After a 1200 pt rally in the Dow the market has come to its senses and started bailing again. It’s a year now since Bear Stearns stumped up $3bln plus to bail out one of its funds thereby signalling the start of the crisis.

The news is bad wherever you look but the focus now is on the banks and whether they will be able to shore up their balance sheets which have more holes than a block of Emmental.

The pressure of continued write downs will simply hasten the inevitable collapse of a major institution. The big question is how the banks will be re-capitalised.

The first wave of capital provided by overseas investors has resulted in major losses and burnt fingers. Sovereign funds may be a little more wary this time round even if the price is way cheaper.

The Naked Capitalist reports on discussions the Fed has been having with private equity companies to see if they might be interested in stumping up some cash. However, there are issues of bank ownership and the size of stake any non-bank organisation can take. The word is that the Fed could seek to relax these rules.

This does not fill one with confidence.

Closer to home NZ finance companies are collapsing like a house of cards. It’s hard to know if any will be left. Already prosecutions are underway against accountants who signed off on the books of failed companies. I wonder how bank auditors will be feeling when they come to sign off the books of the major banks and see a long list of assets “uanble to be valued” properly.

There should be caveats galore.

But the question remains as to whether the crisis will spread to the major banks. If it does we could see queues around the corner of all our financial institutions before too long. I’d certainly advise people to have a bit of cash set aside and money spread around various banks. Having said that NZ is one of the only countries in the OECD not have have deposit insurance for banks.

Given the central banks moves so far it’s safe to say the banking system is underwritten to some degree but if you own shares in a bank i would be very uncomfortbale about that.

New Zealand joins its larger and more illustrious economies, the U.S. and the U.K., on the slippery slope with the release today of pretty poor employment numbers. 29,000 jobs lost is no small number for a small economy and with retail numbers looking very soft as well, the Reserve Bank will soon be reaching for the “cut” lever on its interest rate management dashboard.

Regardless of the credit crunch, employment really is the key to how the economy will fare. As long as people are employed then somehow they can get by and service their debts. Well mostly. But now this will see a deeper problem emerge and that is one where people simply cannot service mortgages or debt in any way.

This will reverberate throughout the whole economy. Added to this is a report out today showing house sales down 40% in the last quarter and 53% lower last month from the previous year.

Ouch.

We’re starting to see real signs of a weakening house market here in New Zealand. Sales for Auckland’s top real estate company are down over 50% and a recent auction saw a 6% clearance rate.

I decided ton investigate this myself in Christchurch and looked at some properties recently. One i saw was a 3 bedroom unit which had been bought for $375,000 a year ago. It could be rented for about $350 a week maybe a bit more if it had some money spent on it. It wasn’t in great condition but looked a reasonable investment property.

It was auctioned yesterday and passed in at $317,500. It still hasn’t sold.

We’re not really seeing this come through into prices yet because we only get the median price which is often misleading. In fact it can go up if a few properties sell in the higher brackets and none in the lower levels.

But it’s clear that prices are falling quite heavily in many areas and there is a buyers strike on at the moment.

Although there is the belief that property prices increase regardless the market is clearly starting to realise that capital gains are not guaranteed and therefore investors are starting to look more closely at the maths.

Mortgage rates are 9.5% for 2 years fixed. Yields are 3-5% and prices are falling. Even with the negative equity tax break that’s a big yield gap to fill. There is also the issue of not being able to borrow 100% of the price anymore.

With many fixed rates rolling over this year to much higher rates, the squeeze is really on. This will really start to impact when banks ask for properties to be revalued and then ask for extra equity.

Property investors, like banks, are facing a major liquidity crisis.  Price falls of 10-20% may not be as outlandish as previously thought.

Following on from their generous bail out of Northern Rock, the UK Government, otherwise know as the taxpayer, has opened its arms to any old piece of paper banks have sitting around on their balance sheet.

Or to be more accurate, the Bank of England will accept mortgage backed securities in return for government bonds. Nice trade if you cant get it. The amounts mentioned are 50 to 200bln pounds (where the hell is my pound key?) but basically it’s a free for all.

Now we can expect to see banks reaching for the refinancing button in order to take advantage of this. RBS has already put its hand up for 10 to 12bln of fresh capital plus a 6bln write down.

Ok so its just more mess. The markets may rally on this hoping it can help clear the looming crisis in the mortgage market but the numbers are really starting to mount up and this is just very bad news indeed.

The key issue here is the capital adequacy of the banking system. It’s proven to be the achilles heel which is why the authorities have had no option but to underwrite the system.

Given this exposure of the fragility of the banking system it is time to ask questions about capital adequacy and the way banks are regulated and allowed to operate.

Merrills realeased another $9bln from trading losses and decided to fire 4000 people who probably never made a trade in their life. That brings the total for 3 quarters to $29bln, a not insignificant sum.

Citigroup was in there as well with another $5bln loss for the quarter and another 9000 jobs to go in addition to the 13000 already on the streets.  Naturally the stock rallied…phew only $5bln!

It’s interesting to see how far this continues because this isn’t a good show at all. The numbers just keep getting bigger and bigger. Citigroup still has $60bln worth of exposure to sub-prime and other loans. What worries me is the 7.7% Tier 1 capital adequacy ratio.

That is what this is all about. Leverage to the hilt and be damned. Banks have become nothing more than licenced fronts for gambling.  Fair enough but that isn’t why people deposit their money in them.

Safe as houses? Well that depends what the house is worth.

The G7 communique from the current meeting makes for interesting reading. Their focus has been wide ranging and, for a change, not just on currencies though the headline statement does make a clear reference to recent moves.

What I took note of was their concerns around bank capital. This is really where the crunch point is located. They call for the Basel Committee to review liquidity risk management guidelines and a quick disclosure of write downs ands revaluations (or in reality devaluations).

The accounting for off balance sheet items was also raised, particularly the valuation of assets in a time of financial stress. That should cause palpitations amongst traders of credit default swaps. Quite frankly some of this stuff can only be valued when its traded. The idea that there is some kind of two way market is really a myth. That in itself should make regulators, as well as bank shareholders, sit up and think about some of the toxic trades sitting around on the books.

They also call for a speedy implementation of Basel II. I think they should tear up Basel II and move straight onto Basel III but more on that another time.

They realise the game is up and the time has come for a thorough overhaul of the system itself. It will be interesting to see how this plays out as more and more unwinding takes place. As far as currencies go, China was gently reminded to hurry up and revalue the Yuan and the market was reminded that G7 wasn’t happy about some of the moves we had in March.  Whether that helps the $ is anyone’s guess but they better have an intervention plan up their sleeves before the $ takes another big dump.

The markets had a nice rally but reality is never too far away in markets and the last couple of weeks may have just been a pause for thought.