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One week on and there are yet more investments into high-profile western financial institutions, possibly prodded along by a helping official hand in Washington - but it won’t solve the fundamental problem, notes CLSA’s Christopher Wood in the latest issue of his client newsletter, Greed & Fear.

The running total is that there has now been $100bn of subprime-related writeoffs and $59bn of capital injections (see FT report on the latest shocker, from Merrill Lynch). If many more tens of billions are coming, the establishment is clearly working overtime to protect itself, notes Wood, who seems to enjoy the occasional bout of conspiracy theorising and detects the “helping hand of the US Treasury department” in orchestrating the injections of equity, with this week the likes of Mizuho, the Kuwait Investment Authority and the Capital Group joining in.

This is “clearly the biggest placement Hank ‘the hunk’ Paulson has ever handled,” says Wood.

But if all this activity - for now - prevents an “Armageddon-style meltdown”, it doesn’t solve the basic issue:

The reason is that it is still early in the game in the US economic downturn, with the US consumer having only seemingly just begun to capitulate. The risk that the unemployment rate rises progressively from here is clear. As a result, the securitised credit mess will surely spread. Fault lines remain - to name just a few, securitised credit-card loans, securitised commercial real-estate loans, securitised leveraged buyout loans, insolvent bond insurers and the scary $45,000bn outstanding in credit default swaps.

Meanwhile, says Wood, “the cheerleaders continue to stress that these capital injections are restoring banks’ capital-adequacy ratios to appropriate levels”. But as one experienced banking investor pointed out this week at CLSA’s first Asia Investors’ Forum in Las Vegas, capital-adequacy ratios are “not really the point when liquidity is the problem”.

The best illustration of that, in Wood’s view, is the “soon-to-be-nationalised” Northern Rock, which blew up last year because of funding issues at a time when its stated capital-adequacy ratio was nearly 20 per cent.

The issue of “funding” is going to become critical in coming months since it raises risks for any business whose business model is based on access to borrowed money — that includes real estate investment trusts, “private equity” players and, of course, hedge funds; especially the fixed income variety, he says. It is going to remain much easier to access credit in Asia and the emerging markets from domestic banks than it is going to be in the western world, notes Wood. “But the game has changed in the sense that easy access to credit can no longer be assumed”.

This means that it is not only investment banks and commercial banks that will be forced to shrink their balance sheets. The complete lack of general provisioning as a result of a bizarre regulatory initiative has prevented banks from putting money aside for the proverbial rainy day. This insane departure from prudential common sense means that the banks have entered this downturn completely unprepared, as have the regulators.

Another point is the IFRS accounting system, introduced for financial institutions three years ago, which has set up all kinds of perverse incentives while also making accounting “incomprehensible”, he warns.

Like new fangled valuation methodologies in the equity world — remember EVA™ - these new approaches will be discredited in the coming downturn.

But if the investment case to remain short western financials is clear, the focus from now will increasingly be on the growing fallout in the real world. The bigger the fallout on main street the more inevitable there will be a massive regulatory backlash, which will dramatically constrain what the financial sector can get up to in the next cycle, according to Wood:

The risks remain that securitisation will be regulated out of existence, and that “structured finance” will be relegated to a chapter in the history books. Still there will be a saving grace for those bank executives presiding over imploding balance sheets. That is because virtually everybody signed up to the securitisation structured finance model, be it central bankers, regulators, bankers or investors. This means they have all been proven wrong, complicit or ignorant, call it what you will, together.

It is clearly better to be wrong in a crowd. It also means, unlike in, say the case of Enron, a lack of obvious scapegoats. Rather the wretched taxpayer will be asked to pick up the bill; as is already clear in the obscene funding extended by the federal home-loans banks and is about to be demonstrated by the pending nationalisation of “Northern Rock”.

The coming “further socialisation” of the banking system in the western world will further undermine the quality of the western growth story, he warns. By contrast, in Asia and emerging markets, the trend away from government regulation towards more open markets should continue, which is fundamentally bullish - especially in India, he says.

If there is one growth story in Asia that has a hope of decoupling from the reverberations spreading globally from the meltdown of structured finance, it is probably the Indian investment cycle.

Meanwhile, the continuing combination of nasty market action and deteriorating US economic data makes it increasing likely that the Fed is going to cut interest rates aggressively, and even potentially before the next FOMC meeting. To Wood, this is clear from market talk of a possible 75bp cut, which “would look like full-scale panic given lingering concerns about stagflation and the like”.

The building inflationary pressures evident in what is going on in the energy and food sectors is a long-term macro issue. But Wood continues to believe it will be overshadowed during 2008 by the deflationary fallout from the global credit crunch.