Monday, December 1, 2008

Debt Rattle, December 1 2008: Trying to avoid the unavoidable, but at what cost?

National Photo Co. Bud 1924
Helen G. Sweeney, Adolph Busch, Joseph Gallegher, Henry Glyn
Helen, who as Miss Washington represented the District of Columbia in the 1924 Miss America pageant, was also Miss Treasury Department that year. She's shown here in front of the Treasury building in a nautical-themed car bearing the insignias of Anheuser-Busch and Budweiser, promoting the company's beverages during the Prohibition years.

Stoneleigh: We at TAE would like to pay tribute to Doris Dungey, better known as Tanta from Calculated Risk, who died on Sunday from ovarian cancer at the age of only 47. She was a sane voice in an insane world, and her wisdom will be sorely missed.

Rumor: Bloomberg has tallied the federal money committed to bailing the financial industry (not bailing out, as it can only be bailing out if you can keep the ship afloat): $7.7 trillion so far. It's not anything that those of us paying careful attention didn't already know, but it's important to keep hammering away at the immense amount of money being wasted. William Poole, former president of the St. Louis Fed, says that most of the Fed and Treasury guarantees to various institutions are "unlikely to lose money." Henry Paulson said much the same thing in October.

It was recently revealed that Citigroup's analysis of their credit default swaps deliberately ignored the risk of a declining housing market. These are all indicative of the same reasoning, exactly the kind of reasoning Nouriel Roubini has been talking about - raving about - on TV panels for the last few weeks. This is exactly the kind of reasoning that all of the now-failed financial institutions have been relying upon and that has driven the derivatives bubble. If the risk of failure is minimal, this reasoning went, then it need not be accounted for, nevermind that the consequence is of catastrophic and systemic collapse. This debt crisis should teach us many things, only one of which is that risk assessment must include an assessment of the consequences of failure, however remote the likelihood of occurrence may be. The final irony, of course, is that the choice to systematically ignore those risks is what made their occurrence inevitable.

The financial industry bought into the ridiculous idea that risk which is low probability can be safely ignored. Now the federal government, whose advisors and actors come from the same blinkered pool, is doing the exact same thing. Is it lunacy to say that these hundred-billion dollar guarantees against balance sheets with unknown assets are in fact bluffs at serious risk of being called? In addition, now every big company is coming hat-in-hand to the government. States and municipalities are also at the door. But the only thing going on here is debt being shifted around. Privatize the profits, socialize the losses - a familiar refrain lately.

One might ask, why bail Citigroup and not American Auto? A cynical answer might be that because the people doling out the money are white collar Wall Street banksters, they don't care about blue collar workers, and because the people helping them dole out the money are government cronies, they don't like unionized blue collar workers. Can it go deeper than that? This Grand Theft America isn't just about class divisions and distaste for unions, as real as those motivations may be. This about continuing the failed prescriptions of a consumer fantasy - that money could be made from money ad infinitum without the need to actually produce anything. Unfortunately, money chasing its own tail generated a mountain of debt large enough to threaten the integrity of the system.

We can approach this from another viewpoint, as well. If the government won't bankroll American Auto, effectively putting their hundreds of thousands of workers and all of the millions of associated auto industry workers on the public payroll, why should it bail the financial institutions? What is going on here? These financial bailouts are ostensibly justified so that the banks will "lend again", except of course that they're not lending, rather they are hoarding the money. Presumably the idea is that, eventually, the banks will have enough money to feel safe enough to start lending. What no one doing the bailing cares to mention is that money provided by taxpayers is shoveled en masse to banks so they can, one day, lend that money back out to taxpayers at interest. This doesn't make sense. Taxpayers pay the government, the government pays the banks, the banks cream off their salaries and perks and bonuses and operating costs and everything else, and then lend back to the taxpayers? Are banks necessary in this scenario or are they merely leeches?

The only difference between this scenario and nationalization of the banking industry is that banking executives and managers pull off a healthy sum for themselves in the process. What's the point of a bank anymore, then? It's not to store savings. There has been almost no incentive to save for the last decade, as real interest rates have been kept negative. So there is very little savings around, relative to corporate and personal debt levels.

As Hugh Hendry said recently, "How can I convey to you?" How can I convey the insanity of what governments around the world are doing? It is probably insane to do the same thing over and over again while expecting a different result. Yet, the solution to global crisis directly caused by too much borrowing is to plow money into banks so they can lend out more money? So that everyone can take on more debt? So we can try to blow this bubble back up, one more time? To what end? We know where this road leads. Sooner or later (and my bet is we have reached this point), that road is a dead end.

Every central banker is now focused on avoiding a Great-er Depression. They believe that if they act cleverly and quickly enough we can all avoid the price of our collective borrowing as if it never happened. But what if a depression is necessary? When there is far more debt to repay than assets to pay for it, and everyone wants their piece of the pie, then there has to be a reckoning. Liabilities - especially financial liabilities in this current situation - need to be clearly valued at what they are worth, which is next to nothing, and a lot of creditors are going to have to walk away with very little of what they are owed. "Money" as debt will vanish, prices will drop, and will must realize we are not as rich as we think. We've simply been borrowing against the future like drunken gamblers.

So reveal the mess of CDOs, SIVs and asset-backed paper, let the losses be tallied, bankruptcies be declared, and then hopefully we can start producing assets again instead of trying make money for nothing. Until that happens, we can't get on with our lives. we can't know what we actually have to work with until debts come clean. No economic system of any form can now function prior to a reckoning. The only thing that can happen is that governments around the globe borrow against the future more than they ever have - just what banks and corporations and individuals have been doing - in order to through that money down a bottomless pit. And the longer we do that, the worse the eventual reckoning will be. Every day the toll grows and, again ironically, as the toll grows larger we approach the end of the road ever faster.

Stoneleigh: I would like to point out that nationalized banking is no panacea. It wouldn't prevent a depression any more than the current proposals are able to, simply because a depression cannot be prevented. As John Stuart Mill said, ""Panics do not destroy capital; they merely reveal the extent to which it has been previously destroyed by its betrayal into hopelessly unproductive works". The losses have already been incurred, and we now face the consequences. Unfortunately, government, in its interventions, has a tendency to make a bad situation worse as expensively as possible.

My prime concern with bank nationalization is that such a degree of central control creates unaccountable discretionary powers that will inevitably be abused, at the expense of the individual. The balance between central control and individual freedom of action is a delicate one that can easily be pushed too far in one direction or the other, especially in times of crisis. While there is no perfect point for that balance to rest, since the appropriate balance depends on the circumstances, both extremes are generally to be avoided. We risk ending our era of individualism with a transition into tyranny, addressing the excess of one extreme with the excesses of the other as the pendulum swings. While greater oversight is clearly warranted, we should not be too quick to embrace much greater centralization without our eyes wide open.

Central powers, once given, are very difficult to reclaim. Moreover, they tend to apply the politics of the personal in an increasingly ponderous, sclerotic and unaccountable way, often leading endemic corruption. One might ask what could be worse than the graft, corruption, hubris, and reckless political complicity that have led us to where we are now, but there are even worse possibilities. Where most of us who write and read TAE live, we have no direct experience of them, but my concern is that we might be on our way to developing that experience. We must tread carefully.

OC: Update 4:30pm EDT:

Bernanke Says Fed May Buy Treasuries to Aid Economy
Federal Reserve Chairman Ben S. Bernanke said he has “obviously limited” room to lower interest rates further and may use less conventional policies, such as buying Treasury securities, to revive the economy. The U.S. economy “will probably remain weak for a time,” even if the credit crisis eases, Bernanke said today in a speech in Austin, Texas. While the Fed can’t push interest rates below zero, “the second arrow in the Federal Reserve’s quiver -- the provision of liquidity -- remains effective,” he said.

Bernanke’s comments pushed Treasury yields to record lows. Bernanke has created more than $2 trillion of emergency lending programs in the past year, using the Fed’s balance sheet and money-creation authority to cushion the economy from the worst financial crisis in seven decades. The central bank may lower its benchmark interest rate to zero, economists said. “Although further reductions from the current federal funds rate target of 1 percent are certainly feasible, at this point the scope for using conventional interest-rate policies to support the economy is obviously limited,” Bernanke said in remarks to the Austin Chamber of Commerce.

One option is for the Fed to buy “longer-term Treasury or agency securities on the open market in substantial quantities,” Bernanke said. “This approach might influence the yields on these securities, thus helping to spur aggregate demand.” Treasury prices rose on Bernanke’s remarks, with yields on 10-year Treasuries tumbling 25 basis points to a record low of 2.67 percent at 2:31 p.m. in New York, according to BGCantor Market Data. The yield was the lowest since daily Fed records started in 1962 and the least since 1955 as measured on a monthly basis. One basis point is equal to 0.01 percentage point.

Last week, the Fed announced two new programs aimed at unfreezing credit for homebuyers, consumers and small businesses. Those include a commitment to buy as much as $600 billion of debt issued or backed by government-chartered housing-finance companies and a $200 billion initiative to support consumer and small-business loans. “It is encouraging that the announcement of that action was met by a fall in mortgage interest rates,” Bernanke said of the Fed’s decision to buy housing debt.

The Federal Open Market Committee next meets Dec. 15-16 in Washington. Economists surveyed by Bloomberg News forecast a quarter-point reduction in the target overnight interbank lending rate to 0.75 percent, with some expecting a half-point cut. The Fed will “continue to explore ways” to keep the market federal funds rate closer to policy makers’ target, after paying 1 percent interest on banks’ reserves failed to stabilize the rate, Bernanke said. The average daily rate has been below the central bank’s target every day since Oct. 10.

That’s because Fannie Mae and Freddie Mac, which are “large suppliers of funds,” aren’t eligible to get interest from the Fed and thus lend below the Fed’s target, Bernanke said. The Fed also aided the rescue of Citigroup Inc. last week by agreeing to backstop a $306 billion pool of distressed assets after the company, the Treasury and the Federal Deposit Insurance Corp. shoulder the first losses.

Bernanke reiterated his defense of the government’s decision to let Lehman Brothers Holdings Inc. fail, which intensified the financial crisis. Lehman’s bankruptcy was “unavoidable,” he said. Since then, authorities have gained the tools to “address any similar situation that might arise in the future.” Bernanke noted that the funds to aid Citigroup came from the $700 billion financial rescue passed by Congress in October.

The U.S. economy officially entered a recession in December 2007, the panel that dates American business cycles declared today. The National Bureau of Economic Research, a private, nonprofit group of economists based in Cambridge, Massachusetts, said the economy was last in a recession from March through November 2001. “Our nation’s economic policy must vigorously address the substantial risks to financial stability and economic growth that we face,” Bernanke said. The Fed’s balance sheet “will eventually have to be brought back to a more sustainable level,” Bernanke said. “However, that is an issue for the future; for now, the goal of policy must be to support financial markets and the economy.”

Signs are increasing that the recession may be the worst in a quarter-century. Even so, Bernanke, a scholar of the Great Depression, said in a response to an audience question that there is “no comparison” between today’s situation and the 1930s. Back then, the Fed kept monetary policy too tight and failed to keep banks from collapsing, Bernanke said.

A private report earlier today showed manufacturing in the U.S. contracted in November at the fastest pace in 26 years, putting American factories at the forefront of the global industrial slump resulting from the lack of credit. The Institute for Supply Management’s factory index dropped to 36.2, the lowest level since 1982, the Tempe, Arizona-based group reported today. A reading of 50 is the dividing line between expansion and contraction. Similar measures from China, the U.K., euro area, and Russia all dropped to record lows. On Dec. 5, the Labor Department will report U.S. employers eliminated 325,000 jobs in November, according to the median estimate in a Bloomberg News survey. That would be the worst month since October 2001, during the last recession. The jobless rate probably increased to 6.8 percent from 6.5 percent, according to the survey.

Recession in U.S. Started in December 2007, NBER Says
The U.S. economy entered a recession a year ago this month, the panel that dates American business expansions said today. The declaration was made by the cycle-dating committee of the National Bureau of Economic Research, a private, nonprofit group of economists based in Cambridge, Massachusetts. The last time the U.S. was in a recession was from March through November 2001, according to NBER.

“The committee determined that the decline in economic activity in 2008 met the standard for a recession,” the group said in a statement on its Web site. The 1.2 million drop in payroll employment so far this year was the biggest factor in determining that start of the contraction, the group said. Federal Reserve policy makers at their last meeting predicted the economy will contract through the middle of 2009, in line with private economists’ forecasts. If correct, the recession would be the longest since the Great Depression.

“It is clearly not going to end in a few months,” Jeffrey Frankel, a member of the group and a professor at Harvard University, said in an interview. “We would be lucky to get done with it in the middle of next year.” The contraction would be the second under President George W. Bush’s watch, making him the first U.S. leader since Richard Nixon to preside over two recessions.

“The most important things we can do for the economy right now are to return the financial and credit markets to normal, and to continue to make progress in housing, and that’s where we’ll continue to focus,” White House Deputy Press Secretary Tony Fratto, said in an e-mailed statement. “Addressing these areas will do the most right now to return the economy to growth and job creation.”

U.S. employers cut 240,000 jobs in October, a 10th consecutive decline in payrolls. The unemployment rate rose to 6.5 percent, the highest level since 1994, according to Labor Department statistics. Employment probably fell by 325,000 workers last month, the most since the last recession, according to the median forecast of economists surveyed by Bloomberg News ahead of a Labor Department’s report due Dec. 5. The jobless rate is projected to increase to 6.8 percent.

The 73-month expansion that ended in December 2007 was well short of the previous record 10-year cycle. At 12 months, the current contraction already exceeds the average of 10 months in the postwar era and would be the longest since the 1981-82 slump that covered 16 months, casting doubt on economists’ view that that the business cycle was moderating in recent decades. “Everyone had thought long, deep recessions were a thing of the past,” Frankel said. “There was a lot of talk of the new economy.”

Although a recession is conventionally defined as two quarters of successive contraction in gross domestic product, the private committee doesn’t require supporting GDP data to make a recession call. Its members focus on month-to-month changes in the economy. The NBER committee defines a recession as a “significant” decrease in activity over a sustained period of time. The decline would be visible in gross domestic product, payrolls, industrial production, sales and incomes.

The U.S. economy shrank at a 0.5 percent pace in the third quarter after expanding 2.8 percent in the previous three months. Economists at Goldman Sachs Group Inc. and Morgan Stanley in New York are among those projecting the economy will contract at a 5 percent pace this quarter. Members of the committee are Frankel; Stanford University professor Robert Hall; Martin Feldstein of Harvard University; Northwestern University economics professor Robert Gordon; NBER president James Poterba; David Romer of the University of California at Berkeley; and Conference Board economist Victor Zarnowitz.

Global Industry Shrinks as Crisis Enters 17th Month
Manufacturing shrank around the world as the financial crisis enters its 17th month, providing fresh evidence that the global economy is in recession and intensifying pressure on policy makers to respond. Industry contracted in the U.S. at the fastest pace in 26 years last month, while factory indexes in Europe, Russia, China and South Africa showed record shrinkages, reports released today showed.

Signs the worldwide slump is worsening pushed down stocks and sent yields on U.S. Treasuries to record lows as investors sought the safest assets. Manufacturers are suffering as the persistent lack of credit hammers demand from companies and consumers, forcing them to cut output and jobs. “The pace of manufacturing decline has been vicious,” said Kevin Gaynor, head of economic and interest-rate strategy at Royal Bank of Scotland Group Plc in London. “If we thought the last quarter was bad for the global economy, the current quarter is shaping up to be a lot worse.”

With the financial crisis that began in August 2007 now morphing into a worldwide economic downturn, economists at JPMorgan Chase & Co. estimate industrial production will decline in developed markets this quarter by the most since 1980. The MSCI World index of stocks in 23 developed markets today fell 3.9 percent to 857.72 at 2:49 p.m. in London as the deterioration in manufacturing unnerved investors. The yield on two-year U.S. notes dropped as low as 0.95 percent and the rate on 30-year bonds fell to a record 3.387 percent.

The Institute for Supply Management’s U.S. factory index dropped to 36.2, the lowest since 1982, the Tempe, Arizona-based group reported today. A reading of 50 is the dividing line between expansion and contraction. The index was projected to drop to 37, according to the median of 61 economists’ forecasts in a Bloomberg News survey.

That leaves economists forecasting one of the most severe U.S. recessions in the postwar era, forcing the Federal Reserve to consider more interest rate cuts and incoming President Barack Obama to mull a stimulus program. Fleetwood Enterprises Inc., the third-largest U.S. maker of recreational vehicles, last week said its second-quarter net loss widened as tight credit and a weak economy eroded demand for motor homes.

Manufacturing in the 15 nations sharing the euro contracted by the most on record in November. A purchasing managers’ index dropped to 35.6 from 41.1 in October, remaining below the expansion threshold for a sixth month. That’s the lowest since Markit Economics began the poll in 1998, and below an initial estimate of 36.2 published on Nov. 21.

With the euro-region economy already in its first recession in 15 years, the malaise leaves the European Central Bank facing calls to accelerate the pace of interest rate cuts this week. Having reduced its benchmark rate twice by 50-basis points since early October, investors are betting the Frankfurt-based bank may lower it as much as three-quarters of a percentage point when its governing council convenes on Dec. 4.

Rautaruukki Oyj, Finland’s biggest producer of carbon steel, said today it will cut output and as much as 6.7 percent of its workforce, reducing annual costs by 60 million euros ($75.9 million), on weaker demand. “There is a compelling case for the ECB to slash interest rates by 100 basis points” for the first time, said Howard Archer, an economist at IHS Global Insight in London.

Investors are already predicting the Bank of England will cut its key rate by at least a percentage point the same day, having slashed by 1.5 points last month, the biggest reduction in 16 years. Chancellor of the Exchequer Alistair Darling said yesterday he may need to take additional steps to combat the slump. “Interest rates have got to fall significantly further,” said Nick Kounis, an economist at Fortis in Amsterdam and a former U.K. Treasury official.

The slump in industrial economies is now infecting emerging markets, depriving the world of power it was relying on to cushion the slowdown. Manufacturing in China, the fastest- growing major economy, fell by the most on record in November, the China Federation of Logistics and Purchasing reported today. Its purchasing managers’ index fell to a seasonally adjusted 38.8 from 44.6 in October.

“Another grim month for China manufacturing,” said Eric Fishwick, head of economic research at CLSA Asia-Pacific Markets in Hong Kong, whose own index for China showed a record drop. “Export orders will weaken further and we expect further cuts in production and employment.” The yuan fell the most since a fixed exchange rate ended in 2005, sliding 0.7 percent to close at 6.8848 per dollar. Economists at Citigroup Inc. said “more immediate policy help” was now needed on top of last month’s $586 billion stimulus package and biggest interest-rate cut in 11 years.

In Russia, VTB Bank Europe said its measure of purchasing managers fell for a fourth month in November to 39.8, below the level recorded in 1998 when the government devalued the ruble and defaulted on $40 billion of debt. OAO Severstal, Russia’s largest steelmaker, shut down a blast furnace that supplied 13 percent of the pig iron produced at its main Russian factory because of its age and as global steel demand weakens, the company said on Nov. 28.

“The sense of doom and gloom was only deepening” in November, Tatiana Orlova an economist in Moscow at ING Group NV said. “The mood isn’t getting any better.” Indexes for Poland, Hungary, Sweden and the Czech Republic also showed some of the steepest-ever declines as recession struck their main export markets. South African manufacturing shrank at the fastest pace in at least nine years, pushing Investec Asset Management’s Purchasing Managers Index to 39.5 last month from 46.2 in October.

Government warned of mortgage meltdown
The Bush administration backed off proposed crackdowns on no-money-down, interest-only mortgages years before the economy collapsed, buckling to pressure from some of the same banks that have now failed. It ignored remarkably prescient warnings that foretold the financial meltdown, according to an Associated Press review of regulatory documents.

"Expect fallout, expect foreclosures, expect horror stories," California mortgage lender Paris Welch wrote to U.S. regulators in January 2006, about one year before the housing implosion cost her a job. Bowing to aggressive lobbying -- along with assurances from banks that the troubled mortgages were OK -- regulators delayed action for nearly one year. By the time new rules were released late in 2006, the toughest of the proposed provisions were gone and the meltdown was under way. "These mortgages have been considered more safe and sound for portfolio lenders than many fixed-rate mortgages," David Schneider, home loan president of Washington Mutual, told federal regulators in early 2006. Two years later, WaMu became the largest bank failure in U.S. history.

The administration's blind eye to the impending crisis is emblematic of its governing philosophy, which trusted market forces and discounted the value of government intervention in the economy. Its belief ironically has ushered in the most massive government intervention since the 1930s. Many of the banks that fought to undermine the proposals by some regulators are now either out of business or accepting billions in federal aid to recover from a mortgage crisis they insisted would never come. Many executives remain in high-paying jobs, even after their assurances were proved false.

In 2005, faced with ominous signs the housing market was in jeopardy, bank regulators proposed new guidelines for banks writing risky loans. Today, in the midst of the worst housing recession in a generation, the proposal reads like a list of what-ifs:

--Regulators told bankers exotic mortgages were often inappropriate for buyers with bad credit.

--Banks would have been required to increase efforts to verify that buyers actually had jobs and could afford houses.

--Regulators proposed a cap on risky mortgages so a string of defaults wouldn't be crippling.

--Banks that bundled and sold mortgages were told to be sure investors knew exactly what they were buying.

--Regulators urged banks to help buyers make responsible decisions and clearly advise them that interest rates might skyrocket and huge payments might be due sooner than expected.

Those proposals all were stripped from the final rules. None required congressional approval or the president's signature. "In hindsight, it was spot on," said Jeffrey Brown, a former top official at the Office of Comptroller of the Currency, one of the first agencies to raise concerns about risky lending. Federal regulators were especially concerned about mortgages known as "option ARMs," which allow borrowers to make payments so low that mortgage debt actually increases every month. But banking executives accused the government of overreacting.

Bankers said such loans might be risky when approved with no money down or without ensuring buyers have jobs but such risk could be managed without government intervention. "An open market will mean that different institutions will develop different methodologies for achieving this goal," Joseph Polizzotto, counsel to now-bankrupt Lehman Brothers, told U.S. regulators in a March 2006.

Countrywide Financial Corp., at the time the nation's largest mortgage lender, agreed. The proposal "appears excessive and will inhibit future innovation in the marketplace," said Mary Jane Seebach, managing director of public affairs. One of the most contested rules said that before banks purchase mortgages from brokers, they should verify the process to ensure buyers could afford their homes. Some bankers now blame much of the housing crisis on brokers who wrote fraudulent, predatory loans. But in 2006, banks said they shouldn't have to double-check the brokers.

"It is not our role to be the regulator for the third-party lenders," wrote Ruthann Melbourne, chief risk officer of IndyMac Bank. California-based IndyMac also criticized regulators for not recognizing the track record of interest-only loans and option ARMs, which accounted for 70% of IndyMac's 2005 mortgage portfolio. This summer, the government seized IndyMac and will pay an estimated $9 billion to ensure customers don't lose their deposits.

Last week, Downey Savings joined the growing list of failed banks. The problem: About 52% of its mortgage portfolio was tied up in risky option ARMs, which in 2006 Downey insisted were safe -- maybe even safer than traditional 30-year mortgages. "To conclude that 'nontraditional' equates to higher risk does not appropriately balance risk and compensating factors of these products," said Lillian Gavin, the bank's chief credit officer.

At least some regulators didn't buy it. The comptroller of the currency, John C. Dugan, was among the first to sound the alarm in mid-2005. Speaking to a consumer advocacy group, Dugan painted a troublesome picture of option-ARM lending. Many buyers, particularly those with bad credit, would soon be unable to afford their payments, he said. And if housing prices declined, homeowners wouldn't even be able to sell their way out of the mess. It sounded simple, but "people kind of looked at us regulators as old-fashioned," said Brown, the agency's former deputy comptroller.

Diane Casey-Landry, of the American Bankers Association, said the industry feared a two-tiered system in which banks had to follow rules that mortgage brokers did not. She said opposition was based on the banks' best information. "You're looking at a decline in real estate values that was never contemplated," she said.

Some saw problems coming. Community groups and even some in the mortgage business, like Welch, warned regulators not to ease their rules. "We expect to see a huge increase in defaults, delinquencies and foreclosures as a result of the over selling of these products," Kevin Stein, associate director of the California Reinvestment Coalition, wrote to regulators in 2006. The group advocates on housing and banking issues for low-income and minority residents. The government's banking agencies spent nearly a year debating the rules, which required unanimous agreement among the OCC, Federal Deposit Insurance Corp., Federal Reserve, and the Office of Thrift Supervision -- agencies that sometimes don't agree.

The Fed, for instance, was reluctant under Alan Greenspan to heavily regulate lending. Similarly, the Office of Thrift Supervision, an arm of the Treasury Department that regulated many in the subprime mortgage market, worried that restricting certain mortgages would hurt banks and consumers. Grovetta Gardineer, OTS managing director for corporate and international activities, said the 2005 proposal "attempted to send an alarm bell that these products are bad." After hearing from banks, she said, regulators were persuaded that the loans themselves were not problematic as long as banks managed the risk. She disputes the notion that the rules were weakened.

In the past year, with Congress scrambling to stanch the bleeding in the financial industry, regulators have tightened rules on risky mortgages. Congress is considering further tightening, including some of the same proposals abandoned years ago.

Stocks fall sharply on consumer spending worries
Confirmation that the nation is in a recession and signs pointing to a prolonged downturn sent Wall Street plunging once again Monday, hurtling the Dow Jones industrials down more than 440 points and erasing a huge chunk of last week's big gains. All the major indexes fell more than 5 percent.
The market began the day sliding on initial reports that the holiday shopping season, while better than some retailers and analysts feared, was mixed, a sign that Americans are very reluctant to spend. That has Wall Street concerned about the impact of a continuing drop in consumer spending on the sagging economy.

According to preliminary figures released by RCT ShopperTrak, a research firm that tracks total retail sales at more than 50,000 outlets, sales rose 3 percent to $10.6 billion on Black Friday. But some analysts are concerned that Black Friday's results aren't indicative of the rest of the weekend; RCT ShopperTrak is expected to release data for the combined Friday and Saturday period later Monday.

Meanwhile, downbeat economic reports on the manufacturing sector and construction spending only added to investors' concerns. The day's news reminded investors, who last week were buying on a burst of optimism, that the economy is still in serious trouble. At midday, Wall Street had confirmation of what everyone has suspected for months, that the nation is indeed in a recession. The National Bureau of Economic Research, considered the arbiter of when the economy is in recession or expanding, said the U.S. recession had begun a year ago, in December 2007.

That assessment made the retail sales figures all the more unnerving. "Unfortunately, two-thirds of the American economy is based on the spending of the American consumer," said Mike Stanfield, chief executive of VSR Financial Services. "When the consumer pulls back, it's very hard for the economy to gain much traction." Investors had been hopeful that last week's rally -- when the major indexes shot up by double digit percentages -- was a sign that some stability had returned to a market badly shaken by months of discouraging economic data. But analysts expect economic concerns to weigh on the market for some time to come.

"Everyone knows the recession is on us, the question is now will it be short and shallow or long and severe," Stanfield said. Chuck Widger, chief executive of investment management firm Brinker Capital, expects the volatility to continue until investors have better visibility on the future. "Investors are looking for better data on the economy," he said. "We've got baked in pretty nasty assumptions for the economy this quarter. The markets are looking ahead to the first quarter for data that will confirm or deny the bad news."

In early afternoon trading, the Dow Jones industrial average fell 441.17, or 5.00 percent, to 8,387.87. The Standard & Poor's 500 index dropped 54.59, or 6.09 percent, to 841.65, while the Nasdaq composite index fell 94.64, or 6.16 percent, to 1,440.93. Declining issues outnumbered advancers by about 9 to 1 on the New York Stock Exchange, where volume came to 563.29 million shares. The Russell 2000 index of smaller companies fell 33.41, or 7.06 percent, to 439.73.

Bond prices rose. The yield on the benchmark 10-year Treasury note, which moves opposite its price, fell to 2.82 percent from 2.92 percent Friday. The yield on the three-month T-bill, considered one of the safest investments and an indicator of investor sentiment, slipped to 0.02 percent from 0.05 percent Friday. The lower the yield, the more anxious investors tend to be.

Both the housing and manufacturing sectors have been suffering for some time, so Monday's economic reports were ultimately unsurprising, although they added to the market's gloom. The Institute for Supply Management, a trade group of purchasing executives, said its index of manufacturing activity fell to a 26-year low in November. Meanwhile, the Commerce Department said construction spending fell by a larger-than-expected amount in October.

Stanfield also said investors have lost some confidence in recent moves by the government to bolster the financial system. "The financials are still lagging, which in my opinion shows a lack of confidence in (Treasury Secretary) Paulson and the undertaking of the Fed and the Treasury," he said. Analysts say investors have been frustrated by the government's change in strategy as it implements its $700 billion financial bailout program; the Treasury originally said it would buy soured mortgage debt from banks, then decided to buy stock in the banks. Last week, with the rescue of Citigroup Inc., the government again said it was buying the bank's failed debt.

The government injected a fresh $20 billion into the banking giant and said it would guarantee up to $306 billion of the bank's risky assets. Citigroup tumbled $1.37, or 17 percent, to $6.92. Morgan Stanley shares dropped $2.68, or 18 percent, to $12.07. Goldman Sachs Group Inc. fell $12.16, or 15 percent, to $66.83. Retailers were among the day's poorest performers. Wal-Mart Stores Inc. fell $2.31, or 4.13 percent, to $55.37, while JCPenny Co. tumbled $2.05, or 10.80 percent, to $16.94.

Wall Street is also awaiting some sort of resolution for automakers, who return to Washington this week in search of $25 billion in government support. Chrysler LLC, Ford Motor Co. and General Motors Corp. are to submit stabilization plans to Congress on Tuesday. The plans will be scrutinized at a Senate hearing Wednesday and a House hearing on Friday.

Meanwhile, Ford said it is considering selling Volvo Car Corp. Ford said it expects its strategic review of the Swedish luxury carmaker to take several months. Automakers are scheduled to report November U.S. auto sales on Tuesday. Light, sweet crude dropped $4.62 to $49.81 a barrel on the New York Mercantile Exchange after OPEC decided not to cut production at an informal meeting in Cairo on Saturday. The Organization of the Petroleum Exporting Countries, which accounts for about 40 percent of global supply, reduced output quotas in October by 1.5 million barrels a day.

The dollar fell against other major currencies. Gold prices also fell. Overseas, Japan's Nikkei stock average fell 1.35 percent. In afternoon trading, Britain's FTSE 100 was down 5.19 percent, Germany's DAX index was down 5.88 percent, and France's CAC-40 was down 5.59 percent.

Deep Discounts Draw Shoppers, but Not Profits
Sales in the nation's stores were strong over the weekend, to the relief of retailers that had been expecting a holiday shopping period as slow as the overall economy. But while spending was up, there were troubling signs in the early numbers. The bargains that drove shoppers to stores were so stunning, analysts said that retailers — already suffering from double-digit sales declines the last two months — would probably see their profits erode even further.

Also, after shoppers flooded stores on Friday, foot traffic trailed off significantly on Saturday and Sunday. Retailing professionals consider the weekend after Thanksgiving a barometer of overall holiday sales, which account for 25 to 40 percent of their annual sales. And in a year marked by an economic crisis, they are desperate for any signs that consumers are still willing to spend.

Their first glimpse came from two industry surveys released on Sunday. ShopperTrak, which does research for retailers, said sales increased 3 percent on Friday, compared with last year. The National Retail Federation, adding up sales Thursday through Saturday and projected sales for Sunday, said that each shopper spent about 7 percent more this year than last year. Shoppers spent an average of $372.57 Friday though Sunday, according to the federation, a trade group.

"It seems that not only did retailers do a good job of attracting shoppers but it seems that shoppers were also excited again to take part in the tradition of Black Friday weekend," said Kathy Grannis, a spokeswoman for the federation. That study also showed that Friday was by far the busiest day of the weekend, with traffic trailing off by more than 16 million people on Saturday.

Analysts said the discounts that drew in shoppers over the weekend were so steep that many ailing chains might be no better off in the long run. "You're looking at discounts of 50 to 70 percent off," said Matthew Katz, managing director in the retail practice of Alix Partners, an advisory and restructuring firm. "You have to sell two to three times as much to break even."

Chains as varied as Target and Neiman Marcus offered goods at some of their lowest prices ever. At Target, a 26-inch LCD HD-TV, originally $429.99, was selling for $299. Last week Tracy Mullin, president and chief executive of the National Retail Federation, noted that "this could be the most heavily promotional Black Friday in history." And those promotions came on top of already radical price cuts.

"There is a sense of desperation among retailers," said Hana Ben-Shabat, a partner in A. T. Kearney's retail practice, "because everybody knows consumers are very stretched." As Marshal Cohen, chief industry analyst for the NPD Group, put it: "This weekend was like having a huge party and just hoping anybody shows up."

Even with the cheery news from industry groups, many retailing professionals worry the shorter holiday shopping season, on top of an ailing economy, will hurt sales through Christmas. There are 27 shopping days between Thanksgiving and Christmas this year; there were 32 last year. Bill Martin, co-founder of ShopperTrak, said the abbreviated season "may catch some procrastinating consumers off guard, leading to lower sales levels."

Also potentially troubling for retailers is that consumers say they are further along in their holiday shopping — on average, 39.3 percent done versus 36.4 percent a year ago, according to the National Retail Federation, whose survey was conducted by BIGresearch. Already, stores had seen double-digit sales declines in the first two weeks of November, according to SpendingPulse, a report by MasterCard Advisors. Michael McNamara, vice president of SpendingPulse, said sectors like electronics and luxury goods declined by more than 19 percent versus the period a year ago.

But both ShopperTrak and the National Retail Federation said Friday was a reminder that shopping remained an American pastime. ShopperTrak said foot traffic was up almost 2 percent, though its estimate for the full holiday season is a nearly 10 percent plunge in sales compared with last year. The National Retail Federation said some 172 million shoppers visited stores and Web sites over Thanksgiving weekend, up from 147 million shoppers last year.

Most people shopped at discount stores. But in what must be welcome news for struggling department stores, about 11 percent more consumers shopped at them this year than last year. Over all, though, most shoppers ended up buying lower-cost items: clothes, accessories, video games, DVDs, and CDs. Gift cards were down 10 percent, perhaps in part because of concerns about retail bankruptcies.

Despite the industry surveys' findings, many consumers and longtime retailing analysts attested to lighter crowds. "There was definitely more elbow room," said John D. Morris, a Wachovia analyst whose retail team fanned out at malls across the country on Friday. Mr. Cohen of the NPD Group said that on Friday foot traffic at stores was down 11 percent and the shopping bag count was down 24 percent compared with last year.

In online retailing, comScore said spending for the first 28 days of November declined 4 percent, to $10.4 billion, compared with $10.8 billion for the period a year ago. Online spending on Friday bumped up 1 percent, to $534 million, compared with $531 million last year. Retailers did not report Friday sales on Sunday; most will wrap them into their November sales reports on Thursday.

J. C. Penney, for instance, said in a statement on Saturday that "in light of the challenging and volatile economic climate, and shifts in this year's retail calendar, we don't believe that reporting sales data for any one day (or weekend), including Black Friday, would provide a meaningful barometer of our business." Black Friday is named for the day when, historically, retailers moved into the black, or became profitable for the year. Retailing professionals now use the whole holiday shopping season, November through December, to help determine the health of a retailer.

Mr. Martin of ShopperTrak cautioned that Black Friday "is just one day" and said he was not changing his prediction for flat holiday sales this year. Other retailing groups have predicted sales declines. Standard & Poor's Equity Research Services estimated a 5 percent drop. IBISWorld, a research firm, said overall holiday spending would sink by about 3 percent.

In the wee hours of Friday morning, retailers were optimistic. In the Herald Square area of Manhattan, the head of Macy's, Terry J. Lundgren, said he was feeling "very encouraged that customers are out," as he stood amid a swirl of bleary-eyed shoppers. There were about 5,000 people lined up outside before 5 a.m. Friday, he said, about the same as last year. "We're all anxious to see how the customer responds."

By Saturday, consumers said the frenzy — which resulted the death of a Wal-Mart worker in suburban New York when shopping commenced on Friday morning — that had accompanied the weekend's limited-time jaw-dropping deals was gone. "The parking lot didn't have a lot of cars in it, so it was easy to find a spot up front," said Kimi Armstrong as she wandered around the Domain, an upscale shopping center in Austin, Texas. "At this exact time last year it was raining, but the sidewalks were packed with people. It was wall-to-wall people. It was hard to walk down the sidewalk without running into anybody."

Some shoppers, including Ms. Armstrong, hit the stores over the weekend just to partake of the Christmas spirit, brainstorm gift ideas or check deals that many expected to improve in the weeks to come. On a bench in front of a Macy's store in Century City, Calif., Jill Capanna, 47, was eating frozen yogurt with her family. It was their only purchase after having wandered the mall for three hours. "Normally we buy presents way ahead of time," Ms. Capanna said, "but this year I'm waiting until the last minute."

At Westfield Century City Shopping Center in California, Harper Mance, 31, said: "I'm looking around, thinking, 'If there are discounts on everything now, what's it going to be like after Christmas?' You know it's going to go down further." Ms. Mance's mother, Zoë, 59, agreed. "They'll be paying us to take things after Christmas," she said.

Whitney: Credit-card industry may cut $2 trillion lines
The U.S. credit-card industry may pull back well over $2 trillion of lines over the next 18 months due to risk aversion and regulatory changes, leading to sharp declines in consumer spending, prominent banking analyst Meredith Whitney said. The credit card is the second key source of consumer liquidity, the first being jobs, the Oppenheimer & Co analyst noted. "In other words, we expect available consumer liquidity in the form of credit-card lines to decline by 45 percent."

Bank of America Corp, Citigroup Inc and JPMorgan Chase & Co represent over half of the estimated U.S. card outstandings as of September 30, and each company has discussed reducing card exposure or slowing growth, Whitney said. Closing millions of accounts, cutting credit lines and raising interest rates are just some of the moves credit card issuers are using to try to inoculate themselves from a tsunami of expected consumer defaults.

A consolidated U.S. lending market that is pulling back on credit is also posing a risk to the overall consumer liquidity, Whitney said. Mortgages and credit cards are now dominated by five players who are all pulling back liquidity, making reductions in consumer liquidity seem unavoidable, she said. "We are now beginning to see evidence of broad-based declines in overall consumer liquidity. Already, we have witnessed the entire mortgage market hit a wall, and we believe it will, for the first time ever, show actual shrinkage over the next few months," she wrote.

The credit card market will be 18 months behind the mortgage market and will begin to shrink by mid-2010, Whitney said. Whitney also expects home prices to continue falling another 20 percent hurt by lower liquidity. They are down 23 percent from their peak, she said. "In a country that offers hundreds of cereal and soda pop choices, the banking industry has become one that offers very few choices," Whitney wrote in a note dated November 30.

She also said credit lines to consumers through home equity and credit cards had been cut back from the second-quarter levels. "Pulling credit when job losses are increasing by over 50 percent year-over-year in most key states is a dangerous and unprecedented combination, in our view," the analyst said. Most of the solutions to the situation involve government intervention, and all of them require more dilutive capital to existing lenders, she said. "Accordingly, we continue to be cautious on our outlook on US banks."

In a column in the Financial Times, Whitney suggested four adoptable changes to make a difference. The first would be to re-regionalize lending, which has gone from "knowing your customer" or local lending, to relying on what have proven to be unreliable FICO credit scores and centralized underwriting, due to the nationwide consolidation since the early 1990s, she wrote in the column.

Expanding the Federal Deposit Insurance Corp's guarantee for bank debt will also help as the banks need to know they can access reasonably priced credit for an extended period to continue to extend new credit lines, she wrote in the column. Whitney also advised delaying the introduction of new accounting rules, which would bring off-balance-sheet assets back on balance sheet, until 2011 or 2012, as the primary assets that will come back are credit card loans. Whitney suggested amending the proposal on Unfair and Deceptive Lending Practices that is set to be adopted in 2010, saying restricting lenders' ability to reprice an unsecured loan will cause them to stop lending or to lend less.

Gas falls for 75th day - cheapest since 2005
Gas prices fell for the 75th consecutive day on Monday, and sold below $2 a gallon in all but three states and the District of Columbia, according to a daily survey of credit-card swipes at gas stations.Gas prices slipped 0.5 cents to a national average of $1.82 a gallon, the cheapest price since January 2005, according to Monday's survey from motorist group AAA. That price is $1.24 less than what gas cost on the same day last year.

Gas prices have fallen by more than 55% since hitting a record high of $4.114 a gallon on July 17. Concern about falling fuel consumption in the midst of the current economic crisis has driven the price of oil, a main component of gasoline, down more than 65% since July. Typically, energy expenditures are the first to be trimmed back during periods of economic sluggishness as business activity declines and consumers try to save money by driving less.

Gasoline prices are now below $2 a gallon, on average, in all states except Alaska ($2.759), Hawaii ($2.70), New York ($2.188), and the District of Columbia ($2.064). Missouri had the lowest prices at $1.558 a gallon. Diesel: The price of diesel fuel, which is used by most trucks and commercial vehicles, fell 1.2 cents to a national average of $2.744 a gallon, according to AAA. Diesel prices have fallen more than 43% since hitting a high of $4.845 in July.

Ethanol: Meanwhile the price of E85, an 85% ethanol blend made primarily corn, fell 0.8 cents to $1.596 a gallon on average, according to AAA. E85 can be used as a gas substitute in special configured "flex-fuel" vehicles. However, it is difficult to find outside of the corn-producing Midwest region, and it is not sold at the pump in some states.
The AAA figures, compiled by Oil Price Information Services, are state-wide averages based on credit card swipes at up to 100,000 service stations across the nation. Individual drivers may see lower fuel prices in different areas of each state.

World stability hangs by a thread as economies continue to unravel
The political bubble is bursting. Spreads on geo-strategic risk are now widening as dramatically as the spreads on financial risk at the onset of the credit crunch. Whether it is the Indian rupee, the Shanghai bourse, or Kremlin debt, the stars of the credit boom have fallen to earth. Investors are retreating into 3-month US Treasury bills – the ultimate safe-haven. The yield has fallen to 0.02pc, less than zero after costs. You pay Washington to guard your money.

The working assumption of the "Great Boom" is – or was – that we live in a benign era where most societies are converging towards some form of market liberalism; where trade and capital flows are unrestricted; where governments have enough legitimacy to keep order by light touch; where a major war is unthinkable. This illusion is now being tested.

We should not to read too much into the Bombay carnage. It may or may not be significant that the Deccan Mujahideen – whoever they are – picked India's financial hub to launch their spectacular. Even so, the love affair with Bombay's bourse was cooling anyway. The Sensex index is down almost 60pc from its peak. The exodus of foreign capital may now quicken, laying bare the horrors of Indian public finance. The combined federal and state deficit is 8pc of GDP. Plainly, spending will have to be slashed.

If the atrocity now propels the Hindu nationalist leader Narendra Modi into office at the head of a revived Bharatiya Janata Party (BJP), south Asia will once again face a nuclear showdown between India and Pakistan. Events are moving briskly in China too. Wudu was torched by rioters this month in a pitched battle with police. Violence has spread to the export hub of Guangdong as workers protest at the mass closure of toy, textile, and furniture factories. "The global financial crisis has not bottomed yet. The impact is spreading globally and deepening," said Zhang Pin, head of the national development commission. "Excessive bankruptcies and business closures will cause massive unemployment and stir social unrest".

We are about to find out whether China has made the wrong bet with a development strategy of vast investment in manufacturing plant for mass export at thin margins to the US and Europe. The shocking detail in the World Bank's latest report on China is that wages have fallen from 52pc to 40pc of GDP since 1999. This is evidence of an economic model that is disastrously out of kilter, and unlikely to retain popular support.

The Communist Party lost its ideological mission long ago. The regime depends on perpetual boom to stay in power. As the economy sours, there must be a high risk that it will resort to the nationalist card instead. Tokyo certainly thinks so. When I visited Japan's Defence Ministry last year the deputy minister showed me charts detailing the intrusion of China's fast-growing fleet of attack submarines into Japanese waters. "We see its warships in the Sea of Japan all the time," he said.

Shoichi Nakagawa, the head of the ruling LDP party, was even more explicit. "What happens when China attacks Japan? Will the US retaliate on our behalf?" he said. As for Europe, it is already fragile. Iceland, Hungary, Ukraine, Belarus, Latvia, and Serbia have turned to the IMF. Russia is a hostage to oil prices. If Urals oil stays below $50 a barrel for long, we are going to see an earthquake of one kind or another.

It is too early in this crisis to conclude whether Europe's monetary union is a source stability, or is itself a doomsday machine. The rift between North and South is growing. The spreads on Greek, Irish, Italian, Austrian, and Belgian debt remain stubbornly high. The lack of a unified EU treasury has become glaringly clear. Germany has refused to underpin the system with a fiscal blitz.

In the 1930s, it was not obvious to people living through debt deflation that their world was coming apart. The crisis came in pulses, each followed by months of apparent normality – like today. The global system did not snap until September 1931. The trigger was a mutiny by Royal Navy ratings at Invergordon over pay cuts. Sailors on four battleships refused to put out to sea. They sang the Red Flag.

News that the British Empire could not uphold military discipline set off capital flight. Britain was forced off the gold standard within five days. A chunk of the world followed suit. Nor was it obvious that Germany would go mad. Bruning persisted with deflation, blind to the danger. The result was the election of July 1932 when two parties committed to the destruction of Weimar – the KPD Communists and the Nazis – won over the half the seats in Reichstag.

We can hope that governments have acted fast enough this time – with rate cuts and a fiscal firewall – to head off such disasters. But then again, the debt excesses are much greater today. If in doubt, cleave to those countries with a deeply-rooted democracy, a strong sense of national solidarity, a tested rule of law – and aircraft carriers. The US and Britain do not look so bad after all.

Bank of Japan plans emergency meeting
Japan's central bank will hold an unscheduled monetary policy meeting Tuesday afternoon to discuss ways to help companies raise money amid a pullback among lenders. Bank of Japan Gov. Masaaki Shirakawa called the meeting Monday after reiterating his concerns about corporate financing earlier in the day.

A growing number of Japanese firms, especially in the construction and real estate sectors, are reporting more difficulty securing loans, he said in a speech to business executives in Fukuoka, southern Japan. Financial conditions "seem to have become less accommodative at an accelerating pace, particularly in terms of availability of funds, reflecting the turmoil in global financial markets," he said.

At the meeting, the policy board will likely finalize measures for smaller companies who need to raise operating capital for the year-end period and remainder of the fiscal year through March 2008, according to Kyodo news agency. Likely steps include the introduction of a temporary lending facility to support banks' commercial loan operations.

The central bank may also begin to accept lower-graded commercial paper and corporate bonds as collateral from financial institutions. The Bank of Japan is not expected to make changes anytime soon to its key interest rate, which now stands at a low 0.3%.

Yields ‘Next to Nothing’ Lure Funds to Riskier Assets
In the best year for Treasuries since 2002, fund managers who only buy government bonds are seeking permission to invest in corporate debt they considered toxic just a month ago. Treasuries “are yielding next to nothing,” said Robert Millikan, who manages $5 billion at BB&T Asset Management in Raleigh, North Carolina, including the $51 million BB&T Short U.S. Government Fund. “Trying to do something for your shareholders, it’s hard to sit there and buy a bond that yields less than any fees you charge.”

While U.S. government debt returned 10.1 percent on average this year, the most since 11.6 percent in all of 2002, Merrill Lynch & Co. index data show, yields dropped so low that fund managers have little chance of offering anything but subpar returns in 2009. Yields on two- and 10-year notes, as well as 30-year bonds fell to record lows today.

That helps explain why BB&T, BlackRock Inc., T. Rowe Price Group Inc. and Sage Advisory Services Ltd. are looking elsewhere for returns, including bonds of the banks that were almost ruined by $967 billion in losses and writedowns since the start of 2007. Treasury funds are receiving permission to buy debt of Morgan Stanley, JPMorgan Chase & Co. and Goldman Sachs Group Inc. after the Federal Deposit Insurance Corp. finalized plans on Nov. 21 to guarantee their debt.

The FDIC program announced on Oct. 14 is part of the more than $1.5 trillion in unprecedented financing from the Treasury and the Federal Reserve to end the worst financial crisis since the Great Depression. The U.S. now guarantees more than $13 trillion of debt.

Goldman, which registered as a bank in September after 139 years as a securities firm, became the first U.S. company to take advantage of the program, selling $5 billion of 3.25 percent FDIC-backed notes on Nov. 25. The debt, which matures June 2012, was priced to yield two percentage points more than Treasuries of similar maturity. Before the government announced the guarantees, New York-based Goldman’s 6.15 percent bonds due 2018 yielded about five percentage points more than government debt.

Morgan Stanley, which also became a bank on Sept. 21, sold $5.75 billion in FDIC-backed debt in three series, including $2.5 billion of three-year, 3.25 percent notes at a spread of 186 basis points. As recently as Oct. 13, the New York-based company’s notes yielded more than six percentage points more than Treasuries. “It’s a great substitute,” said Millikan, whose Short U.S. Government Fund returned 4.55 percent the past year, beating 78 percent of its peers. He gained approval from BB&T’s lawyers to purchase FDIC-backed debt and may buy bonds from New York-based Citigroup Inc. and Bank of America Corp. in Charlotte, North Carolina.

Two-year note yields fell 11 basis points last week to 1 percent as reports showed gross domestic product shrunk 0.5 percent in the third quarter and Americans cut spending by 1 percent in October, the biggest drop since the last recession in 2001. The price of the 1.25 percent security due November 2010 rose 6/32, or $1.88 per $1,000 face value, to 100 16/32 since being auctioned on Nov. 24, according to BGCantor Market Data. The yield fell five basis points to a record low of 0.9251 percent at 10:25 a.m. in New York.

“There are plenty of cheap quasi government-guaranteed alternatives to Treasuries,” said Stuart Spodek, co-head of U.S. bonds in New York at BlackRock, which manages $502 billion in debt. “So why buy a two-year note?” The hunt for alternatives to government debt may become more acute because the Fed is likely to cut interest rates to less than 1 percent this month.

Futures traded on the Chicago Board of Trade show a 76 percent chance Fed policy makers will cut the 1 percent target rate for overnight loans between banks by 50 basis points at their Dec. 16 meeting. All other bets are for a reduction of 75 basis points, or 0.75 percentage point. If the federal funds rate falls to 0.5 percent and two-year Treasury note yields follow, investors would realize an annualized return of 1.5 percent, according to Bloomberg data. That would barely cover the 0.66 percent expenses charged by Millikan’s fund.

Yields will decline in 2009 as the Fed lowers its key rate to zero from 1 percent, JPMorgan Chase & Co. wrote in a report on Nov. 28. Two-year yields will fall to 0.6 percent by June 30 while 10-year yields tumble to 2 percent, JPMorgan said.

The FDIC guarantees opened credit markets for banks shut out of long-term financing alternatives. Yields on investment- grade financial debt rose more than 5 percentage points this year to a near-record high of 7.28 percentage points above Treasuries, according to Merrill Lynch index data. Investment- grade bonds are debt rated Baa or above by Moody’s Investors Service or BBB or above by Standard & Poor’s.

As much as $600 billion of the FDIC-backed bonds may be issued by the time the program ends in June, according to Barclays Plc. Such sales already total $17.25 billion.
That’s on top of $1.7 trillion of securities sold by government-chartered mortgage finance companies Fannie Mae in Washington and Freddie Mac of McLean, Virginia, $1.3 trillion of bonds from the 12 Federal Home Loan Banks and almost $5 billion in agency mortgage securities.

“A lot of Treasury-only funds will be looking at” FDIC- backed notes, said Brian Brennan, who helps oversee $13 billion in fixed-income assets at T. Rowe Price in Baltimore. “For investors who are seeking safety, this is a safe instrument that provides more yield.” Brennan’s U.S. Treasury Intermediate Fund returned 9.27 percent in the past year, beating 99 percent of its peers, according to data compiled by Bloomberg.

Government debt rose 5.38 percent in November, the most since Ronald Reagan was in the White House in 1981, even as demand for company bonds increased. Investment-grade corporate debt returned 3.6 percent, the best performance since September 2003, after falling 15 percent the previous 10 months. There’s little chance that demand for Treasuries will slacken as investors seek a haven from riskier assets, said Ian Lyngen, an interest-rate strategist in Greenwich, Connecticut, at RBS Greenwich Capital. The firm is one of the 17 primary dealers of U.S. government securities that trade with the Fed and are obligated to bid at the Treasury’s auctions.

FDIC-backed bank debt “will have a marginal impact, if any,” said Lyngen, who expects two-year Treasury yields to decline to 0.85 percent in the first quarter. “It’s a bit of a toss up given that the bulk of the move has been a flight to quality.” The FDIC program follows more than a dozen government programs to unlock credit that will be paid in part with Treasuries. Gross issuance in the $5.7 trillion Treasury market will increase to about $1.2 trillion in fiscal 2009, which started on Oct. 1, from $724 billion last year, according to Credit Suisse Group AG, another primary dealer.

President-elect Barack Obama pledged during a Thanksgiving address to forge a “new beginning” from the moment he takes office and said his economic team is already working on a recovery plan. Obama said he will name New York Federal Reserve Bank President Timothy Geithner as Treasury secretary and Harvard University Professor Lawrence Summers, a former leader of the Treasury as White House economic adviser. He also appointed former Fed Chairman Paul Volcker as head of an economic recovery advisory board.

The risk for investors now is that the combination of more government bonds and guaranteed debt will make Treasuries less desirable. “Treasury rates are going higher,” said Mark MacQueen, a partner and money manager at Austin, Texas-based Sage Advisory, which oversees $6 billion. “I plan to invest in the guaranteed debt.”

Unraveling the Mystery Behind U.S. Treasury Prices
In a season characterized by an ever-growing list of unprecedented events—from repeated capital infusions by the federal government into U.S. financial institutions to historically high market volatility—it's tempting to shrug your shoulders when you come across truly puzzling valuations that appear to ignore economic fundamentals. Still, the extent to which investor demand for U.S. Treasury bonds has sent prices soaring and yields plummeting seems to defy reason. To get a sense of how much demand there is for fully-guaranteed government bonds, just look at prices over the past few months. The benchmark 10-year Treasury note was trading at a price of 106-22/32 for a yield of 2.974% on Nov. 26; the price was 102-06/32, and the yield 3.73%, on Sept. 2.

Try as you might to justify these moves by citing the seemingly bottomless hunger for cash at American International Group, to the collapse of Lehman Brothers Holdings, to Citigroup's precarious position, the activity in the Treasury market sparks a flurry of questions. Inexplicably, investors don't seem concerned about the low-to-no yields they are getting for their money. Here are some of the Treasury market's greatest puzzles.

Bill Larkin, portfolio manager for fixed income at Cabot Money Management in Salem, Mass., thinks Treasury bonds are probably one of the most dangerous trades for investors right now. The stock and bond markets are pricing in the worst economy in 30 years, with no inflation expectations. "When you get into yields this low, and you get into this historic expensive zone, if you plan on holding them to maturity, you're fine. But in real terms, adjusted for inflation, you lose," he says. Larkin says there's no doubt that the liquidity programs being enacted by the U.S. Treasury Dept. and the Federal Reserve will eventually stimulate growth and result in rising inflation, despite concerns about how effective these policies have been thus far in responding to the financial crisis.

Jim Sarni, managing principal at Payden & Rygel—an investment firm in Los Angeles that manages more than $50 billion in assets—calls the flight to quality into high-priced Treasury bonds a persistent disconnect between market fundamentals and market valuations on one hand, and people's desperation to avoid risk on the other. He notes how quick the Treasury has been to abandon certain strategies designed to spark lending and restore confidence in favor of new programs, without fully explaining to the public—or possibly even thinking through—how the proposed measures would actually work. "As investors, we're all being bombarded by information that scratches the surface [in terms of trying] to solve the liquidity problems in the market," Sarni says. "Nothing is gaining traction because none of the details are known, and that's manifesting itself in people being skittish, which is driving them to the safest thing out there until there's more certainty about what's going on." The latest announcement on Nov. 25 was that the Federal Reserve plans to buy up to $500 billion worth of mortgages bonds guaranteed by Fannie Mae, Freddie Mac, and Ginnie Mae, as well as an additional $100 billion of securities from mortgage finance companies such as the Federal Home Loan Bank. That caused interest rates on 30-year mortgages to drop three-quarters of a percentage point within one day, to around 5.5%.

Hedge Fund Manager Hendry Bets on Deflation With U.K. War Loans
Hugh Hendry, who oversees about $500 million as co-founder of Ecletica Asset Management in London, said he’s buying World War I debt on the bet the U.K. is due for its worst round of deflation since the Great Depression. The gilts, known as perpetuals because they have no maturity date, have a coupon of 3.5 percent compared with the U.K.’s 4.5 percent inflation rate. Investors hold about 1.9 billion pounds ($2.9 billion) of the securities that still pay interest 90 years after the end of the Great War, according to the U.K.’s Debt Management Office.

“If you have a deflationary shock, the only instrument that will perform will be government debt,” said Hendry, 39, whose Eclectica Fund returned 38 percent this year, putting it in the top 1 percent of 1,817 funds tracked by Bloomberg. “Inflation is going to be back some day. But forget the next 12 years; it’s the next 12 months that matter.”

The Bank of England lowered its benchmark interest rate by 150 basis points last month, its biggest move in 16 years, as the credit crisis pushes the country’s economy into recession. Governor Mervyn King told lawmakers last week that failure to get banks lending again could raise the risk of deflation. As interest rates drop and investors shun risk, even government debt with a low coupon will rise in value, Hendry said.

The five-year breakeven rate, a gauge of inflation expectations as measured by the difference in yield between regular bonds and index-linked debt, has been negative for more than month, suggesting investors are betting a recession will lead to deflation. The gauge fell to minus 102 basis points today; it was at positive 105 basis points at the start of last month.

The “Jolly Long Bond,” as Hendry calls the war loan, will be the most reactive to deflation because not having a maturity means it has long duration, said Charles Diebel, head of European interest-rate strategy at Nomura International Plc in London. A bond with a higher duration will increase more in value than one with a shorter duration for a given decline in yield.

“His philosophy behind it makes a lot of sense,” Diebel said. “If you have an extended period of time where inflation is not a problem, you get no yield at the front end of the curve and people will be forced out the yield curve. You can’t be forced out further on the yield curve than a perpetual.” A yield curve is a chart of yields on bonds of a range of maturities. Longer-dated bonds typically yield more than shorter- dated notes to compensate investors for the risk of holding them over time.

The bonds trade so infrequently Hendry said he bought them for his personal account, rather than for the funds he manages. “You’d become a bit of a hostage” by holding too much of a rarely traded bond like the perpetual, he said. “Managing a hedge fund means reserving the right to change your mind all the time.” The biggest risk to the investment is inflation, which Hendry said ultimately will return because of the actions policymakers are taking today to thaw credit markets.

The U.K. government sold the perpetual in 1917, as British forces deployed tanks at the Battle of Cambrai, to repay loans it had sold since the conflict started in 1914. It marketed the debt with advertisements playing on patriotic sentiment. “If you cannot fight, you can help your country by investing all you can in 5 percent exchequer bonds,” the advertisements said, according to an account in “The Financiers and the Nation,” by Thomas Johnston. “Unlike the soldier, the investor runs no risk.”

The 1917 notes were first sold with a coupon of 5 percent, a rate Prime Minister Lloyd George regarded as “penal,” according to Johnston’s book, first published in 1934 and republished by Ossian Publishers Ltd. in 1994. Neville Chamberlain, then Chancellor of the Exchequer, cut the coupon payment to 3.5 percent in 1932, where it has remained ever since.

The U.K. is unlikely to call the debt or retire it early because it would have to buy the bonds back at par, Hendry added. The gilts trade at about 78 pence today. “The vast majority of this is locked up with retail investors,” said Diebel. Were the government to call the loans “they would be taking it away from households, rather than banks,” he added.

OC: Jeff Rubin gets the quote of the day and makes some valid statements. But, as usual, his big-picture conclusion is wrong.

U.S. facing biggest deficit in 60 years
President-elect Obama can expect to face the biggest U.S federal deficit since the end of WWII when he takes office in January, finds a new report from CIBC World Markets.Before his administration adds on its own stimulus package, the Treasury market will need to finance a minimum of $1.5 trillion of new debt, if not more, pushing the federal deficit to 11 per cent of U.S. GDP. And this will be before the full brunt of the cyclical deterioration in tax revenues that accompanies a recession, has been felt.

At this level the deficit will be larger, in relation to the overall size of the economy that supports it, than the red ink ran up during either the Korean or Viet Nam Wars. In relation to the size of the economy, it will be bigger than any deficit since 1946. "Find a strong enough wind and even pigs can fly," says Jeff Rubin, chief economist at CIBC World Markets. "If you force-feed a $14 trillion economy with $1.5 trillion of fiscal stimulus, GDP growth will respond. But what about the trail of record deficits that lay in the wake of such fiscal action? How many years of program spending cuts and tax hikes will it take to whittle down such a massive deficit. Will future taxpayers simply wish we had bitten the bullet for a few quarters and not mortgaged their future?"

Mr. Rubin says that while politicians and financial markets are currently worrying about deflation risks, history has shown inflation to be a far more common dancing partner for massive government deficits. He notes that by monetizing debt by simply selling the bonds and bills to the Federal Reserve Board instead of the public will drive inflation - and that may be a good thing for government.

"The resulting higher inflation allows the government to pay off bondholders with coupons that have less and less buying power every year," adds Mr. Rubin. "And while the bonds mature at par, inflation will have eroded much of their real value. And higher inflation ultimately brings down the value of your currency, which is a huge benefit, if you are the U.S. and can get other countries to lend you their hard-earned savings in your currency.

"That allows you to repay your lenders, like the People's Bank of China, with greenbacks that buy a lot less Yuan than they did when China first lent you the money. And aside from stiffing your creditors, higher inflation is bound to rub off on asset values, like housing prices, for example. That would certainly boost the value of all those mortgage-backed securities that the Fed is now buying."

An area of the economy Mr. Rubin does not think will be saved by a government bailout is the domestic auto sector. While he recognizes that a Chapter-11 reorganization, levered with billions of dollars in taxpayer-funded assistance, may allow the Big-Three to stay in production and win much needed concessions from its unions and creditors, he does not see this resolving questions of long-term viability.

"The issue is not simply the competitiveness of North American auto producers but the size of the market they will serve in the future," notes Mr. Rubin. "A secular rise in gasoline prices and a lengthy period of consumer deleveraging is fundamentally altering both the size and composition of the U.S. auto market. Currently, U.S. car makers are not only making far too many SUVs for customers who want smaller and more fuel efficient vehicles, but more ominously, their production capacity seems grossly oversized for what is likely to be a steadily shrinking North American vehicle market."

The report notes that since gasoline prices hit their peak in June, vehicle sales have plunged 50 per cent, which is larger than the drop in sales after the first two oil shocks. While it took as long as 10 months for sales to recover after the first two shocks, Mr. Rubin is not certain sales will rebound this time. In fact, while gasoline prices have dropped dramatically in the last six months, the decline in auto sales continues to accelerate. The latest monthly sales numbers in the U.S. have dropped below 11 million units, levels not seen since 1983, following the infamous double-dip recession of the early 1980s.

Mr. Rubin thinks two powerful forces will keep sales from rebounding - energy prices and the end of cheap credit. He notes that oil prices collapsed after the 1982 recession and remained cheap for the next two decades as the oil shocks spawned greater efficiency and new supply from places like the North Sea and Prudhoe Bay in Alaska. While in percentage terms, prices have collapsed as much since the start of summer as they did after 1982, the resulting levels are very different. While $50 per barrel oil is only a third of the peak level of $147 per barrel seen in July, it is a level that only four years ago would have denoted an all-time high price for petroleum.

With the world's new oil supply largely tied to high cost oil sands and deep water wells, many new supply projects are being postponed or cancelled. As a result, there is a very real chance that world supply will contract in the face of depletion rates that every year take out some four million barrels per day of production.

Mr. Rubin believes the end of cheap credit may be almost as important as the end of cheap oil in putting the brakes on future vehicle sales. Over 90 per cent of all new car purchases require financing of some kind. The past twenty or so years not only saw a housing bubble that was fuelled by easy access to credit on favourable terms, but it also applied to automobiles as well. During this period, U.S. vehicle sales reached a peak of over 20 million, and household car ownership rose from 1.9 vehicles per household in the early 1990s to 2.2 in 2007.

"Like today's home buyer, today's auto buyer is finding financing harder and harder to come by," adds Mr. Rubin. "Particularly those looking for lease financing, who until recently had accounted for almost 30 per cent of all new vehicle shoppers. But leasing is a rapidly diminishing source of vehicle financing.

"At a time when there is a growing crescendo of calls for greater infrastructure spending, it is noteworthy that there will soon be fewer and fewer Americans on the road. The shrinking size of the domestic car market suggests that investment in public transit, as opposed to new freeways, would be a far better infrastructure choice."

OC: There's a short but interesting video segment in this one.

Foreclosure sales rise in the US
Across the USA, foreclosure sales are becoming an increasingly popular way of finding a bargain. Almost a third of properties on sale are now owned by banks, and as foreclosures - American for repossessions - continue, prices are being pushed down and driving an expansion in this niche market. In Long Island one real estate company has set up tours of foreclosed homes to bring in the buyers. Punters on the hunt for a bargain are ferried around in a little bus to various foreclosed properties.

The Long Island Foreclosure Tours started operating earlier this year. David Farrell is one of the partners. "Every day you see an increase in the share of the market that is foreclosure business and that is why we started this and got involved," he says. These are vacant houses that the banks need to sell and any buyer who is looking for a deal is looking for a foreclosure."

This is a growing market, and there's not many of those to be had in the present climate. As a result of the increase in foreclosures, the banks now own almost a third of the homes on sale in America. It's a buyers market, if you have the money.

One of the clients on the bus is Andrew Hutchinson. He sees this as an opportunity to move up in the world.
"With foreclosures you can find an area better than the area you live in now, and you can upgrade. Taxes might be a little bit higher, but you might have a house that you wouldn't be able to afford prior to this."

One of the homes on the tour is a sprawling building with an outhouse. It's set on an expensive road in the neighbourhood. Last year houses around here were worth over $1.2m (£783,000). The bank bought this back for just over $1m. It's now listed at $699,000,a drop of almost 50%. The bank has had to bear a considerable loss. That's the irony; at the lower price, the former owners may have been able to afford the mortgage and stay in the property. Both the government and banks are working to staunch the flow of foreclosures, and keep owners in their homes, but critics say it's too little too late.

In another part of New York, there's a seminar in the Bronx to help owners stay in their homes. At the public library, organisations wait for people to turn up. No one comes.
A local official explains advertising budgets have been cut because of the crisis, and there was no money to spread the news. Rebecca Gamez was there. She's from the Neighbourhood Economic Development Advocacy Project (Nedap), a New York non profit organisation.

"I think there definitely needs to be a push at the national level to make homeowners a priority, for those who are facing foreclosure to stay in their homes," she says. "I think that at the national level the government should be pushing banks and lenders to work with home owners, and get them into affordable mortgages so they can stay in their homes for the long term."

In the meantime, the tour continues around the houses. As winter approaches they've started doing after work tours in the dark, which means the properties are being viewed by flashlight. There are five properties on this list. Mr Hutchinson shrugs his shoulders and says he feels bad for those who lost their home, but this is an opportunity.

"Unfortunately due to the economy; foreclosed homes, you might say, are an economic change for some people and a benefit for other people," he says. "So we feel maybe we can get some good out of it for ourselves, some good comes out of the bad." Last month half of the homes bought were foreclosures. That's hardly enough to stabilize the market, but it does show that as prices fall, there is a market out there willing and able to buy.

UK mortgage approvals down 72pc from peak, Bank of England figures show
The number of UK mortgage approvals dropped again in October, equalling their lowest low and 72pc down on their peak in 2007, according to the latest figures from the Bank of England. Approvals fell by 1,000 from September to 32,000 - this equals the figure reached in August which is the lowest since comparable records began in 1993, and a clear signal that the UK housing market crisis is nowhere near recovery. The pace of decline has been sharp, with approvals falling from 88,000 last October and 114,000 in mid-2007.

The value of total new mortgages was also 67pc lower in October at £500m, compared with £1.5bn in September, and well below the monthly average of £2.7bn for the previous six months. Howard Archer, chief economist at IHS Global Insight, said: "Housing market activity is exceptionally low compared to long-term norms. Ongoing very tight credit conditions, still relatively stretched housing affordability on a number of measures, recession, faster rising unemployment and widespread expectations that house prices are likely to fall a lot further form a powerful set of negative factors weighing down on the housing market. "Consequently, house prices seem set to fall markedly further over the coming months even though mortgage lenders have largely passed on last month's 150 basis point interest rate cut by the Bank of England and the central bank is poised to cut interest rates substantially further on Thursday."

UK house prices are expected to fall by a total of 15pc in 2008, with a similar drop expected next year as well. Economists are predicting that the Bank of England's Monetary Policy Committee will reduce interest rates by at least 0.5 percentage points when it makes its monthly decision on Thursday, and possibly more as it attempts to do all it can to limit the effects of a recession.

Ford weighs selling Volvo amid industry downturn
Ford Motor Co. is considering selling Volvo Car Corp. as the beleaguered U.S. automaker seeks to raise cash and survive tight credit markets and a global automotive sales crisis. Goteborg-based Volvo Cars, which Ford bought in 1999, has been struggling with declining demand and a strong euro which made its products more expensive. Volvo sales through October are down more than 28 percent compared with the same period in 2007, according to Autodata Corp.

Ford said Monday it expects its strategic review of the Swedish luxury automaker will take several months. The move is one of several actions Ford is taking to strengthen its balance sheet amid what it called "severe economic instability worldwide. Given the unprecedented external challenges facing Ford and the entire industry, it is prudent for Ford to evaluate options for Volvo as we implement our One Ford plan," said company President and Chief Executive Alan Mulally in written statement, referring to a plan to standardize the company globally.

Ford officials would not speculate on how a potential sale would affect the companies. Spinning off Volvo into a separate entity may be a possibility, since after a prior review, Ford started taking steps last year to allow Volvo to operate on a more independent basis. "Our relationship with Volvo during this time remains unchanged, and we will continue to work together," said Ford spokesman Mark Truby. "What's most important is that we make the right decision."

The Swedish government has said it has been in talks with Volvo and with General Motors Corp.'s Saab unit following reports that the U.S. parent companies were seeking aid for their Swedish carmakers. Stefan Lofven, chairman of Swedish union IF Metall, said it is now extremely important that the Swedish government steps in and shows its support for Volvo in the sales process.

"Volvo is a strong brand. Now they have to find a serious owner who wants to and can develop Volvo in the future," he said. He said previous talks with the government about a worst-case scenario had considered temporary state ownership. He didn't rule out that solution now. Sweden's deputy prime minister, Maud Olofsson, told local news agency TT that she was not surprised by Ford's decision. "I have seen for a long time what problems Ford has. In that situation it becomes natural for an American company to focus on the American market," she said.

For the 2009 model year, Ford and Volvo led all brands with 16 vehicles on the Insurance Institute for Highway Safety's list of the safest cars. But despite its high safety ratings and strong reputation as a family vehicle brand, Volvo captured just 0.5 percent of the market through October, compared with 0.8 percent for the same period last year. That accounts for 3.7 percent of Ford's total sales this year.

Even with tight credit worldwide, Ford could pull off a sale because Volvo would be attractive to automakers in emerging markets such as Tata Motors Ltd. of India, said Kevin Tynan, an analyst with New York-based Argus Research Corp. "There's probably enough money out there for either an emerging market automaker or somebody looking to get a brand with a little bit of cache to it," Tynan said.

Tata in March purchased Jaguar and Land Rover from Ford for $1.7 billion. The Volvo brand would complement Tata's two luxury brands, Tynan said. Ford had considered the sale of Volvo, Land Rover and Jaguar for some time, but since the latter two weren't as intertwined, their sale was less complicated. Depending on how it's structured, a Volvo sale could end up hurting the Ford brand because the companies share safety technology and some Ford vehicles have Volvo underpinnings.

For example, Ford's Taurus sedan, Taurus X crossover vehicle and Mercury Sable sedan are built on Volvo chassis, but Tynan said Ford can maintain manufacturing relationships long enough to transition the vehicles to new platforms. "I think there's enough mutual benefit going back and forth. There's some benefit to whoever buys it to maintain the relationships," Tynan said.

Ford, GM and Chrysler LLC will go before Congress this week to present a proposal for $25 billion in loans to keep them afloat as sales sag. Ford shares rose 8 cents, or 3 percent, to $2.77, in Monday afternoon trading.

Each Player in Big Three to Bring Its Own Plan
The Detroit automakers have been lumped together for decades as the Big Three, and for good reason; their goals have usually been aligned. But this week, as the automakers take a second run at Congress, hoping to persuade lawmakers to give them $25 billion in federal aid, their agendas are diverging as they contemplate futures as drastically different car companies.

Those differences will become clear as they deliver more detailed plans for how they would use that money not just to survive, but also to turn themselves around to be competitive in the long term. That should make for a sharp contrast to the hearings two weeks ago, when the executives presented a united front, saying in lockstep that it was the credit crisis and weak economy, not their strategies, that had put them in dire straits.

General Motors, the biggest of the troubled car companies, is expected to propose a significant shrinking of its North American operations, including shutting more factories and streamlining its sprawling brand lineup, according to people with knowledge of G.M.'s deliberations. One move under discussion, for example, would have G.M. buy out dealers that exclusively sell Saturns and market the cars through its Buick-Pontiac-GMC dealers instead, according to these people.

G.M. is also likely to propose moves that would require cooperation from the United Automobile Workers union, including delaying the company's $7 billion payment to the union's retiree health care fund. The Ford Motor Company, however, is not likely to propose more cuts, as it is further along than Chrysler and G.M. in shifting to a more fuel-efficient lineup of vehicles. It also has more cash to weather the downturn. Instead, people with knowledge of Ford's strategy say the automaker is considering more symbolic moves, including reducing the pay of its chief executive, Alan R. Mulally, who earned more than $21 million last year.

The third automaker, Chrysler, which is privately owned, has acknowledged it is running out of cash and may tell Congress that it needs a merger or alliance with another company to survive long term. The U.A.W., whose members build cars for all three companies, is not involved in developing any of the plans, even though its political influence is a crucial factor in whether a bailout gets approved. On Tuesday, G.M., Ford and Chrysler are scheduled to deliver separate aid requests to lawmakers, who will hold hearings on the plans later in the week.

The critical components in each of the plans will be how the companies expect to spend their share of the money, and what changes each automaker will make to shore up their faltering operations. "We need to understand what this money is going to be used for and why it makes sense for the American people to invest in these companies," said Senator Claire McCaskill, Democrat of Missouri, in an appearance on "Fox News Sunday."

At the forefront is G.M., whose board began a two-day meeting on Sunday to complete its aid request. G.M., which has lost more than $20 billion so far this year, is asking for up to $12 billion to keep its operations running through 2009. The company has suffered a steep decline in revenue this year, in what has been the worst market for vehicle sales in the United States since the early 1990s. G.M. has previously announced huge cuts, including a 30 percent reduction in white-collar costs and the elimination of health care for salaried retirees. But the company, under the direction of its embattled chairman, Rick Wagoner, is expected to reorganize further to win over skeptical lawmakers.

People with knowledge of G.M.'s plans say the automaker may eliminate one or more of its eight domestic brands and downsize its manufacturing capacity to match its shrinking market share. "It's clear that G.M. has to shrink, but the bigger question is, How does the company change its structure and do business if it gets smaller?" said John Casesa, a principal in the automotive consulting firm the Casesa Shapiro Group.

The union's president, Ron Gettelfinger, said Sunday that his members were prepared to reopen bargaining on terms of their contract. But he said the automakers needed to share in any sacrifice by limiting executive pay and other compensation. "They need to establish that executive compensation is something that they're willing to curtail, as well as bonuses and golden parachutes on exiting the business," he said on the CNN program "Late Edition."

During the first round of Congressional hearings on the bailout last month, Mr. Wagoner and his counterpart at Ford, Mr. Mulally, declined to say whether they would cut their salaries. Chrysler's chairman, Robert L. Nardelli, said he would consider taking a nominal $1-a-year salary. All three executives were also roundly criticized for flying to Washington on corporate jets. The companies have said that the chief executives will find other means of traveling to this week's hearings.

While G.M. will lay out specific changes in its future business plans, Ford is expected to detail its efforts to transform itself from primarily a manufacturer of larger vehicles into a producer of smaller, more fuel-efficient passenger cars. Both G.M. and Ford are using up more than $2 billion in cash a month, but Ford has greater cash reserves — $18.9 billion compared with $16.2 billion at G.M. — and a $10.7 billion line of credit from private banks to carry it at least through 2009.

Because it is in better financial shape, Ford is not asking for an immediate infusion of government money. Instead, the company will seek access to about $7 billion in federal aid only if its own cash runs out. "Our position is different," Ford's executive chairman, William C. Ford Jr., said in a recent interview. "Our position is what we'd like to have is access to a line of credit if we need it. And we hope not to need it."

Still, people familiar with Ford's strategy say the company is mulling whether to offer concessions to gain Congressional support — including cutting Mr. Mulally's salary. Of the three automakers, Chrysler may have the most difficult case to make for government assistance. Because its majority owner, Cerberus Capital Management, is a private firm, Chrysler is not required to make public financial data like revenue and earnings.

During the last hearings, Mr. Nardelli revealed under questioning that Chrysler was spending more than $1 billion in cash a month and had already studied the possibility of filing for bankruptcy. In an e-mail message to employees last week, Mr. Nardelli said its explanation for how it would use $7 billion in government loans was a simple one. "In short, the money would be used to support our ongoing operations," he wrote.

But to get support from lawmakers, Chrysler will probably have to open its books to Congress and lay out its longer-term business plans. "We have to know what the financials are internally, particularly Chrysler, since it's a private company," Ms. McCaskill said. Chrysler is expected to reiterate its overall strategy to pursue alliances and partnerships with other automakers to defray the costs of developing new vehicles. The company had been in merger talks with G.M. until Nov. 7, when G.M. canceled the discussions to focus on its own deteriorating financial conditions. People knowledgeable about Chrysler's plan said Mr. Nardelli might suggest that a merger was still the company's best opportunity to survive long term.

Executives from all three companies have said that setting a positive tone at the hearings is critical to winning support from lawmakers. After coming to the previous hearings seemingly unprepared, the Big Three will go into detail on gains they have made in cutting jobs and plant capacity, developing more fuel-efficient cars and investing in alternative technologies like electric vehicles.

But the companies will mostly focus on their own efforts to change, rather than their collective transformation. People close to the Big Three said there were no plans yet for the chiefs of G.M., Ford and Chrysler to share details of their testimonies with one another. And each company has been assured by Congressional leaders that any proprietary information will be kept confidential.

OC: Crocodile crying tears of hypocrisy.

Sir Evelyn de Rothschild calls for action
All of us - countries, corporations and consumers - have neglected basic principles. Ethics - we have lost sight of an honest day's work for an honest day's pay. Careful management - we have indulged our wants without the taxes or the prices or the cash to pay for them.

Oversight - public relations and spin have replaced disclosure and transparency; casual yet complex accounting and accommodating rating agencies left us blissfully unaware of the problems, and we revelled in our ignorance. Hubris has replaced community responsibility as a requirement for executive positions. American automobile executives and British bankers have been unable to form their lips into an apology. Yet their institutions lie in ruins and the rest of us are left feeling embarrassed for them.

Their customers worry that their savings or their working capital will just vanish, their mortgage will be transferred to a new institution they have never heard of. Their employees wonder which of their colleagues - or they themselves - will be unemployed in the coming week, with bleak prospects for working again anytime soon. Where is the shame of those who only months earlier boasted of ever increasing profits, of ever more clever products, of ever easier loans?

The US automakers may be the worst of the lot, so far. Years of incompetence and now manoeuvring in the halls of Congress for a massive bailout. Management prefers to hold onto private corporate jets rather than push for fuel efficiency standards to make their products more competitive. Union members would rather hold onto their gold-plated pensions for life than to save their companies.

Why should taxpayers help those who have so frequently refused to accept responsibility themselves? If the US government uses up its remaining credit to help the auto industry carry on as usual, who will lend the country the money to repair its bridges, build its power stations, clean its water, fuel its navy?

Thirty years ago, New York City found itself in a position similar to GM, Ford and Chrysler today. They asked Washington for help. The government refused. The Daily News summed it up in its front page headline - Ford to City: Drop Dead. Instead New York balanced its budget, taxed itself, reduced hiring, negotiated better labour contracts and gradually worked itself back to fiscal health. It took more than 10 years.

This era of struggle may last as long. Until we can be generous in accepting fault for our predicament, we will have difficulty dropping our suspicions about others so that we can get on with repairing the damage. Unless action is taken soon, we can only see a long time of difficult and very onerous problems continuing. Could be one or two years. It is therefore essential that management must take a firm look at it's problems and accept its faults and redeem them. A lot of talk and a lot of words have been written. But in the end action has to be taken and action must be taken very soon if we are not going to see this stretched out over many years.

US Treasury and the Fed: too close for comfort?
Economic historians must see the actions of today's Federal Reserve as strange. "Very, very unusual," says Allen Sinai, chief economist of Decision Economics, an economic consulting firm. "Unprecedented … uncharted."

The nation's central bank has joined with the United States Treasury in a host of measures this year aimed at stopping the economic slump and financial crunch from plunging the economy into a depression. The Fed's bold activism is apparently based on the view of its chairman, Ben Bernanke, that the Great Depression was caused by a credit freeze – plus a determination not to let it happen again. At Princeton University, where he had taught for years, Mr. Bernanke's research centered on that economically desperate era of the 1930s.

Last Tuesday, for example, the Fed and the Treasury announced $800 billion in new lending programs to help jolt the economy into a more vigorous life. The Fed said it would purchase up to $600 billion in debt issued by or backed by housing-related government-sponsored enterprises, such as Fannie Mae, Freddie Mac, Ginnie Mae, and the Federal Home Loan Banks. It will also back up as much as $200 billion in securities tied to student loans, car loans, credit-card debt, and small-business loans.

A major goal is to lower the interest rate on mortgages and make mortgage money more available. "Hooray," exults Ed Yardeni, an economic consultant and president of Yardeni Research in Great Neck, N.Y. "A home run." He sees the action as needed to deal with the major drop in housing prices that is behind the economic crisis in large degree.

As Mr. Yardeni sees it, the Fed and the Treasury have been playing "Whack-A-Mole" this year, striking at a series of liquidity-related crises, as a number of financial institutions faced going bankrupt and Washington came to their rescue with injections of funds and other measures. The latest was the huge multibillion dollar boost given Citigroup last Monday.

To Murray Weidenbaum, President Reagan's top economic adviser in 1981 and '82, the new Fed has had to take "a more activist stance than the old Fed," considering the serious economic threat facing the nation. He finds it "innovative" to see Chairman Bernanke and Treasury Secretary Henry Paulson working so closely together to deal with the crisis.

At the same time, he worries somewhat about the Fed's historic independence from the president and his administration, a system set up by Congress in 1913 to assure that politicians do not weaken the soundness of the dollar by inordinate influence on the Fed. To veteran economist Anna Schwartz, however, the Fed's current policy of lowering interest rates and rapidly expanding the nation's liquidity is a mistake. "I would like to see the Fed tighten monetary policy," she says in a phone interview from her office in New York at the National Bureau of Economic Research.

Ms. Schwartz is famous among economists as coauthor with Milton Friedman of a book blaming the Fed for the Great Depression by allowing the nation's money supply, that is, cash and deposits in banks, to decline drastically. She and Mr. Friedman are what economists call "monetarists" for their assumption that trends in the Fed's supply of money to the economy lead to cyclical ups and downs.

Schwartz criticizes the Fed's leaders for "handing out money so freely … squandering their funds" and not giving evidence that they are concerned with their prime responsibility, price stability.

As for the danger of deflation – steadily falling prices – she dismisses that as "ridiculous" considering the massive injection of new money into the economy in recent months. She's also astonished that Bernanke has been pushing fiscal stimulus, that is, extra federal spending and tax cuts to boost economic activity. Usually Fed chairmen try to stay out of the fiscal business of Congress.

Now there are reports that President-elect Obama will ask for a stimulus package as big as $700 billion over the next two years. To economist David Levy, the new measures, including those of the Fed, are essential to offset a dramatic reversal in consumer-debt creation (credit cards, car loans, home mortgages, etc.) as consumers fear for their financial safety. In 2004, consumers added $1 trillion to their debts, $2.4 trillion over the next two years, and $880 billion in 2007. This year consumers are probably repaying some debts, says the chairman of the Jerome Levy Forecasting Center in Mt. Kisco, N.Y.

"We are increasing public debt to replace private debt that is vanishing," he says. "A capitalist economy cannot run without debt creation." Neither Levy nor Mr. Sinai are optimistic about the economy. It could be the worst recession since the 1930s, says Sinai, but not a depression.

Switzerland Feels Iceland’s Pain With Banks Teetering
An isolated European country with an economy geared toward finance and winter sports is no longer a monetary bastion as credit evaporates around the globe. Banks teeter, the once-impregnable currency depreciates and a proudly independent people question whether a centuries-old go-it-alone strategy can survive. Even Switzerland is wondering if it’s immune to the forces ravaging Iceland.

The drama playing out in the Nordic nation, whose economy the International Monetary Fund says may shrink about 10 percent next year, offers a cautionary tale for the no less fiercely independent Swiss. While they are in far better shape, their status as custodians of the world’s wealth is under threat by a global economic upheaval they can’t control and miscues by the banks that made them great.

“The Swiss model of isolationism is not an advantage” in the current environment, says Michael Baer, 46, the great- grandson of Julius Baer, founder of Switzerland’s largest independent wealth manager. “Switzerland is absolutely not immune to global developments, especially not as regards the financial crisis and the economy.” Baer -- scion of a legendary family in one of the world’s oldest financial centers -- has moved his own business to one of the youngest: In 2006, he set up Baer Capital Partners in Dubai to tap Middle Eastern wealth.

For the 7.6 million Swiss, signs of stress are evident amid a cataclysm in world markets that has besieged them with reasons to doubt a splendid isolation dating back to medieval times. While the Swiss Market Index has outperformed the Nasdaq Composite Index this year, it has still lost 31 percent of its value. Zurich-based UBS AG, Switzerland’s flagship bank, amassed Europe’s biggest losses in the credit crunch, forcing the government and central bank to offer a $59 billion helping hand. The franc has tumbled against the dollar. And the banking secrecy that attracts offshore wealth is drawing more fire than ever.

Slowly, the pain on Zurich’s Bahnhofstrasse -- the boutique- and bank-lined promenade through Switzerland’s largest city -- is trickling through to main streets countrywide.
Switzerland’s economy will shrink 0.2 percent next year after expanding 1.9 percent in 2008, the Organization for Economic Cooperation and Development said on Nov.25. Manufacturing contracted the most since at least 1995 in November, a report showed today. While the 2.6 percent jobless rate is low by global standards, unemployment rose for the first time in five years in September and is heading higher.

Jobs Picture Looks Dim Absent Any GDP Growth
A chorus of bad news throughout November has paved the way for a bleak U.S. employment report on Friday. Since October, weekly claims for unemployment insurance have reflected broad-based layoffs as the downturn takes its toll on consumers and businesses.

The unemployment rate surged to 6.5% in October from 6.1% the previous month, the Labor Department said. Declines in nonfarm payrolls, which hit 240,000 in October, could surpass 350,000 in the coming report. Such a drop would be the largest since May 1980, when nonfarm payrolls declined by 431,000. Many forecasters expect joblessness to top 8% by the end of next year.

For 2009, "the best-case scenario is 8.2% or 8.3% unemployment, but there's an increasing risk that we could go up to 9%," said IHS Global Insight Chief Economist Nariman Behravesh. For November, IHS forecasts unemployment of 6.8% and a payroll decline of 370,000. Aggressive action by the Federal Reserve coupled with "a fiscal-stimulus package of between $500 billion and $700 billion spread over a couple of years" are essential to effect a turnaround, Mr. Behravesh said.

Just how high the jobless rate will climb -- and how long it will remain elevated -- is difficult to gauge. Many economists say the U.S. is in a recession that could rival the downturn of 1981-82 in severity. Few expect the nation's GDP, which contracted during the third quarter at an annual rate of 0.5%, to show growth before the second half of 2009. That means worsening unemployment through next year.

To get unemployment down, GDP has to show above-trend growth, said Michael Feroli of J.P. Morgan Chase. "Growth roughly has to be 2.5% or above to help improve the unemployment situation," Mr. Feroli said. According to the Labor Department, the U.S. recorded 10 straight months of double-digit unemployment starting at 10.1% in September 1982 and concluding with the same rate in June 1983. The U.S. posted back-to-back 10.8% unemployment in November and December 1982. As the country emerged from the recession of the early 1990s, the unemployment rate hovered between 7.3% and 7.8% in 1992.

Wall Street cloud darkens Lehigh Valley
Some of the biggest names in finance have been forced to shed thousands of jobs from their banking, mortgage and brokerage arms amid the economic calamity roiling the world's markets. Even insurance companies, long a haven for money during bleak economic times, have become vulnerable. Fallout from the soaring job loss is likely to spill beyond the center of high finance in New York City to other areas of the nation. That includes the eight counties of the greater Lehigh Valley region, home to almost 110,000 finance, insurance and real estate workers, according to U.S. Census Bureau estimates. They are traders, brokers, bankers, agents and back office professionals. Some commute on Interstate 78 through New Jersey each morning while others are employed locally. Regardless of where they work, they live, shop, play and pay taxes in the Valley and their future is far from certain.

''The scope of this credit crisis has expanded well beyond Wall Street,'' said Ryan Sweet, an economist for Moody's ''Regional banks are under heavy pressure and credit card companies are feeling the squeeze. Nobody has been immune.'' Brandon Jenzer of Williams Township is beginning to feel the pinch. Jenzer works for a financial services company in Manhattan and while the company so far has avoided layoffs, the 10-year veteran is feeling the angst. When gas prices soared past $4 per gallon, Jenzer searched for a carpool to offset his commuting costs. And when financial companies started laying off workers, he became more frugal. ''Saving is important in case of those unexpected events, such as job loss, which is extremely evident in this economy these days,'' he said. ''I've cut back spending in terms of those items which I found I wasn't using as much, such as a home phone line, when I can use a cell phone,'' he said. ''Saving, say, $20-$30 here and there can add up to a lot.''

The tally of financial industry jobs lost nationwide this year had reached more than 129,000 by the end of October, according to Chicago-based job placement specialist Challenger, Gray and Christmas, which tracks layoffs. Add to that the recent carnage at Citigroup, which announced this month it will lay off as many as 70,000 of its 350,000 workers. The insurance industry has lost 10,000 jobs. Real estate layoffs have added 1,500 jobs to the inventory, a conservative estimate that doesn't include agents who have left the business voluntarily due to lack of sales. Various industry estimates put the financial sector job losses at 200,000 by the end of the year and as many as 350,000 by mid-2009. Overall, unemployment could reach 10 percent by the end of 2009, analysts say. Financial companies are particularly vulnerable as their investments in subprime mortgages continue to tank, draining capital and consumer confidence. As losses mount, so do layoffs as cash-strapped companies struggle to stay above water.

''There is no question that the financial-services sector is far more widespread than just Wall Street, and the repercussions from the credit crisis stretch out all over the country to many different communities and industries,'' said John Challenger, CEO of Challenger, Gray and Christmas. Challenger said that while financial jobs are particularly vulnerable, the ripples from mass layoffs will spread far and wide. ''The fallout is that some of the highest-paying jobs come out of the financial-services sector. Those jobs represent real consumer purchasing power in the community, and as people lose their jobs or get insecure about their jobs, they slow down spending and that damages the local economy.'' The trickle-down effect may ultimately wallop the local economy more than the direct layoffs have, said economist Kamran Afshar. It doesn't take a layoff in the family to scare people into fiscal temperance, Afshar said. ''If, on your street, you see two people that have lost their jobs, that gives a cause for concern and people will cut back in their expenditures,'' he said. ''For those whose income relies on those expenditures, they will get less of that, so they start to trim back as well.''

Sandi Kegley used to be one of the Lehigh Valley faithful who commuted from her Fogelsville home to her job with insurance giant AIG in New Jersey. In 2007, she left AIG for an insurance company in Exton, Chester County. In June, Kegley said, the uncertainties of the economy pushed her to find a new line of work. ''While working (in Exton), I saw many accounting positions eliminated and sent overseas to India, costing people in our country to lose their jobs,'' Kegley said. ''When I finally left my job search was no longer centered on the insurance and financial services industry, as the two careers I had with them did not, in the end, turn out to be pleasant experiences.''

It's not just employees who are worried. Afshar said area businesses also are feeling the malaise. Kevin Flemming, President of Integrity Personnel in Allentown, said he has seen his orders for regular and temporary jobs in all sectors drop 20 to 25 percent over the past six weeks, an indication that businesses are holding off on hiring. While he has not seen a spike in job searches among any specific sector, he said the new year could bring some major changes. ''I think we're going to see unemployment rise through the first quarter of 2009 and we might start seeing a big group of finance employees or other sectors looking for work.''

But despite the grim news, out of work finance professionals in the Lehigh Valley may have have a life raft. Jay Brew, chief executive officer of BNK Advisory Group, a bank research firm in Hanover Township, Northampton County, said many regional banks are expanding. With little or no exposure to the devastating subprime mortgage market, the regional banks have plenty of capital to lend, Brew said. ''I haven't heard anything in the community banks sector that will affect employment,'' he said. ''None of these things that are affecting other banks are affecting them.'' Harleysville National Bank spokeswoman Taryne William said that bank is also well capitalized. Subsidiary East Penn Bank just opened a new branch in Whitehall.''We are a community bank and we have exercised conservative lending principals and as a result we have remained pretty well capitalized and able to serve our community,'' she said.

Sinking economy not bad news for all Rhode Island companies
The repo man has been busy. In three weeks time, Mark and Christine Labbe took back 15 Mercedes Benzes through their Lincoln repossession service, Preferred Recovery and Towing. There was the large Snap-on tool truck, which, with all the products still in it, was probably worth close to a quarter million dollars, Mark ventured, and the $14,000 espresso machine from the doughnut shop, which had fallen behind. Business has been so good that the company just bought another brand new $85,000 truck to add to its already formidable array of stealth-black wreckers, flatbeds and tractors. “We have a warehouse full of [repossessed] vehicles,” says Mark Labbe. “You name it — SUVs, Harleys, snowmobiles. And they’re from all over. It’s been pretty strange out there. It just shows that every sector of society is feeling the hurt.”
By all indications, business is bad. The auto industry is hoping for a bailout, the real estate market went bust, the stock market has been in freefall, and the state’s unemployment rate, at 9.3 percent last month, was tied with Michigan as the highest in the country.

But even in the darkest times, there is still a buck to me made. As the Labbes demonstrate, there are Rhode Island enterprises doing brisk business, despite the dour mood pervading much of the country. Some, like the Labbes’ towing and recovery service, thrive as a result of the economic downturn — others, in spite of it. “It’s sad to say, but what’s happening with the economy is unfortunate for some people, but fortunate for us,” says Christine Labbe.

THE LABBES’ towing business falls into a category of companies that deal with debt, either helping people get out from under or helping companies recoup their losses. Debt collectors come in various forms, including law firms, investigative services and businesses like Preferred Recovery. Providence lawyer Linda Laing is a partner in Strauss, Factor, Laing, & Lyons. She deals in debt collection (she calls it “creditors’ rights”) and bankruptcy law. Laing says the firm has seen a marked increase in inquires from businesses looking to take customers to court for defaulting on a loan or missing a scheduled payment. The businesses range from major credit-card companies to local heating-oil companies and colleges and universities. Often, Laing must remind her clients to weigh the costs of filing a suit with the value of the debt, she says. “The bulk of the increase in inquiries is coming from landlords, and that’s tied to the housing crisis and delinquent rents,” she says. “And those cases we don’t always accept because the money is hard to get to. You can’t get money when the people you’re going after don’t have any money.”

On the other side are the credit counselors — those who help people deal with their debt. Ronald M. Ramos, senior director at Money Management International, in Warwick, says his company has seen a 15-percent increase in people enrolling in its debt-management plan over the last three months. The company, a branch of the largest nonprofit credit counseling organization in the nation, offers free, over-the-phone counseling 24/7. The debt-management program, which is tailored to each person, is not free. Who’s reaching out to the credit counselors? Close to half are homeowners, according to Ramos. They have incomes ranging from $20,000 to $80,000 and are between 25 years and 64 years old. More than two-thirds are women. Men tend not to face up to problems as soon as women, he says. Ramos says the biggest challenges their clients face are job loss, other loss of income, and excessive, unsecured credit.“The average person coming to us has six credit cards and $21,000 of debt,” he says. “They are struggling to make mortgage payments and resorting to credit cards. It’s a cause-and-effect scenario.”

THE HOUSING crisis has created its own side economy, with companies seeing their focus shift because of the high number of foreclosures. Real estate agents who might have showed off the newest million-dollar condo development just a few years ago are now giving walk-throughs of foreclosed properties. Storage warehouses have seen a slight increase in demand in part because some people need to store their stuff when they get evicted. Locksmiths say they’re seeing more jobs from foreclosed properties, changing locks when banks take over a house. The list goes on. Glenn A. Carlson, a lawyer in East Greenwich, used to specialize almost exclusively in real estate closings. But now, he deals with foreclosure and bankruptcy avoidance and mortgage modification negotiation, working on behalf of homeowners seeking lower mortgage payments. “Sixteen years ago, when I started this practice, I never did any of this type of law,” says Carlson. “Now I’m dealing with at least one [mortgage modification negotiation] a day.” But the new work isn’t enough to fully balance his books. “Volume is way down across the board,” he says.

A FACT NOT lost on most business observers is that even when things are rough, people still have to buy the basics. Discount stores have reaped the benefits as people try to save on the essentials, making do with less-than-fancy brands. Which helps explains why German discount grocer ALDI made its first forays into Rhode Island this year with three stores (and another in the works in Providence’s Smith Hill neighborhood) and big-box chains like Wal-Mart are still churning out double-digit profits while shares of most companies have plunged. There’s been such a marked move away from consumerism and expensive tastes that media outlets from Business Week to The Wall Street Journal have been quick to claim a “new frugality” pervading the national consciousness, as if penny pinching could be considered a fad. Savers, a thrift store chain that buys items donated to nonprofits like Big Brothers/Big Sisters, this year opened a store in Woonsocket — the company’s third in the state. Lynne Mitchell, the store’s assistant operations supervisor, says it has already turned a profit. “As of October, we’re in the black. That was a big deal for us,” she says. The store, which has the brightly lit, sterile quality of an off-price retailer such as Marshalls or T.J. Maxx, is in a low-income city, which is home to a number of discounters, including an Ocean State Job Lot next door. But Mitchell says Savers draws shoppers from Cumberland, Lincoln and nearby towns in Massachusetts, comparatively more affluent communities. On bigger ticket items such as cars and larger appliances, Rhode Islanders are, for now, making do with what they have, some business owners say. It’s a problem for car dealers and new appliance retailers, but great for mechanics and repairmen. “People aren’t trying to replace the more expensive items. If it costs $1,000 to buy new, they’re choosing the $200 repair,” says Dave Roy, a salesman at JA Appliance Sales and Service, an appliance retail and repair store in Cumberland. “Sales have been spotty, but we’re doing OK…. People still need appliances.”

FOR PAWNSHOPS, business is brisker because of the economy — but that hasn’t translated into more revenue. Not yet anyway. At Easy Money Pawnbrokers in the Olneyville section of Providence, people are bringing in construction tools and seasonal items like bicycles and air conditioners as collateral for loans, says owner Michael Montella. Normally if people are unable to make good on the loans, the pawnshop sells the items. The only problem has been that people are not buying, and probably won’t be until spring, Montella says. “When the economy’s bad, we loan out money.”

Economic Crisis May Be Limiting the Number of Kids We're Having
Parenting and pregnancy website Mum Zone ( recently surveyed 1,500 subscribers about how the economic crisis is affecting them and their families. Despite the governments' continued efforts to encourage Aussies to expand their families, such as the introduction of the Baby Bonus and former Treasurer Peter Costello's classic catchcry of "One for Mum, one for Dad and one for the country"*, almost 70% of respondents indicated that the current economic conditions are a factor in deciding how many children they would like to have. This response was strongly supported by the fact that 53% of respondents have only one child and less than 40% are either pregnant or are planning/trying to get pregnant.

Almost half of the respondents' households live on between $50,000-$100,000 per annum. But who's the breadwinner? Despite the stereotype of the "super-mum" who works full time whilst raising a family, 53% of respondents belong to a household where only one parent works. Fifty-five percent of respondents expect their household income to remain roughly the same over the next twelve months. Though maybe things are changing - 34% of mums expect to use child care facilities more often over the coming year, with 53% intending to continue using child care at the current rate. Given that 96% of respondents are concerned to some degree about how their families will get through the economic crisis, perhaps some mums are feeling that theyll be requiring more child care as they may have to consider returning to work.

Less than 30% of respondents are able to pay off their credit card each month, with 25% stating they are never able to pay off their monthly credit card balance in full. Interestingly, only 6% indicated that they dont use a credit card. Despite the recent drop in petrol prices, a whopping 78% of respondents find that the cost of fuel affects their travel patterns and car use to some degree. Although petrol prices are currently down, perhaps respondents arent convinced that the low prices are here to stay. Ninety-seven percent of respondents are female and 94% have at least one child. Over half are in the age bracket of 26-34. Sixty percent live in metropolitan areas while 40% live in regional and rural areas.

Seattle's recycling program runs into plunging prices
When world prices for metals and paper were riding high, Seattle had a little gold mine shipping out its recyclables. Then the prices sank by as much as 75 percent. Gold mine became a black hole. Back at the end of the summer, Seattle's recyclers were riding high. Commodity prices for copper, tin, aluminum, and steel, even paper, were scraping the ceiling, driven by what seemed like an insatiable hunger from China and the rest of the Pacific Rim. Every commodity-laden container ship headed west across the Pacific meant bigger profits for Seattle Public Utilities (SPU), which manages the city's recycling program.

That was thanks to one of the recycling program's lesser-known roles — as an international commodities futures speculator. Under a 2001 contract, SPU paid the city's two waste haulers, Rabanco and Waste Management, a benchmark price to collect the program's recyclables — 80,000 tons last year. Then Rabanco processed the stuff and sold it on the world commodities market. If the going price for, say, mixed paper went higher than the benchmark price, Seattle got to deduct its share of the profit from the money it paid to Rabanco to collect the material. If it fell below the benchmark, Seattle added the difference to its collection fee. As commodity prices spiraled upwards through the spring and summer, Seattle's recycling program became a quiet little gold mine, and the city made millions.

But that, as they say, was then. "About a month ago," says George Sidles, a strategic adviser for SPU's recycling program, "commodity prices took one of the most dramatic downturns anyone had ever seen." Sidles and Seattle's recycling staff watched in horror as the going price for paper, metal, and plastics fell off a cliff as the worldwide recession took hold. Copper, steel, and aluminum prices dropped by 75 percent in a month. Recycled plastic went down by two-thirds. Bailed paper — down more than 90 percent.

"There has certainly been volatility in these markets in the past," says Rabanco's general manager, Pete Keller. "But not this far; not this fast." Like SPU, Rabanco, a unit of Allied Waste Services, had been making money on Seattle's recyclables up to September, Keller says. But those profits were all but erased after September's collapse, he says.

Sidles says even with the collapse of commodity prices SPU could end the year with $1 million to $2 million in profit left over from the boom times earlier in the year. But most of the profits will be gone, he admits, and things could get dicier next April when the City and Rabanco are scheduled to begin a new four-year contract. The numbers in the new contract will be updated from the old one, Sidles says, but the basics will stay the same: Seattle will pay Rabanco $27 a ton to process the city's recyclables and they both agree on a benchmark price for the commodities. Then they roll the dice on how much the commodities will fetch on the market.

Keller says he prefers to call the process "a revenue-sharing mechanism" instead of commodities speculation. "There's a floor price we agree on," he says. "And when certain indices are above that price, the City benefits. When they fall below, there's some protection for us."

Unfortunately for SPU, the City negotiated its new contract with Rabanco a year ago, while the commodities market was heading up and benchmarks were set high. Since then, the market for Seattle's recyclables has gone totally dead. Early this year, says Sidles, China couldn't get enough of Seattle's recycled paper, using the fiber for feedstock for boxes for all those items that ended up back on the shelf here at Wal-Mart and Costco. Now, he says, "People who have traveled in China recently tell me they have a huge volume of paper inventory just sitting there."

That means Seattle's recycling commodity speculators may have do some energetic backpedaling next year. "If things get out of kilter," Sidles says, "we may see prices go up or down by a few million in cost to our ratepayers." But with 160,000 single-family recyclers and 8,000 commercial customers, SPU spokesman Andy Ryan says, "we don't see the exposure to ratepayers as significant." And Rabanco? "We'll still be here next year," says Keller. "When you think in terms of who is more recession prone than us, we're probably better off than a guy selling cars."

Can the Climate Survive the Financial Crisis?
Just as the world gathers in Poland to come up with a new climate treaty to replace the Kyoto Protocol, the global financial meltdown threatens to torpedo the effort. But could a world recession actually help the climate? For years, the world has known it was coming. And yet now that the next level of negotiations on a successor treaty to the Kyoto Protocol is beginning in Poznan, Poland on Monday, things have suddenly got more complicated. The global financial crisis and concurrent economic downturn threatens to weaken the resolve of the 186 countries present to take far-reaching steps against climate change. "The financial crisis will have an impact on climate change," said Yvo de Boer, executive secretary of the United Nations Framework Convention on Climate Change on Sunday. "You already are seeing around the world a number of wind energy projects being pushed back."

The Poznan conference will see 10,000 delegates continue the process, begun in Bali last December, of cobbling together a new global treaty to replace Kyoto, which expires in 2012. The timeline agreed to last year calls for the new greenhouse gas emissions reduction agreement to be ready in 2009, allowing plenty of time for the treaty to be ratified by participating countries.

But with stock markets around the world now plunging and a number of industries, particularly auto manufacturing in the United States and Europe, facing difficult futures, calls have been increasing in Europe to delay the introduction of more stringent rules aimed at increasing fuel efficiency and decreasing CO2 emissions from cars.
In Germany, many of those calls have been coming from Chancellor Angela Merkel's conservatives. The latest voice in the chorus is the new Bavarian Governor Horst Seehofer, until recently the Minister of Agriculture in Berlin. In a letter to Merkel last week, he wrote that protecting the climate cannot be allowed to result in a loss of jobs in the auto-manufacturing industry. His plea echoes similar warnings from Christian Democrat honchos Christian Wolff and Jürgen Rüttgers.

The comments have primarily been aimed at Brussels. The European Union has long been planning to introduce strict rules on the amount of CO2 cars manufactured in the 27-member bloc are allowed to emit. The financial crisis has led to a renewed debate on the limits, set to be passed at an EU summit in the middle of December. Merkel has long positioned herself as a leading protector of the environment, both within the EU and further afield. But she has largely remained silent on the current debate. Even her Environment Minister, Social Democrat Sigmar Gabriel, seems to be leaning toward a compromise. He suggested over the weekend that rules under consideration to mandate maximum automobile emissions of 120 grams of CO2 per kilometer by 2012 be pushed back to 2015 -- though at the same time insisting that the much stricter 2020 goal of 95 grams per kilometer be maintained.

But as policy makers seem inclined to back away from climate protection goals in the face of the financial crisis, there is evidence in Germany that the exact opposite tactic may be called for. Carmaker Audi, for example, claims that it is planning to hire more experts and engineers in 2009 in order to optimize fuel-efficiency and reduce CO2 emissions in its models. Over at Siemens, a company report indicates that sales of environmentally-friendly products and technologies rose from €17 billion to €19 billion in a single year. "Any economic stimulus program should match up with climate and energy savings targets," says Norbert Walter, chief economist at Deutsche Bank. "The government should only stimulate purchases of those cars that are environmentally sustainable." An unpublished report produced by the German Environment Ministry, seen by SPIEGEL, comes to the conclusion that, were Berlin to target CO2 reductions of 40 percent relative to 1990 levels, the creation of 500,000 jobs would be the result. (The country has already cut emissions by 22.4 percent relative to 1990 levels and measures already agreed on will result in a 34 percent reduction, say experts.)

"It is especially important in the economic crisis that the automobile industry focuses on saving energy and on efficiency," says Tanja Gönner, the Christian Democrat Environment Minister in the state of Baden-Württemberg, where Mercedes is headquartered. "Those that develop cars with low CO2 emissions now will have a great opportunity on the world market of tomorrow." US President-elect Barack Obama appears to be in favor of such a philosophy. Although he will not be sending a delegation to Poznan, he has indicated that under his leadership the US will take a leadership role when it comes to climate change, once he is inaugurated in January. It would mark a radical shift in direction from the environmental foot-dragging that characterized the eight years under President George W. Bush. Still, there is concern that climate negotiations this year and next could be overshadowed by the worsening global economy. Yvo de Boer warned against making "cheap and dirty" choices when it comes to energy investments. "We must focus on the opportunities for green growth."

'Now Is the Time for a Green New Deal'
With the world gathered in Poznan, Poland to work out a successor deal to the Kyoto Protocol, UN Environment Program Director Achim Steiner spoke with SPIEGEL ONLINE about sustainable transportation and the failures of the auto industry.

SPIEGEL ONLINE: On the eve of the United Nations conference on climate protection in Poznan, Poland, the EU is considering weakening its climate protection goals. Can we keep up with our environmental commitments in the face of this financial crisis?

Steiner: On the contrary -- we need to use this moment to increase support for renewable energy, energy efficiency and cleaner cars if we are going to ensure some sort of future. Now is the time for a green "New Deal."

SPIEGEL ONLINE: Members of the Christian Democrats and the automobile industry are pushing for looser emissions restrictions and temporary exemptions.

Steiner: I just don't understand why it's taking so long to negotiate these emissions restrictions, since they've been worked out at the EU level for almost a decade. We've had similar protracted discussions in the past over the introduction of catalytic converters, unleaded gasoline, and diesel filters. Those are all lost years.

SPIEGEL ONLINE: The auto industry is also worried about protecting jobs.

Steiner: That's exactly why they need to make sure their products are attractive to customers. In the future, the question of mobility will involve a lot more than who's offering a three-liter engine.


Steiner: Our system of transportation -- in which everyone drives their own car -- doesn't fit the times we live in, and isn't going to work in developing countries. The car, along with buses, trains and subways, is going to be just one part of a network of transportation systems. The auto industry needs to offer products that fit with the goal of protecting the environment.

SPIEGEL ONLINE: And a speed limit?

Steiner: This debate has taken on quasi-religious overtones. Wait and see where we are at the end of the decade. If there's a better answer for cutting carbon dioxide from cars, it belongs on the table.

Gloomy outlook for 'Kiwi' farming
A depressed outlook for agriculture as it weathers the global financial crisis is foreseen by the Agriculture and Forestry Ministry in briefing papers prepared for the incoming government. The papers, released yesterday by Agriculture Minister David Carter, say a world economic slowdown is likely to reduce demand for agriculture products and will reduce export revenue. How the ministry sees sectors being affected:

Dairy: Reduced demand from oil producing nations and emerging Asian economies that currently take about 40 per cent of dairy exports.

Meat: Demand for New Zealand lamb is likely to fall as consumers turn to cheaper substitutes. Demand for beef is expected to remain strong as consumers switch to lower-cost ground beef.

Kiwifruit: New Zealand kiwifruit, which sells at a premium 40 to 100 per cent higher than other kiwifruit, faces a potential threat from cheaper substitutes. This is against a background of four years of low returns and slowing demand. Horticultural exporters who typically rely heavily on seasonal finance will be further hit by an increasing cost of credit.

Apples: Exports of pipfruit are largely reliant on markets in the European Union and are likely to face reduced demand and a shift from premium varieties to lower priced products.

Wool: Prices are likely to remain low as new housing is the biggest market for wool carpets.

Forestry: International demand for new housing has decreased, resulting in a reduction in wood panel and sawn timber exports. Volumes and prices for pulp and paper exports will fall due to the decline in sawn timber production from slower housing markets.

Currency: The depreciation in the New Zealand dollar will mitigate the reduction in demand for exports.

The dollar went from 82 cents to the United States' dollar at the end of February, to 58 cents at the end of October - a 28 per cent depreciation in eight months. This is the largest eight-month fall since the New Zealand dollar was floated. At the same time, falls against the Euro have been less and there has been some appreciation against the Australian dollar. The ministry sees the global crisis making it harder to obtain and service debt. This follows a rise in farm indebtedness and an increasing vulnerability to financing costs, particularly for dairy farmers, and lower commodity prices, especially for sheep and beef farmers.

"Therefore any recession is of concern," the ministry says. "It is likely there will be fluctuations in income levels and less ability for farming businesses to obtain and service debt financing." Added to this is the much tighter credit environment that has emerged following the global financial crisis. The combination of these two factors may lead to:
tighter rural lending policies that could harm investment in the agriculture and forestry sector and the ability of businesses to refinance existing debt; reduced availability of trade credit in key markets potentially leading to reduced demand; reduced access to capital and loan financing for acquisitions or new businesses in the sector; a higher likelihood of some producers, processors and agribusinesses becoming financially distressed and either reducing operations, going out of business, or being acquired by new owners; and, difficulties in the wood processing industry - particularly sawmilling - have been accelerated. Sales have further decreased and credit is less available. In the short-term there may be significant impacts on individual businesses, employees and communities, the ministry says.

Why I'm Not Worried About Inflation…At Least for a Good While Yet
Well, I wish I could take the credit for having constructed a brilliant analysis, but really, the best answer I can give is "What she said." That is, Ilargi and Stoneleigh have been running analysis of the credit crisis since before most people knew there was a crisis. I frankly thought Ilargi was out of his mind [Ed: he is] when he told me that the economic crisis would reshape peak oil and climate change discourse, and ought to be our focus. I was wrong, he was right. Their analysis has been solidly spot-on, and I think it will continue to be. We are in a self-reinforcing deflationary spiral. Inflation may eventually be a response to that, but for right now and the immediate future, well, it isn't.

I think it is important that we be prepared for the real crisis - a long term, deep, deflationary Depression. As I've mentioned before, most rhetoric about the Depression tends to look at the deepest part of the Depression, observe that we aren't there yet (something along the lines of "During the Depression, unemployment was 25%, but at present we are nearly at 7%, a long way away from that). All of this ignores the fact that during the Depression, unemployment rose gradually too. In the fall of 1929, unemployment rose only very slowly. But between March 1930 and March 1931, unemployment doubled, and didn't reach its peak until 1933, more than 3 1/2 years after the crash.

My claim is not that we will travel precisely the same road as described in the Depression. But one of the things about crises worth noting is this. They have their moments of screaming and running around, of explosions and flames. And then they have most of the rest of the time, which is rather like life, only with incrementally painful shifts.

One of the incrementally painful shifts we are facing is that addressing peak oil and climate change are likely to be pushed to the back burner. Obama has already noted that some of his energy goals will probably have to be put off. The problem is that the odds are good that if they are put off, they won't happen. Meanwhile, over at The Oil Drum, Gail the Actuary has another clear-eyed post about how this will affect our long term energy infrastructure.

BTW, if you've relied as much as I have on their analysis, and can afford it, you might consider donating to the Automatic Earth's Holiday Fundraiser, on the sidebar. Ilargi has been doing the work of researching and writing full time, and essentially, they are trying to make sure he can keep doing it. His goal - to make as much as a McDonalds burger flipper by exploring the financial crisis and helping people address it - seems pretty reasonable to me - I'd sure as heck rather have the two of them doing this work.

OC: This is a ridiculously long article and a week old but it really does explain a lot in one article and answers many of the financial questions readers have on what to do with their money.

Citigroup collapses! Banking Shutdown Possible
It pains me deeply to announce that, despite the massive government rescue, yesterday’s collapse of Citigroup could ultimately lead to a shutdown of the global banking system. For many years, I hoped this would never happen, and I thought we might be able to avoid it.

Indeed, that’s why, my firm, Weiss Research, first began rating the safety of the nation’s banks in the early 1980s, and why I later founded Weiss Ratings, a separate subsidiary dedicated exclusively to safety ratings — on thousands of banks, insurance companies, brokerage firms, mutual funds and stocks. I subsequently sold the Weiss Ratings subsidiary to Jim Cramer’s organization,; and today, my former company is called Ratings. I continue to own and run Weiss Research, Inc., the publisher of Money and Markets. Moreover, Weiss Research continues to review all financial institutions for their safety; and to support that effort, we acquire’s ratings and data for our analysts.

My philosophy was that, to find safety, your primary task was to identify the weak institutions, move your money to the strong ones, and then monitor them periodically to make sure your money was still safe. If all of us — savers, investors, bankers and banking regulators — used this kind of objective data to make rational, informed decisions, we would reward the safest institutions and help prevent the growth of the riskiest. Not only would we be safer individually, but our banking system as a whole would be more solid.

Unfortunately, however, that’s not how history has unfolded. Few people were interested in bank ratings; they blindly assumed all banks were safe. And over the years, regulators have followed a parallel path. Rather than proactively restrict or shut down the weakest, large institutions, they have encouraged their massive growth, making it very difficult for the smaller, safer institutions to compete.

More recently, in the wake of the biggest financial failures in history — Bear Stearns, Lehman Brothers, Washington Mutual, Wachovia and others — rather than liquidate the failed firms’ bad assets, the authorities have been engineering shotgun mergers. The end result is that they have been sweeping most of the bad assets under the carpet of larger banks like Bank of America, Citigroup, and JPMorgan Chase, each of which already had abundant bad assets of its own. Adding insult to injury, Treasury Secretary Paulson’s decision this month — not to buy up the bad assets from many of these banks — has only heightened this concern. Rather than dispose of the toxic waste, the regulators have been rolling up the garbage to the larger banks.

And now, here we are, nearing the end of the road with the largest banks of all endangered and with no larger bank that can swallow them up. It’s a day of reckoning that leaves me no choice but to issue this three-part warning:

Despite the U.S. government’s massive Citigroup bailout, it is going to be difficult for the global banking system to survive the shock to confidence for very long.

Even if insured depositors do not pull out their funds, uninsured institutional investors are likely to run with their money, threatening to bring the system down.

And alas, even if you have your money in a safe bank with full FDIC coverage, you could be adversely impacted. How will the events unfold? That’s a massively complex question that demands an extremely cautious and thoughtful answer. That’s why, this past August, we devoted a full hour to this question in our “X” List video, naming the most likely candidates for bankruptcy. So let me review its primary conclusions and then take this discussion to the next level.

Most prominent on our August “X” List was Citigroup, America’s second largest banking conglomerate with over $2 trillion in total assets. The bank was already suffering crushing losses in mortgages. But at mid-year, it still had close to $200 billion in other mortgages on its books, denoting the strong possibility of many more to come.

In addition, Citigroup had a massive portfolio of credit cards — 185 million accounts worldwide — that we felt could be the final nail in its coffin. Even before the most recent episode of the global financial crisis, Citigroup’s losses on bad credit cards had surged by 67% from a year earlier. Worse, the number of credit cards 90 days past due was going through the roof, foreshadowing more large losses on the way. All of these weaknesses were detailed in Citigroup’s financial statements. Not detailed, however, was …

The Highly Dangerous Derivatives

Derivatives are bets made mostly with borrowed money. They are bets on interest rates, bets on foreign currencies, bets on stocks, bets on corporate failures, even bets on bets. The bets are placed by banks with each other, banks with brokerage firms, brokers with hedge funds, hedge funds with banks, and more.

They are often high risk. And they are huge. According to the U.S. Comptroller of the Currency (OCC), on June 30, 2008, U.S. commercial banks held $182.1 trillion in notional value (face value) derivatives.1 And, according to the Bank of International Settlements (BIS), which produced a tally six months earlier for the entire world, the global pile-up of derivatives, including institutions in the U.S., Europe and Asia, was more than three times larger — $596 trillion.2

That was ten times the gross domestic product of the entire planet … more than 40 times the total amount of mortgages outstanding in the United States … nearly 60 times greater than the already-huge U.S. national debt.

Defenders of derivatives claim that these giant numbers overstate the risk. They argue that most players hedge their bets and don’t have nearly that much money at stake. True. But that isn’t the primary risk these players are taking.

To better understand how all this works, consider a gambler who goes to Las Vegas. He wants to try his luck on the roulette wheel, but he also wants to play it safe. So instead of betting on a few random numbers, he places some bets on the red, some on the black; or some on the even and some on the odd. He rarely wins more than a fraction of what he’s betting, but he rarely loses more than a fraction either. That’s similar to what banks like Citigroup do with derivatives, except for a couple of key differences:

Difference #1. They don’t bet against the house. In fact, there is no house to bet against. Instead, they bet against the equivalent of other players around the table.

Difference #2. Although they do balance their bets, they do not necessarily do so with the same player. So back to the roulette metaphor, if Citigroup bets on the red against one player, it may bet on the black against another player. Overall, its bets are balanced and hedged. But with each individual player, they’re not balanced at all.

Difference #3. As I said, the amounts are huge — millions of times larger than all of the casinos of the world put together.

Now, here are the urgent questions that, as of today, remain largely unanswered:

Question #1. What happens if there is an unexpected collapse?

Question #2. What happens if that collapse is so severe it drives some of the key players into bankruptcy?

Question #3. Most important, what happens if these players can’t pay up on their gambling debts?

This is the question I have asked here in Money and Markets month after month. Almost everyone said it was far-fetched, that I was overstating the risk. Yet, each of the hypothetical events I cited in the above three questions have now taken place in 2008.

First, we witnessed the unexpected collapse of the largest credit market in the world’s largest economy — the U.S. mortgage market.

Second, we witnessed the bankruptcy or near-bankruptcy of three key players in the derivatives market — Bear Stearns, Lehman Brothers and Wachovia Bank.

Third, we also got the first answers to the last question: We saw the threat of a major, systemic meltdown in the entire global banking system.

What Is a Banking Meltdown And Why Is it Possible?

On October 11, 2008, a single statement hit the international wire services that provides more specific clues:

“Intensifying solvency concerns about a number of the largest U.S.-based and European financial institutions have pushed the global financial system to the brink of systemic meltdown.”

This statement was not the random rant of a gloom-and-doomer on the fringe of society. Nor was it excerpted from a twentieth century history book about the Great Depression. It was the serious, objective assessment announced at a Washington, D.C. press conference by the Managing Director of the International Monetary Fund (IMF).

The unmistakable implication: So many of the world’s largest banks were so close to bankruptcy, the entire banking system was vulnerable to a massive collapse. The primary underlying cause: Derivatives.

The Mafia knows all about systemic meltdowns of gambling networks. In the numbers racket, for example, players place their bets through a bookie, who, in turn is part of an intricate network of bookies. Most of the time, the system works. But if just one big player fails to pay bookie A, that bookie might be forced to renege on bookie B, who, in turn stiffs bookie C, causing a chain reaction of payment failures.

The bookies go bankrupt. The losers lose. And even the winners get nothing. Worst of all, players counting on winnings from one side of their bets to cover losses in offsetting bets are also wiped out. The whole network crumbles — a systemic meltdown. To avert this kind of a disaster, the Mafia henchmen know exactly what they have to do, and they do it swiftly: If a gambler fails to pay once, he could find himself with broken bones in a dark alley; twice, and he could wind up in cement boots at the bottom of the East River.

Unlike the Mafia, established stock and commodity exchanges, like the NYSE and the Chicago Board of Trade, are entirely legal. But like the Mafia, they understand these dangers and have strict enforcement procedures to prevent them. When you want to purchase 100 shares of Microsoft, for example, you never buy directly from the seller. You must always go through a brokerage firm, which, in turn is a member in good standing of the exchange. The brokerage firm must keep close tabs on all its customers, and the exchange keeps close track of all its member firms. If you can’t come up with the money to pay for your shares, the broker is required to promptly liquidate your securities, literally kicking you out of the game. And if the brokerage firm as a whole runs into financial trouble, it meets a similar fate with the exchange. Very, very swiftly!

Here’s the key: For the most part, the global derivatives market has no brokerage, no exchange, and no equivalent enforcement mechanism. In fact, among the $181.2 trillion in derivative bets held by U.S. banks at mid-year 2008, only $8.2 trillion, or 4.5%, was regulated by an exchange. The balance — $173.9 trillion, or 95.5% — was bets placed directly between buyer and seller (called “over the counter”). And among the $596 trillion in global derivatives tracked by the BIS at year-end 2007, 100% were over the counter. No exchanges. No overarching enforcement mechanism.

This is not just a matter of weak or non-existent regulation. It’s far worse. It’s the equivalent of an undisciplined conglomeration of players gambling on the streets without even a casino to maintain order. Moreover, the data compiled by the OCC and BIS showed that the bets were so large and the gambling so far beyond the reach of regulators, all it would take was the bankruptcy of one of the lesser derivatives players — such as Lehman Brothers — to throw the world’s credit markets into paralysis.

That’s why the world’s highest banking officials were so panicked when Lehman Brothers failed in the fall of 2008. As the IMF managing director himself admitted, the threat was not stemming from just one bank in trouble; it was from many; and those banks weren’t lesser players; they were among the largest in the world. Which U.S. banks placed the biggest bets? Based on mid-year 2008 data, the OCC provided some answers:

Citibank N.A., the primary banking unit of Citigroup, held $37.1 trillion in derivative bets. Moreover, only 1.7% of those bets were under the purview of any exchange. The balance — 98.3% — was direct, one-on-one bets with their trading partners outside of any exchange. Bank of America was a somewhat bigger player, holding $39.7 trillion in derivative bets, with 93.4% traded outside of any exchange.

But JPMorgan Chase was, by far, the biggest of them all, towering over the U.S. derivatives market with more than double BofA’s book of bets — $91.3 trillion worth. This meant that JPMorgan Chase controlled half of all derivatives in the U.S. banking system — a virtual monopoly that tied the firm’s finances with the fate of the U.S. economy far beyond anything ever witnessed in modern history. Meanwhile, $87.3 trillion, or 95.7% of Morgan’s derivatives, were outside the purview of any exchange.

One bank! Making bets of unknown nature and risk! Involving a dollar amount equivalent to six years of the total production of the entire U.S. economy! In contrast, Lehman Brothers, whose failure caused such a large earthquake in the global financial system, was actually small by comparison — with “only” $7.1 trillion in derivatives.

The potential havoc that might be caused by a Citigroup failure, with bets that involve five times more money than Lehman’s — and the financial holocaust that might be caused by a JPMorgan failure with close to 13 times more than Lehman — boggles the imagination. How bad could it actually be? No one knows, and therein lies one of the primary dangers. In the absence of oversight, the regulators simply do not collect the needed who-when-what information on these bets.

In an attempt to throw some light on this dark-but-explosive scene, the OCC uses a formula for estimating how much risk each major bank is exposed to in just the one particular aspect I cited a moment ago — the risk that some of its trading partners might default and fail to pay up on their gambling debts. Bear in mind: We still don’t now how much they are risking on market moves against them. All the OCC is estimating is how much they’re risking by making bets with potentially shaky betting partners, regardless of the outcome on each bet — win, lose or draw.

At Bank of America, the OCC calculated that, at mid-year, the bank was exposed to the tune of 194.3% of its capital. In other words, for every $1 of capital in the kitty, BofA was risking $1.94 cents strictly on the promises made by its betting partners. If about half of its betting partners defaulted, the bank’s capital would be wiped out and it would be bankrupt. And remember: This was in addition to the risk that the market might go the wrong way, and on top of the risk it was taking with its other investments and loans. At Citibank, the risk was even greater: $2.58 cents in exposure per dollar of capital.

And if you think that’s risky, consider JPMorgan Chase. Not only was it the largest player, but, among the big three U.S. derivatives players, it also had the largest default exposure: For every dollar of capital, the bank was risking $4.30 on the credit of its betting partners. This is why JPMorgan was so anxious to step in and grab up outstanding trades left hanging after the fall of Bear Stearns and Lehman Brothers: It could not afford to let those trades turn to dust. If it did, it would be the first and biggest victim of a chain reaction of failures that could explode all over the world.

This is why super-investor Warren Buffett once called derivatives “financial weapons of mass destruction.” This is why the top leaders of the world’s richest countries panicked after Lehman Brothers failed, dumping their time-honored, hands-off policy like a hot potato, jumping in to buy up shares in the world’s largest banks, and transforming the world of banking literally overnight. This is also why you must now do more than just find a strong bank.

You also must find a safe place that has the highest probability of being immune to these risks. The reason: As I warned at the outset, at some point in the not-too-distant future, governments around the world may have no other choice but to declare a global banking holiday — a shutdown of nearly every bank in the world, regardless of size, country, or financial condition.

What could happen in the banking holiday? In the past, we’ve seen some financial shutdowns that eventually helped resolve the crisis. And we’ve seen others that only made it worse. Often, savers are forced to leave their money on deposit, giving up a substantial portion of their interest income for many years. And, in other cases, the only way they can get their money back sooner is by accepting an immediate loss of principal. But no matter how it’s resolved, when banks have made big blunders and suffered large losses, it’s the multitude of savers that are invariably asked to make the biggest sacrifices and pay the biggest price. No one else has the money.

Are Bank Runs and National Shutdowns Really Possible in Today’s Modern Era?

Most observers think not. “If deposits are insured,” they ask, “why would anyone want to pull them out?” The reason: Most bank runs are not caused by insured depositors. They’re caused by the exodus of large, uninsured institutions who are usually the first to run for cover at the earliest hint of trouble. That’s the main reason Washington Mutual, America’s largest savings and loan, lost over $16 billion in deposits in its final eight days in 2008. That’s also a major reason Wachovia Bank was forced to agree to a shotgun merger soon thereafter.

During the many banking failures of the 1980s and 1990s, the story was similar: We rarely saw a run on the bank by individuals. Rather, it was uninsured institutional investors — banks, pension funds and others — that jumped ship long before most people even realized the ship was sinking. They’re the ones who hammered the last nail in the coffin of big savings and loans, banks and insurance companies that failed.

How Long Would a Global Banking Shutdown Last? How Would It All Be Sorted Out?

No one can say with certainty. But based on other banking holidays in modern history, it’s safe to conclude that it could last for quite some time and cause severe hardship for hundreds of millions of savers around the world. The first and most obvious hardship is that you could be denied immediate access to most or all of your money for an indefinite period. What about government agency guarantees like FDIC insurance? A large proportion of those guarantees, unfortunately, would have to be suspended in order to give banking regulators the time they need to sort out the mess.

It is simply not reasonable to expect that governments will have the resources to immediately meet the demands of thousands of institutions and millions of individuals if they all want their money back at roughly the same time. “Your money is still safely guaranteed,” banking officials will declare. “You just can’t have it now.” The second and more long-lasting hardship is the possibility that, by the time you do regain access to your money, you will suffer losses. In this scenario, the government would likely create a rehabilitation program for the nation’s weakest banks, giving depositors two choices:

Opt in to the program by leaving your funds on deposit at your bank for an extended period of time, earning below-market interest rates. The bank is then allowed to use the extra interest to recoup its losses over time — income that, by rights, should have been yours. Opt out of the program and withdraw your funds immediately, accepting a loss that approximately corresponds to the actual losses in the bank’s investment and loan portfolio.
Needless to say, neither the opt in nor the opt out choice is a good one:

If you opt in, you take the chance that the government’s rehab program may not work on the first attempt and that it will be replaced by another, even tougher program in the future. Moreover, even if it works out as planned, you will suffer a continuing loss of income and access to your cash over an extended period of time. If you opt out, instead of lost income, you suffer an immediate loss of principal. Moreover, in order to discourage savers from opting out, the government would typically structure the program so that everyone demanding immediate reimbursement suffers an additional penalty.

Again you ask, “What about government guarantees?” By rights, in a fair plan, insured depositors would suffer less severely than uninsured depositors. And if the plan is structured properly, those in strong banks should come out whole, or almost whole, while those in weaker banks should suffer the larger losses. That’s how it should be handled. But there’s no guarantee that’s how it will be handled.

To avoid all of these risks, I recommend seriously considering moving (a) nearly all of your bank deposits and accounts, plus (b) a modest portion of the money you currently have invested in securities to the safest and most liquid place for your money in the modern world:

Short-Term U.S. Treasury Securities

True safety has two elements. The first is capital conservation — no losses, no reduction in your principal. But it’s the second element that most people miss: Liquidity — the ability to get a hold of your money and actually use it whenever you want to, without waiting, penalties, bottlenecks, shutdowns or disasters of any kind standing in your way.

Absolute perfection is not possible. But on both of those aspects — capital conservation and liquidity — the single investment in the world that’s at the top of the charts is short-term U.S. Treasury securities. These enjoy the best, most direct, and most reliable guarantee of the U.S. government, over and above any other guarantees or promises they may have made in the past, or will make in the future.

I know you have questions. So let me do my best to anticipate them and answer them right here.

Question #1. You might ask: “The FDIC is also backed by the U.S. government. So if I have money in an FDIC-guaranteed account at my bank, what’s the difference? Why should I accept a lower yield on a government-guaranteed 3-month Treasury bill when I can get a higher yield on a government-guaranteed 3-month CD?”

Without realizing it, you’ve answered your own question. If the yield is higher on the bank CDs, that can mean only one thing — that, according to the collective wisdom of millions of investors and thousands of institutions in the market, the risk is also higher. Otherwise, why would the bank have to pay so much more to attract your money? Likewise, how can the U.S. Treasury get away with paying so much less and still have interested buyers for its securities?

It’s because the risk is higher for CDs, but much lower for Treasury securities. It’s because even within the realm of government guarantees, there’s a pecking order. The first-priority guarantee: Maturing securities that were issued by the U.S. Treasury department itself. The second-priority guarantee: Maturing securities that were issued by other government agencies, such as Ginnie Mae.

Third: The Treasury’s backing of the FDIC.
This is not to say the Treasury is not standing fully behind the FDIC. Rather my point is that, in the event of serious financial pressures on the government, the FDIC and FDIC guaranteed deposits will not be the first in line.

Question #2. You might also ask: “Isn’t the United States government also having its own share of financial difficulties with huge budget deficits? If those difficulties could get a lot worse, why should I trust the government any more than I trust other investments? Why should I loan my money to Uncle Sam?”

The United States is the world’s largest economy, with the most active financial markets and the strongest military in the world. Despite Uncle Sam’s financial difficulties, this has never been in doubt; and even in a financial crisis, that’s unlikely to change because the crisis is global. So its immediate impact on the finances of other governments is likely to be at least as severe.

More importantly, the United States government’s borrowing power — its ability to continue tapping the open market for cash — is, by far, it’s most precious asset, more valuable than the White House and all public properties; even more valuable than all the gold in Fort Knox. Those assets are like Uncle Sam’s home, land and pocket change. His borrowing power, in contrast, is like the air he breathes to stay alive.

Remember: The U.S. Treasury Department is directly responsible for feeding money to the utmost, mission-critical operations of this country, including defense, homeland security, and emergency response. The Treasury will do whatever it takes to continue providing that funding, and that means making sure they never default on their maturing Treasury securities.

Even in the 1930s, when a record number of Americans were unemployed, and when we had a head-spinning wave of bank failures, owners of Treasury bills never lost a penny.

Even in the Civil War, Treasuries were safe. Investors financed 65 percent of the Union’s war costs by buying Treasury securities. But the war was far worse than those investors had anticipated, leaving over half of the entire economy in shambles, raising serious concerns among those investors. However, the U.S. government made the repayment of its maturing Treasuries it’s number one priority over all other wartime obligations. Investors got back every single penny, and more.

My main point is this: The crisis ahead will not be nearly as severe as the war that tore our nation apart. If Treasury securities were safe then, we have no reason to doubt they will be safe today. Unfortunately, however, I cannot say the same for all of the money you’ve entrusted to a bank.

Question #3. “Suppose there’s a bank holiday and I need to cash in my Treasury bills. Since the Treasury Department and the Treasury-only money market funds use banks for transfers, won’t I be locked out of my money too?”

We actually have a real precedent for a similar situation. In Rhode Island in 1991, when the governor declared a state-wide bank holiday, all the state-chartered savings banks were closed down. Every single citizen with money in one of those banks was locked out.

At the time, one of our Safe Money Report subscribers happened to have a checking account in one of the closed Rhode Island banks. Thankfully, he had almost all of his money at the Treasury Department in Treasury bills, so his money was safe. But he called and asked: “The Treasury is set to wire the money straight into my bank account, which is frozen. Will the money the Treasury wires me get frozen too?”

In response, I told him to check his post office mailbox. Instead of wiring his funds, the Treasury had taken the extraordinary measure of cutting hard checks and mailing them out immediately. They wanted to make absolutely sure he got his money without any delay.

The moral of this story is that, even in a worst-case banking scenario, the Treasury will do whatever is necessary to get your money. We can’t forecast exactly how. But they will probably send you hard Treasury checks. And they’ll probably designate special bank offices in every city in every state where you can cash them in. Ditto for Treasury-only money market funds.

Question #4. “Throughout history, many governments have defaulted on their debts in a more subtle way — by devaluing their currency. Why are you recommending Treasury bills, which are denominated purely in dollars, if one of the consequences of this disaster could be a decline in the dollar?”

The trend today is toward deflation, which means a stronger dollar. But even if that changes, the solution will not be to abandon the safety and liquidity of Treasury bills. It will be to separately set some money aside and buy hedges against inflation, like gold or strong foreign currencies that tend to go up in value when the dollar falls.

How to Buy Treasuries

For funds that you do not need immediate access to on a daily basis, consider the U.S. Government’s Treasury Direct program. They offer a variety of choices, but I recommend you use strictly the 13-week (3-month) Treasury bills.

Meanwhile, for most of your personal or business, savings or checking, you don’t need a bank, an S&L or any other financial institution. All you need is a money market fund that invests in short-term U.S. Treasury bills or equivalent. The Treasuries it buys enjoy the same U.S. government guarantee as Treasuries bought through any other venue. So deposit insurance is simply not an issue.

Moreover, the Treasury-only money fund gives you the additional advantage of immediate availability of your money. You can have your funds wired to your local bank overnight. Or you can even write checks against it, much as you’d write checks against any bank checking account.


Dan W said...

A job well done Rumor!

RE: The appears even Meredith Whitney has joined the chorus:

"...This is no time for partisanship. The situation is too dire. These changes are ones I would never have imagined endorsing a year ago, but these are extraordinary times..." (M. Whitey)

And with a few keystrokes Meredith Whitney has thrown her weight behind the bailout. She joins an illustrious grouping: Dr. Doom (Roubini), Paul Krugman, even President elect Obama. And I DO understand where she is coming from. She, like many, is terrified at what could happen if the economy is simply cut loose and allowed to de-leverage and readjust on its own (relatively speaking of course). She admits above that she has had a change of heart regarding actions the government must take NOT because she sees such actions as a solution, but rather as a way to make the fall from grace less precipitous. I understand that.

HOWEVER, my take on this capitulation is that such actions will only delay the fall, and this delay will leave people LESS prepared because the overwhelming majority of people cannot see beyond tomorrow, let alone act and plan accordingly. With the Obama team ready to spend TRILLIONS more in economic stimulus programs, there seems to be a belief being proffered by the powers-that-be that this Depression, as it were, can (a) have a recognizable bottom and (b) can be "recovered from" in manners similar to those witnessed in the 1930s. (I'll leave the "war solution" out of this discussion for the time being)

I would posit, however, that where Whitney and Roubini and Obama err is in this very comparison. That the assumption of renewed economic growth based upon a model in which money is debt, in which fiat currency still rules the roost and concomitantly bond speculation and governmental check-kiting schemes make people rich beyond the dreams of avarice, in which market gamblers are able to make billions whilst the producers of REAL goods and services barely eek out a living, in which the exponential explosion of environmental costs vis-a-vis climate change increase daily, nay hourly, in which Peak Oil AND Peak potable water are fast becoming reality---I think that the assumption of finding 'solutions through spending' is simply false.

And so when I hear these folks calling for more spending and drilling and loaning and building and producing and...I wonder, how in the world can we survive this if even the best and the brightest are firmly entrenched in the dark tunnel of denial.

Dan W said...

...and I agree with your sentiment, Rumor, RE: banks. It is totally jaw-dropping that the wealthiest people in the world produce NOTHING. All they do is lend and collect and tax and rob. how the hell would one explain "banking" to aliens??

rumor said...

I see Hugh Hendry is pushing UK war bonds today. Just a reminder that Canadians have their own version of war bonds - Canada Savings Bonds. Cashable any time and with a tiny interest rate. I've said before: if you can't or aren't comfortable stuffing your savings into a reasonably theft-proof and fire-proof location, or aren't comfortable doing so with all of it, you could do worse than CSBs.

B said...

Rumor: Thanks for the intro.

Dan W: And so when I hear these folks calling for more spending and drilling and loaning and building and producing and...I wonder, how in the world can we survive this if even the best and the brightest are firmly entrenched in the dark tunnel of denial.
If it wasn't for the fact that so many people will get hurt, I'd be cheering on the end of globalized, industrial civilization. On the other hand, probably more people (and creatures) have been hurt by its success.

dopamine said...

I’ve read that credit card companies will reduce credit lines by 2 trillion dollars henceforth. It seems that this group of predators are pulling in their nets as the sea has been depleted of a profitable catch. Are they working against the TARP and the availability of credit? What about the big tax break the credit card companies were just given? Seems like the government, owned by corporate and financial interests, are helping the big boys cover their ass while the sheriff pulls the home out from under the little guy.

OC said...

Ok, I've finally (mostly) completed today's Debt Rattle.

Just a reminder that Canadians have their own version of war bonds - Canada Savings Bonds.

My thought exactly when I read that article. +2% is a fortune compared to -80%.

FB said...


This is an answer to Greg, while waiting for Stoneleigh.

Greg wrote "you would think there would be selective deflation, some things go down others stay the same?".

I think you are confusing prices with inflation/deflation. The latter are a monetary phenomenon, i.e. the net annual change in the money supply with respect to annual value added (GDP). If the money supply increases faster than GDP, you have inflation, otherwise you have deflation.

Prices are a lagging indicator of "flation", i.e. the broad range of prices will rise in step with, but later than inflation.

However, some prices may fall even during an inflationary period, e.g. computers, which means that the real cost (nominal cost minus inflation) of computers has been dropping very fast.

In a deflation, purchasing power falls fast and prices tend to fall more slowly, i.e. things become less affordable. If the price of an item, e.g. food or energy, remains stable or even rises during deflation, that means its real cost is going through the roof.

This is not only possible, but probable. So yes, relative values (nominal and real costs) of goods will vary sharply as you suspect.


Anonymous said...

Rumor and the other contributer: thank you!!!

Approx. how much time is left to prepare? Are we talking years or months?

OC said...

Approx. how much time is left to prepare? Are we talking years or months?

Preparations should have already begun. And they won't stop for many years, I'd guess. But I think you might be asking when some catastrophic epoch-defining event will happen when every last slack-jawed yokel, bumpkin and/or hick will suddenly understand the gravity of the situation. I doubt anyone can answer that question. Best not to leave it that late.

Anonymous said...

There is an action thriller banking crime movie, "The International" to be premiered worldwide on Feb. 13th and is kicking off the annual Berlin film festival. The German director is Tom Tykwer, known for "Run, Lola, Run". Main star is Clive Owen, star of "Children of Men" which is mentioned from time to time by readers of TAE.

Trailer here


Bigelow said...

Stoneleigh said:
"While greater oversight is clearly warranted, we should not be too quick to embrace much greater centralization without our eyes wide open."

Regarding the eyes wide open part: More power for those who screwed us will never fix anything. As I have learned, Finance was regulated by laws shaped by experience and those laws were systematically removed in order to bubble speculation while our general population --several generations removed from the last finance disaster-- were oblivious to the dangers. We should remember that we have been shown to be ultimately powerless to prevent this, again.

greg said...

François said...

In a deflation, purchasing power falls fast and prices tend to fall more slowly, i.e. things become less affordable. If the price of an item, e.g. food or energy, remains stable or even rises during deflation, that means its real cost is going through the roof."

Still a bit confused, how does purchasing power drop? Less money? I thought it was because of prices...

Less money because people get less for work, assets like homes and equities fall in price etc.?


rumor said...

Less money because people get less for work, assets like homes and equities fall in price etc.?

First, a severe reduction in credit. This then results, and the two reinforce each other downward.

Greenpa said...

Dan W. " It is totally jaw-dropping that the wealthiest people in the world produce NOTHING. All they do is lend and collect and tax and rob. how the hell would one explain "banking" to aliens??"

According to the Keynesian liturgy- you gotta have somebody with big wads of idle money- in order to fund stuff like huge auto factories. You know- growth, and progress.

That's the argument they give- and it's deeply imbedded in their belief system.

If anybody has any ideas for how to explain to these guys that profits should have LIMITS- for the well being of all- I'd love to hear them.

kerrysl said...

Thank you Rumor for a great post. I also especially liked Stoneleigh's comments just after it.

Her concerns of the pendulumn swinging too far match my own concerns.

WebWeasel said...

For those looking to make a map of like minded people you can try Just sign up and start a group.

Yes it's in beta and probably will remain so until the end of the internet.

el gallinazo said...

Great intro Rumor. Thanks. This team certainly has a deep bench.

"This debt crisis should teach us many things, only one of which is that risk assessment must include an assessment of the consequences of failure, however remote the likelihood of occurrence may be. The final irony, of course, is that the choice to systematically ignore those risks is what made their occurrence inevitable."

Well everyone knows that executive talent is interchangeable. And Kunstler insists that the only way to keep the electrons flowing after peak oil and methane is start building nukes like crazy. So I would like to make a modest proposal that we put the CEO's of the multinational banks in charge of our expanding nuclear program. These are men who know how to deal with risk.

el gallinazo said...


Was today the end of the suckers' rally or just a huge pothole in our Sisyphusian climb? Despite my admiration for you, I shorted the market just before Friday's close. My gut told me that Black Friday would be black indeed. Even our herd of wallwildebeasts couldn't ignore it.

Anonymous said...

Rumor, OC, Rick, B, Stoneleigh and others who are working hard to continue Ilargi's blog, a big thank you for the job well done. :)


Anonymous said...

el gallinazo,

I had to laugh when I read your new name. It sounds sooooo funny. Spanish is my first language.


/thehangedman/ said...

Someone pointed to a review of The Ascent of Money the other day, and noted that the author spoke of his inflence by the British polymath Jacob Bronowski and his TV series The Ascent of Man, which appeared in 1973.

In this two-minute clip from the series, which is as near to famous as a science program can get, Bronowski stands at Auschwitz and talks about the rage for certainty and what it does to us.

Put influenced Bronowski into Google and look at what a difference The Ascent of Man has made to so many.

Ningen said...

Compare this, applied in foreign policy:

and this, not applied on climate (and finance):

el gallinazo said...


I figured it was time to move a rung up the food chain, and besides, I aspire to becoming a vulture capitalist.

Stoneleigh said...

El (Pollo) Gallinazo,

So you've gone from chicken to vulture? My Spanish is too rusty to know for sure ;)

The selling pressure today was considerable, and it is possible that we could see another low prior to a longer rally, but unless we break the October low, I think odds are the rally will continue after this pullback. The balance of probabilities is pretty finely balanced though. Market timing is probabilistic rather than being an exact science.

Stoneleigh said...


Still a bit confused, how does purchasing power drop? Less money? I thought it was because of prices...

Less money because people get less for work, assets like homes and equities fall in price etc.?

Purchasing power will drop for many reasons. Almost total lack of access to credit is a major one. Without credit, people will find that there's very little actual cash around - not nearly enough to keep the economy from seizing up. Savings could be lost to bank runs and many investments will crater.

Also, refinancing is no longer possible, so the home ATM is closed, and many people will be losing their jobs and benefits. Public entitlements will be cut at the worst possible time, and will in no way make up for the loss of other income.

People are going to have very, very little purchasing power - probably not even enough for the essentials, let alone any frills.

el gallinazo said...


Thanks for your reply. It will be interesting to see which way the probabilities translate into "reality." Sort of like making a quantum mechanical observation and "freezing" the Psi function.

Actually the best translation for a "gallinazo" is a turkey buzzard.

Anonymous said...

I watched "The Ascent of Man" when it came out years ago.

It inspired confidence in the Human Experiment.

Ironically, Bronowski's TV opus was followed in my area by Monty Python's Flying Circus which, in my household, we referred to as "The Descent of Man"

A tip of the hat to 'Finance"

headly said...

Hi,I come from a land down under and have been observing at tae since this drama has come onto my radar in early september.So far here in oz there has only been ripples on the surface from the events unfolding in the usa and europe.Our government is scared stiff [as they should be] and are dropping interest rates frantically as well as administering fiscal stimulation packages.[give the patient more of what made it sick!]We are told that our banks are sound [where I have I heard that before?] but so far the general population is blissfully unaware of the actual seriousness of the situation although there has been some retreat in top end house prices and car sales.As our welfare relies on chinas appetite for our raw materials [I am a underground miner myself,in copper] and china is cashed up we are told we will ride this out with probably only a mild recession.After reading tea and some other blogs daily I have extreme doubts that that rosy prediction will come true.In the last article Citigroup collapses:Banking shutdownpossible the author promotes the safe haven of us bonds.The story has given me a much clearer understanding of why there is such a sunami of cash piling up in us bonds.So it seems that the end game lies there,will the us default and what would a us default look like theoretically and practically? With so many trillions of debt held by overseas and domestic investors ,what happens if confidence collapses in that debt and the money is repatriated? How would that affect the dollar and what would be the alternative safe haven? Although I have read that this is a real possibility I have not read a description of the end results.Thanks to ilargi and co for giving us this great site.Headly

baa said...

el gallinazo,

just googled it and found Polish blog from Colombia, the author says that in Colombia el gallinazo also means womanizer:)
yes, what would be the consequences of US default?

thanks everybody
baa from Poland

kerrysl said...

Hey Headly,
Welcome to TAE. I am also from Australia and also found TAE around about September.
So far I have switched my super from growth to cash, and sold equities with the money now in a Commsec investment account where every dollar from $1 earns 5.75%. That will probably drop after today's 1% rate cut.
Today I looked at the price of home safes after reading on TAE about how easily governments can declare extended bank holidays effectively freezing access to funds.
The US$ is high because of all the cash flowing into it, mainly US owned cash coming back from foreign investments. It's value could very quickly drop is there is a complete US default. So while it is probably a safe haven for US nationals, it could be riskier for foreigners.
Considering the AUD$ has already dropped to historic lows, and we have large deposits of gold in the ground, our money could well be safer at home.
I guess the Aussie equivalent of TBills would be short term bonds issued by our Reserve Bank. However I don't think small investors can easily participate in those.

Considering the need to possibly use brokers/funds/banks it may be that cash personally controlled may be safer.

What will need to be watched are the statistics on home burglaries.

el gallinazo said...

The rise in the Yen against all other major currencies in the past week and, more so, past 36 hours, is amazing. Can only mean a massive unwinding of the carry trade. Maybe yesterdays crash was from a sell off to cover margin calls. But there may be a sharp rise to cover shorts. Europe and USA futures are up this morning. Anyway, I think the sharp rise in the Yen is important and indicates accelerated de-leverage currently.


I should be so lucky. This turkey buzzard has taken an involuntary vow of celibacy.

goritsas said...


If anybody has any ideas for how to explain to these guys that profits should have LIMITS…

It would seem to be an impossible feat, to be sure. As our economic system discharges all the services our ecology provides as “externalities,” then any hope of convincing any member of that sect that continuous growth, in any form, is an oxymoron, is a fruitless task. Only by understanding our ecology can we understand continuous growth is an impossibility.

While economists have failed to incorporate ecology into their frameworks, they have incorporated us. Since we are, at least as a group, rather creative, and our creativity is limitless, it seems economists have come to the conclusion that since there are no limits to our creativity, and our economies are all based on this human creativity, itself limitless, then endless growth is not only possible but desirable, perhaps even necessary.

The only obvious way to avoid the need for continuous growth is to eliminate our current economic framework(s) and replace them with something grounded in the reality of the biosphere. We often hear we can’t afford this, or that, like CO2 reductions or pollution controls. It seems to me as if no one is actually listening to what is being said. How can we afford not to take steps to alter our habits so as not to destroy the very biosphere we depend upon for our very lives? Sadly, once again we can’t find a way out the conundrum because economics simply cannot respond to ecological signals except through the artifice of price. How do we price a forest? How do we price the hydrological cycle? How do we price predictable planting rainfall and predictable harvest dry weather? Until we can accurately price these “externalities” we’ll never be able to use the present economic system to implement the essential and required changes our lives, and the lives of future generations, depend upon.

Sometimes it seems we are making much ado about nothing here at TAE. We’re wondering what we need to do to “protect” and to “hang on to” as much of our “wealth” as we can. Then when the “end” of the financial crisis finally arrives we’ll have something to use in whatever remnants of the current system remain. But since the current system is itself the problem, and cannot possibly become the solution, maybe we’re simply hanging on to the myth that will kill us.

From what I can see, there is no other option but to completely replace today’s economics with something that can account for our ecology. Something that can guide us when taking decisions. There’s no point in building infrastructure if in the act of building that infrastructure we compromise the capacity of the biosphere to provide for life. Equally, if ecology tells us that infrastructure would likely add benefit to our existence and not compromise the biosphere, then such a decision would be a wise and fruitful one.

The longer we lament the failures of our economics and take the seemingly endless steps and countless gyrations we’re taking now in order to preserve our “wealth” and our “capital,” the longer we enjoy being comforted by the illusion we are doing all we can to protect ourselves and our families, the longer we do nothing. As long as we continue to engage in that waggle-dance, we are doing nothing, absolutely nothing, to advance the cause that must eventually be advanced, how to manage our affairs, how to create an economics that can enable life to survive and flourish without us doing our never ending best to destroy it.

Stoneleigh said...


I completely understand your point, coming initially from a biological sciences background myself. I wish the world could be structured like that, for the sake of humanity and the rest of the biosphere that we tread so hard upon, but for the time being we as individuals must live within the system we have or quite possibly not live at all. We want people to preserve what they have now so they will still have personal freedom of action in the future. Those with nothing will be completely at the mercy of fate, and fate will be exceptionally unkind to the unprepared over the next few years and beyond.

Mass destitution in an economy frozen over like Dante's ninth circle of hell is no recipe for a healthy biosphere. There's a reason why you can see the border between Haiti and the Dominican Republic from space - desperate Haitians reduced to eating mudcakes with a little fat mixed in have stripped every hillside of wood and erosion is rapidly destroying what soil they have left. Desperate people destroy their own remaining carrying capacity, as the only choice they have is to do so or die.

What we preserve now, we can use to rebuild something later. We won't rebuild what we had because we won't be able to, and the losses we are about to incur will give capitalism such a bad name that it may be outlawed for a very long time in favour of far greater state control (which is very much a double-edged sword). What will come later will inevitably be very different, but whatever it is, it will be easier to build if people are thinking along the lines of self-sufficiency now.

The more preparedness we can achieve now, the less desperation there may be later, especially if those who prepare end up in position to help many people besides themselves. The more we help keep wealth as widely distributed as possible, the less the chance that what is left will merely entrench a brutal dictatorship intent on milking a powerless proletariate. I know we can't expect to achieve a great deal towards these ends, but whatever we can do is better than nothing.

I would like to see preserved wealth serve viable communities on a human scale, as despite my distrust of the motives of big government, I am at heart a progressive. Right now though, progressives much be pragmatists, lest least-worst options be lost while we strive for unobtainable ideals.

greg said...

Stoneleigh said...

Purchasing power will drop for many reasons. Almost total lack of access to credit is a major one. Without credit, people will find that there's very little actual cash around - not nearly enough to keep the economy from seizing up. Savings could be lost to bank runs and many investments will crater.

I understand now. Multiple problems at once. I have see this happening now with my brother-in-law. Used his house like an ATM, now having trouble paying bills/debt. Multiple this over many people and it is a major problem...


scandia said...

Goritsas said," While economists have failed to incorporate ecology...they have incorporated us."
I had a real life experience of this statement yesterday. Some may recall I had aplied to be a patient of a new Dr. in town. I learned yesterday that I have been REJECTED as a patient! No phone call, no interview, a refusal to tell me why I was rejected. I rattled by cage in outrage by making some phone calls. The statement that finally slowed me down was " Doctors are entrepreneurs, I can't be responsible for their bedside manners etc". Entrepreneur! What happened to identity as healer!
Took a few hours to get to that pragmatism that Stoneleigh speaks of.Do I spend my limited supply of energy challenging this Dr's policy or do I spend my energy in preparations. Quite simple really. I am going for increased preparation.
I had another difficult decision to make as well. What to do about friends,family and organizations that didn't head the warnings and incurred debt that they don't have the means to clear? An organization I support is in urgent need of money to pay off debt. What is the right action for me to take? I so far don't perceive a grasp of reality from the spenders. If they get it they aren't talking about it. So ,No, I am not spending my limited resources to cover their debt. Have others here had to struggle with the sense of obligation to pay off the debts of others thereby being a " team player ", thereby securing a place in the valued group? A situation entirely parallel to the world gov'ts decision to pay off the misinvestments of the financial system.

greg said...

Bernanke Says Fed May Buy Treasuries to Aid Economy

One option is for the Fed to buy “longer-term Treasury or agency securities on the open market in substantial quantities,” Bernanke said. “This approach might influence the yields on these securities, thus helping to spur aggregate demand.”

Things must be getting pretty bad in the fed has to buy t-bills to keep rates low! How low can they go? So, the gov buys its own debt, how sustainable is that?

perry said...

"How low can they go?"

The mathematics of finance function in such a way that interest rates have no 'bound' -either up or down.


Greenpa said...

Goritsas, and Stoneleigh - I agree with pretty much 100% of what you both said there. I don't think that's a conflict.

One of the serious problems with being fully sentient (as most folks here are) is that you CAN, sometimes, see what SHOULD be done.

The conflict then is, too often what we can see should be done, is not within the boundaries of what CAN be done. Which can lead to sleepless nights.

I've been saying in various places (not sure if I've said it here or not) that what we really need to do is ERADICATE the current discipline of Economics. Close the business schools. Re-train the professors to drive taxis. What they "know" is so deeply false that any attempt to redirect it all by patching bits of truth onto it is doomed to failure.

And, absolutely, any new discipline, built from the ground up, needs to be based first in ecology.

I'm not kidding about that. Abandon economics- it's a false religion, based on false gods.

Unfortunately, this false religion has a huge number of fanatic adherents still extant, and still in positions of great power. They're not going to be willing to drive taxis- they will fight to the death.

My own very grim assessment is that we are going to have to descend into genuine chaos before real change can be made- and bringing an improved order out of chaos is going to be hugely difficult.

And we're still a long way from chaos, it can and will get much worse.

Stoneleigh, way back there I asked if you saw parallels between our current situation and the Chinese dynastic cycle, and I was gratified when you and Ilargi answered an emphatic yes.

An unhappy lesser feature of that cycle is that sometimes, towards the collapse of a dynasty, a brilliant reformer will take power, and attempt to reverse the damage. The outcome, so far- is a few more years of dynastic function, a little more justice for a while- but the ultimate collapse has never been stopped.

I would love to know if Obama is familiar. Graduating from Punahou, the chances are not bad, actually.

FB said...


Again in response to Greg.

Overall purchasing power in a country falls because, as you noted, unemployment rises, house values fall, stock markets fall, the credit bubble deflates, in short, there is less money in the country.

Wealth is unevenly spread so some people may see their purchasing power remain stable or even increase, but they will be a small minority.


goritsas said...


“…lest least-worst options be lost while we strive for unobtainable ideals.”

It was never my intention to suggest we strive for ideals, as such, only to note that regardless of the choices our economics offers us, our economics can provide no outcomes that are not embodied within itself. The outcomes that need to be created are not those our current economics can offer.

I was not intending to disparage TAE either, more to note the research is extensive and the analysis lucid, so I can now use that David Suzuki catch phrase, “the science is in.” The education and outreach are in place and may even last a good while yet. My main point is TAE could be turned into an archive today and still provide more than enough guidance for any member of “the great unwashed” to get clean, real clean.

Sure, we’ll want to monitor the collapse as it unfolds in all its topsy turvy glory to enable us to respond adequately as different conditions and trends become dominant for their 15 minutes of fame. But the fact remains this, everything anyone needs to know in order to understand and navigate these times that try men’s souls is already here.

I think there are two further points I’d like to explore with you as well. The first is the Ninth Circle of Hell. For anyone that accepts the concept of carrying capacity as an ecological reality, and accepts overshoot as a measure of exceeding carrying capacity, I think the Ninth Circle of Hell is inevitable. At some point in the proceedings carrying capacity will dictate population. I believe we do have the choice in how overshoot might be managed. I simply see us choosing to allow events to unfold without intervention that might reduce suffering.

Finally, I fear I don’t share your fears about “big government.” I have come to believe we are in the throws of what John Robb over at Global Gorillas believes is the end of the nation-state. I firmly agree with this part of his paradigm and already see the signs. While I’m sure there’s life left yet in the old dog, I think the dog’s days are numbered and this, more than anything else in our collective political – economic circumstances, will dominate our social environments as it seeks to save itself at any and all costs. He also postulates the rise of the market-state as the replacement for the nation-state, but I am less inclined to adopt the market-state as a viable concept in the face of increasing energy scarcity and decreasing resource availability.

greg said...

FB said...


Again in response to Greg.

Overall purchasing power in a country falls because, as you noted, unemployment rises, house values fall, stock markets fall, the credit bubble deflates, in short, there is less money in the country.

Wealth is unevenly spread so some people may see their purchasing power remain stable or even increase, but they will be a small minority.

Thanks, it is more general than I was thinking. People have less wealth (income & assets), not just falling asset prices.

This is all new to me, in the past, people always worried about inflation when investing and asking for raises.

Anonymous said...

I'd be interested to know if anyone here is familiar with steady-state economics (Daly).

This is one proposed alternative to the growth based economy. The idea is promoted here:


Greenpa said...

Bluemarble- thanks for the link; I'd known a bit about these guys some time ago, but they've gotten a lot more organized since I last looked. Looks interesting. The head is from U of AZ; which has been a serious leader in ecology for some years now-

Rancher said...

My wife and a friend drove to Medford to do some shopping yesterday at the
Medford Mall. The two anchor stores are Kohls and Macy's.

If you were going east, the next Mall would be in Boise, Idaho. If you went south,
it would be in Redding, CA.. If you went north it would be in Eugene, Oregon, and if
you went west, it would be in Hawaii. The closest is a three hour drive not counting
a long swim.

The Medford mall is large for the city, it has a hundred stores and several different
types of eatery and offers just about anything that a shopper could want.

Lynn pulled into the parking lot and found a spot right next to the mall doors in the
front row. The first thing they noticed was the sparsity of shoppers and she told
me later that it was almost eeire walking around the cavernous stores with only a few
people scattered far apart. Lynn and Lil walked through the mall and both of them
started to comment on how empty the place was and what this was doing to the stores.
The walked into Eddie Baur's and they were the only people there. The described
store clerks, the ones they could find, as standing around bored and with a glazed look
in their eyes.

In Christopher Banks, everything was 50% off. In Macy's, almost everything was
on sale and if you used your Macy's card, got another 15% off. Both these ladies
came home shocked at what they had seen. At another store, Michael's Crafts, everything
was on sale, some of the merchandise off as much as 70%. All Christmas decorations were on sale at 50% or more.

Right at 12 noon, they walked down to the food square to get some lunch and
saw only a few people. Usually this place is packed and finding a table is like winning
the lottery. Passing in front of the Chinese food place, the servers were hawking their
wares with free samples, something that has never happened before.

All in all, both Lynn and Lil came away with a heighten awareness of how desperate
the stores are and how close to bankruptcy most of them are. Both of them expressed
the feeling that the stores are desperately trying to cash out as fast as possible and
would probably close after the first of the year. Remember, this is the ONLY mall for
hundreds of miles in any direction and serves hundreds of thousands of people in
every direction.

One more thing. Both ladies told me about the lack of traffic. No waits at lights,
no parking problems. nothing.

Anonymous said...

Hi kerrysl thanks for your reply.I moved all my super to cash about eight months ago and have bought ten g's in gold as a diversification.All my savings are in my super as I am close to retirement .I still have some outstanding on my morgage which I intend to pay off out of my super so I sure hope that our super accounts do not vaporize somehow.I would like to put the question again to the other posters here,..what would a u.s. default look like to ordinary folks around the world,how would it affect us in our daily lives , in our living rooms and on our highways and places of work?...or is it a totaly unknown? Thanks,Headly.

Anonymous said...

If in doubt, cleave to those countries with a deeply-rooted democracy, a strong sense of national solidarity, a tested rule of law – and aircraft carriers. The US and Britain do not look so bad after all.

OMG. What planet is the author from! Tested rule of law failed, the US Constitution is officially DOA. Not so deeply democratic either, given the uncontested thefts of 2000 and 2004 and the history of the southern strategy. National solidarity? When centrist opposition party candidates are openly labeled terrorists and crazed GOP partisan politicos yell 'kill him'? When 'consumers' murder to get a deal at Walmart? Aircraft carriers! Yeah that's the ticket, no blowback worries there!

ArchCarrier said...

Can you please check your RSS feeds? All TAE posts show up (in Google Reader at least) about a week after they are posted. Also, the TAE feeds are the only ones that can't be clicked directly (again, in Google Reader).
I don't know why this is; maybe the default feed settings got changed?