Friday, November 21, 2008

Debt Rattle, November 21 2008: Treading Lukewarm Water

G. G. Bain Wall Street Blood September 16, 1920
Aftermath of the explosion that killed dozens of people in New York's financial district, when a horse wagon loaded with dynamite and iron sash weights blew up in front of the J.P. Morgan bank at 23 Wall Street. The attack, which was attributed to Italian anarchists, was never solved.

Ilargi: Look, I already told you he has to go, but you, Barney Frank, Chris Dodd, you just let him lie to you time after time. And you just sit there pretending to ask tough questions. Do you ever think of the people you represent, your voters, whose money you are letting him give to his buddies? Are you still clinging to the idea that he's trying to "save the system"?

If so, he's doing a worse job of it than anyone of you, or me for that matter, could possibly do. You know what, you would only need to go back and read the transcripts of everything Henry has said in Congress (and beyond, if you wish to be thorough). That says all. Nothing he has said has panned out. Nothing. And yes, you are there too, and that doesn't look all that good, but it's better than the alternative of keeping up this circus.

Your colleague James Inhofe has revealed that it was Henry who threatened Armageddon and martial law unless you'd sign the TARP plan, the conditions and goals of which Henry himself has already admitted he never intended to execute. Since TARP is a law, what Henry has done is against the law, gentlemen, and people who break the law, certainly when it involves a trillion dollars of taxpayer money, must be removed from any government function (s)he occupies, and henceforth be indicted. But no, it's all of it nothing but a bunch of big fat feet treading the same batch of filthy stinking dirty lukewarm water.

Meanwhile, the Treasury's alleged rescue actions have led us to today. Where Citigroup is down another 25%, while Fifth Third Bancorp, JPMorgan Chase, KeyCorp, National City Corporation, Washington Mutual and Wells Fargo are all facing double-digit losses, and there's a whole platoon of other financials retreating between 5% and 10%. Whatever it is Henry -and as long as you let him stay on, you yourselves are of course very much accomplices- have done or intended to do, is the grossest failure ever seen in American politics.

And the people will not forget that, boys, and they will not stay silent about it. You don't have much time left to do something about it, something that is honest and sincere and that serves the interests of the people who have given you their trust. They had better not find out what you did with that trust. Come to think it, they inevitably will, sooner or later.

Where have you been, Joe DiMaggio? Our nation turns its lonely eyes to you.

Citigroup stock dive rebuffs claim by Treasury's Paulson
Many things that Treasury Secretary Henry M. Paulson has said about the credit crunch and financial markets have come back to haunt him. Now many investors appear to expect a U.S. rescue of Citigroup Inc. -- just one week after Paulson sought to assure the American people that the banking system has "been stabilized."

Citigroup shares dived $1.69, or 26.4%, to $4.71, leading another meltdown in financial shares, as investors bailed out on fears that the sinking economy could torpedo the financial giant. The plunge in financial issues Thursday helped drive the Standard & Poor's 500 index to an 11-year low. Citigroup stock failed to get any lift from a promise by Saudi Prince Alwaleed bin Talal, who owns 4% of the firm, that he would boost his stake because he believes the shares are undervalued.

Once the government started pumping capital into banks last month, many investors assumed that the biggest institutions were at least assured of survival. But the market clearly has major doubts about Citigroup, even with $25 billion in government capital now on its books. That was evident Thursday in the market for insurance contracts known as credit default swaps, where the annual cost of insuring Citigroup bonds rocketed to $390,000 per $10 million of debt, from $240,000 on Tuesday, according to Reuters.

The cost surged even though the Federal Deposit Insurance Corp. has agreed to guarantee U.S. banks' debts. Citigroup swaps "shouldn't be trading at these wide levels if in fact there's a backstop from the Treasury, an implicit guarantee," Ricardo Kleinbaum, a credit analyst at BNP Paribas in New York, told Reuters.

One week ago, Paulson was confident that investors were over the worst of their concerns about the banking system. In an NPR interview, he said: "I believe the banking system has been stabilized. No one is asking themselves anymore, is there some major institution that might fail, and that we would not be able to do anything about it. So I think that is a positive."When the interviewer pressed Paulson on the idea of another major failure, the Treasury chief didn't flinch. "I got to tell you, I think our major institutions have been stabilized," he said. "I believe that very strongly."

Paulson Trying to Rewrite His Own History
Treasury Secretary Henry Paulson spoke at the Reagan Library this afternoon, and judging by the speech, it appears as though Mr. Paulson is embarking on a PR campaign to rewrite the history of his handling of the credit crisis.  One line that stood out was when he said, "By pro-actively addressing the problems we saw coming..."  Judging by excerpts of prior comments the Treasury Secretary made during 2007, if Mr. Paulson saw the problems coming, he wasn't telling anybody:
  • Marketwatch 3/13/07: Paulson also said the fallout in subprime mortgages is "going to be painful to some lenders, but it is largely contained."
  • Reuters 4/20/07: "I don't see (subprime mortgage market troubles) imposing a serious problem. I think it's going to be largely contained."
  • Bloomberg 5/22/07: Paulson, also speaking to CNBC, said the housing slump was ``largely contained'' and that market's correction was mostly ``behind us.''
  • Bloomberg 6/20/07: Subprime fallout ``will not affect the economy overall.''
  • Forbes 7/27/07: Appearing on CNBC with other members of the Bush administration's economic team, he again said mortgage industry problems would be 'largely contained.'
  • 8/1/07: Paulson added that he did not see anything that caused him to reconsider his view that the economic damage from the housing correction was "largely contained."

Another classic line from today was, "As I assess our current situation, I believe we have taken the necessary steps to prevent a financial collapse."  Mr. Paulson, what is it going to take for you to consider this a financial collapse? Given that the extent of the credit crisis was underestimated by almost everyone, you can give Paulson somewhat of a pass for missing it. But to try and rewrite history through speeches even while the credit crisis is still playing out is inexcusable.

Just give us the money
My wife and I are the proud owners of all the common stock in a small company, created originally as a vehicle for supplying consultancy services. Because we are both US citizens, the company is registered both in the US and in the UK. Over the years since its creation, an awareness has grown inside me, that what we really own is a bank: money goes out (quite a lot) and money comes in (not quite enough).  All we lack to be a proper bank is leverage and a marble atrium.

To remedy this obvious deficiency, I have decided to submit a request to the US banking regulators (cc’d to Hank Paulson) to grant bank holding company status to our enterprise. If G-Mac can aspire to this status, which gives the qualifying institution access to all the Fed troughs and to what’t left of the TARP, then so can we.

Unlike G-Mac, which provides financing for crappy, environmentally unfriendly vehicles that no-one really wants, our would-be bank holding company is a model of family values at work. Sure, we don’t make loans. But show me a bank today that does.   You may wish to point out that the two principals involved have no experience running a bank. You would be correct. But what really is worse, having no relevant experience or having an extensive track record of running multi-billion enterprises into the ground?  Make a choice between a definite risk and the certainty of abject and costly failure.

If we cannot get bank holding company status for our company, we will fly our (separate) private jets to Washington DC to appeal for congressional support for our business as a quintessential heartland enterprise. The very fact that we are not systemically important makes us systemically important. The reason is that if we can get money from the US government, anyone can. 

And if anyone can, there is no longer any reason for fear, excessive caution and pessimism. Consumers will spend again. Banks will lend again.  Companies will invest again. Just give us the money.

The Simple Arithmetic of Hank Paulson's Financial Disaster
Financial markets just gave Hank Paulson a vote of no confidence. Unfortunately, it's the rest of us who will pay the price. As Paulson made clear this past week, he is stalling, subverting the express intent of Congress when it passed the bailout bill, by his refusal to take action on foreclosure relief for distressed homeowners. Paulson's inaction has triggered a chain reaction that goes something like this:
First: Treasury says it won't take steps to prevent home foreclosures, so that
Second: Prices of mortgage securities collapse, so that
Third: Bank equity gets wiped out, so that
Fourth: Banks, with shrunken equity capital, are forced to cut back on all types of credit, so that
Fifth: Financing for anything, especially residential mortgage loans, dries up, so that
Sixth: Market values of homes decline further, so that
Seventh: Mortgage securities decline further, and the downward spiral becomes self perpetuating.

This phenomenon is best illustrated by the numbers.

The free fall in mortgage securities.
The free fall in market prices for mortgage securities implies that the eventual recovery on distressed mortgage loans will be a lot worse than anyone expected on the eve of Obama's election. We see that from the Markit ABX Indices, which are something like a Dow Jones Average for subprime mortgage securities.
Market Price
ABX-HE-PENAAA 07-1, November 3: 55 November 20: 34.25
ABX-HE-PENAAA 06-2, November 3: 82 November 19: 58.32

When ABX-HE-PENAAA 06-2 traded at 82, or 82 cents on the dollar, the implied recovery rate on the entire mortgage pool is was something like 66%. When the same security trades at 58.32, the implied total recovery is about 47%. Here's why. The way these securities are structured, different classes of creditors, or different tranches, all hold ownership interests in the same pool of mortgages. But the tranches with the lower ratings - BBB, A, AA - take the first credit losses; they are supposed to get wiped out before the AAA bondholders lose anything.

Typically, AAA bondholders represent about 75-80% of the entire mortgage pool. (Market Price@ 82 X approx. 80% of total pool = 66% total recovery). (ABX-HE-AA 06-2 currently sells at about 12; ABX-HE-A 06-2 sells under 6. At those prices, a buyer is betting that the eventual recovery will far exceed the market's expectations.)

Mortgage securities and bank stocks fall in tandem.
From the price graphs of the ABX benchmarks, accessible via hyperlink, you can see how the downward slopes closely match those for bank stocks since election day.
Market Price
ABX-HE-PENAAA 07-1, November 3: 55 November 20: 34.25
ABX-HE-PENAAA 06-2, November 3: 82 November 20: 58.32
Citicorp, November 3: 13.99 November 20: 4.71
Bank of America, November 3: 23.61 November 20: 11.20
JPMorgan Chase, November 3: 40.73 November 20: 17.35
S&P 500, November 3: 966 November 20: 752

Since November 3, Citicorp, Bank of America, and JPMorganChase have lost in excess of $240 billion in market value. Most of the other global banks, such as UBS, Barclays, BNP, have suffered similar declines. The link between ABX indices and bank equity requires some further explanation.

Declines in mortgage securities wipe out bank capital and confidence in our global financial system.
About 18 months ago, banks lost control of their balance sheets. Losses on securities receive different accounting treatment than losses for loans. Comparatively speaking, loan losses are more predictable and more manageable. Before they report their quarterly results, banks review their problem loans and calculate the associated loss provisions. Banks don't expected to be whipsawed by market events on the last day of a fiscal quarter.

Things changed around July 2007, when AAA mortgage securities started trading at prices materially below par, or below100. Up until then, many banks had bulked up mortgage securities that were rated AAA at the time of issue. Why? Because they believed that AAA bonds could always traded at prices close to par, and consequently the bonds' value would have a very small impact on the earnings and equity capital. The mystique about AAA ratings dated back more than 80 years. From 1920 onward, the default experience on AAA rated bonds, even during the Great Depression, was nominal. Similarly, during the Great Depression national average home prices held their value far better than they have in the past two years.

Those assumptions, of a highly liquid trading market and gradual price declines, proved to be way off the mark. Beginning in the last half of 2007, the price declines of AAA bonds was steep, and the trading market suddenly became very illiquid. Under standard accounting rules, those securities must be marked to market every fiscal quarter, and the banks' equity capital shrank beyond anyone's worst expectations. Hundreds of billions of dollars have been lost. The losses in mortgage securities, and from financial institutions like Lehman that were undone by mortgage securities, dwarf everything else.

Before the end of each fiscal quarter, bank managements must also budget for losses associated with mortgage securities. But since they cannot control market prices at a future date, they compensate by adjusting what they can control, which is all discretionary extensions of credit. Banks cannot legally lend beyond a certain multiple of their capital. This uncertainty about banks in general, and the ripple effect of reduced credit, creates a crisis in confidence throughout the financial system and the broader economy.

Why Treasury's intervention was needed to forestall a bigger glut of foreclosures.
Why did mortgage securities and bank stocks fall so much more sharply in the last few weeks? The market was expecting that Hank Paulson would act in a manner consistent with Congressional intent when it passed the bailout. As time passed, anxiety about treasury's inaction increased. Then on November 12, Paulson announced that he would do nothing soon to provide foreclosure relief to homeowners. As we've seen above, stabilizing home prices is key to stabilizing the broader economy. And the key to stabilizing home prices is to limit the spate of foreclosures that would flood the market. If homeowners are able to remain in their homes and make partial payments on their mortgages, lenders may attain a better recovery than from a series of fire sale liquidations.

The problem is concentrated among private-label securitizations. Though they represent only 20 percent of all mortgages, they represent 60 percent of all defaults, according to The Financial Times. Unlike most mortgage securities that follow the standardized underwriting guidelines of Fannie Mae and Freddie Mac, private-label securities make it almost impossible for the lender to negotiate modifications with the homeowner. Congress passed the bailout package on the condition that a large chunk of the $700 billion to assume control of these assets so that the government could renegotiate terms with distressed homeowners.

Paulson ignored Congressional intent, and went off into an entirely different direction, allocating funds to bolster securitization of credit card receivables. Barney Frank, with great specificity, called him on his bad faith bait-and-switch tactics. But that exchange didn't get nearly as much coverage amid Paulson's platitudinous soundbites and talk about bailing out GM. "The primary purpose of the bill was to protect our financial system from collapse," Paulson told the House Financial Services Committee. And the markets signaled what they think of Paulson's job performance.


Here's a taste of how Barney Frank tried to cut through Hank Paulson's dissembling and evasiveness yesterday.
REP. FRANK: Let me just say there are pages -- it's four pages of specific authorization to buy up mortgages and write them down. Section 109(c), "upon any request arising under existing investment contracts, the secretary shall consent where appropriate in considering -- (inaudible) -- by the taxpayer to reasonable requests for loss mitigation measures."

In Section 110, homeowner assistance by agencies. "To the extent that the federal property manager holds on to controlled mortgages, they shall implement a plan that seeks to maximize assistance for homeowners." The bill is replete with authorization to you, not simply to buy up mortgages, but in effect to do some spending -- because we are talking about writing them down. So the argument that, frankly, of all the changes that have come with the program, this -- this wouldn't be a change. This was the program. And my colleague from California, who'll be -- you'll be hearing from shortly, made a big point of this on the floor.

So the argument that this is not part of the program simply doesn't wash. So -- would, do you agree, Mr. Secretary, that in fact the bill does authorize aggressive action, not simply to buy up mortgages, but in buying them up, take some action to reduce in some ways the amount owed so we diminish foreclosures?
SEC. PAULSON: Mr. Chairman, two things. First, I need to just say a word about AIG, because the primary purpose of the bill was to protect our system, protect our system from collapse. AIG was a situation, a company, that would have failed, had the Fed not stepped in. Had we had the TARP at that time, this is right down the middle of the plate for what we would have used the TARP for. As it turned out -- because it should have had preferred (and a ?) Fed facility, and as it turned out, we needed to come in again to stabilize that situation and maximize the chances that the government would get money back. So I just wanted --
REP. FRANK: I'm not objecting to the AIG. I am just saying, though, that the standards of what we do -- and obviously foreclosure is also a serious problem for the economy.
SEC. PAULSON: I agree with you on the bill. There is no doubt that -- and so don't misunderstand what I say, that the --
We came to Congress with the intent to get at the capital program that banks were facing and the system was facing through purchasing large amounts of illiquid assets. And so the bill -- and it was to purchase those assets and then resell them. And our whole discussion -- because that's what we were talking about, was how to use these and use this investment position to make a difference and mitigate foreclosures.

My only point is now that we haven't bought those assets, illiquid assets, that the -- that at least the intent is, I had seen it. At least all the discussions we had went to buying assets and reselling them. It didn't go to a direct subsidy. But
REP. FRANK: No, Mr. Secretary, I have to interrupt you. No, you are talking legitimately about your intent. But we had to get the votes for the bill.
REP. FRANK: Our intent was also relevant. And I read you sections of the bill which says, write it down, give them assistance. So the bill couldn't have been clearer that one of the purposes --
And, by the way, we're talking about, what, 24 billion (dollars) out of 700 billion (dollars)? You're talking about 4 percent of the total amount. But the point is that clearly part of this was not just to stabilize, but to reduce the number of foreclosures, for good macro- economic reasons. And so again, the intent couldn't be clearer, from what I've read.
SEC. PAULSON: Let me then, Mr. Chairman, say what you've heard me say a number of times before, that going back many, many months, before it was as topical as it is now, we've been working very, very aggressively at the individual, helping the individual. As recently as last week --
REP. FRANK: Mr. Chairman, I'm sorry -- Mr. Secretary -- we don't have a lot of time, and I don't usually do this, but --
SEC. PAULSON: Okay, well, let me just --
REP. FRANK: What -- the question is the language in the TARP. We understand that there are other activities going on. I don't accept them as a substitute for using the authority that we very specifically and carefully wrote into the TARP and that was essential to it getting passed.
SEC. PAULSON: Well, what you've heard from me, and what you heard from me last night, and which I will say again, that I am going to keep working on this and looking for ways to use the taxpayer money as they expect me to here, with regard to foreclosure mitigation. We have been, you know, as recently as last week, taking a step which I think will have --
REP. FRANK: No, I'm sorry, Mr. Secretary. Those are not substitutable. Because I will tell you this, and I apologize for taking the time, it is nobody's view that we have been as successful as we need to be for the stake of the economy in reducing foreclosures.

Citigroup stock down again despite sales talk
Shares of Citigroup enjoyed a brief bounce Friday morning before heading lower once again, falling 16% despite reports that the beleaguered bank may be looking to raise more capital or even sell the whole firm. Citigroup executives were set to meet Friday morning to discuss their options, including selling off pieces of the company or even the entire bank, both The Wall Street Journal and The New York Times reported late Thursday.

Calls to Citigroup to confirm the reports were not immediately returned. It has been a rough week for the New York City-based bank. The company announced Monday that it would be cutting more than 50,000 workers. The stock plunged 26% Thursday to $4.71, its lowest level in more than a decade, even though the bank's largest individual shareholder, Saudi Prince Alwaleed Bin Talal, said he would increase his stake in Citigroup to 5%.

On Friday morning, the stock sank below $4. Citigroup has been one of the hardest hit financial firms since the mortgage market first started to unravel in the fall of 2007. Over the past four quarters, the company has recorded close to $21 billion in losses. 

Citigroup Board Said to Weigh Options as Stock Drops
Citigroup Inc.'s board meets today to discuss the bank's options after Chief Executive Officer Vikram Pandit's efforts to rebuild investor confidence failed to halt the stock's descent to a 15-year low, a person with knowledge of the matter said. The board, led by Chairman Win Bischoff and independent director Richard Parsons, will meet at Citigroup's headquarters in New York, said the person, who declined to be identified because the deliberations are private. The panel may choose to sell pieces of the bank or the entire company, the Wall Street Journal reported, citing unidentified people familiar with the situation. The New York Times reported that management isn't actively considering a sale or split up of the bank.

Citigroup, once the biggest U.S. bank, with a stock market value of $274 billion at the end of 2006, dropped yesterday to about $26 billion, slipping to No. 5 after Minneapolis-based U.S. Bancorp. A plan Pandit announced this week to cut costs by shedding 52,000 jobs and an endorsement by billionaire Saudi investor Prince Alwaleed bin Talal didn't assuage shareholders' concern that bad loans and securities writedowns may extend a yearlong run of net losses totaling $20 billion. "Investors right now aren't convinced that we're done seeing dead bodies on the Citigroup balance sheet," said William Fitzpatrick, an equity analyst at Optique Capital Management Inc. in Milwaukee, which oversees about $1 billion and doesn't own Citigroup shares. "That's what the sell-off is, concern over more and more losses over the next couple of quarters."

Citigroup spokeswoman Christina Pretto declined to comment on the board meeting. She reiterated a statement made by the New York-based company earlier this week that it has "a very strong capital and liquidity position and a unique global franchise." Citigroup was up 92 cents at $5.63 in German trading today. Including a $25 billion capital injection from the U.S. Treasury under the $700 billion Troubled Asset Relief Program, the company has at least $50 billion of capital in excess of the amount required by regulators to qualify as "well capitalized." Capital is the cushion banks must keep to absorb losses and protect depositors.

The company's shares fell 26 percent in New York trading yesterday, closing below $5 for the first time since 1994, as stocks worldwide sank on concerns a global recession may deepen. JPMorgan Chase & Co., the biggest U.S. bank, fell 18 percent to $23.38, while No. 2 Bank of America Corp. declined 14 percent to $11.25 and Wells Fargo & Co. fell 7.7 percent to $22.53. U.S. Bancorp fell 6.4 percent to $22.12. "What you're seeing here is more emotional selling, more people throwing in the towel and they are throwing everything out, not just Citi," said Matt McCormick, a portfolio manager and banking analyst at Bahl & Gaynor Investment Counsel in Cincinnati, which manages about $2.9 billion and doesn't own Citigroup stock or debt.

Pandit, 51, has pledged to preserve Citigroup's strategy of combining a wide range of financial businesses in a single company. They include branch banking, retail brokerage, trading, investment banking, credit cards and transaction processing. Pandit was appointed last December to succeed Charles O. "Chuck" Prince, who was ousted as mortgage-bond writedowns saddled the bank with a record fourth-quarter loss of almost $10 billion. Prince was the handpicked successor of former Chairman and CEO Sanford "Sandy" Weill, who built the company through a series of acquisitions over 17 years before stepping down in 2003. Bischoff, 67, was Citigroup's top executive in Europe until he was named chairman when Pandit became CEO.

Bank employees have been telling customers their deposits are safe, and so far corporate clients haven't moved their money elsewhere, said three people familiar with the matter who declined to be identified because they weren't authorized to speak publicly about the accounts. Chief Financial Officer Gary Crittenden, 50, has told colleagues it would be unwise to make hasty decisions to dispose of good businesses to satisfy investor demands for a show of action, one person familiar with the matter said. The bank may try to sell "non-core" units, similar to the divestiture earlier this year of retail-banking operations in Germany and Citi Global Services Ltd., an Indian unit that processes transactions and provides other "back-office" services, Optique's Fitzpatrick said. "They're still going to stick with the game plan of selling off non-core assets, but I don't know what you can sell in an environment like this," he said.

Citigroup executives who spoke on condition of anonymity because they weren't authorized to comment publicly said they felt besieged by negative rumors propagated by short sellers betting on a decline in the share price. Bank officials have discussed with the U.S. Securities and Exchange Commission and lawmakers the prospect of reviving a prohibition on short-selling financial stocks, according to a person familiar with the matter. Few investors are willing to bet on the stock's recovery, said Laszlo Birinyi, president of Birinyi Associates Inc. in Westport, Connecticut.

"The problem is credibility," Birinyi said in a Bloomberg Television interview yesterday. "There seems to be no bottom." Costs for bad loans have almost doubled in the past year to $9.07 billion in the third quarter, and Pandit told employees this week that net credit losses in the banks' consumer divisions may be as much as $2 billion per quarter next year. The cost cuts announced this week may save about $2 billion per quarter. Citigroup is so integral to the global financial infrastructure that the U.S. government is unlikely to let the bank collapse, said Barry James, president of James Investment Research Inc., which manages $1.75 billion in Xenia, Ohio. He doesn't own Citigroup shares.

While the bank's debt holders may be spared, shareholders likely won't fare as well, Bahl & Gaynor's McCormick said. "If I was a Citi shareholder I would expect to see increased volatility, more government stimuli and a possible merger or acquisition," McCormick said. Any government aid would be dilutive to stockholders, he said. Pandit and three deputies who bought about 1.3 million Citigroup shares last week in a show of confidence already are sitting on paper losses. Pandit bought 750,000 shares at an average price of $9.25 apiece. At yesterday's closing price, they're worth about $3.41 million less. Parsons, the 60-year-old lead director and chairman of Time Warner Inc., bought 35,000 shares this week for an average price of $8.15, Citigroup said yesterday in a regulatory filing. The stock "is for speculative investors," McCormick said. "Let's face it."

Citigroup Urging SEC to Bring Back Short-Selling Ban
Citigroup Inc., which fell 26 percent in New York trading today, is seeking to revive a prohibition on short-selling financial stocks, according to a person familiar with the matter. The Wall Street Journal said Citigroup is considering a sale of the company. The New York-based bank has discussed with the Securities and Exchange Commission and lawmakers its proposal to reinstitute the ban on bets that stock prices will fall, said the person, who declined to be identified because the discussions weren’t public.

Buffeted by four straight quarterly losses, New York-based Citigroup has raised about $75 billion since December by selling assets and equity stakes, including a $25 billion injection from the U.S. Treasury. The government will do whatever it takes to stabilize Citigroup, including pouring more money into the company, because of the threat its failure would pose to the global economy, said Peter Wallison, a fellow at the Washington- based American Enterprise Institute. "There is no question that Citigroup will not be allowed to fail," said Wallison, who was Treasury Department general counsel under former President Ronald Reagan. "I would not think it is a good idea to restore the ban on short selling," he said.

Citigroup’s executives are considering selling off pieces of the bank or the whole company, the Wall Street Journal reported, citing people familiar with the matter. Talks are preliminary and don’t suggest Citigroup is backing away from its insistence that it has sufficient capital and funding, the Journal said. The bank isn’t seeking government financial aid, Reuters reported today, citing an unidentified person close to the company. Citigroup may try to find a merger partner or raise cash, CNBC said on its Web site, citing senior officials it didn’t name. Morgan Stanley, Goldman Sachs Group Inc. and State Street Bank are among the possible partners, CNBC said.

Citigroup has lost about $20 billion in the past four quarters as bad loans increased and demand for banking services declined. Chief Executive Officer Vikram Pandit said this week the company will cut 52,000 jobs in the next year to lower costs. SEC spokesman John Nester and Citigroup spokesman Michael Hanretta declined to comment. The short-sale ban, which affected shares of 964 companies, lapsed Oct. 8. The SEC instituted the prohibition in September after Morgan Stanley Chief Executive Officer John Mack and lawmakers including New York Senator Hillary Clinton blamed short sales for driving companies to the brink of collapse.

Hedge funds opposed the restriction, arguing that poor management and an over-concentration in mortgage securities were to blame for declines in financial companies’ stock prices. "It’s an uphill battle to have the ban re-enacted," said Scott Talbott, a senior vice president of government affairs for the Washington-based Financial Services Roundtable. Talbott said his group, whose members include Citigroup, has urged lawmakers and regulators to bring back the prohibition on a temporary basis. Share volatility increased as the ban hampered trading, Nasdaq Stock Market data show. The difference between bids and offers, a measure of trading cost for investors, more than doubled and was almost 60 percent higher than the average for stocks exempt from the restriction.

The SEC has also faced pressure to bring back the so-called uptick rule, which allowed short sales only if a preceding trade boosted a company’s stock price. The regulator’s decision to scrap it in June 2007 has contributed to investors "losing confidence in the integrity of our markets," law firm Wachtell, Lipton, Rosen & Katz said today in a memo to clients. The agency has countered that it extensively studied the rule, which was imposed after the Great Depression, and found it was no longer relevant to electronic markets. "The SEC staff and most of the commissioners do not appear to support a return to an uptick rule, nor do the other U.S. exchanges or a majority of the leading market participants," NYSE Euronext CEO Duncan Niederauer said in a letter to NYSE listed companies last month.

Ilargi: 'It would take a depression every bit as large and long as the 1930s debacle to shake this company's viability.'— Richard Bove, Ladenburg Thalmann

Dick Bove redefines the term "douche" every single day, by being wrong every single day, and still the media turn to him for analysis. Unbelievable.

Citi's CEO Pandit said to reject Smith Barney sale
Shares of Citigroup Inc. fell as much 24% Friday, skidding below the $4 mark amid news reports that CEO Vikram Pandit has blamed "rumor mongering" for the collapse of its stock price and that he has ruled out a sale of the firm's Smith Barney investment-banking business. The report emerged after Pandit spoke with top bank staff on a conference call, during which he also said he wants to keep the embattled company together rather than breaking it up, U.K. newspaper The Telegraph reported Friday. It also said Pandit told participants that the bank has a strong capital position and is not facing any funding crisis.

Earlier reports said Citigroup Inc.'s board of directors was meeting today to consider auctioning off parts of the bank, or even the entire firm. The global credit-card division and its transaction-services arm could be put on the block, according to the Journal report. Citi shares, which rose 15% in pre-open trading, quickly surrendered their gains as word of Pandit's comments reached the market. The shares, part of the Dow Jones Industrial Average, fell as as low as the $3.57, and recently traded off nearly 18% at $3.88. The board's talks are only at a preliminary stage and don't signal a change in management's stance that the bank has ample funding and strategic direction, The Wall Street Journal reported, citing people familiar with the matter.

Citi shares have now fallen more than 50% this week alone, dragged lower as a slew of negative news coincided with U.S. economic worries and a disastrous week for selling equities in general. A bank spokesman said Citigroup declined to comment on the reported meetings. The 26% decline in Citi's stock on Thursday -- it's worst-ever single-day fall -- has left officials at the bank considering scenarios that would have been unthinkable a few weeks earlier, the Journal reported. Writing to clients Friday morning, Deutsche Bank analyst Mike Mayo said, "We believe that there is fundamental value at Citigroup that justifies a $9 price target."

Cracks in the commercial real estate market, the Treasury's recent decision against buying troubled assets from banks and Citigroup's own move to take on around $17 billion of assets from a subsidiary fund have all hit the blue-chip stock. A vote of support Thursday from Saudi Arabian investor Prince Alwaleed bin Talal bin Abdul-aziz, who said he will increase his holdings in Citi back to 5%, couldn't stem the decline in the stock price. On another front, Citigroup along with other banks has been lobbying for further action from lawmakers, including asking the Securities and Exchange Commission to reinstate a ban on the short-selling of financial stocks, the Journal reported. Late Thursday, SEC chief Chris Cox announced he would hold a conference call with international regulators on Monday to discuss short selling and other issues.

Ladenburg Thalmann analyst Richard Bove said he had received numerous calls asking if Citigroup was about to fail but added that he could "see no reason why this should happen." Bove said in a note to clients late Thursday that the bank's liabilities are backstopped by numerous programs, including its access to the Federal Reserve discount window, $780 billion of deposits primarily from overseas and its ability to sell commercial paper to the Fed. "It would take a depression every bit as large and long as the 1930s debacle to shake this company's viability," Bove said. "The current decline in the stock price is reflecting a series of fears related to loans and security values that cannot be actualized without a severe setback in the economy and a very rapid increase in interest rates," he added.

Citigroup's overambition haunts bank as music stops
The tale of Citigroup is really the tale of one man, Sandy Weill – a Brooklyn-born stockbroker who had ambitions to build the biggest banking group in the world. Armed with little more than a relentless energy and aggressive zeal, he set out on his quest to conquer the financial markets in the early 1980s. By 2005, Citigroup's $108bn of revenues eclipsed the economies of countries such as the Czech Republic, Singapore and New Zealand, briefly becoming one of the largest 50 companies in the world. As much as any of the recent crises in the financial markets, the dismantling of Mr Weill's empire signals the end of an era.

Mr Weill began at American Express, where he hired a dynamic young graduate straight out of Harvard Business School as his personal assistant. That man was Jamie Dimon, now chief executive of JP Morgan – the bank that rescued Bear Stearns and Washington Mutual, and remains one of the few resilient Wall Street giants. Mr Weill and Mr Dimon were not sated by AmEx and left to start their own business Primerica in the mid 1980s. At Primerica, they discovered their infamous lust for deal-making, building it into a broad ranging financial services group that ultimately became Travellers. Along the way, Mr Weill picked up an aspiring lawyer called Charles "Chuck" Prince.

For much of Mr Weill's bid to create a one-stop financial "supermarket", Mr Prince was his chief lawyer. Then, in 1998, Mr Weill pushed through the deal that created the Citigroup banking behemoth by merging Travelers with Citicorp. Citi became the biggest bank on Wall Street – a colossus employing over 325,000 people in businesses ranging from high-street banking and credit cards to investment banking and wealth management across the world. But the scale of Mr Weill's ambition was also its undoing. Integrating such a disparate and massive operation was not his strength and the problem was never properly dealt with.

Rows over strategy with Mr Dimon ensued and Mr Dimon left. Mr Dimon's departure thrust Mr Price forward as Mr Weill's successor. As a lawyer, Mr Prince never commanded the same respect on Wall Street, which began to expose the cracks in the lumbering giant. Without room for expansion, critics said, Citigroup's strategy lacked purpose. Mr Prince's tenure since taking over in 2003 was dogged with rumour about his departure as the bank failed to capitalise on its size, but it was his reaction to the financial crisis that sealed his fate. In perhaps the most infamous words of the crisis, he explained last summer that the bank was not pulling back from the markets because "as long as the music is playing, you've got to get up and dance. We're still dancing."

Crippled by the largest exposure to sub-prime and other toxic debt, Citi has wracked up losses of $20bn in the past 12 months. Mr Prince should have sat down before the music stopped. Citi cast its net wide for his successor, after Mr Prince left at the bank end of last year, but few wanted the job. Royal Bank of Scotland's Sir Fred Goodwin and Deutsche Bank's Josef Ackermann are said to have turned the role down.

It ended up with the internal candidate Vikram Pandit, who has begun the inevitable dismantling of the empire. He has grasped the nettle, cutting 75,000 jobs in the past year and shutting down businesses that no longer have a future. Ultimately, Citi – a massive play on growth of the financial markets – outgrew both itself and the capacity for world's banking services. A tale of overambition on the one hand, its misfortunes might also be seen as a proxy for the future of the markets.

Goldman Backs Off Its Oil ‘Super Spike’ Theory
That ‘’super spike" in oil prices that Goldman insisted would lift crude to $200 a barrel ….? Turned out to be a dagger that has pierced Goldman itself. It never really turned out to be that prescient: instead of the 50% jump in oil that Goldman anticipated back in May, when it made the call with crude trading at $132, the price of a barrel never got more than 11% higher. And has since, of course, lost fully two-thirds of that price in the intervening four months.

Now Goldman is left with the ignomy of summarily abandoning the investors who listen to its research calls, telling them effectively that they’re on their own. On Thursday, Goldman said it was "closing" its recommendations for oil trades. Meaning that in a perilous time when the traders who pay attention to Goldman’s recommendations could use some guidance the most, Goldman has opted to give them the least. And some traders are furious about it, comparing the maneuver to then-strategist Abby Cohen’s decision to abandon her targets for equity indexes in the fall 2001, citing the uncertainties abounding in the market.

Goldman specifically talked about four trade recommendations it previously issued, and said clients shouldn’t put any stock in them any longer. One particular trade, a Nymex-WTI swap on the 2012 contract, issued in September, when crude already had declined to below $70, suggested that the contract would reflate to a range of $120 to $140. Obviously, that hasn’t happened. In the end, the last laugh is on Goldman, ironically enough. Back in 2005, when Goldman oil analysts first started talking about a ‘’super spike" in energy prices, the prospect of crude going to as much as $105 a barrel, as they suggested, seemed like folly.

The market subsequently vindicated them. When those same analysts raised their foreecasts last March, and first spoke of the $200 price point, a lot of traders still tittered. When Goldman spoke more determinedly about $200 in May, it seemed less far-fetched. The big losers, of course, would be anybody who continued to trade on Goldman’s recommendations. And the stocks of companies linked to those underlying commodities. Exploration and production names have had an awful go of it Thursday, integrated majors bad to a lesser extent. Apache lost 6%, Chevron fell 2%, and ConocoPhillips 1%. But Goldman …? What did Goldman lose today? It’s worth noting that, for reasons unrelated to its oil trading call, Goldman shares dropped below their 1999 IPO price in Thursday’s trading.

American Hypocrisy in Auto Rescue Spurs Me-Too Trade Ire
Carmaker Aid May Fuel 'Stones-and-Glass-Houses' Spats

A U.S.-triggered spate of global carmaker-bailout proposals may spark trade disputes over whether the Americans are unfairly trying to subsidize their industry or just making up for state aid foreign rivals already enjoy. As the U.S. considers a lifeline for its automakers, officials in Europe, Canada and Asia are considering their own aid packages -- even as the European Union threatens to lodge a complaint against any U.S. bailout to protect manufacturers from Renault SA in France to Fiat SpA in Italy. China also may complain, though the government is considering helping SAIC Motor Corp. and Guangzhou Automobile Group Co.

Any World Trade Organization complaints may open a Pandora's Box, bringing to a head a long-simmering dispute over policies that U.S.-based General Motors Corp., Ford Motor Co. and Chrysler LLC say unfairly aid rivals, including state- financed health-care and retirement benefits, and currency policies. "Frankly, it's stones and glass houses," said Garel Rhys, professor of automotive economics at Cardiff Business School in Wales. "Everybody has been at this game for their own interests; nobody is pure." Neelie Kroes, the European Union's antitrust chief, weighed in on the debate today, urging the bloc's 27 nations to avoid the "costly trap of a subsidy race" that would give some countries unfair advantages. "The temptation may be greater now for member states to give subsidies that can result in their economic problems being exported to their neighbors, but that would only worsen the economic difficulties," Kroes said at a conference in Brussels.

"The European economy and European taxpayers will be better off if politicians choose another, more effective, route," Kroes added. She pointed to EU rules that allow limited aid that doesn't distort competition, including grants for entrepreneurs, research, education and environmental projects. The U.S. kicked off the bailout war. Congress is trying to reach a compromise on giving automakers $25 billion they say they need to survive the next year, either by speeding up the use of funds already approved to develop more fuel-saving technologies and models or providing a new source of funds. President-elect Barack Obama supports helping the industry. Now similar proposals are proliferating around the globe. "When one of the major powers grants subsidies to a high- profile industry, the other is inevitably led to react by defending its own interests," said Pierre Kirch, a trade lawyer at Paul Hastings in Paris.

In Europe, where car sales fell almost 15 percent in October, the sixth consecutive monthly drop, auto companies are lobbying the EU for 40 billion euros ($50 billion) in loans. Society of Motor Manufacturers and Traders chief Paul Everitt responded to Kroes's comments by calling for either "collective action" or individual country bailouts. "If the U.S. gives aid to carmakers, it's fair to have them in Europe as well," said Gian Primo Quagliano head of research at Bologna, Italy-based research firm Promotor. EU officials are drafting a plan to provide loans through the European Investment Bank to promote clean-car technology. The bank plans to increase overall financing levels by as much as 15 billion euros next year, President Philippe Maystadt said Nov. 14; a portion would go to the auto industry.

German Chancellor Angela Merkel said her government will decide on an aid request from GM's Opel unit by Christmas. Opel asked for "somewhat more than" 1 billion euros in credit guarantees, said Carl-Peter Forster, GM's Europe chief. The state government in Hesse, where Opel employs 15,000 people, agreed to give the company and regional parts suppliers loan guarantees of as much as 500 million euros. Carmakers in the U.K., where sales slid 23 percent in October, have asked for tax cuts and permission for their finance companies to access funding available to British banks. French Finance Minister Christine Lagarde called for national and European "actions" to "support" the industry on Nov. 17.

Canadian Prime Minister Stephen Harper said Nov. 15 that his government may follow any U.S. effort with an aid package for his country's manufacturers and parts suppliers, including Magna International and Linamar Corp. Chinese carmakers also want aid. Slowing demand and rising competition have caused SAIC, the nation's biggest domestic automaker, to tumble 78 percent this year in Shanghai trading. Chen Jianguo, an official with China's National Development and Reform Commission, has said the government is considering lowering sales taxes on alternative-energy vehicles. The government's 4 trillion-yuan ($586 billion) stimulus package may also help, said Winfried Vahland, Volkswagen's China head. "The situation is really severe," said Zeng Qinghong, general manager of Guangzhou Automobile Group, a partner of Toyota Motor Corp. and Honda Motor Co., on Nov. 18. "We hope the government can introduce policies to stimulate demand."

Japanese Finance Minister Shoichi Nakagawa told Bloomberg Television his government probably won't object to the U.S. helping GM because its collapse "would be huge -- not just for America, but for Europe and Japan as well." That doesn't mean Japanese carmakers won't also put their hands out. "If the money is given because bankruptcy would cause a lot of problems, this may be unfair" to Japanese carmakers, said Takeshi Miyao, a Tokyo-based analyst at automotive consulting company CSM Worldwide. "The question of why the Japanese government isn't helping the Japanese carmakers will definitely arise." Any American package will be scrutinized by other countries to see if it runs afoul of WTO rules, which allow certain kinds of subsidies, such as those that protect the environment, but bar others, including payments to exporters.

The EU threatened to lodge a complaint against any U.S. auto package on Nov. 14, when European Commission President Jose Barroso said the bloc was examining the rescue proposal and would "certainly act at the WTO" if it contravenes trade rules. Korean President Lee Myung-bak told CNN on Nov. 17 that he supports a U.S. bailout but warned that it must "give more serious consideration to the method" because it "could run counter to WTO rules and set a bad precedent. Then, other countries may follow the example of the U.S. to directly subsidize their automakers." China "quite possibly" may lodge a WTO complaint if the U.S. bails out its industry, said Kirch, the trade lawyer. "It might also bring a case if Europe does." American automakers scoff at the notion that they may be accused of benefiting from unfair subsidies. "We're the only country in the world that expects its auto industry to exist without some government support," said Sean McAlinden, chief economist at the Center for Automotive Research, at a conference in Los Angeles. The Ann Arbor- Michigan-based group's Web site says it "maintains strong relationships with industry" and others in the "international automotive community."

One of the Americans' biggest gripes involves Japan's currency, which they claim is kept artificially cheap against the dollar. The Automotive Trade Policy Council, which represents GM, Ford and Chrysler, said in October 2007 that the weak yen at that time gave Japanese automakers a $4,000-a-car advantage on their imports to the U.S. Toyota dismisses that argument. "Our vehicles sell well, and are profitable, because our operations are efficient, because our vehicles represent quality and value, and because they represent the needs and wants of the public," Toyota spokesman Bruce C. Ertmann wrote on a company blog in January. "Their profitability has nothing at all to do with some nefarious program of currency manipulation." GM Chief Executive Officer Rick Wagoner has repeatedly complained that his company is disadvantaged by pension and retiree-health costs -- benefits that are heavily subsidized in competitor countries, including Italy, Germany and France. Italy also helps companies like Fiat SpA pay unemployment benefits, making temporary production cuts less expensive.

To be sure, taxes in those countries tend to be higher, offsetting the advantage. Rhys, the automotive economics professor, notes that many European carmakers that were once state-controlled -- such as Renault, Volkswagen and Alfa Romeo -- got loans at preferential rates. Renault, which is still 15 percent-owned by the French government and has enjoyed the most state largesse, would have collapsed without it, Rhys said. "Just about every one of the European automakers, apart from Mercedes, have had a rescue of some sort or another," Rhys said. And Toyota has benefited from Japan's "incredible low cost of credit," he added. "It wasn't technically state aid, but it certainly wasn't the sort of conditions companies in Europe or North America could borrow at." Any complaints that grow out of the current bailout- proposal war will be complicated by the industry's web of cross- border subsidiaries, said Ed Kim, an analyst at consulting firm AutoPacific Inc. in Tustin, California.

If Ford gets U.S. help, that may indirectly benefit Hiroshima, Japan-based Mazda, because the American company owns 13 percent of it. GM controls GM Daewoo Auto & Technology Co. of Inchon, South Korea, and it acquired the bankrupt Daewoo Motor Co. in 2002. Chrysler is negotiating a partnership with China's Chery Automobile Co. Chery already has agreed to provide a model for Chrysler to sell in South America. Back in 1979, when the U.S. bailed out Chrysler, things were "remarkably straightforward" because the company lacked a significant international presence, said Maryann Keller, an independent automotive analyst and consultant in Greenwich, Connecticut. "Chrysler today would be more complicated," she said. "Do we subsidize Chrysler so they can work with Chery and create a stronger automotive competitor?"

Dems to Detroit: No Bankruptcy
The chief executives of U.S. automakers struck out with Congress this week. Despite spending more than eight hours testifying on Capitol Hill, they are going home without the $25 billion bailout package they so desperately need. They will get another swing at the money on Dec. 8. But even if they are able to get the votes they need, the money probably isn't enough to save them. Senate Majority Leader Harry Reid (D-Nev.) and Speaker of the House Nancy Pelosi (D-Calif.) said Thursday, Nov. 20, that General Motors, Ford Motor, and Chrysler will have to prove "financial viability" as well as accountability for how the money will be spent and that it can be paid back.

"Until they show us the plan, we cannot show them the money," Pelosi said Thursday. But the finances of GM and Chrysler in particular are so fragile that many believe the $25 billion would only be a first installment. "What would you do with the money? Where would it go? And if sales don't improve next year, won't you surely be back asking for more?" demanded Representative Donald Manzullo (R-Ill.) at Wednesday's House Financial Services Committee hearing. Senator Richard Shelby (R-Ala.) said Thursday: "It's going to be throwing good money after bad.…I don't believe they [the Big Three] have a business model that works."

GM, for example, reported $16.2 billion in cash at the end of the third quarter. It spent $6 billion of its cash reserves in that quarter, and it's burning about $2 billion a month despite suspending many future product programs to conserve cash. Even if GM's cash burn rate drops in half and it gets $10 billion to $12 billion in loans, it could be close to collapse before the end of next year. Chrysler CEO Bob Nardelli told Congress he needs $5 billion to $7 billion of the $25 billion on the table. At the end of the third quarter, Chrysler had $6.1 billion in cash, but during that July-September period, it spent $3 billion more than it took in. After an infusion of loans, Chrysler would have about $12 billion.

But Chrysler's product lineup is much less competitive than its rivals, with poor quality scores and many more soft-selling SUVs than fuel-efficient cars. Moreover, its traditional buyers have lower credit scores than most, and the company is harder hit than GM or Ford by the credit crunch. Ford is in better shape. But a failure of either Chrysler or GM—and the suppliers that would be taken down with them, warn many analysts—would likely drive Ford to fail as well. Dogging all three companies is the bad publicity around them and talk of possible bankruptcy, which turns away a lot of consumers already spooked by the plummeting stock market, huge layoffs, and grim day-to-day economic news.

"Until the Congress acts and then President-elect Barack Obama goes out and encourages those who are buying a car to trust Detroit, you are going to see a lot of buyers on the sidelines or going to companies that aren't threatening to go under," says independent marketing consultant Dennis Keene. "Consumers are much more emotional than rational when it comes to a big-ticket item like a car." Senator Carl Levin (D-Mich.) said Thursday the legislation he hopes to bring to a vote in a lame-duck session next month is a revision of the 2007 energy bill that granted the automakers $25 billion in loans to retool factories to produce more fuel-efficient vehicles. The revision would make loan money available right away that might otherwise take years to draw down. In exchange, the automakers would have to keep to their plans to make those vehicles—and replenish the fund as they pay back the loans.

But the main hurdle is providing Congress with a detailed plan, by Dec. 2 from each automaker, outlining how the money would be spent and how it would keep each company from going bust, as well as guarantees that the money won't be used outside the U.S. Senator Jon Tester (D-Mont.) said he will be looking for a detailed plan from the automakers that shows how the money will be spent in the U.S., not abroad, and for strict oversight. Tester, unlike many senators at the four-hour Senate Banking Committee hearing Wednesday, sat for the whole session.

"But I never heard anything that said they would change their business model to make them a success," he added. The CEOs repeatedly ran afoul of lawmakers this week who chastised them for flying three separate private jets to Washington to ask Congress for bailout money, and for not doing more to give up their own huge salaries. As the automakers put together their plans, company sources say more attention will be paid to, as one executive said, "symbolic as well as substantive details."

The political problem remaining for Democrats is that automakers will likely need more money, which many Capitol Hill staffers and lobbyists say would likely come from an Obama Administration dispensing additional funds from the $700 billion Wall Street bailout legislation. Obama will have to ask Congress for the remaining $350 million of that money in January after he takes office and spell out what portion he plans to allocate to the auto companies. "The job of automakers next month is to convince Republicans to vote for the first $25 billion, and also to give cover to Obama when he has to tell them he's going to spend another $25 billion later on," said one auto industry executive who asked not to be named. Several industry analysts have warned that Chapter 11 bankruptcy of even one automaker would likely cause a cascade of bankruptcies of one or the other two Detroit automakers and hundreds of suppliers. A loss of 3 million jobs has been forecast.

Many influential Republicans, businesspeople, and pundits have called for the automakers to face Chapter 11 bankruptcy instead of being helped by government loans. The chief reason, they argue, is that it would allow the companies to get out of union contracts that, among other things, require them to pay health benefits of retirees too young to qualify for Medicare. Several members of Congress have cited a New York Times op-ed piece by former Massachusetts Governor Mitt Romney advocating bankruptcy. But Pelosi, echoing Obama and other Democrats, said it's not an option. "We reject those advocating bankruptcy," said Pelosi.

Obama Team Said to Explore 'Prepack' Auto Bankruptcy
President-Elect Barack Obama`s transition team is exploring a swift, prepackaged bankruptcy for automakers as a possible solution to the industry's financial crisis, according to a person familiar with the matter. Obama's team has already contacted at least one bankruptcy- law firm to say that Daniel Tarullo, a professor at Georgetown University's law school who heads Obama's economic policy working group, would call to discuss the workings of a so-called prepack, according to this person.

U.S. lawmakers yesterday postponed until December a vote on whether to give General Motors Corp., Ford Motor Co. and Chrysler LLC a $25 billion bailout as an alternative solution. Automakers such as GM could use court protection to reduce debt and reject unfavorable contracts. "It creates the environment to deal with GM's problems but limits government financial commitment," said bankruptcy lawyer Mark Bane of Ropes & Gray in New York. Bankruptcy is just one option being examined. Obama told CBS News's "60 Minutes" on Nov. 16 that government aid to automakers might come in the form of a "bridge loan," advanced if the industry could draw up plan to make itself "sustainable." The president-elect earlier urged Congress to approve as much as $50 billion to save automakers, using the model of Chrysler's bailout in 1979.

Tarullo referred questions on a prepack to the transition team press office. Team spokeswoman Stephanie Cutter said, "We have not put out anything specific for the auto industry except that something needs to be done immediately." GM, the largest U.S. automaker, said it might run out of cash as early as the end of the year and that the risk was even greater by mid-2009. GM Chief Executive Officer Rick Wagoner said this week GM would have to liquidate if it went into bankruptcy. The automaker probably has weeks rather than months left before it runs out of money unless it gets federal aid, Jerome York, an adviser to billionaire Kirk Kerkorian and a former GM board member, told Bloomberg Television yesterday.

In a prepackaged bankruptcy, an automaker would go into court with financing in hand after reaching agreement with lenders, workers and suppliers on what each would give up and on the business plan to be followed. The process might take six to 12 months, compared with two to five years if the automakers followed an ordinary Chapter 11 proceeding and worked out agreements under a judge's supervision, Bane said. Automakers would have to depend on government financing to restructure in bankruptcy court and probably couldn't attract private loans until they were ready to emerge from the process, Bane said.

Officials of the three automakers told members of Congress this week that they had studied a pre-arranged bankruptcy, championed by Republican lawmakers such as Senator Bob Corker of Tennessee, before dismissing the idea as unworkable. "We have looked at all aspects, whether it's a prepackage, whether it's prenegotiated," Chrysler CEO Robert Nardelli told a Senate committee on Nov. 18. The options are all "more negative" than restructuring as a condition of receiving federal aid, he said. Wagoner and Alan Mulally, CEO of Dearborn, Michigan-based Ford, also said under congressional questioning that their companies had studied and rejected the idea of reorganizing under court protection.

House Speaker Nancy Pelosi said yesterday that Democrats reject bankruptcy as an option. In or out of court, automakers will have to submit a viable business plan to gain government funds, Peter Peterson, senior chairman of Blackstone Group LP, said in an interview. "Unless they can show us the plan, we can't show them the money," Pelosi said yesterday. GM, Ford and Chrysler must submit viability plans by Dec. 2, and Congress would meet the week of Dec. 8 to consider aid, Senate Majority Leader Harry Reid said yesterday. Congress must see accountability from automakers, Pelosi said. The congressional deadlock was triggered by disagreement over how to pay for the $25 billion the Big Three automakers are seeking.

Democratic leaders have demanded that the recently approved $700 billion bank-rescue fund be tapped for the auto aid. Their plan stalled with opposition from Republicans and President George W. Bush`s administration. The Bush administration joined Levin, Missouri Republican Senator Christopher Bond and others pushing the alternative that would tap the fuel-efficiency loans instead. "There are other alternatives" to a bridge loan for automakers, Senate Financial Services Chairman Christopher Dodd, a Connecticut Democrat, told reporters yesterday. "The prepackaged bankruptcy is not an idea without constituency here."

A GM bankruptcy is the "only way" for the biggest U.S. automaker to end union costs that make it uncompetitive, Republican Senator James DeMint of South Carolina said in an interview on Bloomberg Radio. "I look at the Republicans that say it shouldn't be saved and should be in Chapter 11, and I agree with that," said James Harris, President of Seneca Financial Group Inc., a restructuring advisory firm in New York. "I look at the Democrats that say these businesses are very important to the economy, and I agree with that, so the logical step is a prepack," with some government financing, he said. Treasury Secretary Henry Paulson said the $700 billion of the Troubled Asset Relief Program shouldn't be used to rescue automakers. "There are other ways," he said at a Nov. 18 House hearing. Treasury Department spokeswoman Brookly McLaughlin declined to comment on the prepack proposal.

The collapse of GM would cost the government as much as $200 billion should the biggest U.S. automaker be forced to liquidate, Nariman Behravesh, chief economist at IHS Global Insight Inc. in Lexington, Massachusetts, estimates. A GM failure would mean "more aid to specific states like Michigan, Ohio, and Indiana, and more money into unemployment and extended benefits," Behravesh said Nov. 15. The domino effect could be "scary," said bankruptcy lawyer Martin Bienenstock of Dewey & LeBoeuf who teaches corporate reorganization at Harvard Law School and the University of Michigan Law School.

Bankruptcy would trigger failures of auto parts suppliers and dealerships, he said. Securitized auto loans and their insurers would fail, creating ripples through the credit markets, he said. "The difficulty is assuring the American people that the bailout money won't simply defer the company's failure for six to 12 months," Bienenstock said.

Democrats demand Big 3 offer survival plan
Democratic congressional leaders, seeking to salvage a bailout of the Big Three automakers, demanded executives provide a business survival plan in exchange for their support of up to $25 billion in loans. The ultimatum came on Thursday after the Democratic leaders failed to persuade the White House and congressional Republicans to use part of a $700 billion financial rescue fund to prop up the auto industry. Hanging in the balance is the future of General Motors, Ford Motor and Chrysler LLC, whose losses have mounted during a severe economic downturn that has prompted Americans to largely stop buying cars.

Shares of GM and Ford rebounded from multi-decade lows as the developments in Washington kept bailout hopes alive. While many lawmakers are anxious to see the companies survive, Republicans have been more wary of whether the money would really help, and Democrats have been more inclined to be generous to the huge employers of unionized labor. Democratic leaders acknowledged on Thursday a growing public resentment over government bailouts of U.S. business in slowing the automakers' demands, saying they will take a look after the auto industry provides a roadmap to its survival.

House of Representatives Speaker Nancy Pelosi, a California Democrat, and Senate Majority Leader Harry Reid, a Nevada Democrat, told a news conference that the automakers must develop a bailout proposal by December 2 and it would be considered during the week of December 8. "Until we can see a plan where the auto industry is held accountable and a plan for viability on how they go into the future... we cannot show them the money," Pelosi said. Said Reid: "We can only help if they (the automakers) are willing to help themselves." Both General Motors and Ford pledged to cooperate.

Amid warnings that General Motors might be facing bankruptcy by the end of the year, a bipartisan group of U.S. senators sketched out a possible compromise. The White House said President George W. Bush could support the proposal spearheaded by Sen. Carl Levin, a Michigan Democrat, and Sen. Christopher Bond, a Missouri Republican, to allow automakers and their suppliers to use $25 billion in Energy Department loans for greener cars to address their current crisis. The senators attached a heavy Washington hand. They proposed letting the government veto any auto investments or asset sales over $25 million. Keeping a low profile was President-elect Barack Obama, who earlier in the week said U.S. automakers needed a government rescue but the help should be conditioned on changes in the industry.

The Big Three's executives testified on Capitol Hill this week about their dire economic situation, but undercut their argument by flying to Washington aboard corporate jets instead of taking cheaper transportation. "I know it wasn't planned, but these guys flying in their big corporate jets doesn't send a good message to people in Searchlight, Nevada, or Las Vegas, or Reno, or any other place in this country," Reid said. The automakers' woes have added to a chaotic U.S. economic picture, with fears that a failure to get a bailout would lead to thousands more layoffs and deepen what many economists believe are recession conditions.

In Detroit, United Auto Workers President Ron Gettelfinger said lawmakers need to take immediate action on a $25 billion loan bill to support the U.S. automakers or one or more could fail by the end of the year. "Inaction is simply not an option," he said. Transplanted automakers are also feeling the pinch. Honda Motor Co Ltd said on Thursday it would cut another 18,000 units from its planned U.S. production in response to the industry downturn. A bankruptcy of one or all of the Big Three could shake vast sections of the U.S. economy, an argument Democrats have emphasized. Some Republicans have argued a bankruptcy could allow the companies to make structural changes needed to assure their long-term survival.

Many analysts believe the Big Three need massive restructuring to reduce their costs and to produce cars that Americans will buy, after years of making gas-guzzling sport utility vehicles that have fallen out of favor after people got a taste of $4-a-gallon gasoline over the summer. The White House and its Republican allies on Capitol Hill have drawn the line against extending part of the $700 billion financial industry bailout to the Big Three saying that could prompt other sagging industries to seek a government handout. Instead, they have called on Democrats to back amending the $25 billion earmarked in September for meeting new fuel-efficiency standards as the way to help the Big Three.

Clint Currie, a transportation analyst at the Stanford Group in Washington, said he believes Congress will pass a bailout with harsh terms for the industry in January. Senior management might have to leave and there might be major mandates for restructuring attached, he said. "I think there's a fairly high likelihood that they'll pass an auto bailout in January, and from all indications it's not going to be something they're going to like," he said. "They're going to have to take it or leave it at that point." Although share gains were tempered after Reid and Pelosi's criticism, GM closed up 3.2 percent at $2.88 and Ford ended 10.3 percent higher at $1.39, both on the New York Stock Exchange. Chrysler is owned by Cerberus Capital Manageme

Four senators reach bipartisan auto aid deal
Four senators have reached a bipartisan agreement on a bill to assist the struggling automotive industry, the lawmakers announced in a joint statement on Thursday. A news conference was planned for 2.30 p.m. "to discuss the details of a bipartisan agreement on a bill to support the auto industry," the statement said. The lawmakers involved are Michigan Democrats Carl Levin and Debbie Stabenow, as well as Ohio Republican George Voinovich and Missouri Republican Christopher Bond.

U.S. automakers General Motors, Ford Motor and Chrysler have been pleading for $25 billion in emergency government aid to weather a steep business downturn. The CEOs of all three companies testified before two congressional committees this week, but came away empty-handed. Shares of GM and Ford turned positive on news of the compromise bill. Chrysler is privately held. The White House favors using $25 billion already authorized and appropriated through the Energy Department to provide loans for ailing automakers.

Democratic leaders in Congress have argued for carving out $25 billion from the $700 billion financial rescue fund. Even with a deal among Senate negotiators, the legislation faces hurdles. There would have to be agreement among all 100 senators, which is rare, to allow the bill to come to a quick vote in the Senate. If that agreement is not reached, the earliest a vote might come is on Saturday and it was unclear if lawmakers would stay in Washington that long ahead of the November 27 Thanksgiving holiday.

Plus, any bill likely would need at least 60 votes to overcome anticipated procedural hurdles by opponents. Also unclear is whether the House of Representatives would stay in session late this week. Another possibility is a vote on an auto bill sometime after the Thanksgiving holiday. Earlier this week, House Speaker Nancy Pelosi ruled out a post-holiday session. But Senate Majority Leader Harry Reid said he would talk to Pelosi later on Thursday about having another short work session.

The Ill-Considered Problem of a GM Bankruptcy
Let us start with the basics. Like it or not, for GM to go under risks a disaster of colossal proportions. Although Lehman, the biggest bankruptcy in US history, appeared to have an orderly settlement of its credit defaults swaps, the disruption occurred before-hand, as protection writers had to post additional collateral PRIOR to settlement. That in turn was a major factor in the horrific downdrafts in October.GM is bigger, ergo bigger collateral damage, and this would take place when the financial system is even weaker than when Lehman hit the wall.

However, a second, and potentially far more damaging issue, may have been largely overlooked. The proponents of letting GM go argue that it can go into Chapter 11 just like other big companies that get themselves in trouble. That may not come to pass, and a Chapter 7 (liquidation) would be a seismic event.

We have noted more than once on this blog that debtor-in-possession financing, along with other forms of credit, has become virtually non-existent and costly. DIP is essential for most Chapter 11 bankruptcies. Why? It actually takes time to get the plan of reorganization approved by creditors and the courts. Most companies, and GM is in that category, head to bankruptcy court when they are at the end of their rope liquidity-wise.

So how do they keep the business going and also pay that army of attorneys they need to get through court? That is where DIP financing comes in. DIP is specifically for companies in, or on the verge of bankruptcy, and the debt is generally senior to other outstanding creditor claims. So it is actually very low risk (the amount spent to shepherd a company through the bankruptcy process is usually not large, relatively speaking), but many types of lending are being severely curtailed right now.

GM would be a massive bankruptcy. It is doubtful whether it could obtain enough DIP financing, which means it might be forced into a partial, perhaps a full liquidation. The ramifications are nightmarish. Aside from the loss of jobs at GM itself (100,000), GM's business is critical to keep many US auto suppliers in business. No GM, pretty soon you see most, possibly even all. of the auto suppliers go under. And those parts suppliers are important to OTHER auto makers. Many foreign car factories would be shuttered due to loss of suppliers. Some analysts put 2009 job losses from one automaker failure as high as 2.5 million due to the knock-on effects.

Now the government could provide the DIP directly. While that idea is does not appear to be on the table, that would solve this conundrum. A government guarantee worked with Chrysler, but given how skittish investors have been over the less than full faith and credit status of Fannie and Freddie debt, it isn't clear that guarantees to possible DIP providers would be as effective as one would hope (look, the government is already yelling at banks to lend, and they aren't).

Normally, you'd expect the government to blink in this game of chicken. What has me worried is the demand for GM to produce a plan in twelve days. Mind you, I think the plan is a great idea. GM should say what it plans to do with the dough and how it plans to straighten itself out. But twelve days to conceive a grand strategy and price it out? Now normally would just be part of a ritual: Congress goes through the motions of due diligence and appears to reluctantly hand out the dough, presumably after making management sweat a little and the unions sweat more.

No, what has me worried is that GM asked for $25 billion. I suspect that if they sharpen their pencils they will determine they need more (I am not saying they deserve more, but GM is a huge mess. and the guys at the helm don't have a clue how to fix it, and with the economy tanking, even if they do all the right stuff, it will take years before you see it in the bottom line). If they ask for more, or cannot truthfully say they will not be back asking for more (the only acceptable answer to this question) the negotiations could go off the rails. The private jet ride to DC was a warning sign that this crowd is capable of blowing a deal that would otherwise be made.

FDIC May Exclude Shortest-Term Loans From Debt Plan
U.S. bank regulators may exclude the shortest-term loans from a $1.4 trillion debt-insurance program, helping the Federal Reserve avoid further unpredictable swings in the country's main interest rate. Federal Deposit Insurance Corp. staffers are likely to recommend excluding loans that mature in 30 days or less, which would encompass overnight interbank loans at the rate targeted by the Fed, a person briefed on the plan said on condition of anonymity. FDIC Chairman Sheila Bair and other board members are scheduled to vote today on regulations governing the plan.

The Fed has failed for two months to keep the federal funds rate close to the target set by policy makers because of more than $1 trillion of loans flooding the banking system. The original FDIC proposal required fees to insure debt, spurring complaints that it would lead to an exodus from the $250 billion market for overnight loans between banks. "It would have made the fed funds rate even more unpredictable," said Lou Crandall, chief economist of Wrightson ICAP in Jersey City, New Jersey. "The FDIC would not want to interfere with a market that has been working, functioning efficiently."

The recommendations or final rule might change before the vote, which will occur during a 2 p.m. meeting at the FDIC's Washington office. Spokesman Andrew Gray declined to comment. Bair, in a speech yesterday in Baltimore, said the agency will "assure a prompt payment mechanism" on debt it guarantees, as well as set variable pricing depending on the debt's maturity. JPMorgan Chase & Co., Bank of America Corp. and Goldman Sachs Group Inc. were among banks that told the FDIC its program lacked a strong enough guarantee. "These changes will create significant investor demand, and dramatically reduced funding costs for eligible banks and bank holding companies," Bair said.

The FDIC is offering the insurance on senior unsecured debt through its Temporary Liquidity Guarantee Program, which also includes expanded deposit insurance for business checking accounts. Companies including JPMorgan Chase & Co. and Bank of America Corp. said the original proposal threatened to make the overnight federal funds market too costly compared with alternatives such as direct loans from the Fed. The Fed sets monetary policy by targeting a level of the federal funds rate, currently 1 percent. Yet the central bank's record injections of liquidity have driven the rate to less than half that level. At the same time, the Fed's rate on direct loans to commercial banks and bond dealers is 1.25 percent and isn't subject to market fluctuations.

The FDIC had proposed charging a standard fee of 0.75 percent to insure all eligible senior unsecured debt. Banks, in comments to the agency, argued that the federal funds market should be treated differently. Rates on short-term loans between banks have tumbled since authorities devised the program. The London Interbank Offered Rate, or Libor, on one-month dollar loans has dropped to 1.40 percent from 4.47 percent on Oct. 14, when the FDIC announced the debt-insurance program. Overnight Libor has declined to 0.44 percent from 2.18 percent.

The FDIC program, separate from Treasury Secretary Henry Paulson's $700 billion bank bailout, is aimed at providing a broad backstop for interbank lending. The FDIC rolled out the plan after European governments announced debt guarantees. As laid out in the interim regulation, the FDIC was to guarantee all new senior unsecured debt issued between Oct. 14 and June 30, 2009, up to a cap that will be set for each institution when it signs up. Coverage expires on June 30, 2012.

3 days after Fannie Mae, Freddie Mac also gets delisting notice from NYSE
Mortgage finance company Freddie Mac said Friday it received a noticed that it may lose its listing on the New York Stock Exchange because its share price has been under $1 for more than 30 days. Freddie Mac, in a Securities and Exchange Commission filing, said it received the notice on Monday. The NYSE requires that the average closing price of a stock remain above $1 per share. Freddie Mac said it has not yet determined its response or any specific action it will take as a result of the notice.

If the company decides to rectify the deficiency, it would have six months from Nov. 17 to bring its common stock and average share price for 30 consecutive trading days above $1. Shares of Freddie Mac and sibling company Fannie Mae have traded below the $1 mark for much of the time since they were seized by federal regulators in September. Fannie Mae stock, which a year ago was trading as high as $40.45, closed at 47 cents Tuesday.

Fannie Mae and Freddie Mac, which own or guarantee around half of the $11.5 trillion in U.S. outstanding home loan debt, operate in a conservatorship that enables the government to inject up to $100 billion in each company in exchange for ownership stakes of almost 80 percent. Freddie Mac has asked for an initial injection of $13.8 billion in government aid, while Fannie Mae has not yet tapped the government lifeline. Shares of Freddie Mac added 1 cent to 50 cents in morning trading. The stock -- which hit a 12-month high of $37.18 last December, slid to a low of 25 cents in September, and is off nearly 99 percent since January.

Fannie, Freddie Halt Foreclosures for Holidays
Fannie Mae and Freddie Mac announced yesterday that they are temporarily suspending foreclosures and evictions during the holiday season in an effort to keep people from losing their homes. The companies said they are taking the step so they can include more people in a newly announced program to change the terms of troubled mortgages to make them more affordable. The mortgage finance giants, seized by the government in early September, have been under pressure by lawmakers and housing advocates to take bolder steps to fight foreclosures. As the owners or backers of trillions of dollars of mortgages, the companies have an unrivaled ability to shape the home loan market and help people with distressed mortgages.

Last week, the companies said they would enact a program to restructure mortgages for borrowers who are falling behind in their payments. That effort would seek to help homeowners who haven't paid their loans for three months but whose homes had not been foreclosed upon yet. In a foreclosure, Fannie Mae or Freddie Mac seizes control of a home and, usually, tries to sell it. The foreclosure freeze announced yesterday will extend the mortgage modification program to those who have been declared in default and are at immediate risk of being forced from their homes. The companies said as many as 16,000 borrowers could benefit. Foreclosures and evictions will be stopped from Nov. 26 to Jan. 9.

"With this suspension, seriously delinquent borrowers may have an opportunity to avoid foreclosure and work out terms to stay in their homes," said Federal Housing Finance Agency director James B. Lockhart III, the regulator in charge of Fannie Mae and Freddie Mac. Under the mortgage modifications program unveiled last week, Fannie and Freddie will seek to modify loan terms to ensure borrowers aren't paying more than 38 percent of their monthly pretax salary on their mortgage. The companies will do this by extending the total term of loans to up to 40 years, reducing the interest rate, and, in some cases, delaying payment on part of the loan. The program will begin Dec. 15. Attorneys working for Fannie Mae and Freddie Mac will contact borrowers facing foreclosure.

"Until the streamlined modification program is fully implemented, we felt it was in the best interest of both borrowers and Fannie Mae to take this extra step to ensure that homeowners with the desire and ability to prevent a foreclosure have an opportunity to stay in their homes," Fannie Mae chief executive Herbert M. Allison said in a statement. Freddie Mac chief executive David M. Moffett said his company is on track to help three out of five troubled borrowers with Freddie Mac-owned loans avoid foreclosure. "Today's announcement builds on this momentum and provides a new measure of certainty to many of these families during the holidays," he said in a statement.

The foreclosure freeze will apply to single-family homes that continue to be occupied. Freddie Mac's program also applies to buildings with two to four apartments. Fannie and Freddie have launched other programs as well. A Fannie Mae program requires employees to take a second look at delinquent loans to ensure the borrower has been contacted and other options have been considered. Freddie Mac gives authority to mortgage lenders to renegotiate loans and offers them financial incentives to do so. "We must and will do more," Allison said.

US seeks $300 billion from Gulf states
The United States has asked four oil-rich Gulf states for close to 300 billion dollars to help it curb the global financial meltdown, Kuwait's daily Al-Seyassah reported Thursday. Quoting "highly informed" sources, the daily said Washington has asked Saudi Arabia for 120 billion dollars, the United Arab Emirates for 70 billion dollars, Qatar for 60 billion dollars and was seeking 40 billion dollars from Kuwait.

Al-Seyassah said Washington sought the amount as "financial aid" to face the fallout of the financial crisis and help prevent its economy from sliding into a painful recession. The daily said the United States plans to use the funds to help the ailing automobile industry , banks and other companies suffering from the global financial turmoil. The four nations, all members of OPEC, produce together 14 million barrels of oil per day, around half of the cartel's production and about 17 percent of world supplies.

The four states are estimated to have amassed close to 1.5 trillion dollars in surplus in the past six years due to high oil prices that rocketed above 147 dollars in July before sliding to just above 50 dollars. The daily also said that the United States has asked Kuwait to forgive its Iraqi debt estimated at around 16 billion dollars.

Europe's superbank EIB enters perilous waters
The European Investment Bank, the world's largest multilateral lender, has seen its arrears rate surge over recent weeks, prompting concern over its ability to fulfil its new role as the spearhead of Europe's spending blitz. The bank said its ratio of non-performing loans has already rocketed from almost zero earlier this year to "nearer 1pc" in October as a result of the "current financial crisis", suggesting that recent expansion into Eastern Europe may have come at a price. A spokesman said the EIB could not elaborate until the audited books are published next year.

Tucked away on the Kirchberg Plateau in Luxembourg, the EIB is a powerful arm of EU policy, using its AAA credit-rating to raise some €45bn (£38bn) a year on global bond market to finance ports, roads, sewers, and lately high-tech projects. Its loan portfolio is three times as big as the World Bank's. Italy's finance minister, Giulio Tremonti, has long sought to turn the bank into a sort of EU treasury, with the task of funding a "New Deal" for Europe. This is now becoming a reality as it takes on an ever bigger role in Europe's rescue plans. The mission creep is a risky game. What remains to be tested is whether investors will keep buying bonds from a body evolving into an all-purpose fireman. At the end of the day, the EIB has no sovereign entity behind it.

Hedge funds are already on the prowl. The EIB must roll over €29bn in loans next year, mostly clustered in the first half. "We will be watching very closely to see what happens," said the manager of one US 'global macro' fund. A leaked draft of the European Commission's plan for the EU's €130bn fiscal stimulus plan includes proposals to boost the EIB's lending power and to use it for up to €15bn in soft loans to Europe's car industry. "Extraordinary circumstances require extraordinary measures," said the EU's industry commissioner Gunther Verheugen.

The EIB is not allowed to plug the budget holes of EU states or cover balance of payments deficits, but this is a grey area. There are already signs that the EIB is being used for covert rescue missions. Latvia received approval for a €600m loan package on October 30, much of it on vague terms. It came after the economy contracted by 4pc in the third quarter. Latvia's government said today that it is seeking a joint EU/IMF bail-out. The EIB lent €45bn last year. It has €340bn of outstanding loans, based on call-able capital of €165bn from the EU's 27 states. This is mostly a promise by these states to provide the money – if push ever comes to shove.

Fitch Ratings says the bank's AAA credit grade is still safe, but has expressed concerns over its expansion into the ex-Soviet bloc and its growing role as a lender to small business. "This could add pressure to the bank's risk profile," it said. The agency said the EIB has a "high gearing ratio", with a liquid assets portfolio of just 9.7pc of total assets. The credit default swaps (CDS) measuring bankruptcy risk on EIB debt have risen modestly since mid-2007, from 4 to 25 basis points. The spreads are lower that those of key states that underpin the EIB – Germany (31), France (45), and Italy (123). This is an anomaly, creating arbitrage opportunities for hedge funds.

Marc Ostwald, a bond expert at Insinger de Beaufort, said the EIB needs to move with care in the current markets. "How much can the EIB borrow and still remain a viable institution? At some point people are going to say it is just leveraged capital," he said. The bank risks the fate of Fannie Mae, Freddie Mac, and other US chartered agencies. For a long time these bodies were able to borrow cheaply under an "implicit guarantee" from the US government. The guillotine has come down abruptly as market psychology shifts. Investors have decided for political reasons that $1.5 trillion of US agency debt is not the same as US Treasury debt at all. This has come as a brutal shock.

How Dubai's fantasy skyline tumbled to earth
The fireworks have fizzled out, 4,000 lobster shells are being scraped into the bins, and Lily Allen's probably reaching for the paracetamol – but, she won't be the only person in Dubai with a hangover today. Yesterday saw the opening of the Atlantis Palm Jumeirah Beach, yet another flash new architectural marvel in Dubai, augmented by yet another onslaught of superlatives, celebrities, and headlines across the world.

Come this morning, it's not just the champagne that's gone flat. It has finally happened: the Dubai bubble has burst. Architecture-spotters like myself have looked on in amazement, or rather incredulity, at the way the tiny emirate has continued to unveil ever grander construction projects – taller skyscrapers, huger hotels, vaster artificial islands – in apparent defiance of the global credit crunch. Now, that crunch has hit home. This week's Architect's Journal reports that "architects and developers in Dubai are freezing recruitment and making redundancies as the emirate's real-estate market begins to crumble." Large developers in Dubai are laying off staff, including Emaar the company behind the Burj Dubai, the world's tallest structure, the magazine reports.

Other headline-grabbing projects like the Palm Deira, the next artificial island planned off the coast, are on hold indefinitely, and foreign architects and construction specialists out there, such as RMJM and Ramboll Whitbyird, are making staff cuts or freezing recruitment as a result, says the AJ. According to one British architect I spoke to, who was in Dubai just 10 days ago, the situation is even worse than that. "Projects are being pulled left right and centre," he said. "Unless they've been funded by a sovereign wealth fund, they're being pulled. A lot of things have to be redesigned more cheaply, to sell at lower prices. Where people have made first down payments on projects, they're not making the second one. And a lot of what has been completed will be standing empty."

Not that anyone in Dubai will officially admit any of the above. The general climate is one of denial, say insiders. "Nobody wants to lose face, and everybody's trying to put a gloss on bad news. No one's come out and cancelled anything, but a lot of things are 'on hold' indefinitely." Dubai's "build it and they will come" philosophy has worked spectacularly so far. It has successfully jostled itself on to the world stage, largely by pulling off previously unthinkable architectural feats and boosting them to the skies with juicy publicity. Remember when David Beckham was buying a house on the Palm? How many people have seen him there since? Still, the publicity worked: properties on the Palm changed hands for huge sums before they were even built, peaking at a preposterous £5m. Today those houses are apparently closer to £1.8m, down from £2.7m just two months ago.

Reality however, has finally come to town: the Dubai Financial Market – the general stock index – has fallen from a high of 6,315 earlier this year to just 2,012 yesterday. Emaar's share price has plummeted 79% in less than a year; according to some estimates, property prices have fallen by as much as 49% in parts of the Dubai market. The overall figure is much lower, in the region of 4%, but this is a place that's become accustomed to its figures only going in one direction and a lot of people are being caught out by the turnaround. So now, it's more a case of "don't build it, because nobody can afford to come." The general destruction of wealth in the rest of the world will not help Dubai's tourist industry either. Fewer people have the income to afford a Dubai-standard holiday, and even those who do might be put off by the authorities' response to the recent "sex on the beach" scandal, in which two Britons were jailed for three months for their public canoodling.

Needless to say, we can expect discounts on rooms at the Atlantis Palm Jumeirah Beach pretty soon. We cannot simply write off Dubai though. It's already too well established for that and it's still in a very strong position to emerge as a dominant global financial centre, having taken less of a battering than, say, London or New York in the past year. The Burj Dubai is likely to remain the tallest building in the world for quite some time (surely nobody in the world has the appetite to challenge it?), but for the time being, the elaborate man-made coastline of the future that has become Dubai's abiding image is likely to remain just that – an image.

How Russia might devalue the rouble and when
The Russian rouble is heading for further devaluation after the central bank spent $58 billion in two months to support the rouble and Urals crude, its main export commodity, fell to $45 per barrel . While Russian officials have said there will be no sharp fluctuations in the rouble's exchange rate, analysts say they can no longer ignore macroeconomic fundamentals which suggest that the currency is too strong. In such an environment the central bank and the government have a limited number of policy options. Three are outlined below, based on interviews with officials, analysts and traders.

- The central bank will allow the rouble to devalue in small steps, combining this with a gradual increase in interest rates. It will time the moves to surprise the market. The central bank may also take advantage of any temporary dollar weakness or increased demand for roubles, for example to meet tax payments, to make the moves against the dollar/euro basket less noticeable to a population which tends to focus on the dollar/rouble rate . The central bank is running a managed float of the rouble, keeping it stable against the basket, made of 0.55 dollars and 0.45 euros . It allowed the rouble to weaken by 1 percent against the basket on Nov. 11.

Households and firms expect the rouble to weaken more and have been converting their cash holdings into foreign currency. Such actions contributed to capital flight and an ongoing speculative attack on the rouble. The risk is that the gradual weakening will boost devaluation expectations without a firm guidance on where such devaluation would stop. As such it should be combined with clear communication from the central bank on its policy goals. The moves could be timed so as to lessen the pain for major Russian firms facing large foreign debt redemptions.

- The central bank removes its support for the rouble allowing the market to find a floor. After such a large fall, a partial recovery would be likely to follow. A one-time large devaluation would be badly received by the public and undermine political stability. It would contradict public statements by both Prime Minister Vladimir Putin and President Dmitry Medvedev, and could crush fragile public confidence in economic policy. However, it will bring the desired flexibility to the rouble exchange rate and make currency speculation very much a two-way bet.

The central bank wants to move to an inflation-targeting regime and freely floating exchange rate in the medium term, and has said it will widen the rouble's trading band further as part of the transition. The bank is also seeking to keep speculators guessing. The fact that major international players are starved of liquidity due to the global crisis has helped the central bank to hold out. Such a devaluation would benefit Russian exporters but would likely be offset by losses on foreign currency denominated debt payments. Some analysts see this ambiguity as the primary reason for the central bank's lack of action on the exchange rate.

- The government may also combine either of the above mentioned scenarios with a clampdown on speculators. A new draft law, currently in the works, will give the central bank sweeping powers to control how the state funds made available to banks and companies is spent. The government may also introduce some exchange and capital movement controls to hinder currency speculation and capital flight but officials have so far indicated they preferred "softer" forms of control.

Argentine Stocks Threatened as Biggest Holders Seized
Argentina’s stock market is fading as the state seizure of the nation’s biggest shareholders undermines investor confidence and threatens an equity sell-off. The Argentine Senate last night approved President Cristina Fernandez de Kirchner’s plan to nationalize about $24 billion in private pensions, a move opposition parties called a cash grab and the government said is a way to protect retirees from the worst financial crisis since the Great Depression. For the Buenos Aires Stock Exchange, the government’s decision underscores the growing irrelevance of a market whose listed stocks dropped to 82 from a record 669 four decades ago and is discouraging outside investment because of capital restrictions.

"It’s a substantial blow to the capital markets," said Eduardo Costantini, the 62-year-old chairman of Buenos Aires- based real-estate and asset management group Consultatio, the sole Argentine company to go public this year. "The only long- term investor with characteristics of the pension fund industry disappears with this." The funds, known by their Spanish acronym AFJPs, hold about a quarter of shares available for public trading in Argentina, data compiled by the companies show. They were net buyers of shares for a third month in September as the benchmark Merval index tumbled 10 percent and emerging-market funds pulled out.

Argentina’s index is down 60 percent this year, compared with the 51 percent decline in Brazil’s Bovespa index and 38 percent slide in the Mexican Bolsa. Argentina’s economy, which slipped into a recession after the government defaulted on $95 billion of debt in 2001 before recovering, is headed for a slowdown. That may lower tax revenue and hurt its ability to meet debt payments, according to Goldman Sachs Group Inc. economist Pablo Morra. The government is taking over pension funds as MSCI Inc., whose stock indexes are tracked by investors with $3 trillion in funds, prepares to remove the biggest stock, Tenaris SA, from its Argentine measure and considers downgrading the nation to frontier from emerging-market status.

"Put all those together and it really spells the death knell of the Argentine equity market as a place where foreigners want to invest," said Citigroup Inc. strategist Geoffrey Dennis. Citigroup this week cut its recommendation for Argentina to "zero" from "underweight." In 1995, a year after the AFJPs were set up to help bolster capital markets, Argentina’s share of emerging market equity fund investments was 4 percent, making it the third most invested Latin American market after Brazil and Mexico, according to fund flow tracker EPFR Global in Cambridge, Massachusetts. That shrank to 0.5 percent at the end of September, putting it in fifth spot among regional peers. The pension funds’ assets include 6.8 billion pesos ($2 billion) held in local stocks, according to Argentine regulators. They will be transferred to the state-run social security agency as part of the government’s decision.

The funds invested about $144 million in domestic equities in September, according to Deutsche Bank AG. Foreigners have been selling at the fastest pace in eight years. Emerging-market funds sold about $340 million in Argentine stocks through September in the biggest outflow since 2000, according to EPFR. The government forced the pension funds to sell more than $500 million in Brazilian stocks in a three-day fire sale last month, as Amado Boudou, the head of the social security agency Anses, said pension accounts shouldn’t hold any foreign assets. In an Oct. 28 speech to lawmakers, Boudou vowed to "protect the value" of the AFJPs’ domestic equity holdings and said the government won’t "rush out and sell at any price." While Mariano Kruskevich, an analyst with Grupo SBS in Buenos Aires, said the social security agency is unlikely to begin a broad sell-off of local stocks given the "shallow" market and continuing credit crisis, some investors speculate it’s possible.

Holdings in individual companies probably will be cut to a maximum of 10 percent over five years, Ambito Financiero newspaper reported Oct. 27, citing people it didn’t name at Anses. AFJPs own at least 20 percent of companies including Buenos Aires-based Telecom Argentina SA and Siderar SAIC. Anses press officials didn’t return phone or e-mailed requests for comment. "If emerging markets stabilize, I think they’ll look to sell whenever they can," said Greg Lesko, who helps manage $1 billion at Deltec Asset Management in New York, including Latin American shares. "A fire sale wouldn’t serve anybody’s interest. They’ll probably do their best to time it. A lot’s going to do with what’s going on in the rest of the world."

The pension nationalization also will hurt Argentina’s asset management industry, which oversees the AFJPs’ foreign holdings, and eliminate demand for share and debt issues, Consultatio’s Costantini said. His company, which raised about $100 million in an initial public offering in May, probably will be the last IPO for "a long time," he said.

California median home price drops 34 percent
Despite an increasingly uncertain economy, homebuyers in California kept snatching up foreclosed homes last month, dragging down the median home price by 34 percent from a year ago, a real estate tracking firm said Thursday. The statewide median home price plunged to $278,000 in October, compared with $424,000 in the year-ago period, according to San Diego-based MDA DataQuick. Last month's median price was down 1.8 percent from September.

About half the drop in the median price was due to depreciation, while the other half came from a shift in sales toward distressed homes and the way those homes are financed, DataQuick said. "What happens next to housing will be determined by the fate of the economy, and especially the job market, as well as the outcome of recently announced efforts to curb foreclosures," John Walsh, MDA DataQuick's president, said in a statement. Despite efforts by government, lenders and others to help strapped homeowners with mortgage payments, foreclosures have continued to rise in California, particularly in inland counties with metro areas such as Stockton, Merced, Riverside, San Bernardino and Modesto.

But the worsening U.S. economy is not dissuading buyers with bargain home prices in their sights, although the latest figures represent homes that closed escrow in October on sales that were initiated probably as far back as August. Statewide home sales jumped nearly 64 percent from a year ago to 42,293 and nearly 5 percent from September. October's sales were the strongest since December 2006, when 43,431 homes were sold, according to DataQuick, which has kept the statistics since 1988. Once more, foreclosure resales accounted for a major slice of sales last month -- nearly 53 of the preowned homes sold.

The trend was evident in a nine-county region around San Francisco Bay, where nearly 45 percent of the preowned homes sold last month had been in foreclosure at some point in the last 12 months. Most of that area's distressed sales took place in Contra Costa, Napa and Solano counties. In all, home sales in the San Francisco Bay Area climbed nearly 39 percent in October from a year ago to 7,613 and nearly 5 percent from September, MDA DataQuick said. In pricier San Francisco County, where the median price slipped 12.1 percent to $699,000 from a year ago, sales plunged 21 percent.

The median home price in the region tumbled 41 percent to $375,000 in October, compared with $631,000 in the year-ago period. The region's median price last month was down 6.3 percent from September and nearly 44 percent from the peak median of $665,000 in the summer of 2007. Contra Costa County saw the steepest drop in price, with the median tumbling more than 46 percent to $285,000 from a year ago. Sales in the county soared by nearly 87 percent. Meanwhile, a six-county region of Southern California also saw a sharp jump in home sales and a decline in median price last month. Sales in the region rose by 67 percent, while the median home price fell 33 percent to $300,000, MDA DataQuick reported Tuesday. Foreclosure resales amounted to 51 percent of all transactions in the region.

Another £3 billion of taxpayer money at risk in Northern Rock
Another £3bn of taxpayer money has been put at risk in Northern Rock after the nationalised lender's off-balance sheet funding vehicle, Granite, was put in to run-off yesterday. Northern Rock triggered the £37bn vehicle's wind-up by breaching rules on the size of cushion provided by the nationalised bank to Granite's institutional bondholders. By declining to transfer any more mortgages into Granite, the lender reduced its collateral below the contractual 8.2pc minimum.

The "non-asset trigger event" means that roughly £3bn of taxpayer funds have been seized by Granite and will only be released once all the bondholders are paid back. One senior banker estimated that, at the current rate of repayment, the Government will not be able to recover the money until 2015 at the earliest. How much is recovered depends on the quality of Granite's mortgage book. The taxpayer will now absorb the first £3bn of any losses in the portfolio, which is rapidly deteriorating in value. Northern Rock revealed yesterday that more than 2pc of the mortgages in Granite are in arrears, compared with the group's 1.87pc in September and 1.18pc in June. If bad debts remain at the current level, the taxpayer will lose about £750m.

At the same time, Northern Rock will forfeit any income from customers' monthly mortgage payments – adding to the bank's woes after a £585m first half loss. It was receiving £15.5m a month, but the money will now be diverted into a "reserve fund" to add to the £3bn taxpayer buffer tied up in Granite. The Government has always insisted that Granite was not part of the Northern Rock nationalisation, when the bank's £50bn of on-balance sheet loans were transferred to the state. Until now, it has been unclear how much exposure the taxpayer bore.

Before triggering the wind-up, losses would have been spread equally between all Granite's investors. Now it is in run-off, though, bondholders are paid out in order of heirarchy, with those holding AAA-rated bonds at the top of the so-called "waterfall" and the taxpayer at the bottom. The Government has been aggressively reducing Northern Rock's exposure to Granite, which was £13bn at its peak before nationalisation in April last year. Coincidentally, the remaining £3bn exposure is exactly the same as the amount of extra capital the Government put into the bank in August as a buffer against rising bad debts.

Senior bankers expect the Government to inject another £3bn before the end of the year. How much the taxpayer recovers will depend on the price the bank fetches when it is sold back to the private sector. Following the Granite default, it might be harder to find a buyer, though. Ben Hayward, a partner at TwentyFour Asset Management, said: "The timing of the breach, albeit not the end result, may surprise and alienate some market participants, making future funding harder and potentially decreasing Northern Rock's value in a future sale."

Northern Rock spokesman Brian Giles said that adding new mortgages to the trust "was not in the best interest of taxpayers given one of our prime objectives under the current business plan is the repayment of the Government loan". With bondholders now keen to get their money back, there is a chance that Granite may also be more aggressive on repossessions.

Banks 'must kick-start lending'
Banks must start lending again to households and businesses, or face being named and shamed, according to the Treasury Select Committee chairman. Demand for full-scale nationalisation of more banks could also grow if loans were not made, John McFall said. The government announced a £37bn recapitalisation for three banks last month - but lending has not picked up. "Banks have a responsibility to society which they must fulfil," Mr McFall wrote in the Daily Telegraph. "They should acknowledge that responsibility and start lending - now".

But the British Bankers' Association (BBA) said that banks were yet to receive the government capital, and that some of it was needed to absorb their losses. Small and medium-sized businesses are finding it increasingly difficult and expensive to get access to loans following the global credit crisis. Next week's pre-Budget report is expected to include a scheme that will allow the government to underwrite small business loans made by banks.

Part of the conditions of the government recapitalisation was that money be made available for lending but Mr McFall said that "pessimism" meant this was not happening. "If the banks believe that more businesses are going to go bust, and they believe that more people will become unemployed and default on their debts, then they will lend less to those businesses and individuals," he said. "As a result, many of these businesses will go bust and people will be rendered unemployed. We need to find ways to make banks loosen the purse strings."

Mr McFall suggested that if the refusal to lend continues, a website should be established where firms can report if they have been refused a loan and record how they were treated. He added there was also a "nuclear option" - where "the demand for full-scale nationalisation may well grow". Northern Rock and Bradford and Bingley have already been fully nationalised while several other High Street banks are being propped up by government cash.

BBA chief executive Angela Knight said that it was a difficult time for banks, but that businesses were "not being stone walled" and that lending was continuing. But she said banks needed to to decide if it made good financial sense to lend money to firms. "There's no desire for banks to lend to companies that are not viable," Ms Knight added. Interest rates on loans had risen because banks' borrowing costs had also climbed sharply, the BBA said.

BBC business editor Robert Peston said that because the bail-out had been described as temporary, the need to pay it back was a "massive drag on banks' ability to lend and is therefore also a ball-and-chain on economic growth". "But if we don't demand our money back, we'd be formalising that there's been a semi-permanent nationalisation of the entire banking system," he added. "And that would massively encroach on the ability of our banks to operate as independent commercial entities."

Report Sees Nuclear Arms, Scarce Resources as Seeds of Global Instability
The drive for dwindling resources, including energy and water, combined with the spread of nuclear weapons technology could make large swaths of the globe ripe for regional conflicts, some of them potentially devastating, according to a report released by the National Intelligence Council yesterday.

The report, Global Trends 2025, covers a range of strategic issues, including great-power rivalry, demographics, climate change, terrorism, nuclear proliferation, energy and natural resources. It makes for sometimes grim reading in imagining a world of weak states bristling with weapons of mass destruction and unable to cope with burgeoning populations without adequate water and food. "Those states most susceptible to conflict are in a great arc of instability stretching from Sub-Saharan Africa through North Africa, into the Middle East, the Balkans, the Caucasus, and South and Central Asia, and parts of Southeast Asia," the quadrennial report says.

At the heart of its deepest pessimism is the Middle East, which it suggests could tip into a nuclear arms race if Iran goes ahead with such weapons. "The prospect of a nuclear-armed Iran spawning a nuclear arms race in the greater Middle East will bring new security challenges to an already conflict-prone region, particularly in conjunction with the proliferation of long-range missile systems," the report says. ". . . If nuclear weapons are used destructively in the next 15-20 years, the international system will be shocked as it experiences immediate humanitarian, economic, and political-military repercussions."

While the appeal of terrorist groups such as al-Qaeda is likely to wane dramatically between now and 2025, the lethality of violent extremists may increase because of their ability to access biological weapons or even nuclear devices, according to the report, which is designed to give policymakers a beyond-the-horizon view of where today's events may lead. It was produced by the intelligence council, the senior analytic body within the Office of the Director of National Intelligence. As the report's authors note, none, some or all of this may come to pass. A "what-if" for wonks, the report, the fourth of its kind, is an effort to stimulate the thinking of the incoming presidential administration, according to Thomas Fingar, the deputy director of national intelligence for analysis.

"It is not a prediction," Fingar said. "Nothing that we have identified in this report is determinative. Nothing in it is inevitable or immutable. These are trends and developments and drivers that are subject to policy intervention and manipulation." In the case of the Middle East and other potentially unstable regions, the report posits that economic growth could become "increasingly rooted and sustained." In that scenario, Middle Eastern leaders would "move forward with political reform that empowers moderate -- and probably Islamic -- political parties; work to settle regional conflicts; and implement security agreements that help prevent future instability."

Among the visible contours of the world in 2025 is a United States experiencing the relative decline of its economic and military power, driven both by the rise of new behemoths such as China and India and domestic constraints on its global leadership. The United States "will have less power in a multipolar world than it has enjoyed for many decades," according to the report's authors, who consulted policy- and opinion-makers in America and abroad over the past 12 months. ". . . We believe that U.S. interest and willingness to play a leadership role also may be more constrained as the economic, military, and opportunity costs of being the world's leader are reassessed by American voters."

The authors say, however, that foreign leaders, including in Beijing, will continue to view U.S. global engagement as essential -- as long as it is not driven by unilateralism. China is said to be "poised to have more impact on the world over the next 20 years than any other country." The study projects that by 2025, China will have the world's second-largest economy, behind the United States', and it "will be a leading military power." Among the other major powers, Russia has the potential to be richer and more powerful, but only if it expands and diversifies its resources-driven economy. And the authors think that countries such as Indonesia, Turkey and a possible post-clerical Iran could play dynamic roles in their neighborhoods.

Looking into the distance at countries that are of major interest today, the study projected that Afghanistan will remain an essentially tribally centered nation facing continual conflict. The future of Iraq does not look much better. The study sees internal ethnic, sectarian and tribal rivalries continuing, so that by 2025, "the government in Baghdad could still be an object of competition among the various factions seeking foreign aid and pride of place, rather than a self-standing agent of political authority, legitimacy, and economic policy." Pakistan is described as a "wildcard," with its northwestern territories remaining "poorly governed" and cross-border activities continuing to cause instability in nearby areas of Afghanistan.

2025: the end of US dominance
The United States' leading intelligence organisation has warned that the world is entering an increasingly unstable and unpredictable period in which the advance of western-style democracy is no longer assured, and some states are in danger of being "taken over and run by criminal networks".

The global trends review, produced by the National Intelligence Council (NIC) every four years, represents sobering reading in Barack Obama's intray as he prepares to take office in January. The country he inherits, the report warns, will no longer be able to "call the shots" alone, as its power over an increasingly multipolar world begins to wane. Looking ahead to 2025, the NIC (which coordinates analysis from all the US intelligence agencies), foresees a fragmented world, where conflict over scarce resources is on the rise, poorly contained by "ramshackle" international institutions, while nuclear proliferation, particularly in the Middle East, and even nuclear conflict grow more likely.

"Global Trends 2025: A World Transformed" warns that the spread of western democratic capitalism cannot be taken for granted, as it was by George Bush and America's neoconservatives. "No single outcome seems preordained: the Western model of economic liberalism, democracy and secularism, for example, which many assumed to be inevitable, may lose its lustre – at least in the medium term," the report warns. It adds: "Today wealth is moving not just from West to East but is concentrating more under state control," giving the examples of China and Russia. "In the wake of the 2008 global financial crisis, the state's role in the economy may be gaining more appeal throughout the world."

At the same time, the US will become "less dominant" in the world – no longer the unrivalled superpower it has been since the end of the Cold War, but a "first among equals" in a more fluid and evenly balanced world, making the unilateralism of the Bush era no longer tenable. The report predicts that over the next two decades "the multiplicity of influential actors and distrust of vast power means less room for the US to call the shots without the support of strong partnerships." It is a conclusion that meshes with president elect Obama's stated preference for multilateralism, but the NIC findings suggest that as the years go by it could be harder for Washington to put together "coalitions of the willing" to pursue its agenda.

International organisations, like the UN, seem ill-prepared to fill the vacuum left by receding American power, at a time of multiple potential crises driven by climate change the increasing scarcity of resources like oil, food and water. Those institutions "appear incapable of rising to the challenges without concerted efforts from their leaders" it says. In an unusually graphic illustration of a possible future, the report presents an imaginary "presidential diary entry" from October 1, 2020, that recounts a devastating hurricane, fuelled by global warming, hitting New York in the middle of the UN's annual general assembly.

"I guess we had it coming, but it was a rude shock," the unnamed president writes. "Some of the scenes were like the stuff from the World War II newsreels, only this time it was not Europe but Manhattan. Those images of the US aircraft carriers and transport ships evacuating thousands in the wake of the flooding still stick in my mind." As he flies off for an improvised UN reception on board an aircraft carrier, the imaginary future president admits: "The cumulation of disasters, permafrost melting, lower agricultural yields, growing health problems, and the like are taking a terrible toll, much greater than we anticipated 20 years ago."

The last time the NIC published its quadrennial glimpse into the future was December 2004. President Bush had just been re-elected and was preparing his triumphal second inauguration that was to mark the high-water mark for neoconservatism. That report matched the mood of the times. It was called Mapping the Global Future, and looked forward as far as 2020 when it projected "continued US dominance, positing that most major powers have forsaken the idea of balancing the US". That confidence is entirely lacking from this far more sober assessment. Also gone is the belief that oil and gas supplies "in the ground" were "sufficient to meet global demand". The new report views a transition to cleaner fuels as inevitable. It is just the speed that is in question.

The NIC believes it is most likely that technology will lag behind the depletion of oil and gas reserves. A sudden transition, however, will bring problems of its own, creating instability in the Gulf and Russia. While emerging economies like China, India and Brazil are likely to grow in influence at America's expense, the same cannot be said of the European Union. The NIC appears relatively certain the EU will be "losing clout" by 2025. Internal bickering and a "democracy gap" separating Brussels from European voters will leave the EU "a hobbled giant", unable to translate its economic clout into global influence.

The Next Crisis: FHA-backed loans
As if they haven't done enough damage. Thousands of subprime mortgage lenders and brokers -- many of them the very sorts of firms that helped create the current financial crisis -- are going strong. Their new strategy: taking advantage of a long-standing federal program designed to encourage homeownership by insuring mortgages for buyers of modest means. You read that correctly. Some of the same people who propelled us toward the housing market calamity are now seeking to profit by exploiting billions in federally insured mortgages. Washington, meanwhile, has vastly expanded the availability of such taxpayer-backed loans as part of the emergency campaign to rescue the country's swooning economy.

For generations, these loans, backed by the Federal Housing Administration, have offered working-class families a legitimate means to purchase their own homes. But now there's a severe danger that aggressive lenders and brokers schooled in the rash ways of the subprime industry will overwhelm the FHA with loans for people unlikely to make their payments. Exacerbating matters, FHA officials seem oblivious to what's happening -- or incapable of stopping it. They're giving mortgage firms licenses to dole out 100-percent-insured loans despite lender records blotted by state sanctions, bankruptcy filings, civil lawsuits, and even criminal convictions.

As a result, the nation could soon suffer a fresh wave of defaults and foreclosures, with Washington obliged to respond with yet another gargantuan bailout. Inside Mortgage Finance, a research and newsletter firm in Bethesda, Md., estimates that over the next five years fresh loans backed by the FHA that go sour will cost taxpayers $100 billion or more. That's on top of the $700 billion financial-system rescue Congress has already approved. Gary E. Lacefield, a former federal mortgage investigator who now runs Risk Mitigation Group, a consultancy in Arlington, Tex., predicts: "Within the next 12 to 18 months, there is going to be FHA-insurance Armageddon."

The resilient entrepreneurs who populate this dubious field are often obscure, but not puny. Jerry Cugno started Premier Mortgage Funding in Clearwater, on the Gulf Coast of Florida, in 2002. Over the next four years, it became one of the country's largest subprime lenders, with 750 branches and 5,000 brokers across the U.S. Cugno, now 59, took home millions of dollars and rewarded top salesmen with Caribbean cruises and shiny Hummers, according to court records and interviews with former employees. But along the way, Premier accumulated a dismal regulatory record. Five states -- Florida, Georgia, North Carolina, Ohio, and Wisconsin -- revoked its license for various abuses; four others disciplined the company for using unlicensed brokers or similar violations. The crash of the subprime market and a barrage of lawsuits prompted Premier to file for U.S. bankruptcy court protection in Tampa in July 2007. Then, in March, a Premier unit in Cleveland and its manager pleaded guilty to felony charges related to fraudulent mortgage schemes.

But Premier didn't just close down. Since it declared bankruptcy, federal records show, it has issued more than 2,000 taxpayer-insured mortgages -- worth a total of $250 million. According to the FHA, Premier failed to notify the agency of its Chapter 11 filing, as required by law. In late October, an FHA spokesman admitted it was unaware of Premier's situation and welcomed any information BusinessWeek could provide. You'd think the government would have had Premier on a watch list. According to data compiled by the FHA's parent, the U.S. Housing & Urban Development Dept. (HUD), the firm's borrowers have a 9.2 percent default rate, the second highest among large-volume FHA lenders nationally. Now, members of the Cugno family have started a brand new company called Paramount Mortgage Funding. It operates a floor below Premier's headquarters in a three-story black-glass office building Jerry Cugno owns in Clearwater. In August 2007, only weeks after Premier sought bankruptcy court protection, the FHA granted Paramount a license to issue government-backed mortgages. "I am the only person in the country who really understands FHA," Cugno says with characteristic bravado.

One day recently, Nicole Cugno, his 27-year-old daughter and a Paramount vice-president, was on the phone at her desk, giving advice to new branch managers. Despite past troubles with Premier, the family says Paramount dutifully serves borrowers. The Cugnos stress that the two companies are legally separate organizations. Similarly worrisome stories are playing out around the country. In Tucson, First Magnus Financial specialized in risky "Alt-A" mortgages, which didn't require borrowers to verify their income. State and federal regulators cited the company for misleading borrowers, using unlicensed brokers, and other infractions. It shut down last summer and laid off its 5,500 employees. But in May, the FHA issued a group of former First Magnus executives a new license to make taxpayer-insured home loans. They have opened a company called StoneWater Mortgage in the same office building that First Magnus had occupied.

G. Todd Jackson, an attorney for StoneWater, said in a written statement that the new company "is not First Magnus." StoneWater employs "a new business model, with different loan products, in a different market," he added. First Magnus had "a long record of compliance," he said. "Isolated incidents and personnel problems occurred, but none were remotely systemic, and all were promptly addressed and corrected by management when discovered." Nationstar Mortgage, based in suburban Dallas, closed its 75 retail branches in September 2007 after the subprime market crashed. But in August, Chief Information Officer Peter Schwartz told the trade paper American Banker that Nationstar now plans to emphasize FHA-backed loans, which he called a "high-growth channel." The lender received federal approval in March to offer government-guaranteed loans. Just a year earlier, it agreed to pay the Kentucky Financial Institutions Dept. a $105,000 settlement -- one of the largest of its kind in that state -- to resolve allegations that Nationstar employed unlicensed loan officers and falsified borrowers' credit scores. Nationstar didn't admit wrongdoing in the case.

"All loans we originate conform to industry best practices, as well as all applicable federal and state laws," says Executive Vice-President Steven Hess. The settlement in Kentucky, he adds, isn't "relevant to our FHA status." Lend America in Melville, N.Y., uses cable television infomercials and a toll-free number (1-800-FHA-FIXED) to encourage borrowers in trouble with adjustable-rate mortgages to refinance with fixed-rate loans guaranteed by the FHA. Anticipating the real estate crash, the Long Island firm switched its strategy in 2005 from subprime to FHA-backed mortgages, says Michael Ashley, Lend America's chief business strategist. This year, the company will make 7,500 FHA loans, worth $1.5 billion, he says. "FHA is a big part of the future," Ashley adds. "It's the major vehicle for the government to bail out the housing industry."

But why the federal government would want to do business with Lend America is perplexing. Ashley has a long history of legal scrapes. One of them led to his pleading guilty in 1996 in federal court in Uniondale, N.Y., to two counts of wire fraud related to a mortgage scam at another company his family ran called Liberty Mortgage. He was sentenced to five years' probation and ordered to pay a $30,000 fine. His father, Kenneth Ashley, was sentenced to nearly four years in prison. "I was just a pawn in a chess game between my father and the government," says the younger Ashley, who is 43. "It doesn't affect my ability to do lending." The default rate on Lend America's current FHA loans is 5.7 percent, or 53 percent above the national average, according to government records.

Asked about FHA oversight of former subprime firms, agency spokesman Lemar Wooley says: "FHA has taken appropriate actions, where necessary, with these lenders with respect to their participation in FHA programs." First Magnus, Nationstar, and Lend America met all applicable federal rules, Wooley says. But on two occasions since 2000 one office of Lend America in New York temporarily lost its authority to originate FHA-backed loans because of an excessive default rate, he says. Wooley says the FHA wasn't aware that Lend America's Ashley had been convicted. The firm didn't list Ashley as a principal, Wooley says. FHA lenders are required to disclose past regulatory sanctions and are forbidden to employ people with criminal records.

Founded during the New Deal, the FHA is supposed to promote first-time home purchases. Open to all applicants, it allows small down payments -- as little as 3 percent -- and lenient standards on borrower income, as long as mortgage and related expenses don't exceed 31% of household earnings. In exchange for taxpayer-backed insurance on attractively priced fixed-rate loans, buyers pay a modest fee. Lenders and brokers can get a license to participate in FHA programs if they demonstrate industry experience and knowledge of agency rules. During the subprime boom, the FHA atrophied as borrowers migrated to the too-good-to-be-true deals that featured terms such as extremely low introductory interest rates that later jumped skyward. But since the subprime market vaporized in 2007, FHA-backed loans have become all that's available for many borrowers. By fall 2008, FHA loans accounted for 26 percent of all new mortgages being issued nationwide, up from only 4 percent a year earlier. As of Sept. 30, the most recent date for which data are publicly available, the FHA had 4.4 million single-family mortgages under guarantee, worth a total of $475 billion.

Congress and the Bush Administration are strongly encouraging lenders to apply for FHA approval and tap into the government's loan-guarantee reservoir. In September, the agency guaranteed 140,000 new loans, up from 60,000 in January. In October, as Congress and the White House scrambled to respond to the spreading financial disaster, the FHA began to extend $300 billion in additional loan guarantees under the banner of a new program called HOPE for Homeowners. The limit on the amount buyers may borrow will rise in January to $625,000 from $362,790 in 2007. Some current and former federal housing officials say the agency isn't anywhere close to being equipped to deal with the onslaught of lenders seeking to cash in. Thirty-six thousand lenders now have FHA licenses, up from 16,000 in mid-2007.

FHA "faces a tsunami" in the form of ex-subprime lenders who favor aggressive sales tactics and sometimes engage in outright fraud, says Kenneth M. Donohue Sr., the inspector general for HUD. "I am very concerned that the same players who brought us problems in the subprime area are now reconstituting themselves and bringing loans into the FHA portfolio," he adds. FHA staffing has remained roughly level over the past five years, at just under 1,000 employees, even as that tsunami has been building, Donohue points out. The FHA unit that approves new lenders, recertifies existing ones, and oversees quality assurance has only five slots; two of those were vacant this fall, according to HUD's Web site. Former housing officials say lender evaluations sometimes amount to little more than a brief phone call, which helps explain why questionable ex-subprime operations can reinvent themselves and gain approval. "They are absolutely understaffed," says Donohue, "and they need a much better IT system in place. That is one of their great vulnerabilities."

Joseph McCloskey, a former director of FHA's single-family asset management branch, says workers reviewing lender applications have had difficulty for years tracking whether executives of previously disciplined mortgage firms were applying for new FHA licenses. "Technologically, they are challenged," McCloskey, now a consultant to FHA lenders, says of his overmatched former colleagues. The FHA's Wooley disputes these criticisms. The agency can cross-check names and thoroughly examine lender applications, he says. There are numerous law-abiding FHA lenders and brokers, just as there are subprime mortgage firms that behaved honestly and cautiously in recent years. But the current economic crisis has turned the FHA into a profit magnet for all kinds of financial players. Major Wall Street investment firms are finding their own angles, which are entirely legal.

In April 2007, Goldman Sachs purchased a controlling stake in Senderra Funding, a former subprime lender in Fort Mill, S.C. Goldman, which has received $10 billion in direct federal rescue money, converted Senderra into an FHA lender and refinance organization. The strategy appears likely to produce hefty margins. In September, Goldman paid 63¢ on the dollar in a $760 million deal with Equity One, a unit of Banco Popular, for a batch of subprime mortgage and auto loans. Through Senderra, Goldman plans to refinance at least some of the mortgages into FHA-backed loans. Because of the government guarantee, it can then sell those loans to other financial firms for as much as 90¢ on the dollar, according to people familiar with the mortgage market. That's a profit margin of more than 40 percent.

Goldman's dealings suggest another reason FHA-insured lending is booming: The federal guarantee creates an incentive for banks to buy FHA loans and bundle them as securities to be sold to investors. This is happening as the securitization of subprime and conventional mortgages has largely ceased. Operating far from Wall Street, the Cugno clan of Clearwater exemplifies a certain indefatigable American spirit in the face of economic setbacks. Whether that enterprising drive is always something to celebrate is less clear. The Cugnos concede that their older mortgage firm, Premier, had its flaws. "My dad's company got too big," says Nicole Cugno. "It was too hard to control." At its peak in 2006, Premier originated $1 billion in loans each month and had annual revenue of more than $200 million. It sold what amounted to franchises to brokers around the country who frequently operated with little supervision from the 200-employee home office. "Everybody had a few bad apples, and I had a few of them," Nicole's father, Jerry, says. "If they got in trouble, we fired them."

Mark Pearce, deputy commissioner of banks in North Carolina, one of the five states that banned Premier, counters that the company seems to have invited abuses. North Carolina investigators concluded that Premier's branch in Charlotte allowed, among other deceptive practices, unlicensed brokers from around the country to "park" loans there for a fee. The aim was to make it appear that the mortgages were associated with a licensed broker trained and supervised by a substantial firm. "This is a company that should not be doing business in North Carolina," Pearce says. But the Cugnos are very much staying in business. While Premier's bankruptcy proceedings continue in Tampa, members of the family are employing essentially the same model with their new company, Paramount. Only this time they are stressing federally guaranteed FHA loans. Paramount charges branches $1,625 a month to use its name, FHA license, and software. On its Web site, it tells brokers that FHA loans are "the new subprime."

"We're taking some of the things Premier did and tweaking [them]," says Barry McNab, a former Premier executive who now heads FHA lending for Paramount. About 9 out of 10 Paramount loans have FHA backing, he explains. It's difficult to evaluate most of those guaranteed loans, since they are so new. But a look at the experiences of some past Premier borrowers isn't encouraging. U.S. District Judge Richard Alan Enslen in Kalamazoo, Mich., began a June 2007 written opinion about Premier's practices with this observation: "The crooks in prison-wear (orange jump suits) are easy to spot. Those in business-wear are not, though they do no less harm to their unsuspecting victims." The case before Judge Enslen concerned Marcia Clifford, 53. She won a civil verdict that Premier had violated federal mortgage law when it replaced the fixed-rate loan it had promised her with one bearing an adjustable rate. Enslen also found that Premier had misrepresented Clifford on her application as employed when she was out of work and living on $700 a month in disability payments. Despite his ire, the judge decided to award Clifford, who did sign the deceptive documents, only $3,720 in damages, an amount based on unauthorized fees Premier had pocketed.

Clifford's name now appears along with a lengthy list of Premier's other creditors in the bankruptcy court in Tampa. Unable to make her $600 monthly mortgage payment, she received an eviction notice in June and says she is likely to lose her three-bedroom house in Belding, Mich. "It was a bait and switch," Clifford says, sobbing. "The folks at Premier are coldhearted." Janice Dixon is also owed money by Premier. In March 2006 an Alabama jury awarded her $127,000 in damages related to a fraudulent refinancing in which, she alleged, the company didn't disclose the full costs of her borrowing. "Who will fix this?" Dixon, 49, asks. "They will continue to do these same things over and over." Wooley, the FHA spokesman, says the agency noticed Premier's default rate rising earlier this year. But he adds that both Premier and Paramount met FHA requirements.

Like the Cugnos, Hector J. Hernandez lately has shifted his mortgage business away from subprime and toward FHA loans. The Coral Gables (Fla.) lender has a different twist on the business: He uses FHA-backed loans to help hard-pressed borrowers buy condominiums in buildings he owns. Sascha Pierson was an unlikely borrower. She had no employment income when she bought a three-bedroom condo in Palmetto Towers, a Hernandez property in Miami, in July 2007 for $318,000. She borrowed almost the entire purchase price from Great Country Mortgage Bankers, Hernandez's loan company. Pierson, 29, says she is pursuing a psychology degree online from Kaplan University. She lives on a $42,000 annual educational grant from the government of the Cayman Islands, where she is a citizen. But the grant ends this year, and even with two roommates, she doesn't know how she's going to pay the $2,600 monthly bill for her mortgage and condo fee. "I am seriously worried about defaulting on my loan," she says.

Less extreme versions of Pierson's situation seem common at Palmetto Towers, a pair of eight-story stucco buildings Hernandez acquired in 1996. BusinessWeek interviewed eight condo owners at the complex, all of whom had obtained FHA-backed loans from Great Country. All eight, including Pierson, say they agreed to terms that required them to make mortgage and condo-fee payments that total considerably more than the FHA's guideline of 31 percent of their monthly income. Four of the eight owners say they received cash payments at closing of $10,000 or more as incentives to buy. The payments, which the FHA says are prohibited, were included in the loans. Pierson says she received $19,500. "They called it a 'cash-back opportunity,'" she explains. Her neighbor, Lorena Merlo, 27, received a Great Country check for $14,640 at the closing in April on her $316,375 three-bedroom unit. Merlo, a part-time legal assistant, and her husband, Renny Rivas, a drywall laborer, earn a total of $52,000 a year and have two young sons. Their monthly home payments amount to 58% of their gross income, way over the FHA limit. "We are four months behind on our mortgage," says a mournful Merlo.

Of the 158 units in Palmetto Towers, 66 are in foreclosure, records show. An additional 33 are unsold. Great Country has originated 1,855 FHA mortgages since November 2006; 923 of those were in default proceedings as of Oct. 31. The firm's 50 percent default rate is the highest in the entire FHA program. Hernandez blames the high failure rate on the disastrous South Florida real estate market, not Great Country's practices, which he says are all legitimate. Asked in a phone interview whether he encourages buyers to purchase condos they can't afford, paying them questionable cash incentives, he says flatly, "That is not true." He adds: "(The buyers) are lying. They are disappointed by falling prices."

In October, however, the FHA decided it had seen enough. It ended Great Country's guaranteed-lending privileges in the Miami and Orlando markets where it had been active. Borrowers on nearly half of the company's defaulted loans made payments for only three months or less; 105 borrowers never made any payments at all. Brian Sullivan, another FHA spokesman, says the agency has referred the case to its inspector general's office. In response to BusinessWeek's questions, the Florida Financial Services Dept. has started a separate investigation, a person close to the state agency says. But don't assume that Hernandez is through with FHA-guaranteed loans. At the Palmetto Towers sales office, Alexis Curbelo, a loan officer for Great Country, explains in an interview that buyers can now obtain FHA loans through Ikon Mortgage Lenders in Fort Lauderdale. Public records show Ikon closed a Palmetto Towers FHA loan in September for $222,957. Edgard Detrinidad, Ikon's president and a former business associate of Hernandez, denies he is financing any other loans for Hernandez's buyers.

A tsunami of hope or terror?
As the world slips into recession, it is also on the brink of a synthetic CDO cataclysm that could actually save the global banking system. It is a truly great irony that the world’s banks could end up being saved not by governments, but by the synthetic CDO time bomb that they set ticking with their own questionable practices during the credit boom. Alternatively, the triggering of default on the trillions of dollars worth of synthetic CDOs that were sold before 2007 could be a disaster that tips the world from recession into depression. Nobody knows, but it won’t be a small event.

A synthetic CDO is a collateralised debt obligation that is based on credit default swaps rather physical debt securities. CDOs were invented by Michael Milken’s Drexel Burnham Lambert in the late 1980s as a way to bundle asset backed securities into tranches with the same rating, so that investors could focus simply on the rating rather than the issuer of the bond. About a decade later, a team working within JP Morgan Chase invented credit default swaps, which are contractual bets between two parties about whether a third party will default on its debt.

In 2000 these were made legal, and at the same time were prevented from being regulated, by the Commodity Futures Modernization Act, which specifies that products offered by banking institutions could not be regulated as futures contracts. This bill, by the way, was 11,000 pages long, was never debated by Congress and was signed into law by President Clinton a week after it was passed. It lies at the root of America’s failure to regulate the debt derivatives that are now threatening the global economy. Anyway, moving right along – some time after that an unknown bright spark within one of the investment banks came up with the idea of putting CDOs and CDSs together to create the synthetic CDO.

Here’s how it works: a bank will set up a shelf company in Cayman Islands or somewhere with $2 of capital and shareholders other than the bank itself. They are usually charities that could use a little cash, and when some nice banker in a suit shows up and offers them money to sign some documents, they do. That allows the so-called special purpose vehicle (SPV) to have "deniability", as in "it’s nothing to do with us" – an idea the banks would have picked up from the Godfather movies. The bank then creates a CDS between itself and the SPV. Usually credit default swaps reference a single third party, but for the purpose of the synthetic CDOs, they reference at least 100 companies.

The CDS contracts between the SPV can be $US500 million to $US1 billion, or sometimes more. They have a variety of twists and turns, but it usually goes something like this: if seven of the 100 reference entities default, the SPV has to pay the bank a third of the money; if eight default, it’s two-thirds; and if nine default, the whole amount is repayable. For this, the bank agrees to pay the SPV 1 or 2 per cent per annum of the contracted sum. Finally the SPV is taken along to Moody’s, Standard and Poor’s and Fitch’s and the ratings agencies sprinkle AAA magic dust upon it, and transform it from a pumpkin into a splendid coach.

The bank’s sales people then hit the road to sell this SPV to investors. It’s presented as the bank’s product, and the sales staff pretend that the bank is fully behind it, but of course it’s actually a $2 Cayman Islands company with one or two unknowing charities as shareholders. It offers a highly-rated, investment-grade, fixed-interest product paying a 1 or 2 per cent premium. Those investors who bother to read the fine print will see that they will lose some or all of their money if seven, eight or nine of a long list of apparently strong global corporations go broke. In 2004-2006 it seemed money for jam. The companies listed would never go broke – it was unthinkable.

Here are some of the companies that are on all of the synthetic CDO reference lists: the three Icelandic banks, Lehman Brothers, Bear Stearns, Freddie Mac, Fannie Mae, American Insurance Group, Ambac, MBIA, Countrywide Financial, Countrywide Home Loans, PMI, General Motors, Ford and a pretty full retinue of US home builders. In other words, the bankers who created the synthetic CDOs knew exactly what they were doing. These were not simply investment products created out of thin air and designed to give their sales people something from which to earn fees – although they were that too. They were specifically designed to protect the banks against default by the most leveraged companies in the world. And of course the banks knew better than anyone else who they were.

As one part of the bank was furiously selling loans to these companies, another part was furiously selling insurance contracts against them defaulting, to unsuspecting investors who were actually a bit like "Lloyds Names" – the 1500 or so individuals who back the London reinsurance giant. Except in this case very few of the "names" knew what they were buying. And nobody has any idea how many were sold, or with what total face value. It is known that some $2 billion was sold to charities and municipal councils in Australia, but that is just the tip of the iceberg in this country. And Australia, of course, is the tiniest tip of the global iceberg of synthetic CDOs. The total undoubtedly runs into trillions of dollars.

All the banks did it, not just Lehman Brothers which had the largest market share, and many of them seem to have invested in the things as well (a bit like a dog eating its own vomit). It is now getting very interesting. The three Icelandic banks have defaulted, as has Countrywide, Lehman and Bear Stearns. AIG has been taken over by the US Government, which is counted as a part-default, and Freddie Mac and Fannie Mae are in "conservatorship", which is also a part default – a 'part default' does not count as a 'full default' in calculating the nine that would trigger the CDS liabilities. Ambac, MBIA, PMI, General Motors, Ford and a lot of US home builders are teetering.

If the list of defaults – full and partial – gets to nine, then a mass transfer of money will take place from unsuspecting investors around the world into the banking system. How much? Nobody knows, but it’s many trillions. It will be the most colossal rights issue in the history of the world, all at once and non-renounceable. Actually, make that mandatory. The distress among those who lose their money will be immense. It will be a real loss, not a theoretical paper loss. Cash will be transferred from their own bank accounts into the issuing bank, via these Cayman Islands special purpose vehicles.

The repercussions on the losers and the economies in which they live, will be unpredictable but definitely huge. Councils will have to put up rates to continue operating. Charities will go to the wall and be unable to continue helping those in need. Individual investors will lose everything. There will also be a tsunami of litigation, as dumbfounded investors try to get their money back, claiming to have been deceived by the sales people who sold them the products. In Australia, some councils are already suing the now-defunct Lehman Brothers, and litigation funder, IMF Australia, has been studying synthetic CDOs for nine months preparing for the storm.

But for the banks, it’s happy days. Suddenly, when the ninth reference entity tips over, they will be flooded with capital. It’s possible they will have so much new capital, they won’t know what to do with it. This is entirely uncharted territory so it’s impossible to know what will happen, but it is possible that the credit crunch will come to sudden and complete end, like the passing of a tornado that has left devastation in its wake, along with an eerie silence.

Ilargi: Michael Panzner unearthed this great piece of history.

The Real Great Depression
The depression of 1929 is the wrong model for the current economic crisis. As a historian who works on the 19th century, I have been reading my newspaper with a considerable sense of dread. While many commentators on the recent mortgage and banking crisis have drawn parallels to the Great Depression of 1929, that comparison is not particularly apt. Two years ago, I began research on the Panic of 1873, an event of some interest to my colleagues in American business and labor history but probably unknown to everyone else. But as I turn the crank on the microfilm reader, I have been hearing weird echoes of recent events.

When commentators invoke 1929, I am dubious. According to most historians and economists, that depression had more to do with overlarge factory inventories, a stock-market crash, and Germany's inability to pay back war debts, which then led to continuing strain on British gold reserves. None of those factors is really an issue now. Contemporary industries have very sensitive controls for trimming production as consumption declines; our current stock-market dip followed bank problems that emerged more than a year ago; and there are no serious international problems with gold reserves, simply because banks no longer peg their lending to them.

In fact, the current economic woes look a lot like what my 96-year-old grandmother still calls "the real Great Depression." She pinched pennies in the 1930s, but she says that times were not nearly so bad as the depression her grandparents went through. That crash came in 1873 and lasted more than four years. It looks much more like our current crisis. The problems had emerged around 1870, starting in Europe. In the Austro-Hungarian Empire, formed in 1867, in the states unified by Prussia into the German empire, and in France, the emperors supported a flowering of new lending institutions that issued mortgages for municipal and residential construction, especially in the capitals of Vienna, Berlin, and Paris.

Mortgages were easier to obtain than before, and a building boom commenced. Land values seemed to climb and climb; borrowers ravenously assumed more and more credit, using unbuilt or half-built houses as collateral. The most marvelous spots for sightseers in the three cities today are the magisterial buildings erected in the so-called founder period.

But the economic fundamentals were shaky. Wheat exporters from Russia and Central Europe faced a new international competitor who drastically undersold them. The 19th-century version of containers manufactured in China and bound for Wal-Mart consisted of produce from farmers in the American Midwest. They used grain elevators, conveyer belts, and massive steam ships to export trainloads of wheat to abroad. Britain, the biggest importer of wheat, shifted to the cheap stuff quite suddenly around 1871.

By 1872 kerosene and manufactured food were rocketing out of America's heartland, undermining rapeseed, flour, and beef prices. The crash came in Central Europe in May 1873, as it became clear that the region's assumptions about continual economic growth were too optimistic. Europeans faced what they came to call the American Commercial Invasion. A new industrial superpower had arrived, one whose low costs threatened European trade and a European way of life.

As continental banks tumbled, British banks held back their capital, unsure of which institutions were most involved in the mortgage crisis. The cost to borrow money from another bank — the interbank lending rate — reached impossibly high rates. This banking crisis hit the United States in the fall of 1873. Railroad companies tumbled first. They had crafted complex financial instruments that promised a fixed return, though few understood the underlying object that was guaranteed to investors in case of default. (Answer: nothing). The bonds had sold well at first, but they had tumbled after 1871 as investors began to doubt their value, prices weakened, and many railroads took on short-term bank loans to continue laying track.

Then, as short-term lending rates skyrocketed across the Atlantic in 1873, the railroads were in trouble. When the railroad financier Jay Cooke proved unable to pay off his debts, the stock market crashed in September, closing hundreds of banks over the next three years. The panic continued for more than four years in the United States and for nearly six years in Europe. The long-term effects of the Panic of 1873 were perverse. For the largest manufacturing companies in the United States — those with guaranteed contracts and the ability to make rebate deals with the railroads — the Panic years were golden. Andrew Carnegie, Cyrus McCormick, and John D. Rockefeller had enough capital reserves to finance their own continuing growth. For smaller industrial firms that relied on seasonal demand and outside capital, the situation was dire. As capital reserves dried up, so did their industries.

Carnegie and Rockefeller bought out their competitors at fire-sale prices. The Gilded Age in the United States, as far as industrial concentration was concerned, had begun. As the panic deepened, ordinary Americans suffered terribly. A cigar maker named Samuel Gompers who was young in 1873 later recalled that with the panic, "economic organization crumbled with some primeval upheaval." Between 1873 and 1877, as many smaller factories and workshops shuttered their doors, tens of thousands of workers — many former Civil War soldiers — became transients. The terms "tramp" and "bum," both indirect references to former soldiers, became commonplace American terms.

Relief rolls exploded in major cities, with 25-percent unemployment (100,000 workers) in New York City alone. Unemployed workers demonstrated in Boston, Chicago, and New York in the winter of 1873-74 demanding public work. In New York's Tompkins Square in 1874, police entered the crowd with clubs and beat up thousands of men and women. The most violent strikes in American history followed the panic, including by the secret labor group known as the Molly Maguires in Pennsylvania's coal fields in 1875, when masked workmen exchanged gunfire with the "Coal and Iron Police," a private force commissioned by the state. A nationwide railroad strike followed in 1877, in which mobs destroyed railway hubs in Pittsburgh, Chicago, and Cumberland, Md.

In Central and Eastern Europe, times were even harder. Many political analysts blamed the crisis on a combination of foreign banks and Jews. Nationalistic political leaders (or agents of the Russian czar) embraced a new, sophisticated brand of anti-Semitism that proved appealing to thousands who had lost their livelihoods in the panic. Anti-Jewish pogroms followed in the 1880s, particularly in Russia and Ukraine. Heartland communities large and small had found a scapegoat: aliens in their own midst. The echoes of the past in the current problems with residential mortgages trouble me. Loans after about 2001 were issued to first-time homebuyers who signed up for adjustablerate mortgages they could likely never pay off, even in the best of times.

Real-estate speculators, hoping to flip properties, overextended themselves, assuming that home prices would keep climbing. Those debts were wrapped in complex securities that mortgage companies and other entrepreneurial banks then sold to other banks; concerned about the stability of those securities, banks then bought a kind of insurance policy called a credit-derivative swap, which risk managers imagined would protect their investments. More than two million foreclosure filings — default notices, auction-sale notices, and bank repossessions — were reported in 2007. By then trillions of dollars were already invested in this credit-derivative market. Were those new financial instruments resilient enough to cover all the risk? (Answer: no.)

As in 1873, a complex financial pyramid rested on a pinhead. Banks are hoarding cash. Banks that hoard cash do not make short-term loans. Businesses large and small now face a potential dearth of short-term credit to buy raw materials, ship their products, and keep goods on shelves. If there are lessons from 1873, they are different from those of 1929. Most important, when banks fall on Wall Street, they stop all the traffic on Main Street — for a very long time. The protracted reconstruction of banks in the United States and Europe created widespread unemployment. Unions (previously illegal in much of the world) flourished but were then destroyed by corporate institutions that learned to operate on the edge of the law. In Europe, politicians found their scapegoats in Jews, on the fringes of the economy. (Americans, on the other hand, mostly blamed themselves; many began to embrace what would later be called fundamentalist religion.)

The post-panic winners, even after the bailout, might be those firms — financial and otherwise — that have substantial cash reserves. A widespread consolidation of industries may be on the horizon, along with a nationalistic response of high tariff barriers, a decline in international trade, and scapegoating of immigrant competitors for scarce jobs. The failure in July of the World Trade Organization talks begun in Doha seven years ago suggests a new wave of protectionism may be on the way. In the end, the Panic of 1873 demonstrated that the center of gravity for the world's credit had shifted west — from Central Europe toward the United States. The current panic suggests a further shift — from the United States to China and India. Beyond that I would not hazard a guess. I still have microfilm to read.


bluebird said...

Tim Geithner named as Secretary Treasury. The market jumped 200!

Barring last minute changes, the nominee for Treasury Secretary will be NY Fed President Tim Geithner -- a career Treasury official under both Bob Rubin and Larry Summers -- who actually had worked at the Treasury in three administrations under five Secretaries -- going back to 1988. Geithner has been a key player in the current economic crisis -- helping Treasury Secretary Hank Paulson and his team manage the wall street bailout.

Ilargi said...


Plugging your blog anonymously is a fool-proof no-go. Plugging it in the first place on another blog out of any context is questionable. Putting white text on a black background is ugly.

Ilargi said...


Yes, Geithner is nothing but another head of the same beast. Different face, same body. Same thing goes, obviously, for Obama.

Anonymous said...

I had no intention of plugging anything. You have a great blog with a lot of content on GM and I am a GM insider. Just wanted to share my opinion. Sorry you don't like black but it seems to suit the mood these days....No offence intended. exranger

Ilargi said...

No ofensa here either, exranger

But yes, I never even try to read white on black, it just makes me tired.

I suggest that next time you come out open and clear about the reason you link to yourself.

Be good.

Anonymous said...

Thanks. And thanks for the excellent Blog...exranger

Anonymous said...

Ilargi - Did you get away to visit your mother? I hope so, but it seems like you've kept cranking out updates here. Thanks! (ps - agree with you 100% about white text on black)

exranger - as a GM insider, could you tell me why the heck GM can't sell a fuel efficient little diesel car here? I saw a nice one on the British Vauxhall site; or something similar to Ford's Fiesta Ecotec, at 70MPG. If government regulations are part of the reason, would it make sense to argue for a short term relaxing of those rules, to get some more reasonable vehicles here. (from a Michigander)

EBrown said...

In response to Dan W's comment yesterday about the necessity of "smallness" in our economic affaris - I think it's going to happen whether we choose it or have it forced upon us.

We can choose it in many respects, but like the many aspects of globalization the last 25 years pressed unwillingly on millions, the reverse is also going to be true. For the last few centuries western civilization has been on a globalization (colonialism, imperialism, capitalism, etc) binge, bringing ever more of the world's population into the western mindset. Many peoples had their cultures outright destroyed, or barring that, subsumed by the power of western ways of business and war. The cultural inertia of the US and Europe is immense and nearly impossible to escape, even if one were to try to run out to the woods or the desert and live a simple life. The Amish have resisted about as much as possible, and they still are very integrated in teh larger economic system. Homesteaders, communal living arrangements, religious communities of various sorts, all hold out for smallness and community in the face of the larger pressures of globalization, resisting its ever-present suction.

I think we will see a similar dynamic in reverse develop. Many people will want to resist and decry the pressure to get smallaer and more local, particularly those that benefited most from teh reverse process - wealthy urban and suburban professionals. But much like the small farmer of the 1950s or 60s or 70s squeezed out by the bigger players, those fighting the contracting economy will ultimately find they're up against a force that is too big and too strong to be countered by simply wishing and hoping for a return to the "good old days."

I think the reverse process of going big down to small is going to be disorderly and more chaotic than the more gradual concentration of power and moey in NY, Wash DC, London, Tokyo, and other big money centers was.

The world is set to get much bigger again - I think the concept of a "global village" is going to disappear within the next decade. People will still travel, but they will do so less often and it will involve a larger percentage of their income than the last few decades. Both the wealthy and the middle class of industrialized nations is set to shrink as dramatically as the money supply has over the last few years.

That's my ramble for the day - make "small/local" economic choices now to foster a resilient community in the face of the coming forced localization...

Anonymous said...

Hi JustJohn,
I agree with you about the european diesels. I love the ECOtech engine in my 2002 grand am. I get mid 30s mileage and it is close to indestrucable. it has 150,000+ miles and runs like it was new. One of the reasons mileage is not that great in the U.S. is the love most people have for big V8s & bells and whistle.

Anonymous said...

Kudos and thanks to Michael Panzer for his excellent piece.

I said it before Hank lifted the curtain on this production and I will say it again, NOW is the time of reckoning.

If we do not get the rule of law re-established in the US, if we do not get out of Iraq and make exit plans from Afghanistan, if we do not place real human beings ahead of the interests of fictitious entities designed to remove their stakeholders (read as corporations, governments and alliances)from all sense of social obligation these folks and all their machinations have no legitamacy.

This is not a matter of crime and punishment, it is a matter of social and economic justice.

Anonymous said...

“I don’t have to tell you things are bad – everybody knows things are bad. It’s a depression, everybody’s out of work, or scarred of losing their jobs. The dollar buys a nickels worth: Banks are going bust; shop-keepers keep a gun under the counter. Punks are running wild in the street and there’s nobody anywhere seems to know what to do and there’s no end to it!

We know the air is unfit to breathe, the food is unfit to eat, and we sit watching our TV’s while some local newscaster tells us that today we had fifteen homicides and sixty-three violent crimes as if that’s the way it’s supposed to be! We know things are bad, worse than bad—they’re crazy—it’s like everything everywhere is going crazy. So we don’t go out anymore, we sit in the house and slowly the world we’re living in is getting smaller and all we say is PLEASE at least leave us alone in our living room, let me have my toaster and my TV and my steel-belted radials, and we won’t say anything—just leave us alone!

Well I’m not going to leave you alone! I want you to GET MAD! I don’t want you to protest, I don’t want you to write to your congressman; I wouldn’t know what to tell you to write. I don’t know what to do about the depression and the inflation or the Russians or the crime-in-the-streets. All I know is that first YOU’VE GOT TO GET MAD! You’ve got to say “I’m a human being—DAMNIT—my life has value! So I want you to get up now, I want all of you to get up out of your chairs. I want you to get up right now and go to the window, open it, stick your head out and yell: “I’m as mad as hell and I’m not going to take this anymore!”

Confront the Delusions

Anonymous said...

The piece from the Chronicle of Higher Ed on the panic of 1873 was an eye opener.

First thought, we are fighting the last war (i.e., 1929) ... that *could* be the wrong model.

Re: Obama: what part of being a member of the DLC did people not understand when he was running for office?

What part of surrounding himself with members of the DLC do people find surprising?

I think the test for this man is whether or not he realizes his main advisers don't know their a$$es from their pie holes and he brings a fresh team ... I suspect he will have to do so by summer 2009.

Otherwise, the republicans may find themselves suddenly back in control by 2010.

Anonymous said...

FROM CNN’s Jack Cafferty:
November 21, 2008
Next 20 years: How worried are you?


Here is the best answer.
Think living without oil is tough? Try living without bread.

Most people are worried.

Come on Ilargi ... let's be positive and make a better world.

el gallinazo said...

The announcement of Tim Geithner as SecTreas raised the Dow almost 7% in the last hour. At 3:00 PM it was sitting at the opening level line. I have read by many insiders (small "i" and not including our mascot with the size 18 shoes), that the chairman of the NY Fed has far more power than the Chairman of the Board of Governors - currently Bernanke. He is the ultimate thug banksta.

The lemmings are crazy. Only the selection of a Messiah should raise the DOW that much in an hour at a Friday close. But was he properly vetted? He is apparently Jewish (simply form his name), but is he from the line of David? I forgot the other qualifications for vetting the Messiah.

ogardener said...

Ilargi: "Look, I already told you he has to go, but you, Barney Frank, Chris Dodd, you just let him lie to you time after time. And you just sit there pretending to ask tough questions. Do you ever think of the people you represent, your voters, whose money you are letting him give to his buddies? Are you still clinging to the idea that he's trying to "save the system"?

Man, is that ever right on!

Anonymous said...

Justjohn, the reason we don't see the small European diesels here is because they don't meet EPA's Tier 2 emission standards, which were fully phased in for light cars and trucks by model-year 2007. And the US market for small diesels has not, as Exranger indicates, been large enough for European companies to justify developing the new induction and catalyst systems that would be needed. For this, we can thank the US auto lobby who, at the time the Tier 2 regulations were being finalized, had little enough reason to like diesel cars. porsena

Ilargi said...

"The announcement of Tim Geithner as SecTreas raised the Dow almost 7% in the last hour."

No it did not.

el gallinazo said...

Ilargi said...
"The announcement of Tim Geithner as SecTreas raised the Dow almost 7% in the last hour."

No it did not.

Kind of reminds me of stopping someone on the street and asking, "Can you tell me how to get to Spring and Madison?" The person replies, "Yes," and then walks away.

OK. I admit that I accepted the Bloomberg take on the rally at face value. Do you figure this was a manipulated, perhaps PPT, operation unrelated to the Geithner appointment?

Anonymous said...

el pollo, today is option expiration day. what would you expect?

team10tim said...


I agree with el pollo. You're too terse. Do you mean that the jump at the end of the day was due to other news or that the steep rise was because of market dynamics, the suckers rally that Stoneleigh is expecting after retesting the 2002 lows or something else all together.

Anonymous said...

Financial Expert “Paulson’s head should be bouncing down capital steps”
Max Keiser as seen on Aljazeera TV English…

Anonymous said...


I think Ilargi's "No it did not" reply is a classic example of second-degree humour.

El Pollo is perfectly correct. It is like asking someone if they have the time, they reply "yes" and walk away. If done correctly, it is very funny. If done really well, you can even induce bystanders to chime in with all sorts of disparaging remarks. (Sorry Tim, but there is humour here.)

Unfortunately, it rarely goes over as well in written form, which is why, now that we have all had a good laugh, I would also like to know what Ilargi meant.

The reply by an Anon concerning options expiring is too vague for my limited understanding.


Anonymous said...

The market makes the news.

The news does not make the market.

"Tim Geithnwe named as Treasury Secretary -- the market jumped 200!" Nope...purely coincidental...and just another more or less meaningless event that gives news folks something to attribute (incorrectly) as causing market action.


Anonymous said...

Don’t be blindsided, find out who’s opinions will shape our future?
Who will Tim Geithner depend on to make his policies?
Who is Tim Geithner?
Who will replace Tim Geithner at the New York Fed?
Long shots for 2009
Nov 19th 2008
From The World in 2009 print edition
By John Andrews
The unlikely, but possible, turn of events
Week of 11.21.08
What's Next for Capitalism?
Read James K. Galbraith
Read David Rothkopf
Read Robert A.G. Monks

Anonymous said...

"The reply by an Anon concerning options expiring is too vague for my limited understanding.


Thats why!




Anonymous said...

el pollo,
You don't strike me as a reader of 'no kick sand in my face' manuals. More of an out an about howdy partner sort of fellow me lad. How about a mountain bike for Peru instead?

BTW I hope you got a kick out of my Link-lite message and that it gave you a fine, "what the Jesus is this idiot dropping in my lap" moment".


Anonymous said...

Are the people who wrote Bush’s speech at the APEC going to have the same influence in directing the repairs to the capitalist system?
Analysts: Bush, Obama not taking lead in righting economy

el gallinazo said...


I'm not in Peru yet. I must stay on my St. John pebble until Aug 1 to fulfill my obligations here. After that I will ship the stuff I want to keep (mainly my tools and some books & electronics) to Miami for storage. Even though I don't like Florida at all, I will set up some sort of temp base in the Miami Fort Lauderdale area. It is the USA gateway to Latin America. If you have the freedom to use their dates, Spirit Airlines is offering some unbelievable fares to Lima and Bogota. They had a $9 special the other day! I think I will start out spending some time in my little city in the Andes valley, Huaraz. May check out Mexico. May look for the right community in the USA. Finally got The Long Emergency by slow boat and started reading it last night. Already informed me what I already know - the Southwest is toast and the Southeast will descend into violent Christian anarchy due to the high incidence of brother-sister incest :-)

I am turning over a new leaf physically. Gave up beer and coffee in the last two months; just completed a ten day cleansing fast, and am awaiting the arrival of my P90X workout DVD. Maybe I'll buy that mountain bike with my next social security check.

This was my first extended fast. Very useful psychologically. Taught me that feelings of hunger are not all that horrible compared to,say, a root canal.

Thanks again for the link. I am going through it. Very informative.

Anonymous said...

"They had a $9 special the other day!"

Is that the one where the passengers have to push at take off? No wonder you are into that P90X!

Glad to hear that Florida is doomed, I have a cousin there:)


Greenpa said...

El Pollo- 10 days is good; enough to get you past hunger and start some changes. I do NOT have time to get into a whole discussion on it; just wanted to say there is more to learn further down that road. I've done 40, once; it was very educational and worthwhile. Not that I do it regularly.

el gallinazo said...


If I fast 40 days, will I put Satan behind me? I have been having erotic dreams.

Anonymous said...,8599,1861311,00.html?xid=site-cnn-partner
Geithner at Treasury: An Insider to the Rescue?

As Treasury Secretary, Geithner will play a large role in erecting the last pillar, regulating risk and leverage in the shadow banking system.

But Geithner's experience does have its downside. The Administration's attempts to shore up confidence in the the stock and credit markets have stumbled and now even previously rock solid institutions like Citigroup are in deep trouble. And if Geithner locked horns with Sheila Bair from his perch atop the New York Fed, he'll have to work even more closely with her from the Treasury building on the other side of the White House, as the two will be key players in saving any big banks that fail. They will also control the shape of any mortgage bailout for Americans who are at risk of losing their homes, an initiative many experts say is necessary if Washington is to get the economy moving again.

Anonymous said...


I imagine you have run across the Baba Ram Dass (formerly Richard Alpert) story about the difference between starving and fasting? Walk up to a guy who says I have been fasting for 40 days and forty nights and you say "good going guy". Then you walk up to some guy who hasn't been able to find food for those 40 and 40 and say the same thing. I guess as long as he hasn't been doing his P90X exercises - no problem.

BTW el pollo, good going guy, now I'd like to see you beat greenpas fasting score, maybe do 60 or 80, what do you say? Maybe get you both going at once, make it a horse race and put some real money on it? (I did almost 30 once but it was the other kind so I guess doesn't count).

el pollo maybe I should have gone hungry that extra 10 or so days as all I could dream about was these dancing doughnuts in cute little tutu's.

Anonymous said...

Re Gardner raising the dow 7%. As Illargi said no, but it was timed to max the effect. Bond trading stops 3 pm eg the drain of money into bonds stops at that time. Rally hard as MM have to reduce losses by puts they wrote. Kudos to them for a close a tiny bit above 800 - lots of puts destroyed. Sensible investment on their part. On Wednesday you had the 3pm rally as well. Markets are not random.

Anonymous said...

Markets are not random."

Right, and nothing is, that's why we can sort of examine the past almost clearly sometimes.

Anonymous said...

Don’t do as I do but do as I say.
The big 3 bail out package has got to be reworded to avoid violating the WTO agreements.
Bush urges against trade barriers
Speaking at Asia-Pacific Economic Cooperation meeting, outgoing President says protectionism is not the answer to global crisis.
Last Updated: November 22, 2008: 12:14 PM ET

Anonymous said...

anon @ 12:25,

well said. you answered the comments from FB regarding the OpEx day comment I left earlier.

the put contract writers only have the ability to do a rally for a very short period of time. still, 800 is not the max pain level and they will have loads of stocks put in their hands to unload in the coming week. could be a perfect set up for a black Monday.

markets are not moving in random. that's why TA works. according to one of the best TA out there, markets actually work in perfect mathematical harmony. his prediction: after the 770 level is breached, which happened on Thursday, we shall see S&P at 400 in 12 weeks. many people are expecting a multi-month counter trend move which should start after a panic selling off that we haven't seen so far. time is running out, so we should see a hard selling off really soon followed by a multi-month rally and in time to crash back down to 400 level within 12 weeks...


bluebird said...

anonymous Z @ 1:40 - What is 'TA'? I'm a bit limited in acronyms.

Anonymous said...

Bluebird my guess was Tranactional Analysis but here are some that don't fit either from wikipedia

Farmerod said...
This comment has been removed by the author.
Anonymous said...


TA: technical analysis.


Farmerod said...

markets actually work in perfect mathematical harmony.

Ergo, the PPT has mathematicians on the payroll.


Anonymous said...

anonymous Z @ 1:40 - What is 'TA

technical analysis. other
'school" is fundamental analysis.

Anonymous said...


the math that markets move in harmony with factors everything in including PPT and their behavior patterns. some TAs like Robert McHugh even have a PPT indicator.

anon @ 3:00pm

fundamental analysis is good for long term trend prediction but so is TA if one knows how to do it. you can be fundamentally correct yet still be broke. as the saying goes, market can stay irrational longer than you can stay solvent.