of offering proceeds go toward working capital to consummate an acquisition.

So for a private equity investor, there are three ways to go about getting into the SPAC game, notes the SPAC lady herself, Tina Pappas, a managing director with boutique investment bank Morgan Joseph & Co.:

• Sponsoring a SPAC as an issuer: PE firms that have done so include: MBF Healthcare Partners LP, Steel Partners, LLM Capital Partners LLC, Camden Partners Holdings LLC and GSC Group, while several others are in registration.
• Exits for existing investments: 72 SPACs have more than $12.3 billion in capital looking for acquisitions. She calls a reverse merger one of the most compelling options.
• Co-investing in a SPAC acquisition: In an arrangement where an existing consortium of SPACs just need some more cash to complete a transaction, a firm could come in and perhaps be entitled part of the founders' 20% ownership right and warranty options.

A DIFFERENT ANIMAL

And in a then-recent twist, Tenoiro noted in July:

SPACs have now tapped the Rule 144A [under which an issuer can offer a private sale of securities to qualified institutional buyers, or QIBs, without government oversight] market for privately issued, unregistered securities, which coincidentally is an increasingly popular alternative for private equity firms looking to go public.

It affords more flexibility, she writes, as QIBs are perceived as sophisticated institutional buyers who don't need the same protections as individual or smaller investors. They're not subject to the long SEC review process (drawn out to guard against potential abuses). And how many 144A SPACs there have been is hard to say, given that they're private placements, she writes. "Not surprisingly, sources say investors in these offerings are essentially the same community of hedge funds that invest in SPACs."

And after the IPO come the mergers. McDermott Will & Emery LLP's Joel L. Rubinstein and Dennis J. White weighed in on the nuances in September. Unsurprisingly, competition for the listings is fierce. As The Deal's Donna Block noted Feb. 21: Nasdaq's move to institute new listing standards for special purpose acquisition vehicles is an attempt to capture American Stock Exchange listings. - Carolyn Murph

Programmers free thyselves

You weren't meant to have a boss
March 2008
http://www.paulgraham.com/boss.html

A few days ago I was sitting in a cafe in Palo Alto and a group of programmers came in on some kind of scavenger hunt. It was obviously one of those corporate "team-building" exercises.They looked familiar. I spend nearly all my time working with programmers in their twenties and early thirties. But something seemed wrong about these. There was something missing.And yet the company they worked for is considered a good one, and from what I overheard of their conversation, they seemed smart enough. In fact, they seemed to be from one of the more prestigious groups within the company.So why did it seem there was something odd about them?I have a uniquely warped perspective, because nearly all the programmers I know are startup founders. We've now funded 80 startups with a total of about 200 founders, nearly all of them programmers. I spend a lot of time with them, and not much with other programmers. So my mental image of a young programmer is a startup founder.The guys on the scavenger hunt looked like the programmers I was used to, but they were employees instead of founders. And it was startling how different they seemed.So what, you may say. So I happen to know a subset of programmers who are especially ambitious. Of course less ambitious people will seem different. But the difference between the programmers I saw in the cafe and the ones I was used to wasn't just a difference of degree. Something seemed wrong.I think it's not so much that there's something special about founders as that there's something missing in the lives of employees. I think startup founders, though statistically outliers, are actually living in a way that's more natural for humans.I was in Africa last year and saw a lot of animals in the wild that I'd only seen in zoos before. It was remarkable how different they seemed. Particularly lions. Lions in the wild seem about ten times more alive. They're like different animals. And seeing those guys on their scavenger hunt was like seeing lions in a zoo after spending several years watching them in the wild.TreesWhat's so unnatural about working for a big company? The root of the problem is that humans weren't meant to work in such large groups.Another thing you notice when you see animals in the wild is that each species thrives in groups of a certain size. A herd of impalas might have 100 adults; baboons maybe 20; lions rarely 10. Humans also seem designed to work in groups, and what I've read about hunter-gatherers accords with research on organizations and my own experience to suggest roughly what the ideal size is: groups of 8 work well; by 20 they're getting hard to manage; and a group of 50 is really unwieldy. [1]Whatever the upper limit is, we are clearly not meant to work in groups of several hundred. And yet—for reasons having more to do with technology than human nature—a great many people work for companies with hundreds or thousands of employees.Companies know groups that large wouldn't work, so they divide themselves into units small enough to work together. But to coordinate these they have to introduce something new: bosses.These smaller groups are always arranged in a tree structure. Your boss is the point where your group attaches to the tree. But when you use this trick for dividing a large group into smaller ones, something strange happens that I've never heard anyone mention explicitly. In the group one level up from yours, your boss represents your entire group. A group of 10 managers is not merely a group of 10 people working together in the usual way. It's really a group of groups. Which means for a group of 10 managers to work together as if they were simply a group of 10 individuals, the group working for each manager would have to work as if they were a single person—the workers and manager would each share only one person's worth of freedom between them.In practice a group of people never manage to act as if they were one person. But in a large organization divided into groups in this way, the pressure is always in that direction. Each group tries its best to work as if it were the small group of individuals that humans were designed to work in. That was the point of creating it. And when you propagate that constraint, the result is that each person gets freedom of action in inverse proportion to the size of the entire tree. [2]Anyone who's worked for a large organization has felt this. You can feel the difference between working for a company with 100 employees and one with 10,000, even if your group has only 10 people.Corn SyrupA group of 10 people within a large organization is a kind of fake tribe. The number of people you interact with is about right. But something is missing: individual initiative. Tribes of hunter-gatherers have more freedom. The leaders have a little more power than other members of the tribe, but they don't generally tell them what to do and when the way a boss can.It's not your boss's fault. The real problem is that in the group above you in the hierarchy, your entire group is one virtual person. Your boss is just the way that constraint is imparted to you.So working in a group of 10 people within a large organization feels both right and wrong at the same time. On the surface it feels like the kind of group you're meant to work in, but something major is missing. A job at a big company is like high fructose corn syrup: it has some of the qualities of things you're meant to like, but is disastrously lacking in others.Indeed, food is an excellent metaphor to explain what's wrong with the usual sort of job.For example, working for a big company is the default thing to do, at least for programmers. How bad could it be? Well, food shows that pretty clearly. If you were dropped at a random point in America today, nearly all the food around you would be bad for you. Humans were not designed to eat white flour, refined sugar, high fructose corn syrup, and hydrogenated vegetable oil. And yet if you analyzed the contents of the average grocery store you'd probably find these four ingredients accounted for most of the calories. "Normal" food is terribly bad for you. The only people who eat what humans were actually designed to eat are a few Birkenstock-wearing weirdos in Berkeley.If "normal" food is so bad for us, why is it so common? There are two main reasons. One is that it has more immediate appeal. You may feel lousy an hour after eating that pizza, but eating the first couple bites feels great. The other is economies of scale. Producing junk food scales; producing fresh vegetables doesn't. Which means (a) junk food can be very cheap, and (b) it's worth spending a lot to market it.If people have to choose between something that's cheap, heavily marketed, and appealing in the short term, and something that's expensive, obscure, and appealing in the long term, which do you think most will choose?It's the same with work. The average MIT graduate wants to work at Google or Microsoft, because it's a recognized brand, it's safe, and they'll get paid a good salary right away. It's the job equivalent of the pizza they had for lunch. The drawbacks will only become apparent later, and then only in a vague sense of malaise.And founders and early employees of startups, meanwhile, are like the Birkenstock-wearing weirdos of Berkeley: though a tiny minority of the population, they're the ones living as humans are meant to. In an artificial world, only extremists live naturally.ProgrammersThe restrictiveness of big company jobs is particularly hard on programmers, because the essence of programming is to build new things. Sales people make much the same pitches every day; support people answer much the same questions; but once you've written a piece of code you don't need to write it again. So a programmer working as programmers are meant to is always making new things. And when you're part of an organization whose structure gives each person freedom in inverse proportion to the size of the tree, you're going to face resistance when you do something new.This seems an inevitable consequence of bigness. It's true even in the smartest companies. I was talking recently to a founder who considered starting a startup right out of college, but went to work for Google instead because he thought he'd learn more there. He didn't learn as much as he expected. Programmers learn by doing, and most of the things he wanted to do, he couldn't—sometimes because the company wouldn't let him, but often because the company's code wouldn't let him. Between the drag of legacy code, the overhead of doing development in such a large organization, and the restrictions imposed by interfaces owned by other groups, he could only try a fraction of the things he would have liked to. He said he has learned much more in his own startup, despite the fact that he has to do all the company's errands as well as programming, because at least when he's programming he can do whatever he wants.An obstacle downstream propagates upstream. If you're not allowed to implement new ideas, you stop having them. And vice versa: when you can do whatever you want, you have more ideas about what to do. So working for yourself makes your brain more powerful in the same way a low-restriction exhaust system makes an engine more powerful.Working for yourself doesn't have to mean starting a startup, of course. But a programmer deciding between a regular job at a big company and their own startup is probably going to learn more doing the startup.You can adjust the amount of freedom you get by scaling the size of company you work for. If you start the company, you'll have the most freedom. If you become one of the first 10 employees you'll have almost as much freedom as the founders. Even a company with 100 people will feel different from one with 1000.Working for a small company doesn't ensure freedom. The tree structure of large organizations sets an upper bound on freedom, not a lower bound. The head of a small company may still choose to be a tyrant. The point is that a large organization is compelled by its structure to be one.ConsequencesThat has real consequences for both organizations and individuals. One is that companies will inevitably slow down as they grow larger, no matter how hard they try to keep their startup mojo. It's a consequence of the tree structure that every large organization is forced to adopt.Or rather, a large organization could only avoid slowing down if they avoided tree structure. And since human nature limits the size of group that can work together, the only way I can imagine for larger groups to avoid tree structure would be to have no structure: to have each group actually be independent, and to work together the way components of a market economy do.That might be worth exploring. I suspect there are already some highly partitionable businesses that lean this way. But I don't know any technology companies that have done it.There is one thing companies can do short of structuring themselves as sponges: they can stay small. If I'm right, then it really pays to keep a company as small as it can be at every stage. Particularly a technology company. Which means it's doubly important to hire the best people. Mediocre hires hurt you twice: they get less done, but they also make you big, because you need more of them to solve a given problem.For individuals the upshot is the same: aim small. It will always suck to work for large organizations, and the larger the organization, the more it will suck.In an essay I wrote a couple years ago I advised graduating seniors to work for a couple years for another company before starting their own. I'd modify that now. Work for another company if you want to, but only for a small one, and if you want to start your own startup, go ahead.The reason I suggested college graduates not start startups immediately was that I felt most would fail. And they will. But ambitious programmers are better off doing their own thing and failing than going to work at a big company. Certainly they'll learn more. They might even be better off financially. A lot of people in their early twenties get into debt, because their expenses grow even faster than the salary that seemed so high when they left school. At least if you start a startup and fail your net worth will be zero rather than negative. [3]We've now funded so many different types of founders that we have enough data to see patterns, and there seems to be no benefit from working for a big company. The people who've worked for a few years do seem better than the ones straight out of college, but only because they're that much older.The people who come to us from big companies often seem kind of conservative. It's hard to say how much is because big companies made them that way, and how much is the natural conservatism that made them work for the big companies in the first place. But certainly a large part of it is learned. I know because I've seen it burn off.Having seen that happen so many times is one of the things that convinces me that working for oneself, or at least for a small group, is the natural way for programmers to live. Founders arriving at Y Combinator often have the downtrodden air of refugees. Three months later they're transformed: they have so much more confidence that they seem as if they've grown several inches taller. [4] Strange as this sounds, they seem both more worried and happier at the same time. Which is exactly how I'd describe the way lions seem in the wild.Watching employees get transformed into founders makes it clear that the difference between the two is due mostly to environment—and in particular that the environment in big companies is toxic to programmers. In the first couple weeks of working on their own startup they seem to come to life, because finally they're working the way people are meant to.

Notes[1] When I talk about humans being meant or designed to live a certain way, I mean by evolution.[2] It's not only the leaves who suffer. The constraint propagates up as well as down. So managers are constrained too; instead of just doing things, they have to act through subordinates.[3] Do not finance your startup with credit cards. Financing a startup with debt is usually a stupid move, and credit card debt stupidest of all. Credit card debt is a bad idea, period. It is a trap set by evil companies for the desperate and the foolish.[4] The founders we fund used to be younger (initially we encouraged undergrads to apply), and the first couple times I saw this I used to wonder if they were actually getting physically taller.

Thanks to Trevor Blackwell, Ross Boucher, Aaron Iba, Abby Kirigin, Ivan Kirigin, Jessica Livingston, and Robert Morris for reading drafts of this.

Lower P/Es now may mean... lower P/Es in the future

MARKET MOVER

Are Low P/Es A Valid Reason To Buy Stocks?

With Earnings Shaky And Inflation Climbing, More Declines Possible

By TOM LAURICELLA
March 10, 2008

(WSJ) With the economy showing clear signs of recession and the credit markets in turmoil, the floor under stock prices seems to be getting thinner. Here is another reason to worry: Stock prices aren't as cheap as they seem, and based on other periods when inflation was accelerating and the economy weak, the market can struggle for prolonged periods.

Some argue stocks are attractively priced after a 17% decline in the Standard & Poor's 500-stock index since October. Based on earnings forecasts for 2008 collected by Reuters Estimates, the S&P 500 is trading at 13.2 times projected earnings, compared with an average of 16.5 times going back to 1989, according to data compiled by Morgan Stanley.

Price-to-earnings ratios reflect the amount investors are willing to pay for future earnings. When these ratios fall below long-term trends, conventional wisdom is that stocks are cheap and it is time to buy.

Until 2000, investors feasted on the combination of rising P/E ratios and rising stock prices. At the end of the 1980-82 bear market, S&P stocks changed hands at a price-to-earnings ratio of 8.7, according to Morgan Stanley's data. In the next 17 years, the ratio moved higher, topping out just shy of 30 in the spring of 1999. During that time, when the S&P rose an average of about 17% a year, roughly one-third of returns on the S&P 500 were the result of rising P/E multiples, according to Ibbotson Associates.

That period also featured a long downtrend in inflation and interest rates, which generally lead directly to higher multiples. Now, inflation is quickening, and interest rates, while heading down, can't fall much further. This suggests an environment less conducive to rising stock multiples.

That was the case in the most recent bull market, when price-to-earnings multiples actually fell even as the market rose. When the bull market began in early October 2002, the S&P 500 had finished the previous month at a P/E ratio of 17.6 when measured against the previous 12 months earnings. This past September, just before the market began its descent, the ratio was 16.8.

It is a similar story when looking at expected earnings, the basis on which stocks currently look cheap. At the end of September 2002, the S&P 500 was priced at 14.5 times the coming 12 months expected earnings, according to Morgan Stanley. This past September, after a five-year run in which the S&P 500 rose an average of more than 15% a year, the P/E on the index was 14.8 times the coming year's expected earnings.

"The growth in stock returns came mostly from earnings growth," says Peng Chen, chief investment officer at Ibbotson Associates.

Morgan Stanley analysts contend that stubborn inflation means investors won't be willing to pay big premiums for future earnings. Goldman Sachs Group strategists say that based on typical declines in P/E ratios in the past four recessions, stock multiples can go much lower.

Nicholas Bohnsack, of Strategas Research Partners, says it is a mistake for investors to assume multiples will head higher. There have been extended periods in which multiples went down or were flat, most recently in the 1970s, he notes. Today, he says, "We're in a secular period of multiple contraction," which features lots of "sideways, grinding of multiples."

Part of the problem is that the earnings side of the equation is looking shaky. Wall Street analysts predict a double-digit increase in corporate profits for 2008, but forecasts have been pared back. As of Friday, S&P 500 stocks are expected to generate $98.25 in earnings a share this year, down from the $101.87 a share predicted at the end of last year, according to Reuters.

Analysts have taken an especially sharp knife to estimates of first-quarter earnings, which now are expected at $22.58 a share, compared with the $23.64 forecast at the end of December. That means instead of rising at a 5.1% rate, first-quarter earnings are expected to be basically flat.

Another problem is inflation. In a number of recent sessions, the stock market has reacted positively to higher commodity prices on the theory that it will boost profits of energy and materials companies. But if inflation stays stubbornly high despite the U.S. economic slowdown, it would be a negative for multiples, because it reduces the value of future earnings.

Abhijit Chakrabortti, Morgan Stanley's chief global and U.S. equity strategist, says inflation is running about 0.8 percentage point above the long-term trend of 3.5%, and value for the S&P 500 should be reduced by the same amount. With that factor taken into consideration, he argues that current fair value for the index is about 17 times trailing earnings, not much above its present reading.

Ed Easterling, president of Crestmont Research, argues that record increases in earnings and profit margins in recent years make prices look artificially cheap. He prefers to look at the 10-year trends in earnings, from which he removes the impact of inflation and smooths out the short-term ups and downs in profit margins. That, he contends, provides a cleaner picture of stock valuations.

Mark-to-market apologist defends regime

The credit crunch

Mark it and weep

Mar 6th 2008
From The Economist print edition

Mark-to-market accounting hurts, but there is no better way

WITH memories of their drubbing in the dotcom bust still fresh, accountants have kept their noses clean in this financial crisis. Once again, though, they are being dragged into the fray. That is because they are enforcing fair-value accounting, in which assets must be marked regularly to the market price: that is, what they would be expected to fetch right now in a sale. Regulators and bankers fear that this “mark-to-market” approach is helping to turn a liquidity crisis into a solvency one. As holders of mortgage-backed securities and the like revalue their assets at fire-sale prices, they are running short of capital—which can lead to further sales and more write-downs. Are the beancounters ensuring a crash?

All accounting regimes are flawed, and fair-value is no exception. It is timely and transparent, but when markets collapse, prices become less reliable. How do you mark to market when there is barely any market? Some firms rely on credit-derivative indices, but these are far from perfect proxies (see article). Others cling to internal computer models, but their accountants are cracking down on them. Banks are also being asked by their auditors to put more assets into the fair-value regime's lowest bucket (for the most illiquid assets). This adds to their woes, since such assets carry a higher capital charge.

egulators worry that mark-to-market may create a “liquidity black hole”. Nerves jangle at every fire-sale, for fear that this will become the new benchmark for sticky assets. The fear is that value-at-risk systems force investment firms and banks to offload securities, leading to price falls and further sales. The temptation is to sell now, before the next lurch down. The result will be excessive write-downs—as the stable value of assets is above today's distressed level.

That is a damning list of failings. And yet, for all its pain, fair-value accounting is still the best way to value businesses. Especially if investors and regulators treat accounting rules sensibly: as a measuring stick, not a source of universal truth.

On that score the old system of historic-cost accounting was worse. In a crisis prices fall until bottom-fishers start to buy. Yet when assets were booked at their original price, rather than the market one, banks could delude themselves—and investors—that dross was gold. Under historic-cost accounting, the banks had every reason not to restructure assets, because that meant owning up to their losses. Look at Japan, where the economy was sunk for most of the 1990s by stagnant loans to “zombie” companies. Historic-cost left investors in the dark about valuations; it was also prone to fraud and fraught with moral hazard, since sloppy lending went unpunished.

The sticky end

Mark-to-market does not have to be as bad as its critics fear. Not everyone has gorged on toxic assets, and not everyone has to mark to market. This biodiversity means there will be buyers, even in the most strained markets, at the right price. Sovereign-wealth funds have poured money into troubled banks. This week PIMCO, a big fund manager, bought $1.5 billion of American municipal bonds, where yields have jumped as the crisis spread. Warren Buffett is also sniffing around.

The place for regulators to be subtle is not in reporting the figures, but in dealing with the problems they reveal. The task is to make markets resilient when the cycle turns. Central banks could offer more protection against crises in liquidity (see article). Thicker buffers could be built into the Basel II framework for bank capital. Securitised assets could be hauled from murky over-the-counter markets to exchanges, where values are clearer. Models for valuing complex securities will be refined. And regulators and accountants could ease up when banks risk a liquidity spiral—as in Europe in 2002, when insurers faced a solvency crisis over falling share prices.

It would be perverse to ignore market signals when finance is increasingly based on broad capital markets. Fair-value accounting is indeed flawed. To paraphrase Winston Churchill, it is the worst kind of accounting, except for all the others.

The credit fallout continues

The Federal Reserve's rescue has failed
By Ambrose Evans-Pritchard, International Business Editor
Last Updated: 12:56am GMT 03/03/2008

(Telegraph) Yields on two-year US Treasuries plummeted to 1.63pc on Friday in a flight to safety, foretelling financial winter.

The debt markets are freezing ever deeper, a full eight months into the crunch. Contagion is spreading into the safest pockets of the US credit universe.

It is hard to imagine a more plain-vanilla outfit than the Port Authority of New York and New Jersey, which manages bridges, bus terminals, and airports.

The authority is a public body, backed by the two states. Yet it had to pay 20pc rates in February after the near closure of the $330bn (£166m) "term-auction" market. It had originally expected to pay 4.3pc, but that was aeons ago in financial time.

"I never thought I would see anything like this in my life," said James Steele, an HSBC economist in New York.

No sane mortal needs to know what term-auction means, except that it too became a tool of the US credit alchemists. Banks briefly used the market as laboratory for conjuring long-term loans at Alan Greenspan's giveaway short-term rates. It has come unstuck. Next in line is the $45trillion derivatives market for credit default swaps (CDS).

Last week, the spreads on high-yield US bonds vaulted to 718 basis points. The iTraxx Crossover index measuring corporate default risk in Europe smashed the 600 barrier. We are now far beyond the August spike.

Sub-prime debt is plumbing new depths. A-rated securities issued in early 2007 fell to a record 12.72pc of face value on Friday. The BBB tier fetched 10.42pc. The "toxic" tranches are worthless.

Why won't it end? Because US house prices are in free fall. The Case-Shiller index for the 20 biggest cities dropped 9.1pc year-on-year in December. The annualised rate of fall was 18pc in the fourth quarter, and gathering speed.

As the graph shows below, US households are only halfway through the tsunami of rate resets - 300 basis points upwards - on teaser loans.
The UK hedge fund Peleton Partners misjudged this fresh leg of the crunch. After an 87pc profit last year betting against sub-prime, it switched sides to play the rebound. Last week it had to liquidate a $2bn fund.

Like many, Peleton thought Fed rate cuts from 5.25pc to 3pc (with more to come) would end the panic. But this is not a normal downturn, subject to normal recovery. Leverage is too extreme. Bank capital is too eroded. Monetary traction eludes the Fed. An "Austrian" purge is under way.

Credit Suisse says the cost of the credit debacle will reach $600bn. "Leveraged risk is a cancer in this market."

Try $1trillion, says New York professor Nouriel Roubin. Contagion is moving up the ladder to prime mortgages, commercial property, home equity loans, car loans, credit cards and student loans. We have not even begun Wave Two: the British, Club Med, East European, and Antipodean house busts.

As the once unthinkable unfolds, the leaders of global finance dither. The Europeans are frozen in the headlights: trembling before a false inflation; cowed by an atavistic Bundesbank; waiting passively for the Atlantic storm to hit.

Half the eurozone is grinding to a halt. Italy is slipping into recession. Property prices are flat or falling in Ireland, Spain, France, southern Italy and now Germany. French consumer moral is the lowest in 20 years.

The euro fetches $1.52 (from $0.82 in 2000), beyond the pain threshold for aircraft, cars, luxury goods and textiles. The manufacturing base of southern Europe is largely below water. As Le Figaro wrote last week, the survival of monetary union is in doubt. Yet still, the ECB waits; still the German-bloc governors breathe fire about inflation.

The Fed is now singing from a different hymn book, warning of the "possibility of some very unfavourable outcomes". Inflation is not one of them.

"There probably will be some bank failures," said Ben Bernanke. He knows perfectly well that the US price spike is a bogus scare, the tail-end of a food and fuel shock.

"I expect inflation to come down. I don't think we're anywhere near the situation in the 1970s," he told Congress.

Indeed not. Real wages are being squeezed. Oil and "Ags" are acting as a tax. December unemployment jumped at the fastest rate in a quarter century.

The greater risk is slump, says MIT Professor Paul Krugman. "The Fed is studying the Japanese experience with zero rates very closely. The problem is that if they want to cut rates as aggressively as they did in the early 1990s and 2001, they have to go below zero."

This means "quantitative easing" as it was called in Japan. As Ben Bernanke spelled out in November 2002, the Fed can inject money by purchasing great chunks of the bond market.

Section 13 of the Federal Reserve Act allows the bank - in "exigent circumstances" - to lend money to anybody, and take upon itself the credit risk. It has not done so since the 1930s.

Ultimately the big guns have the means to stop descent into an economic Ice Age. But will they act in time?

"We are becoming increasingly concerned that the authorities in the world do not get it," said Bernard Connolly, global strategist at Banque AIG.

"The extent of de-leveraging involves a wholesale destruction of credit. The risk is that the 'shadow banking system' completely collapses," he said.

For the first time since this Greek tragedy began, I am now really frightened.