Thursday, May 7, 2009

May 7 2009: See Through Bizzarro

Ben Shahn Staying Put October 1935
One of the few remaining inhabitants of Zinc, Arkansas, deserted mining town

Ilargi: A headline at UPI this morning:"Geithner touts transparency of tests". My first thought was to leave it at that; I mean, what can I possibly add, it certainly can't get any clearer. It's straight out of Bizzarro world. There is no transparency in the stress test process, we only get to see what the administration and the tested banks agree to make public, at a time of their choosing. I’m starting to get the feeling that perhaps folks like Geithner have genuinely forgotten the meaning of the term transparency.

All this refers of course to the US stress tests for 19 banks, the "results" of which are to be released today at 5.00 PM EDT. Geithner, in all his transparent splendor, has already said that all banks are fine, no need to worry, granted, some may need some cash, but none are insolvent. You're going to have to take his word for it. Here's a simple question: what would Geithner say if one or more banks were insolvent? And here's the simple answer: in order to prevent a bank run, he would say the exact same thing he's saying now. There you see his excuse to not be transparent.

The majority of the population will believe him. After all, he works for a man they'd follow blindly, no questions asked. That majority today prevails not only on the political scene, but also in the markets. Still, you have to wonder how the smarter parties will react. My guess is a lot of them are just pulling out. If a government does little more than look for new ways to stand in the way of a market to work, for the strong to prevail and the weak to fail, you can only make money if you're in the inner circle of that government. Which may have something to do with Goldman's record trading volumes lately, but which also is likely to make trading too risky for the uninitiated. If the rules of the game change on the fly, who wants to be on the field? The stress tests won't separate the strong from the weak, at least not in a business or financial sense. It will separate the connected from those out in the cold.

For a realistic picture of what state the US economy -and its banking system- is in, it's far more useful to look at unemployment numbers, foreclosures, debt levels, a GDP diving at a 6% annual rate, that sort of thing. And even then you have to be really careful, because those numbers, too, have as little transparency as their issuers -think they- can get away with. At least we can see through that.

US initial unemployment claims fall, continuing claims hit fresh record high
The number of people filing initial claims for unemployment benefits fell last week, as the number of people filing claims on an ongoing basis rose to a fresh record high, according to a government report released Thursday. In the week ended May 2, 601,000 people filed initial jobless claims, down 34,000 from an upwardly revised 635,000 in the previous week, said the Labor Department. Economists had expected 635,000 new claims, according to a consensus survey by

The 4-week moving average of initial claims reached 623,500, down 14,750 from the previous week. But the number of people continuing to file jobless claims rose to a fresh all-time high. In the week ended April 25, the most recent data available, 6,351,000 continuing claims were filed. That's a record high and an increase of 56,000 from the previous week. The 4-week moving average for continuing claims was was 6,207,250, an increase of 125,250 from the week prior. Elevated levels of continuing claims for unemployment insurance are considered a sign that more people are struggling to reenter the workforce.

Thursday's report comes one day after two private sector reports showed signs the job market is improving. Looking ahead, the government is set to release its closely watched monthly employment report Friday. Economists surveyed by think the economy lost 620,000 jobs in April, which is 43,000 fewer than the previous month. The unemployment rate is forecast to rise to 8.9% from 8.5%.

U.S., Europe Are Ocean Apart on Benefits, Human Toll of Joblessness
In Germany, losing his factory job didn't stop Alfred Butt from taking a Mediterranean vacation this winter. Thanks to generous jobless benefits, being out of work "hasn't changed my life that much," Mr. Butt says. In the U.S., Dylan DeRoberts lost similar work -- but there's no seaside getaway for him. Instead, he's giving up life's little pleasures, like riding his snowmobile, because he lost his insurance, too. "I've learned to live at a new level," Mr. DeRoberts says. Unemployment is taking a very different human toll on opposite sides of the Atlantic, which helps explain why Europe and the U.S. can't agree on how to attack the global recession. The U.S. is spending hundreds of billions of dollars -- including increased assistance to the unemployed -- to prop up the economy, and wants Europe to follow suit. But most of Western Europe already has a strong, if costly, social safety net, so governments feel less pressure to spend their way out of trouble.

The irony is that for years, Europe tried to rein in its own worker protections -- long considered a drag on growth in good times -- to emulate the faster-growing U.S. economy. Now the U.S. is moving toward a more European system. The differing U.S. and European approaches toward worker protections can influence recovery prospects. Unemployment is similarly high, above 8% and rising, both in the U.S. and among the 16 European countries that use the euro currency. But Europe's high payroll taxes, along with restrictions on when and how companies can lay off workers, make employers slower to rehire when a recession ends.
That's one reason why economists expect the U.S. to stabilize faster than Europe. Last month the International Monetary Fund predicted that the euro-zone economy will keep shrinking next year, whereas the U.S. should bottom out by then.

For Mr. Butt, losing his job as a raw-materials buyer for a German auto-parts maker was a serious blow. But state benefits will replace the bulk of his salary until May 2010. And he still has full medical insurance under Germany's universal system. Mr. DeRoberts, who lost his job at a Chrysler assembly plant in Belvidere, Ill., near Rockford, last year, saw his medical benefits expire several months later. He says he can't afford to pay the premiums on his own. "It's scary being without insurance," Mr. DeRoberts says, but adds: "What do I give up? Food?"

Western Europe is seeing its share of worker discontent. On Friday, the annual "May Day" demonstrations in France and Germany attracted more people than in recent years. But most protests are being aimed at specific employers rather than governments -- including France's recent spate of "boss-nappings," in which workers detain executives in their own offices to protest job cuts. Despite widespread unease at unemployment, there's relatively little public clamor to adopt U.S.-style stimulus spending. The public mood isn't as bleak as the economic data. In Germany, gross domestic product has been in free fall since September. Most people think the crisis will get worse, according a recent poll by market-research group Emnid -- but 62% say they aren't feeling it themselves so far. In the U.S., only 13% say they're not at all affected personally, according to a recent Wall Street Journal/NBC poll.

Germany has built up a system of state-backed insurance for workers against illness, disability, old-age poverty and unemployment since the late 1800s. But benefits don't stay generous forever. Under a controversial labor overhaul in force since 2005, German unemployment benefits fall to a subsistence level after one year. The government decided the long-term jobless didn't have enough incentive to get off the dole, so it upped the pressure. Jobless benefits vary around Europe, just as they can vary state-by-state in the U.S. But in most Western European countries, the state replaces 60% to 80% of the average worker's lost salary, compared with just over half on average in the U.S., according to the Organization for Economic Cooperation and Development.

European benefits also tend to last longer. In Belgium, jobless benefits have no time limit at all. In Denmark, the state replaces up to 90% of lost wages and invests over 4% of gross domestic product every year in supporting and retraining the jobless. By contrast, before the current crisis struck, the U.S. spent about 0.4% of GDP on retraining and benefits, according to the OECD. Less-generous European countries include Greece, where initial benefits replace less than half of lost wages, on average. Heavily indebted households in countries such as the U.K. and Ireland, where property and lending bubbles have burst, are also particularly vulnerable in the recession. Economic pain in less-developed Eastern Europe is a separate and much deeper problem. The European way takes a toll in taxes. In Germany, over half the total cost of employing somebody consists of income tax and mandatory contributions to programs including unemployment insurance and pensions. In the U.S., that figure is 30% -- meaning employees take home more of the money it costs to employ them.

The upshot: German workers cost significantly more to hire, on average, than U.S. workers, even though they can't buy quite as many goods with their take-home pay. That impacts both employment and consumer spending in Germany. On the other hand, Americans must pay extra for health insurance, unlike most Europeans. The U.S. recently expanded unemployment and food-stamp benefits. New money for retraining the jobless, part of President Barack Obama's stimulus program, echoes government efforts in parts of Europe to give laid-off workers new skills. In Illinois, Mr. DeRoberts, 32 years old, is benefiting from increased funding for the Dislocated Worker Program. The federal initiative provides job training and career counseling, and is being expanded by President Obama's stimulus spending.

The local Dislocated Worker office is providing about $6,000 of financing for Mr. DeRoberts to attend a two-year course in electronic engineering at Rock Valley College. He's hoping his studies might lead to a career in alternative energy, which President Obama has been touting as a future engine of the economy. Rockford recently attracted a Chinese solar-panel maker. The big threat hanging over Mr. DeRoberts's plans is that his unemployment benefits run out in June, with a year of school to go. He worries he might have to cut his studies. "I'll get my last check and be going, 'What do I do now?'" he says, scratching his head in an exaggerated motion. He and his girlfriend are expecting a baby in August, and he fears flipping burgers could be in his future. Anything to avoid a retreat into debt. "If I'm facing not being able to put food on my table, I'll take the first job I can get," he says, sitting on the edge of a chair in his living room.

Mr. DeRoberts, who worked for Chrysler from the age of 19, used to earn around $5,000 a month. Over the years, he'd moved up from bolting basic car parts into place, to troubleshooting the assembly-line machines. He even moved from Syracuse, N.Y., to the Belvidere plant as production shifted -- reflecting American workers' greater mobility compared with Europeans. But then the Belvidere plant began struggling, eliminating a shift last year. With less seniority than other workers, Mr. DeRoberts felt vulnerable to further cuts. So he took a buyout. "I felt I could either take the buyout offer, or be forced to leave later, with nothing," he says. He ended up with about $64,000, after taxes, which he used to clear debts. He also liked the idea of improving his education. "With a degree, I'll be ahead of the regular Joe Blow," he says.

Now he gets $1,426 a month in jobless benefits. In Illinois, benefits were extended to 59 weeks from 26 as part of the stimulus measures. Last month a special Illinois program, targeting prolonged unemployment, added 13 more weeks for some people; Mr. DeRoberts doesn't know yet whether he qualifies. His girlfriend makes slightly more at a local elementary school. Their combined income is enough to cover rent for their two-bedroom apartment, electricity, groceries, car insurance and gasoline, but few frills. The couple rarely eat out, and they usually wait for $5 discount nights to see a movie. The Rockford area was once among the most prosperous in the U.S., buoyed by thriving automotive and machine-tool industries. Its fortunes have declined, and today unemployment is hovering around 14%.

The little German town of Hohenlockenstedt, where Mr. Butt worked, also used to be a manufacturing powerhouse. In the 1970s it had more industrial jobs than inhabitants; factories had to bus workers in. Today, hardly any industry is left. In December, the auto-parts factory where Mr. Butt worked for eight years, HWU GmbH, announced its own shutdown. Workers protested, occupying the factory for a week. Mr. Butt, a burly 42-year-old, participated as employees barricaded the gates with forklifts and slept in the factory's canteen. Their demand: Save our jobs. It was hopeless. Mr. Butt found himself out of work in January. Normally, German workers get severance pay in large-scale layoffs, but HWU didn't have enough money. As a result, Mr. Butt's benefits are about as bad as it gets for a laid-off German factory worker.

Still, compared with the U.S., it's a lucrative package. First, he (and everyone else) got a job at a so-called "transfer" company, a private business that offers training and job-hunting advice with funding from the state and the former employer. Through transfer companies, German workers can receive the bulk of their former salary for as much as a year before they even have to apply for unemployment. Mr. Butt is getting four months at 80% of his old salary of €2,700 (roughly $3,600) a month. After tax, he's taking home about €350 less than before. From this month, he's on unemployment benefits for a year, which will cut his disposable income by an additional €200 a month. If he's still jobless by May 2010, he'll start feeling the pain. At least his wife has a job; she's a nurse at a rheumatism clinic. However, people with employed spouses don't qualify for Germany's long-term benefits. He and his wife no longer go as often to their favorite Greek restaurant. But other than that, he says, he can still afford his lifestyle.

The couple decided to take a week's winter break in Cyprus as planned, even after he learned his factory would shut. "We still have enough income, and it was good to get away," says Mr. Butt. It helps that he has only a small mortgage and no credit card. Like many Germans, Mr. Butt says, he and his wife "were brought up to believe that if you don't have the money to pay for something, you don't buy it." Germany's economy is expected to contract by around 6% this year, by far its worst performance since World War II, and worse than most U.S. forecasts. Still, Mr. Butt's biggest worry isn't surviving while jobless, it's finding another job -- because employers frown on applicants who've been unemployed a whole year. "People think you don't want to work," he says. "That's the main source of time pressure, not the benefit rules." He spends most mornings searching online for vacancies in sales, purchasing or administration at all kinds of companies. There's little out there. "I thought finding a job wouldn't be a problem," he says. "I didn't think it would be so tough."

Global Crisis 'Vastly Worse' Than 1930s, Taleb Says
The current global crisis is "vastly worse" than the 1930s because financial systems and economies worldwide have become more interdependent, "Black Swan" author Nassim Nicholas Taleb said. "This is the most difficult period of humanity that we’re going through today because governments have no control," Taleb, 49, told a conference in Singapore today. "Navigating the world is much harder than in the 1930s." The International Monetary Fund last month slashed its world economic growth forecasts and said the global recession will be deeper than previously predicted as financial markets take longer to stabilize.

Nouriel Roubini, 51, the New York University professor who predicted the crisis, told Bloomberg News yesterday that analysts expecting the U.S. economy to rebound in the third and fourth quarter were "too optimistic." "Certainly the rate of economic contraction is slowing down from the freefall of the last two quarters," Roubini said. "We are going to have negative growth to the end of the year and next year the recovery is going to be weak." Federal Reserve Chairman Ben S. Bernanke told lawmakers May 5 that the central bank expects U.S. economic activity "to bottom out, then to turn up later this year." Another shock to the financial system would undercut that forecast, he added.

The global economy is facing "big deflation," though the risks of inflation are also increasing as governments print more money, Taleb told the conference organized by Bank of America- Merrill Lynch. Gold and copper may "rally massively" as a result, he added. Taleb, a professor of risk engineering at New York University and adviser to Santa Monica, California-based Universa Investments LP, said the current global slump is the worst since the Great Depression that followed Wall Street’s 1929 crash. The Great Depression saw an increase in global trade barriers and was only overcome after President Franklin D. Roosevelt’s New Deal policies helped revive the U.S. economy.

The world’s largest economy may need additional fiscal stimulus to emerge from its current recession, Kenneth Rogoff, former chief economist at the International Monetary Fund, told Bloomberg News yesterday. "We’re going to get to the point where recovery is just not soaring and they’re going to do the same again," he said. "We’re going to have a very slow recovery from here." The U.S. economy plunged at a 6.1 percent annual pace in the first quarter, making this the worst recession in at least half a century. President Barack Obama signed a $787 billion stimulus plan into law in February that included increases in spending on infrastructure projects and a reduction in taxes. Gold, copper and other assets "that China will like" are the best investment bets as currencies including the dollar and euro face pressures, Taleb said. The IMF expects the global economy to shrink 1.3 percent this year.

Gold, which jumped to a record $1,032.70 an ounce March 17, 2008, is up 3.6 percent this year. Copper for three-month delivery on the London Metal Exchange has surged 55 percent this year on speculation demand will rebound as the global economy recovers from its worst recession since World War II. Commodity prices are also gaining amid signs that China’s 4 trillion yuan ($585 billion) stimulus package is beginning to work in Asia’s second-largest economy. Quarter-on-quarter growth improved significantly in the first three months of 2009, the Chinese central bank said yesterday, without giving figures. China will avoid a recession this year, though it will not be able to pull Asia out of its economic slump as the region still depends on U.S. demand, New York University’s Roubini said. Equity investments are preferable to debt, a contributor to the current financial crisis, Taleb said. Deflation in an equity bubble will have smaller repercussions for the global financial system, he added.

"Debt pressurizes the system and it has to be replaced with equity," he said. "Bonds appear stable but have a lot of hidden risks. Equity is volatile, but what you see is what you get." Currency and credit derivatives will cause additional losses for companies that hold more than $500 trillion of the securities worldwide, Templeton Asset Management Ltd.’s Mark Mobius told the same Singapore conference today. "There are going to be more and more losses on the part of companies that have credit derivatives, those who have currency derivatives," Mobius, who helps oversee $20 billion in emerging-market assets at Templeton, said at the conference. "This is something we’re going to have to watch very, very carefully." Taleb is best known for his book "The Black Swan: The Impact of the Highly Improbable." The book, named after rare and unforeseen events known as "black swans," was published in 2007, just before the collapse of the subprime market roiled global financial institutions.

The Worst Case Scenario (Someone Has to Say It)
Since the economy began sliding downhill in late 2007, mainstream economic and market experts have consistently erred on the sunny side. As late as June 2008, mainstream consensus held that the U.S. was heading for a "soft landing" and would avoid recession. Several months later, the slump was acknowledged to have started in January 2008, but we were supposed to see renewed growth by mid-2009, with unemployment peaking in the eight-to-nine percent range. A quick "shovel-ready" stimulus bag was supposed to set us back on the road to prosperity. In January, recovery projections were pushed forward to late 2009. Today, the consensus is for a mid-2010 recovery, with unemployment peaking at just over 10 percent. Clearly, the mainstream has struggled to catch up to reality for well over one year. What are the chances that they finally have it right this time?

Moreover, the mainstream continues to see what is going on as a plain-vanilla recession that will be quelled with some on-the-fly monetary and fiscal tinkering. Washington, we are told, will pull us out of this slump—as soon as the masses can be enticed back to the shopping malls. Then things will return to how they were before. But what if the experts and politicians are wrong not only on their ever-changing recovery timeline, but also on the nature—nay, the very existence—of a recovery? America’s reigning political-economic ideology has demonstrably failed. Given that its government is obviously fumbling along without a clue, its foreign and domestic credit is tapped out, and its 300 million people are discovering that their hopes for continuous material improvement will never be met, could the U.S. be headed the way of the USSR?

Instead of a recovery as the mainstream envisions it, what if America permanently bankrupts, impoverishes, and marginalizes itself? What if its cherished institutions fail across the board? For example, what happens when the police realize that their under-funded pension plans cannot support a decent retirement? Will they stay honest, or will they opt to survive by any means necessary? These are questions that the mainstream does not even begin to contemplate. In the interests of providing you with an alternate vision—something outside the mainstream—below are ten predictions for America through the year 2012.

This is not boilerplate doom-saying. Rather, I am laying out in highly specific terms what will happen over the next three-odd years. Others have thrown around the term "Depression", but I am going to tell you precisely what it means for you, your investments, and your community. When these predictions come true, I expect to be rewarded with a seven-figure consulting gig, a book contract, or a high-level position in whatever administration succeeds the doomed Obama team—that is, if anyone succeeds it at all.

Prediction one. The twenty-five-year equities bubble pops in 2009. U.S. and foreign equities markets will stop treading water and realign with economic reality. Stock prices will cease to reflect the "greater fool" mentality and will return to being a function of dividend yields, which have long been miserable. The S&P 500 will sink below 500. In a bid to stem the panic, the government will enforce periodic "stock market holidays", and will vastly expand the scope of its short-selling prohibitions—eventually banning short-selling altogether.

Prediction two. With public pension systems and tens of millions of 401k holders virtually wiped out—and with the Baby Boomers retiring en masse—there will be tremendous pressure on the government to get into the stock market in order to bid up prices. Therefore, sometime in 2010, the Federal Reserve will create and loan out hundreds of billions of fresh dollars to the usual well-connected suspects, instructing them to buy up stocks on the public’s behalf. This scheme will have a fancy but meaningless name—something like the "Taxpayer Assurance Equities Facility". It will have no effect other than to serve as buyer of last resort for capitulating smart-money types who want to get out of stocks entirely.

Prediction three. Millions of new retirees—including white-collar people with high expectations for a Golden Retirement—will be left virtually penniless. Thousands will starve or freeze to death in their own homes. Hundreds of thousands will find themselves evicted and homeless, or will have to move in with their less-than-enthusiastic children. Already strained by the rising tide of the working-age unemployed, state and local welfare services will be overwhelmed, and by 2012 will have largely collapsed and ceased to function in many parts of the country.

Prediction four. "Quantitative easing" will fail to restart previous patterns of lending and consumption. As the government sends out additional "rebate" checks and takes ever-more drastic measures to force banks to lend, hyperinflation could take hold. However, comprehensive debt relief via a devaluation of the dollar is even more likely. This would entail the government issuing one "new" dollar for some greater number of "old" dollars—thus reducing both debts and savings simultaneously. This would make for a clean slate a la Fight Club. As there are many more debtors than savers in the U.S., the vast majority would support devaluation. The Chinese and other foreign holders of our bonds would be screaming mad, but unable to do anything. Every country that has not found a way out of dollar-denominated reserve assets by 2012 will see its reserves eliminated.

Prediction five. The government will stop pretending that it can finance continuous multi-trillion-dollar deficits on the private market. By late 2010, the sole buyers of new U.S. Treasury and agency bonds will be the Federal Reserve and a few derelict financial institutions under government control. This may or may not lead to hyperinflation. (See prediction four).

Prediction six. As the need for financial industry paper-pushers declines and people have less money to spend on lawyers and Starbucks, unemployment will rise until the private sector has eliminated all of its excess capacity and superfluous or socially needless jobs. The government’s narrow unemployment figure (U3) will rise into the high teens by late 2010. The government’s broader unemployment figure (U6) will cease to be reported when it reaches 25 percent—it will simply be too embarrassing. Ultimately, one in three work-eligible Americans will be unemployed, underemployed, or never-employed (e.g. college grads permanently unable to find suitable work).

Prediction seven. With their pension dreams squashed, and their salaries frozen or cut, police and other local government workers will turn to wholesale corruption in order to survive. America’s ideal of honest, courteous, and impartial cops, teachers, and small-time local functionaries will have come to an end.

Prediction eight. Commercial overcapacity will strike with a vengeance. By 2012, thousands of enclosed malls, strip malls, unfinished residential developments, motels, truck stops, distribution centers, middle-of-nowhere resorts and casinos, and small-city airports across America will turn into dilapidated, unwanted, and dangerous ghost towns. With no economic incentive for their maintenance or repair, they will crumble into overgrown, plywood-and-sheet-rock ruins.

Prediction nine. By the end of 2010, tens of millions of households will have fallen behind on their mortgages or stopped paying altogether. Many banks will be unable to process the massive volume of foreclosure paperwork, much less actually seize and resell the homes. Devaluation (as mentioned in prediction four) could ease the situation for those mortgage holders still afloat, but it would also eliminate any incentive for most banks to stay in the mortgage business. In any case, the housing market in many parts of the country will lock up completely—nothing bought or sold. With virtually no loans being made, even the government will finally acknowledge that most banks are fundamentally insolvent. A general bank run will only be averted through a roughly one trillion-dollar recapitalization of the FDIC, courtesy of new money from the Federal Reserve.

Prediction ten. As an economy is never independent of the society within which it functions, the next few paragraphs will focus on social and political factors. These factors will have as much of an impact on market and consumer confidence as any developments in the financial sector.

Whether rightly or not, President Obama, having come to power at the dawn of this crisis, will be blamed for it by over 50 percent of the population. He will be a one-term president. In response to his perceived socialization of America, there will be a swarm of secessionist and extremist activity, much of it violent. Militias and armed sects will be more prominent than in the early 1990s. Stand-off dramas, violent score-settlings, and going-out-with-a-bang attacks by laid-off workers and bankrupted investors—already a national plague—will become an everyday occurrence. For both economic and social reasons, millions of immigrants and guest workers will return to their home countries, taking their assets and skills with them. The flow of skilled immigrants will slow to a trickle. Birth rates will plummet as families struggle with uncertainty and reduced (or no) income.

Property crime will explode as citizens bitter over their own shattered dreams attempt to comfort themselves by taking what is not theirs. Mutinies and desertions will proliferate in an increasingly demoralized, over-stretched military, especially when states can no longer provide the educational and other benefits promised to their National Guard troops. There will be widespread tax collection issues, and a huge backlash against Federal and state bureaucrats who demand three-percent annual pay raises while private sector wages remain frozen or worse. In short, the "Tea Parties" of tomorrow will likely not be so restrained.

Finally, between now and 2012, we are likely to see another earth-shaking national embarrassment on the scale of the 9/11 attacks or Hurricane Katrina and its aftermath. This will demonstrate conclusively to all Americans that their government, even under a savior-figure like Obama, cannot, in fact, save them. By 2012, there will be a general feeling that the nation is in immediate danger of blowing up or coming apart at the seams. This fear will be justified, given that the U.S. has always been held together by the promise of a continuously rising material standard of living—the famous "pursuit of happiness"—rather than any ethnic or religious ties. If that goes, so could everything else. We were lucky in the 1930s—we may not be so lucky again.

Federal aid is top revenue for states
In a historic first, Uncle Sam has supplanted sales, property and income taxes as the biggest source of revenue for state and local governments. The shift shows how deeply the recession is cutting. Federal stimulus money aimed at reviving the economy and a sharp drop in tax collections have altered, at least temporarily, the traditional balance of how states, cities, counties and schools pay for their operations. The sales tax had been the No. 1 source of state and local revenue since the mid-1970s, according to the Bureau of Economic Analysis. Before that, property taxes were the primary source. That changed in the first three months of 2009.

Federal grants — early stimulus money plus conventional federal aid — soared 15% in the first quarter to a seasonally adjusted annual rate of $437 billion, eclipsing sales taxes, which fell 2%. The dominance of federal money is set to expand dramatically this year because tax collections are sinking while the bulk of federal stimulus aid is just starting to arrive. "This money isn't manna from heaven. It comes with a price," says Indiana state Sen. Jim Buck, a Republican. He worries that the federal money will leave states under greater federal control and burden future generations with debt. Nick Johnson, a state finance expert at the liberal Center on Budget and Policy Priorities, says the federal aid is well-timed. "This has more to say about the severity of the recession than anything else," he says. "Congress stepped in on a temporary basis to help states."

The federal government plans to provide about $300 billion in extra aid to state and local governments over the next two years, mostly for health care, education and transportation projects. State and local governments spend about $2 trillion a year, and the federal government is now paying about 23% of those costs. States are counting on tax collections rebounding by 2012, when stimulus money starts to run out. The early flow of stimulus money helped lift total state and local revenue by 1.6% in the first quarter compared with a year earlier despite a 2.9% drop in total tax collections. Spending rose 1.5%.

Things are getting worse for states that rely on the income tax. Reason: Unexpectedly large refund checks in March and April are going to workers who lost jobs or had wage cuts last year. Michigan's income tax collections are down $200 million and refunds are up about $200 million — a $400 million swing. Connecticut has paid nearly $1 billion in tax refunds this year, about 20% more than expected. "These are big numbers. It's put us in a very bad situation," says Connecticut Comptroller Nancy Wyman.

Key state and local taxes:
  • Sales tax. Collections started falling at the end of 2008 for the first time since the Bureau of Economic Analysis first reported data in 1958. The drop in sales of automobiles and construction materials has taken a big bite out of sales tax revenue.
  • Property tax. The most stable tax is generating increasing revenue, mostly for schools, despite plunging property values. One reason: Forty-six states limit how fast property taxes rise or fall.
  • Income tax. The most volatile tax produces big increases during boom times and giant declines during hard times. California, New York, Oregon, Connecticut and other states that depend heavily on taxing year-end bonuses and capital gains on investments have been hardest hit by the worst income tax drops since 2002.

Top revenue sources for state and local governments in the first quarter, compared with the same period last year:
  • Federal grants: 15%
  • Income taxes: -11%
  • Property taxes: 2%
  • Sales taxes: -2%
  • Other taxes: 2%

Sources: U.S. Department of Commerce, Bureau of Economic Analysis

Off their trolleys: American consumers struggle with their debts
Whether it is for affordable homes or cheap goods, Americans are peering through the wreckage of the credit crunch and starting to buy again. After falling sharply in the second half of last year, consumer spending rose in the first quarter, and even sales of homes and cars have edged up from deeply depressed levels. Anticipating a rebound, shares of retail companies, especially those selling inexpensive items, have soared. Ben Bernanke, the Federal Reserve chairman, characterised the news on consumers as "somewhat better" on Tuesday May 5th. Still, that cautious endorsement qualifies as downright ebullient compared to the gloom of a few months ago. A Fed survey of bankers, released on Monday, gave a hint of good news for consumers; though banks are still tightening standards on consumer loans, fewer of them are doing so than three months before.

Meanwhile, there has been a long-overdue flurry of activity in the Fed’s programme for restarting the securitisation market. On Tuesday it supported the issuance of $10.6 billion of securities backed by student, auto, credit-card, small-business and equipment loans. But do not mistake a bottom for a vigorous rebound. Consumption may be growing again, but there is every chance it will remain depressed in coming years because of weak income growth, depleted wealth, and tightened credit. Since the early 1980s, spending by households on goods, services and homes has grown faster than GDP, making it the locomotive of American—and global—expansion. By 2006, it accounted for 76% of nominal GDP, the highest since quarterly data begin in 1947.

This was accompanied by a steady decline in the personal saving rate and a rise in household debt relative to income. By itself, this was not a problem; household debt has risen relative to income since the 1950s, as a growing share of the population bought homes with mortgages. Despite the higher debt burden, falling interest rates kept total household financial obligations—interest payments, rent, and leases—range-bound during the 1980s and 1990s. An inflection point occurred around 2000. Income growth stagnated but debts continued to grow rapidly from 94% of income to 132% in 2007. The share of income devoted to servicing those obligations also jumped. A study in 2007 by Karen Dynan and Donald Kohn of the Federal Reserve attributed that partly to more of the population reaching home-buying age, and mostly to a rise in home prices which made it possible to borrow more.

Financial innovation also played a role, they say, as the industry devised new ways for Americans to borrow against their homes. One manifestation was the plethora of credit-card offers to even marginal borrowers: more than 8 billion poured through Americans’ mailboxes in 2006, according to Mintel Comperemedia, a consumer-research firm. From 2003 to the end of 2006, consumers borrowed almost $2 trillion against their properties via home-equity loans and "cash-out" mortgage refinancings. A dramatic reversal is now under way. Last year, household wealth fell by 18%, or by $11 trillion. Macroeconomic Advisers, a forecasting firm, estimates the resulting negative "wealth effect" will depress consumption by 2% this year.

The financial crisis has killed off many of the loan products that had expanded access to credit during the boom. Subprime mortgages have disappeared and refinancings that deliver cash to homeowners are subject to stricter underwriting standards and higher fees. In the first quarter, the credit-card industry sent out just one-quarter as many solicitations as it did a year earlier. A more enduring restraint will be the pressure on consumers to reduce their debts to more manageable levels relative both to income and to the much lower value of their homes. This effect is difficult to quantify since so many factors determine consumers’ preferred saving rate and level of debt: assets, retirement goals, expected income, risk tolerance, access to credit, age, and so on.

Some bearish analysts argue that debt ratios and saving rates have to return to their levels of the 1950s, but others argue it would be sufficient to return to their levels of 2000 for households to feel comfortable with their debts again. This process, known as deleveraging, requires consumption to grow more slowly than income in coming years. The longer it takes for debt to return to more sustainable levels, the more it can occur through rising incomes. A sudden rush to return debt ratios to their level of 2000 would require ridding households of some $3 trillion in mortgage debt—an impossible task. More likely, mortgage debt will grow more slowly than income through a combination of lenders writing off impaired loans, homeowners paying down existing mortgages, and new homeowners taking out smaller mortgages than in the past.

Bruce Kasman of JPMorgan Chase estimates that the most dramatic phase of rising saving has already occurred and spending will grow only a bit less income. But Martin Barnes of BCA Research, a financial-forecasting service, is more pessimistic. For debt to return to a more sustainable level, real consumer spending would grow just 1.3% a year from 2009 to 2013, the weakest such five-year stretch since the 1930s. It could grow even more slowly if taxes rise more quickly, he reckons, or if stagnant productivity impedes real income growth. This implies that for America to grow at a trend rate of about 2.5% something else will have to grow more quickly. Ideally that would be exports and investment. But given the torpor in the rest of the world that will not be easy.

Economic casualties pile into tent cities
Jim Marshall recalls everything about that beautiful fall day. The temperature was about 70 degrees on Nov. 19, the sky was "totally blue," and the laughter from a martini bar drifted into the St. Petersburg park where Marshall, 39, sat contemplating his first day of homelessness. "I was thinking, 'That was me at one point,' " he says of the revelers. "Now I'm thinking, 'Where am I going to sleep tonight? Where do I eat? Where do I shower?' " The unemployed Detroit autoworker moved to Florida last year hoping he'd have better luck finding a job. He didn't, and he spent three months sleeping on sidewalks before landing in a tent city in Pinellas County, north of St. Petersburg, on Feb. 26.

Marshall is among a growing number of the economic homeless, a term for those newly displaced by layoffs, foreclosures or other financial troubles caused by the recession. They differ from the chronic homeless, the longtime street residents who often suffer from mental illness, drug abuse or alcoholism. For the economic homeless, the American ideal that education and hard work lead to a comfortable middle-class life has slipped out of reach. They're packing into motels, parking lots and tent cities, alternately distressed and hopeful, searching for work and praying their fortunes will change. "My parents always taught me to work hard in school, graduate high school, go to college, get a degree and you'll do fine. You'll do better than your parents' generation," Marshall says. "I did all those things. … For a while, I did have that good life, but nowadays that's not the reality."

Tent cities and shelters from California to Massachusetts report growing demand from the newly homeless. The National Alliance to End Homelessness predicted in January that the recession would force 1.5 million more people into homelessness over the next two years. Already, "tens of thousands" have lost their homes, Alliance President Nan Roman says. The $1.5 billion in new federal stimulus funds for homelessness prevention will help people pay rent, utility bills, moving costs or security deposits, she says, but it won't be enough. "We're hearing from shelter providers that the shelters are overflowing, filled to capacity," says Ellen Bassuk, president of the National Center on Family Homelessness. "The number of families on the streets has dramatically increased."

Pinellas Hope, the tent city run by Catholic Charities here since December 2007, has been largely for the chronically homeless, some of whom suffer from mental illness or struggle with drugs or alcohol. About 20% of its 240 residents became homeless recently because of the economic downturn, says Frank Murphy, president of Catholic Charities, Diocese of St. Petersburg. "We're seeing a change in the population. … We're seeing a lot more that are just plain losing their jobs and their homes," says Sheila Lopez, chief operating officer of the charity. "A lot are either job-ready or working but have lost their home because they were laid off, or their apartment, and now can't go to work because they're not shaven, they're not clean, they're living in a car, or they're living on the street." The charity plans to expand the tent city and build an encampment in a neighboring county, an idea that has drawn objections from nearby homeowners and businesses.

Communities elsewhere are facing similar pressures:
  • In Massachusetts, a record number of homeless families need emergency shelter, says Robyn Frost, executive director of the Massachusetts Coalition for the Homeless. In mid-April, there were 2,763 families in shelters, including 655 in motels because the shelters were full, an increase of 36% since July, she says. "We have a high number of foreclosure properties, and many of them are multifamily apartments," Frost says. "We were seeing a great number of families being displaced."
  • Reno officials shut down a tent city in October after making more shelter space available, but new encampments are popping up along the Truckee River and elsewhere, says Kelly Marschall of the Reno Area Alliance for the Homeless. The homeless include "a startling number of first-time homeless," she says. "We asked them what industries they were involved in. The majority were talking about construction, the housing industry, real estate. There was a direct correlation to the housing market crash."
  • In Santa Barbara, Calif., 84 men and women sleep in their cars, trucks or recreational vehicles in 17 parking lots around the city, says Jason Johnson with the New Beginnings Counseling Center, which runs the RV Safe Parking Program. The city, which allows the use of three municipal lots at night, supports the program, says city parking superintendent Victor Garza. Last May, there were 58 participants and no waiting list. Now 40 people are waiting. "People's last refuge has become their vehicle," Johnson says.

Pinellas Hope in Florida looks like a cookie-cutter subdivision, except that the orderly rows are of tents, not houses. Besides 250 tents, all of similar size, shape and color, there are 15 wooden sheds, 6 feet by 8 feet, that Catholic Charities built as shelters. The charity plans to reduce the number of tents to 150 and erect 100 sheds, which are more durable, and build as many as 80 permanent studio apartments on the property, Murphy says. His group also wants to open a campground for 240 homeless people in neighboring Hillsborough County, he says, primarily using wooden sheds. Unlike Pinellas Hope, which doesn't border residential neighborhoods, the Hillsborough County parcel is across the street from a tidy 325-home subdivision called East Lake Park. There, opponents of the tent city have a website:

Hal and Cindy Hart are raising three grandchildren in their home on the lake. The kids, 4 to 13, fish for bass, ride their bikes to friends' houses and attend neighborhood parties. The Harts fear that large numbers of homeless people, some with addictions and criminal backgrounds, would loiter in the neighborhood. "We will not be able to let our grandchildren ride their bikes outside without constant supervision," says Hal Hart, 52, a paralegal. The Harts agree that the homeless population needs services, but they think the emphasis should be on programs that will help families, not single adults. Murphy says the diocese wants to address the neighbors' concerns and has lowered the number of proposed occupants from 500.

Pinellas Hope, which has a waiting list of about 150 people, is attracting a growing stream of homeless men, women and couples. Families with children are sent to area shelters. New arrivals must agree to rules, such as not using drugs or alcohol, and perform chores, Lopez says. They get mats, sleeping bags, toiletries, flip-flops for showers and lockable boxes in their tents to store valuables. Within one week, they must make a plan describing how they will work their way out of homelessness. Residents are expected to move on within five months, but some stay longer. Campers have access to trailers with bathrooms, showers, computers, washers and dryers and a room of donated clothes. They get a free bus pass the first month and advice on writing résumés.

By day, some leave camp to look for work or ride the bus to pass the time. Others stay, watching TV in large communal tents, doing laundry or playing Monopoly. At night, an off-duty police officer patrols the camp, which is governed by curfews: 10:30 p.m. on weeknights and midnight Fridays and Saturdays. The camp bustles at dinnertime, when everyone gathers for a hot meal provided by churches and other organizations. A year ago, there were 5,500 homeless people in Pinellas County, says St. Petersburg police officer Richard Linkiewicz, a homeless-outreach officer. This year, there are 7,500, including 1,300 children in homeless families, he says. Many of the newly homeless worked in construction, a booming industry in Florida before the economic bust, he says.

David Grondin, 48, moved in on Feb. 7 and stayed for two months. A union carpenter, he graduated from the University of South Florida in 1999 with a bachelor's degree in fine arts. He struggled as carpentry work and odd jobs disappeared. When his 1992 Saturn died in August, he could no longer get to jobs far from public transportation routes. Frustrated by his inability to find a job in Florida, last month Grondin took a bus to Portland, Maine, where he's staying with friends and looking for carpentry work. "I was definitely middle class," he says. "I had a car. I got a paycheck every week." Kevin Shutt, 53, moved into Pinellas Hope in March after he was laid off from his job waiting tables because diners "stopped coming through the doors," he says. Shutt has decorated his tent with house plants, including a ficus tree his mother gave him nearly 30 years ago, and pinned Tampa Bay Rays and Buccaneers jerseys to the inside walls.

He tearfully recounts how he got kicked out of his apartment by a roommate when he couldn't come up with the rent. A former homeowner who made Caesar salads tableside at restaurants, now he can't get a job at Taco Bell, he says. "This is the first time in my life I ever dreamed about living in a tent," he says. An optimist by nature, Shutt vows that his stay will be short. He has filled out more than 175 job applications and occasionally works for a friend doing canvas work on boats. "This is a temporary situation," he says. Marshall, the former autoworker, has an associate's degree in electronic engineering and is less encouraged. He remembers a comfortable life in Michigan, where he worked in automotive testing, owned a brick ranch-style home, made up to $50,000 a year and played in softball leagues. Companies he worked for started losing contracts a few years ago, and eventually the work dried up, he says. He sold his house and moved into an apartment, but by 2007 he couldn't pay the rent. He came to Florida in August, thinking the job market was better. But he couldn't pay the rent here, either.

At Pinellas Hope, Marshall searches online job sites or takes the bus to apply for work at McDonald's, factories and Wal-Mart. He gets $45 a week selling his blood plasma. "I have my résumé online. I go door to door. I make phone calls," he says. "I have not received one phone call, one e-mail. I thought with my experience and my degree, it wouldn't be this difficult." Marshall feels ill at ease in the camp and has trouble sleeping, and not just because of the armadillos that burrow under his tent. "I'm scared," he says. "If I can't find a job, where do I go next?" At this point, he has lowered his expectations. "I don't expect ever to make $50,000 a year working in the auto industry, but just enough to survive, have my own place, buy my own food, my own clothes," he says. "What every American would expect."

Can we pay for pensions without working until we drop?
The ticking of the pensions timebomb is deafening. Could radical reform of the welfare system and a rising birth rate spare us, asks Edmund Conway. When she died six years ago, there was little on the face of it to distinguish Gertrude Janeway from any other elderly American. Bedridden for the best part of a decade, the 93-year-old from Tennessee spent her final days contemplating her life, reflecting sadly on the modern world with its binge drinkers and teenage pregnancies, and saying the odd prayer. But Mrs Janeway had a secret: she was the very last of the Yankee civil war widows. Every two months until the end of her life, she claimed a $70 government pension that was hers because of a connection with the war fought 140 years earlier between the Union and Confederate armies. At the age of 18, she escaped poverty by marrying an 81-year-old civil war veteran, who had himself joined the fight when he was 18, in 1864.
Mrs Janeway was not merely a precious link with the past; she was also one of the most vivid reminders of a lesson that governments are learning only now: namely, don't make promises you can't afford to keep. When the army generals and politicians devised the war pensions system, they envisaged that they might have to carry on paying out until the mid-20th century. Instead, their obligations lasted a good 50 years longer. Imagine Mrs Janeway's case writ large: pensions bills lasting longer than anticipated, and not for an army of thousands but for hundreds of millions of people spread across vast continents. This gives some idea of the problem we face.

The crisis is not a new one – we have been facing a pensions black hole for many years – but the current financial and economic situation makes it impossible to avoid for much longer. The dilemma was spelt out by the National Institute for Economic and Social Research (NIESR) this week. The debt being racked up by the Government during this crisis is so gigantic that it must consider raising the official retirement age to 70 in little under a decade, increasing taxes by 15 per cent or cutting spending by 10 per cent. Ideally, the institute added, it should do a bit of everything. The problem is twofold. First, taxpayers have to contend with a bill of war-time proportions for cleaning up the economy and financial system in the wake of this crisis. Second, in the words of the International Monetary Fund – "in spite of the large fiscal costs of the crisis, the major threat to long-term fiscal solvency is still represented, at least in advanced countries, by unfavourable demographic trends.

In other words, we have promised both current and soon-to-be pensioners over-generous stipends. And, partly due to myopia in calculating the benefits and partly because the population is ageing, the cost of tending to them will soon become unbearable. In the past, one could easily shrug off the prospective crisis and make small, far-off tweaks to pensions plans – such as Lord Turner's plans to raise the retirement age to 68 by the distant future of 2044 and to enrol everyone automatically in a national savings scheme. Such small, gradual changes may no longer be enough. In the first place, private-pension deficits have entered terrifying territory in the wake of the financial crisis, eroding families' wealth. More fundamentally, should the Government fail to show it has convincing, long-term plans to sort out its own pensions crisis, it faces the prospect of a buyers' strike, with investors simply refusing to buy its debt.

Such an eventuality would make the current economic crisis look like a walk in the park. It would involve swingeing tax rises and spending cuts; it would include a trip to the IMF and give rise to social unrest of a kind not witnessed since the 1970s and 1980s. Appropriately enough, the seeds of the quandary lie in the fall-out from the last epoch-defining financial and economic crisis. For it was in the wake of the Great Depression that governments around the world built the foundations of the modern pensions and benefits system. In the 1940s and 1950s, Britain went, via the Beveridge Report, from being a warfare state to a welfare state. We may take the current system for granted now, but it was nothing short of a massive economic experiment, one forged in the shadow of terrible suffering. Moreover, it is a system that has been in operation, in its full embodiment, for less than a lifetime.

Unfortunately, it has been an experiment based on unrealistic assumptions about Britons' longevity and their fecundity. Since the 1940s, life expectancy at birth has climbed from just over 60 years to just under 80. And fertility rates, which peaked at an average of almost three children per family in the baby boom era of the 1960s, have now seen a drop to below two children per family for three decades. The result is that there will be more pensioners and fewer workers in the future. Had the original architects of state and private-pensions schemes realised this, they would presumably have set up finite funds into which workers paid contributions that would then be paid out to them when they retired. Instead, until relatively recently, most funds were designed either as defined benefit schemes, with pensioners given a guaranteed payment no matter how much they paid in, or plain unfunded schemes, with pensioners paid from the current account.

Several companies suffer a hangover from large versions of the former British Airways and British Telecom being prime examples. Many insiders fear that before long we could see a major British company taken down by the burdens of its pension scheme. But these bills are as nothing compared to the unfunded liabilities of the state. By even conservative estimates, the state and public- sector pensions liabilities could more than double the total national debt, causing far more damage than the current financial crisis. The situation is hardly any better in the US, where the unfunded liabilities for social security and Medicare health care for the old are more than $50 trillion. For all the talk of waste in the public sector, of inefficiency and of profligacy under Gordon Brown, nothing that this Government has done to dent Britain's public finances can compare with the damage imposed by decades of this demographic disaster.

Despite the impression we have of the 1980s as a prolonged public-sector bonfire, the Thatcher government did little to roll back the costs associated with welfare, instead focusing its reforms on industry privatisation and market deregulation. This more significant battle has yet to be waged. The current economic crisis could mark that turning point. While the Great Depression ushered in a new era in which the state took on responsibility for its citizens' welfare, the Great Recession of 2009 – or whatever you care to call it – could mark the moment this experiment ended, or was at least replaced with a properly planned, modern version. Whereas the previous era was defined by careers for life and a pension to match, those currently in their thirties and forties are likely to lead far more nomadic professional lives and to take direct responsibility for their retirement finances as a consequence.

The next 20 years will be about repaying the enormous debts associated with this crisis and extricating ourselves from bankruptcy because of our future liabilities. Solutions exist but they are not pretty. The first, as the NIESR pointed out, is to work longer or receive lower benefits. The second is for future taxpayers to pay more to fund pensioners, although the consequence of this is weaker economic growth. The third is to reconsider the scale and generosity of both out-of-work benefits and the National Health Service, which together constitute the biggest item of public spending. The fourth possibility is to throw out the existing pay-as-you-go welfare systems in favour of programmes in which taxpayers have to contribute a certain amount into a fund each month something the Government has considered for public- sector workers, but shamefully avoided following a confrontation with the unions.

There is, however, a fifth option: to try to set the demographics back in our favour. Given that life expectancy shows little sign of deteriorating, this would mean increasing the fertility rate. And here, at least, there is a glimmer of good news for the UK. For thanks partly to our relatively open immigration policy and partly to a rise in births, Britain's old age dependency rate is set to increase far less rapidly than that of any other major country between now and 2050, according to UN projections. In and out of wedlock, babies are being born at a higher rate than for many years, and every new child represents another prospective taxpayer to help reduce that bill. Teenage pregnancies may bemuse nonagenarians such as Gertrude Janeway, and they may cause hand-wringing among social commentators; but in economic terms, they may be the best hope we have for solving the impending fiscal timebomb.

China fears bond crisis as it slams quantitative easing
China has given its clearest warning to date that emergency monetary stimulus by Western governments risks setting off worldwide inflation and undermining global bond markets. "A policy mistake made by some major central bank may bring inflation risks to the whole world," said the People's Central Bank in its quarterly report. "As more and more economies are adopting unconventional monetary policies, such as quantitative easing (QE), major currencies' devaluation risks may rise," it said. The bank fears a "big consolidation" in the bond markets, clearly anxious that interest yields will surge as western states try to exit their QE experiment.
Simon Derrick, currency chief at the Bank of New York Mellon, said the report is the latest sign that China is losing patience with the US and aims to diversify part its $1.95 trillion (£1.3 trillion) foreign reserves away from US Treasuries and other dollar securities. "There is a significant shift taking place in China. They are concerned about the stability of the global financial system so they are not going to sell US bonds they already have. But they are still accumulating $40bn of fresh reserves each month, and they are going to be much more careful where they invest it," he said. Hans Redeker, head of currencies at BNP Paribas, said China is switching into hard assets. "They want to buy production rights to raw materials and gain access to resources such as oil, water, and metals. They know they can't keep buying bonds," he said

Premier Wen Jiabao left no doubt at the Communist Party summit in March that China is irked by Washington's response to the credit crunch, suspecting that the US is engaging in a stealth default on its debt by driving down the dollar. "We have lent a massive amount of capital to the United States, and of course we are concerned about the security of our assets. To speak truthfully, I do indeed have some worries," he said. Days later, the central bank chief wrote a paper suggesting a world currency based on Special Drawing Rights issued by the International Monetary Fund. Some economists say China is suffering from "cognitive dissonance" by anguishing so much over its reserves, accumulated as a result of its own policy of holding down the yuan to promote exports.

Quantitative easing by the US Federal Reserve and fellow central banks may have saved China as well, since the country's growth strategy is built on selling goods to the West. China's fears of imported inflation may reflect its concerns about over-heating. The M2 money supply rose 25pc in March on a year earlier, and there has been explosive credit growth since the government relaxed loan restraints. There are concerns that the stimulus is leaking into a new asset bubble rather than promoting job growth. The Shanghai bourse is up over 50pc since November.

How We Tested the Big Banks
by Timothy Geithner

This afternoon, Treasury, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency and the Federal Reserve will announce the results of an unprecedented review of the capital position of the nation’s largest banks. This will be an important step forward in President Obama’s program to help repair the financial system, restore the flow of credit and put our nation on the path to economic recovery. The president came into office facing a deep recession and a damaged financial system. Credit had dried up, forcing businesses to lay off workers and defer investment. Families were finding it difficult to borrow to finance a new house, buy a car or pay college tuition. Without action to restore lending, we faced the prospect of a much deeper and longer recession.

President Obama confronted these problems with dramatic action to address the housing crisis and to restart credit markets that are responsible for roughly half of all business and consumer lending. The administration also initiated a program to provide a market for legacy loans and securities to help cleanse bank balance sheets. These programs are helping to repair lending channels that do not rely on banks, and will contribute to fixing the banking system itself. However, the banking system has also needed a more direct and forceful response. Actions by Congress and the Bush administration last fall helped bring tentative stability. But when President Obama was sworn into office in January, confidence in America’s banking system remained low.

Because of concern about future losses, and the limited transparency of bank balance sheets, banks were unable to raise equity and found it difficult to borrow without government guarantees. And they were pulling back on lending to protect themselves against the possibility of a worsening recession. As a result, the economy was deprived of credit, and this caused severe damage to confidence and slowed economic activity. We could have left this problem as we found it and hoped that, over time, banks would earn their way out of the mistakes they had made. Instead, we chose a strategy to lift the fog of uncertainty over bank balance sheets and to help ensure that the major banks, individually and collectively, had the capital to continue lending even in a worse than expected recession.

We brought together bank supervisors to undertake an exceptional assessment of the strength of our nation’s 19 largest banks. The object was to estimate potential future losses, and ensure that banks had enough capital to keep lending even in the face of a deeper recession. Some might argue that this testing was overly punitive, while others might claim it could understate the potential need for additional capital. The test designed by the Federal Reserve and the supervisors sought to strike the right balance. The Federal Reserve marshaled hundreds of supervisors to spend 45 days rigorously reviewing the banks’ detailed loan data. They applied exacting estimates of potential losses over two years, along with conservative estimates of potential earnings over the same period, and compared them with existing reserves and capital. The results were then evaluated against strict minimum capital standards, in terms of both overall capital and tangible common equity.

The effect of this capital assessment will be to help replace uncertainty with transparency. It will provide greater clarity about the resources major banks have to absorb future losses. It will also bring more private capital into the financial system, increasing the capacity for future lending; allow investors to differentiate more clearly among banks; and ultimately make it easier for banks to raise enough private capital to repay the money they have already received from the government. The test results will indicate that some banks need to raise additional capital to provide a stronger foundation of resources over and above their current capital ratios. These banks have a range of options to raise capital over six months, including new common equity offerings and the conversion of other forms of capital into common equity. As part of this process, banks will continue to restructure, selling non-core businesses to raise capital.

Indeed, we have already seen banks, spurred on by the stress test, take significant steps in the first quarter to raise capital, sell assets and strengthen their capital positions. Over time, our financial system should emerge stronger and less prone to excess. Banks will also have the opportunity to request additional capital from the government through Treasury’s Capital Assistance Program. Treasury is providing this backstop so that markets can have confidence that we will maintain sufficient capital in the financial system. For institutions in which the federal government becomes a common shareholder, we will seek to maximize value for taxpayers and enable these companies to attract private capital, thereby reducing government ownership as quickly as possible.

Some banks will be able to begin returning capital to the government, provided they demonstrate that they can finance themselves without F.D.I.C. guarantees. In fact, we expect banks to repay more than the $25 billion initially estimated. This will free up resources to help support community banks, encourage small-business lending and help repair and restart the securities markets. This crisis built up over years, and the financial system needs more time to adjust. But the president’s program, alongside actions by the Federal Reserve and the F.D.I.C., is already helping to bring down credit risk premiums. Mortgage interest rates are at historic lows, putting more money in the hands of homeowners and helping slow the decline in housing prices. Companies are finding it easier to issue new debt to finance investment. The cost of borrowing for municipal governments has fallen significantly.

Issuance of securities backed by consumer and auto loans is increasing, and the interest rates on these securities are falling. The Federal Reserve reports that credit terms are now starting to ease a bit. This is just a beginning, however. Our work is far from over. The cost of credit remains exceptionally high, and businesses and families across the country are still finding it too hard to borrow to meet their needs. We are continuing to execute our programs to relieve the burden of legacy assets, help small businesses and community banks, and tackle the mortgage and foreclosure crisis. The ultimate purpose of these programs is to ensure that the financial system supports rather than impedes economic recovery. We have not reached the end of the recession or the financial crisis, but the bank stress tests should advance the process of repairing our financial system and provide a better foundation for recovery.

Stress Tests Separate Strong From Weak
Banks Need at Least $65 Billion in Capital

The Federal Reserve directed at least seven of the nation's biggest banks to bolster their capital levels by $65 billion while effectively blessing the stability of six others, marking for the first time a bold line between some of the nation's stronger and weaker banks. As a result of the government's two-and-a-half-month examination of the U.S.'s 19 largest financial institutions, at least half a dozen -- J.P. Morgan Chase & Co., Goldman Sachs Group Inc., MetLife Inc., American Express Co., Bank of New York Mellon Corp. and Capital One Financial Corp. -- won't be told to raise additional capital, according to people familiar with the matter.

By contrast, regulators have told Bank of America Corp. it must take steps to address a roughly $34 billion capital shortfall, the biggest gap among its peers. Wells Fargo & Co. needs to find $13 billion to $15 billion; GMAC LLC, $11.5 billion; Citigroup Inc., $5 billion; and Morgan Stanley, $1.5 billion. Also in need of more capital: Regions Financial Corp. and State Street Corp. of Boston. Results for the remaining six banks couldn't be learned, but analysts and investors expect several of them to face sizable capital holes. Financial markets seemed to shrug off news of the capital shortfalls. Stocks of banks under duress rose dramatically and the Dow Jones Industrial Average rose 101.63 points by 4 p.m. trading to close at 8512.28, a four-month high. In Tokyo Thursday morning, stocks were up 4.2%, boosted by financial shares.

Some investors said the news was less negative than many feared. Others held out the idea that many banks would be able to boost their capital without having to seek fresh government funds. The stress tests -- designed to examine individual banks' ability to withstand future losses -- helped alleviate the near-panic that investors felt at the beginning of the year as many worried some banks might have to be nationalized. One possible impediment to luring back private capital is lingering unease about the tests' rigor. Perhaps adding to such jitters, the Fed backtracked from its early estimates of some banks' losses. In addition, it isn't clear what happens to hobbled regional banks that could have a hard time finding extra capital. Many are facing a deluge of bad loans to finance residential and commercial properties.

Regions, based in Birmingham, Ala., is among a handful of the tested banks without any privately held preferred shares that it could convert into common stock to boost its capital buffer, according to Deutsche Bank. That leaves it with a narrow range of options beyond turning to the government for aid. "The stress test gets us a lot closer to the bottom," said Trabo Reed, Alabama's deputy banking superintendent. "But the job isn't finished." Final results of the government's tests will be released Thursday after the close of trading and are expected to include a wealth of information about the industry's longterm health. "I think this will be a confidence-instilling announcement," Federal Deposit Insurance Corp. Chairman Sheila Bair told a Senate panel Wednesday. "There will be additional needs for capital buffers for some institutions, but I think there will be mechanisms to do that within the next six months."

The moves mark the beginning of a new phase for both the banking sector and the Obama administration. One reason investors and depositors fled large banks several months ago was uncertainty as to whether the institutions were even solvent, a problem the tests were designed to address. The question now is whether the stronger banks can stand on their own feet and how well the weaker banks can recover. Until this point, the Bush and Obama administrations had tried to paint all banks equally, a posture designed to promote investor confidence as financial markets tottered. Now, some of the stronger banks will be permitted to repay funds borrowed from the government under its Troubled Asset Relief Program and escape the related restrictions on compensation and dividend payments.

White House spokesman Robert Gibbs declined to rule out the possibility that the stress tests could lead the government to push out top executives at the weaker banks. The results could also propel the break up of some of the country's largest institutions into smaller, more manageable pieces. Citigroup and Bank of America have already begun shedding assets. The testing process "does end what I would call the 'convoy' or 'herd' period where the government tried to keep everyone looking pretty much the same," said Arthur Wilmarth, a banking-law professor at George Washington University Law School. "Now they are going to have to say, in fact, some banks are better off than others." Banks are being told to boost their capital not because they are in trouble, but because regulators think they don't have a big enough buffer to continue lending if the economy worsens in coming months.

Administration officials continue to believe many banks will be able to add to their capital without tapping the TARP's remaining $109.6 billion. They are optimistic much of the money will come from private investors, selling assets or offloading bad debt to a program set up by the Treasury. Those that can't tap private markets would be encouraged to replenish their coffers through a novel form of capital known as "mandatory convertible preferred" shares. Banks could apply for new funds from the government by agreeing to sell these preferred shares to the Treasury. Banks could also swap the government's existing preferred stakes, received in exchange for TARP funds, for this new type, which would convert into common equity only if the bank posts losses in the future. That would allow the U.S. to recapitalize banks without controlling them. By keeping the investments as preferred stakes, at least for the time being, the government would remain a passive investor, helping it defer tricky questions about how deeply it would engage in banks' daily operations.

Bank of America intends to outline its strategy Thursday, according to people familiar with the matter. It maintains it has a number of options and doesn't need government capital. It doesn't agree with all of the Fed's findings and intends to spell out those differences, these people said. One option would be to convert about $33 billion in private preferred shares into common stock. It also is exploring the sale of business units such as private bank First Republic and asset manager Columbia Management, according to people familiar with the situation. Those businesses could collectively fetch $4 billion, estimates analyst David Hendler of CreditSights Inc. About $8 billion could be raised with a partial sale of its stake in China Construction Bank. The company also believes it may outperform the government's projections, which would reduce its burden over time. If these moves don't fill the hole, Bank of America could convert the government's existing $45 billion investment into common stock or mandatory convertible preferred stock.

One question mark hanging over the tests is whether they will be perceived as tough enough. From the start, some economists and bank analysts argued that the Fed's worst-case economic scenario was overly rosy. Since the Fed informed banks of the preliminary test results, the government appears to have softened somewhat as banks pushed back. Among other things, regulators accepted banks' bullish arguments about their profit outlooks. The Fed initially planned to use banks' lackluster 2008 revenues as a jumping-off point to predict future incomes, according to people familiar with the matter. But many big banks logged robust first-quarter profits and argued that should serve as the "run rate" for the stress-test period. Any bank needing more capital will have until June 8 to develop a plan and Nov. 9 to implement it. The banks must also review their management and assure regulators that leadership has "sufficient expertise and ability," to manage through the current environment.

The Preferred Answer to Stress Tests
On Wall Street, it has been called the Debacle Trade -- and it gives useful insight into how large banks may be about to boost their capital. Debacle is derived from BAC-L, the symbol for Bank of America's L-series preferred shares. Investors have been buying these, and other bank preferreds, at steep discounts to par value. Some are betting they can profit as shaky lenders convert preferreds into common stock to improve their capital bases. Money is made if the dollar value of common received is higher than the cost paid for the preferred. Now, following the government stress tests, big conversions look set to occur.

BofA needs to boost common equity by about $35 billion following the tests. Conveniently, it has about $33 billion of private preferred shares. One extreme option is to convert all of these into common, while finding a way to protect the Treasury's TARP preferreds. This way, management avoids having the government own voting common stock -- something that would give it more sway over the bank. True, forcing a conversion solely on private investors could make it hard for banks to sell preferreds into private markets for years to come. But that mightn't be such a bad thing. Preferreds -- because they were often seen as debt-like -- lowered the quality of bank capital. Meanwhile, amid the euphoria, it is important to remember that switching preferred for common is just juggling capital, not raising new money. As a result, bank creditors will remain fearful of another debacle until they are convinced the stress tests were rigorous enough.

G.M. Posts Quarterly Loss of $6 Billion, Burns Through $10.2 Billion ($113 million a day)
General Motors, which faces a June 1 deadline to cut debt and expenses or else file for bankruptcy protection, on Thursday said it lost $6 billion in the first quarter. G.M. said it depleted $10.2 billion from its cash reserves in the quarter, or $113 million a day, leaving the company with $11.6 billion as of March 31. That is roughly the minimum amount of liquidity needed to keep G.M. in business, the automaker has said. "Our first-quarter results underscore the importance of executing G.M.’s revised viability plan, which goes further and faster to lower our break-even point," G.M.’s chief executive, Fritz Henderson, said in a statement.

The first-quarter loss, equal to $9.78 per share, is the eighth consecutive quarterly loss for G.M. A year ago, the company lost $3.3 billion, or $5.80 a share. Excluding special items, G.M. lost $5.9 billion, or $9.66 a share, which is better than the $6.7 billion that analysts were expecting the company to lose. Revenue fell 47 percent to $22.4 billion due to a 40 percent drop in global sales during the quarter. G.M. has borrowed $15.4 billion from the federal government since December to stay afloat, and the company says it needs $11.6 billion more. But the chances that it will end up in bankruptcy court at the end of this month are growing, particularly after Chrysler’s Chapter 11 filing last week.

Mr. Henderson, who took over running the company after the Obama administration forced Rick Wagoner to resign a month ago, has said bankruptcy is a probable outcome for G.M. but one that executives still hope to avoid. G.M. is resuming negotiations with the United Automobile Workers union on Thursday as it seeks a deal to cut labor costs before the government’s deadline. The company also has offered to swap equity for more than $27 billion in debt held by bondholders, but analysts are skeptical of the chances that enough of the bondholders will accept the deal.

Under a plan unveiled last week, G.M. would give a majority stake in a restructured version of itself to the Treasury Department and more than a third of the company would be held by the U.A.W.’s new retiree health care fund. Bondholders would own roughly 10 percent and existing shareholders would account for just 1 percent of the new company. G.M. is planning a reverse stock split, which would turn every 100 shares outstanding into one new share. Shares of G.M. have lost more than 90 percent of their value in the last year as the company has descended toward a possible bankruptcy.

As part of its restructuring, G.M. now says it will, by the end of 2010, cut 21,000 factory jobs, close 13 plants and get rid of about 2,600 dealerships. More job cuts and plant closings would occur in later years. G.M. intends to slash its brand portfolio in half, by closing Pontiac and trying to sell Saturn, Saab and Hummer. "This is a defining moment in the history of General Motors, and we are committed to our plan, which we believe will lead to a stable and sustainable operating structure with a strong balance sheet," Mr. Henderson said. "Our goal is to fix this business once and for all to position ourselves to win in the long-term."

GM Faces Exile From Dow as It Mulls 60 Billion Shares
The Dow Jones Industrial Average may lose its lowest-priced stock with General Motors Corp. facing a bankruptcy or reorganization, said John Prestbo, the editor and executive director of Dow Jones Indexes. GM costs the least among the 30 companies in the Dow, representing 0.2 percent of the price-weighted measure, according to data compiled by Bloomberg. International Business Machines Corp., priced the highest, has a 9.8 percent weighting. The Dow fell as much as 54 percent from its 2007 record, driving five companies below $10 in March. GM is poised to lose its position in the gauge that Dow Jones says measures the health of the economy.

"There are two choices for GM: bankruptcy or increased government ownership," Prestbo said in an interview yesterday. "Definitely the trend is in the direction that would force us to remove it." GM proposed last week to issue more than 60 billion shares, with 89 percent going to the Treasury and the automaker’s retiree health-care fund, and 10 percent for unsecured bondholders. GM now has 610.5 million shares outstanding. The company and New York-based bank Citigroup Inc. still trade for less than $10, giving them the smallest weightings in the Dow. Armonk, New York-based IBM, which closed at $104.62 yesterday, exerts the most sway.

The Standard & Poor’s 500 Index is weighted by stock-market value. Exxon Mobil Corp., the Irving, Texas-based oil producer that’s worth $334.7 billion, is its biggest company. American Tower Corp., the Boston-based owner of mobile-phone antenna, has the same weight in the S&P 500 as GM does in the Dow. GM dropped 10 percent yesterday to $1.66, giving it a 93 percent loss in the past year. It has been in the Dow since 1925, the longest tenure after Fairfield, Connecticut-based General Electric Co. Julie Gibson, a GM spokeswoman, had no immediate comment. The Detroit-based company reported its eighth straight quarterly loss today. The Dow, created in 1896 by Wall Street Journal co-founder Charles Dow, is intended to "provide a clear, straightforward view of the stock market and, by extension, the U.S. economy," according to the company’s Web site. Dow Jones & Co. is a unit of New York-based News Corp.

Ford Motor Co. of Dearborn, Michigan, the only self- sufficient U.S. automaker, is a potential GM replacement should Dow Jones decide it wants the industry to remain represented, according to Jeff Rubin, the director of research at Birinyi Associates Inc. in Westport, Connecticut. The most recent change in the Dow was in September, when Northfield, Illinois-based Kraft Foods Inc., the world’s second- largest foodmaker, replaced American International Group Inc. after the government took over the New York-based insurer.

Lehman Bosses Walk, While Small Fry Walk Plank
The nation’s top securities cop once again has shown it knows how to go after little fish. There is still no sign it’s capable of bagging any powerful sharks. Give the Securities and Exchange Commission and its new chairman, Mary Schapiro, credit where it is due. This week, the SEC filed a securities-fraud lawsuit against the management company for the Reserve Primary Fund and the father-and-son team who operated it: Bruce R. Bent and Bruce Bent II. The SEC contends they misled investors about the money-market fund’s health before losses on Lehman Brothers Holdings Inc. debt securities forced the fund into liquidation last year and created a near panic in the money-market industry.

It might be years before the suit is resolved; the defendants are disputing the SEC’s claims. Let’s stop and dwell on the irony for a moment here: The first people to get pinched by the SEC in connection with the collapse of Lehman Brothers didn’t work for the bank. They were two guys who invested other people’s money in Lehman Brothers and lost a bundle. Almost eight months after the New York-based investment bank ended up in bankruptcy court, none of the firm’s executives has been accused by the government of doing anything wrong, although plenty of investors claim to have been misled about its health. It’s quite possible that nobody from Lehman Brothers will ever be called to account.

If the government can’t find anyone who broke any rules at Lehman Brothers, that’s not a promising sign for investigations into other corporate train wrecks, from American International Group Inc. to Freddie Mac. For there is one thing that now sets Lehman Brothers apart: The state has no stake in the firm. Were the SEC ever to target any of the large banks or insurance companies that are partly owned by the Treasury Department, by contrast, it may threaten the government’s financial interests. So the presumption for the time being remains: Guppies such as the Bents are fair game. So are mega-guppies such as Ponzi- schemer Bernard Madoff. As for a government-backed Godzilla such as Bank of America Corp., which kept investors in the dark about most of the losses at Merrill Lynch & Co. last year until after its purchase was completed, it’s an open question if the SEC would dare lift a finger.

Just a few months into her new post, Schapiro is trying to convince investors she can restore the SEC to respectability. Under her predecessor, Christopher Cox, the five-member commission gummed up its enforcement division’s lawyers with procedural roadblocks to keep securities-fraud suits to a minimum. Schapiro, previously the chief executive of the private-sector Financial Industry Regulatory Authority, says the shackles are now off and that the proof will be in the results. “If we cannot show investors that we are looking out for their interests as much as the interests of the financial institutions, then we will have little success in restoring confidence,” Schapiro said in an April 27 speech at a Society of American Business Editors and Writers conference in Denver.

“Investors need to see that we are going after those who engage in wrongdoing. They need to see that we are forcing companies to be truthful and transparent in their reporting.” She added: “They need to see that we’re rooting out fraud.” Even so, the ghost of Cox looms large. While he wasn’t much of an enforcer himself, he spent his last weeks at the SEC repeatedly cautioning the public that the government was too compromised to investigate companies where its own money and reputation are at stake. His admonitions made perfect sense. “From the standpoint of the SEC, the most obvious problem with breaking down the arm’s-length relationship between government, as the regulator, and business, as the regulated, is that it threatens to undermine our enforcement and regulatory regime,” Cox said in a Dec. 4 speech.

“When the government becomes both referee and player, the game changes rather dramatically for every other participant. Rules that might be rigorously applied to private-sector competitors will not necessarily be applied in the same way to the sovereign who makes the rules.” It’s imperative that Schapiro lead the SEC to find its footing again and prove Cox’s warnings overblown. Until then, though, there’s every reason to believe the U.S. government has two standards of enforcement when it comes to securities laws: one for the people and companies that are touchable, and one for those that aren’t. The Bents could be forgiven for wondering if their worst offense, in the eyes of the SEC, was being on the wrong side of that line.

Why Obama's Economic Plan Will Fail
To begin, I should make these disclosures. This is not a critique on the Presidency of Mr. Obama. To the extent that I am able to support any politician, I have supported this President now and during his candidacy. Secondly, I do not really know if his economic plan will fail or not. In this, at least I am being honest. The airwaves have enough self proclaimed experts professing their certainties of what will unfold. There are so many that no matter what your opinion, you will find a pundit in your corner.
The charismatic nature of President Obama has raised people's hopes, dreams and expectations.  At the time of this writing, the US stock market has been stuck in a range from 7900--8400. I submit to you that this stabilization is a direct result of the high hopes placed on President Obama. He inspires confidence, but has the bar been set too high? In reality, there continues to be only bad economic news. Banks are sure to need more money. Retail spending is way down. People are still not buying cars. More and more homes are going into foreclosure and every jobless report in worst than the preceding report. There is constant talk from the White House that things are going to get worse before they get better, and yet the stock market has stabilized (for now.)
I've confessed that I do not know if the stimulus plan will work, but I am highly skeptical that we can just buy our way out of this problem. Isn't spending money we did not have a big reason we got in to this problem? It becomes even more problematic when you place trillions of dollars in the hands of career politicians, who really have no clue how the economy works or how to run a business. They only need to look like they know what they are doing to get elected and that is their primary self focus. There is little actual substance. Even if it were possible to buy our why out, why would we think that these people are qualified to provide the proper direction?
The plan has been approved, so let the game begin. Does anyone really think that the public has the patience to see this plan out over many months or even years? Of course not. Instant gratification is alive and well and the expectation will be for positive change quickly. So what happens when the first sign appears that perhaps this plan will not work? Whether the plan has a chance or not (probably not), doubt will begin to spread, patience will be evicted and an unforeseen level of fear will move in. As confidence disappears, people will run for their foxholes and the markets will visit new lows. There is so much anxiety in the air right now, that it will not take much to get the dominos rolling.

It is very likely that the money in this stimulus will be wasted and we will face and even worsening economy deeper in debt. If we cannot buy our way out, then what is the way out, or better yet, is there a way out? Economists worldwide have spoken on how the interconnectedness and interdependency of the global economy was not fully understood until this crisis. Despite this understanding, nations are trying to fix this global issue on a national basis. There is little discussion on the cooperation needed to fix the world's economy. Please do not suggest that the G 20 Summit was more than a dog and pony show. It is good news that we recognize the problem as global, now if we could just take a cooperative global approach to its cure.
We should not discount our insatiable egos and the greed they inspire as a primary cause for this financial collapse. It seems like every other day we see another example of unmitigated selfishness. We should be careful not to pin the problem on these extreme examples because honest self examination will reveal a little of this greed in us all. Our world has become every man for himself and our motto, "he who dies with the most toys wins."- It is non-sense and more importantly, there is no evidence that all this wealth is creating more happiness.
President Obama can't fix this. We have to fix this and it might be as simple as living by the Golden Rule. You remember, "Do unto others as you would have then do unto you."- What if we as people, as nations truly began to live by this rule?  We live an existence of luxuries that we do not need. If we can learn to take what we need and pass along the rest we will find that there is plenty for all. I am not talking about a bare bones existence. There are enough resources on this planet for everyone to live a good life. All we need to do is to switch from competing for these resources, to sharing these resources.

Obama Releases $3.4 Trillion Budget Plan
The Obama administration today unveiled details of a $3.4 trillion federal budget for the fiscal year beginning in October, a proposal that includes substantial increases for a number of domestic priorities as well as a plan to trim or eliminate 121 programs at a savings of $17 billion. In a statement delivered at the White House after the budget details were released, President Obama defended the cuts from critics on both sides -- those he said would fight to preserve the targeted programs and others who consider the reductions insignificant. "We can no longer afford to spend as if deficits don't matter and waste is not our problem," he said. "We can no longer afford to leave the hard choices for the next budget, the next administration -- or the next generation."

While many government employees do valuable, thankless work, Obama said, "at the same time, we have to admit that there is a lot of money that's being spent inefficiently, ineffectively and, in some cases, in ways that are actually pretty stunning." He cited several examples, including a $465 million program to build an alternate engine for the Defense Department's joint strike fighter, a program that Pentagon brass neither wants nor plans to use. Obama said some proposed cuts are larger and more painful than others, while some would produce less than $1 million in savings. "In Washington, I guess that's considered trivial," he said. "But these savings, large and small, add up." He said of the $17 billion total in projected savings, "Even by Washington standards, that should be considered real money." Obama also stressed that the proposed cuts do not replace the need for "large changes" in entitlement spending.

The new budget documents, totaling more than 1,500 pages, fill in the details of a broad outline that Obama released in February. They include a massive appendix listing program-by-program information on the roughly 40 percent of the fiscal 2010 budget that constitutes discretionary spending, which will be set by Congress in what is expected to be a contentious appropriations process. Also included is a separate tome that provides details on the programs targeted for cuts or elimination. If approved by Congress, those trims would amount to only about one-half of 1 percent of the $3.4 trillion federal budget. But the proposed reductions are expected to be equally controversial on Capitol Hill, with some lawmakers battling for programs they favor and others demanded deeper cuts.

Congressional Republicans immediately denounced the cuts as insufficient when some details of them emerged yesterday. The criticism drew a retort this morning from White House budget director Peter Orszag, who went on MSNBC to stress that the cuts are just a start on the long-term work of curbing government spending, notably the growth of the Medicare and Medicaid health care programs. In any case, Orszag said, "$17 billion a year is not chump change by anyone's accounting." About half of the trims would come from curbing defense programs that have been identified by Defense Secretary Robert M. Gates as expendable. They include ending production of the F-22 fighter plane and canceling a new presidential helicopter fleet. Obama's list of proposed cuts is less ambitious than the hit list former president George W. Bush produced last year, which targeted 151 programs for $34 billion in savings. Like most of the cuts Bush sought, congressional sources and independent budget analysts predict, Obama's also are likely to prove a tough sell.

"Even if you got all of those things, it would be saving pennies, not dollars. And you're not going to begin to get all of them," said Isabel Sawhill, a Brookings Institution economist who waged her own battles with Congress as a senior official in the Clinton White House budget office. "This is a good government exercise without much prospect of putting a significant dent in spending." Administration officials defended their approach, saying the list of program reductions and terminations is just the start of a broader effort to cut spending and rein in a skyrocketing budget deficit, which is projected to approach $1.7 trillion this year. They also noted that the list does not include more than $300 billion in savings Obama proposes to squeeze from federal health programs and use to finance an expansion of coverage for the uninsured. "This is an important first step, but it's not the end of the process. We will continue to look for additional savings," said a senior administration official, speaking on condition of anonymity because the list of cuts had not been officially released. "You have not heard everything to be said on this topic from us."

The president has already scored a victory on the budget. Congress last week decisively approved his request to devote billions of dollars in new spending to health care, energy and education in the fiscal year that begins in October. But that plan depends in part on the administration's ability to identify budget cuts elsewhere. The document being released today details some of those savings. The relatively short list of proposed program cuts quickly drew fire from Republicans who learned of them yesterday. "While we appreciate the newfound attention to saving taxpayer dollars from this administration, we respectfully suggest that we should do far more," House Minority Leader John A. Boehner (R-Ohio) said. In separate briefings with congressional Democrats and reporters, administration officials yesterday said the proposed savings were evenly split between defense and nondefense programs, and that many of the most significant reductions had already been revealed by the president or by Gates.

They also said the majority of the reductions were new targets not previously identified by the Bush administration. But the two lists clearly have some overlap. For example, congressional sources said Obama is proposing to eliminate a program that reimburses states and localities for holding suspected criminals who turn out to be in the country illegally. Created in 1994, the program was repeatedly targeted by Bush officials, who argued that it is ineffective. But Congress restored funding for the program because it was popular with state and local officials. The program handed out $400 million last year. Administration officials said Obama also wants to do away with Even Start, a program created in the late 1980s to promote literacy for young children and their parents. Starting in 2005, Bush tried annually to persuade Congress to eliminate the program. Lawmakers gradually reduced funding from $247 million to $66 million, but never proved willing to eliminate it.

Yesterday, an administration official said that, though Obama considers early childhood education a priority, "The evidence is unfortunately clear that this specific early childhood program does not work very well."
The officials previewed four other programs marked for termination on the grounds that they are not needed or are not effective. Obama officials have previously identified three of them as being out of favor: a $35 million-a-year long-range radio navigation system that officials said has been made obsolete by Global Positioning System devices; a Department of Education attache based in Paris that costs $632,000 per year; and a $142 million program that officials said continues to pay states to clean up abandoned mines even though that task has been completed. In addition, the White House is proposing to cancel the Christopher Columbus Fellowship Foundation, an independent federal agency established to "encourage and support research, study and labor designed to produce new discoveries in all fields of endeavor for the benefit of mankind," according to its Web site. The program costs $1 million a year, and officials said 80 percent goes to administrative overhead.

The proposed cuts, if adopted by Congress, would not actually reduce government spending. Obama's budget would increase overall spending; any savings from the program terminations and reductions would be shifted to the president's priorities. But the more likely outcome, budget analysts said, is that few to none of the programs targeted by Obama will be terminated. Presidents from both parties have routinely rolled out long lists of spending cuts -- and lawmakers from both parties routinely ignore them. "You can go through the budget line by line, but there's no line that says 'waste, fraud and abuse,'" said Robert Bixby, executive director of the nonprofit Concord Coalition, which promotes deficit reduction. "What some people think is waste, other people think is a vital government service."

The administration officials said they think their cuts will be taken more seriously by lawmakers because the economic crisis and the accompanying rise in deficit spending is focusing fresh attention on the need to trim spending. House Speaker Nancy Pelosi (D-Calif.) has told committee leaders to offer their own spending cuts by the beginning of June. "The spirit on Capitol Hill is now cognizant of the need to find some efficiencies," the administration official said. "I think you're going to see proposals not just from us, but from lawmakers to find savings." Still, in the context of an enormous deficit, the sums under discussion are a drop in the bucket, analysts said. "Obviously, the bottom line is frightening," said Rudolph Penner, a senior fellow at the Urban Institute and a former director of the Congressional Budget Office. "They have a long way to go to show fiscal restraint."

ECB unveils measures to fight recession
The European Central Bank sought to kickstart the flagging eurozone economy on Thursday by reducing interest rates to record lows and announcing bold plans to buy corporate bonds as part of a credit easing programme. The ECB cut its main interest rate by a quarter-point to 1 per cent, pledged to buy €60bn in covered bonds issued by eurozone companies and said it would lend banks unlimited funds for up to 12 months. Jean-Claude Trichet, president of the ECB, said financing operations would be extended to 12 months from the current six months in an effort to encourage banks to lend longer-term. Money market rates have hit record lows in recent weeks in response to the ECB’s generous liquidity provision and interest rate cuts but lending growth to firms and households is still slowing. Traders say lending beyond six months has virtually dried up.

The move on credit easing comes after months of deliberation about how the central bank should support the eurozone economy and follows similar measures announced by the Bank of England, the US Federal Reserve and Swiss National Bank. Covered bonds are some of the safest corporate securities in the market place, as they are backed by the issuer’s balance sheet and typically hold a top-grade triple-A rating. Germany, Spain and France are the biggest issuers, which analysts said could favour these countries. Mr Trichet said: ”These decisions have been taken to promote the ongoing decline in money market term rates, to encourage banks to maintain and expand their lending to clients, to help to improve market liquidity in important segments of the private debt security market, and to ease funding conditions for banks and enterprises.”

Significantly, the ECB left unchanged, at 0.25 per cent, the interest rate on its deposit facility, which is used by banks to park funds overnight and has become an increasingly important benchmark for market interest rates. A zero interest rate policy would distort the economy, the ECB believes. The 16-country eurozone – and especially Germany, its largest member – has been badly hit by the collapse in global demand since the failure of Lehman Brothers last September. Earlier this week, the European Commission forecast the eurozone would contract by 4 per cent this year – significantly faster than the US – with a recovery not expected until 2010. Some signs have emerged that the pace of decline has slowed. German industrial orders provided further evidence of “green shoots,” rising unexpectedly by 3.3 per cent in March compared with February, according to the Berlin economics ministry. It was the first month-on-month rise since August. Foreign orders were up 5.6 per cent.

However, total German industrial orders were still 26.7 per cent lower than a year before. At the same time, eurozone unemployment is rising steeply, and inflation is undershooting massively the ECB’s target of an annual rate “below but close” to 2 per cent. Annual eurozone inflation was just 0.6 per cent in April and is expected to turn negative in coming months. That has increased the pressure on the ECB to consider “non-conventional” measures already being taken by the US Federal Reserve and Bank of England, for instance, to buy private sector or government debt. So far, ECB efforts have focused on pumping unlimited amounts of liquidity into the banking system at a fixed interest rate. One likely option is that it will extend to 12 months, from the current six months maximum, the period over which it is prepared to offer such liquidity.

Since October, the ECB has cut its main interest rate by 325 basis points. But it has been among the last of the world’s main central banks to reach a point at which it feels official borrowing costs cannot go lower.
Eurozone credit growth has all but dried up. Companies and households made net repayments of debt in March, according to latest ECB figures. The annual growth rate of loans to households fell to just 0.4 per cent.

European central banks $40 billion poorer after decade of gold sales
European central banks have lost $40bn (£26bn) in the past 10 years by following Britain's lead and shrinking gold reserves, the Financial Times reports. Gordon Brown, the then Chancellor, announced on May 7 1999 that the Government would sell a large share of the Bank’s gold reserves in favour of assets offering a return, such as government bonds. An analysis by the newspaper claims this was the "high water mark of so-called 'anti-gold' sentiment among European central banks". Central banks in France, Spain, the Netherlands and Portugal, decided later in 1999 to follow Britain and sell off their reserves. At that time, gold was worth around $280 an ounce, less than a third of its current level of more than $900.
European banks sold about 3,800 tonnes of gold, reaping about $56bn, the FT reports citing calculations from official sales data and bullion prices. Taking into account the likely returns from the investments in bonds, the banks have gained another $12bn. But because today’s gold prices are far higher, they are about $40bn poorer than if they had kept their reserves. The biggest loser is the Swiss National Bank which sold 1,550 tonnes over the decade and at today’s gold prices is $19bn poorer, followed by the Bank of England, which is $5bn poorer. Germany and Italy are the only two big European central banks which did not follow the UK, mostly because of domestic disputes about what to do with the proceeds, the report said. The US, the world’s biggest holder of gold, decided not to follow Europe’s move, while central banks outside Europe have become net buyers of gold.

Société Générale Swings to Loss on Write-Downs
Société Générale SA swung to an unexpected net loss in the first quarter, as write-downs at its investment-banking operations and higher provisions dragged it into the red, but the French bank said Thursday it aims to return to profit in coming quarters. For the three months ended March 31, SocGen posted a net loss of €278 million ($370.6 million) compared with a net profit of €1.1 billion a year earlier. Revenue slid 14% to €4.91 billion from €5.68 billion. Analysts polled by Dow Jones Newswires had forecast, on average, a €381 million profit on revenue of €5.61 billion. Most of the damage came from the corporate and investment-banking division where SocGen took €1.5 billion in write-downs on high-risk exposures, including monolines and exotic credit derivatives. Fluctuations in the value of other items took a further toll of €340 million. These elements drowned out improved performances at the unit's equities and fixed-income trading businesses.

"Wanting to be prudent, we worked on the hypothesis of future losses in the real-estate market, which has further deteriorated, and because of that the corporate and investment bank is again loss-making," Chief Executive Frederic Oudea said on French radio station Radio Classique. "But the underlying activity is particularly dynamic." The bank's results contrast starkly with those of cross-town rival BNP Paribas SA, which Wednesday posted better-than-expected earnings with less pollution from risky assets and strong revenue growth driven by its fixed-income activities. International peers, such as J. P. Morgan Chase & Co., Credit Suisse Group and Deutsche Bank AG, have also topped expectations in recent weeks. Gross operating profit shrank 36% to €1.14 billion from €1.77 billion. The bank said it isn't ruling out further write-downs, but those posted in the first quarter "already reflect the current deterioration in the U.S. real-estate market and monoline insurer counterparties."

SocGen booked €1.35 billion in provisions for the quarter, as the worsening international economic climate drove up the cost of risk on assets. The figure was more than double the €598 million allocated a year earlier, with sharp increases across most divisions. The bank said its Tier 1 capital ratio stood at 8.7% at the end of March, down from 8.8% at the end of December. The core Tier 1 ratio declined to 6.5% from 6.7%. SocGen said it plans to issue €1.7 billion in preference shares, subject to shareholder approval, under the second phase of the French government's support for the banking sector. This move would improve the Tier 1 ratio to 9.2% and the core Tier 1 ratio to 7%, the bank said.

The Perils of Global Banking
JA Solar Holdings, a once-thriving Chinese manufacturer of solar-power cells, is getting a rude introduction to the dangers of global finance. So is Peter Howard, a retired British tax official. And so are Cedric Ruber, a Belgian school inspector, and his father, Rene, a retired employee of the U.S. Army. Each is trying to recoup money from Lehman Brothers, whose bankruptcy in September paralyzed the world economy. They're just a few of the tens of thousands of burned investors around the world complaining loudly that they were sold toxic bonds that were supposed to be safe. In street demonstrations from Hong Kong to Hamburg, protesters are demanding that their governments do something to get their money back.

Now there's a growing fear among economists, policymakers, and business groups that in the name of protecting their citizens from global financial institutions, governments could slow the flow of capital between countries—at a time when the world economy is already contracting. "We're looking at a period of, at best, a pause of globalization, and more likely a period of 'de-globalization,' " Mohamed El-Erian, chief executive officer of bond giant PIMCO, said at a conference on Apr. 27. Governments are already moving to impose new hurdles on foreign firms. Regulators in Britain have started asking U.S. banks selling bonds there to provide hundreds of pages of proof that the mighty U.S. government, which is backing the bonds, could actually repay them.

A revelation from Lehman's bankruptcy illustrates why public confidence has been so shaken. It turns out that during the credit boom, a little-known Amsterdam unit called Lehman Brothers Treasury churned out $35 billion worth of dubious bonds, fully a quarter of the parent company's total bond debt when it went bust. Many of those bonds, baroque in their complexity, were sold to small investors in Europe and Asia—high finance for the masses. In the U.K., at least 6,000 retirees bought in. Brokers in Asia plied small investors, a few of them mentally ill, with free digital cameras and flat-screen televisions. As Lehman fought for its life in its last six months, it pushed harder to sell the bonds, most of which were "guaranteed" by the parent company in New York.

Or so the investors thought. When Lehman Brothers Holdings collapsed in September, the bonds lost virtually all their value. JA Solar ate $100 million. Howard lost $74,000 of his retirement savings. Rene and Cedric Ruber are out some $200,000. The Amsterdam debacle offers a rare glimpse into Wall Street's relentless drive to exploit foreign markets. Overseas locales provide banks great opportunities for "regulatory arbitrage," the practice of searching high and low for the most beneficial legal environments for particular lines of business. Lehman chose Amsterdam because of the tax benefits there. In recent years Wall Street firms have set up thousands of overseas subsidiaries for various purposes. Among other things, the entities have sold trillions of dollars worth of risky "derivatives" like the ones bought by Howard and the others. Lehman had 433 subsidiaries when it blew up—and it was relatively small. Citigroup has more than 2,400 .

That global tangle of bank subsidiaries is creating bigger problems than anyone realized. The Lehman case shows how hard it can be for burned investors to get their money back in the event of disaster. Its bankruptcy alone has spawned more than 75 insolvency proceedings in 15 countries, each with differing rules. Without coordinated efforts, countries could find themselves pitted against one another. Even Belgium and the Netherlands, two close friends, clashed after the multinational Fortis Bank began to collapse in September. The bankruptcy proceeding quickly devolved into each country looking out for its own citizens.

Equally worrisome, Wall Street's embrace of foreign markets makes it nearly impossible for national regulators to keep watch over what's being sold abroad and to whom. Even now, in the thick of the credit crisis, the biggest firms on Wall Street, Goldman Sachs among them, are setting up deals to sell potentially risky investments through foreign subsidiaries. This is one reason why the current financial debacle is unlike any that policymakers have had to confront. "I wouldn't want to be a regulator today," says Fried Frank partner Thomas P. Vartanian, who served as general counsel to the Federal Home Loan Bank Board at the start of the savings and loan crisis of the 1980s. "Some of the buttons on the control panel simply don't work." Prominent regulators concede the point. "A lot of these institutions [that got into trouble] were already regulated," Sheila C. Bair, head of the Federal Deposit Insurance Corp., said at an Apr. 23 industry conference in Washington.

It's no wonder that Lehman's Amsterdam operation is fueling outrage. The operation was created in 1995 to sell "structured notes," a type of derivative that's like a bond except that the payments are tied to the performance of other investments. The subsidiary had an Amsterdam address but was run out of London by Lehman Brothers International (Europe), itself a subsidiary of Lehman Brothers Holdings in New York. Bankers call such enterprises "special purpose entities," but a more direct term might be "shell company." The Amsterdam unit had no independent staff and was overseen, nominally, by a board of five directors. Two worked for Equity Trust, a Dutch company that provides administrative services for companies and investors—everything from setting up trusts to serving as directors on boards. Equity Trust counted Lehman as a client. What's more, the Amsterdam subsidiary used Equity Trust's mailing address as its own. In the past, the address was used by a unit of Enron. Equity Trust declined to comment.

The Netherlands has emerged as a haven for companies that want to avoid certain taxes on profits. A 2006 report by SOMO, a research group that focuses on multinational companies, found that some 20,000 "mailbox companies" had set up shop in Amsterdam for this purpose alone. That's one reason the Obama Administration is proposing a crackdown on offshore corporate tax havens. Jeremy Isaacs, head of Lehman Brothers International (Europe), oversaw the Amsterdam unit. He had been something of a wunderkind, embarking on his career in finance at age 18, with a back-office job at a U.K. brokerage. In 1989 he got a job as a derivatives trader at Goldman in London. Isaacs joined Lehman in 1996, at age 31, and within four years had taken the helm of Lehman's entire European operation.

From 1995 through 2002 the Amsterdam subsidiary was a bit player in the Lehman empire. But as the global credit boom began, Isaacs turned the operation into a virtual factory, issuing $30 billion in structured notes from 2003 through August 2008. At industry conferences during those years, Lehman executives, including CEO Richard S. Fuld Jr., said the Amsterdam notes were an important source of revenue. Isaacs left Lehman two days before it collapsed. Lehman's Amsterdam notes were bafflingly complex. In all, the unit issued some 4,000 variations, and the documentation for each type often ran to 600 pages. Lehman tailored the notes in an amazing array of styles to cater to just about any investing need. Would someone like a bond that would pay on the "outperformance" of Japanese stocks vs. U.S. stocks? Lehman created them, along with a "rocket tracker" on the Dow Jones Euro Stoxx 50 index. How about a bond for a thrifty soul who wanted to guard against inflation in Italy?

Lehman had notes tied to consumer price indexes there, and in Spain and Mexico, too. It shipped the proceeds from selling the bonds back to New York. JA Solar bought $100 million worth last summer, at the urging of its Lehman bankers. It says the bankers pitched the notes (which paid a little interest each quarter if a certain commodity index registered a gain) as no riskier than a money market fund. JA Solar says it was told that at worst the investment would come out flat. "We did not anticipate [the notes'] coming even close to risky," says Anthea Chung, JA Solar's chief financial officer. Now the company is reeling. It has written off the entire $100 million on its books. Its stock, which is traded in New York, is down 66% since Lehman filed for bankruptcy. JA is becoming one of the pioneers of de-globalization, preferring to keep its financial deals closer to home. "For the near future, we are quite comfortable with Chinese banks," says Chung. "They are backed by the Chinese government."

Lehman also tapped retail banks, including Citigroup and UBS, to hawk the Amsterdam notes, which were part of an enormous market. All told, Wall Street has sold more than $640 billion of structured notes to small investors around the world, according to—most of them from overseas units. That's about the size of the market for subprime collateralized debt obligations (CDOs), which brought on the global crisis. "[Lehman's notes] were sold directly by the banks to their retail customers," says Erik Bomans, a partner at Deminor, an advisory firm specializing in investor protection. Deminor, based in Brussels, is working with attorneys representing buyers of Lehman notes sold in Belgium, Italy, and the Netherlands. To date, the firm says, it has been contacted by 1,600 investors. "You can't even call them investors—they were savings bank customers," says Bomans.

The Rubers are among those who claim they were misled. Rene Ruber says a banker at a Citigroup office in Belgium sold him and his son about $200,000 of Lehman notes, promising an annual return of up to 6%. He says the notes were presented as a risk-free savings tool. "In plain English, we were screwed," says Rene. "I was lied to. They are not honest bankers." His son Cedric says some of his lost money had been earmarked for a new home, and some for college savings for his two children. UBS says it "properly sold these investments to its clients. The offering materials clearly identified Lehman as the issuer and discussed all the relevant risks." A Citi spokesman in Belgium says the bank "is committed to helping affected customers retrieve as much of their original investment as possible through Lehman's bankruptcy proceedings in the U.S. and the Netherlands."

In Britain it's a somewhat different story. Most of the notes sold there were marketed under the names of various London-based brokerages. Investors say they never knew that Lehman originated the bonds or guaranteed them. "If people knew it was Lehman, many wouldn't have bought them," says Howard, the retired British schoolteacher, who purchased notes in February 2008. "Many [American banks] were having a sticky time back then." Howard, 58, is trying to organize U.K. investors to recoup their money. Working from his home in Wantage, in Oxfordshire, he has spoken with about 100 people so far, he says. "The average age is 65," says Howard. "Most of them took some of their pension money and invested in these notes." He says he has been talking to members of Parliament to get them to pressure brokerages to reimburse investors. In the next few weeks, his grassroots group, SPIRIT—short for Structured Products Investors Recovery & Information Team—plans to launch a Web site to draw more attention.

Similar stories abound in Asia, where investors have taken to the streets in Hong Kong several times since Lehman collapsed. The government says the Hong Kong Monetary Authority received more than 20,800 complaints about the notes, called minibonds there. Government officials on Apr. 28 alleged that some banks sold minibonds to mentally ill investors, although more details couldn't be obtained. The minibonds were similar to the Amsterdam notes except that they weren't "principal protected." Instead, a marketing leaflet said the minibonds were "credit-linked to a basket of well-known international financial institutions," such as JPMorgan Chase. In fact, they were tied to a CDO. The leaflet said the minibonds were safe and that returns "may reach 48.4%." But they were no more secure than Lehman's ability to pay back the cash. That risk was buried in the fine print, below icons for gifts—digital cameras, LCD TVs, even grocery coupons.

Now investors are trying to get their money back. —We feel totally cheated,— says Alex Chow, 51, who lost about $130,000 and is organizing more protests. "The bank stole our money," he says. Two firms that distributed Lehman minibonds have agreed with regulators to repay investors. About 6,000 investor claims are being settled, says the Hong Kong government. Meanwhile, in Amsterdam, the untangling of Lehman Brothers Treasury is just beginning. Rutger Schimmelpenninck, a partner with law firm Houthoff Buruma who is serving as the bankruptcy trustee, is daunted by the task. His exasperation came through in an Apr. 16 report in which he complained that "almost all the notes are governed by English law, while the validation of debt…is under Dutch bankruptcy law. … Obligations under the notes are governed by New York State law [and claims] have to be calculated and filed in accordance with the bankruptcy law of the United States."

There's no clean way to slice through the Gordian knot of contracts, he tells BusinessWeek: "The legal practices for resolving disputes in bankruptcy situations around notes with embedded derivative elements have not yet developed." Regulators have worried about that sort of problem for years. "Insolvency proceedings from one country to another are completely different," says Michael H. Krimminger, special adviser for policy to FDIC Chairman Bair. Despite the mess in Amsterdam, new deals are hatching in Europe. On Feb. 11 Goldman registered a plan in Ireland to sell notes that seem similar in structure to the ones sold by Lehman in Amsterdam. The notes will be issued by an Irish unit called Goldman Sachs Financial Products Europe, according to the prospectus. Like Lehman's notes, some of Goldman's will be backed by the parent company in New York. Goldman declined to comment.

Ireland, like Amsterdam, has become a favorite place for global banks to set up subsidiaries to sell financial instruments. A recent Government Accountability Office report listed Ireland among more than 30 nations where U.S. companies have established units to take advantage of easier regulation. Goldman's operation is similar to Lehman's in another way. Two of the subsidiary's directors are executives with Deutsche International Corporate Services, a unit of Germany's Deutsche Bank that provides trustee and securities services to scores of investment vehicles set up by Goldman and others. The mailing address for Goldman's Ireland subsidiary? It's the one used by the Deutsche operation. If more structured notes go sour or if bank bailout burdens grow, the biggest loser could be globalization itself. Josef Ackermann, chairman of Deutsche Bank, warned of the consequences of financial protectionism in a recent speech at the London School of Economics. "Market integration, for goods and services and for capital, is the bedrock of our prosperity," he said. But by selling risky instruments to unwitting investors around the world, Wall Street is placing that prosperity in jeopardy.

Ilargi: Yeah, and that's the scary scenario.

Wall Street Firms Will Revert to Pre-Crisis Model, Cohen Says
Wall Street, after getting billions of taxpayer dollars, will emerge from the financial crisis looking much the same as before markets collapsed, said H. Rodgin Cohen, chairman of law firm Sullivan & Cromwell LLP. "The system will look more like what preceded the current environment than many people seem to believe," Cohen said yesterday at a panel discussion on the future of Wall Street sponsored by Bloomberg News in New York. "I am far from convinced there was something inherently wrong with the system." Cohen, 64, joined Lazard Ltd. Deputy Chairman Gary Parr, 52, and Carlyle Group co-founder David Rubenstein, 59, in discussing the industry’s future after the deepest financial crisis since the Great Depression forced the government to take equity stakes in hundreds of financial institutions. The panelists projected a future led by core banking and lower risk for established firms.

"There’s a good chance there are five to seven or eight global institutions, of which three or four will be clear winners and then some others will be good, doing full-service banking and securities business sort of as we knew it five years ago," Parr said. They will operate "with a lot lower return on equity and a lot lower risk profile," he added. Banks and other financial institutions reported more than $1.37 trillion in writedowns and losses since the mortgage markets collapsed in 2007, and Parr said more are ahead. "There is still hundreds of billions of dollars of losses to be realized at a number of financial institutions," he said. "There will be a need for substantial capital raising."

Rubenstein said that while Wall Street will likely rebound after the recession, competition probably will emerge from global banks being formed in China and the Middle East as well as from so-called boutique investment banks at home. "Wall Street will be reshaped," Rubenstein said. "People once thought that American brand-name institutions could do no wrong and that if they sold a product, it was a good product, and if they said something was worth a certain value, it was worth a certain value. Now that has changed." U.S. Treasury Secretary Timothy Geithner has urged broad changes in regulating the U.S. financial system to address a lack of confidence caused by the credit crisis.

President Barack Obama in the New York Times Magazine May 3 called for "an updating of the regulatory regimes comparable to what we did in the 1930s, when there were rules that were put in place that gave investors a little more assurance that they knew what they were buying." Obama stopped short of calling for a restoration of the Depression-era separation between banks and brokerages created by the Glass-Steagall Act of 1933, which was repealed in 1999. "Some people say, did all of this arise due to the elimination of Glass-Steagall and we should put Glass-Steagall back into place," Parr, a specialist in advising financial firms, said at the panel. "I’ve observed that that had little or nothing to do with this crisis."

Rubenstein said private-equity firms will take advantage of the financial crisis by investing in "smaller" financial companies. "This is a good opportunity for private equity to show what it can do," Rubenstein said. Carlyle is preparing a bid for BankUnited Financial Corp., a Florida lender deemed "critically undercapitalized" by federal regulators, with Blackstone Group LP and billionaire Wilbur Ross, people familiar with the offer said April 22. "Whenever there is disequilibrium or imbalance in a system, there is always opportunity," Rubenstein said, declining to comment on BankUnited. "Opportunities will be in smaller banks where you can do the due diligence and where you can have some involvement in management and you can effectuate some changes in the way the company is run."

Results of the bank stress tests on 19 major U.S. banks may lead some lenders to raise more capital than they require, which he said is "not necessarily a bad thing." The Obama administration is relying on "blunt instruments" to ensure banks have a sufficient cushion to withstand a souring economy and some institutions are going to be pushed. "Being overcapitalized is better than the alternative," Parr said. Cohen withdrew his name from consideration to become deputy Treasury secretary in March, according to a Democratic official. Cohen, who joined Sullivan & Cromwell in 1970 and became chairman in 2000, has worked on bank regulatory matters with U.S. governmental agencies on behalf of financial institutions and trade associations, including the Troubled Asset Relief Program.

Ilargi: Priceless video...

Texas police accused of highway robberies

CNN reports that police are accused of having robbed at least 150 drivers in Tenaha, Texas. The amount stolen is close to $3 million, says a lawyer who has filed a class action suit against the town and police department there. Some of the victims (who are mostly African American) said that when they complained to the police about the police, the police threatened to take the victims' children away.
In one case, the district attorney sent a couple who'd been robbed a form letter to sign that said, in exchange for forfeiting the $6000 that had been stolen from them, " criminal charges shall be filed...and our children shall not be turned over to [child protective services]." The video is loaded with lots of other tragicomically sordid details.


mistah charley, ph.d. said...

he works for a man they'd follow blindly, no questions askedsee Chris Hedges' Buying Brand Obama

Weaseldog said...

The banks are not insolvent. Insolvency is for institutions that don't get quarterly bailouts.

Red Ink + Infinite Money = Solvency

dan w said...

Ilargi...I love it. Bizzarro to the Nth degree. I feel like I'm watching a play authored by Eugene Ianesco and directed by Jean Renoir.

brendan said...

Everyone's favorite IMF alum catches up with Ilargi:

But why doesn't he predict a dislocation of the bond market? Seriously, he's not dumb. What's the missing link?

jal said...

I have good new for all of you ...
I am no longer part of the HERD!!!
I cashed out at yesterday's high and got a 1% gain.


Anonymous said...

The Worst Case Scenario (Someone Has to Say It)

Rise in psychics, faith healers, alternative medicines, and charismatic religions.
Rise in barter and alternate currencies.
Increase in inexpensive "handy men".
Massive increase in victimless crime, prostitution and drugs.
Increase in weapons sales.
Increase in people protecting their property with force.
Increase in surveillance devices.
Massive riots and protests many due to relatively minor incidents.
Minorities creating new demeaning terms for poor whites.
Massive shift in slang and language usage with new terms for poor, poverty, employment and every aspect of a drained culture.
Rise in musicals and comedies, general feel good stuff.
New and reinvented political movements.
New charismatic leaders that "speak for the common man".
EvilWizardGlick out now.

Anonymous said...

I forgot the Balkanization of the United States.
Take the time and read Thirteen by Richard K. Morgan.
Fear to be in Jesusland when the breakup hits.
(Oh and defines the death of "maleness" and the rise of feminized man and why we fear strong males)
EvilWizardGlick out now.

Iconoclast421 said...

Why is it so hard to find retail sales data for april. All I'm seeing is same store sales crap. Same stores sales dont include stores that were closed. They dont really tell us anything, other than the fact that income tax refunds are up 10-12% vs last years, leading to an extra $20 billion being spent at the stores in these few months. I want to know what are "April US retail sales, in billions, for this april vs last april, and for the first 4 months of this year, vs the first 4 months of last year?"

el gallinazo said...


"I for one would be appreciative and impressed if the U.S. public finally made the effort to come up with a more equitable and accurate name for itself. I have no doubt that the result would be most interesting and, again, revealing."

Much of the rest of the world liked "Yankee," only it pisses off the Bostonians and the Crackers. My personal favorite is Jesustan.

el gallinazo said...

So we should refer to ourselves as "Jesustanis."

Vinca said...

"The debt being racked up by the Government during this crisis is so gigantic that it must consider raising the official retirement age to 70 in little under a decade, increasing taxes by 15 per cent or cutting spending by 10 per cent."

Assuming these figures are correct, what is so hard about cutting 10% of "defense" spending?

el gallinazo said...
This comment has been removed by the author.
el gallinazo said...


I prefer Max Keiser's definition of quantitative easing as "dogs eating their own vomit," over Denniger's definition as a "circle jerk." I would love to ask Uncle Ben in front of the C-Span cameras which of the two he finds more appropriate.

Anonymous said...


How dare you even suggest such an un-Duhmerikan, un-patriotic remark as to cut defense by 10%.

You must not be part of the neo-con, right-wing, conservative, or many Jesus believers.

Sarcasm now off.

In all honestly, we could probably trim 25-50% of the military and still go further, later on.

Alas, we will never do so. For better or worse Eisenhower warned of the industrial-military complex in his farewell address, although a little self-serving since he benefitted so much from it!

However, he did warn us and we failed to listen. Then again, Washington told us to stay out of Europe's problems. We didn't listen then either.

Why, oh why, can't we just take care of this country FIRST?

Anonymous said...

El G,

Alright already. We got it.
Isn't it nap time?

Anonymous said...

dan w. @3.21

will a little bit (or a lot) of felini thrown in!


Anonymous said...

The current fountain of lies from the administration is truly Surrealistic.

Reminds me of the scene in the Truffaut movie "The Discreet Charm Of The Bourgeoisie" featuring an elegant dinner soiree with guests all seated around the dinner table on toilets instead of chairs, pontificating their opinions on how much waste the average person produces per day.

VK said...

WASHINGTON (MarketWatch) - Long anticipated, controversial stress tests for the health of 19 financial institutions Thursday showed that the banking sector is secure, however based on a pessimistic forecast considered by bank regulators, losses for 2009 and 2010 could be $600 billion. According to the report, ten institutions are ordered to raise $74.6 billion in private capital over the next seven months. Treasury Secretary Timothy Geithner indicated that bank credit losses will continue across asset classes. "Banks will need strong capital to weather these losses while making loans," Geithner said.

VK said...

A must read from Steve Keen,

"From Fisher’s point of view, such a belief is futile. In an economy with an excessive level of debt and low inflation, he argued that confidence was irrelevant–and in fact dangerously misleading, as he knew from painful personal experience. Given over-indebtedness and low levels of inflation, a “chain reaction” would occur in which:

“(1) Debt liquidation leads to distress selling and to

(2) Contraction of deposit currency, as bank loans are paid off, and to a slowing down of velocity of circulation. This contraction of deposits and of their velocity, precipitated by distress selling, causes

(3) A fall in the level of prices, in other words, a swelling of the dollar. Assuming, as above stated, that this fall of prices is not interfered with by reflation or otherwise, there must be

(4) A still greater fall in the net worths of business, precipitating bankruptcies and

(5) A like fall in profits, which in a “ capitalistic,” that is, a private-profit society, leads the concerns which are running at a loss to make

(6) A reduction in output, in trade and in employment of labor. These losses, bankruptcies, and unemployment, lead to

(7) Pessimism and loss of confidence, which in turn lead to

(8) Hoardinq and slowing down still more the velocity of circulation.The above eight changes cause

(9) Complicated disturbances in the rates of interest, in particular, a fall in the nominal, or money, rates and a rise in the real, or commodity, rates of interest.” (Fisher 1933; The Debt Deflation Theory of Great Depressions)"

Frank said...

@el G In my experience the rest of the world calls us 'yanks'. Many of them call Canadians yanks too. As a real yankee, I'm cool with this. Pissing off the Jesusstanis is a benefit.

I must however categorically deny that New England, the Great Lakes, the West Coast or the NYC-DC corridor is part of Jesusstan. Since that's 1/3 the area of the lower 48 and half the population of the whole 50, I do not agree that jesusstani is an appropriate collective name for all US citizens.

el gallinazo said...

Anon 4:43

Our cowardly anon sniper making more ageist ad hominem attacks. How about some more Rudy Vallee links to ridicule people over 60. I will admit that after Stoneleigh asked to stop the sniping you were able to keep your viscous little snout in your muzzle for a couple of days. Do you have any ideas to discuss? Oh, we wouldn't know because you don't want to become an "egotist," by actually tagging your sniveling comments.

"General Washington, they signed the Declaration of Independence, but they didn't want to be egotists so all 56 of them signed it "anonymous." Washington- "Might be a tad difficult to raise an army." A new character in Oz - the cowardly asshole.

Greenpa said...

Youse guys have GOT to quit listening to Obama's public statements; press releases, etc, and expecting them to be "transparent" and honest and all that.

Whaddayou, nuts?? Those statements are for the herd. Here's exactly what they mean:

Whoopie Ti-yi-yay! Gettalong little dogie! hheeeyaaa! git git... yeeeehaaa.

Now, if you want that to somehow have deep meaning for the intelligentsia - you're silly!

:-) Herding whoops are only that. And their only measurable effect is - on the behavior of the herd.

Which is awfully darn happy, at the moment. And- getting more -- manageable.

Heeya! Giddup there!

Greenpa said...

I like "usacos" because it rhymes with "tacos".

Anonymous said...

Anon 4:50 pm - "The Discreet Charm Of The Bourgeoisie" was directed by Luis Buñuel, identified on IMDB as "the father of cinematic Surrealism" ... right genre, in any case.

Anonymous said...

Anonymous jal said...

I have good new for all of you ...
I am no longer part of the HERD!!!
I cashed out at yesterday's high and got a 1% gain.

I didn't know one could get paid to join us ne'er-do-wells! They charged me!

Speaking of odd things, ain't it odd that they decide to announce budget cuts the same day they announce the stress test. What is that some sort of stress test for the citizenry's grinding teeth, or some attempt at slight of hand ... up our collective noses?

Hey el gallinazo Make those common hoy paloi of anons work for it , you are rising to the bait too easily and encouraging a wimpy insipid technique. Incidentally I take a trifle of offence with you ascribing my previous rapier like work to that of a low life troll, to date my sword remains in baldric's arms.


Anonymous said...

"I like "usacos" because it rhymes with "tacos".

I like it cause it rhymes with locos

adj. Slang Mad; insane.

Anonymous said...

VK !

nothing from Steve Keen is a must read!

He has a statue in his chalet of R Reagan whom he worships daily...


Anonymous said...


My apologies. (my comment above-wrong)

Wrong steve Keen.


VK said...

@ Anon

LOL, that was quite funny, the mix up of the steve keen's :D

Anyone else noticing the 10 year US treasuries at 3.34%? Me thinks the bond market bull stirs.

Ilargi said...

New post up

AR said...

Interesting choice of photograph for this post, Ilargi. I had never heard of Zinc, Arkansas until a couple of days ago when I read this Newsweek article about hate groups' (KKK) rebranding themselves as 'love of white people' at a weekend meeting of the Christian Revival Center and the Knights Party in Zinc, Arkansas. These folk aren't blindly following.

Posted at dK: WF is now charging a 'deposit fee' of .1% on deposits over $5,000.

PKP said...

Stress Test Saves Bankrupt Banks Via Outright Lies

Anonymous said...

“"The Greatest Depression" -- that we forecast would begin to set in by the end of this year -- may have been postponed, but it has not been averted. When it does set in, it will do so with enhanced intensity and at a pace accelerated by complex financial finagling ... all under the guise of nation-saving action. Rather than let the failing industries fail and the failed banks go bankrupt, the government is deliberately bankrupting the nation.

The lesson to be learned from the financial crisis that began in the summer of 2007, is that nothing succeeds like failure. The greater their failure, the bolder they become. The more they lose, the more they take. The greater the chaos, the more control they exact. The bigger they fail, the harder we fall.

No act is too unthinkable or measure too draconian for the Washington-Wall Street Mob to concoct in order to maintain power, make money and cover their losses. While it is impossible to second-guess what the government will do next, it is absolutely certain that they will stop at nothing.”
Green Shoots or Greatest Depression?-- Gerald Celente

Anonymous said...

This is going to end bad, big time bad. These lower interest rates scare the heck out of me, as does everything I read here.
I went to pay off my used car loan and the lady I dealt with asked me if I regretted getting out of my MFs and going into GICs, now that the markets have rallied. The markets always improve before the rest of the economy - she said. Scary comments! And the media is no better.
Whatever - I listen to Ilargi, Stoneligh, and all the other wise people who comment on this site.
You're all totally the best.

Weaseldog said...

Kluane, I'm hearing everywhere in the MSM, that markets predict the future. The market is up, so the economy is improving.

Markets are magic, and have psychic powers. Day traders, brokers and speculators have the uncanny ability to see the future, before it happens.

Forget all that BS about fundamentals and math and any understanding of how the world actually works. What you need is a nice comforting psychic reading.

But in truth, markets are now whimsical, emotional, flighty and have no basis in fundamentals. They go up and down based on the MSM mood of the day.

If the market had any grounding in reality, it would be based on solid fundamentals and it would be much lower than it is today.

We're in a sucker rally. The MSM wants you back in, so the savvy folks fleece you at the top.

Anonymous said...

Thanks for your comments - not sure I need a comforting psychic. I knew the woman at the bank made dumb remarks, and I said they were scary!
I also know the creeps at the top are making the markets rally to benefit themselves while the rest of us get duped bigtime and suffocate in the coming avalanche.
Her goofy remarks just left me dumbfounded - like do they think we are all that simple! But the sad part is that I know people who totally believe this crap.

Anonymous said...

El Gal,

1) Have you looked in the mirror of late?

Pot belly, a bit smelly and dishevelled pretell?

2) Do you like what you see?

Yes-sir-ee - you are one refined, elegant, chic, high class act!!!

I really really mean it.

getyourselfconnected said...

Back from vacation and Ilargi is still hitting it out of the park. great post!