“Dear readers, let us begin this week’s missive by acknowledging its partial incompleteness. For understandable considerations, there are some capital market situations that we cannot discuss. We thank all our readers for their support and look forward to continuing to provide you with timely analysis.”

This is how Lehman Brothers’ strategists began their last ever weekly research note, published on Saturday – only two days before the U.S. investment bank collapsed.

In the 146-page research, Lehman strategists argued that bonds are performing well in September thanks to rising risk aversion and financial institution uncertainties.

“September already shapes up as a splendid month for bonds, thanks to the usual seasonal elevation in risk apprehension accompanied by special amplification through financial institution uncertainties,” wrote strategists at Lehman.

Ironically, Institutional Investor magazine named Lehman Brothers as its top All-America fixed income research team for a ninth straight year on Tuesday.

“September has been a prosperous month for credit risk shorts,” Lehman strategists noted. “With third-quarter earnings for some financials coming out this week and the rest of major corporates over October, with the global economic outlook wilting, and with a hyper-risk sensitive capital market regime in effect, we will maintain our predilection toward short credit exposure.”

Little did they know that their own bank’s collapse would reinforce their argument. Investors dumped risky assets across the board, including equities and credit, sending government bonds sharply higher as Lehman filed for bankruptcy protection and Bank of America agreed to buy another Wall Street giant Merrill Lynch.

Merrill Lynch is giving a refresher course on Ten Markets Rules to Remember, created by Bob Farrell, the bank’s former dean of research during his tenure from 1957-2001.

Below are  the original rules:

#1: Markets tend to return to the mean over time
#2: Excess in one direction will lead to an opposite excess in the other direction
#3: There are no new eras, excesses are never permanent
#4: Exponentially rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways
#5: The public buys the most at the top, the least at the bottom
#6: Fear and greed are stronger than long-term resolve
#7: Markets are strongest when they are broad, and weakest when they narrow to a handful of blue-chip names
#8: Bear markets have three stages: sharp down, reflexive rebound and a drawn-out fundamental downtrend
#9: When all experts and forecasts agree, something else is going to happen
#10: Bull markets are more fun than bear markets

So what does this mean today? 

David Rosenberg, Merrill’s North American economist  says: ”Rule #4 could be about the sliding U.S. dollar, as it now revives in mean-reverting fashion (back to Rule #1) .”  

Any other thoughts on offer?

Britain’s banks may have borrowed over 200 billion pounds from the Bank of England, four times the amount they were expected to take under an emergency liquidity scheme. It leaves them facing a sharp funding strain next month when the rug gets pulled away.

Alastair Ryan, analyst at UBS, reckons banks have taken over 200 billion pounds under the BoE’s Special Liquidity Scheme since it was offered in April. They had been expected to borrow about 50 billion pounds, although estimates were lifted to near 100 billion as wholesale markets stayed closed. The scheme allows banks to exchange hard-to-trade mortgage assets for government bills.

The problem is the BoE isn’t planning to extend the funding beyond a Oct. 20 deadline . If the borrowing from UK banks has been as high as Ryan estimates, it will have eased a short-term problem but shows how much the liquidity is needed. It also leaves even more medium and long-term funding that the banks will need to replace at some point.

European and U.S. central banks aren’t closing their funding windows. By shutting its window the BoE is pinning its hopes on securitisation markets re-opening, but that seems unlikely soon and could force banks to further shrink their mortgage books at a tough time for them and the housing market.

As the deadline looms, UK regulators, criticised for their handling of Northern Rock at the start of the credit crunch, will face mounting pressure to extend the scheme as confidence among UK banks clearly isn’t back yet.

More stress on its balance sheets is just about the last thing that the banking sector needs. The subprime mortgage crisis has already battered banks, leading to huge losses, scrambles for funding and free-falling banking shares. The S&P index of financial stocks has lost more than 30 percent so far this year. At its worst, the index plunged around 55 percent between a high in May last year and a low in June this year.

Now, after a brief respite, comes more bad news. First, hedge funds still seem to be wedded to betting on further losses. Laurence Fletcher, who writes about hedge funds here at Reuters, notes that more than 6 percent of British banks’ equity is on loan to short sellers.

More worrying yet for banks, however, may be their exposure to embattled Fannie Mae and Freddie Mac. In a report, Societe Generale economists estimate that U.S. commercial banks hold about $1 trillion in Fannie and Freddie debt. That amounts to a whopping 9 percent of the commercial banks’ balance sheets.

Then again, maybe the danger to the banks will simply add pressure on the U.S. government for make sure Fannie and Freddie don’t fail.

It’s not all doom and gloom — just ask steelmakers.

Germany’s ThyssenKrupp and Salzgitter have both raised their profit forecasts, fuelled by demand from fast-growing China, India and Russia. Profits are soaring on sky-high prices for rolled and flat steel.

Both companies are cashing in on growth outside Europe, and they join Hochtief and Kloeckner who this week also showed that industrial Germany is insulated against a global economic slowdown.

It is now official — Swiss bank UBS has ditched its much-cherished “One Bank” strategy.

The bank said it would split its business in three autonomous units, after taking yet another credit hit and posting a worse-than-expected second-quarter loss.

The news will spark further talk the bank may hive off business units such as its embattled investment bank. UBS in a conference call would not rule out divestments further down the line, though it said it was not now working on such plans.

The bank is already Europe’s biggest victim of the credit crisis. Today, it took another $5.1 billion hit on credit positions, bringing the total to $41 billion. More importantly, it saw hefty outflows out of its wealth management business for rich clients.

The news comes just days after it was forced to buy back billions of dollars worth of auction-rate securities to compensate for client losses in the United States.

In reply, it is now saying it is “repositioning” itself. It is splitting up its business in three separate units. It is calling its wealth management unit — for rich clients — its “core asset”. It says it will continue to invest in wealth management, but does not put equal stress on its investment bank.

These may be small steps, but markets liked the news. UBS shares were more than three percent up in early trading.

It doesn’t seem much to cheer about but Societe Generale investors breathed a sigh of relief when second-quarter net profit only fell 63 percent.

The investment banking unit may have taken a 1.2 billion euro hit but higher profits from its international retail banking and consumer credit businesses offset the damage and kept the group in the black.

In today’s doom-laden markets that was something to celebrate - and the shares jumped more than 6 percent.

It has been the year from hell for the venerable French bank, still in the shadow of the world’s worst rogue trader scandal and struggling - like its peers - with the global credit crunch.

In January, it revealed 4.9 billion euros of losses following rogue deals by junior trade Jerome Kerviel, forcing a 5.5 billion euros rights issue and making SocGen a takeover target in the eyes of many.

Magistrates are still studying what went wrong and who knew what about the Kerviel

affair. But SocGen may be back from the brink.

SocGen CEO Frederic Oudea, in any case, doesn’t favour a merger. ”In this environment, throwing yourselves into big deals is very risky,” he told reporters.

And echoing comments from HSBC this week, he argued the universal banking model remains viable and will emerge as the “winner” from the current credit crisis.

Attention turns next to BNP Paribas, France’s biggest listed bank, which reports second-quarter earnings on Aug. 6.

(Reuters photos: SocGen branch in Paris; Jerome Kerviel)