Saturday, November 29, 2008

Debt Rattle, November 29 2008: "Inflation" deflated

Lewis Wickes Hine Scavengers November 1912
Children going through Whitman Street dump. Pawtucket, Rhode Island

Stoneleigh: There are many things we have discussed here frequently that come up as questions in the comments because we are attracting new readers all the time. I thought it would be a good time to answer those questions en masse, so that there would be a URL to point to if the same questions should come up again.

The basic point is that we here at TAE are expecting deflation. Although inflation and deflation are commonly thought of as descriptions of rising or falling prices, this is not the case. Inflation and deflation are monetary phenomena. The terms represent either an increase or a decrease, respectively, in the supply of money and credit relative to available goods and services. Rising prices are often a lagging indicator of an increase in the effective money supply, as falling prices are of a decrease. There is an important distinction to be made between nominal prices and real prices, however. Nominal prices can be misleading as they are not adjusted for changes in the money supply and so do not reflect affordability. Real prices, which are so adjusted, are a far more important measure.

Nominal prices typically rise during inflationary times as there is more money available to support higher prices, but prices need not rise evenly, and some prices may fall, depending on other factors. In real terms the picture would be quite different, as increases would be smaller and decreases would larger. When nominal prices fall despite inflation, it means that the price in real terms is plummeting. For instance, global wage arbitrage allowed the price of imported goods to fall drastically in real terms. In deflationary times, nominal prices typically fall across the board, but prices need not fall in real terms, and, in cases of scarcity, may well rise.

The easy availability of cheap credit has conveyed a considerable amount of price support - price support that will be progressively withdrawn as credit tightens. Prices will fall, but the collapse of credit will cause purchasing power to fall faster than price, leading to the apparent paradox of nominally cheaper goods being less affordable in the future than nominally more expensive goods are today. Moreover, there are likely to be substantial changes in relative prices between essentials and non-essentials. As a much larger percentage of a much smaller money supply will be chasing essentials such as food and energy, there will be relative price support for those items. In other words, while everything is becoming less affordable due to the collapse of purchasing power, essentials such a food and energy will be the least affordable of all, whatever the nominal price. People commonly speak of unaffordable prices as a result of inflation, but do not realize that deflation can have the same effect, only much more abruptly.

Thanks to a credit boom that dates back to at least the early 1980s, and which accelerated rapidly after the millennium, the vast majority of the effective money supply is credit. A credit boom can mimic currency inflation in important ways, as credit acts as a money equivalent during the expansion phase. There are, however, important differences. Whereas currency inflation divides the real wealth pie into smaller and smaller pieces, devaluing each one in a form of forced loss sharing, credit expansion creates multiple and mutually exclusive claims to the same pieces of pie. This generates the appearance of a substantial increase in real wealth through leverage, but is an illusion. The apparent wealth is virtual, and once expansion morphs into contraction, the excess claims are rapidly extinguished in a chaotic real wealth grab. It is this prospect that we are currently facing today, as credit destruction is already well underway, and the destruction of credit is hugely deflationary. As money is the lubricant in the economic engine, a shortage will cause that engine to seize up, as happened in the 1930s. An important point to remember is that demand is not what people want, it is what they are ready, willing and able to pay for. The fall in aggregate demand that characterizes a depression reflects a lack of purchasing power, not a lack of want. With very little money and no access to credit, people can starve amid plenty.

Attempts by governments and central bankers to reinflate the money supply are doomed to fail as debt monetization cannot keep pace with credit destruction, and liquidity injected into the system is being hoarded by nervous banks rather than being used to initiate new lending, as was the stated intent of the various bailout schemes. Bailouts only ever benefit a few insiders. Available credit is already being squeezed across the board, although we are still far closer to the beginning of the contraction than the end of it. Further attempts at reinflation may eventually cause a crisis of confidence among international lenders, which could lead to a serious dislocation in the treasury bond market at some point. If a debt-junkie economy can no longer easily raise funds, then interest rates would rise substantially and spending at home would be drastically cut. This would be the financial equivalent of hitting the 'emergency stop' button on the economy, as it would cause a far larger rash of defaults than anything we have seen so far. We are not there yet though. Currently the dollar is benefiting from an international flight to safety, and it will probably continue to do so for some time, despite temporary counter-trend pullbacks from time to time.

We have seen a pattern of ebb and flow of market liquidity since February 2007, when the credit crisis arguably began. A constellation of market trends has largely moved in synch with liquidity. As liquidity falls, equities fall, bond yields fall (and prices rise), commodities fall, precious metals fall, real estate falls and the dollar rises, as cash becomes king. When we see market rallies, in contrast, rallies in bond yields, commodities, and metals are also common, and the dollar experiences a pullback. We appear to be beginning a market rally at the moment, which should lead to precisely this set of trend reversals. Such a rally is only temporary relief however. It may last for a couple of months, but then the decline should resume with a vengeance.

We have a very long way to fall, and the deleveraging process is likely to play out over several years. During this time we can expect to be mired in a worse depression than the 1930s, as the excesses that led to our current situation are far worse by every measure than were those of the Roaring Twenties. Unfortunately, we are much less prepared to face such an occurrence than were our grandparents. Our expectations are far higher, our knowledge and skill base is much less appropriate, we are far less self-sufficient and we have a structural dependency on cheap energy. This will be a very painful time. Deflation and depression are mutually reinforcing, leading to a vicious circle of decline that is very difficult to escape. It will be over when the (small amount of) remaining debt is acceptably collateralized to the (few) remaining creditors. At that point trust will begin to rebuild.

For a longer and more detailed explanation of the credit bubble and deflation see The Resurgence of Risk - A Primer on the Develop(ed) Credit Crunch. This an article I wrote in August 2007 that was recently rerun on The Oil Drum, where I used to be an editor.

Lifeline of €30 Billion Thrown to BayernLB Bank
Germany's troubled BayernLB bank will be granted a bailout package worth 30 billion euros to help it survive the financial chill. Bavarian Governor Horst Seehofer warned the bank's predicament was "very, very serious." BayernLB has already earned itself the unenviable accolade of becoming Germany's first bank to request help from the government bailout funds. On Friday it added a massive bailout package to its trophy shelf: a €30 billion lifeline will be thrown to the ailing business.

To restore it to health, Bavarian Governor Horst Seehofer said the Munich-based BayernLB would be granted €10 billion ($12.9 billion). He also said the bank requires lending guarantees to the tune of €20 billion. Of that he said he would seek €15 billion in interbank lending guarantees under the federal plan. Germany's second biggest regional bank has been hit hard amid the financial domino effect. First, the US subprime lending crisis and subsequent credit crunch left it, and many peers, with hefty write-downs. Then, BayernLB's problems deepened with losses generated by bank failures in Iceland. Earlier BayernLB said it has applied for €3 billion from the federal bailout fund -- a move which would mean that the state would have a relatively small say in the running of the bank.

Officials in Bavaria, whose state government owns half of BayernLB, last month presented plans to seek an injection of €6.4 billion -- but apparently its needs have intensified amid rising credit risks and new write downs. The German government's rescue plan is worth up to €500 billion ($645 billion) in total. Seehofer, who stayed away from the annual Christian Democratic Union party conference in Stuttgart (Seehofer himself is from the Christian Social Union, the Bavarian sister party of the CDU) to deal with the bank's emergency, warned that no one could ensure the bank has complete security "for ever and ever." And these have been testing times for the regional lender.

There was October's news that BayernLB faced a loss of up to €3 billion by the end of the year: in the third quarter alone its pretax loss amounted to an estimated €1 billion, far exceeding expectations of €100 million. Then the bank signalled it would need to draw on Berlin's €500 billion rescue fund. And the downward spiral even claimed a political victim, Bavarian Finance Minister Erwin Huber who resigned after Bavarian public-sector bank BayernLB reported bigger-than-expected losses. There had been speculation that he may have known about the hefty losses for some time. And on Friday the gravity of BayernLB's situation was surmised by the new Bavarian Finance Minister Georg Fahrenschon: "It is facing the biggest challenge of its almost 40-year history."

Commerzbank purchase accelerated
Commerzbank will now pay 5.1bn euros ($6.6bn; £4.2bn) for its rival, substantially less than the 9.8bn euro deal originally announced in September. The deal's acceleration is a result of falling share values with Commerzbank's down 61% since the deal was unveiled. Commerzbank shares were up 4.96% and Allianz shares ended up 9.12% at the close of trading in Frankfurt. Commerzbank already owns 60% of Dresdner and the remaining 40% will be purchased in January.

The revised deal will mean that Commerzbank will no longer have to issue new shares, but will pay for the remainder in cash. A major factor in Commerzbank's ability to pay more cash was the 8.2bn euro capital boost it received from the German government on November 2. Allianz will receive 1.4bn euros for the remaining stake.
Allianz said that the deal could now go ahead six to nine months ahead of plan. The deal will leave Allianz with approximately 18% of the combined bank. Allianz had originally paid 14bn euros for Dresdner in 2001.

Allianz Chief Executive Michael Diekmann said: "In the current situation on the financial markets an accelerated takeover of Dresdner by Commerzbank is to the advantage of all parties." Commerzbank's chairman, Martin Blessing saw the accelerated transaction as "speeding up the integration process". The ability for Commerzbank to pay cash and not cause more shareholder dilution has been the driving force in leading its share price higher.

It is expected that approximately 9,000 jobs will be lost worldwide. In London 1,000 jobs are expected to be lost with Dresdner Kleinwort, the group's investment banking arm expected to bear the brunt of the job losses. Commerzbank will see the number of retail clients almost double as a result of the deal.

Brussels blocks French bank bail-out
The French government’s plan to shore up the capital position of France’s six main retail banks is being blocked by the European Commission, which insists they must reduce their lending in return for state support. Christine Lagarde, French finance minister, on Friday spoke to Neelie Kroes, EU competition commissioner, to persuade her to lift her veto on France’s €10.5bn ($13.3bn) support package but Ms Kroes is sticking to her view that banks cannot use state aid to increase their lending books. “We have to apply the same criteria to everyone . . . support should be sufficient to offset the negative impact of the current financial crisis and no more,” said one official.

The French government reacted furiously to the Commission’s argument. One senior official described it as “ridiculous” and “stupid” because it would exacerbate the credit crunch – the very thing Paris said it was trying to avert when it decided last month to inject capital into all its large high-street banks. France – unlike the UK, Germany or Italy – intended to recapitalise all its lenders at the same time to ensure they did not tighten credit to business and households. Paris argued that without state support, and in view of the frozen interbank lending markets, banks would have shored up their capital positions by reducing loans, with catastrophic consequences for the real economy. The finance ministry wanted to provide €10.5bn in subordinated loans to BNP Paribas, Société Générale, Crédit Agricole, Caisse d’Epargne, Banque Populaire and Crédit Mutuel. In return, the banks agreed to increase the stock of credit to households, business and local government by 3-4 per cent in 2009.

French officials said they accepted the argument that banks rescued from collapse by injections of public money, such as the UK’s Northern Rock or Dexia, the Franco-Belgian lender, should have to wind down their loan portfolios and eventually sell off their assets. However, France’s six high-street banks were fundamentally sound but were under pressure from the markets to bolster their balance sheets, officials said. They added that EU leaders and the Commission endorsed this preventative recapitalisation approach in October. The French plan is one of a number of banking aid measures notified to Brussels but still not approved. The Austrian, Spanish and Hungarian framework schemes are still awaiting a green light.

A number of aid packages to individual institutions, such as that proposed for Germany’s Commerzbank, also remain under discussion. However, it has also already approved some schemes with a recapitalisation element. Germany’s framework scheme included recapitalisation proposals, for example, although beneficiaries would have to give behavioural commitments and maintain high solvency ratios. Separately, it emerged that the French plan to underpin credit insurance for risky companies may also run into state aid issues.

State left with £2.3bn loss as RBS fundraising snubbed
The Government was nursing a £2.3bn loss yesterday after Royal Bank of Scotland shareholders snubbed the lender's £15bn fundraising, leaving the state with 57.9pc of the bank and 22.9bn shares that are already worth less than the taxpayer paid. The result of the placing was not a surprise as the offer price of 65½p was 10½p higher than the level at which RBS shares closed on Thursday. Existing investors took up just 56m shares, or 0.24pc of the issue. RBS stock rose 0.3 to 55.3p, leaving the Government already showing £2.3bn paper loss on the investment.

A Treasury spokesman said the stake "supports financial stability, protects ordinary savers, depositors, businesses and borrowers while safeguarding the interests of the taxpayer". Taxpayers are also expected to be left with a large holding in the giant bank created from the merger of HBOS and Lloyds TSB. Both banks are raising capital in share placings underwritten by the taxpayer. The placings complete on January 9, and if Lloyds and HBOS's share prices remain where they are the state will end up with a 43.5pc stake. The Government is on course to inject a total of £37bn into the three banks – £28bn by buying shares and £9bn in preference stock, a form of high-yielding debt.

The investments will be managed by UK Financial Investments, the new holding company run by John Kingman, one of Gordon Brown's most trusted civil servants. Earlier this week, UKFI hired John Crompton from Merrill Lynch, an experienced equity capital markets banker, to devise and execute a strategy for the sale of the holdings. Sales are not expected until markets recover, which could leave the state holding the stakes for several years, analysts said. RBS chief executive Stephen Hester said: "We regret that existing shareholders did not take up their pre-emptive rights but understand that market sentiment toward the banking sector made this uneconomic in the short term. "We must put the past behind us and move forward with a clear focus on what we need to do next. There remain substantial uncertainties and challenges outside our control but for our part the job is underway."

Everyone except the Government knows we’re spending too much
Imagine the scene earlier this month: somewhere in the bowels of the Treasury, Alistair Darling was wrestling with a box of budgetary horrors left behind by the next-door neighbour. His mission was to devise a way of going forward when so much of the economy was powering in reverse. The Chancellor may seem dim-witted, but on this occasion he had at least worked out the big issue: spending. There had been far too much of it. From 1997 to 2007, household outgoings way outstripped increases in disposable income. Many consumers sacrificed their personal balance sheets on the altar of retail mania. Credit cards, store cards, overdrafts and loans were used to acquire goodies that old-fashioned wages could not deliver. Others confused purchasing property with a get-rich-quick scheme: the more it cost, the richer they became (or so it seemed). Houses were no longer just homes; they were assets that yielded juicy dividends. So borrowing to buy one wasn’t really borrowing, as such. It was money for nothing. Wasn’t it?

The upshot was £1•4 trillion of private debt. Quite an achievement. This sum is equal to Britain’s annual GDP, our national output. With such an amount, you could cover the United Kingdom’s defence budget for 40 years, or buy 100 Barclays Banks — not branches, but the whole company 100 times over. With the midnight oil burning away, Mr Darling was desperate. He thought about blaming his predecessor, but not for long. He needed something devilishly clever before the pre-Budget report. If too much debt and too much spending were the problem, what could possibly be the answer? What? Just then, the door opened and in marched a deranged adviser. “Boss,” she said, “I’ve got it. If the problem is too much debt and too much spending, the answer is obvious… loads more debt and a new surge of spending. “We’ll tell the Bank of England to slash interest rates, enabling over-stretched borrowers to take on extra credit. We’ll force commercial banks — it’s ok, we own them — to crank up lending, even though they have already maxed out. “And — get this, it’s genius — you will cut VAT by 2•5 per cent. Shoppers won’t be able to resist cheaper prices and they’ll spend, spend, spend. Job done.”

And so it came to pass. A reduction in value-added tax was slotted in as a new cornerstone of the crumbling edifice that is New Labour’s fiscal credibility. Just when central bankers are saying that deflation — falling prices — is the gravest threat to our system’s stability, Mr Darling cooks up a scheme to make them fall further. While he’s alive, voodoo economics will never die. Setting aside the desirability of encouraging consumption over saving, Oxford University’s Centre for Business Taxation reckons that the move will fail because the cut will not be fully passed on in lower prices (retailers round up awkward numbers), hard-pressed consumers will save the tax cut rather than spend more, and it will largely by-pass less well-off shoppers who spend a higher part of their income on zero-rated goods, such as food and children’s clothes.

Stephen Haddrill, director-general of the Association of British Insurers, says: “After a decade of promoting consumption, the Government is unable to break the habit. The crisis is built on debt and credit, but the Government has still failed to recognise the importance of savings and tackle the country’s savings crisis. This [PBR] is a badly missed opportunity.” In 1997, Britain’s savings ratio (the slice of income tucked away) was 9•6 per cent. Last year, it had fallen to 2•5 per cent. And in the first half of this year, the ratio turned negative: we spent more than we earned. Thus the average household’s debt-to-income ratio has reached 155 per cent. This is the end of the road. From here, there has to be retrenchment. No amount of jiggery pokery can defy forever the force of financial gravity.

For the retail sector, New Labour’s decade of irresponsibility was a wonderful dream. While consumers were speeding down the road to ruin, many shopkeepers believed they had found the keys to a magic kingdom. They looked in the mirror and liked what they saw. The public’s high tide of instant gratification floated quite a few boats that were not remotely seaworthy. Now, with the waters having receded, commercial rust-buckets are sinking. This week, we lost Woolworths and MFI, the kitchen company. I’m amazed they lasted so long. In June, I visited a Woolworths store at London’s Elephant & Castle and was shocked by empty shelves and shabby decor. It felt like an outlet for losers. Unfortunately that includes the staff, up to 30,000 of whom are going to be searching for new jobs after Christmas.

As for MFI, a company that has lurched from crisis to crisis, the less said the better. These were weak operators with outdated business models whose demise forms part of a healthy high street evolution. Elsewhere, however, there is growing evidence that consumers are — not before time — waking up to the fact that if they want celebrity lifestyles, it’s advisable to have an income to match. Many are throwing in the towel, cancelling all but essential expenditure. Yesterday, DSG (formerly Dixons) issued downbeat results and a gloomy forecast. Kingfisher (owner of B&Q) said that trading was becoming tougher.

There will, of course, be a last-minute rush to the shops for seasonal treats; there always is, even in the darkest of times. But this year’s will be restrained. Falling house prices and rising unemployment, once just topics for discussion by commentators, are now harsh realities across Britain. Interest-rate cuts that were meant to boost confidence have not been passed on in full. And the availability of unsecured credit (plastic) is shrivelling. Everywhere, it seems, the debt boom is over. Everywhere except in the Government. For, just as the rest of us are learning through bitter experience to live within our means, the Prime Minister and Chancellor, are letting rip. Self-imposed rules on spending that were designed to prevent madhouse management have been flushed away in the water closets of Downing Street.

Over the next few years, astonishing sums of taxpayers’ money will follow. Budget deficits are no longer measured in tens of billions, but hundreds. The Chancellor claims it is to head off recession, but we know different. This is what Gordon Brown has always wanted. Having finally got rid of Tony Whatisname, the Prime Minister is dumping any pretence of New Labour discipline. He’s heading back to the future like a man possessed. Don’t talk to him about saving: the Government is on course for £1 trillion of debt by 2012. The Clunking Fist has grabbed the levers of power and will not let go until he’s thrown out of office.

Euro membership now impossible until at least 2014
If there's one thing to be said for the atrocious public finance figures in the pre-Budget report it is that at least they will prevent us from joining the euro. There had been talk in recent weeks about Britain finally embracing the single currency, as sterling slumped to new lows against other world currencies and the plight of the UK economy took a general turn for the worse. Leaving aside the wisdom (or to be precise the utter lack thereof) in such a suggestion, following the PBR I doubt the euro members would even have us anymore.

Two of the strictures of euro membership are that a member country's budget deficit should not exceed 3pc of gross domestic product and that national debt should be below 60pc of GDP. The UK had been comfortably below these levels for most of the past few years, give or take the occasional budget deficit just above 3pc. However, under the new figures presented by the Treasury yesterday, we will remain ineligible for entry all the way through to 2014 or later.

They show that, after leaping to an unprecedented 8pc of GDP next year our annual budget deficit will remain well above 3pc all the way through to 2013/14, while the UK's total government indebtedness will smash through the European-recommended ceiling, rising from 43.2pc to 68.5pc by 2013/14 (this is calculated on a Maastricht basis which measures gross government debt).

According to Stephen Lewis of Monument Securities: "With UK public finances running along current lines, it is doubtful whether present euro zone members would relish the prospect of UK inclusion in the zone. The danger that the UK would wreck the euro as it came so near to wrecking the [European Exchange Rate Mechanism] in 1992 would probably outweigh the political attractions of such an arrangement."

Can the US do an IMF on itself?
In previous years and decades whenever a third world country would get into financial difficulty it would turn to the IMF for a bailout. Because of the way the global financial system was structured in the post-Bretton Woods era (World Bank, IMF, WTO, etc.), the US was always in the forefront of such efforts. The bailout examples are numerous and well known: Latin America, Mexico, Asia, Russia. By and large the process worked pretty well, based on the premise that in an interconnected world if your neighbor's house is on fire you don't haggle about the garden hose.

Let's explore this fire simile a bit further. Picture the US as the Global Fire Department (GFD). In the last ten years or so the GFD became extremely irresponsible. It ignored the fire safety of its own firehouse, which became choked with highly flammable material (i.e. debt and derivatives), and relaxed the rules about the health and fitness of its firemen (i.e. oversight and regulation were weakened).

Seeing this, the good citizens in the neighborhood (i.e. other western nations) also adopted the same attitude. And why not? If the fire department itself didn't care about all that dead wood and turpentine piling up in its own back yard, why should they? A whole raft of nations from the UK and Australia, to Bulgaria, Poland, Iceland and Romania bought the same highly flammable "growth" model. Borrow - spend - inflate assets - borrow.

It was only a matter of time until a fire started somewhere. Unfortunately, it started in the worst possible place: the GFD firehouse itself. Predictably, the unfit firemen could not contain it and the fire quickly spread to the rest of the town. So, who's going to put it out now and how? The current plan is to take all that dry firewood and turpentine and stow it someplace else: to replace and guarantee private debt, plus issue additional government debt. But with the entire town now threatened by the blaze, that's just a delaying tactic. What we need is less wood and less turpentine, plus more, better and smarter firemen. And even that's not enough. The entire town should get together to fight this fire before it scorches everything in its path.

Previous IMF bailouts transferred some of the risk from, say, Mexico or Argentina to the IMF (essentially, the US) by providing fresh loans and guarantees. By current standards, the sums involved were tiny: $20-50 billion.

But the US cannot perform a similar IMF bailout on itself, as it is currently attempting to do. The United States IS the IMF. Astronomical guarantees and bad-asset purchases merely transfer and spread out the problem internally, instead of solving it. There is simply way too much debt; too much dead wood, too much turpentine and, naturally, no one else wants it in his back yard. Just think of China, Japan, the Gulf States or Russia and how much US debt they have already piled up. How much more "firehouse debt" are they willing to accept, particularly when the flames are already licking their own houses?

What we need right now is water: a.k.a. debt liquidation. And the longer we fail to recognise this simple fact, the longer we fail to provide it, the worst it's going to get later on.President-elect Obama is currently hiring firemen, his economic policy team; and it doesn't look good. They are the exact same bunch that let the firehouse get full of tinder in the past, if they didn't necessarily also strike the match. I sincerely hope they can teach new tricks to old dogs - but does Larry (Summers) look trainable to you? Woof.

Final thought (and Happy Thanksgiving to all): Turkeys destined to become roasters think they live in gobble heaven, right up to the point they turn into Butterballs. We got to change the way we look at things folks, and the past isn't necessarily the best guide to the future.

Lehman’s Neuberger Division Sale May Be Scuttled By S&P Drop
Lehman Brothers Holdings Inc. may not get to close a $2.15 billion sale of its investment- management business to Bain Capital LLC and Hellman & Friedman LLC as a result of a provision tying the deal’s completion to the value of the Standard & Poor’s 500 Index. The purchase by Bain and Hellman of the division, which includes the Neuberger Berman unit, is conditioned on an S&P 500 average closing price of more than 902 for the 10 trading days before the sale closes. The average for the last 10 days has been about 844, after the index reached its 52-week intraday low of 741.02 on Nov. 21. When the parties signed the deal Oct. 3, the S&P closed at 1099.23.

“The buyer gets the comfort of knowing that a certain market decline does create an out on the deal that is clean,” said Owen Pell, a commercial and securities litigation lawyer at White & Case, about tying the deal to the market. He isn’t involved in the Lehman transaction. By setting a floor for the S&P 500’s value as a closing condition, rather than relying on the material adverse event clause in the agreement, the buyers may avoid potentially difficult and expensive litigation, Pell said. The buyers may also choose to waive the condition. Carlyle Group, the second-largest private-equity firm, said in court papers that Bain and Hellman may get Lehman’s investment management business for as little as $900 million.

Another bidder may top the Bain-Hellman offer by Dec. 1, spurring a court-supervised auction Dec. 3. Carlyle has said it is interested in bidding on the Lehman business and is working with former Neuberger executive Jeffrey Lane. Sales of assets in bankruptcy are often subject to higher offers. Bain Capital spokesman Alex Stanton and Hellman spokesman Pen Pendleton declined to comment. Carlyle lawyer Philip Mindlin of Wachtell Lipton Rosen & Katz didn’t return a call for comment.

A hearing before U.S. Bankruptcy Judge James Peck in New York to approve a sale to the winning bidder is set for Dec. 22. The deal may close shortly thereafter. A worst case scenario for Lehman would be if there were no other bids, the S&P 500 wouldn’t reach the closing average required in the Bain and Hellman offer and the private equity firms would choose not to waive the condition and walk away.

Lehman was the fourth-largest investment bank before it filed the biggest bankruptcy in history Sept. 15 with $613 billion in debt. Peck approved New York-based Lehman’s plan to auction its investment management business in October. His approval came only after the bank reduced the breakup fee and expense reimbursement to be paid to Bain and Hellman if they are outbid, making it easier for rivals to submit bids.

The breakup fee was cut to $52.5 million from $70 million. The lead bidders must now document any expenses they seek to have reimbursed. Previously, the bidders were allowed as much as $35 million for expenses without itemizing them, according to court filings. Competing bidders may submit offers that exceed that of Bain and Hellman by only $25 million, rather than the $50 million overbid originally proposed. The modified rules don’t prohibit joint bids and management buyouts.

Lehman bought Neuberger Berman in 2003 for $3.2 billion to expand its wealth-management business and later consolidated its asset-management operations into a single division. Bain and Hellman agreed Sept. 29 to buy most of the asset- management business from bankrupt Lehman for $2.15 billion, minus $400 million for executive bonuses. Peck said he was hopeful the looser rules would encourage other bidders, though he added, “this transaction appears to be a private sale masquerading as a public one.” The case is In re Lehman Brothers Holdings Inc., 08-13555, U.S. Bankruptcy Court, Southern District of New York (Manhattan).

U.S. Stocks Post Biggest Weekly Gain Since 1974 as Banks Rally
U.S. stocks staged the biggest weekly rally in more than 30 years after the government agreed to protect Citigroup Inc. from more losses and automakers weighed cutting costs to win federal aid. Citigroup doubled on the government’s plan to insure $306 billion in toxic assets owned by the bank, helping push financial companies in the Standard & Poor’s 500 Index to a record 31 percent advance. General Motors Corp. soared 71 percent as the company considered selling some U.S. brands. Ford Motor Co. jumped 88 percent.

The S&P 500 rose 12 percent to 896.24, the steepest weekly gain since 1974. The Dow Jones Industrial Average increased 782.62 points, or 9.7 percent, to 8,829.04. The Russell 2000 Index of small-cap stocks climbed 16 percent to 473.14. “It’s refreshing to see some rationality returning to stock prices,” said Richard Weiss, chief investment officer at City National Bank in Beverly Hills, California. “The central banks and central finance authorities are doing exactly what’s needed at this point.” Stocks advanced after the Federal Reserve stepped up efforts to unfreeze credit markets and President-elect Barack Obama picked a team of financial and economic advisers, including former Federal Reserve Chairman Paul Volcker. U.S. exchanges were closed on Nov. 27 for the Thanksgiving holiday.

The gains ended a three-week slump in the S&P 500 spurred by concern the U.S. auto industry may collapse and profit reports that showed the recession intensifying. The stock benchmark is down 39 percent this year, the worst performance since 1931. Citigroup, the second-biggest U.S. bank by assets, rose 120 percent to $8.29. A 60 percent plunge in the company’s stock price the previous week pushed regulators to stabilize the bank by injecting $20 billion and agreeing to cover losses related to its troubled assets. The government gets preferred shares and warrants equivalent to a 4.5 percent stake.

Financials in the S&P 500 climbed the past five trading sessions, the longest stretch of gains since October 2007. This week’s advance was the steepest since S&P created the industry group 19 years ago. JPMorgan Chase & Co., Bank of America Corp. and Goldman Sachs Group Inc. surged more than 39 percent each.

“People are looking for any reason to hope and that’s why this has all the markings of a relief rally,” said Daniel McMahon, director of equity trading at Raymond James & Associates Inc. in New York. “I don’t know how sustainable it is.” The VIX, as the Chicago Board Options Exchange Volatility Index is known, tumbled 24 percent to 55.28. The index measures the cost of using options as insurance against declines in the S&P 500.

GM had the biggest gain in at least 28 years, rallying $2.18 to $5.24. The largest U.S. automaker is considering shedding its Saturn, Saab and Pontiac brands, according to people familiar with the matter. Ford increased $1.26 to $2.69. “We envision the current Congress will authorize a short- term bridge loan that carries” GM, Ford and Chrysler LLC to the start of President-elect Obama’s administration in January, JPMorgan analyst Himanshu Patel wrote in a note dated Nov. 25.

Homebuilders in the S&P 500 jumped 59 percent on a new central bank plan to revive mortgage lending. The Fed pledged to buy $600 billion in debt issued or backed by government- chartered housing finance companies and said it would start a $200 billion program to support consumer and small-business loans. D.R. Horton Inc., the largest U.S. homebuilder, rose 58 percent to $6.87 even after cutting its dividend and reporting a sixth straight quarterly loss.

Car companies and homebuilders helped lead the S&P 500 Consumer Discretionary Index to a 17 percent advance, the steepest in the history of the group. Apple Inc. climbed 12 percent to $92.67, the most in two years. JPMorgan analysts boosted the company’s fiscal 2009 profit estimate and said sales growth for notebook computers is accelerating. Just 17 stocks in the S&P 500 fell this week. Campbell Soup Co. posted the biggest loss, dropping 12 percent to $32.05. The world’s largest soupmaker reported sales that trailed analysts’ average estimate by 2.6 percent, according to Bloomberg data.

Employers probably slashed more jobs and manufacturing may have contracted at the fastest pace in a quarter century as the recession worsened, economists said before reports next week. Sears Holdings Corp., Big Lots Inc. and Staples Inc. are among the S&P 500 companies scheduled to report earnings next week.

Stoneleigh: At the end of this essay, Bonner quotes Nassim Taleb expressing the opinion that market blow ups are inevitable, but unpredictable, and too rare to be modeled or predicted statistically. To this I would say that perhaps Mr Taleb hasn't been looking at the right models. Mechanistic models will fail for the reason that Bonner points out here - the market doesn't operate on mechanistic principles. The efficient market hypothesis is simply bunk. There are, however, models based on the human herding behaviour that are far more successful because they do reflect real market drivers. This credit crunch is not a Black Swan event. It did not come out of nowhere, and should not have been a surprise to anyone who had been watching the development of the largest credit boom in history. Credit booms always deflate.

Inevitable and disgraceful, but still unpredictable
Who’s to blame for the worldwide financial meltdown, a crisis that has so far wiped out a notional $30 trillion dollars...give or take a trillion or so? “Lax central bankers...reckless investment bankers...the hubristic quants,” says Niall Ferguson, writing in Vanity Fair. “Regulate them,” is the universal cry. “Tax them,” say the politicians. “Hang them,” say investors.

First, let us look at the charges:
They skinned millions of investors – with their outrageous bonuses, spreads, fees, incentive shares, performance charges, salaries, and “profits” – leaving the financial industry severely under-capitalized...and unprotected. Guilty as charged. They ginned up “securities” that no one really understood and sold them to unsuspecting investors, including widows, orphans, colleges, pension funds and municipal governments. Uh...guilty again. They put the whole financial world in a spin – churning positions back and forth between each other in order to collect commissions...leveraging...flipping...stripping assets...securitizing...derivatizing...making wild bets based on flim flam mathematics.... No point in going on about it...guilty.

Yes, the financial hotshots did all these things. And more. They sold the world on ‘finance,’ rather than making and selling things. Then, it was off to the races. Everybody wanted to bet. Perfecta, place bets, odds-on...double or nothing. Of course, investors would have been better off at the race track. The track takes about 20%. In the financial races, Wall Street took 50% to 80% of all the profits.

Before 1987, only about one of every 10 dollars of corporate profits made its way to the financial industry – in payment for arranging financing, banking and other services. By the end of the bubble years, the cost of ‘finance’ had grown to more than 3 out of every 10 dollars. Total profits in the United States reached about $6 trillion last year; about $2 trillion was Wall Street’s share. What happened to this money? Other industries use profits to build factors and create jobs. But the financial industry paid it out in salaries and bonuses – as much as $10 trillion during the whole Bubble Period. And now that the sector finds itself a few trillion short, it waits for the government to open its purse.

But Wall Street’s critics have missed the point. Yes, the financial industry exaggerates. But so does the whole financial world. Both coming and going. It’s madness on the way up; madness on the way down. Investors pay too much for “finance” when the going is good. And then, when the going isn’t so good, they regret it. This regret doesn’t mean the system is in need of repair; instead, it means it is working.

The financial industry was just doing what it always does – separating fools from their money. What was extraordinary about the Bubble Years was that there were so many of them. There is always smart money in a marketplace...and dumb money. But in 2007 there were trillions of dollars so retarded they practically cried out for court-ordered sterilization. What other kind of money would pay Alan Fishman $19 million for 3 weeks work helping Washington Mutual go bust?

Whence cometh this dumb money? And here we find more worthy villains. For here we find the theoreticians, the ideologues...and the regulators, themselves, who now offer to save capitalism from itself. Here is where we find the bogus statistics, the claptrap theories and the swindle science. Here is where we find the former head of the Princeton economics department, too, Ben Bernanke... and both Hank Paulson and his replacement, Tim Geithner. Here, we find the intellectuals and the regulators – notably, the SEC – who told the world that the playing field was level...when everyone could see that it was an uphill slog for the private investor.

“Six Nobel prizes were handed out to people whose work was nothing but BS,” says Nassim Taleb, author of The Black Swan. “They convinced the financial world that it had nothing to fear.” All the BS followed from two frauds. First, that economic man had a brain but not a heart. He was supposed to always act logically and never emotionally. But there’s the rub, right there; they had the wrong guy. The second was that you could predict the future simply by looking at the recent past. If the geniuses had looked back to the fall of Rome, they would have seen property prices in decline for the next 1000 years. If they had looked back 700 or even 100 years...they would have seen wars, plagues, famines, bankruptcies, hyperinflation, crashes, and depressions galore. Instead, they looked back only a few years and found nothing not to like.

If they had just looked back 10 years, says Taleb, they would have seen that their “value at risk” models didn’t work. The math was put to the test in the LongTerm Capital Management crisis...and failed. Their models went sour faster than milk. Things they said wouldn’t happen in a trillion years actually happened while Bill Clinton was in still in office.

In the real world, Taleb explains, things are stable for a long time. Then, they blow up. Then, all the theories and regulators prove worthless. These blow ups are inevitable, but unpredictable...and too rare to be modeled or predicted statistically. “And they are almost always much worse than you expect.”

Yen Advances Fourth Month Against Euro as Carry Trades Unwind
The yen gained for a fourth straight month against the euro, the longest wining streak since 1999, as the deepening global economic slump prompted investors to sell high-yielding assets and pay back loans made in Japan. The euro weakened against the dollar for a fifth month as investors added to bets the European Central Bank will cut interest rates next week after inflation in the region slowed by the most since at least 1991. Russia’s ruble declined against the dollar to the weakest level since March 2006 as the central bank let the currency depreciate and raised interest rates to halt an exodus of foreign capital.

“The yen is still our favorite currency,” said Derek Halpenny, head of global currency research at Bank of Tokyo- Mitsubishi Ltd. in London in an interview on Bloomberg Television. “The interest-rate differential argument is still very, very powerful for the Japanese yen as yields around the world continue to plunge. Past performance tells you that the Japanese yen is going to be the currency that outperforms.”

The yen gained 3.4 percent to 121.22 per euro, from 125.30 at the end of October. The currency advanced 3.1 percent this month to 95.52 per dollar, from 98.46. The euro dropped 0.3 percent to $1.2691, from $1.2726 on Oct. 31. The ruble slumped as low as 27.99 per dollar yesterday, the weakest since March 2006, as the 63 percent drop in crude oil prices from a July peak erodes the country’s export revenue. The currency declined 3 percent against the dollar and the euro this month.

Bank Rossii widened the ruble’s trading band yesterday for the second time this week by about 30 kopeks (1 U.S. cent), or 1 percent, on each side, according to Mikhail Galkin, head of fixed income and credit research at MDM Bank in Moscow. The central bank said yesterday it will raise its benchmark refinancing rate to 13 percent from 12 percent to help stem currency losses.

India’s rupee fell yesterday the most in two weeks, losing 1.4 percent to 50.1075 per dollar, after terrorist attacks across Mumbai left at least 124 people dead. The rupee lost 1.3 percent this month. The Thai baht dropped to 35.56 per dollar yesterday, the lowest level since February 2007, after the government declared a state of emergency at airports in Bangkok, which were seized and shut by anti-government protesters this week. It lost 1.2 percent this month on concern political unrest will slow growth in Southeast Asia’s second-largest economy.

Japan’s currency strengthened 9.4 percent against the New Zealand dollar this month, 7.8 percent versus the British pound, and 5 percent against the Australian dollar as investors pared carry trades in which they buy higher-yielding assets with funds borrowed in low-interest-rate countries. The Bank of Japan’s 0.3 percent benchmark rate is the lowest among developed nations.

The Reserve Bank of Australia will lower its main interest rate three quarters of a percentage point to 4.5 percent on Dec. 1, and the New Zealand central bank will cut its key borrowing costs to 5 percent from 6.5 percent two days later, according to the median forecast of economists surveyed by Bloomberg News. The Bank of England will reduce its benchmark lending rate one- percentage point to 2 percent on Dec. 4, according to a separate forecast.

The euro fell 1.5 percent to 82.52 pence yesterday, the biggest drop since June 3, 2001, after the European Union statistics office in Luxembourg said inflation in the region slowed to 2.1 percent in November from 3.2 percent in October. A separate report showed unemployment in the region rose to 7.7 percent in October from 7.6 percent in September, the highest level since January 2007.

Investors added to bets the ECB will cut its main refinancing rate about 75 basis points by March from 3.25 percent. The implied yield on three-month Euribor futures contracts expiring in March fell to 2.67 percent yesterday, from 3.15 percent at the end of October. The yield averaged 16 basis points above the ECB’s benchmark over the past year.

The ECB will cut its benchmark lending rate by half a percentage point to 2.75 percent on Dec. 4, according to the median of 56 economist forecasts in a Bloomberg News survey. “The ECB has to come to the party, and they have to be aggressive cutting rates,” said Lane Newman, a director of currency trading at ING Financial Markets LLC in New York. “To buy the dollar is the path of least resistance. You’d better be prepared for a worse-than-expected time ahead.”

The ICE’s Dollar Index, which tracks the greenback against the euro, the yen, the pound, the Canadian dollar, the Swiss franc and Sweden’s krona, climbed to 88.463 on Nov. 21, the highest since April 2006. Investors sought refuge in Treasuries from a global recession, sending the yield on two-year notes below 1 percent on Nov. 20, the lowest since regular sales began in 1975.

The Federal Reserve said on Nov. 25 it will assign $800 billion in new funding to bolster credit flows to homebuyers, consumers and small businesses and will take on credit risk by buying debt. Investors should buy the euro versus the greenback because repatriation of U.S. investments abroad and demand for dollar funding is waning, according to Bank of America Corp.

The Fed’s support of financial markets will flood the economy with excessive dollars, creating “additional downside risks” for the U.S. currency, strategists David Powell and Robert Sinche wrote in a research note yesterday. “The recent advance of the dollar rests on a weak foundation,” Powell and Sinche wrote. “The rapid expansion of a country’s monetary base should prove to be inconsistent with a strengthening of its currency.” The dollar may weaken to $1.4180 per euro, a 50 percent retracement of its rally from a record low of $1.6038 in July to a 2 1/2-year high of $1.233 in October, they wrote.

Clock ticks for sovereign debt markets
The recent rally in government bonds globally may be nearing its eleventh hour after a historic flight to safer assets pushed yields down to their lowest since World War II. But the moment the proverbial clock will strike midnight is the multi-trillion dollar question for bond investors.

A massive tide of bond issues that the United States and other major governments are making to finance the rescue of the global banking system and to fund economic stimulus packages will ultimately overwhelm these markets, sending yields spiking up as swelling supply cheapens prices, bond analysts worry. "The iron law of fiscal expansion means government issuance cannot be revised down. The bonds will be sold, the question is (at) what price,'' said Meyrick Chapman, rates strategist with UBS in London.

Timing is everything for fund managers still betting government debt yields can go lower, or for those temporarily hiding out in those markets and waiting for treacherous selloffs in corporate debt and stocks to abate. Once the credit crisis eases, allowing lending to flow more smoothly among banks and corporate debt markets and the downtrodden global economy shows signs of bottoming out, then investors could desert government debt in their droves, triggering a vicious sell-off.

"Somewhere along the line, and I am not smart enough to tell you when, some of this massive amount of money will start moving back into other types of instruments,'' said Leonard Santow, managing director of economic and financial consulting firm Griggs & Santow in New York and a former financial economist at the Dallas Federal Reserve. "Come on: three basis points on Treasury bills,'' said Santow. "If that's the way things are forever, we have real problems, so somewhere here, whether it's three months or six months away, those rates will start to be more normal. That will obviously push rates up along the curve to something half-way reasonable,'' he said.

While the US three-month Treasury bill rate has fallen to near zero, as panicked investors flee equity markets for the shelter of ultra short-dated government instruments, the benchmark 10-year US Treasury note yield slipped this week just below 2.99%, the lowest in five decades. But a year from now the 10-year note's yield will have jumped to between 4.25% and 4.75%t, Santow estimates.

"A very strong case can be made that Treasury rates will have to go up,'' as issuance inundates the pool of $US4.9 trillion ($7.5 trillion) Treasury securities outstanding, Santow says. He expects between $US1.75 trillion and $US2 trillion of US government debt supply in the remainder of the fiscal year through September 2009, with between $US600 billion and $US700 billion in Treasury bills; the rest in notes and bonds. In the euro zone, sovereign debt issuance is likely to run to at least 700 billion euros ($1.37 trillion) in 2009. In the UK, the Debt Management Office plans to increase sales of Gilts to a record 146 billion pounds ($338 billion) in the current financial year.

Ironically the eventual trigger for a sovereign debt selloff that would plunge major govermments and corporate borrowers deeper into debt may be signs that today's bailouts costing trillions of dollars are starting to succeed in refloating the global economy. But for now, government bailouts are still swimming against the economic tide. In what may prove to be the most severe global downturn since the Great Depression, hefty investment flows are unlikely to shift out of government debt and into corporate bonds anytime soon.

For now, rising US government supply "can be absorbed fairly well,'' said Derrick Wulf, portfolio manager at Dwight Asset Management in Burlington, Vermont. The danger of corporate debt "crowding out'' Treasuries will be limited, Wulf says. Yet he is starting to hedge against the risk that Treasury prices could drop once the economy starts to show signs of life. "You buy risk assets. Now it's as good a time as any. Some of them are providing equity-like returns,'' Wulf said, although he is buying corporate bonds cautiously, he said.

Though deflationary pressures are now taking hold across the world as commodity prices fall, bond market analysts do worry that the dramatic expansion of debt issuance may later rekindle inflation; anathema for bonds. Excessive borrowing by the private sector expanded the debt pool of mortgage and corporate paper so much that these bubbles burst dramatically, causing the worst credit crisis in a generation. Now governments could be making the same mistake of borrowing too much, analysts worry.

"There is (also) an irony that the reason we got into this mess is ostensibly due to lax lending,'' says Chapman. "Now governments everywhere are doing their best to be as lax as possible in their lending,'' he said. That destabilising scenario for government bonds could be a distant prospect, some fund managers reckon. "Until we arrest the decline in prices or deflation, it (inflation) is not a huge concern,'' said Wulf "Inflation concerns may come in 2009,'' he said, but added that it may take five years from now for yields to move a lot higher.

Once US note and bond yields do start to jump however, the move could be swift, warns Santow. "That of course will substantially add to the interest on the public debt and it's a real problem if you are trying to get the economy to recover,'' Santow said. The US 10-year Treasury note's yield is a critical consideration, since this benchmark largely determines the rates at which 30-year fixed rate mortgages, a key driver of demand in the beleaguered housing market, are set.

Growth won't pay the bills in Florida
For the dozen state economists huddled around a table this month to fine-tune Florida's annual revenue forecast, something was different and disturbing. Their projections from just a year ago were way off. Their new math: In the next four years, the state will take in $31.4-billion less in taxes than expected. That's more than six times the Pinellas and Hillsborough county budgets combined, the cost of more than 60 waterfront stadiums for the Tampa Bay Rays, and almost half this year's state budget.

The freefall in revenues the economists saw Nov. 21 was not as shocking as what caused it: Fewer newcomers were moving to the state for the first time in decades. The state's legendary growth machine had ground to a halt, compounding the troubles brought on by the global recession. For years, governors and legislators relied on population growth to create jobs, avoid raising taxes and shield the state from recession. They saw Florida's population swell annually by 2 to 3 percent, enough to add a city the size of Miami or Tampa each year. By marketing itself as a low-tax, low-cost retirement haven, Florida literally bet its future on growth.

Every few years, an event would expose weaknesses in Florida's economic system: a recession in 1991, school overcrowding crisis in 1997, a steep drop in tourism after the terrorist attacks of Sept. 11, 2001. But the growth machine always roared back to life until now. With the mortgage crisis, credit crunch and flat-lining of population, the twin industries that buffered Florida through two previous recessions, real estate and construction, are weighing down Florida's economy, complicating a recovery and making it likely Florida will be among the last to bounce back.

"This recession is not only going to be bad for us. It's going to be worse than the nation's," said David Denslow, a University of Florida economist. The primary reason: Florida's residential construction boom grew at twice its normal rate and "we got overbuilt." The backlog of unsold homes nationwide coupled with the credit crisis makes it almost impossible for Florida to lure people from other states when they can't sell their homes, he said. At the same time, cuts in property taxes and a deepening state budget shortfall squeeze basic public services, making the state less appealing to retirees. State economists this month predicted the recession will linger throughout 2009 with a gradual return to very slow growth in employment and population in 2010. The pessimism of the revenue experts, however, stands in stark contrast to the optimism of Gov. Charlie Crist, who said, after economists completed their latest forecast: ''Florida will probably come out of it first. I mean, the sun always comes up in Florida first."

How quickly did Florida's once-bright economy turn gloomy? The state led the nation in job growth in 2005 and now leads the nation in job losses. After five years of double-digit increases in housing starts and price increases, it's now second in the nation in foreclosure filings, with 444,000 homeowners in default, according to industry researcher RealtyTrac. Florida had the lowest unemployment rate in June 2006. Now it has the ninth highest. And in the most important indicator of a productive economy, gross domestic product, Florida led the nation in 2005 and now ranks 47th.

"We are in trouble," Chief Financial Officer Alex Sink, who pays the state's bills, said earlier this month. "We're writing checks like crazy and the money isn't coming in." During a single week in November, she said, the state took in a half-billion dollars in tax revenue and wrote checks totaling $1.3-billion, a recipe for fiscal disaster. "We can't rely any more on attracting fixed-income retirees from up north and selling them cheap land," Sink said. "Those days are over.Hopefully, this is a wake-up call for the state of Florida," said Frank Nero, president of the Beacon Council, Miami-Dade's economic development organization. "We can no longer be dependent on population growth as the base of our economy."

Nero predicted that regions of Florida with more diversified economies, such as South and Central Florida, will rebound faster than those that don't, like Southwest Florida, where Lee County has the highest housing foreclosure rate in the country. Just as the state's growth-based economy now seems lopsided, Florida's revenue model also looks wildly out of sync with the times. The state clings to a decades-old dependence on a sales tax applied only to goods like cars, furniture and appliances. Left untaxed are Internet sales and such items as bottled water and charter fishing boat excursions. The idea of a state income tax remains taboo, both in the state Constitution and in the psyche of most Floridians. "It's obvious that if we don't find new sources of revenue, the existing revenue sources are going to have to go higher," said John Ramil, chief operating officer of TECO Energy and president of the Greater Tampa Chamber of Commerce Committee of 100.

Nowhere are the ups and downs in Florida's economic roller­coaster more apparent than in Port St. Lucie, a city of 166,000 whose motto is "A City for All Ages." In January 2002, while most of Florida was still reeling from the recession brought on by the 9/11 attacks, Port St. Lucie was bustling. Jobs increased 4 percent. Wages were up 11 percent. Home construction soared.

Then-Mayor Bob Minsky's biggest worry was traffic, and the head of the city's Economic Development Council held a presentation for local developers titled: "What recession?" The New York Times called it the "fastest growing economy'' in the fastest growing state. Fueled by low home prices that lured people up the coast from heavily congested, high-cost South Florida, the city's population had soared by 133 percent by 2007. Fast-forward to 2008: New construction is down 70 percent, unemployment is at 10 percent and one in every 113 homes is in foreclosure.

Now, no region of the state has escaped the downturn. By the time the national recession hit this fall, Florida was already a year into it. The construction industry felt it first, with 79,000 jobs lost. By October, unemployment had reached every sector, and 156,200 Floridians had lost their jobs in a year. A once-robust housing market has a record inventory of 300,000 unsold homes, six times the normal average of 50,000.

The credit crisis has spread from home mortgages to delinquencies on car loans and credit cards, said Amy Baker, the state's chief economist and director of the Legislature's office of Economic and Demographic Research. Until the excess inventory goes away, Baker said, "we're looking at probably 15 months before things improve." But they will, she said. "This may be our life for the next 18 months to two years, but after that, things will return. We will have population growth and all the things that made Florida attractive to the baby boomers before are still going to be here."

For some, things will get worse before they get better. About 410,000 homeowners are vulnerable to the worsening economy and being able to keep their homes, Baker said. For years, Florida had a home ownership rate of 66 percent, close to the national average, but during the housing boom, that rate increased to 72 percent and those new homeowners are most at risk.

The economic meltdown is only part of the problem. Unemployment in Florida is at a 15-year high. The "brain drain'' of college professors accelerates as state money for universities has evaporated, university officials complain. The state pension fund has lost one-third of its value. And for the third year in a row, the state will take in less tax revenue this year than the year before.

For the past year, the official response from Crist and the Legislature to the economic crisis has been to cut spending, borrow from cash reserves, hold back 4 percent of state agencies' budgets and take largely cosmetic steps such as accelerating the construction timetable for roads. Crist said he's open to a special session in January, so that legislators can make deeper budget cuts. But he has said he wants to shield public schools and health care from more reductions, which make up the bulk of the budget. Crist's agency heads warn that more cuts will mean layoffs of state workers, which would drive the jobless rate higher.

Secretary of Corrections Walt McNeil said he has ordered spending reductions such as an end to travel and training, but fears additional spending cuts. "The only way we can achieve that is to let people go. We will have to lay people off," McNeil said. Some short-term budget fixes have emerged, but many of them produce too little money or lack widespread support from the Republican majority that controls both houses of the Legislature.

They include selling or leasing to private investors such assets as the Florida Lottery, Florida's Turnpike or Alligator Alley; hiring more auditors to aggressively chase tax cheats; raising fines and fees for state services, as the Legislature did for the court system last spring; raising the cigarette tax by up to $1 a pack, which would generate about $1-billion a year; expanding gambling and validating the compact with the Seminole Tribe, which would generate more than $100-million a year; and extending the sales tax to Internet sales, which would produce an estimated $3-billion a year.

None of those represent any structural change in the Florida tax system, which some economists say is needed to avoid future cyclical downturns made worse by recessions. "The weaknesses reveal themselves under stress," said Sean Snaith, an economist with the University of Central Florida's Institute of Economic Competitiveness. "Hopefully that will underscore the need for some real tax reform to find a stable, equitable way to fund the things we agree on."

But in the Republican-led Legislature, little support exists for a review or overhaul of the tax system, which is typically framed by critics as a back-door way of increasing taxes. Last spring, a far-reaching proposal to eliminate property taxes for schools and replace the revenue by expanding the sales tax and repealing tax exemptions never reached voters because the Florida Supreme Court ruled that it was misleading.

As the economy worsens, demand for government help goes up. For example, complaints to the state child-abuse hot line are up by 1,000 a month so far this year compared to last year. Florida State University President T.K. Wetherell, a former House speaker and community college president, sees a state unwilling to face its challenges. He sees his university as the "training ground'' for young professors who leave for better-paying jobs elsewhere. "You can't be a world class state and use the tax system that we have," Wetherell said. "This system is not going to produce the resources that we need to run one of the largest states in the nation and provide the services that people want. You can't keep putting Band-Aids on it."

Saudi Arabia wants oil price at $75 a barrel
Saudi Arabia said Saturday that it hoped to raise oil prices to $75 a barrel, but indicated that no measures would probably be taken until an OPEC meeting next month in Algeria. Saudi Oil Minister Ali Naimi said that OPEC will "do what needs to be done" to shore up falling oil prices when the cartel meets next month in Algeria, even as his king told a Kuwaiti newspaper that $75 a barrel was a fair price for oil.

Naimi did not entirely rule out the chance that the Organization of Petroleum Exporting Countries would slash output at the hastily convened meeting Saturday, but he did say the bloc needed to wait until the meeting in Oran, Algeria on Dec. 17 to assess the impact of two previous rounds of cuts. His comments came after Saudi King Abdullah told the Kuwaiti daily Al-Seyassah that oil should be priced at $75 a barrel, far above its current rate.

"We believe the fair price for oil is $75 a barrel," he said, without elaborating on how this would be achieved. Whereas crude stood at about $147 a barrel in mid-July, it now hovers about $90 lower. On Friday, the U.S. benchmark West Texas Intermediate crude for January delivery was trading at about $54 per barrel. The king was echoed by Qatar's Oil Minister Abdullah Bin Hamad al-Attiya, who told the Arab news channel Al-Arabiya just before the opening of the meeting of the Organization of Arab Petroleum Exporting Countries Saturday that prices needed to rise to guarantee investment into the oil sector.

"The price between 70 to 80 (dollars a barrel) is the one encouraging in investment and developing new or current oil fields. It falls below 70, the investment would freeze, which will lead to a crisis in supply in the future." The representatives of the OPEC face their third test in as many months to engineer a rebound in prices hammered by plummeting crude demand amid a global economic meltdown.

The cartel has already held one emergency meeting -- on Oct. 24 in Vienna -- to try to halt the slide in prices with an announcement of a 1.5 million barrel per day drop. It failed to support prices, and the cartel hastily convened the Cairo gathering on Saturday on the sidelines of the OAPEC meeting. Kuwait's oil minister Mohammed al-Aleem said Friday he believes there was "no need" for OPEC to take a decision in Cairo on cutting output. But he warned the market is oversupplied, and didn't rule out the need for OPEC to cut production further.

"We believe a decision could be taken ... but I think it will happen in Algeria," he said. Al-Aleem said current prices could undercut investment in future projects and were not good for either producers or consumers. The recent price drop has left price hawks Venezuela and Iran clamoring for further reductions of at least 1 million barrels a day. Both countries need crude of about $90 per barrel to meet current spending needs aimed in part at propping up domestically unpopular regimes.

Other OPEC members, such as Nigeria and Ecuador, face budget problems too, making them reluctant to implement more cuts that might shrink revenues further. Unlike many of their fellow members, the Saudis are better positioned to cope with the drop in prices. The International Monetary Fund estimates Riyadh needs crude in the range of about $50 per barrel for 2008 fiscal accounts to break even.

Also unclear, after two earlier cuts failed to push prices higher, is what the group can do without prolonging the global economic downturn. OPEC itself, along with the International Energy Agency, has significantly revised down its projections for demand growth in 2009. Meanwhile, global crude inventories are growing, as evidenced by a U.S. government report showing a surprisingly large 7 million barrel build in stocks last week in the world's largest energy consumer.

OPEC's last round of cuts would put its total production at about 30.5 million barrels per day, according to the IEA. That is about 500,000 barrels per day higher than the forecast call on OPEC crude in much of 2009. Those factors argue against restraint if some in OPEC want crude back up to at least $70. A Nov. 24 research report by the New York-based Oppenheimer & Co. in New York said that for oil to rebound to $65 a barrel, OPEC would need to cut crude production by more than 3 million barrels per day from its September levels -- a move it called highly unlikely.

Canada: No further stimulus in the works
Canada already has a “stimulus package” in the form of tax cuts, Finance Minister Jim Flaherty said Friday, and anything more far-reaching will not be forthcoming unless the economy declines further. In a speech to the Economic Club of Toronto, Mr. Flaherty said he considers the tax cuts already planned for 2009 sufficient to meet promises the Prime Minister made at the recent meeting of G20 leaders.

Canada committed to stimulus equal to 2 per cent of our gross domestic product, and the $31-billion in tax cuts to take effect next year are exactly that value, he said. Still, he said after his speech, “if we need to do more, because of the deteriorating economic circumstances, we will do more.” He didn't offer specifics, except to say that more infrastructure spending might be one way to pump even more money into the economy.

Tax reductions for next year include an increase in the income threshold below which individuals won't pay any income tax, the implementation of the Tax Free Savings Account, and reductions in corporate income tax. Mr. Flaherty insisted that Canada is actually doing more than Britain or the United States, which have introduced, or have planned, sharp stimulus packages.

“When you contrast [Canada's stimulus] with the United Kingdom and the United States, you will see that both of those countries are trying to catch up with what Canada has already done in terms of stimulus,” Mr. Flaherty said. “Even [U.S.] president-elect Obama's plan for January would only be 1.1 per cent or 1.2 per cent of GDP, and it would be temporary.”

Canada's permanent tax cuts, some of which are already in place, are one reason our economy has outperformed other major industrial countries, Mr. Flaherty said. Temporary stimulus packages are far less effective and only give a brief boost to the economy, he added. Some economists, however, questioned the value of counting on existing – or already announced – tax cuts to give a boost to the economy. Moves such as the GST reductions “have already given their boost to the economy,” said Douglas Porter, deputy chief economist at BMO Nesbitt Burns Inc.

Some of the coming changes, such as the corporate income tax cuts, “are very welcome,” Mr. Porter said, “but I doubt they're really going to encourage too many businesses to go out on a capital spending spree in the kind of environment we're in.” More visible stimulus would give the economy a better kick, he said. While Mr. Porter said he would normally agree with Ottawa's go-slow approach, as it takes time to design a stimulus package properly, “these are not normal times.” Mr. Porter's colleague at BMO, economist Michael Gregory, said in a report Friday that “stimulus delayed is still stimulus denied during these uncertain economic times.”

Australian Government, States Agree on Spending Plan
Australian Prime Minister Kevin Rudd said the federal government and the states agreed to a A$15.1 billion ($9.9 billion) spending package that will create jobs as the country confronts the global financial crisis. The plan, chiefly targeting health and education, will generate work for 133,000 people, Rudd said in Canberra. Forecast budget surpluses will fund new spending to start this fiscal year and extend over the following four years. “This A$15.1 billion addition to the states will create jobs and stimulate the economy,” Rudd told reporters in Canberra today after meeting with eight state and territory leaders. “It will drive a reform agenda in health, education, as well as housing and businesses deregulation.”

Today’s meeting was part of annual talks on national government funding for the states, including allocations from the 10 percent tax on goods and services. The package adds to A$332 billion of funding for the states forecast for this and the next three financial years. The government on Oct. 14 announced A$10.4 billion in grants to pensioners, families and first-home buyers as the global financial crisis freezes credit. Rudd increased health funding by A$5.55 billion to A$64.4 billion over five years and added A$1.4 billion to an education package worth a total of A$42.4 billion. He also bolstered funds to build properties for the homeless.

The spending programs, which have an average timespan of four to five years, won’t push the government into deficit, and would allow it to maintain “a modest surplus,” Rudd said. “Projecting surpluses four years out is pretty heroic, particularly in current economic times, and we hope to see the government’s accounts in good shape,” said Craig James, a senior economist at Commonwealth Bank of Australia in Sydney. “Still, Australia needs to invest in infrastructure and be ahead of the curve on spending to boost the economy.”

Treasurer Wayne Swan on Nov. 5 slashed the forecast budget surplus by 75 percent, citing the slowest economic growth in eight years. Rudd said Nov. 26 the government may allow its budget to go into deficit for the first time in seven years if the global economic slowdown worsens. Reserve Bank Governor Glenn Stevens said Nov. 19 he would be comfortable if state and federal governments increased public spending, “even if that involves some prudent borrowing.”

Australia would join other developed nations forecasting budget deficits in 2009. The U.S. government shortfall may top $1 trillion next year and spending in the U.K. will swell the budget deficit to 118 billion pounds ($181 billion) in the year starting April 2009. Australia’s budget was last in deficit in the year ending June 30, 2002. The budget was in deficit for eight years of Labor’s last term in office between 1983 and 1996.

The Reserve Bank of Australia this month reduced its 2008 economic growth forecast to 1.5 percent from 2 percent. The central bank has slashed its benchmark interest rate 2 percentage points since September to 5.25 percent. Australia’s leading economic index fell in September, signaling the nation may slip into a recession, ending 17 straight years of economic expansion, Westpac Banking Corp. and the Melbourne Institute said on Nov. 19. “This investment will deliver a significant stimulus to the Australian economy in the face of the global financial crisis,” Rudd said. “2009 is going to be a tough year.”

Australian business confidence plunged in October to a record low, consumers were pessimistic in November for a 10th straight month and house prices dropped in the third quarter by the most since 1978. “These are important steps towards better outcomes in health, education, business regulation and other fields,” Business Council of Australia Chief Executive Katie Lahey said in an e-mailed statement. “This commitment to reforms that build the productive capacity of the economy can provide a timely boost to business confidence.”

Economy boost for Spain and Italy
Italy approved an 80bn euro ($102bn;£66bn) emergency package that included tax breaks for poorer families, public works projects and mortgage relief. Spain unveiled an 11bn euro plan aimed at creating 300,000 jobs. The announcements are the latest in a series of attempts by EU governments to shore up their economies as the financial crisis bites.

Italian Prime Minister Silvio Berlusconi called on to Italians to keep on spending. "We have helped citizens, the less well off, so that they can continue to consume," he said. "The intensity and duration of the crisis depends on all of us."

Spain's Prime Minister, Jose Luis Rodriguez Zapatero, said the money will be mainly invested in infrastructure and public works. Spain's unemployment reached 12.8% in October - the highest in the eurozone. The Spanish government said it would invest 0.8bn euros in the ailing car industry, which has been through a severe downturn and seen sales plummet 54.6% since the beginning of the year. The construction industry has also been severely hit by the financial crisis, with property prices falling and companies slashing thousands of jobs.

The Spanish economy shrank by 0.2% in the third quarter, putting an end to 15 years of continuous growth. The European Commission has demanded that each EU member must spend about 1.2% of Gross Domestic Product (GDP), or economic output, to fight the economic slowdown. Spain's plan is worth 1.1% of its GDP. Germany launched a similar 50bn euro package, while next week France is expected to unveil economic measures worth 20bn euros.

How Much Are You Down For in the Obligatory Spending Spree?
What does it take to get you in the holiday spirit? How about $7.4 trillion ($7,400,000,000,000) in giving? If that won't do it, then I just don't know what will. Oh, wait -- that's right, the person doing the giving is you. Sorry about that. I'm giving too. I feel your pain. On the long-shot chance you haven't heard about how deeply the government has gotten into the bailout business, $7.4 trillion is the answer to the question, "How deeply?"

So, you can forget about the $700 billion bailout. It's old news -- mostly old, anyway. The weekend announcement of the $306 billion Citigroup bailout did remind me of a certain comment less than two weeks ago. On November 13, Treasury Secretary Paulson did an interview on NPR's All Things Considered radio broadcast. He was asked about the $700 billion bailout, specifically if he could "tell Americans who are listening something [positive] that should have affected their lives by now?" Here was Paulson's reply:

"I believe the banking system has been stabilized. No one is asking themselves anymore is there some major institution that might fail and that we would not be able to do anything about it. So I think that is a positive." Is it unfair to contrast Paulson's words with events that move at a pace he can't control? Perhaps. Then again, I'd be more inclined toward "fairness" if he conducted himself as Secretary of the Treasury, instead of Deus Optimus Maximus of the Federal Piggy Bank.

Anyway, back to the $7.4 trillion: people are starting to do the math, and that is the figure Bloomberg News published today. The article spelled out their analysis in arriving at that amount, I don't think it's overstated. Bloomberg has been virtually alone among the major media in objecting to the Treasury's secrecy regarding the bailout, secrecy their article noted as well:

"When Congress approved the TARP on Oct. 3, Fed Chairman Ben S. Bernanke and Treasury Secretary Henry Paulson acknowledged the need for transparency and oversight. Now... regulators commit far more money while refusing to disclose loan recipients or reveal the collateral they are taking in return." In case you're wondering how much the Treasury has put you down for in their obligatory spending spree, "the money that’s been pledged is equivalent to $24,000 for every man, woman and child in the country."

Insanity - Over And Over Again
Here we go again. Bernanke and pals have over the last two days rolled out some $1.3 trillion in new so-called "facilities", including buying agencies and consumer debt. While there are many screaming about the agency purchases, this is permitted under The Federal Reserve Act (actually an amendment passed in the 1960s, although it has never before been used.)

But consumer credit obligations are a different matter. They are both unsecured and not federal instrumentalities at their source, and there is absolutely no authority for Bernanke to do this. Loan against them, yes. Buy them? No.

Obviously, the smashing of the TNX along with agency spreads came of this; gee, is this a surprise? But how does this help the banks? Remember, banks borrow short and lend long. They ain't doing any lending with that sort of spread. Of course we already knew that, right? So what is this? It's a raw attempt to support house prices - an attempt that will (just as have the others) fail.

I come back to first principles - the root of the problem is that banks and others made loans to people who could not pay. That is, on balance there is too much debt in the system overall, and the quality of it is too poor. It might be nice to think you can "unring" this bell, but you can't. Nor can you solve anything by shifting who has or is guaranteeing the debt. All that does is change who eats the default - it does not change the fact of the default, nor the credit quality.

The unfortunate second-order effect of all this bad credit is that it pumped consumption - that is, GDP - by about 15-20% from where it would have been without it. That is, the majority of the GDP increase over the years from 2003-2007 was due to the granting of bad credit, not organic growth in wages and productivity. Now we can deny this for as long as we'd like, but until we face this truth we will not solve the problems that ail this economy. Sustainable growth will not return, jobs will not "come home" and productivity will not mount a sustainable increase.

Attempting to drive down the cost of money (credit) to "restart" lending is a fool's errand. That simply extends more bad credit into the economy which of course puts on the table even more defaults over time. Down this rathole lies Japan's experience of the 1990s, and ours to come - or worse. You can only drive asset prices in a sustainable fashion by driving up real wages through productivity and new technologies. If you do it through protectionism you get the 1930s. If you instead depress wages through illegal immigration economic "growth" reverses unless you start making unsound loans, which is exactly what we did in the 2000-2007 timeframe. The latter always blows up in your face, and once it does, you can't reverse it.

I am happy that Volker is on Obama's economic team. I am not happy with the idea that we're going to play FDR, because any dispassionate analysis of the "New Deal" infrastructure and "make work" programs shows that they were quite counterproductive to economic recovery (never mind the other things FDR did like burning farmer's fields and shooting their livestock to "boost prices"!) Paulson needs to be fired and Bernanke sacked - or he needs to resign. Today. These "promises" have no more ability to be kept than do promises that everyone can have free unlimited health care from 65 years of age onward.

Paulson and Bernanke are effectively writing checks that President Obama is going to have to cash. I suspect he is going to find that this will get extraordinarily difficult some time in 2009, and when it does, that's when the real trouble will come. Just as President Clinton discovered that he's not really the "guy in the charge", so will President Obama - one way or another. Enjoy this bounce in the market and if you're trapped long use it to raise cash, and for God's sake, don't do anything stupid shopping over the holidays.

Making a list, keeping it short
Tammy Trinneer let her children know early on that Santa may not be bringing as many goodies this Christmas. "We just told them to find something they really wanted from Santa and, if they get that, then they should be happy, and if they get anything beyond that, they should be really excited," the Hackettstown woman said Friday at the Toys "R" Us at the Rockaway Townsquare mall, where shoppers were searching for Black Friday deals.

"We're not spending as much," Trinneer said, while holding a store flier, adding that she gave her four kids a sales circular from the toy store ahead of time and asked them to zero in on something they really liked. Trinneer's story was similar to that of many other shoppers. The down economy is forcing them to be more specific in their shopping. "Everybody's spending a little bit less," said Jessica Bonano of Rockaway. "I find that I'm a little bit more price conscious with the sales. ... I'm out after Thanksgiving, which I don't normally do."

Bonano's approach to finding toys for her children mirrored Trinneer's. She told them to "try to keep their lists to what they really, really want, as opposed to making a list just for the sake of making it." Scott and Marcy Kight of Stanhope also were toy shopping, and said their jobs -- Scott's a college professor, Marcy is a social worker -- seem more secure than other struggling sectors. "I don't think it's affected us much is because we're in jobs that are pretty much resilient to what's happening," Scott Kight said. Although they felt confident in their job security, they said they still know that others are hurting and are paying attention to prices.

Jason Carabetta, of Pittstown, Pa., who grew up in Lake Hopatcong, said he's cutting back on spending on his three children. "I think you limit it to the things that are at the top of their lists," he said. Kay Crane of Hackettstown went shopping early Friday at the mall with her two adult daughters, Susan Wells of Maryland and Laura Reed of Hackettstown. Crane specifically pointed out saving 60 percent on a $1,200 piece of jewelry at JC Penney, in addition to an extra 15 percent, driving the final cost below $400. "I think the things we're looking for, we're finding," Crane said. "They're still on the shelves."

Wells also said she was price-watching and spoke to her children about how they might not be getting as much this Christmas because Santa was donating toys to children who wouldn't otherwise get them. One thing that was available this Christmas season that was practically nonexistent a year ago was the Nintendo Wii. GameStop had them in stock for $249; however, a Wii-related accessory, the Wii Fit -- a platform that allows a user to stand on it and perform yoga exercises, among other moves -- was sold out. "Wii Fit is by far the most popular thing that we have, and it sold out," GameStop clerk Annie Vogel said, adding that the store had 40 when it opened Friday morning and they were gone before 11 a.m.

Toys "R" Us was packed Friday morning, with almost every parking space filled. The main mall, too, was crowded, but seemed to have fewer people bustling about. Some customers said they were pleased with some of the sales while others said they were unimpressed. "I don't think they're that great this year; I'm kind of surprised," said Vilma Sosa, of Orlando, Fla., who was shopping with her daughter from Morristown. "I'm a shopper; I shop all year so I know prices," Sosa said. "This is basically what I pay normally."

Nirmala Jyoti of Rockaway Township said she found very good deals at Express and Macy's. "I had to do the winter shopping for the kids," she said. "I'm done." Art Woods of Lodi said he and his wife probably weren't going to spend as much this holiday season. He said he was curious about how people -- mindful of the credit crisis on Wall Street -- were paying for the goods, whether they were using cash or credit cards. "Basically, I think it's affected all of us," he said of the economic downturn. Woods is part owner of a business and elected to lower his salary rather than lay off workers. He said he took a second job to make up for the cut. Woods said he was pleased with the selection the mall had to offer. He said he pays in cash and also tries to use store coupons on top of the sales offered by stores.

UK Retailers ‘Going to the Wall’ as Recession Bites: Chart of Day
Store failures may accelerate after Woolworths Group Plc and MFI Retail Ltd. went into administration, reeling from the worst slump in European retail sales in at least five years. “The outlook is very negative, particularly in the U.K., where consumers are more indebted,” said Suzanne Cassidy, a London-based analyst at debt research firm CreditSights Inc. “I wouldn’t be surprised to see more retailers going to the wall, particularly the smaller, more levered players in areas where spending is discretionary.”

The Chart of the Day shows the rising cost of insuring debt sold by retailers against default. A five-year credit-default swap on DSG International Plc, the U.K.’s largest consumer- electronics retailer, has surged to 2.85 million euros ($3.7 million) upfront and 500,000 euros a year, according to CMA Datavision. At the end of September the contracts cost 420,000 euros a year with no advance payment.

Contracts on PPR SA, the Paris-based retailer that owns Gucci Group NV, have soared to 618 basis points from 286 in September. LVMH Moet Hennessy Louis Vuitton SA, the maker of Dior watches and Krug champagne, is also suffering, with credit- default swaps linked to the Paris-based company’s debt tripling to 190 basis points in the past two months.

Contracts on Dusseldorf, Germany-based Metro AG, the world’s fourth-largest retailer, which were at 91 basis points on Sept. 30, are now at 338. A basis point on a credit-default swap protecting 10 million euros of debt from default for five years is equivalent to 1,000 euros a year. Credit-default swaps, contracts conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a country or company fail to adhere to its debt agreements.

Retail Sales to Suffer in 2009 as U.S. Consumers Curtail Spending
Retail experts are predicting one of the most dismal holiday shopping seasons in decades this year – a crucial stretch that will set the stage for poor retail sales throughout 2009. As the U.S. economy decelerates, pummeled by the aftershocks of the worldwide financial crisis, consumers have been hit from every direction: Unemployment has spiked, and will continue to rise, economy unwinds and continues to work through the aftershocks of the global credit crisis, consumers have been beset on all sides. Unemployment is up, home prices are down, and credit is hard to come by.

And although inflation is beginning to moderate somewhat – slowing to a pace of 3.7% year-over-year in October – it’s still well above the U.S. Federal Reserve’s desired target rate of 2.0%. With rampant inflation no longer artificially propping up consumer spending figures, retail sales have really started to lose their luster. Sales figures are based on the value of goods sold – not the volume – so the recent decline commodity and energy prices will translate into a sharp decline in retail sales.

That decline will be dreadfully apparent in this year’s holiday sales, but it will also carry into 2009. The question, now, is how much worse consumer behavior will get. "The great unknown is just how much lower can consumer spending go?" Piper Jaffray Cos. (PJC) analyst Jeff Klinefelter told Reuters. "With savings rates at historic lows and constraints on the availability of consumer credit, I just think there’s concern that the perfect storm is brewing." According to the Fed, a recession is already under way in the United States. Gross domestic product (GDP) shrank 0.5% in the third quarter, and the Fed predicts the economy will continue to contract in the first six months of 2009, and possibly beyond.

Tighter credit standards and lower home prices mean consumers have less of an ability to finance their purchases through debt. And even those with cash to spend are opting to save instead, as the economic outlook continues to dim. Would-be consumers are also scrambling to rebuild savings that were decimated by a bear market that has dragged the Standard & Poor’s 500 Index down more than 40% this year.

"We expect to see consumer spending to be flat before inflation," Gus Faucher, chief U.S. economist with Moody’s (MCO), told the Los Angles Times. That means once inflation is factored in, consumer spending will see a sharp decline in 2009, and retail sales will be left to twist in the wind. According to a recent retail outlook report from Fitch Ratings Inc., personal consumption expenditures are projected to decline 1.6% in 2009. A wave of consolidation and bankruptcies will spread through the retail sector as weaker chains fail and stronger brands shut down underperforming stores. Department stores and specialty stores will be hit especially hard, as consumers cut back on discretionary purchases in favor of staples.

Bankruptcies of stores such as Sharper Image Corp. (OTC: SHRPQ) and Circuit City Stores Inc. (OTC: CCTYQ) are having a negative effect on the sale of gift cards, which stores traditionally have counted on to boost sales after the holiday season. Gift card purchases are tallied when the card is redeemed, not when the card is purchased. In the past, the sale of gift cards have given New Year sales a healthy boost as gift card recipients go shopping after the holidays are over.

But consumers are wary of getting left holding onto worthless cards while bankruptcy courts decide how to divvy up assets. For the 2007 holiday season, 70% of consumers purchased gift cards. This holiday season, just 40% of consumers are projected to go the gift card route. And that’s going to weigh down sales and profits for the 2009 first quarter. "I think you will see a six-point drop in sales for those first three months," C. Britt Beemer, chief executive officer of America’s Research Group and author of “The Customer Rules,” told CRM Magazine.

While the big chains are struggling and grabbing the bulk of the headlines, small business owners are barely getting by. That might not seem like a big deal if the stock market is your focus, but small-businesses are integral to the economy. According to the Small Business Administration, businesses with less than 500 employees account for almost half of private-sector employment. A recent National Federation of Independent Business survey showed 15% of small business owners anticipate layoffs in 2009, which will put even more strain on an already weak U.S. labor market.

And small business layoffs mean slower sales for big box stores like Best Buy Co. Inc. (BBY) and Target Corp. (TGT) as another wave of unemployed workers grapple with lost income. Online retailers are starting to feel the pinch, too. Web sales have been one of the fastest growing retail sectors for years, but popular sites such as Inc., the No. 1 online shoe retailer, and QVC Inc., which sells online and on television, have each announced layoffs, as well as declining sales. Inc. the top online retailer, also is struggling. Amazon’s stock is down 55% year-to-date, and the outlook is grim. “[Amazon is] seeing a slowdown in their business that shouldn’t really shock anybody,” Jeffrey Matthews, a general partner at hedge fund Ram Partners LP in Greenwich, Conn., told Bloomberg. “They sell books. They sell movies. They sell blenders. They don’t sell magic potions or the fountain of youth.”

There are a few retailers that – while they don’t sell magic potions or the fountain of youth – have managed to position themselves as offering more value for the money, which has allowed them to buck this downward spiral in consumer spending have managed to buck dismal consumer spending. And that focus on value will continue in 2009.

The best example of this value exception is the world’s largest retailer: Wal-Mart Stores Inc. "This is Wal-Mart time," Chief Executive Officer H. Lee Scott Jr. told Wall Street analysts during an Oct. 27 presentation at company headquarters in Bentonville, Ark., BusinessWeek reported. "This is the kind of environment that Sam Walton built this company for." The economic slump has found Wal-Mart returning to the basic strategies that the late founder made famous. The retail titan has given up on the brand-name designer strategy of competitors such as Target and Kohl’s Corp. (KSS) to offer rock-bottom prices on hundreds of consumer staples.

That bodes well, as consumers will continue to stretch household budgets and consolidate trips to save on gas. “It is a great time to be Wal-Mart,” Howard Davidowitz, chairman of Davidowitz & Associates, told Bloomberg News. “It sells everything you need cheap.” Stores like Wal-Mart, that can capitalize on this new value-seeking behavior will be able to turn a profit even in this bleak retail environment. And those that can’t, will be bought out or disappear.

London Luxury-Home Values Slide for Eighth Month in November
Luxury-home values in central London, the world’s most expensive location for prime real estate after Monaco, fell for an eighth month in November as fewer sellers held out over prices. The estimated average value of a house or apartment in the city’s nine most expensive neighborhoods fell 3.6 percent from October, according to an index compiled by Knight Frank LLP. It was the second-largest drop since the index started in 1976. Property values declined 14 percent from a year earlier, the broker said today. The index covers homes mostly valued at more than 1 million pounds ($1.54 million).

“The last few months have seen vendors gradually accepting that prices need to be cut if a sale is to be achieved,” said Liam Bailey, Knight Frank’s head of residential research. “Further price falls are to come.” Prime central London real estate has taken longer to register declines seen elsewhere in London because of a standoff between sellers and buyers over price. That ended in September, when the bankruptcy of Lehman Brothers Holdings Inc. caused demand to collapse from those employed in financial services, traditionally the mainstay of demand for expensive homes.

The worst banking crisis since World War I has translated into job cuts and reduced bonuses. October’s 3.9 percent monthly decline in the index set a record. Citigroup Inc., Credit Suisse Group AG, Deutsche Bank AG and the failed investment bank Lehman Brothers are among the companies shedding staff. Job vacancies in London financial services fell 48 percent in October from a year earlier, recruitment firm Morgan McKinley said earlier this month.

As many as 62,000 finance-related jobs may be lost in London by the end of next year, according to the Centre for Economics & Business Research. Least affected by the slide in values are properties worth more than 5 million pounds, which dropped 1.9 percent in value from October, Knight Frank said. Their depreciation, coupled with the British pound’s 23 percent slide against the dollar this year, may attract wealthy overseas buyers. “Many prime properties are unique and only occasionally come up for sale,” Bailey said. For a buyer with dollars, a 15 percent property valuation drop equates to a 35 percent slide when exchange rates are taken into consideration, he said.

London and southeastern England accounted for more than three quarters of sales of million-pound homes last year, according to an index compiled from government data by HBOS Plc. Million-pound homes represented 0.6 percent of the 1.38 million U.K. property transactions last year. Knight Frank compiles its monthly index from appraised values of properties in the Mayfair, St John’s Wood, Regent’s Park, Kensington, Notting Hill, Chelsea, Knightsbridge, Belgravia and the South Bank neighborhoods of London.

GM Pondering Brand Cuts
The Detroit Free Press reported today that General Motors, in its attempt to put forth a workable restructuring plan to keep it from going bankrupt, is at least looking at killing off three brands—Pontiac, Saab and Hummer. Everyone knows that GM is over-branded. The problem has long been that the company does not want to have to pay dealers to fold the brands it does not need as it did with Oldsmobile in 2001. State franchise laws prevent a car company from simply ending a brand. Closing down Oldsmobile cost the company around $2 billion.

It’s unclear how GM could avoid paying big money to shutter the three brands. Hummer has been on the selling block for months. The automaker has circulated a document to prospective buyers, which have ranged from Russian business moguls to Turkish private equity groups. Saab is not thought to have any hot buyers. According to past conversations with GM execs, Saab Cars has never turned an annual profit for GM. It has, at times, made money in Europe. But those gains have always been off-set by losses in the U.S. Saab is one of two Swedish car companies with limited interest from both consumers and investors. Ford, too, tried to sell Volvo earlier this year, and found no takers willing to pay Ford’s asking price.

Both Saab and Volvo have a problem of not being quite luxury. Both premium brands have long had followings of people who place safety above all other vehicle characteristics. Saab has also attracted some performance-oriented buyers as the company has long offered turbo chargers in some of its models. Volvo is on track to sell about 82,000 vehicles this year. Sales through October were down 28%. Saab is on track to sell about 20,000 vehicles this year. Sales were down 32% through October.
Earlier this year, GM CEO Rick Wagoner said GM did not have too many brands.

Pontiac has been starved of hot new products for two decades. The current lineup consists of the Vibe (a twin of the Toyota Matrix and engineered by Toyota, built at the joint-venture NUMMI plant in Calif.), the G6/G5, Pontiac Torrent (twin of the Chevy Equinox) and the G8 sedan. The G8 has been well received by auto journalists since its debut last year, but the large sedan category is so soft and sleepy that few have noticed. The Pontiac Solstice roadster convertible, while also well received by journalists, is such a niche product that it can’t hold up the whole brand. Pontiac sales are on track to sell around 280K to 290K vehicles this year. Sales through October were down 21%. A hefty percentage of Pontiac sales, though, are fleet sales to rental agencies.

At the core of GM’s problems is that it does not have, and has not had, enough resources to feed eight brands with unique products, and then the resources to feed each brand with unique and competitive brand campaigns. Every industry analyst and consultant has told GM management that for 20 years. It is one of the reasons that Pontiac, Buick and Saturn in particular have had a revolving door of brand campaigns—each new brand chief groping in the dark for a new big idea that will kick-start bigger interest in these product portfolios.

The contrast with Toyota and Honda is astonishing. Toyota manages a 14.9% market share (throughOctober) with just its one brand. Yes, it has added Scion and Lexus. But the Toyota brand is amazingly efficient by putting so many efficiently produced vehicles under its flagship brand. Ditto Honda, whish has a 9.8% share. Hummer, Pontiac and Saab together only manage a 2.5% share of the U.S. market, and I’m willing to bet at least .5 of that is rental fleet. Nah….GM doesn’t have too many brands.
A few years ago, ad agency Deutsch, which currently handles advertising for the Saturn brand, cooked up a brand positioning for Pontiac that focused on the gritty side of Detroit, and surrounded the brand with music reminiscent of Bruce Springsteen. The strategy was centered on performance, street rods and American car culture. But the decision was made that while the positioning was attractive, GM couldn’t fund a product program that would live up to the ads.

GM has been merging dealerships into a single network of GMC/Buick/Pontiac stores wherever it can. That way, each dealer can manage a single showroom of products that has depth and breadth of sports cars, sedans, SUVs and trucks. But that strategy also depends on supporting three different, attractive brand strategies. If GM can execute this plan, that would leave it with Chevy, Cadillac, Saturn, Buick and GMC. One of the arguments for keeping Buick is how well it sells in China. The Chinese are mad for the Buick brand. I’m not entirely sure, though, that GM would lose sales in China if it killed the brand in the U.S. Sure, some brands are global. But I’m thinking Buick would do just fine in China without U.S. sales.

Now, we are down to Chevy, Cadillac, Saturn and GMC. GMC sells well, and GM execs have long said there is now reason to kill it. There are a flock of consumers who go for the “Professional Grade” nonsense. GMC is, after, all just a slightly stepped of version of Chevy trucks and SUVs. There is much argument for killing Saturn, too, leaving GM to concentrate in the U.S. on Chevy and Cadillac as the company. Indeed, without the GMC/Buick/Pontiac sales channel, I don’t know how you would support GMC as a brand, unless you engineered a rapid consolidation of retail distribution perhaps selling GMC through Chevy or Cadillac dealerships.

But, as I said earlier, the big barrier is the state franchise laws, which give dealers a lot of legal firepower to get paid off if GM moves to shutter these brands. It seems like a reach that it would just close Hummer anyway as it still sees a market to sell the brand. GMC/Pontiac/Buick dealers would surely miss the sales volume from Pontiac. But is a GMC/Buick network really worth keeping long term? As GM faces its near-death experience, asking Congress for survival money, it has to make some moves that tell analysts and legislators that is doing the things to fix its operations that everybody in the room knows it has to do.

GM tries to block corporate jet tracking
General Motors has asked the US Federal Aviation Administration (FAA) not to allow tracking of its private jets. The call comes after the company's boss flew to Washington in a jet to ask for $25bn (£16.3bn;19.7bn euros) of public money to bail-out the US car industry. Chief executive Rick Wagoner was taken to task at a special Senate hearing and pilloried in the worldwide media for such extravagance and poor judgement.

"Couldn't you have downgraded to first class?" said Democrat Gary Ackerman. GM has subsequently returned two of its fleet - reportedly five strong - of private jets. The carmaker made the request to the FAA despite insisting this week that Mr Wagoner will not repeat the mistake when he returns to Washington for further discussions about the bail-out next week. "We availed ourselves of the same option as others have," said GM spokesman Greg Martin.

Rival carmakers Ford and Chrysler, whose chief executives also flew to Washington in separate jets, have kept a much lower profile since the hearing. All three companies are desperate for funds to help stave off potential bankruptcy. Sales have plummeted due to the credit crunch and the economic slowdown, and they are burning through billions of dollars in cash each month.

With little or no ability to raise capital in the private markets, they have been forced to go cap in hand to the government. GM has warned that it could run out of cash in a matter of weeks and cannot wait until President-elect Barack Obama - who has promised to help the industry - is sworn in in January.

The End
The changes were camouflage. They helped distract outsiders from the truly profane event: the growing misalignment of interests between the people who trafficked in financial risk and the wider culture.

I’d not seen Gutfreund since I quit Wall Street. I’d met him, nervously, a couple of times on the trading floor. A few months before I left, my bosses asked me to explain to Gutfreund what at the time seemed like exotic trades in derivatives I’d done with a European hedge fund. I tried. He claimed not to be smart enough to understand any of it, and I assumed that was how a Wall Street C.E.O. showed he was the boss, by rising above the details. There was no reason for him to remember any of these encounters, and he didn’t: When my book came out and became a public-relations nuisance to him, he told reporters we’d never met.

Over the years, I’d heard bits and pieces about Gutfreund. I knew that after he’d been forced to resign from Salomon Brothers he’d fallen on harder times. I heard later that a few years ago he’d sat on a panel about Wall Street at Columbia Business School. When his turn came to speak, he advised students to find something more meaningful to do with their lives. As he began to describe his career, he broke down and wept.

When I emailed him to invite him to lunch, he could not have been more polite or more gracious. That attitude persisted as he was escorted to the table, made chitchat with the owner, and ordered his food. He’d lost a half-step and was more deliberate in his movements, but otherwise he was completely recognizable. The same veneer of denatured courtliness masked the same animal need to see the world as it was, rather than as it should be.

We spent 20 minutes or so determining that our presence at the same lunch table was not going to cause the earth to explode. We discovered we had a mutual acquaintance in New Orleans. We agreed that the Wall Street C.E.O. had no real ability to keep track of the frantic innovation occurring inside his firm. (“I didn’t understand all the product lines, and they don’t either,” he said.) We agreed, further, that the chief of the Wall Street investment bank had little control over his subordinates. (“They’re buttering you up and then doing whatever the fuck they want to do.”) He thought the cause of the financial crisis was “simple. Greed on both sides—greed of investors and the greed of the bankers.” I thought it was more complicated. Greed on Wall Street was a given—almost an obligation. The problem was the system of incentives that channeled the greed.

But I didn’t argue with him. For just as you revert to being about nine years old when you visit your parents, you revert to total subordination when you are in the presence of your former C.E.O. John Gutfreund was still the King of Wall Street, and I was still a geek. He spoke in declarative statements; I spoke in questions.

But as he spoke, my eyes kept drifting to his hands. His alarmingly thick and meaty hands. They weren’t the hands of a soft Wall Street banker but of a boxer. I looked up. The boxer was smiling—though it was less a smile than a placeholder expression. And he was saying, very deliberately, “Your…fucking…book.”

I smiled back, though it wasn’t quite a smile. “Your fucking book destroyed my career, and it made yours,” he said. I didn’t think of it that way and said so, sort of.
“Why did you ask me to lunch?” he asked, though pleasantly. He was genuinely curious.

You can’t really tell someone that you asked him to lunch to let him know that you don’t think of him as evil. Nor can you tell him that you asked him to lunch because you thought that you could trace the biggest financial crisis in the history of the world back to a decision he had made. John Gutfreund did violence to the Wall Street social order—and got himself dubbed the King of Wall Street—when he turned Salomon Brothers from a private partnership into Wall Street’s first public corporation.

He ignored the outrage of Salomon’s retired partners. (“I was disgusted by his materialism,” William Salomon, the son of the firm’s founder, who had made Gutfreund C.E.O. only after he’d promised never to sell the firm, had told me.) He lifted a giant middle finger at the moral disapproval of his fellow Wall Street C.E.O.’s. And he seized the day. He and the other partners not only made a quick killing; they transferred the ultimate financial risk from themselves to their shareholders. It didn’t, in the end, make a great deal of sense for the shareholders. (A share of Salomon Brothers purchased when I arrived on the trading floor, in 1986, at a then market price of $42, would be worth 2.26 shares of Citigroup today—market value: $27.) But it made fantastic sense for the investment bankers.

From that moment, though, the Wall Street firm became a black box. The shareholders who financed the risks had no real understanding of what the risk takers were doing, and as the risk-taking grew ever more complex, their understanding diminished. The moment Salomon Brothers demonstrated the potential gains to be had by the investment bank as public corporation, the psychological foundations of Wall Street shifted from trust to blind faith.

No investment bank owned by its employees would have levered itself 35 to 1 or bought and held $50 billion in mezzanine C.D.O.’s. I doubt any partnership would have sought to game the rating agencies or leap into bed with loan sharks or even allow mezzanine C.D.O.’s to be sold to its customers. The hoped-for short-term gain would not have justified the long-term hit.

No partnership, for that matter, would have hired me or anyone remotely like me. Was there ever any correlation between the ability to get in and out of Princeton and a talent for taking financial risk?

Now I asked Gutfreund about his biggest decision. “Yes,” he said. “They—the heads of the other Wall Street firms—all said what an awful thing it was to go public and how could you do such a thing. But when the temptation arose, they all gave in to it.” He agreed that the main effect of turning a partnership into a corporation was to transfer the financial risk to the shareholders. “When things go wrong, it’s their problem,” he said—and obviously not theirs alone. When a Wall Street investment bank screwed up badly enough, its risks became the problem of the U.S. government. “It’s laissez-faire until you get in deep shit,” he said, with a half chuckle. He was out of the game.

It was now all someone else’s fault. He watched me curiously as I scribbled down his words. “What’s this for?” he asked. I told him I thought it might be worth revisiting the world I’d described in Liar’s Poker, now that it was finally dying. Maybe bring out a 20th-anniversary edition. “That’s nauseating,” he said.

Hard as it was for him to enjoy my company, it was harder for me not to enjoy his. He was still tough, as straight and blunt as a butcher. He’d helped create a monster, but he still had in him a lot of the old Wall Street, where people said things like “A man’s word is his bond.” On that Wall Street, people didn’t walk out of their firms and cause trouble for their former bosses by writing books about them. “No,” he said, “I think we can agree about this: Your fucking book destroyed my career, and it made yours.” With that, the former king of a former Wall Street lifted the plate that held his appetizer and asked sweetly, “Would you like a deviled egg?”

Until that moment, I hadn’t paid much attention to what he’d been eating. Now I saw he’d ordered the best thing in the house, this gorgeous frothy confection of an earlier age. Who ever dreamed up the deviled egg? Who knew that a simple egg could be made so complicated and yet so appealing? I reached over and took one. Something for nothing. It never loses its charm.


Anonymous said...

I can't help chuckling at the Amazon stock/sales drop article. So much for Insider's ability to predict something that was about as obvious as saying the sun will rise tomorrow: yes kids, in fact, when people have neither money nor credit, they don't spend money. That's a shocker.

So much for the ability to predict anything more complicated.

But Insider, don't worry, the people here will keep doing your thinking for you, just don't try to do anything on your own for the next few years, and make sure to keep taking credit for the work of others among your peers... and don't forget the tip jar on your way out, I'd say you owe these guys...

el gallinazo said...

I want first dibs on his size 18 shoes and red nose makeup.

Anonymous said...

Still not sure about investments, cash is king? I wonder about US treasuries, rates will go up next year and the value of bonds will drop. Of course if you buy individual bonds and hold them to the end probably ok. Will the US bonds get a BBB rating soon?

What about bond mutual funds? Probably a bad idea? Since one has less control over them than individual bonds...

Anonymous said...

Stoneleigh: "the excess claims are rapidly extinguished in a chaotic real wealth grab."

can you give some examples?

Anonymous said...

Stoneleigh, thanks for your thorough post and insightful articles/links. The article on Florida's economy is an eye-opener.


EBrown said...

I'm thinking about taking OC up on the proposal to write an article comparing and contrasting the current credit crisis with that of the Great Depression. Has anyone else started on such an endevour already? I don't want to step on toes or rehash work that is already done, and I agree with OC that it could be quite valuable to elucidate the similarities and differences...

I did read the piece in the debt rattle a few days ago that compared the crisis of 2007-20?? to the depression of the 1870s an d1880s, and I found it pretty compelling. The essay I imagine writing would be more academic (footnoted), but not peer reviewable. I will primarliy rely on internet sources because they are so readily accessible.

Anonymous said...

Stoneleigh: "When we see market rallies, in contrast, rallies in bond yields, commodities, and metals are also common, and the dollar experiences a pullback."

we've seen all of those recently except bond yields which have kept going down. why?

Anonymous said...

Florida was insightfull
Will deflation create a Haiti situation in Florida?
"... depression of the 1870s and1880s ..."
The financial center moved to the USA.
I assume that you would be able to demonstrate that the new financial center is in the process of moving to the far east.

el gallinazo said...

"we've seen all of those recently except bond yields which have kept going down. why?"

Maybe TAE readership is not the only group that knows we are in a suckers' rally. Shirtless people are still fleeing to apparent safety.

Anonymous said...

Stoneleigh, thank you for your posts and for keeping this site alive!

Deflation is scary stuff and would turn our economy and lives upside down. Mortage/salary ratio will increase rather than decrease over time, it will make more sense to save money rather than spending (and make no sense at all to issue credit), unemployment will rise (Philips curve) and so forth. The system is simply not designed for deflation and we were never thought how to live without it.

The thing is, should we not have stable deflation over the last 200 years or so? Especially since the industrial revolution production, transport and trading has become more and more efficient. Not to mention globalization/cheap labour overseas or the world wars that left the participating countries in great economical trouble. Wouldn't the big banks of the world that issue the debth benefit greatly from a low and stable deflation? (inflation decreases the value of their loans over time).

As I see it, by adding 1 and 1 we should have had deflation all the time, but yet we have had inflation. Is that not simply because money is a virtual tool for trading goods and services? A tool fully controllable (or at least it seemed until recently) by the governments and their money controlling organs?

Stoneleigh said...

For anyone who may be interested, and hasn't already read it, here's a link to an article I wrote in March 2007 which expands on the theme of why the financial centre is moving to the far east. It also ties in with the connection between empires and pyramid dynamics that I wrote about the other day. The article, from The Oil Drum:Canada archives, is called Entropy and Empire.

Stoneleigh said...


I would be very interested in seeing you write such an article. There are many instructive parallels between all such episodes. May I suggest using Galbraith's A Short History of Financial Euphoria as a reference? It really is short, so it would take very little time to peruse.

For those interested in a longer and more in depth version of the same history, Kindleberger's Manias, Panics and Crashes is the standard work, and MacKay's Extraordinary Public Delusions and the Madness of Crowds, first published in 1865, gives some good historical perspective.

el gallinazo said...

Anon 6:08

The way I understand it (Initially and primarily from the Money as Debt animation) is that the fractional reserve system does not create money to pay interest on lending - just the debt itself. So the interest money must be borrowed from the future, and this can only be done by increasing the credit/money supply. In a finite world, the fractional reserve system can only function in an inflationary environment. It flips and flops like a flayed flounder in a deflationary environment. Not only is there no money being created to pay the interest, put the credit/money supply is actually shrinking. Bankers do not favor debt destruction through default.

Stoneleigh said...

Anon @6:08,

There's no such thing as a stable deflation I'm afraid, as deflation is a positive feedback spiral of defaults, margin calls, increasingly distressed assets, more defaults, etc.

Once can have periods of gradually falling prices, for instance due to the effects of globalization, international wage arbitrage, and removing the middle men using the internet, but this is not deflation. Some call it disinflation, but I think that's a woolly term. Deflation is a contraction of the money supply, and that isn't something anyone would favour as losses can be very large over a short timeframe.

Stoneleigh said...

Anon @4:53,

The great crash of 1929 played out as a chaotic extinguishing of excess claims. There was a rush for the exits as everyone tried to cash out at once. The exchanges were overwhelmed and trades were unable to be processed. Traders were stuck on the sidelines not knowing how far their holdings had fallen and unable to do anything about it. Waves of margins calls ensued as falling prices left margins too large in comparison with the value of the holding, but that only forced further selling in order to meet those margin calls. This lowered prices further, resulting in another round of margin calls.

There were also bank runs, where depositors converged on banks perceived to be weak and demanded the return of their deposits. As banks can never repay depositors if they all turn up at once, thanks to our fractional reserve banking system, banks were forced to close their doors and depositors lost their savings.

Businesses and individuals were bankrupted due to huge losses and forced to default on their debts, which left creditors vulnerable to collapse themselves. The effect is analogous to a chain reaction, or a house of cards. From small beginnings, a cascade can develop, which is exactly what will play out (probably several times at least) over the next few years, with the bulk of the collapse over the next couple of years I would think.

Only a few can cash out (ie grab wealth) before the stampede, and as the stampede develops, excess claims are extinguished as their owners are unable to redeem them. The early movers take what there is available, and leave nothing for the rest, as there is very little real wealth available to be grabbed in comparison with the number of claims.

Margin calls are also a wealth grab, in this case from higher up the financial food chain. Powerful creditors can force those able to raise money by selling assets to hand over the proceeds of the sale, forcing prices down further in the process. Eventually, all manner of assets will be offered for sale at pennies on the dollar in order to meet margin calls, or merely in order to pay other debts and living expenses. For those (few) who still have money, it will be a time of plenty, but for the vast majority it will be the beginning of the road to destitution.

Stoneleigh said...


For the time being, bond yields are low due to a flight to safety. That should persist for quite a bit longer (with temporary trend reversals as markets rally), but eventually yields will shoot up as international debt financing becomes harder to find. At that point, the debt-junkie economy will have to go cold turkey by cutting entitlements drastically.

I would only own short-term bonds, where you don't have to worry about finding a buyer. You can decide to roll over your investment, or not, every three months, so you can get out easily if you need to. That's why they're a cash equivalent.

Stoneleigh said...

Anon @5:51,

Trend reversals don't all happen exactly in synch. The low bond yields we're seeing now should increase as the stock rally builds momentum. The recent lows should give way to lower lows once the market decline resumes though, some time in the new year.

Farmerod said...

I was going to write something today about el pollo being so hard on Garth in yesterday's comments (you know, like, Garth is doing some good, at least he understands the real estate situation fairly well, better than most financial advisors or politicians). Now I think I'd like to add to the insult. This is what GT wrote today on his blog in response to a letter recieved from a reader about whether to sell her mutual funds, among other things:

As for selling your mutual funds, are you on drugs? That is absolutely the worst thing you could do, as the markets have lost half their value and are surely closer to the bottom than the top. That means hang on, girl. While this week’s advance looks like a bear market rally, to be followed by some more disgusting drops, the stock market will anticipate a better economy six or eight months before it happens, and up to a year before real estate stabilizes. So, you will have lots of time to regain fund values, and still score on a house.

OMFG! Stoneleigh, pleeeeease talk to this man! I sensed that Garth was starting to get it but apparently I was wrong.

team10tim said...
This comment has been removed by the author.
Farmerod said...


You can send your essay/intro to the site email or to me at Galbraith's book is excellent; quick, informative and comically entertaining. Mackay's book ... well, it's 900 pages. In other words, it's one example of why Stoneleigh is waaaay smarter than me. The date stamp on the copy I just got was November 2008 (which is interesting in itself because the book was first published in 1841; is there a sudden demand for more copies of this tome?) but I was the third person in line waiting for it ... and I got it 2 weeks ago. All I'm saying is don't blow your brains out on this assignment... should you choose to accept it, which I hope you will. Kindleberger's book was also really good. Again, Berton's book was great but he refers to the US maybe twice. Canada handled the Depression, in his view, much worse than the US did but doesn't take much time writing why.

Stoneleigh said...

As OC says, Galbraith's book is the quick and entertaining version that would be worth reading if you want to write on this topic. The others are just for future reference if you, or anyone else, happen to be interested.

Anonymous said...

many thanks to Stoneleigh for the answers.

the anomaly in bond yields dropping while the equity market rally may have yet another explanation: the announced FED purchase of MBS papers may have a string attached -- the sellers must use the proceeds to purchase Treasuries. if this is confirmed, there could be a wide range of implications.

el gallinazo said...


That was the same Garth response (brought to this blog through an Anon - I don't read Garth) which inspired my admittedly vitriolic comment.

Stoneleigh said...

If I could access Garth's site I would add a comment, but access has been blocked by some spam-prevention mechanism that his webmaster says is very difficult to do anything about. When I click on a link to the site I get a message telling me to clean my computer of viruses and try again, but I have up to date virus protection and firewall, and repeated scans have said my system is clean. Maybe I'll try to access it via my BlackBerry, as that's on a different network. Typing on that tiny keyboard is a bit of a pain though.

Hey Mr Bill said...

"The End"
great and wonderful writing!
bill (washington, dc)

Farmerod said...

Stoneleigh: You can write the text on a different computer and then email it (or otherwise e-transfer it) to your BB. Truthfully, I think Garth needs a slap to start off with.

el pollo: Right. I've been doing a lot of skimming these days, what with the deluge of info that I now receive and process. I somehow missed the whole context of that exchange, which was all right there.

Anonymous said...

comment from Dr. G. Gono, chairman of the Reserve Bank
of Zimbabwe (no hoax):

"As Monetary Authorities, we have been humbled and have taken heart in
the realization that some leading Central Banks, including those in the
USA and the UK, are now not just talking of, but also actually
implementing flexible and pragmatic central bank support programmes
where these are deemed necessary in their National interests.
...That is precisely the path that we began over 4 years ago in pursuit
of our national interest and we have not wavered on that critical path
despite the untold misunderstanding, vilification, and demonization
we have endured from across the political divide.
...Here in Zimbabwe we had our near-bank failures a few years ago and
we responded by providing the affected Banks with the Troubled Bank
Fund (TBF) for which we were heavily criticized even by some multilateral
institutions who today are silent when the Central Banks of UK
and USA are going the same way and doing the same thing under very
similar circumstances thereby continuing the unfortunate hypocrisy that
what's good for goose is not good for the gander.
...As Monetary Authorities, we commend those of our peers, the world
over, who have now seen the light on the need for the adoption of flexible
and practical interventions and support to key sectors of the economy
when faced with unusual circumstances."

Anonymous said...

Attempts by governments and central bankers to reinflate the money supply are doomed to fail as debt monetization cannot keep pace with credit destruction,...

Why not? I'm not trying to be dense here, but as of now, there doesn't seem to be a limit on the (US) federal government's power to borrow and print as much money as it wants.

It doesn't have to give the money to the banks and let them hoard it. It could spend the money in the "real" economy on the social safety net, public infrastructure, health care and education. There are plenty of local economies here and elsewhere in the world that seem to do quite well with nothing other than government support (try Los Alamos, NM, the richest county in the US, for starters).

Until we see the rates on Treasuries rise past 6-7% and the value of the dollar fall more than 50%, I would think that the government can borrow and print as much as it wants.

EBrown said...

Stoneleigh and OC,
Thanks for the encouragement. I ordered a few used books today at your recommendation. I read pretty quickly so I'll peruse them once they arrive and then decide whether to write a piece. I'll let you know in about two weeks whether I've begun a comparison between today and past crises.

team10tim said...
This comment has been removed by the author.
Unknown said...

I'm a relatively new reader, but I've been browsing the archives and you folks have done some amazing work here!

I read your work and frankly grow more and more concerned about the state of the economy. My question is what the hell do I do now? My wife and I held off buying a home because it made no financial sense and focused on repaying debts. I'm now completely debt-free, except for one more year of car payments.

Is there anything should I be doing to protect my savings in this uncertain time? I have my down payment savings sitting in a GIC, I'm wondering what happens to those savings if the deflationary scenario you describe occurs.

Anonymous said...

El pollo 6:45.

Thank you for you answer. The interests you pay on a loan is not removed from the economy. The principal is.
What happends when you issue a loan is that a negative account is created in yout name. The downpayments add to this negative amount until it reaches 0. If a lender defaults, the bank must cover the pricipal with real money ( which is not scalable in fractional reserve banking ).

Anonymous said...

Nick, in theory deflation is good for your savings - as deflation assumable will result in lower prices and hence making your money more valueable.

On the other hand we do NOT know for sure that this will work that way in real life.

Stoneleigh said...


I'll answer your question in today's into.

el gallinazo said...

Anon 5:34

"The interests you pay on a loan is not removed from the economy. The principal is. "

The nice thing about blogs is that your actual comments are set in virtual stone. What I wrote was:

"The way I understand it (Initially and primarily from the Money as Debt animation) is that the fractional reserve system does not create money to pay interest on lending - just the debt itself."

The money was not removed - it was never created in the first place, yet demanded in payment.

"On the other hand we do NOT know for sure that this will work that way in real life."

Speaking as a defrocked physical scientist, we do not know that releasing an apple from one's hand allows it to fall downward instead of upward. General Relativity gives some theoretical backing that it should fall downward, but do we really KNOW that. I am willing to offer very attractive odds against the upward direction. Let me know.

scandia said...

OC, forgive the political reference in my question...the Cdn gov't announced it was selling off assets to " balance" the budget. To this novice that seems like an extreme move. Is it perhaps a response to a margin call on the Cdn treasury? Or is it a real wealth grab of hard assets by insiders with money to spend. Has anyone knowledge of what assets are being sold and to whom and especially at what price?

Anonymous said...

El polo, I sincerely apologise if I misunderstood, my english is a little rusty u see.

Mind you tell me the difference between a bank demanding payment for their product and any store or market demanding payment for presenting and selling products that they never made?

Anonymous said...

I'm a new reader. Thanks for the insightful article. I'm wondering what your opinion is on the effect China will have on the dollar? With the fall off of imports what reason will China have to buy treasuries? China has announced a domestic spending program to stimulate their economy. Could the dollar crash and lose it's place as the world's reserve currency? If that happened, what would replace it? During a panicked sell off of the dollar, what would the sellers be buying?

Anonymous said...

Stoneleigh said:
"I would only own short-term bonds, where you don't have to worry about finding a buyer. You can decide to roll over your investment, or not, every three months, so you can get out easily if you need to. That's why they're a cash equivalent."

I guess a ladder would be wise. I can buy through Vanguard (no commission on treasuries) or open an account with Treas. Direct. I have some in Vanguard bond funds, but they can drop in value.
Bond funds are easier but more risk.

CDs will not be good since banks can fail. ??

One wonders if things get really bad will Treasuries be safe? If they get down graded then rates will rise.

People say money market funds are safe, but there was a run on them in Sept.

I have been out of debt for several years, I know a lot of people have borrowed like crazy are now in trouble.
I asked them why they used their house as a ATM and they said they needed to money to "make it". They threw their future out the window!

Stoneleigh, how far do you think the credit bubble will deflate? 50% from peak? It probably will not go to zero, or will it?

I read "Manias, Panics and Crashes" a couple of years ago, interesting...


Anonymous said...

OC said

"Mackay's book ... well, it's 900 pages. In other words, it's one example of why Stoneleigh is waaaay smarter than me. The date stamp on the copy I just got was November 2008 (which is interesting in itself because the book was first published in 1841; is there a sudden demand for more copies of this tome?)"

OC, what's the title of Mackay's book?

Anonymous said...

Markets Don't Make Bubbles, People Do

"The curses and the blessings, the seductions and the traps of money give Niall Ferguson the most redolent of subjects for The Ascent of Money, his excellent, just-in-time guide to the history of finance and financial crisis. A lively writer (author of Empire and The War of the World), a professor of history at Harvard and a master of anecdote and aphorism, Ferguson says he took Jacob Bronowski's hymn to human invention, "The Ascent of Man," as a model. Just as Bronowski's 1973 BBC documentaries traced the beneficial impact of science and art, Ferguson shows how promises and paper have lifted humans from subsistence farmers in Babylon to Masters of the Universe on Wall Street."

goritsas said...

Get Mackay's book here.

Anonymous said...

goritsas said...

Get Mackay's book here.


el gallinazo said...

Anon 8:45

"El polo, I sincerely apologise if I misunderstood, my english is a little rusty u see.

Mind you tell me the difference between a bank demanding payment for their product and any store or market demanding payment for presenting and selling products that they never made?"

Since you have no sign in, there is no way I can tell whether English is your first language. You may be the Queen of England for all I know :-)

As to the difference between a bank making a loan and a store lending credit, when a bank makes a loan under the fractional reserve system, that loan amount may be multiplied 90 times or more into the money supply. If you have broadband internet, the easiest and (as the under 40 crowd would say) funnest way to understand this is to download the 45 minute animation, "Money as Debt."

el gallinazo said...

Greg, IMO the only sensible way to purchase short term treasuries is Since it is a government agency, the only risk is with the T-bills themselves, not some intermediate broker deep sixing. Once you are set up, the computer interface is among the best and most secure I have seen.

The only danger to 13 week T-Bills is the Treasury itself defaulting. If it defaults, then currency won't be worth shit either. The only way to protect yourself against this is to invest in things of real value like solar panels and AK-47's.

Anonymous said...

The Internet is a wonderful ting El Pollo. You won't know who I am, but I think you will take my word for not being Queen Elisabth:)

What I'm actually trying to say is that banks charge interests to cover their expenses and to profit. Just like any other business - transferring wealth because they offer something that customers desire.

It would be the same thing for full reserve banking, only that the interest would be much higher to cover the costs of 100% securities.

ogardener said...

Apparently the writings and analysis of the collective TAE has fanned the flames of the hopelessly entrenched and increasingly desperate.

gener said...

Hi. I wonder about US treasuries, rates will go up next year and the value of bonds will drop.

usadrug said...

Hello. I would be very interested in seeing you write such an article.

Unknown said...

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