Saturday, November 22, 2008

Debt Rattle, November 22 2008: Ordinary People

Timothy H. O'Sullivan Hero July 1863
John L. Burns, the 'old hero of Gettysburg,' with gun and crutches. Born ca. 1793, a 70-year-old veteran of the War of 1812 when he was wounded in the Battle of Gettysburg, having volunteered his services as a sharpshooter to the Federal Army. Died of pneumonia in 1872.

Ilargi: Most financial and economic news, both historically and in these days, is focused on large corporations, governments and central banks. This may be logical, after all that's where the biggest numbers are, but it's also a major mistake, certainly in times of crisis.

We need to start looking much closer at what's going on beyond the big numbers. Because if we do, we can find out what is happening to all the millions of people whose purchases and tax revenues combine to make multi-trillion dollar economies possible. With that idea in mind, what we see in the real world should be a wake up call, a realization that we can indeed predict what will be the future of large banks, insurers and carmakers.

Most North Americans and Europeans don’t just have little money left, their effective net worth is negative, they have more debts than assets. This is the result of easy credit, used for anything from home and car purchases to all the gadgets and trinkets charged to their credit cards. The whole system has been based on a promise to pay back later, to spend now what will be earned at a later date.

But now the easy credit is gone, and it drags an entire way of life, and even entire economies, down with it. People can no longer get loans to buy houses or vehicles. And that should make us pause and ask why our governments are so eager to bail out the large banks and other corporations. The notion that certain enterprises are essential, too big to fail etc. needs to have a question attached to it: can these companies return to profit, will they be able to persuade consumers to come back and purchase their goods and services?

The answer is as brief as it is clear: no. The easy credit is gone, perhaps not forever, but for a very long time. There comes a point where the promise to pay in the future loses its credibility. That's the essence of what we're looking at. Banks don't believe other banks’ promises, and they don't believe their customers will be able to pay them back either. A classic example of a grinding halt.

Since all our economic dealings in the past 25 years have been increasingly funded by credit, by spending -ever more- before earning -more or less the same-, the disappearing act of credit will grind to a big and devastating halt the entire chain we have based our societies on. Governments at all levels borrow money -against interest- based on expected future tax revenues. Stores and factories use credit to accumulate inventory that is supposed to be sold at a profit, which is to be used to pay the loan plus the interest. These loans to governments and companies are vanishing as rapidly as those the man in the street has used to buy his shelter and vehicles.

And no amount of federal bail-out can restore the easy credit that has provided the loans. This is not hard to understand. The US Treasury and Fed rely on the very same principle that has led to the credit halt in the first place. And in this case, the principle is put on steroids: a huge increase in spending now what is expected to be earned later. By now it's obvious that the debt involved cannot possibly be paid back with earnings of the present population; it has become necessary to rely on future generations’ earnings. But no bank, even in good times, would let you use the earning power of your grandchildren as collateral for a loan, and in the end it's no different if a government tries it.

70% of the US GDP is determined by consumer spending. It would thus seem glaringly obvious that in order for the economy to be revived on anything resembling sound principles, the purchasing power of ordinary people needs to be restored. Still, this is not even attempted. The money that the ordinary people will have to earn in the future is today handed out to the corporations that are inevitably doomed to failure if they can no longer do business with ordinary people. And the more the companies receive from the government, the higher the likelihood that they will fail, because the money they get is the money the man is the street would need to buy the same companies' goods and services.

Unless governments change their tactics and their views, and very soon, their legitimacy and credibility will be questioned ever more, and ever louder. None of the bail-outs have had any positive effect on the economy, because they can't; they ignore the most important party in the economy.

The man in the street is too big to fail, not the corporations.

Job Losses Surge as US Downturn Accelerates
Rising unemployment across the nation reveals a pervasive downturn that is spreading at an accelerating pace. In data released Friday by the Bureau of Labor Statistics, 12 states, including Florida, Idaho, North Carolina and Illinois, reported a rise of at least two percentage points in unemployment rates over the past year. For many states, the pace of decline is more severe than during the 2001 recession. Job losses have spread beyond construction and manufacturing to service sectors such as tourism, hospitality and professional and business services.

"It's remarkable how fast the unemployment rate is increasing" in several states, said Luke Tilley, a senior economist at IHS Global Insight. "We are now seeing the full ripple effects." In October, month-over-month unemployment rates increased in 38 states and the District of Columbia. Unemployment rates held steady in seven states and fell in five. Many economists forecast the national unemployment rate, currently at 6.5%, will top 8% in the next few months.

The weakest states are those with concentrations of construction and manufacturing jobs. Michigan and Rhode Island, both heavily dependent on manufacturing, posted October unemployment rates of 9.3%, highest in the nation. Ohio's rate rose to 7.3% from 7.2% in September. Unemployment generally was higher in Western states, which have been hit particularly hard by the housing bust, and the Midwest, which continues to bleed manufacturing jobs. But joblessness affected the entire country, even touching energy-producing states that had been resilient up to this point.

Florida has lost 156,000 jobs over the past 12 months, but the weakness has spread beyond the state's housing industry. About half the losses were in the construction sector, but the state also lost 47,000 jobs in the professional and business service sector, 38,000 in trade, transportation and utilities, and 20,000 in manufacturing. Unemployment rose throughout the Sunbelt, as falling home prices and surging foreclosures continued to weigh on employers. Florida and Georgia both posted unemployment rates of 7%, while Nevada's rose to 7.6% and California to 8.2%.

While Sunbelt states have been buffeted by the housing bust and subsequent falloff in consumer spending, they may have further to fall. In Florida, Arizona and Nevada, construction jobs account for between 6.5% and 9.4% of employment, compared with 5.3% nationally, according to economists at Goldman Sachs. An exception is California, where construction employment is now in line with the national average. Energy states remain the lone bright spot, but not necessarily for long. Wyoming and South Dakota had the lowest unemployment rates in the nation, at 3.3%. North Dakota's unemployment rate fell to 3.4%. Falling energy prices have removed an economic buffer from many of those states. Unemployment rose 0.5 percentage point to 5.6% in Texas; in Oklahoma, the rate rose to 4.3% from 3.8% last month.

Bank Failure Count: FDIC closes 22nd bank of 2008
The FDIC took over three banks yesterday, bringing the total number of bank failures so far this year to 22. The FDIC likes to close banks on Friday after hours so they can reopen as branches of the acquiring bank on the following Monday morning. But the U.S. better be working overtime this weekend because Citigroup is going to need a merger partner or a government rescue to keep it from becoming history's biggest bank failure.

Of the three banks that failed Friday, two were in California -- Downey Savings and Loan Association (with $12.8 billion in assets and deposits of $9.7 billion), based in Newport Beach, and PFF Bank & Trust of Pomona (with assets of $3.7 billion and $2.4 billion in deposits) -- and the third was in Georgia: The Community Bank, with $681 million in assets and $611.4 million in deposits in Loganville.

In each case, the FDIC arranged for a healthier bank to take over the deposits, branches, and some of the assets of the failed one. U.S. Bancorp acquired the deposits of the two California banks that were brought down by Option ARM mortgages -- which allow a borrower to skip payments and add the amount to the loan principle -- and housing construction loans. Bank of Essex, of Tappahannock, Va., bought all the bank deposits and $84.4 million of The Community Bank's assets -- the FDIC took on the rest.

Is this the end? Far from it. The FDIC has 117 banks on its problem bank list out of roughly 8,500 it insures. And while it is reassuring that the FDIC can handle these small bank failures, the real problem will come when the U.S. tries to deal with Citi -- since the FDIC's $45.2 billion deposit insurance fund would be only 6% of Citi's $780 billion in total deposits.

The question is whether the entire U.S. government can craft a solution that keeps the global financial system from imploding -- after all with $2 trillion in assets, the bankruptcy of Citi would be more than three times bigger than the $639 billion Lehman collapse.

Ilargi: No, the markets didn't surge yesterday afternoon because Geithner was announced as Secretary of the Treasury, what sense would that make? Instead it's Sheila Bair's unilateral, out of Congress pledge, twice as large as TARP, which puts the risk for just about all bank transactions squarely on the tired and numb heads of the taxpayers.

FDIC pledges $1.4 trillion backing for bank debt, deposits
The FDIC will guarantee up to $1.4 trillion in U.S. banks' debt for more than three years as part of the government's financial rescue plan. The directors of the Federal Deposit Insurance Corp. voted Friday to approve the plan, which is meant to break the crippling logjam in bank-to-bank lending. The FDIC will provide temporary insurance for loans between banks -- except for those for 30 days or less -- guaranteeing the new debt in the event of payment default by the borrowing bank.

The FDIC also will guarantee deposits in non-interest-bearing "transaction" accounts by removing the current $250,000 insurance limit on them through the end of next year. That could add as much as $500 billion to FDIC-backed deposits. The guarantee program has been in effect since Oct. 23. All federally-insured banks and thrifts have been automatically covered since then but will have to decide by Dec. 5 whether to participate or "opt out." Well over half of the roughly 8,500 U.S. banks and savings and loans are expected to tap the FDIC's temporary guarantees, which are in addition to the government's $250 billion program of directly buying shares in banks and financial companies.

The FDIC guarantee program "is an important step to strengthen the financial system by increasing confidence in the markets," said Brookly McLaughlin, a spokeswoman for the Treasury Department. Some analysts have said that freeing up bank-to-bank lending with the guarantees won't necessarily translate into a thaw in broader lending as banks are still wary of making loans to businesses and consumers. The FDIC first announced the program in mid-October. Invoking risk to the financial system, it was the first time the agency called on special authority under a 1991 law to undertake a special guarantee program of industrywide scope. The program doesn't rely on taxpayer funding, FDIC officials say, because the banks will be charged special fees for the guarantees.

The agency said it received more than 750 comment letters on the program when it was proposed last month, and made some changes to the original plan in response to concerns raised by the banking industry. The original plan called for FDIC guarantees for the new debt in the event the issuing bank failed or its holding company filed for bankruptcy. That didn't correspond to the usual practice in the marketplace, bankers told the FDIC, in which payment default is normally the event that triggers insurance. In addition, short-term debt issued by banks -- for 30 days or less -- was removed from the guarantee program to avoid creating more volatility for the Federal Reserve's primary interest rate. The Fed on Oct. 29 slashed the rate to 1 percent, a level seen only once before in the last half-century. Many economists predict the Fed will lower rates again next month at its last meeting of the year.

The FDIC will back new senior unsecured debt that banks issue to each other between Oct. 14 and June 30, 2009. It would be insured by the agency through June 30, 2012. Senior unsecured debt does not have collateral underlying it but must be repaid before other classes of debt. The FDIC also will guarantee deposits in non-interest-bearing "transaction" accounts by removing, through the end of next year, the current $250,000 insurance limit on them. Businesses often use the deposit accounts for processing their payrolls and other transactions.

A significant proportion of business accounts are said to be uninsured, forcing businesses to juggle funds among multiple bank accounts to remain under the $250,000 insurance ceiling. If fully utilized, the government estimates that change would add $400 billion to $500 billion in FDIC-guaranteed deposits. As part of the $700 billion financial rescue law, the insurance cap for regular deposit accounts was lifted to $250,000 from $100,000, also through the end of next year.

Citi slammed, but J.P. Morgan in greater need of capital
Investors may be punishing Citigroup, but according to one analyst, J.P. Morgan Chase may need even more capital than Citi to shore up its balance sheet. Indeed, Paul Miller at Friedman Billings Ramsey calculates that J.P. Morgan may require at least $188 billion in additional equity capital, compared with $160 billion for Citi.

Mr. Miller reckons that J.P. Morgan will need more capital than any of the the other largest banks—Bank of America/Merrill, Citi, Wells Fargo/Wachovia, Goldman Sachs and Morgan Stanley—or financial services giants AIG and GE Financial. Though those companies have about $12 trillion in assets in total, their tangible common equity is just north of $400 billion, or about 3.4% of assets. And since tangible common equity is “the first loss position” when it comes to bad loans, that number is “simply too low,” according to Mr. Miller.

Mr. Miller assumes that banks need capital equal to 5% to 6% of risk-weighted assets to cover possible losses. If the underlying capital is financed in the short-term funding market, then banks should set aside at least 10% to 14% more to account for the possibility that short-term money could suddenly become less available. Though J.P. Morgan has more tangible common equity, at $90 billion, compared with Citi’s $35.5 billion, J.P. Morgan also has more risk-weighted assets, at about $1.3 trillion, compared with Citi’s $1.2 trillion. As such, the bank could need at least $127 billion to cover those assets, compared with almost $97 billion for Citi.

Overall, the eight financial services companies examined in the FBR research may need between $1 and $1.2 trillion in funds from the government to work their way out of the current imbalance, which developed over a period of years as financial institutions placed too much reliance on short-term funding. “The U.S. financial system became too lax with respect to capital levels and the use of short-term funding to finance assets,” Mr. Miller wrote in a note dated Nov. 19. “Capital levels have plummeted, while short-term funding exploded over the last few years.”

Add to that the mispricing of credit and interest rate risk, and you have a “dangerous cocktail” in a credit crisis such as this, he added. Financing from the Treasury’s Troubled Asset Purchase Program is helpful, but because it doesn’t go directly to tangible common equity, it’s not going to the right place. Only in the case of AIG did the government get it almost right, Mr. Miller noted. “If the government would convert TARP capital issuances into pure, tangible common capital (akin to the $23 billion C class investment in AIG), it would go a long way toward encouraging subsequent private investment,” he wrote.

Returning to older—and more stable—funding models will also help. “Through higher interest rates on loan products, significantly larger loan loss reserves, and more common equity, the banking industry will eventually return to a sustainable business model,” according to Mr. Miller.

US Needs to Pump $1.2 Trillion Into Banks
The U.S. may need to spend another $1.2 trillion to recapitalize the eight largest financial institutions and stabilize the markets because private investors won't take the risk, an FBR Capital Markets analyst said. "The sheer size of the capital deficiency, coupled with the opaque nature of credit risk, will keep private capital sidelined," Paul Miller said in a research note yesterday. Treasury Secretary Henry Paulson has committed $290 billion of the $700 billion Troubled Asset Relief Program to buying stakes in banks and in insurer American International Group Inc. to stabilize markets. Paulson said he wants to use the rest of the money to bolster lending for student loans, credit cards and auto loans.

Miller, who's based in Arlington, Virginia, said Treasury's preferred equity investments aren't "real capital" and won't ensure the firms will survive. Though Treasury's cash injections so far have bolstered bank capital, they give Treasury a senior repayment position that leaves common equity holders to absorb the majority of the losses, Miller said. "Only injections of true tangible common equity will solve the current crisis," Miller said. Treasury spokeswoman Brookly McLaughlin declined to comment on Miller's report.

The eight largest U.S. financial companies, including Bank of America Corp. and JPMorgan Chase & Co., have a combined cushion of roughly $405.7 billion in "tangible common equity," FBR estimates. They also have as many losses, $408.3 billion, on their balance sheets that will eventually hit earnings and wipe out that equity. "If losses are large enough to affect book value and stock price significantly, a company's probability of failure increases, regardless of the level of preferred or regulatory capital," he said. Miller is the world's most accurate bearish equity analyst, according to a Bloomberg survey of stock picks of 3,000 analysts at 432 research and investment firms worldwide for the 12 months ended March 31.

The U.S. needs to temporarily inject at least $1 trillion to $1.2 trillion in common equity to restore investor confidence and weather losses stemming from the worst housing market since the Great Depression, Miller said. He said it will likely take three to five years for the financial system to fully recover. The industry is still "over-levered," he said, estimating the amount of tangible equity at the eight firms at 3.4 percent of total assets and the leverage ratio at 29 to 1. "Eventually, capital levels will be strengthened by both private capital raises and internal capital generation, but the federal government will have to be the primary first responder to the crisis," Miller said.

The other companies in Miller's analysis are Citigroup Inc., Wells Fargo & Co., Morgan Stanley, AIG, Goldman Sachs Group Inc. and GE Capital Corp. The companies, which include GE Capital parent company General Electric Co., have a total stock market value of about $475 billion.
Recapitalizing those eight largest firms would help stabilize the rest of the U.S. financial system, he said. Other mid-sized and small financial firms aren't as heavily leveraged and should rebound once credit starts to loosen up. "Once the system is running smoothly and private capital begins to return, we can debate the best way for the government to extract itself," he said.

Though the investments would dilute current shareholders, Miller said that should not be a primary concern. "To get the credit markets functioning now, the government must" suspend dividend payments for all banks, convert TARP funding into common stock, force banks to raise more capital above current requirements and create a central clearinghouse for credit default swaps, Miller said. "The quicker the government acts, the sooner the financial system can work through its current problems and begin to supply credit again to the economy," he said.

U.S. foreclosure filings increased 71 percent in the third quarter from a year earlier to the highest on record as home prices fell and stricter mortgage standards made it harder for homeowners to sell or refinance, RealtyTrac, a provider of real estate data based in Irvine, California, said on Oct. 23.
Lower property values will keep eroding home equity. The S&P/Case-Shiller home-price index of values in 20 U.S. cities dropped 16.6 percent in August from a year earlier, the fastest pace on record. The index has been lower every month since January 2007.

Citigroup, Under Siege, Opens Talks With US Government
With the sharp stock-market decline for Citigroup rapidly becoming a full-blown crisis of confidence, the company’s executives on Friday entered into talks with federal officials about how to stabilize the struggling financial giant. In a series of tense meetings and telephone calls, the executives and officials weighed several options, including whether to replace Citigroup’s chief executive, Vikram S. Pandit, or sell all or part of the company.

Other options discussed included a public endorsement from the government or a new financial lifeline, people involved in the talks said. The course of action, however, remained uncertain on Friday night, these people said, and other options may yet emerge. But after a year of gaping losses and an accelerating decline in share price, Citigroup, which has $2 trillion in assets and operations in scores of countries, is running out of time, analysts said.

After a board meeting early Friday morning, Citigroup’s management and some board members held several calls with Henry M. Paulson Jr., the Treasury secretary, and with the president of the Federal Reserve Bank of New York, Timothy F. Geithner, who later emerged as President-elect Barack Obama’s choice to be Treasury secretary. As Citigroup’s stock sank during the day, falling 68 cents to close at $3.87, the Federal Reserve was carefully monitoring how much money corporations and other customers were withdrawing from the bank, people involved in the discussions said.

The Fed was trying to ascertain whether the tumult in the stock market could escalate into something worse. So far, these people said, most customers and clients remained committed to Citigroup. But with Citigroup’s troubles opening a new chapter in the long-running financial crisis, government officials said that the Treasury Department was considering whether to ask for the second half of the $700 billion rescue fund approved by Congress in September. It was unclear whether any of that money would be used to make a cash infusion into Citigroup, which received $25 billion from the government in October. A second financial rescue for banks might be difficult politically at a time that the struggling auto industry is being turned away in Washington.

As Citigroup’s fortunes diminished on Friday, Mr. Pandit, the company’s embattled chief executive, went on the offensive. He worked the phones and held a companywide call to shore up the confidence of anxious employees. Later in the day, the company held a similar call with large corporate customers. On Sunday, Citigroup plans to run full-page advertisements in major newspapers that acknowledge “our financial markets have been tested in unprecedented ways,” but argue that the company has a broad range of businesses and enough management expertise to pull through. In a nod to the company’s slogan, the text concludes: “That’s why now, more than ever, you can feel confident that Citi never sleeps.”

Still, Citigroup’s executives are not expected to sleep much this weekend as they continue to pursue contingency plans, including what they might need to calm anxious investors before the stock market opens on Monday morning. One maneuver that Mr. Pandit has championed is for the Securities and Exchange Commission to reinstate the “uptick rule,” which prevents short-sellers from betting against companies whose stock price is falling. Mr. Pandit has been lobbying the S.E.C. for the past week, as have other Wall Street chiefs. Mr. Pandit and others have suggested that Citigroup is a victim of short-sellers, which some have blamed for speeding the demise of other financial companies this year.

In September, Richard X. Bove, an analyst at Ladenburg Thalmann, predicted that short-sellers would turn their attention to larger and larger financial companies, including Citigroup, which he said at the time was strong enough to withstand the pressure. “They’re going to hit a company that is too well grounded, too well capitalized, and I think that will be Citigroup,” he said. Still, while Citigroup is widely regarded as too big and too interconnected to be allowed to fail, its immediate future is uncertain. Executives at other financial firms said that there are not many options left, and that Citigroup’s stock has reached a level that may force government action.

“The reason you have to ‘save’ Citibank is you cannot allow this hysteria,” said Peter J. Solomon, chairman of the Peter J. Solomon Company, a small investment bank. Investors and executives at other banks said that one way the bank might be able to give itself some breathing room would be for Mr. Pandit, who became chief executive less than a year ago, to step down. Executives in New York have also begun pointing out that Citigroup has a huge global presence. They suggested that perhaps a government bailout should involve money from other countries in addition to the United States.

“If there’s a flight from Citi’s stock, that’s unfortunate, but I don’t think that’s the government’s business,” said David M. Walker, the president of the Peter G. Peterson Foundation and a former United States comptroller general. Mr. Walker said that the government should be concerned about Citigroup only if there were a run on the bank that threatened the financial system. The government should not, he said, be concerned about shareholders. Some executives, however, argued that it was important to protect Citigroup’s shareholders because if they lose their investment, that will send other bank stocks diving. Among the other ideas being bandied about Washington and the halls of Citigroup would be an assisted merger between Citigroup and another major bank. The merger might be structured with government assistance based on the blueprint that was developed for the Wachovia and Citigroup merger.

That deal ultimately did not go through because Wells Fargo stepped in with a higher offer, but it would have involved the Federal Deposit Insurance Corporation sharing the losses on $312 billion of Wachovia’s loans with Citigroup. Citigroup would have absorbed the first $42 billion in losses, and the government would have absorbed the rest. The F.D.I.C. would have been given $12 billion in warrants and preferred shares of Citigroup in exchange. That structure could be used in a merger, but this time around, the government would be absorbing losses on Citigroup’s loans. But it remains unclear what other bank is in a strong enough position to merge with Citigroup.

Inside Citigroup on Friday, some angry senior executives said that the government had “allowed” Wells Fargo to take Wachovia from them, people at the firm said. They argued that had Citigroup and Wachovia been allowed to merge “we wouldn’t be in this position,” one executive said. Another option might be for the government to purchase a large chunk of Citigroup’s assets in one swoop.

Such an action could be structured similarly to the proposed deal in Switzerland for UBS. A spokesman for UBS, Mark Arena, said on Friday that the arrangement would allow UBS to have “one of the cleanest balance sheets of our peers.” At the time of the deal’s announcement in October, Jean-Pierre Roth, president of the Swiss National Bank, said the government had the time to wait for the values of the assets to improve. “UBS does not have time,” Mr. Roth said.

Citi eyeing merger candidates
Citigroup lost more than one-quarter of its market value on growing worries over whether it has enough capital to withstand billions of dollars of potential losses and despite new support from its largest individual investor. The second-largest U.S. bank by assets is looking at options now, including a sale of parts of the company or a merger with another company, after its stock fell 50% this week, a person familiar with the matter said on Thursday.

Discussions so far have been internal, and some options—such as entering into a merger where other executives end up running the company—are unpalatable to managers at Citigroup, the person said. The bank’s board of directors is set to meet on Friday, and Morgan Stanley is not considering a possible bid, the Wall Street Journal reported. Citigroup did not comment on the report, repeating that it has a “very strong capital and liquidity position” and is focused on a strategy that will generate benefits “over time.” Morgan Stanley did not immediately return a call for comment.

Earlier Thursday, Saudi Prince Alwaleed bin Talal said he plans to increase his stake in Citigroup to 5% from less than 4%, calling its shares “dramatically undervalued.” Mr. Alwaleed expressed “full and complete support” for management, including Mr. Pandit, who said this week the bank will slash 52,000 jobs and 20% of expenses. Investors were unimpressed, and drove the bank’s shares below $5, a level not seen since 1994. The market value of Citigroup has fallen $48.7 billion this month alone.

Citigroup is not seeking any government financial aid, and is not seeing any unusual business activity, a person close to the bank said.But government aid may have to be part of any deal for Citigroup, investors said. Raising capital, whether through a share sale or selling businesses, would be difficult in the current environment. Citigroup “will get bailed out, and that’s another unfortunate strain on the U.S. government,” said Saj Karim, an investment adviser at Cannacord Capital in Waterloo, Ontario.

The government may look to augment the $25 billion it injected last month from a $700 billion industry rescue package. The bank has raised another $50 billion since the middle of 2007. Analysts said the bank could face more than $20 billion in losses in 2009 on commercial real estate, credit cards and emerging markets, as the world economy sinks into recession. “How much capital is Citi going to need?” said Keith Davis, a bank analyst at Farr, Miller & Washington in Washington, D.C. “I don’t think anyone knows, and so the knee-jerk reaction is to sell first and ask questions later.”

The bank has asked the U.S. Securities and Exchange Commission to reinstate a ban on the short-selling of financial stocks, in an attempt to arrest their downward spiral, a person familiar with the matter said. A prior ban expired Oct 8. Other banks’ shares also tumbled on Thursday, with J.P. Morgan Chase falling nearly 18% and Bank of America closing down almost 14%. Along with Citigroup, the banks are components of the Dow Jones industrial average, which shed 5.6%. J.P. Morgan is eliminating about 3,000 investment banking jobs, or 10% of that unit, to cope with the deteriorating economy, people familiar with the matter said. Bank of New York Mellon Corp announced 1,800 job cuts.

And KeyCorp, a Midwest regional bank, reduced its common stock dividend for the second time in six months. Citigroup’s market value, which once topped $270 billion, fell to $25.7 billion on Thursday. The bank was overtaken in market value this week by U.S. Bancorp and Bank of New York Mellon, despite being more than four times larger by assets than those companies combined. Five-year credit default swaps for Citigroup rose to 395 basis points, meaning it would cost $395,000 annually to protect $10 million of debt, according to Phoenix Partners Group. That’s up from $357,000 of annual payments on Wednesday, according to Markit.

But those levels are not as high as they were for other banks just prior to failure. Combined with the low share price, markets seem to be implying that either Citigroup will raise capital without government help, or it will receive government help that does not hurt bondholders and derivatives trading partners. Earlier this year, the government has rescued giant insurer American International Group Inc and mortgage giants Fannie Mae Freddie Mac. U.S. Treasury Secretary Henry Paulson declined to comment on Citigroup.

Despite its troubles, Citigroup is one of three final bidders, along with J.P. Morgan and Capital One Financial for Chevy Chase Bank, a Bethesda, Maryland, lender with $11.4 billion in deposits, people familiar with the matter said. Mr. Pandit suffered a setback last month when Wells Fargo & Co agreed to buy Wachovia Corp, trumping Citigroup’s bid to buy much of the Charlotte, North Carolina-based bank and add $418.8 billion of deposits. Mr. Alwaleed said the bank is “taking all the necessary steps to position the company to withstand the challenges facing the banking industry and the global economy.”

The Saudi billionaire, a nephew of Saudi King Abdullah, said he is “fully confident that Citigroup’s universal banking model and global franchise will make it a long-term winner in the financial services industry.” Mr. Alwaleed also came to the bank’s aid in 1991, when he invested $590 million in Citigroup predecessor Citicorp, which at the time needed cash as it struggled with Latin American loan losses and a collapse in U.S. real estate prices. Citigroup has lost $20.3 billion in the last year and taken tens of billions of dollars in writedowns on mortgage and other toxic debt. Analysts expect it to lose money in the fourth quarter, and some don’t see any profit in 2009.

Citigroup May End Up With U.S. Government Rescue
The U.S. government may step in to rescue Citigroup Inc. after a crisis in confidence erased half the bank’s stock-market value in three days, according to investors and analysts. Citigroup’s $2 trillion of assets dwarfs companies such as American International Group Inc. that got support from the U.S. government this year. Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben S. Bernanke may favor a rescue to avoid the chaotic aftermath of Lehman Brothers Holdings Inc.’s bankruptcy in September.

“Citi is in the category of ‘too big to fail,” said Michael Holland, chairman and founder of Holland & Co. in New York, which oversees $4 billion. “There is a commitment from this administration and the next to do what it takes to save Citi.” One option is for the Federal Reserve and U.S. Treasury to create a special vehicle to purchase bad assets from Citi. The Fed has already erected several such funds, such as the Commercial Paper Funding Facility, to provide liquidity to the financial system. Typically, the Treasury would provide some first-loss equity or insurance fee, such as $50 billion provided to the CPFF, to protect the central bank and give the fiscal authority a stake.

The arrangement allows the Fed to leverage the money provided by the Treasury with loans, enabling the purchase of assets worth a multiple of the money. Funding the purchases with loans makes them less onerous to the U.S. budget. “That is the working relationship they have settled into with the Fed providing $1 trillion of the funding and the Treasury providing the equity tranche,” said Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey. Citigroup management and some board members discussed “several options” for the company in a series of phone conversations with Paulson and New York Federal Reserve Bank President Timothy Geithner yesterday, the New York Times reported today, citing unidentified people involved in the talks.

Among those options were the possible replacement of Chief Executive Officer Vikram Pandit, a public endorsement of Citigroup by the government or a new financial lifeline, the Times said. No decisions had been taken as of late yesterday, it said. While Citigroup executives say the company has adequate capital and liquidity to ride out the crisis, its tumbling share price may shake the confidence of creditors, clients and rating companies. A similar scenario played out at Lehman, when Chief Executive Officer Richard Fuld declared the firm was “on the right track” five days before the firm went bankrupt.

“The market may be implying some sort of regulatory intervention,” Jason Goldberg, a former Lehman analyst who now works at Barclays Capital in New York, wrote in a note to clients yesterday. “In situations where the government has stepped in, the equity holders have not fared well.” Pandit told employees yesterday that he doesn’t plan to break up the company, aiming to reassure workers as the stock resumed its skid. Citigroup shares dropped 94 cents, or 20 percent, to $3.77 in New York trading, giving the company a market value of about $21 billion. The stock pared its loss after the close of official trading, fetching $4.07 as of 4:35 p.m.

Pandit and Chief Financial Officer Gary Crittenden, speaking on a worldwide conference call yesterday, also said they don’t expect to sell the Smith Barney brokerage unit, according to two people who listened to the call and declined to be identified because it wasn’t open to the public.
The call came as Citigroup’s board, led by Chairman Win Bischoff and independent director Richard Parsons, prepared to meet yesterday at the bank’s headquarters in New York, said a person familiar with the company’s plans who declined to be identified because the deliberations are private. Bischoff, interviewed at a conference in Portugal yesterday, declined to comment on any potential changes to the board. “Providing stability” and “securing the future” are the themes of a new print advertisement that Citigroup plans to start running tomorrow in major markets in the U.S. and overseas. “Now, more than ever, you can feel confident that Citi never sleeps,” the ad reads.

Once the biggest U.S. bank, with a market value of $274 billion at the end of 2006, Citigroup has now slipped to No. 5 behind Minneapolis-based U.S. Bancorp. A plan by 51-year-old Pandit 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. “To be consistent with the last few government interventions, I don’t think Citigroup’s going to be allowed to fail,” said William Fitzpatrick, an analyst at Optique Capital Management Inc. in Milwaukee, which oversees about $1 billion and doesn’t own Citigroup shares. “This company’s too intertwined with the rest of the financial system to allow any further deterioration.”

Citigroup spokesman Michael Hanretta declined to comment. On the call yesterday with employees, Pandit said the company’s capital and liquidity are strong. 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 above the amount required by regulators to qualify as “well capitalized.” Capital is the cushion banks must keep to absorb losses and protect depositors.

Deutsche Bank AG analyst Mike Mayo wrote in a report yesterday that the bank’s $25 billion of reserves, when combined with other resources, “should be enough to cover estimated cumulative losses of $50 billion on loans.’” Mayo rates the stock “hold” and has a $9 price target. “With Citi being as big as they are, the government will make a special case and step in and find another reason to dispose of more TARP funds,” 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 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. 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.

Obama Aims to Create 2.5 Million Jobs in Plan to Abate 'Historic' Crisis'
President-elect Barack Obama said he aims to save or create 2.5 million jobs in a two-year plan to stimulate an economy facing a “crisis of historic proportions.” “It’s likely to get worse before it gets better,” Obama said today in his weekly radio address. He said that this week “financial markets faced more turmoil,” potentially leading to a “deflationary spiral” that may plunge the nation further into debt and cost millions more jobs.

The economic slowdown has been exacerbated by the worst credit crisis in seven decades. More firings will weigh on the economy and consumer spending, putting pressure on Obama and Congress to agree on legislation that will stimulate growth. The incoming 44th president is expected to announce, as early as Monday, his economic team, to be headed by Timothy Geithner, head of the Federal Reserve Bank of New York, as Treasury secretary. Others include Jacob Lew, former President Bill Clinton‘s White House budget director, who will serve as National Economic Council director; and Peter Orszag, head of the Congressional Budget Office, who will be the next White House budget director.

Obama hailed this week’s enactment of a $6 billion extension of unemployment benefits, and said more needs to be done, and quickly. “We have now lost 1.2 million jobs this year, and if we don’t act swiftly and boldly, most experts now believe that we could lose millions of jobs next year,” Obama said. Obama opened his weekly address with a litany of grim economic developments. New home purchases in October were the lowest in half a century and 540,000 more jobless claims were filed last week, the highest in 18 years, he said today.

“And now we risk falling into a deflationary spiral that could increase our massive debt even further,” the president- elect said. Obama said he and his top economic advisers will be working out the details of an “economic recovery plan” that will be “big enough to meet the challenges we face that I intend to sign soon after taking office” on Jan. 20. “It will be a two-year, nationwide effort to jumpstart job creation in America and lay the foundation for a strong and growing economy,” Obama said. “We’ll put people back to work rebuilding our crumbling roads and bridges, modernizing schools that are failing our children, and building wind farms and solar panels; fuel-efficient cars and the alternative energy technologies that can free us from our dependence on foreign oil and keep our economy competitive in the years ahead.”

The initiatives will address “this immediate crisis” and represent “long-term investments in our economic future that have been ignored for far too long,” he said. Obama also said in his radio address he would seek input from Republicans as well as Democrats. “But what is not negotiable is the need for immediate action,” he said. The president-elect’s address was also recorded on video and was posted on the official presidential transition website - - -- at 6 a.m. New York time today.

Not Everything Can Be Too Big to Fail
There is a really bad idea circulating in the nation's capital. Of course, that's not surprising -- but when it's endorsed by the Treasury secretary, we'd better pay attention. This week, Henry Paulson said in an interview with the Washington Post that he wants the Federal Reserve to be able to regulate and ultimately take over any failing financial institution that it considers crucial -- including hedge funds. This echoes a notion that has been endorsed by executives of some industry associations, that to prevent a recurrence of today's financial crisis it will be necessary to impose tough new regulations on financial institutions deemed "systemically significant."

If this approach were to be adopted in the panicked Washington of today, it would substantially change our financial system and guarantee -- rather than prevent -- future crises. For starters, because the definition of a systemically significant institution is highly dependent on context, it's impossible to identify one in advance. Consider Drexel Burnham Lambert. When it failed in 1990 it was one of the largest securities firms in the United States, not much smaller in relation to the market at the time than Lehman Brothers was when it collapsed earlier this year. Yet Drexel's collapse, which happened when the market was functioning normally, did not put the financial system or the economy at risk.

On the other hand, when Germany's Herstatt Bank failed to meet its international payment obligations in the mid-1970s, that event caused a serious globalized payment-system crisis -- even though Herstatt itself would not have been on anyone's list of major financial institutions at the time. And then there's Northern Rock in London. When it collapsed recently, the British government was forced to bail it out even though it was not considered significant before its depositors started to run. In fact, in today's fragile markets, almost any financial institution is systemically significant -- if what we mean by the term is that its collapse will stimulate fear about the stability of others.

In short, predicting the true sources of systemic risk in advance of their actual failure is probably impossible. But even if it could be done, should we want to? The answer is no. An institution designated as systemically significant, or "crucial," would be marked as too big to fail. After all, that's what such a designation means -- that the institution's failure must be avoided because of its potential impact on the economy or financial system. But once we designate a financial institution as too big to fail, and regulate it as such, a lot of unpleasant things follow.

First, we will have created "moral hazard" and impaired market discipline. The markets will understand that a loan to a systemically significant institution will carry less risk than a loan to an institution that does not have this status. Accordingly, systemically significant institutions will have an easier time raising funds than others, will pay lower rates and grow larger than others, and it will be able to take more risks because of the absence of market discipline. This in a nutshell is the story of Fannie Mae and Freddie Mac. The two companies were implicitly backed by the U.S. government, which in practical terms meant that they would not be allowed to fail. As a result, they were able to borrow as much as they wanted and take risks with those funds that they couldn't have taken unless the markets believed -- correctly as it turned out -- that Uncle Sam would stand behind them.

Second, systemically significant institutions would suddenly have an unfair competitive edge that would warp the market. Why? Because their lower funding costs would make them more profitable than others, and enable them -- as it enabled Fannie and Freddie -- to drive competitors from any markets they enter. The effect of designating certain companies as systemically significant would cause a consolidation of the industries in which they are located, with the systemically significant companies gobbling up those that couldn't survive, and others seeking mergers simply to claim designation as systemically significant or too big to fail.

Finally, the support voiced in Washington for the idea of regulating systemically significant financial institutions is based on the fundamental misperception that regulation can prevent them from taking the huge risks their protected status would permit. This New Deal notion should be discarded.
Exhibit A is the banking system, now mired in the worst financial crisis since the Great Depression -- even though it has always been the most heavily regulated. Exhibit B is the S&L debacle less than 20 years ago. Thousands of S&Ls and more than 1,500 commercial banks collapsed in another memorable regulatory failure.

It is completely inexplicable -- after the blindingly obvious failure of bank regulation -- that Washington (and European Union) policy makers would now want to spread regulation beyond banking and into other financial institutions, including hedge funds, brokerage houses and others that the government designates as systemically significant. This would give the government the opportunity to pick winners in each financial industry -- ultimately creating Fannies and Freddies everywhere. Among bad ideas, this one stands out.

The Truth About Bailouts
As the Federal bailout bonanza prepares to spread beyond the mortgage and financial sectors to fill Detroit's depleted coffers, few economic or policy analysts have spared a thought for the destitution of the U.S. government itself. Put simply, our government doesn't have enough spare cash to bailout a lemonade stand let alone a bloated and failing industry that is losing tens of billions of dollars per month. Washington can only offer funds that it has borrowed from abroad or printed. Unfortunately, the nation is in the grips of a delusion that money derived from these sources has the power to heal. But history has clearly shown that borrowed or printed money only has the power to destroy.

The argument that energizes the pro-Detroit camp is that the government should extend the same courtesy to the rank and file auto workers that it lavished upon the fat cats of Wall Street. While two wrongs certainly do not make a right, the fact remains that the Wall Street firms are still floundering despite the bailouts. What's worse, the money spent was either printed or borrowed from abroad. Both options are destructive to America.

When it comes to bailouts, the real discussions are not centered in Washington but rather in Beijing, Tokyo, and Riyadh. With no money of our own, our ability to bailout our own citizens is completely dependent on the world's willingness to foot the bill. While I am sure that Bush and Paulson are doing their best to convince the world that open ended financing of the United States is in the global interest, my guess is that, unlike Congress, our foreign creditors will see through the self-serving nature of our plea.

Like any bailout, our foreign creditors should consider the moral hazard of rewarding bad behavior, and the old investment adage of not throwing good money after bad. By continuing to "lend" us money, the world is merely delaying the necessary rebalancing of our upside down economy. By continuing to subsidize our reckless and outsized consumption, the world merely delays the inevitable re-balancing and exacerbates the underlying problem at the root of the current global financial crisis.

If Washington bails out General Motors, the funds will never be recovered. GM will simply burn through the bailout money and then be back for more. Talk of designing a new fleet of "green" cars that will pave the way to profitability by spurring a new buying spree is simply delusional. Given the staggering "legacy" costs of health care and pensions for millions of current and former workers, Detroit cannot produce cars profitably. Unless these costs are seriously brought down, and there is very little chance that they will be, Detroit will remain a bottomless money pit.

Similarly any money that the world lends to America to finance more consumption will never be repaid. We will simply blow through it, and be back, hat in hand, begging for more. As we painfully learned in the housing bust, lending people money that they cannot pay back makes no sense. This applies equally to foreign central banks lending to America as it does to commercial banks lending to homeowners.

So for the same reasons that Washington should not bail out General Motors, the world should not bailout America. Like GM, our economy is in desperate need of a restructuring. Spending must be replaced with savings, and consumption with production. The service sector must shrink and manufacturing must expand to fill the void. The dollar must fall, wages in America must be brought down to a competitive level, and hopefully government spending and burdensome regulation can be reduced.

This transformation will not be fun, but it is necessary. Our standard of living must decline to reflect years of reckless consumption and the disintegration of our industrial base. Only by swallowing this tough medicine now will our sick economy ever recover. By accepting a lower standard of living today, we will eventually be rewarded with a higher one tomorrow.

US help for investors to buy ailing banks
US federal banking regulators have created a national charter system to allow private equity groups and other investors to buy troubled or failed institutions. The move comes as regulators brace for a growing number of bank collapses following 20 failures so far this year. The Federal Deposit Insurance Corporation, which insures customer deposits, brokers the sale of failed banks to other banks or savings and loan institutions.

Under a “shelf charter” system, the Office of the Comptroller of the Currency would grant conditional preliminary approval of a national bank charter to non-bank investors, thereby expanding the pool of potential qualified buyers available. The 18-month conditional charter would remain inactive or “on the shelf” until an investor group is in a position to acquire a troubled bank. It would allow the group access to the FDIC’s list of failed or troubled banks and let it bid for them. A final charter approval can be granted once a bid is accepted.

Julie Williams, OCC’s chief counsel, said: “The big picture here is that we have taken a look at the situation and decided that this new charter system will enable transactions that get new capital into the banking industry.” “But not just anybody can come in and get a charter ... We are looking for management that has the capacity and experience to manage a bank safely and soundly, has the ability to inject a substantial amount of capital into the troubled institution and will be subject to significant regulatory oversight.”

The OCC said on Friday that it had granted the first such preliminary approval to a management and investor group led by a 30-year banking veteran, Gerald Ford. The group, backed by investors including three private equity funds, has about $1.38bn in capital to invest in troubled institutions, according to a letter from the OCC. The banking regulator is considering other applications for preliminary approvals. Separately, the FDIC on Friday strengthened its guarantee programme for bank-issued debt to address concerns the scheme would fall short of restoring confidence in bank lending markets unless further safeguards were in place.

The revised terms of the programmes, finalised on Friday, will allow financial institutions to tap debt investors for funds backed by the “full faith and credit” of the US government. The FDIC will insure that if a bank defaults, investors will receive timely payment of interest and principal on senior unsecured debt issued by the bank. The FDIC also replaced a flat 75 basis point fee on each debt issue with a tiered pricing system that would charge different fees for the insurance depending on the maturity of the bond issued.

Banks had argued that the original system was prohibitively expensive for short-term debt in particular and could undermine the market for overnight interbank loans. Loans with maturities of less than 30 days are now excluded. JPMorgan filed a shelf registration on Friday with the Securities and Exchange Commission that cleared the way for the bank to issue debt under the FDIC’s programme at any time, while Goldman Sachs said it intended to issue FDIC-backed debt early next week.

Are stocks cheap? It depends on earnings
Call it the Great Give-Back. The market's latest swoon this week sent the Standard & Poor's 500 Index to its lowest level in more than a decade, and the benchmark has lost almost half of its value since October 2007. Optimism is in short supply; so are stocks cheap? Is the U.S. market now the Great Give-Away? The answer depends on who you ask, and which yardsticks are used to measure valuation.

Investors were cheered Friday on reports that President-elect Barack Obama will name Timothy Geithner, the president of the New York Federal Reserve and a former Treasury official, as Treasury secretary. The Dow Jones Industrial Average rallied in the final hour of trading, tacking on almost 500 points to close back above 8,000 -- a gain of 6.5%. But that upbeat finish can't gloss over a market that seems to be littered with land mines. Citigroup Inc. has been pushed to the brink after a stunning decline in the banking giant's shares, and the strapped Big Three automakers begged Congress for a bailout this week. A fierce debate is raging between bulls and bears over whether U.S. stocks are beaten down enough to risk wading in. Even after Friday's rally, the bears are winning the argument.

Yet in these extraordinary times, it can be helpful to put emotions on the back burner and consider market history. There is no doubt that fear is propelling markets, but over the long haul, the gravity of fundamentals and valuation drives returns. One of the most common metrics of stocks' valuation is price-to-earnings ratio, or P/E, which is a rough gauge of how much investors are willing to pay for each dollar of future earnings. Price is simply the stock's value, but a big and nagging problem of P/E is how to measure earnings. For example, investors can use forward-looking earnings estimates or trailing profits. Based on 2009 projected operating earnings, the P/E on the Standard & Poor's 500 Index this week was around 10, according to Standard & Poor's. Valuations haven't been this cheap in decades, at least according to this measure. Meanwhile, 12-month trailing P/E was around 11, a level last seen in the late 1980s, according to Boston-based money manager Eaton Vance Corp.

Many market pundits think Wall Street's earnings expectations for 2009 are way too rosy as corporate America braces for what could be a nasty recession and more job losses. The financial system also looks susceptible to more tremors with credit markets still unsettled. Highlighting the fear, yields on three-month Treasury bills are virtually zero. "Corporate earnings-per-share continue to be revised sharply lower, especially in cyclical sectors," said Sam Stovall, chief investment strategist at S&P. "While equity prices will likely precede an upturn in the fundamentals, we think the global economic and EPS outlook need to at least show tentative signs of stabilization before a lasting rally will ensue."

Nouriel Roubini, a New York University economics professor who predicted the financial crisis, in a recent commentary piece for Forbes magazine called 2009 consensus estimates for earnings "delusional" and "outright silly." Roubini, who warned of the worst consumer recession in decades, wrote the U.S. consumer is "shopped-out, saving less and debt-burdened." If earnings do fall sharply in an economic slowdown and profit margins are squeezed, then the market won't appear so inexpensive and stocks could sink to new depths, bears say.

Howard Silverblatt, senior index analyst at S&P, says profit estimates need to come down to reflect the economic challenges, and this is the time of year when companies and analysts typically cut forecasts. Most S&P 500 companies have already reported third-quarter earnings, and the results weren't pretty. Operating earnings fell 22% from the year-ago period, marking the fifth straight quarter of negative earnings growth, according to S&P. Much of the damage has been centered in the financial sector, which has been pounded by the credit tsunami and write-downs on soured credit investments. The Financial Select Sector SPDR Fund, an exchange-traded fund tracking large-capitalization financial stocks, was down 67% year to date through Nov. 20, trailing the S&P 500 by 19 percentage points, according to investment researcher Morningstar Inc.

Since October 2007, the weighting of the financial sector in the Russell 1000 Index has fallen, to under 15% from more than 20%. By comparison, after the Internet bubble popped, the technology sector's representation in the index slumped to about 12% in late 2002 from 31% at its height. Uncertainty in the financials and other sectors has led to huge and unsettling swings in stock prices. Volatility is "off the wall," Silverblatt said. One-day shifts of 5% or more -- as happened on Friday -- have become routine. The S&P 500 has moved at least 1% up or down on more than half the trading days this year, and investors have to go back to the Great Depression to see comparable volatility, Silverblatt noted.

Wall Street's "fear" indicator, the CBOE Volatility Index, has spiked during the market turmoil. The market-sentiment benchmark measures the implied volatility of options on the S&P 500. Highlighting investors' skittishness, the VIX jumped to a record intraday high of 89.5 on Oct. 24 and broke through 80 again this week. Prior to October, the VIX had only closed above 45 on four days, according to Russell Investment Group. Since Oct. 12, the VIX has stayed above 45 with an average reading well over 60. Markets can certainly fall much further from here and this week's sell-off was a stark reminder of that, but successful contrarian investors know that trying to take advantage of opportunities when others are fearful requires an iron stomach and a long-term mindset.

Many investors have already thrown in the towel on stocks for the foreseeable future, and the flight to quality has pushed Treasury bond yields to rock-bottom levels. Stocks look cheap relative to bonds, but investors face the dilemma of trying to catch a falling knife, said Ernest Ankrim, chief investment strategist at Russell. It might be a good time to buy stocks, but they could get even cheaper if investors simply wait. "The momentum against stocks is so strong that we have a hard time ringing the bell to overweight stocks," Ankrim said. "The nature of bear markets is that they can go to extremes," added Duncan Richardson, chief equity investment officer at Eaton Vance. "Valuations can quickly go from reasonable to ridiculous."

An elevated VIX, fast-moving markets and investors trading on fear makes it even more difficult to value equities. Nervous investors have dumped stocks and piled into money market funds on overwhelming evidence the economy is worsening. "It's easy to be pessimistic with all the selling," Richardson said. "The question is at what point does the market say it's safe to get back into the water." It seems like U.S. companies are about halfway through the earnings decline, said Richardson, adding that stocks will have a tough time rallying until there is some improvement in troubled pockets of the fixed-income markets. Merrill Lynch's investment strategy team is advising a cautious stance even though stock valuations have come down. "The key question is when will equity expected returns outweigh the risks imbedded in the economy," Merrill wrote in a Nov. 17 note to clients.

Even though some well-respected investors such as Warren Buffett are moving back into stocks, "history shows quite clearly that being early can carry substantial performance penalties," Merrill said. "We believe it has historically been better to actually be somewhat late." In other words, sometimes it doesn't pay to be a hero in a bear market. Until the risk-reward picture improves, the strategists recommended conservative themes such as high-quality bonds, defensive sectors and secure dividend-paying stocks. At the same time, investors have reason to hope. The stock market has historically rebounded before the economy gets back on its feet. There have been nine recessions since 1950. At the midpoint of these slowdowns, the U.S. stock market jumped about 29% on average over the following 12 months.

No one knows how long this recession will last, but if investors wait for absolute evidence the economy and job market are turning around, they could miss out on much of the gains when stocks turn. A combination of low Treasury bond yields and pessimistic forecasts for long-term capital appreciation in stocks has led to renewed interest in dividends. Since 1926, dividends have accounted for about 42% of the S&P index's total return. The dividend yield on the S&P 500 is now higher than the yield on the 10-year Treasury bond -- the first time this has occurred in almost 50 years. Bob Doll, global chief investment officer of equities at BlackRock Inc., in a Nov. 17 report noted more than 60% of the stocks in the S&P 500 have a P/E of less than 10, a situation not seen since 1982.

"To us, this suggests that valuation levels are helping to create a floor for equity prices," Doll wrote. Still, the broader economy faces serious headwinds in the form of weaker consumer spending, falling home prices, rising unemployment and lingering credit issues. "The bad news is that the severity of the credit issues may push the economy into a deeper recession and could limit the strength of any recovery," Doll said. "The risks clearly remain to the downside and the economy remains vulnerable to additional financial shocks." Investors truly do have to go back to the Great Depression to see something similar to the pain and fear currently gripping the markets. Aside from Black Monday in 1987, the three next largest one-day declines in the Dow were during in 1929 Crash. During that year, the Dow peaked at 381.17 and fell to 198.69, a drop of 48%.

However, worse was to come and the 1930s were the most volatile decade on record for stock prices, according to Dow Jones Indexes. The Dow plunged about 53% in 1931 and 33% in 1937, but it surged 67% in 1933 and jumped roughly 39% in 1935. Huge one-day swings were common during the 1930s as the Great Depression caused fits of euphoria and fear, a situation that today's investor can appreciate.

GM, Awaiting Aid Verdict, to Idle Plants, Return Jets
General Motors Corp., under pressure after Congress delayed action on automaker aid, is idling four plants for an additional week, extending the shutdown of an engineering center and returning some corporate jets. The closure of a truck factory in Oshawa, Ontario, is also being moved up by two months to May 14, Tony Sapienza, a spokesman for Detroit-based GM, said yesterday. The plants that will shut down for an extra week in January are in Michigan, Ohio, Kansas and Missouri. GM, which has said it may run short of operating cash by the end of this year, acted a day after Democratic leaders in Congress put off deciding on loans to automakers until next month. Congressional leaders want GM, Ford and Chrysler LLC to make a case for the help.

“At this point, GM is not thinking about 2015, they are thinking about 2009,” said Mike Robinet, an analyst at CSM Worldwide Inc. in Northville, Michigan. “Ninety percent of their decisions are focused on what they need do to bolster revenue and save cash.” House Speaker Nancy Pelosi, a California Democrat, and Senate Majority Leader Harry Reid, a Nevada Democrat, told the automakers in a letter yesterday that they must provide “a forthright, documented assessment” of their current operating cash position, short-term funding needs “and how they will meet the financing needs associated with the plan to ensure the companies’ long-term viability.” Pelosi told reporters that even if the automakers fail to make a convincing case, Congress must do something to help them. Some members of GM’s board of directors are open to filing for bankruptcy protection, the Wall Street Journal reported today, citing unidentified people familiar with the company.

GM is in the process of returning two leased corporate jets after sending back two others in September, said Tom Wilkinson, a company spokesman. The largest U.S. automaker will have three jets still in use, he said. Ford, the No. 2 U.S. automaker, also is exploring the sale of its five corporate jets, Mark Truby, a spokesman for the Dearborn, Michigan-based company, said yesterday. GM’s decision on returning two additional planes was made before criticism this week from some members of Congress about GM Chief Executive Officer Rick Wagoner, Ford CEO Alan Mulally and Chrysler’s Robert Nardelli flying in private jets to hearings in Washington to ask for a bailout, Wilkinson said. The company has cut back on travel, using methods such as more video conferences, and doesn’t need as many jets, he said. GM rose 18 cents, or 6.3 percent, to $3.06 yesterday in New York Stock Exchange composite trading. The stock has declined 88 percent this year, the most among the 30 companies in the Dow Jones Industrial Average.

The automaker is scaling back production after its U.S. sales of cars and light trucks tumbled 45 percent in October, part of a 20 percent decline so far this year. The plants affected by yesterday’s announcement are in Orion Township, Michigan; Lordstown, Ohio; Fairfax, Kansas; and Wentzville, Missouri. The Michigan and Ohio factories will be idled the week of Jan. 5, and the Kansas and Michigan facilities the following week. GM will also shut its engineering operations in Warren, Michigan, and vehicle test facilities in Arizona and Michigan on Dec. 19, four days earlier than initially planned, to save money, Wilkinson said. The employees are being asked to use vacation days, he said. Those actions follow GM’s announcement Nov. 18 that it would idle five plants for as long as two weeks and limit overtime.

In addition, GM said on Nov. 7 that it would shut down production at eight plants through the beginning of February and permanently slow production at 10 factories, eliminating 3,600 jobs, starting in January and February. Those actions were part of a plan to cut an additional $5 billion after GM said it may run out of cash to pay its bills by year-end. “The longer the debate goes on in Washington, the longer the stall on sales: Customers are waiting it out to see what’s going to happen,” said Dennis Virag, president of Automotive Consulting Group in Ann Arbor, Michigan. “GM needs to take these production cuts.” Ron Gettelfinger, president of the United Auto Workers, said his union is “at the bargaining table every day working on things to make these companies, to put them in better shape.” The UAW leader spoke in an interview on Bloomberg Television’s “Political Capital with Al Hunt.”

Gettelfinger said he backs a “low-interest bridge loan” to the automakers to keep them out of bankruptcy. GM is still negotiating local agreements with the UAW at 19 plants. The automaker has eliminated about $500 million in U.S. union-related annual costs by hiring out jobs such as janitors and getting more flexibility from remaining workers. The company said on Nov. 17 that it also has cut expenses by paying fewer workers who are idled by plant closings and don’t have a new job. The so-called Jobs Bank has fallen to about 1,000 workers, after peaking at more than 7,000 before the 2007 accord.

GM board won't rule out bankruptcy
Members of the board of directors at General Motors Corp. may be at odds with the ailing automaker's top executive in their willingness to consider all options, even bankruptcy, according to a published report. A story in the online edition of The Wall Street Journal citing people familiar with the matter reported GM's board, which in the past has publicly offered Chairman and Chief Executive Officer Rick Wagoner its strong support, agrees that seeking government funding is the company's top priority but isn't willing to dismiss the possibility of a bankruptcy filing.

Wagoner told lawmakers in Washington last week that GM management thinks bankruptcy protection is not an option for the automaker and the company would focus on convincing Congress to provide financial support. The Journal reported that in a statement on Friday, the company said its board had discussed bankruptcy but didn't see that as a "viable solution to the company's liquidity problems." A GM spokesman, Tony Cervone, said that management is considering doing everything in its power to avoid a filing, the Journal reported.

The Journal also noted GM said Wagoner declined to be interviewed and several of GM's board members could not be reached for comment on Friday. On Friday, GM shares closed at $3.06, up 18 cents, or 6.25%. A year ago, the stock was trading at about $42. GM, Ford Motor Co. and privately held Chrysler LLC went to Washington last week to ask for $25 billion in bridge loans. Lawmakers gave them until Dec. 2 to submit detailed plans for how they mean to better compete and innovate. Congress could then reconvene in a second lame-duck session to consider providing monies.

House Speaker Nancy Pelosi, D-Calif., and Senate Majority Leader Harry Reid, D-Nev., sent a letter to the chief executives of the Big Three that lays out what the lawmakers mean by "viability" for their firms and accountability to taxpayers. The letter said the companies must detail their current operating cash positions, provide estimates of the terms of the loan requested, bar the payment of dividends and excessive executive compensation and demonstrate the companies' abilities to achieve strengthened fuel efficiency requirements.

Pelosi also rejected Chapter 11 bankruptcy as an alternative for the Big Three. "I just think that would be digging a hole far too deep," she said, adding that such a scenario would prove devastating for workers, the economy and the U.S. manufacturing base.

Ontario on the hook for billions in GM pensions
Ontario could be responsible for "billions" in General Motors pensions if the tottering company goes bankrupt, Finance Minister Dwight Duncan said yesterday. "It's a substantial amount of money. I'm not privy to the company's up-to-date books (but) it would be in the order of magnitude of billions," Duncan told reporters. "This is one of the reasons, one of the very real costs associated, if General Motors is not able to continue viable operations."

Because of a complicated deal cut back in 1992 to preserve plants and jobs in Ontario, GM, Ford and Chrysler -- along with some steelmaking firms -- were allowed to cut back on their pension funds, instead of paying into what auto consultant Dennis DesRosiers says was a "Too Big To Fail Fund." GM is the only one of the firms that still pays into the government's Pension Benefits Guarantee Fund instead of having to fund its pension on a solvency basis. DesRosiers said the latest estimate he saw for the GM's unfunded liability was more than $4 billion. "It's seriously underwater," he said.

The pension situation makes it even more difficult for the Ontario government to say no to bailing out the automakers, who directly employ about 30,000 Ontarians and up to 400,000 indirectly. "We need to ask ourselves and fairly consider what's at stake here," Premier Dalton McGuinty said, acknowledging the business is bound to shrink in Ontario no matter what. "It may be very integral to maintaining our quality of life and an important part of our economic foundation."

Long a supporter of the auto sector, McGuinty has kicked in more than $500 million worth of taxpayers' money to carmakers already, much of it in long-term loans that could disappear in the event of bankruptcy -- a prospect he said he won't even consider. "I'm not even going to think about that," McGuinty said. "We're going to work as hard as we can to make something good come out of this." Prime Minister Stephen Harper also signalled support for the industry in the Throne Speech.

Canadian autoworkers worry about their pensions
A steady stream of worried General Motors employees, retirees and spouses has been trickling through Bill Reeve's office near the Windsor Transmission plant for the past few months. With GM's financial health staggering from weak to weaker to terminal, the company's 1,200 hourly workers and 2,400 retirees in Windsor have all been asking the same thing of the president of CAW Local 1973: Are our pensions safe?

Not completely. An unfunded liability of at least $4.5 billion has opened up in the GM fund, CAW pension expert Sym Gill told the union during an annual update on the state of the pension plan delivered last month. And the gap is likely to have grown substantially since the meltdown began in world financial markets. Ontario Finance Minister Dwight Duncan confirmed Wednesday that taxpayers would be on the hook for "billions" in pension guarantees if General Motors were to declare bankruptcy. "This is one reason why we believe that the continued operation of General Motors is important to the overall economy," he said at Queen's Park.

According to published reports, the province of Ontario had an exposure of at least $2.5 billion to a GM bankruptcy through its Ontario Pension Benefits Guarantee Fund, based on a valuation of its pension assets made in late 2006. "I'm not at liberty to go through the whole report with you," Reeves said Wednesday when asked about the size of the shortfall. "I don't fully understand it all myself because pensions are pretty complicated. But you don't have to be a rocket scientist to understand that the markets are down" -- and therefore, so is the pension fund.

"I have a lot of inquiries from our members -- 'What happens if this happens, what happens if that happens,' " Reeves said in his Walker Road office a few kilometres south of the huge plant. "Everyone is certainly nervous and concerned because we don't know what's going to happen." Reeves was cheered Wednesday after learning that Prime Minister Stephen Harper's government had used its throne speech Wednesday to pledge some form of aid to the struggling parts of Ontario's automotive industry.

"That's certainly good news, Reeves said of the aid. "Even for him to say something is a big step," he said of the prime minister. GM's pension fund, which Reeves said was well over $10 billion in size at one point, was overfunded in 2001 and 2002, allowing GM to take a contribution holiday, putting nothing into the fund. But by November 2006, the last time it was formally evaluated, Duncan says, it had slid into the red. "The valuations change literally on a daily basis but it is a substantial sum of money," Duncan said of the shortfall. Preventing a bankruptcy and taxpayers having to step in "is part of what informs our decision to participate with the government of the United States and with our federal government" in ensuring GM keeps operating.

"What people need to realize is there are very real costs associated with the demise of one or all of any of the Detroit three and those range from pension costs, foregone tax revenue to government," the minister said. "We have to be cognizant of what the real impact is to both the provincial treasury, number one, and number two, Ontario working families," Duncan said. Duncan said his ministry was working to compile estimates of how badly the provincial economy would be impacted if any one of the Detroit automakers were to declare bankruptcy. "You are talking about an enormous impact on not only Ontario but the Canadian economy."

The GM pension fund is assumed to have suffered additional losses in recent weeks because it is invested in stocks, bonds and other securities -- all of which have been hammered in value. As a double whammy, a large chunk of the fund was invested in GM's own stock, which has plummeted about 98 per cent in value since its peak in 2000. The pension funds at Chrysler Canada Inc. and Ford of Canada were not considered to be at risk at their last valuation, although they too have probably seen some losses. Chrysler's fund was fully funded and Ford's was short about $900 million as of January, Gill has said.

Goldman Falls Below IPO Price, Erasing Almost 10 Years of Gains
Goldman Sachs Group Inc. dropped below $53 for the first time since it went public almost a decade ago as the earnings outlook dims for a company that last year set a record for Wall Street earnings. The stock fell as much as $2.83 to a low of $52.35 in New York Stock Exchange composite trading this morning, giving Goldman a market value of $25 billion. At 9:38 a.m. the stock was down $1.89 to $53.29. The New York-based company's value reached a high of $105 billion, or $248 per share, on Oct. 31, 2007.

Goldman, which converted from the biggest U.S. securities firm into a bank holding company in September, has given up more than 75 percent of its market value this year as investors shy from companies that derive financing and revenue from capital markets. Lloyd Blankfein, Goldman's chief executive officer, said last week that the firm intends to stick to its strategy of serving as an adviser, financier and investor. Earnings dropped 47 percent in the first nine months of the year compared with the same period in 2007, and several analysts expect Goldman to report its first quarterly loss for the three months through the end of November.

After going public in May 1999, Goldman surpassed rivals including Merrill Lynch & Co. and Morgan Stanley to become the largest U.S. securities firm by market value and the most profitable in Wall Street history. On their first day of trading in 1999, Goldman's shares climbed 33 percent to $70.375. The company last year became one of about a dozen in the U.S. with a stock price above $200.

Investors pull $40 billion from hedges in October
Investors withdrew $40 billion from hedge funds in October as the industry suffers record losses, Hedge Fund Research said Thursday. Funds of hedge funds, which allocate money to a range of underlying managers, saw the most redemptions at $22 billion last month, HFR reported. Such funds have lost 18.5% on average this year, while the average single-manager fund is down 16%, according to HFR indexes. That may be disappointing because funds of funds are supposed to be more diversified and less risky than single hedge funds.

The problems may be driven by more than disappointing performance, though. In October, investors withdrew almost $11 billion from global macro hedge funds, in spite of returns of more than 4% from those types of funds so far this year, HFR noted. "Performance of the hedge-fund industry has declined over 17% since October 2007, making the current performance drawdown the largest in history," said Kenneth Heinz, president of Hedge Fund Research, in a statement. "The industry has now registered five consecutive months of losses, another inauspicious first.

"Consolidation is likely to continue into 2009 as investors across all asset classes indiscriminately liquidate assets to move portfolios into cash," he added. Including fund performance, industry assets dropped $155 billion to $1.56 trillion in October. That follows a $210 billion decline during the third quarter, according to HFR.

Volatile markets may tempt hedge-fund fraud
While fraud can happen any time, the loosely regulated $1.7 trillion hedge-fund industry looks especially vulnerable following record losses. Losses of roughly 15 percent this year and a growing sense of panic as hedge-fund clients exit worldwide are creating ripe conditions for a small number of the estimated 9,000 hedge-fund managers to break the law, according to forensic accountants, private investigators and former prosecutors.

"In volatile markets there is a greater likelihood that a manager might want to try and cover up his tracks by issuing bogus reports or making false valuations of securities if the market has turned against him," said Walter Pagano, a former Internal Revenue Service agent who now heads the Litigation Consulting & Forensic Accounting Services Group at Eisner LLP. Whether managers fabricate returns to salvage ailing funds or spend clients' cash on fast cars or famous paintings for themselves, industry experts said fraud is often accompanied by warning signs.

"There usually isn't one big red flag," said Peter Turecek, a managing director at Kroll Inc, a risk consultancy owned by Marsh & McLennan Cos Inc , the world's largest insurance broker. "But often there is a pattern of little red flags." These include returns that look too good to be true, accountants said. Investors should ask secretive hedge-fund managers to show more than top-line numbers and to provide details on how they make money. Investors should also keep an eye out for sudden and unexplained expenses or news of big purchases of yachts or planes, the experts said, noting that the manager of a $2 million fund should not be flying around in a private jet.

If staff suddenly leave a hedge fund, investors should pay attention. "If anything improper is going on, the person most likely to know is someone who just left," said Randy Shain, a private investigator who works with hedge funds at First Advantage Investigative Services. Unlike mutual funds, hedge funds are allowed to use trading techniques like selling stocks short and using borrowed money and regulators do not require them to make their performance or other details public.

All communication with hedge funds is especially important during turbulent markets. If investment letters arrive late or not at all, it is time to probe further, the experts said. Several experts said they have seen situations where managers sold off the office furniture and computers and left behind only a receptionist to answer the phones. "We are experiencing some of the most difficult times ever, and difficult times create desperate people who may do desperate things," said Richard DelBello, senior partner at hedge-fund service provider Conifer Securities.

Some of the hedge-fund industry's most egregious fraud cases made headlines just a few months ago. Samuel Israel, whose collapsed hedge fund Bayou Group stole $450 million from clients with the help of a phony accounting firm, staged his own suicide in June in a failed bid to avoid jail after he was sentenced in April to 20 years in prison. In May, former fund manager Kirk Wright killed himself while in jail after his conviction for swindling professional athletes out of more than $100 million which he spent on a Bentley, Jaguar and Aston Martin, jewelry and art. While industry experts said it is impossible to predict how many more fraud cases will emerge in coming months, U.S. lawmakers have already hinted that hedge funds may face additional regulation next year, in part to deter fraud.

Even before hedge funds may face additional government oversight, would-be investors are spending more time and money on trying to obtain a clearer picture of where their money is going. Firms that specialize in conducting this kind of due diligence, like Kroll, are being called more often by hedge fund investors, executives said. "We have seen a lot more investors carrying out more due diligence," said John Donohoe, chief executive of hedge-fund consultant Carne Global Financial Services. "They want information."

Buffett's huge derivatives bet proves costly
Shares of Warren Buffett's insurance holding company are on the ropes this month, plunging 30% in part because the famed investor dabbled in an area of the market he has long publicly derided: derivatives. And due to a tangled web of financial relationships, they may be taking Goldman Sachs shares down with them.

Investors are concerned about a $37-billion bet that Buffett made last year that U.S. and world equity values would be higher in 15 to 20 years than they were then, when the Dow Jones Industrials were trading around 13,000. Through his firm, Berkshire Hathaway, Buffett sold option contracts, known as "naked puts" to an undisclosed group of investors for around $4.85 billion, reportedly using Goldman as broker. The buyers saw the puts as a type of insurance that would pay off royally if stocks fell over the next decade. They were seen by Buffett as an easy way to pocket a quick $4 billion-plus, which was booked much like an insurance premium, even though he is famous for scoffing at derivatives as "weapons of mass financial destruction."

But easy money is the worst kind. The problem is that stocks worldwide have gone downhill in a hurry, and with a lot of the sort of volatility that makes put contracts swell in value. And due to accounting rules, this has made Buffett already need to mark down a $6.7 billion loss on the trade even though the trade has another 14 years to work out. Because of its solid-gold credit rating, Berkshire Hathaway was not required to put up collateral to make this trade. But now rumors are flying on Wall Street that the owners of the contracts have demanded that broker Goldman Sachs put up collateral for the rest of the amount due. Since the value of the trade could be enormous, the collateral demands are said to be very large, and fears that Goldman will struggle to make good on its obligation has panicked shareholders.

Indeed one theory making the rounds this week is that Buffett put $5 billion into Goldman at around $125 per share in September not as an investment but to help provide funds for the collateral. Of course, there are other reasons for investors to sell Berkshire shares, which are down 42% overall this year, back to 2003 levels. Many of its biggest stock holdings have plunged in value this year, including American Express, General Electric, SunTrust and Goldman itself. And like most insurance companies, it holds a lot of bonds that have plunged in value during the credit debacle.

SEC asked Buffett's Berkshire for derivative data
Warren Buffett's Berkshire Hathaway Inc provided details to the U.S. Securities and Exchange Commission on how it values what has so far been a money-losing $37.04 billion derivatives bet, after the regulator asked for better disclosure. The SEC completed its review on October 7 without further comment, four days after Berkshire said it did not need to buy equities that underlie its derivative contracts. On June 4, the SEC had demanded "a more robust disclosure" of factors that Berkshire used to value the contracts.

The SEC released correspondence between Berkshire and the regulator on Friday, two weeks after Berkshire said more than $1 billion of losses on derivatives led to a 77 percent overall profit decline at the Omaha, Nebraska-based company. Buffett's derivatives bet has faced much scrutiny from analysts and investors this year. They have led to paper losses for Berkshire, and Buffett, perhaps the world's most admired investor, has previously called derivatives "financial weapons of mass destruction." Berkshire's derivatives could require the company to pay up to $37.04 billion between 2019 and 2027 if the Standard & Poor's 500 index .SPX and three other stock indexes were lower than when Berkshire entered the contracts.

The company obtained about $4.85 billion of premiums upfront, which Buffett may invest as he wishes. Buffett has said he expects the contracts to be profitable. But falling equity values had by September 30 forced Berkshire to write down $6.73 billion on the contracts. Losses have almost certainly mounted since then as stocks worldwide tumble. On July 3, the newly released correspondence shows, Berkshire Chief Financial Officer Marc Hamburg told the SEC that the company's model to value the contracts was based on such factors as equity prices, interest rates, dividend payouts and currency fluctuations. "Berkshire believes the two most significant economic risks relate to changes in equity prices and foreign currency exchange rates," Hamburg wrote.

Hamburg also told the SEC that Berkshire's nearly 20 percent stake in Moody's Corp did not mean Berkshire could "control or significantly influence" activities at the parent of credit rating agency Moody's Investors Service. Connecticut Attorney General Richard Blumenthal in May said he was examining the potential for conflicts of interest arising from Berkshire's stake in Moody's and its operation of a bond insurance unit, Berkshire Hathaway Assurance Corp.

In a separate development on Friday, USG Corp said Berkshire agreed to buy $300 million of convertible senior notes yielding 10 percent from the building materials supplier. USG also sold $100 million of the notes to Canada's Fairfax Financial Holdings Ltd. Berkshire owns a 17.2 percent stake in USG. Shares of USG rose as much as 30.7 percent on Friday. Berkshire Class A shares rose $3,000 to $80,500 in late afternoon trading on the New York Stock Exchange. Their record high is $151,650 set last December 11.

Cuts in corporate spending slams self-employed, small businesses
Wall Street’s pain is spreading to small businesses, as bankers who once pulled in million-dollar bonuses lose their jobs and cut back spending on everything from parties to home improvements. Among those hit is Felice Pomeranz, a Boston-based harpist who has weathered two major recessions in 26 years and has never seen times so tough. “This is the worst. It’s terrible,” said Ms. Pomeranz, a performer who also books other musicians to perform at corporate events. “Musicians are dying to work.” Bookings for corporate events by her company, Gilded Harps, are down as much as 70% from a year ago, with work for financial firms practically nonexistent.

The major financial services firms that are not collapsing, such as Goldman Sachs, Bank of America and Fidelity Investments, are tightening up as they prepare for the worst, making headlines as they lay off thousands of workers. “They are driving demand for all kinds of other industries—whether it’s home improvement, contracting, landscaping, furniture, entertainment, restaurants,” says University of Massachusetts economist Michael Goodman. “Small business will bear more than its fair share of the pain.”

Small businesses employing 49 or fewer people shed 25,000 jobs in October, the first time they had cut employment since 2002, according to figures from Automatic Data Processing, the payroll processing company. Budgets for big corporate events are down from last year. “When the economy is like this, It turns into things that are not as expensive. It’s no longer a tenderloin and shrimp party. It’s beer and wine instead of a full bar,” said Michele Stump, a manager at Boston’s East Meets West Catering. “People are hesitant to do anything expensive because of how it looks,” Ms. Stump added. “It almost doesn’t look right.”

Some 3.9 million Americans are now drawing jobless benefits, a 25-year high, according to Labor Department data released on Nov. 13. Retailers and restaurants—about 90% of which are small businesses according to the U.S. House of Representatives Committee on Small Business—are also feeling the pinch. In Boston, a hub of the hard-hit mutual fund industry, restaurant sales dropped off suddenly mid-September, as the credit crunch forced Lehman Brothers into bankruptcy and prompted the U.S. Federal Reserve to make an emergency loan to American International Group.

Higher-priced eateries have been worst hit, said Peter Christie, chief executive of the 5,000-member Massachusetts Restaurant Association. “Monday and Tuesday nights have gotten quiet as the economy has slowed,” Mr. Christie said, pointing to dearth of business travelers looking for sustenance. Massachusetts restaurants posted their first sales decline in years in October as meal tax payments dropped 3.5% from a year earlier, according to state Department of Revenue data.

Decorators are also seeing a downturn as middle-income customers cancel remodeling projects and more affluent ones look for less costly options. “Wealthy people are less likely to buy frivolous things... They’re reluctant to buy a $7,000 side table,” said Petra Hausberger, proprietor of interior design firm Somerton Park Interiors in Brookline, a wealthy suburb in Massachusetts. She typically charges $150 an hour for her services. While small businesses, which account for about half of U.S. jobs, are feeling the heat from corporate America’s massive layoffs, they are less likely to give their own employees pink slips, preferring to keep people on the payroll but working fewer hours.

“The small business says, ‘I can’t afford outplacement, I can’t afford severance, I don’t want my unemployment insurance to go up, that’s a long-term legacy cost that is going to kill me,’” said Marilyn Landis, president of Pittsburgh-based Basic Business Concepts Inc, a financial consultant to small firms. “I’ve done that with my own employees—to cut back hours rather than a layoff—because you don’t want to lose staff. They’re too important to you,” said Ms. Landis, who is also chair of the National Small Business Association. Economists say that the suffering will last into 2009, though they are divided on whether it will continue into 2010.

More California cities hurtling into fiscal void
When the city of Vallejo filed for bankruptcy protection in May, the logical question was: Is this a sign of things to come? Now two more California cities – Rio Vista and Isleton – are considering bankruptcy protection as an option as they face large budget shortfalls and staggering debt. While experts caution against ringing the alarm bells just yet, they do say tough economic times could push municipalities already on the brink over the edge.

"I think it's quite possible municipal bankruptcies could become somewhat more common but will still be very rare," said Jason Dickerson, budget and policy analyst at the state's Legislative Analyst's Office. "There are more municipalities that will look at what it means." Cities, counties and other governing bodies across the state are reeling as budget projections many considered to be conservative at the start of the fiscal year, July 1, are proving to be wildly optimistic as the housing slump is affecting property tax revenue and sales tax receipts are well below last year.

Many municipalities not only are looking ahead to cuts next year but also are actively trimming expenditures to fix shortfalls in the current fiscal year's budget. "California cities are like the rest of the country and rest of the state, really struggling right now," said Eva Spiegel, spokeswoman for the League of California Cities. Rio Vista is facing an $816,000 deficit in its general fund budget for the current fiscal year and a $1.6 million deficit in its sewer fund, said Hector De La Rosa, the city manager. While officials and the City Council are looking at other cuts and ways to save money – hiring freezes, work furloughs and increased fees, among others – bankruptcy protection is an option.

"There are some benefits to Chapter 9 bankruptcy," De La Rosa said. "It holds off creditors until the city has time to get a plan in place." On Wednesday, Isleton's city manager said if his city couldn't borrow $1 million by Jan. 1 to pay off $950,000 in years of accrued debt, he would urge the City Council to seek bankruptcy protection. If both cities file a bankruptcy action, they would become just the third and fourth cities in California to do so since 1980. Vallejo filed for bankruptcy protection in May. The best way to get out of bankruptcy protection – or avoid it in the first place – is to cut expenditures and raise revenue, said Marc Levinson, lead bankruptcy attorney at the firm representing Vallejo. "It's not rocket science," he said.

The problem is municipalities have little control over the markets, voters don't want to raise taxes, and large expenditures – pension obligations, health care costs and collective bargaining agreements – limit a city's options, he said. "I'm surprised not every city is discussing (bankruptcy)," Levinson said. "It's absolutely horrible out there." That doesn't mean the state will suddenly see a spike in municipal bankruptcies, said Bob Leland, Fairfield's director of finances. That city is expecting a $5 million to $6 million budget shortfall next year. But like most municipalities, Fairfield should be able to fix its budget with cuts and reserve funds. Cities that do opt for bankruptcy filings "often have issues that are so unique you can't really extrapolate," Leland said.

Vallejo spent an inordinate amount of its budget on public safety salaries and benefits; Isleton has had years of debt that added up; and Rio Vista has had problems with its sewer system for decades. While Vallejo's bankruptcy filing could encourage other cities to at least consider filing bankruptcy as an option, such a move still carries a stigma, said Dickerson, the budget analyst. "Bankruptcy is a really big deal," he said. "It's a mark of shame." It also means a municipality might have trouble borrowing money in the future as wary lenders worry about getting repaid, Dickerson said.

Keenly aware of the drawbacks to filing for bankruptcy protection, Rio Vista officials are looking at all other options, but times are tough, said De La Rosa, the city manager. "A lot of municipalities are going through the same situation Rio Vista is going through," he said. "For those communities that do not have healthy reserves, they will look at all options."

New England Faces Big Downturn
New England is headed for a "significant recession" that will strip the region of 250,000 jobs, or about 3.6 % of its employment, through the end of the decade, economists said. Total employment in the six New England states is expected to decline through 2009 and remain flat through 2011, according to a new forecast from the New England Economic Partnership, a group of prominent regional economists. NEEP said the crisis has extended from the housing market to construction, financial services, retail and other sectors of the regional economy.

The forecast predicted that unemployment will peak in the six-state region at over 8% in mid-2010, but remain below the national average because of a better-educated populace and a slow growth of the overall labor force in the region. Among the six New England states, Rhode Island will have the highest unemployment, peaking at 10.3%, the forecasters said. Maine was predicted to peak at 8.7%, and Connecticut and Massachusetts at 8.3%. New Hampshire (7.4%) and Vermont (6.9%) will have the lowest peaks, according to the forecast.

The forecast said New England will experience a "more pronounced and prolonged employment decline" than in other parts of the U.S., and a "weak economic recovery." "The recovery is expected to be weaker and slower in New England than in the nation" because of the region's relatively high concentration in business investment and high-income dependent industries," the NEEP forecast said. Also, the decline in real per capita income growth in New England is expected to be greater than the national average in this recession.

With the exception of Vermont, housing prices have declined sharply across New England, but the declines are not as sharp as in the "overheated" housing markets of California, Florida, Nevada, Arizona and some parts of the Midwest, the economists said. Other than in Rhode Island, mortgage past-due rates are below the national average in New England. Separately, MFS Investment Management, a Boston mutual fund company owned by Sun Life Financial Inc., of Toronto yesterday said it would lay off 90 people, or 5% of its staff, as a "response to the decline" in the stock markets.

Jersey pension fund down 20% in four months
Losses in the stock market have knocked New Jersey's pension investment funds from $82 billion last June to less than $58 billion now, prompting one state senator to call for twin probes into how the funds lost so much money. The State Investment Council heard about the losses at a public hearing Thursday. Sen. Bill Baroni Jr. said legislative leaders should appoint a bipartisan panel of lawmakers to look into the pension fund, and he wants state Attorney General Anne Milgram to investigate if the pension fund may have fallen victim to fraud.

"The folks I represent, their whole pension is being discussed here," said Baroni, R-Mercer, whose legislative district spills over with state workers. Baroni said he wanted the joint legislative committee to have subpoena power, enabling it to force witnesses to testify. William Clark, director of the state Division of Investment, told the assembly of state workers, "What's been happening in the markets has brought out so many emotions. ... We are feeling it too."

He said, though, that New Jersey's pension fund -- on which state workers rely for their retirements -- performed better in the 2008 fiscal year than other similar funds, down 2.9 percent over those 12 months while others averaged losing 5 percent. Since August, New Jersey's pension funds are down 18.6 percent, Clark said. The Standard and Poor's 500 index is down nearly 25 percent in that time, he said. "Our job is to be level-headed and cool and to run the portfolio," said Clark, adding later, "I think we are going to turn this around." That brought applause from the state employees gathered in the basement of the War Memorial building.

Massachusetts state pensions lose $5 billion, 13.3%, in one month
Massachusetts’ pension system fell by a staggering 13.3 percent last month alone, losing another $5 billion amid a Wall Street free fall that’s hammered investors across the nation. So far this year, the pension system for state employees has lost about $13 billion, down 26.9 percent. It ended October at about $40 billion.

The state can take some solace in knowing that others are getting hit harder. The Standard & Poor’s 500 is down 33 percent for the year, while the average large pension fund has lost about 28 percent, according to a spokeswoman for Treasurer Tim Cahill, who serves as chairman of the state pension’s board of overseers.

Mike Travaglini, executive director of the pension, said the system’s U.S. and international equity portfolios got hit the hardest last month, with each category losing 19 percent in October. The system was buffered by the relatively stronger performance of its hedge-fund and private-equity investments, which lost 1.6 percent and 5.5 percent, respectively. But they were still losing money.

“There’s not one asset class that has positive returns this year,” said Travaglini. While saying the markets are going through “very challenging times,” Travaglini expressed optimism that fund returns will reverse course again someday. The state’s pension system has averaged a 10.5 percent annual return since 1985, he said.

Bush, Obama not taking lead in righting economy
As the United States writhes in a collapsing economy, analysts and observers are wondering: Who's skippering the ship? President Bush has been noticeably absent from the machinations aimed at righting the nation's financial course. Analysts and key players differ over whether President-elect Barack Obama should get his economic team in place and take charge, or sit back and await his turn at the helm.

"Somebody has to speak up soon," said CNN senior political analyst David Gergen, explaining that he understands why Americans are growing anxious and yearning for direction and leadership. "I think ... sort of the bottom feels like it is falling out for many people," said Gergen, who has advised four presidents. "They sense there's a total lack of leadership in Washington, that the White House is silent, the treasury secretary has been battered, the Federal Reserve can't speak up. These automakers come up to Capitol Hill and fail. And the president-elect is silent in Chicago."

Senate Majority Whip Dick Durbin said Obama has avoided entering the congressional tussle over whether to bail out the Big Three automakers. "I think that President-elect Obama is being very careful to remind people that we still have a president who still makes the final decision about things being signed into law," said Durbin, one of Obama's closest Senate confidantes. Asked if Obama was offering guidance on the issue, Durbin replied, "No, no." Obama noted shortly after his election that "the United States has only one government and one president at a time, and until January 20th of next year, that government is the current administration."

Meanwhile, jobless numbers are skyrocketing, the stock market is plummeting and the banking industry continues a decline, outpaced only by the fall of the U.S. auto industry. The Bush administration has not said much about the issues other than to quietly state its positions. The executive office has approved extending unemployment benefits, has opposed a wholesale bailout of the auto industry and frowns on the idea of using the $700 billion in Temporary Asset Relief Program funds to help homeowners or to provide bridge loans to automakers. Obama said last week that neglecting to provide relief to the auto industry would be disastrous, but he has done nothing to break a deadlocked Congress.

House Speaker Nancy Pelosi said Thursday that automakers must come up with a plan if they expect to receive any federal loans or funds. "Until they show us the plan, we cannot show them the money," she said. "That will only happen if they can get their act together," added Senate Majority Leader Harry Reid. Durbin said Obama is staying out of it for now because the present Congress is divided, and that won't change until Obama and the 111th Congress take their posts next year. "There's a limited amount of opportunity and authority on a very contentious issue," he said.

Greg Valliere, chief political strategist for the Stanford Group, a policy research firm based in Washington, D.C., concurred, saying earlier this week, "The lame-duck session of Congress will earn its 'lame' label and pass only a grab-bag of modest stimulus, leaving the heavy lifting until early 2009." But even if the Big Three were to present a viable plan to Congress by their December 2 deadline, there are other troubling matters on the U.S. economic horizon. Most notably, the S&P 500 -- used to gauge the stock market's health -- has hit an 11-year low. The Dow Jones Industrial Average, another indicator, closed Thursday around 7,552 points -- it was hovering around 14,000 just over a year ago.

And jobless claims -- the number of people filing for unemployment benefits -- is close to doubling in the span of a year, from about 300,000 people in January, to 524,000 people this week. Four million people -- about the population of Oregon -- are on unemployment insurance as well. "If all these people are out of work getting money from the government, they're not net spenders or contributors to the economy. They're not net taxpayers. It means it's going to be a lot longer to get us out of this recession," said CNN senior business correspondent Ali Velshi. Gergen said he has spoken to investment advisers who are downright fearful, especially after this week's economic convulsions.

It's understandable that Obama is staying visibly out of the fray, Gergen said, but the president-elect needs to work behind the scenes to persuade Congress to provide bridge financing for the automobile companies, and the White House has to take a more active role in mitigating the situation. No president since Franklin Roosevelt has faced this sort of economic crisis, Velshi said, but the tumult also provides an opportunity that hasn't been seen since the days of FDR. If Obama can quickly name a treasury secretary and get working on the green economy that he says will drive U.S. finances for the next 15 to 20 years, it could create the jobs necessary to reverse the tumbling economy, Velshi said. "We need to see if this is an opportunity we can turn around into the new New Deal," he said, referring to the program Roosevelt kicked off in 1933 to create jobs and mend the broken economy.

The Wall Street Journal reported Friday that Obama plans to nominate New York Federal Reserve President Tim Geithner to lead the Treasury Department. Other names on Obama's short list to head Treasury include JP Morgan Chase President Jamie Dimon, former Treasury Secretary Robert Rubin, former Treasury Secretary Lawrence Summers and former Federal Reserve Chairman Paul Volcker. CNN senior political analyst Gloria Borger said Obama and his team are probably trying to gauge the totality of the situation, and many internal questions also have to be answered: Do we need someone younger? Would a former treasury secretary bring vital experience? Does it matter if the secretary has ties to Sen. Hillary Clinton? "I think they're having these kinds of conversations, and so I would expect, though, that we're going to see something on the economic team in early December, if not sooner," she said.

There is speculation that Obama may name the incoming treasury secretary by Thanksgiving, but he may be distracted by the hullabaloo surrounding the potential appointment of Clinton as secretary of state. "I cannot stress enough that, while we go through this Kabuki dance about Hillary -- will she, won't she, will she be there or not -- the issue, increasingly, for the president-elect is the economy," Gergen said. Borger concurs that the Obama team may be preoccupied with the prospect of appointing Clinton to head the State Department, but, she said, "I'm surprised, honestly, that they haven't put in a treasury secretary yet." However, Borger said she thinks Obama is already working behind the scenes through his chief of staff, Rahm Emanuel, and she doesn't think the Democrats would have postponed their decision on a Big Three bailout without checking with Obama.

Borger said she expects a "big push" from Democrats to find a way to save Detroit when the lame-duck Congress reconvenes in December, and Emanuel and Obama will be a part of it. "But honestly, you can't expect a president-elect, who hasn't even been sworn in, to use all of his political capital -- and, by the way, he's going to have a lot -- before he takes office," she said. There's a lot of risk involved in Obama pushing his economic agenda before he takes office, and it would be unwise to publicly state what the Bush administration should do, said Stephen Hayes, a conservative columnist and CNN contributor. "Politically, he wants to stay as far away from this as he can," Hayes said. "I think it's smart of him to say, 'We have one president at a time; I have got my four years.' "

Ilargi: If we don’t, very soon, take our food production out of the grip of market capitalism and the dirty fat fingers of Monsanto and ADM, people will start dying by the side of the road. We're running out of time.

Fields of Grain and Losses
The farmers said it would not last, and they were right. When the price of wheat, corn, soybeans and just about every other food grown in the ground began leaping skyward two years ago, farmers were pleased, of course. But generally they refused to believe that the good times would be permanent. They had seen too many booms that were inevitably followed by busts.

Now, with the suddenness of a hailstorm flattening a field, hard times are back on the American farmstead. The price paid for crops is dropping much faster than the cost of growing them. The government reported this week that the cost of goods and services nationwide fell by a record amount in October as frantic businesses tried to lure customers. While lower prices are good for consumers in the short run, a prolonged stretch of deflation would wreak havoc as companies struggled to stay afloat.

In this lonesome stretch near the Texas border, farmers are getting an early taste of a deflationary world. They have finished planting next year’s winter wheat, turning the fields a brilliant emerald green. But it cost about $6 a bushel in fuel, seed and fertilizer to put the crop in. That is $1 more than they could sell it for today, and never mind other expenses like renting land. This looming loss sharpens their regret that they did not unload more of this year’s crop back when they harvested it in May. They knew the boom would end, but not so soon. “I waited all my life for wheat to go from $4 to $5,” said Jimmy Wayne Kinder, a fourth-generation farmer. “Then it hit $10, and we were all asking, ‘What are we going to do?’ ”

Mr. Kinder, who farms about 5,000 acres with his father, James Kinder Jr., and his brother, Kevin, held onto much of his wheat, hoping that prices would go still higher. Instead, they plunged. “I lay in bed at night kicking myself,” Mr. Kinder said. The farmers in Walters still have to worry about drought and floods and grain bugs and army worms, as they have for decades, but they have new anxieties beyond their control: Manic commodity markets. A rising dollar that makes their crops more expensive overseas. And — an urgent new concern this fall — the solvency of their banks.

In September, when banks began failing at the height of the credit crisis, Mr. Kinder called Mickey Harris, his banker at the First State Bank of Temple. “Are we going to be O.K.?” he asked. Mr. Harris offered reassurances that the privately owned, one-location bank was fine, but he feels the fate of farmers, until recently one of the strongest sectors in a slumping economy, is less certain. Unless wheat stages an unexpected recovery, Mr. Harris said, “a year from now these farmers’ net worth will surely be less.” Oklahoma exports two-thirds of its wheat, more than the country as a whole. That worked to the state’s advantage in 2007 and the first half of 2008, as a combination of bad harvests in Australia, the cheap dollar and rising Asian consumption created intense international demand.

The state’s farmers responded, naturally enough, by ramping up production. Because of better weather and therefore a better yield, 166.5 million bushels of wheat were harvested in Oklahoma this spring, a 10-year high. And because of the high prices, the crop was valued for the first time at more than $1 billion, nearly twice as much as 2007 and nearly three times as much as 2006. “They made a killing,” said Kim Anderson, a grain economist at Oklahoma State University. Assuming, that is, they sold. The farmers who cashed in at the right moment are acquiring legendary status. “I know a fellow that sold some wheat for $12 a bushel. That was almost beyond belief,” said James Kinder, 74. But his son suspects that most were like the Kinder family: they either did not sell or did not sell enough.

The Kinders still have about 40 percent of their wheat, stored on the farm and in commercial grain facilities. “Farmers are terrible marketers,” said Jimmy Wayne Kinder, 50. “We fall in love with our crop.” It was the same misguided optimism that caused homeowners to think their houses would always keep increasing at a 20 percent annual clip. Farmers across the country fell prey to it. David Kanable at the Oregon Farm Center, a mill near Madison, Wis., was paying $7.25 a bushel for corn in June. “We never had a farmer lock in at that price. They wanted $8,” Mr. Kanable said. On Thursday, the mill was paying $3.17 a bushel.

When commodity prices were feverish, the price of good farmland exploded, too. Cropland values rose about 20 percent in the Midwest farm belt last year, capping a multiyear rise, according to the Agriculture Department. Walters and other areas southern Oklahoma, where the land is not as rich and the crops have to be coaxed from the soil, were swept up in the excitement. The previous land boom around Walters was in the late 1970s, a reaction to the high commodity prices of that era. Land went for as much as a thousand dollars an acre. “Doctors and lawyers were buying the land from farmers,” said the senior Mr. Kinder. “Then prices fell, and those same doctors and lawyers were begging the farmers to take it off their hands.”

Prices dropped to $500 an acre. Only in the last few years did they begin to approach the records set three decades ago. On a recent sparkling Saturday morning, two dozen farmers showed up for an auction of 160 acres owned by a Kansas woman whose family had held it for decades. The farmer who worked the land, Russ Scherler, brought his checkbook but little hope that he would be top bidder. Rick High, the auctioneer, chatted up the farmers from the back of his pickup, saying that credit was tight but land was a safe haven. His opening demand: $150,000. Not a farmer moved. “How about 120?” Mr. High asked. No luck. And so the price sank to $60,000, where the first bid was made.

From there, it slowly climbed back up, finally going for $122,000 — about $760 an acre — to a farmer who had sold some land earlier and now needed to buy to avoid tax charges. Mr. Scherler was disappointed, but not surprised. “Missed me by about $30,000,” he said. A half-mile up the road, a parcel the same size that was deemed slightly inferior had sold a few weeks earlier for $128,000. The market for land is definitely weakening. One reason is that the investors and part-time farmers are once again dropping away. Jim Mumford, an equipment dealer in Walters, says demand for small tractors has dried up. Where part-timers might once have put in a small crop, there are only weeds. “They’re holding off till things get better,” Mr. Mumford said. The Kinders are making their own adjustments.

“The market says, ‘Here’s the price. You want to make any money, get below it,’ ” said Jimmy Wayne Kinder. One way to do that is by diversifying, so they bought 2,000 head of cattle. This has its own risks: a hard winter will mean less grazing for the cattle, which translates into buying more feed. It is also a gamble that cattle prices will rise instead of sinking, as they have been all fall. Another way to get under the market price is by trying to do more with less. The Kinders are practically spoon-feeding nitrogen and phosphate fertilizers onto their wheat.

It is a queasy time. “Given the current economic environment, I don’t think anyone can predict commodity prices,” said Mr. Anderson, the economist. If production costs do not fall or wheat prices do not rise by next spring, he said, farmers will be contacting their representatives in Congress and requesting higher price supports. The elder Mr. Kinder, who is pessimistic enough to think land values will once again fall 50 percent, is taking it philosophically. “People have great prosperity and everyone gets spoiled,” he said. “Then there are times of great hardship and everyone learns patience.”

China's rising unemployment increases the pressure for misguided trade policies
The unemployment situation here has gotten grim enough that the government is trying to mediate labor and pay disputes and to make it harder for companies to lay off workers. They are especially worried about the implications for social unrest. According to a Bloomberg piece today:
A survey of 84 cities showed demand for workers fell 5.5 percent in the third quarter, the first decline in years, Vice Minister for human resources Zhang Xiaojian said at the press conference today. The ministry should be able to keep the urban unemployment rate within the government’s target of 4.5 percent this year, although the rate will “worsen” next year, Zhang said. That figure does not include an estimated 200 million migrant workers who have left their home town in the countryside to work in cities. Even before the current global crisis, the country faced a huge gap between 24 million new job seekers and the 12 million jobs created annually, according to the ministry.

Most people believe that the official urban employment rate significantly understates real urban unemployment, and although I have hear that real unemployment is as high as 10-11%, I have seen nothing very credible on the issue. I assume unemployment is higher but I don’t really know what it is.

If unemployment is rising, however, it does mean that there will be serious pressure to do whatever it takes to support employment growth. One thing that I am worried about (and this was the subject of the “longish writing commitment” I mentioned above) is that it puts pressure on the government to engineer measures to expand export growth. For example I suspect that the fight over whether or not to continue appreciating, and even depreciate, the RMB is intense. Two days ago Bloomberg had a piece that said the following:
The yuan fell as policy makers focus on supporting exporters amid signs the world’s fourth-largest economy is slowing because of global financial turmoil…”We expect the dollar to move higher versus the yuan as the focus shifts decisively to growth,” said Thomas Harr, a senior foreign exchange strategist with Standard Chartered Plc in Singapore. “But not a massive move though, probably up to close to 7 in the first half” of next year, he said. The currency traded at 6.8270 per dollar in Shanghai as of 9:45 a.m., compared with 6.8269 yesterday, according to the China Foreign Exchange Trade System.

Perhaps more importantly, Xinhua said in an article on Monday that:
China’s Ministry of Finance announced on Monday a list of 3,770 items involved in the third export tax rebate increase this year.  The items include labor-intensive, mechanical and electrical products. New export tax rebate rates on these items were also announced. The change take effect Dec. 1.

The announcement came four days after the State Council, or cabinet, said it would raise export tax rebates for the third time this year as part of the government’s 4-trillion-yuan (571.4 billion U.S. dollars) economic stimulus package.  Rises in tax rebate rates varied among different items. For example, the rate on tires was raised from 5 to 9 percent while glassware was up 5 to 11 percent. Rates on labor-intensive products such as luggage, shoes and umbrellas were elevated from 11 to 13 percent.

The 3,770 items accounted for 27.9 percent of the country’s total exports, according to a statement posted on the government’s website.  The statement said the government would also eliminate export duties on certain types of steel, chemical and grain products and reduce export duties on some fertilizer products, also effective Dec. 1.   China raised export tax rebates in Aug. and at the beginning of this month on a range of goods to shore up flagging exports.

Export subsidies, depreciating RMB – all of this might seem to make sense if you look at China as divorced from the global balance of payments system. These measures to boost exports are, after all, pretty standard ways of increasing production. But if you think of China’s role within the global balance of payments, it seems to me that this is little more that a form of Smoot-Hawley-with-Chinese-characteristics. Global demand is slowing, just as it did in the 1930s, and China as the leading source of global overcapacity is trying to address its global demand problem by shifting the burden abroad.

In that light I should mention a recent exchange I had with some friends. Reference was made to a recent Washington Post OpEd piece by the British historian Niall Ferguson in which I think he got absolutely correct the importance of the China-US link in the global balance of payments, but he was wrong when called for a significant fiscal boost from the US. My response to his piece was:
Ferguson is probably right to compare the 2008 G20 with the failed 1933 London conference, but the problems with this account, I think, is that he has the US playing the same role in the 1930s as today. But the positions are very different.

In the 1930 it was the US who had huge overcapacity which it exported abroad (via huge trade surpluses) and it was Europeans who were over-consuming, financed by capital exports from the US.  When the credit crunch came it was unreasonable, as Keynes argued bitterly, to expect the rest of the world to continue demanding US goods, especially since the financing of their consumption had been interrupted.  Since US production significantly exceeded US consumption (with the balance consisting of course of the trade surplus), the need for demand creation most logically rested in the US.

As we all know, in spite of FDR’s Keynesian reputation (he wasn’t) the US not only failed to expand fiscally as much as it needed to but it actually tried to use trade restrictions to protect its overcapacity problem and “export” its lack of demand to the rest of the world.  That didn’t work, and when world trade collapsed the US had to bear the full adjustment cost of the gap between production and consumption, and it did so in the most difficult possible way, by contracting production.

Today it is China who is exporting overcapacity and it is the US who is consuming too much, fed by Chinese financing. With the collapse of bank intermediation US households and businesses are cutting consumption and raising savings. This is a necessary adjustment. Calling on the US government to engage in massive fiscal expansion to replace lost private demand is crazy. It means that we should continue the current game that has led us into so much trouble, but instead of having US over-consumption and rising debt at the private level we must have it at the public level.

If Keynes were around today he would probably make the same point he did over 60 years ago. Demand must be created by the current account surplus countries, which have, to date, relied on net exports to protect themselves from the consequence of their overcapacity. They must force demand up quickly in order to close the gap, and since expecting private consumption to rise quickly enough is unrealistic, it has to be public consumption – a large fiscal deficit.

Just as the US stupidly tried to increase its ability to dump capacity abroad by creating import restrictions (which has the effect of further expanding domestic production), China seems to be hoping for the same thing by increasing export rebates and slowing the currency appreciation (there is even increasing talk of depreciation). This can’t work for long.  The world has excess production and there is a need for the US to reduce its demand and increase its savings. The only proper place for new demand to originate is, once again as in the 1930s, from current account surplus countries.  They should be engaged in demand creation, not supply creation.  

If they continue trying to export their way out of a slowdown, there will almost certainly be a trade war, as in the 1930s, and the full force of the adjustment will be borne by the current account surplus countries, again as in the 1930s. Remember that back then the current account deficit countries, like Germany after 1932, found it relatively easy to limit the impact of the crisis by forcing balanced trade — which has the effect of increasing demand (domestic) and reducing supply (foreign).

It is amazing to me that people like Ferguson, who have been arguing correctly for years that US consumed too much and saved too little, are now terrified of the necessary adjustment, and are arguing that it should be stopped and even reversed.  The process cannot be stopped – US savings are too low and will rise one way or the other.  The global imbalance between production and consumption must grow because US and European consumption must decline, and if we cannot find a new source of demand, there will have to be a contraction in production. In an open world, the contraction will be paid for by everybody more or less equally, with those aggressively pursuing export growth getting off relatively lightly and the rest doing worse.  In a closed world most of the cost will be borne by the countries with overcapacity. If Asian countries continue to try to boost exports it is not hard to see why this could easily lead to trade barriers.

China needs to resolve this problem by expanding fiscally, not by stimulating exports. The US in the same position sixty years ago tried to do the same thing China is doing (half-hearted fiscal stimulus and more interfering with trade in order to alter the terms in its favor), with disastrous consequences mainly for itself. Instead of looking for and dreading Smoot-Hawley in US or European policy-making, we really need to worry about an Asian Smoot-Hawley. Remember that there is no difference in this case between restricting imports and subsidizing exports and, by the way, currency depreciation does both.


Chaos said...

I enjoy all of your posts, but I happen to like this one more than some others, primarily because I anticipated it by a day or's something I posted at the NYTimes website (Krugman's column) yesterday (I moderated it somewhat for the MSM):

"Ok, somebody please explain this to understanding is that 2/3 or so of the US economy runs on consumer spending. So, where is that going to come from this time? We know it won't be from internet stocks, real estate refinancings, and credit cards; all those are over with and gone. If we bail out the automakers, for example, who's going to buy their cars? With what money? I seriously question whether attempting to reflate the economy with government stimulus will work in the face of collapsing asset values. Dr. Krugman, any answers?"

bluebird said...

Another excellent post, Thanks!

So far, I still see people using credit cards for all kinds of purchases - gasoline, retail, groceries, restaurants, Internet purchases, etc. I assume there is going to be a major event that causes all types of businesses to stop accepting credit cards. Because where I live in SW Ohio, it's still party, party, party (even with large layoffs looming for GM, DHL, Armco Steel). Especially today with the annual Ohio State vs Michigan football game, Ohio State won, so more celebrating in Ohio!

Anonymous said...

I also found a few interesting items to add to this informative blog.

Bush says, (paraphrasing),
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
Bush, (USA), recognizes that the financial power has shifted to the EAST.
This was accomplished by the EAST flooding the rest of the world with cheaper products.
The Real Great Depression
The depression of 1929 is the wrong model for the current economic crisis
However, does he recognize that when the financial power shifted from EUROPE in 1873 to the Americas, same mechanism, that there greater turmoil and hardship in Europe.
It appears that the thinking is that the USA will be able to avoid the same fate of 1873?
Looking farther into the future, the next shift will be to Africa.
It will be the next financial power and cause the next turmoil and hardship.
What does Harper have to say?
Global trade key to surviving crisis, Harper says

The Arabs might not have discovered, yet, that the Congo basin, Sudan, Ethiopia, Mozambique and Tanzania as the place to invest, laying railroads and digging mines and buying million acre mega farms, but India, China and Japan have and are doing it. That is where the next frontier since AIDS and civil warfare is wiping out most of the local population.
Deja vue.
Buying the world
Nov 19th 2008
From The World in 2009 print edition
By Max Rodenbeck, DUBAI
The Gulf’s plans for its petrodollars
As most countries tighten their belts, the Arab monarchies along the Persian Gulf face a different problem: what to do with the $4.7 trillion-$8.8 trillion that their oil sales are expected to garner by 2020 (based on an oil price of $50-$100 a barrel). Whatever the actual sum—and cheaper oil will mean some belt-tightening even in the Gulf—that is a great deal of cash, and even more so considering that the six-nation Gulf Co-operation Council is home to fewer than 40m people.
Cuba is ready to buy newer models of cars.
The World in 2009
The Americas
Old order, new oil
Nov 19th 2008
From The World in 2009 print edition
By Michael Reid
Cuba’s future will become a little clearer
Two other developments in 2009 should make the island’s medium-term future a bit clearer. The first is a new American president. A change in the White House brings with it at least a chance that the United States will loosen its economic embargo and encourage some sort of political dialogue with the Cuban regime, rather than leave United States policy frozen in futility.
A second big question is oil. During 2009 a group of foreign oil companies will bring a drilling rig to the Cuban waters of the Gulf of Mexico to sink several exploratory wells. If they find oil, that will strengthen Mr Castro’s position—and also reduce his dependence on Mr Chávez.

Stoneleigh said...


Credit cards are still available, but credit limits are already being cut without warning by card issuers. That will continue and cards will also become less available, probably in the near future. Eventually, credit cards, if they are available at all, will only be available to the very wealthy. As ordinary people have become accustomed to using their credit balance as their rainy day fund - in place of savings - this will cause hardship quickly as jobs are lost.

Ilargi said...


We don't need a 2nd Debt Rattle in the comments section. If you would like to contribute though, that's fine, send us an email. We are assembling a roving reporter team that is poised to start next week.

theautomaticearth at gmail dot com

Anonymous said...

Great post today. I think we will end up with the american version of the lost decade. Every company and every individual is going to have to slowly work through their debts until they get to a point where they are somewhat liquid. While that is going on who knows what else we will have to deal with, and without ready cash. This could take a very long time. exranger

Anonymous said...

I would be happy to help.


Anonymous said...

"The man in the street is too big to fail, not the corporations."

But he is small enough to be spun off, marginalized, disinherited - until the centre holds.

Anonymous said...

“If the SEC completely stops naked short selling, then demand will more closely reflect the supply of real stock. Prices could get a boost, as they did last summer, when the SEC issued an “emergency order” temporarily cracking down on naked short selling of stock in 19 big financial companies. And the massacres of public companies would stop.

Of course, it might be too late. A sinking economy can’t revive a sinking market – no matter who threw us down the well. The criminals should have been stopped before they put us in here.

It says something awful about the state of the nation that we began having a half-conversation about this issue only after CEOs of big Wall Street banks – the very banks whose prime brokerages happily profited from the naked short selling of their hedge fund clients – found themselves looking down the gun barrels of their former partners in crime.

A few quivering Mafiosi pee in their pants, and now we wonder whether one Mob boss should be protected from another Mob boss. Not a word about the hundreds of smaller, innocent companies that have been brutalized by these goons.” Live On CNBC: Naked Shorts “Causing” Market Mayhem

Anonymous said...

Brilliant essay, Ilargi.
Cuts to the essence of what's going on. Until the chains of debt are broken, the banks' death grip (mort-gage) will not be escaped.

I've never seen this thought so clearly articulated: "But no bank, even in good times, would let you use the earning spower of your grandchildren as collateral for a loan...." Exactly so. But the central bank is quite willing to saddle future generations with unpayable debt, at terms you never agreed to, using your own money as principal.

Truly a monstrous alchemy at work.

Anonymous said...

"aThe mortgage gift your kids won't thank you for
An inter-generational home loan seems cheap initially, but will cost in the long-term, warns James Daley"

Anonymous said...


good post today
'70% of the US GDP is determined by consumer spending. It would thus seem glaringly obvious that in order for the economy to be revived on anything resembling sound principles, the purchasing power of ordinary people needs to be restored. '

This is exactly the point and a problem that has been building and building over the years.

We have an economy that depends on growth.
That growth depends on 'the people' buying ever increasing amounts of stuff.
The problem is that 'the peoples' share of the total economic pie has been shrinking and more and more of the pie going to the elites (for want of a better word).
So how is it that 'the people' could buy the stuff that growth required? - more and more credit of course.
Sooner or later this had to hit the wall and it did.
So now what?

So I agree – none of this will ever really get 'fixed' until this core issue is addressed somehow.

I think that both ends of this will have to be looked at – purchasing power for 'the people' (or to put it differently – 'the peoples' share of the fruits of the economy) and the necessity of out of control 'growth' to keep the wheels turning.

But it's a long way from here to there.


John Hemingway said...

Excellent post!

Farmerod said...

MrMoto said ...none of this will ever really get 'fixed' until this core issue is addressed somehow.

The only way that it will be addressed is when it completely unwinds. Stoneleigh said it best Once a deleveraging event has begun, it will proceed to its natural conclusion - the point where the (small amount of) remaining debt is acceptably collateralized to the (few) remaining creditors. All governments can do is to make it worse in the meantime.

Anonymous said...

ilargi, that essay yesterday re the 1873 depression was an eye opener, thanks for digging that one up.

Insider, re your predictions: just for fun, and given the fairly superficial nature of your predictions, here's one back at you: Aazon will not see much growth at all, if any, this holiday season. In fact, I wouldn't be surprised at all to see YoY numbers lower for December. Why? Very simple, as you noted, expect deal hunters to buy more as they try to save money, but, as you forgot, expect the country to buy much less as a whole, for a total of either steady, or a decline. Why, because they simply don't have any money. Hard concept to grasp I know.

ilargi, your post today raised the points that must be raised, and I believe, will be raised, But not until people turn off their self imposed brainwashing, aka, televisions, and start relearning the art and skill of thinking for yourself, and learning from non-corporate influenced sources, like your neighbors. This is known as 'talking', reading, etc.

It's looking increasingly unlikely that the planet will be able to sustain the current oil production plateau much longer, and when it starts to drop, you can forget those 9 billion population estimates now, as well as any prospects for 'growth' based economic systems to surviving taking a corresponding nosedive. (Insider, that's a prediction too).

Unknown said...

Obama said he and his top economic advisers will be working out the details of an “economic recovery plan” that will be “big enough to meet the challenges we face that I intend to sign soon after taking office” on Jan. 20. “It will be a two-year, nationwide effort to jumpstart job creation in America and lay the foundation for a strong and growing economy,” Obama said. “We’ll put people back to work rebuilding our crumbling roads and bridges, modernizing schools that are failing our children, and building wind farms and solar panels, fuel-efficient cars and the alternative energy technologies that can free us from our dependence on foreign oil and keep our economy competitive in the years ahead.”

Can someone please explain to me why this either can't be done or won't work?

It seems like the obvious answer to me. Even in this dark hour, people are basically willing to give their money to the U.S. federal government for free on a short-term basis and at very low interest rates for longer terms. Even if a massive public spending program ultimately results in the dollar coming under some pressure, for a lot of Democratic constituencies that's not such a bad thing: more manufacturing, better prices for agricultural exports, more foreign tourism, less junk flooding our markets from China.

If I were Obama, I would make this program truly massive, in the trillions. Nobody has yet shown me where there's a real (not legal) debt limit that applies to the U.S. federal government. The key is that the money is invested in ways that work to our benefit in the long-term: infrastucture, education, etc., as well as relieve our suffering in the short term (unemployment extensions, increased food stamps, etc.)

Am I missing something here?

Anonymous said...

as I have heard: the lenders do not want to lend and the borrowers do not want to borrow.

Paulson throws money at the lenders, to keep lending, but they don't lend. The borrowers are tapped out, (high oil and gas prices) and they don't want to borrow. bear in mind food prices are still high, though commodities have been cut in half. so one would think the prices of food and other goods would go down, but 18 wheelers use diesel, and it's only down to $3 a gallon, so don't expect food and other goods to fall by much.

the borrowers will continue to cut back on expenses, and I think the lenders will have to sweetin the deal for a borrower to borrow.

Anonymous said...

Hello Moto

People have this funny idea that governments create economic value and can *grow* an economy. This is simply magical thinking.

Governments skim off economic surplus from the productive economy in the form of taxes and use this money to spend on whatever gov't programs it has going at the time.

In the US the Gov't has a policy of skimming off of *future* economic surplus in the form of borrowing, rather than taxing present economic surpluses exclusively. This borrowing can go on so long as the government can sell bonds to people who have faith that they will see their investment returned with interest.

We are careening rapidly toward the point where the potential market for US Gov't debt is gonna say, "Um ... I don't think so." And *that* is the day the lights go out in Washington.

Even if this Gov't did get someone to pony up the cash for their trillions in new debt, the very idea that the government can spend on investments for the future is ludicrous. In the 1930's the US had massive infrastructure needs for transportation, housing, electrification etc. etc. There is no such need on virgin soil, so to speak now. Obama is promising investments in last century's needs (albeit with less petroleum dependence ... or so he says). There is every reason to suspect that these "investments" will not give the future returns that he or others envision.

We are at a high state of complexity, and resource poor into the 21st century. I am not convinced that the Panic of 2008 will work out anything like the other Panics for the very reason that energy inputs cannot grow from present.

Anonymous said...

Hi folks..gone several days working as many hrs as I can before that becomes not possible.It is possible to work 24 hrs straight w/2 pots of coffee,light work,and a 20 min. nap mid-way.42 hrs work in 48 hrs.

[I will admit,since I hit the 1/2 century mark it hurts a bit more to pull long shifts...and it will take 3-5 days before I feel well again]
I hope the stars are aligning in Washington with this administration to hit the ground running,and ram thru the kind of progressive programs that will make this coming phase-change transition a little better/easier to live through.I am about as prepared as one may be...but in my heart I dream this coming earthquake to only be a shudder and groan,instead of the 9 Richter that is headed from possible to dead certain

More folks I meet up with have the same kind of blood-red and bone-mad anger at this group of thieves in the government now than I have ever seen before.These are plain ,garden-variety construction workers,steel-fabricators,and owners of small businesses.I think those in power ignore this quiet rage at their peril.There is one hellava lot of really really pissed off citizens out there.They are not saying much,but when the fuse gets lit on these folks watch out.

I can see things getting tighter now.When the shelves empty is when it will start to get weird I think .Later


Stoneleigh said...

Pragmatic Progressive,

Unfortunately, there will be neither the money nor the energy to engage in Keynesianism to any great extent, and even if it were possible it wouldn't necessarily work. Japan spent vast sums of money trying to do exactly that after their peak in 1989, at a time when they had vast surpluses to spend, international capital was freely available and energy was not in short supply. They built four lane highways from nowhere to nowhere in an attempt to create jobs to stimulate the economy, but their slump was persistent, and still isn't over.

The US is in a much worse position, being already so indebted and facing its own moment of truth at a time when energy production capacity is peaking globally and international capital is about to become extremely scarce. At the moment, and for some time to come, the US is benefiting from a flight to safety in the capital markets, but that can only continue for so long.

At some point we will see a substantial dislocation in the bond market, leading to a spike in interest rates - probably into the double digits. The implication is that international debt financing will be far more difficult, and that very significant cutbacks will be forced on the US government. Not only will it not be able to afford the proposed infrastructure programme, but it won't be able to afford its social programmes either. In other words, what we'll see is infrastructure continuing to crumble and the social safety net being withdrawn when it is needed most. The population will be cut loose in a pay-as-you-go world just as they are losing jobs, homes, savings, investments, benefits, entitlements and access to credit.

Unfortunately for Barack Obama, he will be presiding over the worst economic conditions probably ever experienced in the US, and there will be essentially nothing he can do about it. In winning the presidency now, he has accepted the biggest poisoned chalice ever, and at a time when expectations are somewhere in the stratosphere. He will inevitably disappoint virtually everyone, but through no fault of his own. As with Hoover before him, large economic downturns are very unkind to those in power at the time.

scandia said...

About where the money will come from to finance Obama's plans, I recall an article about the " green" Gore venture funds. I believe he heads more than one and they are very large. Would this now be a time for venture funds to step up? Certainly there are opportunities for gain with an inside track to the White House via Gore?

Greenpa said...

I think readers here would get a kick out of this cartoon:

This guy produces some pretty lame stuff; but also sometimes nails it; like this one.

Also, for part of the ongoing "where are the riots" thread:

Stolid elderly Swiss investors are reaching for their pitchforks, forsooth, and becoming angrily confrontational.

Greyzone said...

Pragmatic Progressive, please tell me where they will get the money for these programs? Taxes? Unemployment is set to soar, probably well into double digits even with these "massaged" stats from the BLS. (Note that the unmassaged stats, available in an appendix to the BLS monthly employment report, indicate unemployment over 11% and rising.)

Ok, they can't raise taxes without choking off even more jobs so... taxes on corporations? Do you think that will hurt job creation? Yep it will and it won't amount to the $700 billion that the Department of Transportation needs to rebuild the highways and railways, nor will it amount to the additional $300 billion that the Department of Energy needs to rebuild the aging (and near collapse) electrical grid. Ooops, looks like raising taxes on corporations is a bad idea...

Can they borrow it? From whom? Already our current bondholders are nervous about what they hold, let alone trillions in new debt. Oh, by the way, BEFORE we get to Obama's progressive programs we are already on track to try to borrow $2 trillion this year ($550 billion by December 31 according to the OMB). You realize that government borrowing crowds out private borrowing, right? And that causes fewer new business starts, meaning more job losses.

So this leaves... print your way out of it. But printing your way out of it assumes that the current dollar holders will sit still and let themselves be raped financially. If the US government even tries to go down that path in any significant way, expect the dollar to collapse. And if the dollar collapses, the US government stands a very strong chance of collapsing, Soviet style, along with the dollar.

So, long story made short - Obama does not have nor can he acquire the funds necessary to do what he proposes. His hands are tied. Ilargi's "poisoned chalice" is very apt as a metaphor. Bush has handed Obama the largest chalice of hemlock ever handed out and is telling him "Here you go! Drink up!"

This is going to end badly. Badly beyond almost anyone's wildest dreams.

Anonymous said...

"But he is small enough to be spun off, marginalized, disinherited - until the centre holds."

There are more ways to scratch a back and the ordinary folks are getting both itchy and scratchy.

In a total aside from all the numberjumbo:

Last night's local high school Winter holiday production was a collection of single dramatic acts featuring "The Devil and Daniel Webster" in which Mr. Webster's grand defense fell flat and the devil and his jury truly stole the show.

The night ended in success as the children had been attempting to pull off "The Gift of the Magi" for several years running. Opening night, they forgot to bring their Gifts onto the stage. You can imagine how truly proud and surprised they were to finally pull it off.

According to my analytic stylings, investing in the future begins with all of them.

Handing back the rattle...

Anonymous said...

Greyzone said:

"You realize that government borrowing crowds out private borrowing, right?"

No, I didn't, how does that work? The rest of what you say sounds pretty good but why wouldn't interest rates from the private sector attract lenders better than government rates?


Wyote said...

Grayzone : "This is going to end badly. Badly beyond almost anyone's wildest dreams."
The question comes to mind, Why follow this blog at all? You seem so certain of the fate of the nation. Perhaps you should find a nice cozy hole and deposit yourself in it.

Some of us have a few plans to make, communities to organize and hell, hopes to further. We want to be sponsors of our kid's futures and tend to fall in the survivor camp. This is one blog that can further solid decisions.
The constant echo of the author's darkest comments is more a king -o -the Heap game for the nihilist crowd.

Unknown said...

Greyzone and Stoneleigh: thank you for your thoughtful answers. I probably agree, but I'm not as sure as you. For the moment, Obama can borrow as much as he wants. People are basically begging the U.S. Treasury to take their money. Will any of it ever be paid back? Who knows, but as long as people are willing to lend it, isn't that what matters?

Is there no question that the bond market will "dislocate" all at once, rather than experience gradually rising rates?

What about printing? The dollar has been doing better lately, and in any event, I would think a weak dollar would be beneficial in a lot of ways that would be attractive to Obama: manufacturing, tourism, agricultural export, etc. Hasn't China deliberatively depressed the value of their currency to their benefit for years? Would we not as well?

As to whether or not the investments would pay off in the long run, it seems too obvious to state that any investments in energy conservation, alternative energy, energy efficiency, etc., would definitely be to our medium- and long-term benefit. Education and health care are goods in and of themselves (at least in my opinion), but tend to also support long term economic prosperity.

If Japan failed in a similar effort by building "highways to nowhere", then OK, let's not do that. But just to bring our public infrastructure up to the standard currently enjoyed in Western Europe and Japan (i.e. mass transit, high-speed trains, free education, universal health care) would cost trillions and nobody says they wasted their funds in those investments, do they?

If it finally comes down to having to pay for it all with printed "monopoly money" that is worthless except as a medium of exchange within the United States for goods and services produced in the United States, I don't see that we'd be THAT bad off, at least by that very fact alone (OK, I allow that a lot of other bad things might be fellow travelers with such a scenario). After all, I can take you to quite a few areas of the United States where the entire economy is based on federal expenditures already, some of them quite well-off actually (try Los Alamos, New Mexico for starters).

But unless we believe that our debt and the dollar will collapse suddenly instead of gradually, it would seem that there will be the chance to travel down this path for at least a while. Nobody has expressed doubt that Obama will be able to borrow or print the money, the only question lies in the consequences for having done so. If interest rates on our debts begin to rise, and the dollar comes under pressure, I would think that he could still change course at that later date.

team10tim said...


The government crowds out private buying by offering the lowest risk. If you are worried about the future or are retired and have a low risk fixed income portfolio then Treasuries are the first choice. Treasuries are perceived as the safest investment, all other borrowing is set at a higher rate. If there was no government debt available it would remove the floor on interest rates set by the Treasuries. It would also take billions of dollars of debt off the market forcing lenders to look for new borrowers which would channel more investment to the private sector.

I think Milton Freedman was the first to advance this idea.

Anonymous said...

Thanks team10tim but wouldn't the interest rates offered reflect and therefore offset that risk? As well couldn't government insure portions of private borrowing if the monies borrowed were to go to areas of interest to the government, for instance investment in electrical infrastructure and power generation? That would allow government to direct while not having to spend.