The  Board  of  Directors  of  Courage Marine Group  Limited  (the  “Company”)  is  pleased  to
announce  that  Zorina  Navigation  Corp.  (“Zorina”),  a  wholly-owned  subsidiary  of  the
Company’s  wholly-owned  subsidiary,  Courage  Marine  (Holdings)  Co.,  Limited,  has  on  2
October  2008  entered  into  a  Memorandum  of  Agreement  with  Soft  Holdings  S.A.,  to
purchase a secondhand vessel, MV Marigold (the “Vessel”), for US$16 million.

The Vessel was built in 1982 in Korea with 48,355.1 Dead Weight Tons.

The purchase price of the Vessel will be funded from the proceeds of  the Company’s initial public offering (“IPO”) and the Company’s retained earnings. This is in accordance with the use of proceeds as stated in the prospectus dated 3 October 2005 issued in connection with the IPO.

The price of US$16 million was arrived at on a willing buyer, willing seller basis, taking into account recent transactions for the sale and purchase of vessels of similar type and age. No formal valuation was commissioned on the Vessel as the market practice is to consider the value of a vessel to approximate that of the prevailing market prices (which are available on the open market) of vessels of similar type and age.

Zorina  expects  to  take  delivery  of  the  Vessel  between  15 October  2008  and  30 October 2008 and subject  to  the charter or hire of  the Vessel  thereafter,  the Company expects  the Vessel to contribute to the revenue of the Group for the last quarter of FY2008.

For  the avoidance of doubt, as  the acquisition of  the Vessel  is  carried out  in  the ordinary course of the business of the Group, it does not fall under Chapter 10 of the Listing Manual.

None of the Directors or controlling shareholders of the Company has any interest, direct or indirect, in the acquisition of the Vessel.

Perhaps second hand ships are really getting very cheap, as according to this article from Lloyds:

DRY bulk owners could find themselves in breach of their loan conditions and some may face bankruptcy after a record drop in secondhand values.

The issue of falling asset values that are linked to loans is now a big problem according to brokers.

“As long as secondhand vessel prices continue to fall, which seems likely in the short-term, and equity prices fall or at the very least remain at current levels, our industry has a serious problem,” Imarex frieght options broker Jeffrey Landsberg told Lloyd’s List.

“As the weeks and months progress, I expect more companies will have problems paying back their loans.”

In the last 12 days there has been on average one bankruptcy every three days, which is “just the start”, according to Tufton Oceanic research director Andreas Vergottis.

Mr Vergottis told Bloomberg that a fifth of the world’s listed dry bulk companies may soon have a “negative net worth,’’ based on fleet value compared with outstanding debt.

“Maybe by some fluke, these 20% of companies will find money from somewhere, but then there will be others,” he said.

While companies such as Industrial Carriers and Svithoid Tankers marked the start in a chain of bankruptcies this month, Britannia Bulk Plc’s recent problems are being seen as the first signs of the effects of falling ship prices for many listed dry bulk companies.

On Wednesday, Nordea Bank Denmark and Lloyd’s TSB Group asked dry bulk operator Britannia Bulk for immediate repayment of $158.7m outstanding on a loan due to a default on the terms.

By today the New York Stock Exchange had suspended trading of Britannia Bulk Holdings and said that the company was in the process of de-listing.

“The Company is currently in ongoing negotiations with the lenders regarding a sale of certain of its operating assets to settle this bank default, which if consummated, would not be expected to result in any return to the Company’s common shareholders,” the NYSE explained in a statement.

Britannia Bulk had previously warned of the high risk of it breaching the terms as the asset values of the five ships used to secure the loan had plummeted.

Loans agreements normally include a loan to value clause that states the loan should only be 70% of the value of the ships used to secure it, and if the value falls then the bank can ask the borrower to repair it.

The secondhand cost of capesize carriers has dropped to $68.8m, from an all-time high of $153.8m in July, according to the Baltic Exchange.

DVB Bank board member Dagfinn Lunde told Lloyd’s List that he expects the larger dry bulk listed companies will be OK, as many are “cash rich and should be able to repair” the loan.

Repair can include providing extra cash or security and also if the owner finds additional income for the ship that makes it look “OK for the bank”, said Mr Lunde.
“If you have bought a ship in last two years and leveraged it very high or done newbuildings at higher prices then that is where the big issues will come up from.

“For the moment it will be only the marginal players that leveraged up recently [that are most at risk]. I would expect that to be the smaller players,” Mr Lunde added.

What do Starbucks and China have in common? A lot! Both got us hooked on consumption: one of fancy, expensive caffeinated liquids; the other on cheap foreign made goods. Both have defied the conventional wisdom – they grew faster and longer than common sense told us was possible. They also share another striking commonality: both are suffering from late stage growth obesity (LSGO).

The Starbucks story

With the beautiful benefit of hindsight we know what happened to Starbucks – it grew too fast, opened too many stores, and sacrificed its own standards to meet unrealistic targets. The company first claimed that it only had a few hundred stores that it needed to close, and then the few hundred spilled into six hundred. Weak consumer spending will likely push Starbucks to re-examine its store count again, doubling or tripling the store closures.

Starbucks percentage of new stores growth in 2007 was only slightly lower than it was in 1999. But in 1999 it had 2,000 stores; in 2007 it was pushing a 10,000 company owned stores mark. Let’s put this in perspective: in 1999 Starbucks opened 447 stores – 1.8 stores per working day; in 2007 that number more than tripled to 1,403 stores a year – 5.5 stores per working day.  At this level of growth physical limitations come in: there is only so much real estate that fits a company’s criteria at a certain point in time. Management started sacrificing on the quality of their decisions, compromises were made that were unthinkable several years before. Stores were opened too close to each other or on the wrong side of the street, expensive leases were signed, they even hired baristas that would have fit in better at McDonalds – you get the idea.

Unfortunately the present and the future will pay for the decisions of the past: stores will need to be closed, long-term leases terminated, charges taken, corporate costs created in hopes of high growth eliminated, and corporate culture of partnership strained by barista layoffs.

Starbucks needs to go on a permanent growth diet (at least in the US), and realize that it has the metabolism of a 37 year old and can digest fewer new stores. By tightening its standards for opening new stores the company will be on the way to recovery, though at slower growth. Starbucks is blessed with financial strength, capable management and unbelievable brand.  If management admits to themselves that the heydays of growth are behind, recovery should be fairly painless. Starbucks generates tremendous operating cash flows, which in the past were completely consumed by opening new stores.  If the company were to go on the LSGO diet, its capital expenditures would decline and free cash flows balloon – the value unlocked.

But this discussion is not about Starbucks, it is about what is taking place in China.

The Great China story

The benefit of hindsight that provides clarity in analysis of Starbucks today is not there for China, at least not yet. But if you were to open your mind and look past today’s cheery newspaper headlines you’d see that China is suffering from a severe case of LSGO.

Ten for ten. Since 1998 its GDP has grown at about a 10% annual real growth rate, and its economy more than tripled in size (in real terms). There were no recessions, just expansion – the Chinese miracle growth? The origins of China’s tremendous growth are well known: large population migrating from low (farming) to higher productivity (manufacturing) activity, cheap labor, a capitalism-friendlier communist government, and insatiable demand from the US and the rest of the developed world for cheap goods.

Unlike Starbucks – a private enterprise that has free market principles deeply inbred in its DNA – China is a communist country.  Though it is moving towards free market capitalism, it is not there yet. The rule of law is weak, the country infested with corruption, and due to central planning and tight government control of the banking system capital is often allocated based on cronyism (or political relationships) not merit.

Prolonged high growth in this environment results in inefficiencies that are compounded year after year. In other words, though the growth is high, the quality of growth is low, thus asset allocation decisions are likely to be poor. The ten year super-high growth marathon put China at high risk, actually more likely of a certainty, of a severe case of LSGO.

From today’s perch we can only guess of the consequences of LSGO, but we’ll gain that clarity after the fact – a luxury we don’t have. Newspapers that are praising the Chinese growth miracle today will write exposes on what went and is going wrong in China.

I have absolutely no facts to back up what I am about to say, but it is not hard to imagine future stories about poverty stricken farmers that moved to big cities for a better life and found despair; or that inland migration (from farming to factories) only brings a onetime productivity jump as poorly educated farmers-turned-factory-workers add little to productivity improvements afterwards; or how weak and debt ridden the financial system is; or the devastating impact that pollution has on health and productivity; or how the biggest shopping mall in the world, that happens to be in China, is almost completely empty.

Oh wait, the story about the shopping mall is not a figment of my imagination (I am not that good) but has already taken place.  In 2005 NY Times ran an article titled China, New Land of Shoppers, Builds Malls on Gigantic Scale, it talked about the biggest shopping mall in the world that happened to be in Dongguan, China. The article said:

“Not long ago, shopping in China consisted mostly of lining up to entreat surly clerks to accept cash in exchange for ugly merchandise that did not fit. But now, Chinese have started to embrace America’s modern “shop till you drop” ethos and are in the midst of a buy-at-the-mall frenzy…. by 2010, China is expected to be home to at least 7 of the world’s 10 largest malls… Already, four shopping malls in China are larger than the Mall of America. Two, including the South China Mall, are bigger than the West Edmonton Mall in Alberta, which just surrendered its status as the world’s largest to an enormous retail center in Beijing.” (emphasis added)

Fast forward three years and you find a very different story: the biggest mall in the world – the South China mall, with space for fifteen hundred stores, only has a dozen stores open for business – it is empty. Shoppers never materialized. Billions of dollars have been wasted.

Analyzing the Chinese economy while it is growing at superfast rates is like analyzing a credit card company or a mortgage originator during an economic expansion – all you see is reward – the growth.  But the defaults – the risk – are masked by a healthy economy and constantly increasing new business that is profitable at first. The true colors of that growth only appear after the economy slows down and new accounts mature.  (In fact, the banks or credit card companies in the U.S. that showed the lowest loan growth during last expansionary cycle have a lot fewer credit problems than those that did – U.S. Bank Co comes to mind here.)

The consequences of LSGO are likely to be very painful for China. As of today we don’t know how much of the recent growth came from wasteful, unproductive growth. Only after a slowdown will the true problems surface.

The Speed. What makes things even worse is that China cannot afford a slow down. I discussed this in the past but it is worth repeating. The Chinese economy is like the bus from the movie “Speed”. In the movie the bus is wired by a villain (played by Dennis Hopper) with explosives, and will explode if its speed drops below 50 miles per hour. The Chinese economy has 1.3 billion unsuspecting people on board. It could blow if economic growth drops below its historical pace.

A combination of high financial and operation leverage sprinkled with past high growth rates will send this economy into a severe recession if growth rates slow down. Let me explain:

High operational leverage. China has become a de facto manufacturer for the world. With the exception of food products, it is difficult finding a product that was not, at least in part, manufactured in China. Industrial production accounts for 49% of GDP, double the rate of most developed nations (i.e. industrial production for the United States is 20.5 % of GDP, UK 18.2% , and Japan 26.5%).

Chinese miracle growth is largely driven by the manufacturing sector; historically its industrial production grew at a faster rate than GDP. The manufacturing industry is very capital intensive. Building factories requires a large upfront investment. High commodity prices and rapid wage inflation has driven those costs up. Once a factory is built the costs of running it are to a large degree independent of the utilization level – they are fixed – a classical definition of operational leverage. On top of these factors, laying-off workers is a politically sensitive process in China, which creates another layer of fixed costs.

High financial leverage. Debt is the instrument of choice in China. Due to a lack of equity-fund- raising alternatives (their stock market is very young), bank debt and underground finance companies that charge very high interest rates are the predominate sources of capital in China – this generates a great degree of financial leverage. (Though according to my friend Bill Mann, The Motley Fool’s advisor of Global Gains newsletter, a frequent visitor to China, state owned enterprises are much more leveraged than private enterprises.)

Total operational leverage. Large piles of debt (financial leverage) combined with high fixed costs (operational leverage) create a very high total operational leverage.

Total operational leverage in China is elevated further as factories are built to accommodate future demand – this is a classical byproduct of LGSO. It is a human tendency to draw straight lines and thus making linear projections from the past into the future. During the fast growth period the angle of the straight lines is tilted upward, causing an over investment in fixed assets, as inability to keep up with demand may cause manufacturers to lose valuable customers. (Fear of over investment is overrun by fear of losing customers.)

This type of thinking results in tremendous overcapacity when demand cools. Here is an example: let’s say a company saw demand for its widgets rise 10% year after year. It builds a new factory to accommodate future demand, let’s say five years. It will likely model a 10% annual increase in demand as well. But what if demand comes in at 6% a year over the next five years? This will translate into overcapacity – not 4% but 20% (4% per year times five years). Suddenly you don’t need to build factories or add capacity for awhile.

This greatly leveraged growth is terrific as long as the economy continues to grow at a fast pace: sales rise, costs rise at a slower rate (in large they are fixed) – margins expand – the beauty of leverage. However, leverage is not so sweet and soft when sales decline. Overcapacity is a death sentence in the manufacturing (fixed costs) world. As companies face overcapacity or slowdown in demand, they try to stimulate sales by cutting prices, which in part lead to price wars (similar to what we observed in the U.S. between Sprint, MCI and AT&T in the long distance business during the mid 90s) and to a fatal deflation. Sales decline, costs remain the same – margins collapse.

The weakness in the US and European economies will temper demand for Chinese made goods. China is already showing first signs of slow down – inflation is increasing and rate of real growth is decreasing.

It gets worse: high commodity prices

Chinese demand for stuff (oil, metals, machinery etc…) has a tremendous impact on commodities, driving their prices many fold. High (and rising) commodity prices are negative for developed world economies but they are catastrophic to developing economies – they bring comparatively higher inflation and often stagflation. Here is why:

Inflation is sourced from two broad categories: commodities (stuff) and wages. Emerging markets are twice as cursed when it comes to inflation:

1. Commodity prices (less shipping costs and government controls – the Chinese government limits price increases on certain commodities, but we know that doesn’t work in the long-term) are the same around the world. Thus the U.S. and China will see a similar increase in commodity prices (at least in dollar terms). But the commodity component represents a larger portion of the total product cost in China than in the U.S., as wages in China are a less significant component of a total cost. For instance, bread baked in the U.S. and China will require the same amount of wheat and wheat will cost as much. But baker wages will be significantly larger in the U.S. than in China and will result in a much higher cost of the finished product. Therefore, a spike in wheat prices will have a larger impact on the loaf of bread in China than in the US.
2. Wage inflation: the US and Europe have little wage inflation, as rising unemployment has diminished the already weak bargaining power of the labor force, keeping wages in check. Economic expansion has put significant upward pressure on wages inflation in China (and India as well).

In combination, these two factors were responsible for inflation in high single digits in China, double the rate of inflation in the U.S.

China is not the cheapest place in the world to manufacture, not anymore. To its benefit, cheaper countries (Singapore, Vietnam etc…) are not big enough to steal a significant amount of capacity and the US in many cases doesn’t have the needed infrastructure to bring manufacturing back. Appreciation in the renminbi and high oil prices (which are driving shipping rates up, placing a significant premium on the distance factor) are making Chinese produced goods even less attractive. Something has to give: either the U.S. will consume less or China will keep prices low to stimulate the demand, swallowing the loss, or a combination of both.

It gets even worse…

I constantly catch myself wanting to say “the story only gets worse”, but unfortunately it does. The US and Europe can cope with energy and food inflation a lot better than China and other developing nations, as we spend a lot less on food and energy as a percent of our income and have a lot more discretionary income. (Just take a look at magazine section in the book store. There is probably a fishing magazine for the left handed fishermen.)

Though the Chinese consume a lot less gasoline than Americans. They don’t have as many cars and don’t drive as much, but they do have stomachs – they eat. High energy prices have translated in food inflation that in China runs in the high teens. The average American family spends only 15% of their household budget on food, whereas the Chinese spend 37% . Maybe this is one of the reasons their shopping malls are empty. People that pay high gasoline prices but are full don’t riot, but hungry people do. The current situation raises political risk in China and also the chances that government (social) intervention will rise. This also puts in doubt the significant development of a Chinese middle class, at least in the near future.

When I wrote an article for Financial Times in May discussing risks in stuff stocks (commodities, energy and industrials) I called today’s environment “a global commodity bubble”. I was imprecise, after a conversation with the brilliant Ed Easterling of Crestmont Research (by the way, Ed wrote “Unexpected Returns” – a must read) and reading a wonderful interview with James Montier by Kate Welling, I’d like use James’ more precise definition of today’s environment: a “global growth expectations” bubble. After all, it is the supply demand (to a large degree) that was responsible for this unprecedented growth in “stuff”, shifting the mentality of the market into “this time is different” gear. It is not.

In the past “stuff” stocks were cyclical, their margins played a very predictable foxtrot of bouncing together with the whims of the US economy. Today they are behaving if as Google is their middle name – their sales are climbing in double digits, margins keep expanding and now they are called “growth” stocks. They are not.  It is just Chinese late stage growth obesity, which has disproportionately impacted the demand for stuff, creating an expectation that the “growth story” will continue forever. Nothing is forever. Starbucks discovered that and so will China. China is likely to have a bright future, but it doesn’t consist of straight to the sky growth trajectories.

Implications. Demand for commodities will decline, while more supply from past investments (there is a significant lag) will be coming to the market – they’ll come crushing down to earth. Companies that make stuff will suffer, their margins are at multi-multi-multi-year highs, margins pendulum will swing the other way, to the other extreme. Suddenly they won’t appear to be as cheap. (Take a look at my January Barron’s article in which I discuss the risk in corporate margins and May Financial Times article which explores China and stuff stocks.)

Economist Nouriel Roubini have always come across as a perma-bear. He was especially critical during this economic crisis and forecast more problems to follow.

This is a long Barron’s interview with him and he shares his thoughts on this crisis and explains he is not a perma-bear.

LIKE THE EXHORTATIONS OF JEREMIAH TO THE NATION OF Israel before the first temple’s destruction, the warnings of economist Nouriel Roubini fell on deaf ears. For the past two years Roubini, a professor at New York University, has cautioned about a huge housing bubble whose bursting would lead to a 20% drop in home prices; a collapse in subprime mortgages; a severe banking crisis and credit crunch; the near-failure of Fannie Mae and Freddie Mac , and a U.S. recession of a magnitude not seen since the Great Depression. So far, this latter-day prophet of doom has been on the mark, though time will tell about the recession part.

A Turkish native who grew up in Italy, Roubini trained at Harvard and later advised the Clinton White House, after his blog on the Asian financial crisis attracted the attention of Washington’s economic and political elite. Roubini still publishes the blog — the RGE Monitor — and teaches economics at NYU’s Stern School of Business. We caught up with him recently at his offices in lower Manhattan, and continued the conversation at Barron’s. For his latest predictions, please read on.

Barron’s: Unfortunately for the rest of us, you have a pretty good track record. How much more misery lies ahead?

Roubini: We are in the second inning of a severe, protracted recession, which started in the first quarter of this year and is going to last at least 18 months, through the middle of next year. A systemic banking crisis will go on for awhile, with hundreds of banks going belly up.

Which banks, specifically, will fail?

I don’t want to name names, but many, given the housing bust, will become insolvent. Their losses are mounting because they have written down only their subprime loans so far. They haven’t started writing down most of their consumer-credit losses, and reserves for losses are much less than they should have been. The banks are playing all sorts of accounting gimmicks not to recognize them. There are hundreds of millions of dollars outstanding in home-equity loans that eventually could be worth zero, too.

So far, we have seen no recession in the technical sense: two consecutive quarters of negative growth in real GDP. Why not?

The definition of a recession isn’t only two consecutive quarters of negative growth. The NBER (National Bureau of Economic Research) puts a lot of emphasis on things like employment, and employment has already fallen for seven months in a row. It also emphasizes income and retail and wholesale sales. Many of these things are declining.

Maybe the recession started in January; if you look at the data on gross domestic product on a monthly basis between February and April, GDP was falling. Saying this is not a recession is just a joke. Maybe instead of a ‘U’ recession and recovery, it will be a ‘W,’ with a rebound in the second quarter. But by the third quarter, the effect of the government’s tax rebates is totally gone, because other forces on the consumer are more persistent and negative.

Which forces, for instance?

The U.S. consumer is shopped out and saving less. Debt to disposable income has risen to 140% from 100% in 2000. Hit by falling home prices, the consumer no longer can use his house as an ATM machine. The stock market is falling and (issuance of) home-equity loans (has) collapsed. We have a credit crunch in mortgages, and gas is around $4 a gallon. Everyone says, ‘yeah, that’s true, but as long as there is job generation there is going to be income generation and people are going to spend.’ But for seven months in a row, employment in the private sector has fallen.

The most worrisome thing is that in spite of the rebates, retail sales in June were up only 0.1%. In real terms, they were down. If people were not spending their rebate checks in June, what will happen when there are no more checks?

Good question. How do you think Federal Reserve Chairman Ben Bernanke has handled the crisis so far?

The Fed’s performance has been poor. More than a year ago the Fed said the housing slump would end, but it hasn’t. They kept repeating this was a subprime-debt problem only, whereas the problems of excessive credit involve subprime, near-prime, prime, commercial real estate, credit cards, auto loans, student loans, home-equity loans, leveraged loans, muni bonds, corporate loans — you name it.

The Fed’s other mistake was to believe the collapse of the housing market would have no effect on the rest of the economy, when housing accounted for a third of all job creation in the past few years. When the proverbial stuff started to hit the fan last summer, the Fed went into aggressive-easing mode. But it has always been kind of catching up.

What should Bernanke have done a year ago, or even prior to that?

The damage was done earlier, beginning when the Greenspan Fed lowered interest rates in 2001 after the bust of the technology bubble, and kept them too low for too long. They kept cutting the federal funds rate all the way to 1% through 2004, and then raised it gradually instead of quickly. This fed the credit and housing bubble.

Also, the Fed and other regulators took a reckless approach to regulating the financial sector. It was the laissez-faire approach of the Bush administration, and (tantamount to) self-regulation, which really means no regulation and a lack of market discipline. The banks’ and brokers’ risk-management models didn’t make sense because no one listens to the risk managers in good times. As Chuck Prince (the deposed CEO of Citigroup) said, ‘when the music plays you have to dance.’

Now the regulators are attempting to make up for lost time. What do you think of their efforts?

The paradox is they’re going to the opposite pole. They are overregulating, bailing out troubled participants and intervening in every market. The Securities and Exchange Commission has accused others of trying to manipulate stocks, but the government itself is now the manipulator. The regulators should investigate themselves for bailing out Fannie Mae (FNM) and Freddie Mac (FRE), the creditors of Bear Stearns and the financial system with new lending facilities. They have swapped U.S. Treasury bonds for toxic securities. It is privatizing the gains and profits, and socializing the losses, as usual. This is socialism for Wall Street and the rich.

So the government should have let Bear Stearns fail, not to mention Fannie and Freddie?

If you let Bear Stearns fail you can have a run on the entire banking system. But there are ways to manage Bear or Fannie and Freddie in a fairer way. If public money is to be put at stake, first all the shareholders of these companies have to be wiped out. Management has to be wiped out, and the creditors of Bear should have taken a hit. Why did the Fed buy $29 billion of the most toxic securities, and essentially bail out JPMorgan Chase (JPM), which bought Bear Stearns?

Because JPMorgan was a counter-party?

Exactly. The government bailed out everyone. Even the unsecured creditors of Fannie and Freddie should have taken a hit. Sometimes it is necessary to use public money to rescue institutions, but you do it in a way in which you’re not bailing out those who made the mistakes. In each one of these episodes the government bailed out the shareholders, the bondholders and to some degree, management.

At what point does the government run out of money to lend to troubled banks?

Many public institutions are themselves going bankrupt. The FDIC (Federal Deposit Insurance Corporation) has only $53 billion of funds, and has already committed almost 15% of it to bail out depositors of IndyMac. The FDIC’s deposit-insurance premiums weren’t high enough, and now it is asking Congress to raise them. Plus, the agency claims only nine institutions are on its watch list. IndyMac wasn’t on the watch list until June, the month before it collapsed. Studies done by experts in banking suggest that at least 8% of U.S. banks are in big trouble. Eight percent of the roughly 8,500 that the FDIC essentially is insuring equals about 700 banks. Another 8% to 16% also are shaky, so some 700 potentially are going bust and another 700 eventually could join them. Yet the FDIC is watching only nine institutions. It’s a joke.

What recourse will the taxpayer have?

The taxpayer’s bill is going to be huge. I estimate this financial crisis will lead to credit losses of at least $1 trillion and most likely closer to $2 trillion. When I made this analysis in February everybody thought I was a lunatic. But a few weeks later the International Monetary Fund came out with an estimate of $945 billion, Goldman Sachs (GS) estimated $1.1 trillion and UBS (UBS) $1 trillion. Hedge-fund manager John Paulson recently estimated the losses would be $1.3 trillion, and late last month Bridgewater Associates came up with an estimate of $1.6 trillion. So, at this point $1 trillion isn’t a ceiling, it’s a floor. And the banks, as I’ve said, have written down only about $300 billion of subprime debt.

How long will it take for the collapse in the banking sector to play out?

It is happening in real time. Many smaller banks are going bust already. More than 200 subprime-mortgage lenders have gone bust in the past year alone. And many community banks will go bankrupt. Community banks usually finance everything: the homes, the stores, the downtown, the commercial real estate, the shopping center. If you are in a town or a municipality where there is a housing bust, the bank is gone. Of three dozen or so medium-sized regional banks, a good third are in distress. That includes the Wachovias and Washington Mutuals of the world. Half of this group might go bankrupt. Even some of the majors could end up technically insolvent, though they might be deemed too big to fail.

Take Citigroup. In 1991 there was a small real-estate bust, though the quarterly fall in home prices was only 4%, based on the S&P/Case-Shiller indices. Citi was effectively bankrupt and signed a memorandum of understanding with the Fed that allowed the government to give the bank regulatory forbearance. Citi was allowed to ride it out and try to recapitalize in a few years, and thereby avoid bankruptcy protection. This time around the S&P/Case-Shiller indices indicate home prices already have fallen 18%. The decline could be as much as 30%, because the excess supply is huge.

Nouriel, have you always been so negative about everything?

No. I’m actually a pretty mainstream economist. I was trained first in Italy and then in the U.S. and earned my Ph.D. at Harvard. My interests are in international market economics and international finance, and I’m not a ‘perma-bear’ on the stock market nor an eternal pessimist.

Leaving aside the fact that we are going to have a pretty nasty recession and international crisis, the global economy is going to grow at a sustained rate once this downturn is over. There are significant financial and economic problems in the U.S., and that’s why I’m bearish about the U.S. But the emergence of China and India and other powers is going to shift global economics and politics radically, and the world is going to be more balanced in the future, rather than relying on one engine, which has been the U.S. There are big issues ahead: How do you integrate the 2.2 billion Chinese and Indians into the global economy? There will be transitional costs and the displacement of workers, both blue-collar and white, in the advanced economies. But I’m quite bullish about the state of the global economy, and I’m positive about the medium and long term.

That’s a relief. Thank you.

In trouble times in one sector, there is bound to be losers. Likewise, there will be the winners, the sharks that take advantage of others’ pitiful plight to consolidate and expand their position. Such is the nature of business. Jubak here writes on 5 of the most likely winners.

Where there are losers, there are going to be winners.

In my previous column I picked five financial companies that had lost part or all of their competitive edge because of the current crisis in the financial industry.

All these companies — American International Group (AIG, news, msgs), Citigroup (C, news, msgs), Merrill Lynch (MER, news, msgs), Wachovia (WB, news, msgs) and Washington Mutual (WM, news, msgs) — will, at best, lose market share to rivals.

Today’s column is about the five financial companies that are best positioned to pick up the pieces. Each one is an intense rival of one or more of the five companies so damaged by the meltdown in the markets for everything from mortgages to credit cards to car loans to complex instruments that were supposed to take the risk out of buying debt.

Each one of these winners is going to gain market share at the expense of its challenged competitors. It’s pretty easy to pick up business against a competitor that’s still firing people, selling off whole businesses and scrambling to find enough capital to keep regulators at bay. The issue for these five winners isn’t whether they’ll grab market share but how much they’ll seize.

My five winners from the financial crisis are ING Group (ING, news, msgs), JPMorgan Chase (JPM, news, msgs), Toronto Dominion (TD, news, msgs), US Bancorp (USB, news, msgs) and Wells Fargo (WFC, news, msgs). I’ve written about ING, Toronto Dominion and US Bancorp before. All three are members of my ‘unfixed-income’ portfolio, and US Bancorp is a current Jubak’s Pick. But the two others are new to this column.

After discussing each of these five, I’ll name three other financial stocks that I’d add to this group if things broke in their favor in the near future.

ING

This Dutch bank and insurance company is positioned to pick up the pieces dropped by Citigroup and American International, both internationally and inside the United States. To give you just one glaring example of the way that ING is expanding into markets where challenged competitors are pulling back: In July, Citigroup announced the sale of its German consumer-loan business, with 340 branches and 3.2 million clients. In May, ING announced that it would buy German online mortgage broker Interhyp for about $644 million.

Before the current crisis, I would have identified Citigroup, American International and HSBC (HBC, news, msgs) as the leaders in the race to build dominant global financial brands. Stumbles by Citigroup and American International have thrown the race open to new players.

Of these, I think ING is most likely to come out of this crisis as a new member of the global top three. The company already has 75 million customers around the world, and it’s making all the right moves to expand that number. About half of ING’s business is insurance. In that business, ING has been busy shifting capital from mature West European markets to faster-growing markets in Central Europe and Asia. For example, on July 9, the company received regulatory approval to enter the insurance market in Ukraine.

In the banking part of its business, ING has stepped up its penetration of the U.S. market through its online ING Direct business. ING is an aggressive accumulator of online deposits, with more than $300 billion in online deposits worldwide. In the post-crisis world, raising funds for making loans from relatively low-cost deposits instead of in the capital markets will be a huge competitive advantage.

The company is also going after the lucrative and fast-growing market for managing retirement money. On July 1, the company acquired CitiStreet, a retirement plan and benefit service and administration business. The deal makes ING the third-largest defined-contribution pension business in the U.S., with $300 billion in assets under management. The company’s strategy is to make smaller acquisitions of businesses that add to its existing core. In the current crisis, there are likely to be lots of businesses that fit that bill for sale.

(The stock now yields more than $7. Be careful when calculating yields because the company pays dividends twice a year instead of the customary four times.

JPMorgan Chase

It’s not that the bank has been managing its business perfectly during the financial crisis; the company admits it made a mistake when it increased its mortgage lending in California in 2007 in an effort to take advantage of competitors’ problems.

It’s just that JPMorgan Chase’s mistakes have been so much smaller and are supported by a much stronger balance sheet. For example, it looks like the charge-offs on its $95 billion home-equity portfolio will peak at about $700 million per quarter. That’s about a 3% annual rate. No bank ever likes to take a $700 million charge, but it’s surely better to be talking about millions with an “m” rather than billions with a “b.”

And unlike many of its competitors, JPMorgan Chase doesn’t have any need to raise new capital. With a Tier 1 capital ratio of 8.4%, the bank has one of the strongest balance sheets in the sector. (A 6% ratio is the minimum to be considered well-capitalized by regulators.) It’s that strength that let the bank pick up investment bank Bear Stearns for a song in a deal brokered by the Federal Reserve. That deal moved the bank’s investment banking business into new markets.

The bank hasn’t ignored its retail side either. The 2007 grab for market share in the most distressed mortgage markets may have increased charge-offs for bad debt, but it increased the bank’s market share as well. Net revenue at the mortgage banking unit climbed 46% in the second quarter of 2008 from the second quarter of 2007, and net income climbed 138%.

What’s ahead? The bank will use its balance-sheet muscle to pick up the businesses it finds most attractive around the world. On July 25, the bank began talks with National Australia Bank (NABZY, news, msgs) and Banco Santander (STD, news, msgs) to buy and break up deeply troubled United Kingdom mortgage lender HBOS (HBOOY, news, msgs). Right now, JPMorgan Chase can sit back and see what gems the crisis might put into play. Nice position to be in.

Toronto Dominion

The Canadian bank acquired Commerce Bancorp of the U.S. at exactly the right time. Toronto Dominion didn’t overpay (the premium on the deal was just 25%, low by the standards of bank deals) because Commerce was coming out of a period of regulatory troubles.

And now, just when deposits are moving back to center stage as the cheapest source of bank capital, Toronto Dominion finds itself owning a deposit-gathering machine. Commerce Bancorp’s emphasis on service and convenience has long let the bank pull in deposits at a pace that far outstripped bank industry averages.

The recent decision to rebrand Commerce branches with the TD logo, which the company says it was forced to do by the threat of litigation, isn’t a positive. But in the short run, it shouldn’t send current Commerce customers running to find another bank. And in the long, run it gives Toronto Dominion, which had acquired BankNorth in 2005, a single brand identity in the U.S. market. With its home Canadian market essentially closed to foreign competition, Toronto Dominion can use the extraordinary profitability of its north-of-the-border operations to fund further expansion in the U.S.

US Bancorp

Here’s what I wrote about US Bancorp after the company announced second-quarter earnings: “US Bancorp missed Wall Street earnings estimates by 7 cents a share in the second-quarter results announced on July 15. The disappointment delivered by this very conservatively managed bank is evidence of exactly how deep the crisis is facing the financial sector. Revenue grew by 8% for the quarter, beating Wall Street projections by roughly $20 million. But the company wound up taking charges that reduced earnings 11 cents a share: a $66 million impairment charge for structured investment vehicle securities and a $200 million provision for credit losses.

“My thesis that this conservatively managed bank will be able to grab market share thanks to troubles at other banks remains intact. Total average loans grew by 12% from the second quarter of 2007. Total average deposits climbed 14% for the quarter.”

One comment stood out in the conference call: The company said it would conserve capital by reducing its expenditures on buying back shares in order to protect the current dividend of $1.70 a share (the yield on July 25 was 5.86%) and have enough cash to make opportunistic acquisitions in a battered financial industry.

I like that thinking.

Wells Fargo

The bank is now reaping the rewards of keeping its powder dry. The company did add $1.5 billion in the second quarter to its provisions against bad loans, but net charge-offs climbed to just an annualized 1.55% for the quarter.

The relatively modest losses have let Wells Fargo increase its lending just as its capital-constrained competitors have pulled back. Earning assets grew at an annualized 15% rate from the first to the second quarter of 2008 and 20% from the second quarter of 2007. Average total loans climbed 18% from the second quarter of 2007 and at an 8% annualized rate from the first quarter of 2008.

The bank’s decision to increase its quarterly dividend by 10% to 34 cents a share was the equivalent of taking out a huge billboard saying, “Hey, we’ve got the cash to raise the dividend, so we’ve sure got the cash to lend to you.”

Having the cash to lend when other banks don’t has let Wells Fargo increase the already hefty difference between what it pays to raise capital and what it collects from borrowers. That difference, the net interest margin, climbed to 4.92 percentage points in the second quarter, up 0.32 from the first quarter of 2008. As of July 25, the stock showed a yield of 4.67%.

3 also-rans and a warning

These five stocks are, at this point in the crisis, the clearest winners. But I’ve got three other stocks that could join this group if things break right in the next six months to a year. This group consists of, in alphabetical order, Banco Santander, HSBC and State Street (STT, news, msgs).

It’s too early to tell whether these three have put their biggest losses behind them. They all still hold the possibility of a big negative surprise on their balance sheets. If the worst is indeed over for these three companies, then I’d move them to my winners group. Until then, it’s wait and see.

That is pretty much my reaction to the sector — even to these winners. Financial stocks rallied 30% in a matter of days before selling off. I don’t think the rally is sustainable, and I don’t think it is based on fundamentals.

Credit write-offs are just now spreading to credit cards. If you want to see the big problem now looming, take a look at the most recent quarterly earnings from American Express (AXP, news, msgs). It’s clear that the same consumers who couldn’t pay their mortgages now can’t pay their credit card bills either.

I’d look for another drop in the sector before I even thought about buying. And then I’d start by looking at the stocks where the dividend yields are high enough to give the price some support and you some income while you wait for the sector to turn upward in a lasting way.