Saturday, December 20, 2008

Debt Rattle, December 20 2008: War in the Labour Markets

Unknown POW's 1864
Chattanooga, Tennessee.
Confederate prisoners at railroad depot waiting to be sent north.

Ilargi: The credit crisis yesterday brought down a first entire government, in Belgium. As Niall Ferguson writes today:
”It is all but inevitable that we shall see serious political and geopolitical upheavals in 2009, as the recession takes its toll on weak governments (Thailand and Greece are already reeling) and raises the stakes in inter-state rivalries (India-Pakistan)”.
In the same vein, Stoneleigh looks ahead at the equally inevitable upcoming wars in the labour markets. Millions upon millions of people around the globe will lose their jobs in the next year, and many if not most of the lucky ones who will still be employed can expect drastic cuts to their benefits and salaries. Since governments at all levels, if only to prevent having to fire employees, will try to raise taxes at the same time that people get poorer, widespread mayhem is guaranteed. And that's before people start figuring out what happened to their savings and pensions.

As regular readers know, I've often asked questions concerning the legitimacy, or even the legal status, of a government that loses control of its economy. Today, with small but rich Belgium out for the count, I can't help wondering what it would take to bring down the governments in countries like China, Japan, Britain, Germany, Canada or the US.

NOTE: My news of the day is that $550.000 worth of previously confiscated, illegally imported, caviar, 40 kilos (90 lbs) of it, has been donated by the police in Milan, Italy, to be handed out for Christmas to those living in the streets of the city. Nice! You have to realize that yes, if they could sell it, much more could be done. But the stuff is illegal, so selling is out. And throwing away, someone figured, is silly if you can instead make the kind of gesture they decided on.

Stoneleigh: The attempts on both sides of the US-Canadian border to bail out the auto industry are a taste of things to come for many other sectors. The cuts that unions will be required to agree to will be very significant, probably unacceptable to the membership, and ultimately will not be sufficient to save the companies in any case. Bailouts can postpone, but not prevent the recognition of losses that have already occurred.

In order to shed light on why the current situation will be so divisive, we return to an important distinction - that between nominal and real terms. During inflationary times (ie where the money supply is increasing relative to available goods and services), people do not notice their purchasing power being eroded, as they only see their pay in nominal terms. They collect their annual wage increases and almost never notice that inflation usually consumes that increase and then some. In real terms, the change in their purchasing power would be the increase minus inflation, where inflation is usually the larger factor, especially if the full effects of credit expansion are factored into the inflation figure rather than just the CPI.

Moderate inflation serves to dull the perception of economic decline, so that unrest is less likely. For instance, since the year 2000, the money supply approximately doubled by conventional measures, and the increase would have been even more substantial had the effects of shadow banking on credit expansion been included. In other words, unless one's pay doubled then purchasing power was substantially eroded. However, the effect was obscured by a substantial fall in the price of goods, thanks to price pressure imposed by global wage arbitrage. 

Rising prices are typically a lagging effect of inflation, but only where other factors do not interfere. As the costs of production were falling, with jobs out-sourced to the third world, prices were forced down even  in the face of inflation. This means that in real terms, the price of many goods was plummeting. Thus people didn't notice what was happening to their wages in terms of everyday goods, but they did notice the skyrocketing price of assets such as real estate. Only access to cheap credit prevented people from being priced out of asset markets, but that cheap credit was a trap that led to debt slavery.

During deflation (ie a fall in the effective money supply relative to available goods and services), there is no disguising economic malaise, in fact its appearance is enhanced. As the value of money increases, wages would have to fall in order for purchasing power to remain the same, but people will do not tolerate falling wages well, especially when their own budgets have been increasingly squeezed by the demands of debt repayment. They think in nominal terms, not real terms. To compound the problem, employers, who are also being squeezed, cannot afford to pay wages that leave purchasing power where it used to be. They will need to pay wages that amount to a cut in purchasing power, a cut that in nominal terms will look far worse than it actually is. This is very likely to lead to unrest.

Unions are unlikely to agree to cuts of the magnitude that would be required for businesses, municipalities and public services to remain viable. Their members have fixed costs which prevent them from working for less than a certain amount, but that amount will almost certainly be more than employers are in a position to pay. This means war in the labour markets.

My guess is that employers, particularly in public services such as education, will decide to break the unions, even at the cost of, for instance, an entire school year. I can imagine them firing all their teachers, or other public service workers, and inviting them to reapply for their old jobs at half the pay and no benefits. This is the kind of action that can easily lead to a general strike, where other unions come out in support of the particular workers under threat. The potential for extreme disruption is very high. This is yet another reason to have ready cash, stored supplies, and the essentials of your own existence under your own control to as great an extent as you can manage.

Joe Biden: US Economy At Risk Of 'Absolutely Tanking'
Vice president-elect Joseph Biden, in his first interview since the November 4 election, told ABC TV that the US economy was in "much worse shape" than he thought and needed a second stimulus package to prevent it from tanking. "The economy is in much worse shape than we thought it was in," Biden told ABC's George Stephanopoulos in an interview to be broadcast on Sunday. He said a second big stimulus package would be needed to keep from "absolutely tanking."

"Every single person I've spoken to agrees with every major economist. There is going to be real significant investment, whether it's 600 billion or more, or 700 billion, the clear notion is, it's a number no one thought about a year ago," he added. He said president-elect Barack Obama's team was absolutely focused on creating jogs and spending on energy and information technology infrastructure to get the economy on the right path. "There is no short run other than keeping the economy from absolutely tanking. That's the only short run," Biden said in an extract of the interview provided to AFP.

He said all other foreign and domestic policy objectives of the Obama administration, which takes office on January 20, depend entirely on turning the US economy around. "The single most important thing we have to do as a new administration ... is we've got to begin to stem this bleeding here and begin to stop the loss of jobs in the creation of jobs," he added. Obama on Friday also said that a "bold" stimulus plan was needed to pull the US economy out of recession. "I won't give you a number, because we are still making these evaluations," Obama said at a press conference.

"What we've seen, in terms of the evaluation of economists from across the political spectrum, is that we're going to have to be bold when it comes to our economic recovery package." Obama expressed confidence in his ability to steer the country out of recession but warned a solution to the "daunting" challenges he will inherit when he takes office. "It will take longer than any of us would like -- years, not months. It will get worse before it gets better," Obama said.

FedEx delivers ominous new twist with forced pay and benefit cuts
Federal Express Corp's decision this week to force its salaried workers to take at least a 5 percent pay cut and to suspend its 401(k) match isn't just bad news for the shipping giant's employees. Experts say the takebacks are an ominous sign of things to come at many other U.S. companies as businesses -- even healthy ones like FedEx -- adopt defensive corporate crouches in response to the worst economic downturn in decades. The moves also underscore how much the tables have turned on U.S. workers as a result of the economic crisis, which has put employers firmly back in the driver's seat.

According to the employment consulting firm Watson Wyatt, 11 percent of all the companies it recently surveyed either already had cut wages or planned to do so over the next 12 months. And 10 percent either have reduced their employer 401(k) match or planned to do so. "There's some real opportunism operating here," said Lawrence Mishel, president of the labor-oriented Economic Policy Institute. "The companies are counting on the fact that people will be scared and won't resist. I mean in this environment, who wants to quit and look for another job?"

Salary cuts are normally considered a last-resort nuclear option when it comes to corporate cost-cutting measures. Companies are typically loath to roll back wages because of the devastating effect such moves have on employee morale. Indeed, experts say companies would rather lay off workers than force them to take a paycut. The reason: layoffs create disgruntled ex-employees; pay cuts create disgruntled employees. "The fact that we've got more than one in 10 companies saying they've already reduced pay or plan to do so is pretty dramatic," said Laura Sejen, global director of strategic rewards consulting at Watson Wyatt. "The thing about base pay is it is the most basic, fundamental attraction and retention tool that companies have. So historically, it's been sacrosanct."

Sejen said the record drop in consumer prices -- those prices fell in November at the fastest rate since the government started collecting the data in 1947, pulled down by a 17 percent drop in energy prices -- was probably providing some cover for benefit-cutting companies. "If the price of gas was still $4 a gallon, it might be a more difficult discussion," she said. But the irony is falling energy prices -- U.S. crude oil prices have tumbled more than 75 percent since mid-July -- are good news for FedEx and likely to bolster the company's profitability during otherwise tough times.

FedEx is not the first U.S. company to respond to the current economic mess by cutting benefits and demanding givebacks from employees. A host of companies, including AK Steel, General Motors Corp, Eastman Kodak Co, Dollar Thrifty Automotive Group and Frontier Airlines Holdings Inc, have asked workers to take it on the chin in one way or another in recent months, citing the downturn. But those companies were all in serious straits. Frontier is in Chapter 11 bankruptcy. GM is teetering on the edge. Kodak, already scrambling to play catch-up in the digital photography game, now contends with the dramatic pullback in consumer spending. "Normally when companies suspend the match, it's because they are facing significant economic challenges," said David Wray, the president of the Profit Sharing/401(k) Council of America, a trade group representing 1,200 companies that sponsor defined contribution plans.

FedEx is different: The company announced its takebacks on Thursday in the same breath that it reported higher profits. It said the measures would reduce expenses by $800 million by the end of its fiscal 2010 year. Those kinds of savings mean FedEx will not be the last. Indeed, a report published on Thursday by Watson Wyatt found that 6 percent of the businesses that responded to a December survey said they planned to cut salaries in the coming year, up from 4 percent in October, and 7 percent planned to reduce their 401(k) matches, up from 4 percent in October. "As the economic downturn has both broadened and deepened," Sejen said, "the need to contain costs has resulted in stronger measures that that are ultimately affecting more workers."

Wray at the Profit Sharing/401(k) Council said that so far, the 401(k) suspensions appear limited in number and confined to big-name companies such as Cushman & Wakefield, Ford Motor Co and Motorola Inc. But because the employer match is a big incentive for employees to start saving for retirement, he worries the suspensions could discourage new hires and younger employees from planning for old age. "Certainly if there's no match, it's much harder to get people to join these plans," he said. The good news for workers is that historically, companies that suspend their 401(k) matches in bad times turn around and reinstate them once the good times return. But the lost matches -- and the money vaporized by pay cuts -- are gone for good. "There would never be a retrospective makeup," said Sejen at Watson Wyatt. "If your salary is reduced by 5 percent or 10 percent for 12 months, that's just lost income opportunity."

November jobless rates up in 37 states
Unemployment rates rose in 37 states and the District of Columbia in November as the recession hammered nearly every job sector, according to a government report released Friday.  The Bureau of Labor Statistics release said five states reported decreases in unemployment, while eight states saw no change. The national unemployment rate rose to 6.7% from 6.5% the previous month and from 4.7% in November 2007.  Over the past year, jobless rates were up in 49 states and the District of Columbia, the report said. Unemployment was unchanged in West Virginia.  "One clear takeaway is that this recession is incredibly broad-based," said Mark Vitner, senior economist at Wachovia Corp. "Nearly every industry, almost every region was slammed. The year-to-year decline is sizable, and very few states are seeing growth."

Michigan had the highest monthly unemployment rate in November, at 9.6%, the report said. That state, home to the Big Three car manufacturers, has struggled under the weight of the companies' collapsing finances - though President George Bush announced a Detroit rescue plan Friday. Both General Motors and Chrysler have idled plants and laid off thousands of employees. Rhode Island posted the second-highest monthly unemployment rate, at 9.3%, according to the report. California and South Carolina each reported 8.4%. Oregon, a manufacturing state, reported the largest month-over-month unemployment rate increase, rising to 8.1% from 7.2%, the report said. Florida lost the most jobs, 58,600, followed by North Carolina (46,000) and California (41,700). Florida and California's numbers were likely exacerbated by the housing market collapse.

Nonfarm payroll employment rates rose in 9 states and fell in 41 states and D.C., the department said. The largest month-over-month job gains were in Washington (17,400), where 27,000 aerospace workers ended their strike and returned to the payrolls. Texas added 7,300 jobs, and Oklahoma was third with 3,000 new jobs.  Alaska saw the largest month-over-month percentage gain in employment (up 0.8%), followed by Washington (up 0.6%), and Hawaii, North Dakota, and Oklahoma (which each saw an increase of 0.2%).

It's unlikely that the employment picture will improve any time soon. "The first half of 2009 is going to be very tough, and [keep in mind that] unemployment rates continue to rise for about a year after a recession ends," Vitner noted.  He added that although healthcare is one sector that "seems to be holding up relatively well, many hospitals are experiencing funding difficulties of their own." The energy sector was also comparatively stable, but with oil prices in "free fall," Vitner said he expected to see a slowdown there as well. He noted construction is the source of many of the job cuts, but he predicted the sector will rebound "because there's only so low the rates can go."  "The recession started this time last year," Vitner said. "When you compare these numbers to those from a year ago, it's a bleak but accurate snapshot of how this recession has played out."

Money is the new secret of a happy job
Last week, I sent an e-mail to a friend who had just lost his job. “I’m so sorry,” I wrote. “Your bosses are morons to have got rid of such a genius as you. I can only suppose a queue will shortly stretch round the block as less brain-dead employers clamour to take you on. Hope you are OK.” The e-mail was heartfelt except for one word, and that was “shortly”. I don’t expect a queue to form for my friend shortly. Even geniuses are not getting snapped up quickly – unless they happen to be security guards, social workers, accountants or teachers. In a trice, I had a message back. He said he had had a brief panic about the mortgage and school fees but otherwise was really rather cheerful. Indeed, he was in such high spirits that he even sent me a funny anecdote*.

I could not help comparing the tone of his message with one that I got the very same afternoon from another friend who works for a company that has also been celebrating Christmas with some savage job cuts. Never, she said, had her morale been as bad. The weight of work was crippling as she was now doing the jobs of three people. There was talk of pay cuts. The office was spookily quiet, too; since most of her friends had been sacked, there wasn’t even anyone around to moan to. Worst of all was the fear that her job would be next. It is tempting to conclude from these two messages that, if there is one thing worse for hitherto successful, well-paid people than being fired, it is not being fired. Those who have been axed don’t need to take the sacking personally, and not working in the days before Christmas can be rather jolly. Whereas for those who have not been fired, the not-so-festive season this year is an orgy of fear and drudgery.

There might be some truth in this now but it is not going to stay true for long. The grimness of the unemployed will get worse as no queues form to take them on, while the grimness of those in work will, in time, start to recede. This is not because the economy will improve – it is because the grimness itself will bring on a sounder and altogether more realistic approach to work. Over the past decade, the rich, professional classes have developed an increasingly unhealthy attitude to their jobs. We took our jobs and our fat salaries for granted and felt aggrieved if our bonuses were not even bigger than the year before. We demanded that the work be interesting in itself and, even more dangerously and preposterously, that it should have meaning. The result of all these demands was, of course, dissatisfaction. We had climbed to the very top of Maslow’s hierarchy of needs and discovered that, at the top of the pyramid, the air was very thin indeed. As an agony aunt, I found that by far the most common problem readers submitted came from rich and senior professionals who had all their basic needs more than catered for, leaving their souls in torment. Help me, I’m bored, they cried. Or, worse: what does my work mean?

In the past few months, anguish of this sort has vanished. When one’s job is at risk and one’s savings are a shadow of their former selves, the search for meaning at work is meaningless. The point of a job becomes rather more basic: to feed and house (and, at a pinch, to educate) one’s family and oneself. If we can do this, then anything we manage over and above this is a bonus. Once expectations have fully adjusted to this new reality and we see earning money as the main reason for work, greater satisfaction will follow. Low expectations have an awful lot to be said for them. In surveys women turn out to be more satisfied at work than men, in spite of earning less for the same jobs and doing most of the work at home too. The reason is simple: women’s expectations of working life are lower. Similarly, Denmark is the happiest country in the world in spite of having a cold, dark climate and a top tax rate of 68 per cent. The stoical Danes do not expect so much of life and, expecting less, find what little they have rather nice.

Climbing down Maslow’s pyramid is painful and progress is slow. However, there is something that managers can do to make the descent a little less grim. The easiest and cheapest way of cheering up demoralised workers is to tell them that they are doing a great job. It is one of the great mysteries of office life why most managers are so resistant to this when it does not cost one penny. Here is all they have to do: pick people off one by one (to do it in groups is lazy and quite spoils the impact) and say thank you and well done, and look as if they mean it.

Gussying Up an Ugly Portfolio at Year End
If history is any guide, a lot of portfolios may get a makeover between now and 4 p.m. on Dec. 31, when the 2008 trading year will finally take its last putrid breath. This cosmetology can lure more clients in good years and keep more clients from fleeing in bad years. While you mightn't be able to stop it, you should be able to spot it. Here are several ways that investment managers can gussy up an ugly portfolio at year end:

Window dressing. This tactic is old as the hills; the Pecora Commission, which investigated the 1929 crash, found that banks and investment firms scrubbed their lists of holdings on the last day of the reporting period "to present a financial statement of sound appearance." Money-market investors still window dress, says finance professor David Musto of the Wharton School. "There's a flight to quality," he says, "not just because the managers like quality but because they want to show quality." Commercial paper, short-term corporate debt, has higher yields than U.S. Treasury bills. But it is riskier. So money-market managers want it in their funds, but not in their funds' annual reports.

This Dec. 16, the price of 15-day loans to companies with lower credit ratings fell, and the yield leapt from 3.6% to 4.73% overnight. Buyers likely stepped away because any money-market fund that bought after Dec. 15 would have to disclose the holding at year end. Meanwhile, any money-market fund that does hold this paper can report a fattened yield. But this window dressing, warns Prof. Musto, is "transitory and doesn't reflect what you'll get long term." In much the same way, your stock-fund manager is likely to get rid of his worst dogs just before year end, making it harder for you to notice that he was running a kennel for most of the year. Reading your December 2008 fund report alongside the one from June will ensure you don't get a naively rosy view.

Painting the tape. In what also is called "banging the close," managers run up the price of what they already own. Changes in Nasdaq's trading rules have made this tactic rarer. But it may not have disappeared. Consider the case of American Technology Corp., a San Diego-based producer of audio equipment. On Dec. 31, 2007, the company's total market value jumped to $77 million from $58 million in a single day. Why? The firm announced no news that day. Robert Putnam, Atco's head of investor relations, says: "All we can guess is that some institution was doing something to make its statements look better" -- in other words, buying extra shares at an artificially high price to boost the other shares it owned. Atco's stock closed at its high for the day, up 33% from the day before -- a pretty peculiar move for a stock that lost 35.5% for the year.

A fund that does this with a few dozen stocks would not only pump up its return, but also boost the fund manager's revenues, which are based on the assets it manages. Next, the fund would bail out right after the New Year. On Jan. 2, 2008, Atco dropped more than 10%; it has lost roughly 80% for 2008 as a whole. Painting the tape is a one-day wonder. Historically, 80% of all U.S. stock funds and 91% of small-company funds have beaten the market on the last trading day of the year -- and roughly two-thirds have given most of that gain right back on the first day of the following year. "So we know how investors can avoid losing money," says finance professor Dan Bernhardt of the University of Illinois: "Don't buy small stocks or a small-cap fund on Dec. 31, and don't sell on Jan. 2."

Comparison shopping. Finally, mutual funds are required to compare their returns to the results of a "benchmark," or index of market performance. The comparison is supposed to be fair; a fund owning little stocks in Europe shouldn't measure itself against the Standard & Poor's 500 index of big U.S. companies. But fairness is a judgment call, so funds are free to use whichever index puts them in the best light. A study by finance scholar Berk Sensoy shows that 31% of U.S. stock funds pick a benchmark that doesn't closely reflect what they own -- but does make it easier to beat "the market." In recent years, smaller stocks did better than large, so the S&P 500 was easy to beat for many funds. But this year, small stocks lost even more than large ones, so you need to watch whether any of your mutual funds shift their benchmarks away from the S&P 500 to other indexes tilting toward smaller firms. If your fund starts comparing itself against a new benchmark, it is probably time to get a new fund.

Japan Offers a Possible Road Map for U.S. Economy
When the Federal Reserve cut its benchmark rate to virtually zero earlier this week, what was a historic move in Washington seemed old hat here in Tokyo. The Bank of Japan kept rates near zero for most of the last decade in an effort to end a long economic stagnation, and raised them only two years ago. Many economists say they believe that the zero interest-rate policy finally worked in Japan after regulators took aggressive steps that succeeded in restoring faith in Japan’s financial system and Tokyo’s ability to oversee it.

Now, with the Fed and President-elect Barack Obama turning to the same sorts of unconventional policy tools to battle the worst global economic crisis since the Depression, economists and bankers say they hope that Japan’s lessons are not lost on Washington. They say the United States needs to take the same kinds of confidence-building steps, and much more quickly than Japan did. "Japan had years of trial and error to gets its response right, but the United States doesn’t have that kind of time because markets are changing so fast," said Akio Makabe, an economics professor at Shinshu University. "The Fed has to move, and has to move fast, to restore confidence."

On Friday, the Bank of Japan cut its benchmark rate to 0.1 percent, from 0.3 percent, saying in a statement that it was following the Fed’s "dramatic rate cut" to lower borrowing costs and jolt global demand. On Tuesday, the Fed lowered short-term rates to a range of zero to 0.25 percent, and vowed to pump money directly into the credit markets by buying mortgage-related debt and corporate bonds. The Bank of Japan also announced that it would try to shore up Japan’s credit markets by buying commercial paper, a type of short-term corporate debt. Central banks in Europe have also reduced rates amid concerns the global economy could contract next year for the first time in decades.

Tuesday’s rate cut by the Fed also made short-term borrowing costs lower in the United States than in Japan for the first time in 15 years. This helped drive up the yen to 13-year highs, as investors tend to favor currencies that offer higher rates of return. The Bank of Japan said its rate cut on Friday was partly aimed at capping the yen’s gains. The Bank of Japan first lowered interest rates to zero in 1999 for a year and then again in 2001 for five years. The Japanese central bank was trying to contain a domestic financial crisis not unlike the one now crippling global markets, in which collapsing real estate and share prices caused the bankruptcy of large financial companies, like Yamaichi Securities in 1997.

The central bank’s hope was that by lowering borrowing costs to virtually nil, it could encourage commercial banks to lend more money to businesses and consumers, rekindling demand. Economists and former Bank of Japan officials say the biggest lesson they learned was that cutting rates alone has almost no effect when the financial system has fallen into a crisis as deep as the one Japan faced in the 1990s. Japanese banks simply refused to lend in an environment where borrowers could suddenly go bankrupt, saddling lenders with huge, unforeseen losses. The Bank of Japan tried even more extreme measures, like using its powers to create money to essentially stuff cash into the nation’s commercial banks in hopes they would start lending again.

Exasperated central bankers found that commercial banks just let the money pile up instead of lending it out. Economists say the United States faces a similar situation, after the sudden collapse in September of Lehman Brothers created fears of additional failures. Economists also fault Washington for its inconsistency in dealing with the financial crisis, leaving the impression that it does not have a clear strategy for dealing with ailing lenders. In Japan’s case, economists and former bankers say, credit began to flow freely again only after 2003, when regulators adopted a tough new policy of auditing banks and forcing weaker ones to raise new capital or accept a government takeover.

Economists said the audits finally removed paralysis in credit markets by convincing bankers and investors that sudden failures were no longer a risk, and that the true extent of problems at banks and other companies was finally being revealed. Economists say Washington needs to do something similar to make banks and financial companies more transparent, and reassure investors that there were no more collapses like that of Lehman Brothers on the horizon. "The United States needs to do it like Takenaka did," said Anil Kashyap, a professor of business at the University of Chicago, referring to Heizo Takenaka, the former banking minister who started the 2003 audits. "We need someone to come in and give a good housekeeping seal to banks."

Economists and former central bankers said another lesson from Japan’s experience was the importance of consistency. This became apparent in 2000, they said, during one of the bank’s more embarrassing episodes, when it raised interest rates, and lowered them back to zero a year later when the economy faltered. Former Bank of Japan officials said they learned that bankers and investors would lend in difficult times only if they believed that rates would stay low for a long period, ensuring them adequate profits. By raising the possibility of future interest rate increases, the Bank of Japan dampened enthusiasm for lending, say bankers and economists. "We learned that zero rates work by building expectations," said Rei Masunaga, an economist and former director general at the Bank of Japan. "Zero interest rates take time to be effective."

Japan Budget Deficit Swells to Record as Aso Spends to Resuscitate Economy
Japan’s government expenditure will increase to a record next year as Prime Minister Taro Aso tries to spend his way out of a recession and lift his slumping popularity ahead of an election. Spending will rise 6.6 percent to 88.5 trillion yen ($988 billion) in the year starting April 1, a third year of expansion, according to a budget proposal released by the Finance Ministry in Tokyo today. The government will sell 33.3 trillion yen of new debt, the most in four years, to help fund a revenue shortfall. In his first budget since taking the helm in September, Aso is expanding a debt burden that’s already the largest in the industrialized world as the economic slump cuts revenue and forces him to spend more to spur growth. His approval rating fell by half this month as voters and lawmakers in his own party shunned his handling of the world’s second-largest economy.

"Aso has little choice but to take more measures to restore his political leadership and regain support from voters," said Katsutoshi Inadome, a fixed-income strategist at Mitsubishi UFJ Securities Co. in Tokyo. "Fiscal reform may be put on the shelf for the next three years as the economy is getting worse, forcing the government to spend more." Aso’s approval rating fell to 16.7 percent from 38.8 percent last month, Jiji Press reported yesterday. The budget deficit will widen to the most in four years. The so-called primary deficit, the excess of spending over revenue excluding bond sales and interest payments, will balloon to 13.1 trillion yen from this year’s 5.2 trillion yen, the ministry said. The yen has rallied even though Japan is borrowing more to finance the deficit. The currency is up 25 percent against the dollar this year as the seizure in credit markets leads investors to reverse so-called carry trades, where they took out loans in Japan to take advantage of the lowest benchmark interest rates among the Group of 10 industrialized nations. They then sold the yen and invested the proceeds in high- yielding assets outside the country.

The ministry estimates growth in tax revenue will fall 13.9 percent to 46.1 trillion yen next year, compared with this year’s 0.2 percent gain. The government will increase new bond sales 31.3 percent, compared with a 0.3 percent cut in the initial budget last year. Increasing spending at a time when tax revenue is falling threatens the government’s goal of balancing the budget by 2011. Aso has said that the government shouldn’t prioritize fiscal discipline when the economy is ailing. "The primary balance goal has turned out to be a pie in the sky," said Hitomi Kimura, a bond strategist at JPMorgan Securities Japan Co. "There are very few people who believe it will be achieved in 2011." With receipts dwindling, Aso tried to come up with ideas to find new sources of revenue, only to have them rejected by members in his party. LDP politicians decided not to pursue an increase in the nation’s tobacco tax next year because the move would alienate tobacco farmers and hurt cigarette sales. The government owned 50 percent of Japan Tobacco Inc., the world’s third-largest publicly traded cigarette maker, as of March 31, according to Bloomberg data.

Lawmakers also shrugged off Aso’s pledge to raise the consumption tax from 5 percent in three years, omitting it from its tax reform plan this month. The shortfall in revenue prompted the government to tap so- called special accounts, bureaucrat-run funds set aside from the regular national budget. The government will use the money to pay for an increase in its contribution to the national pension program. Using such stop-gaps may spur concern among investors that Japan won’t be able to keep refinancing its increasing debt burden. "The clock is ticking," said Carl Weinberg, chief economist at High Frequency Economics in New York. "Any run-up in the fiscal deficit in 2009 will drive JGB yields higher." The cost of paying interest and redeeming bonds will total 20.2 trillion yen, about a quarter of total spending. A 1 percentage point gain in the yield on benchmark 10-year government bonds will increase those costs by about 1.3 trillion yen next year, the ministry projects.

In his stimulus packages, Aso has pledged 2 trillion yen in financial assistance for families, 1 trillion yen for local authorities and about 1 trillion yen in tax cuts. Japan’s Finance Minister Shoichi Nakagawa said that his ministry compiled the budget in the hope it will keep economic and employment conditions from worsening and make Japan a leader in recovery efforts. "In the big recession we have now, a big budget is probably a good idea," said Robert Feldman, head of economic research at Morgan Stanley Japan in Tokyo. "However, it is very important that money will be spent by the government wisely." Tax grants and other subsidies to local government will increase 6.1 percent to 16.6 trillion yen next year to aid rural areas, according to the proposal. The budget will be approved by the Cabinet on Dec. 24 and submitted to parliament in January for passage by March 31.

The age of obligation
Fallow years and a golden jubilee Every seven years, God told Moses, the children of Israel should neither sow their fields nor prune their vineyards – a kind of self-imposed recession. After seven such sabbatical years, the trumpet of jubilee should be sounded: "And ye shall hallow the fiftieth year, and proclaim liberty throughout all the land unto all the inhabitants thereof: it shall be a jubilee unto you; and ye shall return every man unto his possession." Land that had been sold was to be redeemed or returned to the original seller and the poor were to be relieved: "If thy brother be waxen poor, and hath sold away some of his possession, and if any of his kin come to redeem it, then shall he redeem that which his brother sold ... If thy brother be waxen poor ... then shalt thou relieve him: yea, though he be a stranger ... Take thou no usury of him ..." In addition, Jews who were slaves were to be set free. To modern eyes, however, the most striking of these divine injunctions was that debts were to be cancelled as part of "the Lord’s release"

In the Old Testament Book of Leviticus, God commands the children of Israel to observe a jubilee every 50 years. Nowadays we tend to associate the word with celebrations of royal anniversaries such as Queen Elizabeth’s golden jubilee in 2002. But the biblical conception of a jubilee was more precise: that of a general cancellation of debts. This point is spelt out in Deuteronomy: "Every creditor that lendeth ought unto his neighbour shall release it; he shall not exact it of his neighbour, or of his brother; because it is called the Lord’s release." Such injunctions may strike the modern reader as utopian. How could any sophisticated society function if all debts were cancelled twice a century – much less, as Deuteronomy seems to suggest, every seven years? Yet we know that such general cancellations of debt really did happen in the ancient world. In 1788 BC, for example, about 500 years before the time of Moses, King Rim-Sin of Ur issued a royal edict declaring all loans null and void, wiping out some of history’s earliest known moneylenders.

The idea of a generalised debt cancellation is not wholly unknown in modern times. The late Gerald Feldman, the world’s leading authority on the German hyperinflation of 1923, drew a parallel between the ancient Hebrew yovel and the wiping out of all paper mark-denominated debts as a result of the collapse of the German currency (though, as he was quick to point out, those whose savings were wiped out were far from jubilant). In the hope of avoiding the mark’s meltdown, the economist John Maynard Keynes had repeatedly called for a general cancellation of the war debts and reparations arising from the first world war. Though no such intergovernmental jubilee was ever proclaimed, debt cancellation was effectively what happened after 1931, beginning with President Herbert Hoover’s one-year moratorium on both war debts and reparations. As 2008 draws to a close, there are many people on both sides of the Atlantic who yearn for such a simple solution to the problem of excessive indebtedness. Parallels with the interwar period are not inappropriate. It is all but inevitable that we shall see serious political and geopolitical upheavals in 2009, as the recession takes its toll on weak governments (Thailand and Greece are already reeling) and raises the stakes in inter-state rivalries (India-Pakistan). In the words of Hank Paulson, the US Treasury secretary: "We are dealing with a historic situation that happens once or twice in 100 years." The stakes are high indeed. Has the time arrived for a once-in-50-years biblical jubilee?

Excessive debt is the key to this crisis; it is the reason we are confronting no ordinary recession, curable by a simple downward adjustment of interest rates. It is the reason we still have to fear, if not a second Great Depression, then very likely the biggest recession since the 1930s. We are living through the painful end of an age of leverage which saw total private and public debt in the US rise from about 155 per cent of gross domestic product in the early 1980s to something like 342 per cent by the middle of this year. With average household debt rising from about 75 per cent of annual disposable income in 1990 to very nearly 130 per cent on the eve of the crisis, a large proportion of American families are submerging under the weight of their accumulated borrowings. British households are in even worse shape. Looking back, we now see just how big a proportion of US growth since 2001 was financed by mortgage equity withdrawals. Without that as a means of financing consumption, the economy would barely have grown at 1 per cent a year under President George W. Bush. Looking forward, we see just how hard it will be to stabilise property prices and the prices of the securities based on them. Already, at the end of September, one in 10 American home owners with a mortgage was either at least a month in arrears or in foreclosure. One in five mortgages exceeds the value of the home it was used to purchase.

The financial sector’s debts grew even faster as banks sought to bolster their returns on equity by "levering up". According to one recent estimate, the total leverage ratios (on- and off-book assets and exposure divided by tangible equity) for the two biggest US banks were 88:1 for Citibank and 134:1 for Bank of America. The bursting of the property bubble caused such ratios, which were already too high on the eve of the crisis, to explode as off-balance-sheet commitments and pre-arranged credit lines came home to roost. Only by borrowing from the Federal Reserve on an unprecedented scale have the banks been able to stay in business. With estimates of total losses on risky assets now ranging from $2,800bn (£1,850bn, €1,960bn) to $6,000bn, a chain reaction is under way that will leave no sector of the world economy untouched. The American economy is contracting at an annualised rate of 5 per cent. Commercial property is following the residential market into freefall. The Standard & Poor’s 500 index is down 43 per cent since its peak in October last year. The market for credit default swaps is pointing to a surge in defaults on corporate bonds. The automotive industry is already (against the will of Congress and the original intention of the Treasury) on life support. The US is at the centre of the crisis but Europe and Japan may suffer even larger aftershocks. As for the much feted emerging market "Brics" – Brazil, Russia, India and China – their stock markets have been dropping like, well, bricks.

What makes this crisis of burning interest to financial historians is the knowledge that we are witnessing a real-time experiment with not one but two theories about the Depression. On one side, Ben Bernanke, Fed chairman, is applying the lesson of Milton Friedman’s and Anna Schwartz’s A Monetary History of the United States, which argued that the Depression was in large measure the fault of the central bank for failing to inject liquidity into an imploding financial system. Mr Bernanke has not merely slashed the federal funds rate to below 0.25 per cent. He has lent freely to the banks against undisclosed but probably toxic collateral. Now he is buying securities in the open market. The result has been an explosion of the Fed’s balance sheet and of the monetary base. With assets approaching $2,263bn and capital of less than $40bn, the Fed increasingly resembles a public hedge fund, leveraged at more than 50:1. On the other side, Mr Paulson has emerged as an unwitting disciple of Keynes, running a huge government deficit in an effort not merely to bail out the financial sector but also to provide a public sector substitute for sharply falling private sector consumption. Even before President-elect Barack Obama launches his promised infrastructure investment programme, estimates of next year’s deficit run as high as 12.5 per cent.

Once, monetarism and Keynesianism were considered mutually exclusive economic theories. So severe is this crisis that governments all over the world are trying both simultaneously. Although commentators like to draw parallels with Franklin Roosevelt’s New Deal, in truth the measures taken since the crisis began in August 2007 more closely resemble those taken during the world wars. After 1914, and again after 1939, there was massive government intervention in the financial system. Banks and bond markets were reduced to mere channels for the financing of huge public sector deficits. That is what is happening today, but without the stimulus to manufacturing that the world wars provided. We are having war finance without the war itself. Yet the effect of these policies is essentially to add a new layer of public debt to the existing debt mountain. Added together, the loans, investments and guarantees made by the Fed and the Treasury in the past year total about $7,800bn, compared with a pre-crisis federal debt of about $10,000bn. The Treasury may have to issue as much as $2,200bn in new debt in the coming year.

For the time being, the distress-driven demand for dollars and risk-free assets is pushing down the cost of all this borrowing. Treasury yields are at historic lows. But it is not without significance that the cost of insuring against a US government default has risen 25-fold in little over a year. At some point, with most big economies adopting the same fiscal policy, global bond markets are going to start choking. Is it really plausible that the cure for excessive leverage in the private sector is excessive leverage in the public sector? Might there not be a simpler way forward? When economists talk about "deleveraging" they usually have in mind a rather slow process whereby companies and households increase their savings in order to pay off debt. But the paradox of thrift means that a concerted effort along these lines will drive an economy such as that of the US deeper into recession, raising debt-to-income ratios. The alternative must surely be a more radical reduction of debt. Historically, such reductions have been done in one of four ways: outright default, restructuring (for instance, bankruptcy), inflation or conversion. At the moment, more and more American households are choosing the first as a way of dealing with the problem of negative equity, while more and more companies are being driven towards bankruptcy. But mass foreclosures and bankruptcies are not a pretty prospect.

Inflation, by contrast, is hard to worry about in the short term, not least because the Fed’s expansion of the monetary base is leading to no commensurate expansion of the broad money supply; the banks would rather shrink than expand their balance sheets. That leaves conversion, whereby, for example, all existing mortgage debts could be wholly or partly converted into long-term, low and fixed-interest loans, as recently suggested by Harvard’s Martin Feldstein. (In his scheme, the government would offer any homeowner with a mortgage the option to replace 20 per cent of the mortgage with a low-interest loan from the government, subject to a maximum of $80,000. The annual interest rate could be as low as 2 per cent and the loan would be amortised over 30 years. At the very least, this would rescue many homeowners from the nightmare of negative equity. A similar operation might also be contemplated for the debts of those banks that have been partially or wholly recapitalised by the state. This would not add to the federal debt in net terms and would reduce the interest burden, if not the absolute debt burden, of households. Such radical steps would naturally represent a haircut for creditors, notably the holders of mortgage-backed securities and bank bonds. Yet they would surely be preferable to the alternatives. And they would certainly be a less extreme solution than the general debt cancellation envisaged in the Old Testament. Financially, 2008 has been an annus horribilis. The answer may be to make 2009 a true jubilee year.

Ilargi: Sure, it's tragic that rules to protect customers turn out to work against them, sort of. That is ironic. But so is Whitney's statement: "We view the credit card as the second key source of consumer liquidity, the first being their jobs". You can say that a credit card is a "cash flow management vehicle", but we're still talking about credit here. For one thing, that means interest has to be paid. And also, it's still a continuation of living on borrowed money and borrowed time.

New credit card rules will reduce consumer liquidity - Meredith Whitney
The new credit-card rules approved by U.S. regulators to curb unfair practices will reduce liquidity at a time when consumers need it the most, and in turn impact consumer spending, prominent banking analyst Meredith Whitney said. "The regulators believe they are actually doing what is best for the consumer... we argue that the unintended consequences of such actions will at least do a commensurate amount of harm to the economy by stifling consumer spending," the Oppenheimer & Co analyst wrote in a note to clients. U.S. regulators on Thursday approved new rules to curb unfair credit card practices such as surprise fees and interest rate hikes. The rules are due to take effect on July 1, 2010.

Analyst Whitney said this regulation will reduce the current economics of the credit card industry to a level in which lenders will ultimately choose to provide fewer credit lines to fewer customers. The inability to maintain pricing flexibility on unsecured loans will result in a "dramatic" reduction of risk taking and therefore credit lines outstanding, Whitney said. "This line reduction will strain credit quality not just for credit card loans but for all consumer loans," she added. Whitney said more than 70 percent of U.S. households have credit cards and that 90 percent of those households use cards as a cash flow management vehicle. "We view the credit card as the second key source of consumer liquidity, the first being their jobs," Whitney said.

"Pulling credit at a time when job losses are increasing by over 50 percent year on year in most key states is a dangerous and unprecedented combination," she added. The analyst expects lenders to pull back well over $2 trillion of lines over the next 18 months as a result of risk aversion, funding challenges and the just finalized regulatory changes. This means available consumer liquidity in the form of credit card lines is expected to decline by 45 percent over the same period, Whitney said. Closing millions of accounts, cutting credit lines and raising interest rates are just some of the moves credit card issuers are using to try to inoculate themselves from a tsunami of expected consumer defaults.

Hedge funds gain access to $200 billion Fed aid
Hedge funds will be allowed to borrow from the Federal Reserve for the first time under a landmark $200bn programme intended to support consumer credit. The Fed said on Friday it would offer low-cost three-year funding to any US company investing in securitised consumer loans under the Term Asset-backed Securities Loan Facility (TALF). This includes hedge funds, which have never been able to borrow from the US central bank before, although the Fed may not permit hedge funds to use offshore vehicles to conduct the transactions. The asset-backed securities to be funded under the programme are pools of credit card receivables, automobile loans and student loans. The idea is to increase the supply of these loans and reduce borrowing rates by ensuring that the companies that make the loans can sell them on to investors who have guaranteed access to low-cost funding from the Fed.

The TALF is a key plank of the unorthodox strategy set out by the Fed last week as it cut interest rates virtually to zero. Washington insiders expect the programme will be dramatically expanded next year with further capital support from Treasury once the Obama administration takes office. A senior official in the outgoing Bush administration told the Financial Times it could also be broadened to include new commercial and residential mortgage-backed securities. The Fed thinks risk premiums or "spreads" for consumer loans are much higher than would be justified by likely default rates, even assuming a nasty recession. It attributes this to a lack of buying interest in the secondary market where the loans are sold on to investors. By making loans to these investors on attractive terms it aims to increase market liquidity.

Making the scheme open to all US companies is a radical departure for the Fed, which normally supports financial market liquidity indirectly by ensuring banks have adequate liquidity to make loans to other investors. However, the liquidity the Fed is providing to banks is not flowing through to financial markets, because banks are balance-sheet constrained and risk-averse. So it is channelling funds directly to investors. The scheme is not designed specifically for hedge funds and a wide range of financial institutions are likely to participate. Nonetheless, Fed officials hope that hedge funds will be among those investors that take advantage of the low-cost finance to drive down spreads.

The loans will be secured only against the securities and not the borrower. However, the Fed will lend slightly less than the value of the securities pledged as collateral. The Treasury has committed $20bn to cover potential losses. Since the credit crisis erupted, hedge funds have complained that they cannot get the leverage they need to arbitrage away excessive spreads and meet high hurdle rates of return. "Demand is there for leverage but not supply," said Sylvan Chackman, head of global equity financing at Merrill Lynch. In effect, the Fed will now take on the role of prime broker – the lead bank that lends to a hedge fund – for specific assets

How to spend $350 billion in 77 days
President Bush has grudgingly allowed General Motors and Chrysler to drive away with the last few billion bucks in Treasury's TARP till, which boasted $350 billion a mere 77 days ago. How did it all slip away so fast? The money pot -- intended to save the teetering financial system -- was formally proposed in a three-page missive that Treasury sent to Congress on the morning of Saturday, Sept. 20. Over the course of two weeks, lawmakers debated the potential moral, ethical and financial hazards of handing over unprecedented power and unprecedented sums of taxpayer money to the Treasury. Their responses ranged from gobsmacked to apoplectic. By Friday, Oct. 3, Congress had passed a 451-page bill that President Bush signed into law within hours. The law granted Treasury up to $700 billion, half of which was made available right away. Since then, Treasury has:
  • sent checks totaling $168 billion in varying amounts to 116 banks;
  • committed another $82 billion to capitalize more banks;
  • bought $40 billion in preferred shares of American International Group so the troubled insurer could pay off an earlier loan from the Federal Reserve;
  • committed $20 billion to back any losses that the Federal Reserve Bank of New York might incur in a new program to lend money to owners of securities backed by credit card debt, student loans, auto loans and small business loans;
  • committed to invest $20 billion in Citigroup on top of $25 billion the bank had already received;
  • committed $5 billion as a loan loss backstop to Citigroup;
  • agreed to loan $13.4 billion to GM and Chrysler to get them through the next few months.

Now, it's likely that Treasury will ask for the second tranche of $350 billion. "It's clear Congress will need to release the remainder of the TARP to support financial market stability," Treasury Secretary Henry Paulson said Friday. "I will discuss that process with the congressional leadership and the president-elect's transition team in the near future." It's not clear, however, whether Paulson will formally ask Congress for the second tranche of TARP money before turning over the keys of the Treasury to his likely successor, Tim Geithner. Even if Paulson wants to, however, he's likely to face an uphill battle getting it. "It seems very unlikely that Congress will give the final TARP installment to the Bush administration," said Jaret Seiberg, a financial services analyst at policy research firm Stanford Group. That's because the apoplexy among those who originally opposed the TARP or who voted for it reluctantly has grown and spread for several reasons.

One cause of Capitol Hill's bailout rage: the Treasury has not used TARP money to help prevent foreclosures. Democratic lawmakers, who crafted the legislation and purposefully included language about foreclosure prevention, beg to differ. They have said repeatedly they will not release any more TARP money until the Treasury commits to use some of it to help troubled homeowners. Second, lawmakers are not happy Treasury has given so much capital to banks without requiring them to lend more and do more to oversee how the banks are using the money. Paulson has said Treasury told TARP recipients that it expects them to lend. "But it's not practical or prudent for the government to say 'make this loan, don't make that loan,'" he said Thursday, speaking at an event in New York. And third, Republicans in particular resent what they see as TARP mission creep. House Minority Leader John Boehner, R-Ohio, was one of many who opposed the auto bailout, and the fact that TARP was the source of the bridge loans in particular.

"The use of TARP funds is also regrettable, the latest in a growing list of TARP money uses that were not discussed with or envisioned by Congress when the program was authorized," Boehner said Friday. House Speaker Nancy Pelosi, D-Calif., has said she is working on a bill to add more guarantees that future TARP funds be used to prevent foreclosures and protect taxpayers. But it's not clear yet how much Democratic support that will get. And there is near total Republican opposition in the House to approve any more TARP funding. If that remains the case, the Obama team will have to add yet another entry to its ever-growing to-do list when they take power on Jan. 20.

Bush: auto plan only way to stave off collapse
President George W. Bush on Saturday said offering government loans to U.S. automakers was the only option left to prevent the industry from collapsing after alternatives were ruled out or failed. Bush on Friday announced the government would provide $17.4 billion in emergency loans to financially strapped General Motors and Chrysler LLC to prevent them from failing. Ford decided it did not immediately need similar loans. In return, the carmakers would provide a restructuring plan by March 31 that would show they would survive, or they would be required to repay the loans.

Lawmakers from Bush's own Republican Party criticized the plan, which can be changed by the incoming administration of Democratic President-elect Barack Obama after he takes office January 20. "We have ended up with an agreement open to interpretation, that eliminates the sense of crisis, where taxpayer dollars are expended and we are left to hope that the next administration has the will to enforce the tough concessions necessary to make these companies viable for the long term," Sen. Bob Corker, a Tennessee Republican said.

Bush in a weekly radio address said his economic advisers warned that if the automakers filed for bankruptcy it would lead to a "disorderly collapse" of the industry and send the economy into a "deeper and longer recession." After Congress was unable to pass legislation to bail out the auto industry, the only way to stave off a collapse was for his administration to step in, Bush said. The automakers are capable of demonstrating by the end of March that they can restructure into viable companies, he said. If not, the loans would provide time for the carmakers to prepare for an "orderly" Chapter 11 bankruptcy process that offered a better prospect of long-term success, Bush said.

"This restructuring will require meaningful concessions from all involved in the auto industry -- management, labor unions, creditors, bondholders, dealers, and suppliers," he said. "The actions I'm taking represent a step that we all wish were not necessary," Bush said. "But given the situation, it is the most effective and responsible way to address this challenge facing our nation."

Congress Will Set Conditions for $350 Billion in Rescue Funds
Congress will use the remaining $350 billion in a U.S. bank-rescue package to force the Bush administration and President-elect Barack Obama into providing foreclosure aid as the pace of people losing their homes soars. Lawmakers will agree to release the funds in exchange for Treasury Secretary Henry Paulson and Obama agreeing to programs that cut interest rates and forgive a portion of a mortgage’s principal, House Financial Services Committee Chairman Barney Frank said in a telephone interview yesterday. Frank said legislation is being drafted that will set the conditions on spending the cash after Paulson used almost half the $700 billion Troubled Asset Relief Program to boost bank capital. Paulson resisted calls to support foreclosure relief.

"The Democrats are finally getting it, that this administration is not going to do anything to help homeowners, and they are getting more proactive," John Taylor, president of the National Community Reinvestment Coalition, said in a telephone interview. "Paulson has had the chance to do something like this all along, but has chosen not to. I think he’ll do it if a quid pro quo is held over him." Frank, a Massachusetts Democrat, said in the interview he’s drafting legislation with Senate Banking Committee Chairman Christopher Dodd that would release the remaining $350 billion in exchange for foreclosure help, aid for General Motors Corp. and Chrysler LLC and provisions to hold banks accountable for stepped up lending to consumers. The measure would adopt a Federal Deposit Insurance Corp. foreclosure plan, revamp the Hope for Homeowners loan-relief program that has attracted few lenders and support a Treasury program to cut rates on some fixed-rate home-loans.

"We should have an agreement among Obama, Paulson and the congressional leadership to release the $350 billion with conditions on how it’s spent," Frank said. "We need the second $350 billion, but it can only be done if there’s an agreement as to how to do it." Paulson urged Congress yesterday to release the second half of the rescue funds after the government exhausted $350 billion in less than three months. "Congress will need to release the remainder of the TARP to support financial market stability," Paulson said in a statement released in Washington. "I will discuss that process with the congressional leadership and the president-elect’s transition team in the near future." Frank said the legislation will include FDIC Chairman Sheila Bair’s foreclosure-prevention plan, which provides a U.S. guarantee for troubled mortgages to spur loan modifications.

Paulson has declined to adopt the proposal, while Bair has said the law enacted in October gives the Treasury authority to fund a plan she said might prevent 1.5 million foreclosures through next year at a cost of $24 billion. U.S. foreclosure filings climbed 28 percent in November from a year earlier, data provider RealtyTrac Inc. said Dec. 11. Frank also plans to revise Hope for Homeowners passed by Congress in July. The program, run by the Federal Housing Administration, is aimed at helping about 400,000 homeowners by insuring as much as $300 billion in refinanced loans after servicers forgive part of the loan balance. Few lenders have signed up because banks must cut a large portion of the loan and pay high fees. Frank said he wants to include a proposal Paulson is considering that would use Fannie Mae and Freddie Mac, the federally chartered mortgage financers the U.S. seized in September, to reduce 30-year, fixed home-loan rates to about 4.5 percent from an average of about 5.54 percent.

He also plans to adapt a plan from Harvard University economist Martin Feldstein to let the government substitute a new loan with a lower interest rate for a portion of an existing troubled mortgage. "I just view this as Barney with a cattle prod, saying ‘put more emphasis on foreclosure relief,’" Gilbert Schwartz, a former Federal Reserve counsel and now a partner at law firm Schwartz & Ballen in Washington, said in an interview. Frank said he’s ready to act on the legislation during the final month of the Bush administration, without waiting until Obama’s Jan. 20 inauguration. "Why wait three weeks? Let’s do it," Frank said. "We’re in a crisis now. How many people’s homes will be foreclosed?" Lawmakers will have a chance to vote for a bill to reject Paulson’s request for the funds, "but I think they should also have a chance to vote for a bill that allows it to go forward with these conditions," Frank said.

Carmakers Christmas bail-out threatens New Year hangover
At 8pm on Thursday, a call came in to Rick Wagoner's office in General Motors' Detroit headquarters. After months of lobbying the US government for emergency funding, the call – from the White House – was one of life or death. Fortunately, for Wagoner, it was life. Within an hour, he and other GM directors had a high-level summary of the proposed $17.4bn loan package the US government would advance to GM and Chrysler. By 2.30am on Friday morning, they had a draft term sheet, and by 8.56am, all sides had signed off on the deal. Moments later, President George W. Bush announced the funding package, and shares in GM – Chrysler is owned by private equity firm Cerberus - and the wider market soared. Good news for the car manufacturers, and good news for the market as a whole. Or so it seemed.

But assessing the detail of the loans, it seems that it may not be such good news for the financial viability of the industry in the long-term, or indeed the American taxpayer. The loan terms are very much what the two car manufacturers were looking for when they appeared before Congress at the start of this month, albeit someway short of the combined $25bn they had first asked for. The three-year-loans carry an average interest rate of 5pc, not high in the scheme of things, and although executive pay will be checked and corporate jets must be sold, such stipulations had already been taken into account by the companies. What is of concern, however, particularly to those Republican politicians who vetoed a Congressional bail-out package as recently as last week, is that the two companies are under no legally-binding obligation to restructure their businesses by the end of March. Terms such as reducing debt by two-thirds via a debt-for-equity exchange and making wages competitive with foreign car manufacturers by the end of 2009 are simply "non-binding," with the pair able to veer from the requirements as long as they can prove it makes business sense to do so.

Furthermore, the Bush administration has dropped the profitability goalpost many Republican politicians were pushing for, in favour of the companies proving that they are viable by the end of March - the definition of which is to have a "positive net present value." So while the loan agreements pay lip service to real, structural change, they do not demand it, which is likely to be a problem, particularly for the US taxpayer, who is likely to see demand for more financing in the not-too-distant future. As a result, in his desire to help the auto industry, while at the same time preserving what little legacy he has left, President Bush has failed to tackle key issues such as labour contracts and how the companies might restructure their debt piles head-on, and instead left it to his successor. Within hours of the loans being announced, the influential United Auto Workers union said it would lobby President-elect Barack Obama to reverse what it called the "unfair bail-out" terms. GM chief operating officer Fritz Henderson explains that the company has already got its hourly labour costs down from $18bn a year in 2003 to $8bn this year, but needs to reduce that bill to $4.5bn if it wants to be truly competitive with its foreign rivals. "We've covered a substantial amount of ground but not completely covered that," says Mr Henderson of his discussions with the UAW, but judging by the union's statement on the loan terms, he may have yet another fight on his hands.

Similarly when it comes to debt restructuring, it will not be easy. GM's financing arm GMAC – which is 51pc owned by Cerberus, Chrysler's parent, and 49pc by GM – has been attempting to perform a $38bn debt exchange for some time, in the hopes of reducing its debt pile to a degree that will allow it to become a bank holding company and also tap the $700bn bail-out fund. But that exchange has been fraught with problems, and as of Friday, was still not complete after weeks of trying, reflecting just how difficult a two-thirds debt-for-equity swap might be for both companies. As to whether the $17.4bn – to be split in two tranches, the second to be paid in February – also remains to be seen. Interestingly, when Mr Wagoner was asked if industry estimates that GM might need $40-$50bn in extra funding to survive the next year or two were accurate, he dodged the question, and noted that GMAC was hoping to get its own bail-out funding, and that GM still was hoping for money from the Department of Energy's $25bn loan programme to "green up" the car industry. Whether the new funding is enough, only time will tell, but by then, it will be the new President's problem.

GMAC's fate still hangs in the balance
While the $17.4 billion bailout for the U.S. auto industry may prevent General Motors Corp. from sliding into bankruptcy protection this year, the fate of its struggling financing arm remains up in the air. Time is running out for GMAC Financial Services to get the needed capital to turn itself into a bank holding company and become eligible for its own piece of the $700 billion bank rescue plan. If it doesn't receive the necessary backing, analysts say GMAC could be forced into bankruptcy protection. Meanwhile, Chrysler LLC's financing arm is also awaiting word on its application for federal financial help. GMAC is in the midst of a $38 billion debt exchange designed to raise the $30 billion in regulatory capital the company needs to become a bank holding company. It faced a key deadline on Friday for bondholders to participate and receive financial incentives to tender their notes.

But it's unclear if the company, which provides financing for both GM dealers and customers, along with home mortgage loans, will find enough takers. As of the end of Wednesday, the company was well short of the percentage needed for the deal to succeed. It's also uncertain what impact Friday's automotive bailout by the government will have on GM's financing arm. GMAC spokeswoman Gina Proia declined to comment on whether GMAC will ultimately see any of the bailout money going to GM. She said the company remains focused on completing its tender offers and becoming a bank holding company. "The auto aid package doesn't reference provisions for financing companies, but clearly we're encouraged that government recognizes the importance of the industry," she said.

Fritz Henderson, GM's president and chief operating officer, told reporters in Detroit that the automaker and GMAC are "on the same timetable but different paths." He said GM will do what's necessary to help GMAC's situation, but he declined to provide additional details. Henderson noted the importance of GMAC and said the automaker needs to resolve some significant issues involving it. GMAC warned last week that failure to convert to a bank holding company would have a "material adverse effect" on its business. And analysts have speculated that without financial help, the company could be forced to file for bankruptcy protection or shut down Residential Capital LLC, its money losing mortgage division.

A failure at GMAC, which is 51 percent owned by Cerberus Capital Management LP, could also spell disaster for GM itself, which owns the rest of the company. A GMAC bankruptcy filing could cut off financing to the about 85 percent of GM's North American dealers it does business with. GMAC hopes the debt exchange offer will result in the regulatory capital it needs to meet federal reserve requirements to become a bank holding company. GMAC has said it needs about 75 percent participation from bondholders in order to raise the needed capital. The most recent figures available, however, show that only about $16.9 billion, or 58 percent, of the GMAC notes had been tendered, along with about $3.5 billion, or 38 percent, of the notes issued by ResCap.

Bondholders who tendered their shares before the Friday deadline were eligible for incentive payments in the form of cash or the new notes. Those who tender shares after the deadline would not receive the incentive payments, which means most bondholders who ultimately tender their shares most likely did so before the deadline. The final deadline for the offer remains Dec. 26. Meanwhile, the future of Chrysler's financing arm, while not as dire as that of GMAC, is also uncertain. It's application for federal financial help also is pending. "We are optimistic that the U.S. Department of Treasury will take action soon to assist the domestic automotive finance industry," Chrysler Financial said in a statement. Last week, Chrysler Financial, which provides financing for 75 percent of Chrysler dealers, said it could be forced to temporarily suspend funding for dealer vehicle inventories if dealers keep pulling large amounts of their money out of an account used to fund those loans. The withdrawals, which have totaled $1.5 billion since July, have resulted in a drop in Chrysler Financial's wholesale capacity, leaving it with less funding to provide loans to dealers, the company said in a letter to dealers.

S&P downgrades 11 of world’s top banks
Eleven of the world’s biggest banks were downgraded Friday by Standard & Poor’s after the ratings agency said the current downturn could be longer and deeper than previously thought. Six major US banks were downgraded, including JPMorgan Chase, Bank of America and Wells Fargo, as well as five banks in Europe. The agency cut its ratings on Citigroup, Morgan Stanley and Goldman Sachs by two notches each. In Europe, S&P shaved one notch off the ratings of Barclays, Credit Suisse, Deutsche Bank, Royal Bank of Scotland and UBS. While the downgrades were driven in part by the worsening economic climate in the US and abroad, S&P noted specific causes for concern at each institution.

S&P analyst Tanya Azarchs said that, in addition to the economic woes, the banking sector’s "lax underwriting standards due to excess competition mean this cycle will be worse than prior cycles". UBS saw its rating fall from AA- to A+ as S&P highlighted the extremely high level of losses suffered by the Swiss bank since the start of the business cycle, reflecting "larger risk concentrations and weaker risk management than we had previously perceived". Deutsche Bank also saw its ratings lowered from AA- to A+ as S&P pointed out that it viewed asset quality "as likely to weaken materially and risk management to be weaker relative to risks". Barclays was downgraded from AA to AA- as S&P said that although Barclays had diversified its loan book many of its geographic exposures were in countries such as Spain and the UK, where it believed there was potential for a severe slowdown. S&P also singled out Barclays’ increased exposure to capital markets from the acquisition of the former businesses of Lehman.

The agency also downgraded Royal Bank of Scotland from AA- to A+, despite the £20bn of capital it has received from the UK government. It said the bank had been lossmaking in the first half and it expected earnings to remain severely under pressure. S&P also downgraded Goldman Sachs and Morgan Stanley, raising questions about the ability of both investment banks to thrive after their conversion to bank holding companies. But, of the two, S&P was more negative on the outlook for Morgan Stanley. "We view Morgan Stanley as very much in a turnaround mode and we do see somewhat more potential for further deterioration there than at Goldman Sachs," S&P credit analyst Scott Sprinzen said Friday.Bank of America’s acquisition of Merrill Lynch also raised concerns, particularly since Merrill could generate more writedowns in commercial real estate and leveraged loans. Despite BofA’s history of integrating companies it acquired, "the purchase of Merrill Lynch carries unique integration risk", the agency said.

Foreign Investors Trade Safe for Safest
As foreign investors pour cash into United States securities, particularly short-term Treasury bills, they are pulling it out of the higher-yielding bonds issued by the government supported-entities Fannie Mae and Freddie Mac. The moves appear to indicate that even after the government bailout of the two agencies, there is some lingering doubt that the government would actually stand behind their debts if their situation grew much worse. The Treasury Department reported this week that in October, overseas investors and governments were net sellers of $50 billion of agency securities, even though they yield significantly more than comparable Treasuries, which the investors bought at a record rate.

Over the summer, prices of agency securities fell as the financial crisis grew worse and some investors began to doubt whether the "implicit" government guarantee behind the agencies could be trusted. In July and August, foreigners were net sellers of $64 billion of such securities, an outflow unlike any previously seen. That flight was one reason the government stepped in on Sept. 7 to effectively nationalize the agencies, although shares remain publicly traded. At first investors seemed reassured, but the confidence has now waned. Despite the nationalization, the government has stopped short of putting its full faith and credit behind the bonds. The new data is the first indication that may have mattered to many overseas investors.

The accompanying chart at the top shows the monthly flows this year of foreign cash into Treasury securities and agency securities. More foreign money came into Treasuries in October — almost $91 billion — than in any previous month. Most of the money — $56 billion in October — has gone into Treasury bills rather than into longer-dated bonds and notes. That flow helped to push down interest rates on bills to historically low levels, sometimes even a bit below zero, as investors sought complete safety. Until the housing market began to show significant weakness in 2007, foreign flows into agency securities were running at almost $300 billion a year, and the flow stayed strong until the summer scare.

The other chart shows that over the 12 months through October, foreigners put just $65 billion into Fannie Mae and Freddie Mac, the lowest for any such period since 1998. Unless there was a revival of overseas interest in those securities in November and December, 2008 could become the first year to see net sales, at least since the data became available in the early 1990s. Until the late 1990s there was relatively little overseas investment in agency securities. But as the Clinton-era budget surpluses reduced the supply of available Treasuries, foreign investors discovered these investments, which seemed to be close substitutes. Even after large budget deficits resumed early this decade, the overseas demand for agencies continued to grow until questions about their solvency began to be heard. Now, virtually all the foreign money is going into Treasuries — at a rate of more than half a trillion dollars a year.

The Fed's Risky Backdoor Bailouts
As part of its effort to prop up the markets, the Fed is giving billions to banks—and putting taxpayers at risk. The U.S. Treasury Dept. has been blasted for handing out huge sums of money to banks without clear taxpayer safeguards or ground rules for the recipients. Yet the Federal Reserve is pouring trillions into banks with little transparency. The moves have helped to shore up the wobbly financial system in the short term. But some of the deals could end up hurting taxpayers, weakening the central bank, and weighing on the economy in the future. In one of its latest transactions, the Fed in November channeled $20 billion—more than the size of the proposed auto bailout—to a group of U.S. and European banks, including Société, Deutsche Bank, and Goldman Sachs, according to people familiar with the deals. The only evidence that the vast sum had changed hands was an entry on the Fed's most recent balance sheet called "Maiden Lane III" and a series of cryptic regulatory documents.

By making loans to financial institutions that can't get credit elsewhere, the Fed is the only part of the government that has the power to pump capital quickly into the financial system to stave off crisis. Historically such moves have been rare, and they've been made behind a curtain of secrecy on the thinking that public disclosure could spark a market panic. "We keep these transactions private because the Fed, as a lender of last resort, seeks to provide liquidity and not stigmatize those who seek it," says Calvin Mitchell, a spokesman for the New York branch of the Fed, which set up the Maiden Lane III transaction. The banks likely welcomed the fresh capital from Maiden Lane III. But in recent months the Fed has pushed the boundaries of its authority by taking larger and more opaque risks on its books. The central bank currently has $2.2 trillion in outstanding loans, up from $900 billion in September. It's also using new and untested weapons. Until this year the Fed mainly loaned to banks. Now it's buying securities, some tied to poisonous mortgages. If those bets don't pay off, the Fed will eat the loss.

That could spell trouble for taxpayers—and the economy. If the Fed's new deals don't work out and the losses are too great, the central bank may have to print more money, flooding the financial system with dollars. Inflation could surge, making it harder for the Fed to focus on other objectives, such as economic growth. "We have to wonder if the Fed's balance sheet might be in danger," says Roy C. Smith, a finance professor at New York University's Stern School of Business. "It is legitimate to ask the Fed to defend [its actions]." There are growing calls for more accountability of the government's far-flung bailout efforts. The Congressional Oversight Panel, which monitors how Treasury spends its $700 billion bailout pool, is closely watching the Fed's moves as well. Elizabeth Warren, the independent chair of the panel and a Harvard Law School professor, says that's because the Treasury's actions dovetail with those of the Fed. Warren recently met with Fed staff to discuss how the central bank spends taxpayer money. As part of the ongoing inquiry she is also looking at Treasury money that indirectly funded the Maiden Lane III deal. "There were good reasons the Fed was made independent of oversight," says Warren. But "these are not ordinary times, and the amount of money and intervention by the Fed is extraordinary."

The roots of Maiden Lane III can be traced to the Fed's rescue of troubled insurer American International Group in September. With AIG on the brink of collapse, the Fed and Treasury stepped in to prevent a meltdown of the financial system. Disentangling AIG from Wall Street has proved difficult, though, and the aid package has been expanded from $85 billion to more than $150 billion. To stabilize the banking system, the Fed decided to quarantine some of AIG's riskiest holdings. Especially worrisome: the tens of billions of dollars' worth of insurance AIG had sold to banks on toxic mortgage securities. If those mortgage securities continued to fall in value and AIG couldn't pay out on the insurance, known as credit default swaps, the banks would lose desperately needed capital. So the Fed created Maiden Lane III, an entity named after the location of the central bank's New York branch, to buy the assets from the banks and cancel the insurance. The Fed put in $15 billion of its own capital and took an additional $5 billion from AIG, which had received the money from Treasury. Maiden Lane used the $20 billion to purchase so-called collateralized debt obligations—the toxic mortgage securities that AIG had insured for banks—with a face value of $46 billion, paying 43¢ on the dollar. AIG also paid the banks $26 billion in insurance payouts on the CDOs.

The result: The banks were paid in full for securities that were virtually impossible to sell in the marketplace. That strengthened their balance sheets, helping them to better weather the financial crisis in recent weeks. "It certainly seems like it was a good deal for the [banks]," Maurice R. "Hank" Greenberg, former chairman and current major shareholder of AIG, wrote in a letter to AIG management. AIG and the banks declined to comment. But beyond the basic framework, little is public about Maiden Lane III. Société, Deutsche Bank, and Goldman Sachs received money, but the Fed didn't disclose how much each got. And the list of recipients is likely longer than those three banks. Nor does the Fed offer any clue about the composition of the 100 or so CDOs it now owns. An exhibit in a Dec. 2 regulatory filing by AIG provides most of the specifics, but AIG only makes public a heavily redacted version. The few known details about Maiden Lane III raise questions about the Fed's risk-taking. The central bank usually makes short-term loans that the borrower must repay within a few months. In this case, the Fed will recoup its capital on the CDOs only if the securities pay off or can be sold to outside investors. That's a dicey bet. Merrill Lynch sold similar securities last summer for just 22¢ on the dollar. Since then, the housing market on which they're based has deteriorated even further. The anxiety could grow if the central bank remains silent. "If the Fed doesn't want to give us the specifics, they should tell us something that makes us comfortable that they are properly capitalized and not presenting an undue risk to the financial system," says veteran Fed watcher Jim Bianco of Bianco Research. "The integrity of the Fed is in play here."

New Fed Role Undercuts its Regional Presidents
With the Federal Reserve's interest-rate target near zero, the central bank's regional bank presidents could exert even less sway than before. The Fed's shift toward establishing credit programs is forcing the central bank to reshape the role of its 12 regional policy makers. With plans to keep rates low for "some time," the Fed now must rely on tools other than interest rates to rescue the economy. The move could sidestep the Federal Open Market Committee -- a group including the reserve bank presidents that manages rates -- in favor of Fed leadership in Washington. Regional officials will continue to discuss policy behind closed doors with the Fed's seven-member Board of Governors as part of the FOMC. The 12-member panel includes a permanent vote for the New York Fed president and four rotating seats for the other regional bank presidents.

By law, the Federal Reserve Board in Washington -- not the FOMC -- has the power to lend directly to nonfinancial companies in "unusual and exigent circumstances." The Fed has invoked this authority for a host of emergency loans. It also has the power to create lending programs. Fed officials in Washington briefed regional bank presidents on such recent initiatives, including programs to support the housing and commercial-paper markets, but regional officials played almost no role in creating them.

One notable exception is the New York Fed president because the programs are tied to financial institutions in that Fed district. The divide led some regional officials to raise questions publicly about the Fed's actions. One of the sharpest critics, Richmond Fed President Jeffrey Lacker said in a June speech that the central bank's credit programs "might induce greater risk taking" and "in turn could give rise to more frequent crises, in which case it might be difficult to resist further expanding the scope of central-bank lending." Mr. Lacker will be a voter on the FOMC next year.

Up to 40% of buy-out groups could fail
The deepening economic crisis could see up to 40 per cent of private-equity firms go out of business within the next three years as their portfolio companies default on debts, according to one of the darkest outlooks for the industry yet published. The Boston Consulting Group and Spain’s IESE Business School are predicting that, while 30 per cent of buy-out groups seem certain to survive the crisis, between 20 and 40 per cent of the world’s largest funds will fail. They based their predictions on publicly available data for private-equity firms, portfolio companies, banks and credit default swap rates, and their own analysis of loan trading levels and default probabilities. The stark warning comes just a day after SVG Capital, the biggest investor in European buy-out fund Permira, raised £200m ($297m) in a share sale and cut investments in the private-equity firm by more than half to bolster its balance sheet as deteriorating market conditions reduced the value of its investments.

Multiples of earnings before interest, tax, depreciation and amortisation have collapsed, intensifying the negative outlook for the industry. Between 2003 and the end of 2007, multiples grew by 41 per cent in the US and by 43 per cent in Europe. "Private-equity firms were able to earn a good return from this appreciation without having to improve their portfolio companies," said Prof Heinrich Liechtenstein of IESE. "But in 2008, the 45 per cent drop in valuations has changed the situation dramatically, pushing multiples below the level of the previous three to four years." The shakeout in the industry will also be driven by the next fundraising round.

The climate for fundraising has already deteriorated rapidly as turmoil in the credit markets has forced investors to pull back sharply from the sector. The authors are also predicting rising defaults for buy-outs. Investors who over-committed during the boom, when cash flowed back fast from buy-outs, are struggling to meet commitments as the flow of cash dries up. Any debt with a credit spread in excess of 1,000 basis points is considered distressed with a high expectation the company will default within the next three years. They analysed the credit spreads of 328 portfolio companies in November and found that about 60 per cent of buy-out debt was trading at distressed levels. "This suggests almost 50 per cent of these companies could default during the next three years. With profits deteriorating that number could grow," Mr Liechtenstein said.

Harvard’s top money managers paid $26.9 million for losing $ 8.1 billion
Harvard, the world’s wealthiest university, said on Friday it paid six senior investment officers a combined $26.9m (£17.5m) this year to manage its endowment. The fund has lost $8.1bn since the summer. The Harvard endowment earned 8.6 per cent during the last fiscal year but has since taken a big hit. Drew Gilpin Faust, Harvard’s president, said in a letter to university deans this month that the endowment lost about 22 per cent of its value between June 30 and the end of October, bringing it from $36.8bn to roughly $28.7bn.  tephen Blyth, who oversees Harvard’s international fixed-income investments, was the highest paid with $6.4m. Marc Seidner, in charge of domestic fixed-income investments, received $6.3m. Stanley Zuzic, domestic stock investment manager, picked up $4.9m and Steven Alperin, head of emerging market stocks, got $4.4m. Andrew Wiltshire, who manages natural resource investments, was paid $3.9m. Mohamed El-Erian, who left as president of Harvard Management at the end of 2007, received $921,000.

As a non-profit organisation, the university is legally required to identify publicly its most highly paid employees. The pay-outs have attracted criticism from some Harvard alumni who balk at money managers earning more than the university’s president and faculty members. They argue that multimillion dollar salaries are inappropriate for an educational institution. But pay has declined recently as the university outsourced more of its money management. “The Harvard Management Company has a long history of outstanding management,” said James Rothenberg, the chairman of Harvard Management Company and the university’s treasurer.  “In the recent economic environment, we are fortunate to have the talented investment professionals at HMC, shepherding the university’s resources through the volatility and uncertainty in the markets.”  The endowment funds about 35 per cent of Harvard’s annual operating budget. The university is preparing for a 30 per cent reduction in its endowment by the end of the year.

No questions asked
Looking down on a sunlit Manhattan skyline from the seaplane carrying him to work, Bernard Madoff must have felt on top of the world. In the late 1980s, when his morning routine involved a short hop from Long Island to the East River, a stone’s throw from his office in New York’s financial district, Mr Madoff was just another successful Wall Street operator. A prominent member of the securities industry with deep ties to the wealthy Jewish community that divides its time between New York and Florida, Mr Madoff had an otherwise fairly ordinary lifestyle and could have been forgiven the extravagant touch of an aerial commute. But after last week, when US prosecutors say he confessed to what could be the largest fraud ever perpetrated, nothing will ever be ordinary again for the 70-year-old Mr Madoff.

There will be no more seaplanes after a court ordered Mr Madoff to submit to electronic monitoring and remain in his Manhattan duplex daily from 7pm to 9am. Gone, too, is the adulation of the rich investors who used to beg "Bernie" to take their money – replaced by the shock and pain of huge financial losses and betrayal of trust. As details begin to emerge of a "Ponzi scheme" that is alleged to have swindled up to $50bn (£33bn, €36bn) from investors ranging from HSBC, the giant UK bank, to the charity of Steven Spielberg, the film director, one central question remains unanswered. How could Bernie have duped so many investors for so long? Those who met Mr Madoff during a career that began in 1960, when he founded his securities firm with $5,000 earned installing garden sprinklers and patrolling Long Island beaches, talk of a private, self-effacing man. "The last thing Bernie Madoff wanted was publicity," says one of his fellow travellers on the East River seaplane.

Affable and polite but not overly talkative, Mr Madoff was active on the social and charity scenes in Manhattan and Palm Beach – the Florida town that serves as an escape hatch for rich New Yorkers. Yet despite his wealth – he owns a yacht and houses in Palm Beach and Cap d’Antibes in France as well as his Upper East Side apartment – Mr Madoff did not stand out from the crowd of well-off middle-aged people with whom he socialised. "He was low-key," recalls Charles Gradante, a hedge fund adviser who met him regularly on the Palm Beach social circuit. "When I saw him at cocktail parties, he would be in the corner and investors would sometimes go over to him. He didn’t have a charismatic presence; he wasn’t exuding confidence." Senio Figliozzi, owner of the Everglades Barber Shop in Palm Beach, cut his hair and gave him facials, manicures and pedicures for 17 years but rarely heard him talk about business. He describes Mr Madoff as a "very nice man who was always polite and gentlemanly" and tipped the standard 20 per cent.

But behind that everyman persona, Mr Madoff weaved a complex web of connections that lured more and more investors into his fold. Ponzi schemes – pyramid arrangements named after the Italian immigrant to the US who first attempted the scam in the 1920s – are relatively unsophisticated frauds in which the organisers repay old investors not with genuine gains but with funds from new investors. Investigators allege that Mr Madoff’s was in operation from at least 2005. If he did indeed craft one, there were no outward signs when, more than a decade ago, Mr Madoff added an investment firm to his brokerage house and later moved to the tall, thin midtown skyscraper known as the Lipstick Building. With a reputation as a leading market-maker – the middle-man between buyers and sellers – on Nasdaq, the stock market he chaired for a few years, Mr Madoff was not unusual in moving from broking to investing.

Nor did it seem strange that, as a self-made man of a certain standing in the Jewish community, Mr Madoff’s should tap his friends and acquaintances in New York society and Palm Beach’s exclusive Country Club. To be sure, Mr Madoff did not move in the top circles of American social life – the parties dominated by film celebrities, tycoons such as Donald Trump or super-rich donors such as Sandy Weill, the former Citigroup chief. His was a more intimate, less flashy group, according to David Patrick Columbia, the editor of – a tightly-knit community centred on Upper East Side synagogues and charitable organisations. Many of these pious, often elderly, people looked to increase their retirement nest-eggs without taking too many risks and thought they had found the holy grail in Mr Madoff’s enviable record: he consistently beat other fund managers and the market, year after year.

"This is a community of affluent Jewish people who basically socialise with each other. They are very philan?thropic and all support each other’s charities," Mr Columbia says. "Even though Mr Madoff was not a top member of this community, his business made him the man to know. He became an icon of financial success for them." But after a few years, word of Mr Madoff’s ability to generate steady returns, by employing a seemingly simple strategy of buying shares in large companies and selling options on the same names to mitigate risk, began spreading beyond his inner circle. Yet as more and more people wanted in on Mr Madoff’s outstandingly consistent performance, he played it cool. "He never pushed investing with him: he would turn people away sometimes or tell them, ‘it is not for you’, recalls Mr Gradante. "That all added to the mystique and made people want to get in."

Barbara Rosenthal, a Palm Beach property agent, says Mr Madoff’s standing was such that people felt "you had to be lucky for him to talk to you", while another resident recalls that many people joined the Country Club "so they could meet this guy". Experts on "affinity frauds" say the strong demand for Mr Madoff’s services – and the fact that many investors were coming in through "friends" – had a crucial consequence: those who did get in felt they had a special deal and were less inclined to ask questions. But as the friends and family network became inadequate to satisfy investors’ craving for a piece of Mr Madoff’s miraculous returns, an informal marketing system began to take shape. In Palm Beach, one of the main middlemen for Mr Madoff’s business was Robert Jaffe, according to several investors. Dapper and well-spoken, Mr Jaffe got a number of individuals and charities to place their money with Bernard Madoff Investment Securities. Mr Jaffe is the son-in-law of Carl Shapiro, founder of the Kay Windsor clothing company and a renowned Boston philanthropist. Mr Shapiro’s foundation is believed to have lost nearly half of its $345m in assets and both he and his family are thought to have suffered significant losses as a result of the collapse of Mr Madoff’s firm. There is no suggestion that either Mr Jaffe or any members of his family knew about Mr Madoff’s alleged fraud. A spokeswoman for Mr Jaffe did not return calls.

As the years went by without any sign of a dip in performance, the tentacles of Mr Madoff’s operations began stretching beyond Palm Beach’s manicured lawns and Manhattan’s skyscrapers. The long list of potential victims of his alleged actions includes Swiss and Austrian private banks, hedge funds owned by large insurance companies such as MassMutual’s Tremont Capital Management, as well as famous names such as Fred Wilpon, owner of the New York Mets baseball team. Other high-profile investors, such as Mr Spielberg’s Wunderkinder foundation and several charitable organisations that now face ruin, went in through the more traditional route of their long-standing financial advisers. Some of the funds that fed international money into Mr Madoff’s operation were run by well-known financiers such as Walter Noel, the founder of Fairfield Greenwich Group. A Harvard-educated former banker, Mr Noel had the ability to reach investors around the globe, partly thanks to the help of Andres Piedrahita, a well-connected banker who is Mr Noel’s son-in-law and runs Europe and Latin America for Fairfield. Fairfield, which is the largest potential victim of Mr Madoff’s alleged fraud with some $7.5bn invested in his firm, declined to comment.

Ascot Partners, a hedge fund run by Ezra Merkin, also chairman of GMAC, General Motors’ former finance arm now owned by Cerberus, the private equity group, was also an active recruiter of funds for Mr Madoff’s enterprise. Ascot and Mr Merkin could not be reached. The "feeder funds", whose returns were augmented by billions of dollars in loans from banks such as HSBC and Royal Bank of Scotland, had a powerful incentive to persuade investors to place money with Mr Madoff: lucrative returns. He forwent the standard 20 per cent cut on profits demanded by most fund managers and, by and large, charged feeder funds only commissions on trades. Crucially, not many of the investors appear to have challenged that unusual structure, let alone Mr Madoff’s suspiciously good returns over the years.

Those who did were less than impressed with Mr Madoff’s answers. Jim Hedges, an asset manager, said that when they met in the late 1990s, Mr Madoff was unable to explain his winning strategy. "He made little conversation – he looked interested in ending the meeting as soon as possible," says Mr Hedges, who decided against investing. Another hedge fund expert recalls that he once approached Mr Madoff at a party and quipped that his performance was too good to be true. Mr Madoff chuckled and replied: "A lot of people say that." Now, as investors contemplate the ruins of the financial edifice he built, the tragedy is that among that "lot of people", so few paused to ask themselves why.

Madoff promises to open books for SEC by new year
Bernard Madoff, the broker accused of perpetrating a $50bn fraud, is to provide regulators with "a verified written accounting" of his firm’s records by New Year’s Eve, according to a court document. As the list of victims of the alleged fraud continued to mount, Mr Madoff also agreed to an extension of the court orders that have frozen his assets and put his firm, Bernard L. Investment Securities, into receivership. Mr Madoff is to provide the accounting of his firm’s records by December 31, including all assets, liabilities, property, bank accounts, brokerage accounts, investments, business interests, loans and lines of credit, according to court order signed by a judge late on Thursday. The agreement with the US Securities and Exchange Commission, which is conducting the civil case into Mr Madoff’s alleged "Ponzi" scheme, led to the cancellation of a hearing scheduled for yesterday. A federal court froze the assets of Mr Madoff’s firm last week.

Mr Madoff, who also faces a criminal charge of securities fraud, is free on $10m bail. He was this week placed under home detention in his Manhattan home after he was unable to meet some of his original bail conditions. He appeared unable to find enough co-signers for the $10m bond secured on his $7m Manhattan apartment, prosecutors said. Yesterday, the court- appointed trustee and other examiners from the Securities Investor Protection Corporation – a body set up by Congress to help investors in failed brokerages – were continuing to compile a list of alleged victims. Stephen Harbeck, president of SIPC, said Mr Madoff had left behind a trail of "falsified" and "unreliable" records, and it could take at least six months to "get a handle" on the situation, while the entire liquidation process – including collection of any remaining assets – could take "several years". Mr Madoff kept "several sets" of books and false documents and provided false information involving his advisory activities, according to Christopher Cox, SEC chairman, who this week admitted the regulator had not responded to "credible and specific allegations" of alleged wrongdoing dating back to 1999.

While investigators from the SEC and the federal prosecutor’s office pored through records at Mr Madoff’s Manhattan office yesterday, many questions remained unanswered, including whether others had knowledge of his activities or helped him in the alleged fraud. According to the complaints filed against him, Mr Madoff told senior employees, who are also his sons, the scheme was one big "lie". Mark and Andrew Madoff have said through their lawyer that they were "not involved in the asset management business, and neither had any knowledge of the fraud before their father informed them of it". "The brothers were among the many victims of this scheme and will continue to co-operate fully with the US attorney and the SEC," their lawyer has said.

Mr Madoff’s wife was ordered this week to surrender her passport and put up her properties in Montauk, New York, and Palm Beach, Florida, to secure the bond as part of the modified bail conditions for Mr Madoff. She was one of two bondsignatories. The number of co-signers was reduced from four this week. The other was Mr Madoff’s brother, Peter, who worked at the firm as a senior executive. Frank DiPascali, a Madoff official, has hired an attorney, Marc Mukasey, who said yesterday: "We are trying to sort through the facts like everybody else." He declined to comment further.

Madoff Scheme Kept Rippling Outward, Across Borders
By the end, the world itself was too small to support the vast Ponzi scheme constructed by Bernard L. Madoff. Initially, he tapped local money pulled in from country clubs and charity dinners, where investors sought him out to casually plead with him to manage their savings so they could start reaping the steady, solid returns their envied friends were getting. Then, he and his promoters set sights on Europe, again framing the investments as memberships in a select club. A Swiss hedge fund manager, Michel Dominicé, still remembers the pitch he got a few years ago from a salesman in Geneva. "He told me the fund was closed, that it was something I couldn’t buy," Mr. Dominicé said. "But he told me he might have a way to get me in. It was weird." Mr. Madoff’s agents next cut a cash-gathering swath through the Persian Gulf, then Southeast Asia. Finally, they were hurtling with undignified speed toward China, with invitations to invest that were more desperate, less exclusive. One Beijing businessman who was approached said it seemed the Madoff funds were being pitched "to anyone who would listen."

The juggernaut began to sputter this fall as investors, rattled by the financial crisis and reaching for cash, started taking money out faster than Mr. Madoff could bring fresh cash in the door. He was arrested on Dec. 11 at his Manhattan apartment and charged with securities fraud, turned in the night before by his sons after he told them his entire business was "a giant Ponzi scheme." The case is still viewed more with mystery than clarity, and Mr. Madoff’s version of events can only be drawn from statements attributed to him by federal prosecutors and regulators as he has not commented publicly on the case. But whatever else Mr. Madoff’s game was, it was certainly this: The first worldwide Ponzi scheme — a fraud that lasted longer, reached wider and cut deeper than any similar scheme in history, entirely eclipsing the puny regional ambitions of Charles Ponzi, the Boston swindler who gave his name to the scheme nearly a century ago.

"Absolutely — there has been nothing like this, nothing that we could call truly global," said Mitchell Zuckoff, the author of "Ponzi’s Scheme: The True Story of a Financial Legend" and a professor at Boston University. These classic schemes typically prey on local trust, he added. "So this says what we increasingly know to be true about the world: The barriers have come down; money knows no borders, no limits." While many of the known victims of Bernard L. Madoff Investment Securities are prominent Jewish executives and organizations — Jeffrey Katzenberg, the Spitzers, Yeshiva University, the Elie Wiesel Foundation and charities set up by the publisher Mortimer B. Zuckerman and the Hollywood director Steven Spielberg — it now appears that anyone with money was a potential target. Indeed, at one point, the Abu Dhabi Investment Authority, a large sovereign wealth fund in the Middle East, had entrusted some $400 million to Mr. Madoff’s firm.

Regulators say Mr. Madoff himself estimated that $50 billion in personal and institutional wealth from around the world was gone. It vanished from the estates of the North Shore of Long Island, from the beachfront suites of Palm Beach, from the exclusive enclaves of Europe. Before it evaporated, it helped finance Mr. Madoff’s coddled lifestyle, with a Manhattan apartment, a beachfront mansion in the Hamptons, a small villa overlooking Cap d’Antibes on the French Riviera, a Mayfair office in London and yachts in New York, Florida and the Mediterranean. Just as the scheme transcended national borders, it left local regulators far behind. Its lies were translated into a half-dozen languages. Its larceny was denominated in a half-dozen currencies. Its warning signals were missed by enforcement agencies around the globe. And its victims are now scattered from Hollywood to Zurich to Abu Dhabi. Indeed, while the most visible pain may be local — an important charity forced to close, an esteemed university embarrassed, a fabric of community trust shredded — the clearest lesson is universal: When money goes global, fraud does too.

In 1960, as Wall Street was just shaking off its postwar lethargy and starting to buzz again, Bernie Madoff (pronounced MAY-doff) set up his small trading firm. His plan was to make a business out of trading lesser-known over-the-counter stocks on the fringes of the traditional stock market. He was just 22, a graduate of Hofstra University on Long Island. By 1989, Mr. Madoff ‘s firm was handling more than 5 percent of the trading volume on the august New York Stock Exchange, and Financial World magazine ranked him among the highest-paid people on Wall Street — along with two far more famous financiers, the junk bond king Michael Milken and George Soros, the international investor. And in 1990, he became the nonexecutive chairman of the Nasdaq market, which at the time was operated as a committee of the National Association of Securities Dealers. His rise on Wall Street was built on his belief in a visionary notion that seemed bizarre to many at the time: That stocks could be traded by people who never saw each other but were connected only by electronics. In the mid-1970s, he had spent over $250,000 to upgrade the computer equipment at the Cincinnati Stock Exchange, where he began offering to buy and sell stocks that were listed on the Big Board. The exchange, in effect, was transformed into the first all-electronic computerized stock exchange.

"He was one of the early innovators," said Michael Ocrant, a journalist who has been a longtime skeptic about Mr. Madoff’s investing success. "He was known to promote the idea that trading would be going electronic — and that turned out to be true." He also invested in new electronic trading technology for his firm, making it cheaper for brokerage firms to fill their stock orders. He eventually gained a large amount of business from big firms like A. G. Edwards & Sons, Charles Schwab & Company, Quick & Reilly and Fidelity Brokerage Services. "He was really a low-key guy. No one knew him outside of the sphere of market makers and people in the trading and brokerage business," said Richard B. Niehoff, who was president of the Cincinnati exchange in the mid-1980s. Mr. Madoff’s push to modernize trading did not make him popular with the traditional traders on the floor of the New York Exchange, as more of its orders were sent to his firm — partly because he was faster and cheaper, but also because he paid for those orders. Mr. Madoff pioneered a controversial practice called "payment for order flow." He would pay big players like Fidelity and Schwab to send their customer orders to his firm instead of to the New York Exchange or other regional exchanges.

The floor traders at those traditional exchanges claimed he was, in essence, paying bribes and that brokers steering business to him were not really getting the best prices for their customers. Those complaints led to Congressional hearings, but Mr. Madoff made no apologies. He insisted the order-flow payments were necessary to inject greater competition into the marketplace and reduce the near monopoly of the Big Board. As the debate received more attention, Mr. Madoff became increasingly better known in the financial world. By the end of the technology bubble in 2000, his firm was the largest market maker on the Nasdaq electronic market, and he was a member of the Securities Industry Association, now known as the Securities Industry and Financial Markets Association, Wall Street’s principal lobbying arm. Still, one Wall Street heavyweight who knew him in those days said he remained "a self-effacing kind of guy," more likely to spend time on the Riviera than at parties with other traders.

Unlike some prominent Wall Street figures who built their fortunes during the heady 1980s and ’90s, Mr. Madoff never became a household name among American investors. But in the clubby world of Jewish philanthropy in the New York area, his increasing wealth and growing reputation among market insiders added polish to his personal prestige. He became a generous donor, then a courted board member and, finally, the money manager of choice for many prominent regional charities. A spokeswoman for the New York Community Trust, Ani Hurwitz, recalled a Long Island couple who asked the trust in 1994 to invest their proposed $20 million fund with Mr. Madoff. "We have an investment committee that oversees all investments, and they couldn’t get anything out of him, no information, nothing," Ms. Hurwitz said. "So we told the donors we wouldn’t do it." But many charities did entrust their money to Mr. Madoff, to their eventual grief. The North Shore-Long Island Jewish Health System, for instance, reported that it had lost $5.7 million on an investment with Mr. Madoff that was made at the donor’s behest. (That donor has pledged to cover the loss for the hospital system, its spokesman said.)

Other groups saw the handsome returns on those initial investments and put more of their money into Mr. Madoff’s firm, their leaders said. "Look, for years we made money," one said. Most successful business executives intertwine their personal and professional lives. But those two strands of Mr. Madoff’s life were practically inseparable. He sometimes used his 55-foot fishing boat, Bull, as a floating entertainment center for clients. He used his support of organizations like the Public Theater in Manhattan and the Special Olympics to build a network of trust that began to stretch wider and deeper into the Jewish community. Through friends, the Madoff network reached well beyond New York. At Oak Ridge Country Club, in suburban Hopkins, Minn., known for a prosperous Jewish membership, many who belonged were introduced to the Madoff firm by one of his friends, Mike Engler. The quiet message became familiar in similar pockets of Jewish wealth and trust: "I know Bernie. I can get you in." Mr. Engler died in 1994, but many Oak Ridge members remained clients of Mr. Madoff. One elderly member, who said he was too embarrassed to be named, said he had lost tens of millions of dollars, and had friends who had been "completely wiped out." Dozens of now-outraged Madoff investors recall that special lure — the sense that they were being allowed into an inner circle, one that was not available to just anyone. A lawyer would call a client, saying: "I’m setting up a fund for Bernie Madoff. Do you want in?" Or an accountant at a golf club might tell his partner for the day: "I can make an introduction. Let me know."

Deals were struck in steakhouses and at charity events, sometimes by Mr. Madoff himself, but with increasing frequency by friends acting on his behalf. "In a social setting — that’s where it always happened," said Jerry Reisman, a lawyer from Garden City, N.Y., who knew Mr. Madoff socially. "Country clubs, golf courses, locker rooms. Recommendations, word of mouth. That’s how it was done." At exclusive retreats like the Palm steakhouse in East Hampton, Mr. Madoff would work the tables or receive friends at his own, building a following that came to include lawyers, doctors, real estate developers and accountants. Tomas Romano, a manager at the Palm, recalled that "people always came to talk with him" at the restaurant. "He was very well known." At his golf clubs — the Atlantic in Bridgehampton and the Palm Beach Country Club in Florida, for example — he frequently shot in the 80s, but often seemed far more interested in his fellow members, many of whom became investors, than in the game itself. With his wife, Ruth, a nutritionist and cookbook editor, they were considered affable and charming people. "They stood out," Mr. Reisman said. "Success, philanthropy, esteem — and, if you were lucky enough to be with him as an investor, money." He added: "That was the most important thing; he was looked on as someone who could make you money. Really make you money."

By the mid-1990s, as Mr. Madoff’s wealth and social standing grew, he had moved far beyond the days when golf-club buddies were setting up side deals to invest with him through their lawyers and accountants. Some of the most prominent Jewish figures in high finance and industry began to court Bernie Madoff — and, through them, he reached a new orbit of wealth. He could not have had a more effective recruiter than Jacob Ezra Merkin, a lion of Wall Street who would be president of the Fifth Avenue Synagogue. Mr. Merkin’s father, Hermann, was the founding president of the synagogue and Herman Wouk, the author, wrote its constitution. As a direct descendant of the founder of modern Orthodox Judaism and a graduate of Columbia’s English department and Harvard’s law school, Mr. Merkin easily held his own in a congregation that included such luminaries as the author Elie Wiesel, the deal maker Ronald O. Perelman and Ira Rennert, a wealthy financier perhaps best known for building one of the biggest houses and compounds in the Hamptons. Mr. Merkin was fluent in Jewish and secular studies, as comfortable quoting Psalms as William James. In 1985, after a few years of practicing law at a top-tier firm, now known as Milbank, Tweed, Hadley & McCloy, he started the investment firm that would become Gabriel Capital Group. He contributed to a popular textbook on investing, lived in an art-filled Park Avenue apartment and continued his family’s legacy of generosity.

Philanthropies embraced him. He headed the investment committee for the UJA-Federation of New York for 10 years and was on the boards of Yeshiva University, Carnegie Hall and other nonprofit organizations. He became the chairman of GMAC. Installed in these lofty positions of trust, Ezra Merkin seemed to be a Wall Street wise man who could be trusted completely to manage other people’s money. One vehicle through which he did that was a fund called Ascot Partners. It was one of an unknown number of deals that prominent financial figures set up in recent years and marketed to investors, who thought they were tapping into the acumen of some Wall Street titan, like Mr. Merkin. As it turned out, their money wound up in the same place — in Bernie Madoff’s hands. These conduits began to steer billions of dollars into the Madoff operation. They operated below the financial radar until Mr. Madoff’s scheme collapsed, when investors suddenly got letters from the sponsoring titan disclosing that all or most of their money was probably gone. Ascot itself attracted $1.8 billion in investments, almost all of which was entrusted to Mr. Madoff. New York Law School put $3 million into Ascot two years ago, and has now initiated a lawsuit in federal court that accuses Mr. Merkin of abdicating his duties to the partnership.

Mortimer Zuckerman, the billionaire owner of The Daily News, rebuked Ascot in a televised interview, saying he had been misled about what Mr. Merkin had done with some $30 million from Mr. Zuckerman’s charitable foundation. Behind a wall of lawyers, Mr. Merkin did not take calls this week. In the "Dear Limited Partner" letter he sent on Dec. 11, he noted that he, too, was one of Mr. Madoff’s victims and suffered big losses alongside his investors. He has taken steps to wind down his Ascot, Gabriel and Ariel funds. Still, some of his clients are stunned, and angry, to learn what Mr. Merkin did with their millions, while collecting an annual management fee of 1.5 percent of the assets for his services. But before the losses and the outraged cries of betrayal, this was a heady way to steer money into an operation that has now been branded, by its own architect, as a Ponzi scheme. And nothing illustrates what a quantum leap it was for Mr. Madoff than the connections that led Tufts University to entrust him with $20 million in 2005. Tufts did not actually send a check to Bernard L. Madoff Investment Securities. Rather, it invested in Ascot Partners, Mr. Merkin’s partnership. Mr. Merkin had been a major investor in a company whose board included James A. Stern, the chairman of the Tufts investment committee and a principal in a major private investment firm in New York called the Cypress Group. Behind these veils of paperwork and partnerships, Mr. Madoff’s reach now extended into the top tiers of Jewish finance and philanthropy, where he rubbed shoulders with corporate directors and prominent hedge fund managers. But there were wider worlds to conquer.

Walter M. Noel was the courtly public face of the Fairfield Greenwich Group, the investment firm he started in 1983. A native of Tennessee, Mr. Noel had spent time at larger firms, notably at Chemical Bank, where he headed its international private banking practice, before setting out on his own. From the beginning, the Noel family was built on access to prestigious social circles. Mr. Noel’s wife, Monica, was part of the prominent Haegler family of Rio de Janeiro and Zurich, and their daughters would marry into international families that provided additional connections for the firm. In 1989, Mr. Noel merged his business with a small brokerage firm whose general partner was Jeffrey Tucker, a longtime New Yorker who had a law degree from Brooklyn Law School and a résumé that included eight years with the enforcement division of the Securities and Exchange Commission. Again and again, this pedigreed experience was emphasized by Fairfield as it built itself into a fund of funds, investing in other hedge funds. It boasted to its prospects that its investigation of investment options was "deeper and broader" than those of most firms because of Mr. Tucker’s experience in the regulatory ranks.

Though he is not nearly as prominent as the Noels, who move in the forefront of Connecticut society, Mr. Tucker benefited just as much from Fairfield’s success. Indeed, last year he led a coalition of thoroughbred racing interests that sought to bid for New York State’s horse-racing franchise. But it was Mr. Tucker who introduced Fairfield to Mr. Madoff. In the early 1990s, Fairfield began placing money with him, according to George L. Ball, the former president of E. F. Hutton and Prudential-Bache chief executive who knows Mr. Noel socially. That began a long partnership that helped the Fairfield firm earn enviably steady returns, even in down markets — and that lifted Mr. Madoff into a global orbit, one that soon extended his reach into some of the most fabled banking centers of Europe. If the wealthy Jewish world he occupied was his launch pad, the wealthy promoters he cultivated at Fairfield Greenwich were his booster rocket. The Fairfield Sentry fund was one of several so-called feeder funds that became portals through which money from wealthy foreign investors would could capitalize on Mr. Madoff’s investment prowess — collecting those exclusive, steady returns that had made him the toast of Palm Beach and the North Shore so many years ago.

The Sentry fund quickly became Fairfield’s signature product, and it boasted of stellar returns. In marketing materials, Fairfield trumpeted Sentry’s 11 percent annual return over the last 15 years, with only 13 losing months. It was a track record that grew increasingly attractive as markets grew more volatile in recent years. Though Fairfield Greenwich has its headquarters in New York City and its founder, Mr. Noel, operated from his hometown, Greenwich, Conn., a recent report showed that foreign investors provided 95 percent of its managed assets — with 68 percent in Europe, 6 percent in Asia, and 4 percent in the Middle East. Friends and associates say that Mr. Noel’s sons-in-law spent much of their time marketing the firm’s funds in either their home countries or regions where they had their own family connections. One of his most visible representatives was Andrés Piedrahita, a Colombian who had married Mr. Noel’s eldest daughter, Corina, and was eventually named a Fairfield founding partner. Based in Madrid and London, Mr. Piedrahita became one of the firm’s most visible representatives in the world of European banking and investment. But his brothers-in-law also had international roots. Yanko Della Schiava, who married Lisina Noel, was the son of the editor of Cosmopolitan in Italy and of the editor of Harper’s Bazaar in Italy and France. Philip J. Toub, who married Alix Noel, is the son of a director of the Saronic Shipping Company, in Lausanne, Switzerland.

Matthew Brown, who married Marisa Noel, is the son of a former mayor of San Marino, Calif. All three joined Fairfield, eventually becoming partners in marketing. Thanks to the efforts of Mr. Piedrahita, Mr. Della Schiava and others, Fairfield reaped many millions of dollars in investor capital from Europe. The firm set up feeder programs with institutions like Banco Santander, Swedish Bank Nordea and Banque Benedict Hentsch. All became conduits that carried fresh money to Mr. Madoff. Among his new investors were the Mugrabis, extremely wealthy art collectors from Colombia who have lived in New York for more 20 years. It was their longtime friendship with Mr. Piedrahita that led them to invest in the Sentry fund. "We had very little money with the fund — just under a million dollars — so I am not that upset personally," said Alberto Mugrabi, a son of the family patriarch. "It was a very informal thing. We know Andrés since forever, from Bogotá, he’s a great guy, and he says to us, ‘This is the Madoff thing, he’s the master.’" He added: "I trusted Andrés. I still trust him."

Mr. Madoff’s higher profile in the highly competitive world of hedge fund management intensified the skepticism about his remarkably consistent returns. Rival money managers complained that when they sought to replicate his trading strategy based on the statements the Madoff firm sent its clients, they found it wasn’t possible. There was a scattering of inconclusive regulatory investigations — efforts so unavailing that the chairman of the S.E.C. in Washington has ordered an internal investigation to determine how the agency could have missed so many red flags and ignored so many credible complaints over the years. But foreign regulators were not any quicker to notice Mr. Madoff’s oddities — or the rapidly expanding pool of money entrusted to the various feeder funds he serviced. There was the small Austrian merchant bank, Bank Medici, which had $2.1 billion invested in funds that ultimately wound up under Mr. Madoff’s control. It collected those investments through two main funds, the Herald USA Fund and the smaller Herald Luxemburg Fund, sold to banks, insurance companies and pension funds since 2004. The funds, which were closed for private investors, were incredibly popular among investors and no questions were ever asked about its constant returns of about 7 percent, said a former employee at the bank who declined to be identified because he is not authorized to talk to the news media.

Bank Medici sold the funds to investors around the world from its offices in New York, Vienna, Gibraltar, Zurich and Milan. About 93 percent of the funds’ investors are outside Austria. Just last month, the Herald USA fund won Germany’s annual Hedge Fund Awards for "proving consistency in turbulent times." Peter Scheithauer, chief executive of Bank Medici since September, accepted the award, saying Bank Medici’s products "should represent mainly one thing: security and returns in good as well as bad times." But as he prepared to brief his management board on potential losses connected to the Madoff investments on Friday, he sounded downbeat. "It’s a real tragedy," Mr. Scheithauer said. "It’s not just us, it’s so many other people as well. If only we knew, but he was paying out fine until just recently." Bank Austria, which is now owned by UniCredit of Italy, owns a stake in Bank Medici and also wound up investing with Mr. Madoff through a range of different funds offered under the name Primeo by its hedge fund unit, Pioneer Alternative Investments.

Mr. Madoff was not a well-known presence on the social circuit in Switzerland. Instead, Swiss money managers would go to him, visiting his offices in the Lipstick Building in Midtown Manhattan. Seeing Mr. Madoff there was a bit like visiting the Wizard of Oz: despite his unerring success in generating smooth returns, he seemed quite ordinary, lacking the flamboyance of other well-heeled money managers. "He did not look like a huge spender; seemed like a family man," said one veteran Geneva banker, whose firm had money with Mr. Madoff but insisted on anonymity because of the likelihood of lawsuits from angry clients. "He talked about the markets." The only thing that struck the Swiss banker as odd was the bull memorabilia strewn about his office. "It seemed strange for a guy to have all these bulls, little sculptures, paintings of bulls," he recalled. "I’ve seen offices with bears. This was bulls." But the aura of exclusivity was the constant, he said. "This was the usual spiel: ‘It’s impossible to get in, but we can get you some if you’re nice.’ He made it look difficult to get into."

What began as a quietly coveted investment opportunity for the lucky few in the Jewish country clubs on Long Island became, in its final burst of growth, a thoroughly global financial product whose roots were obscured behind legions of well-dressed, multilingual sales representatives in the financial capitals of Europe. Indeed, often with the assistance of feeder funds, Mr. Madoff was now in a position to seek and procure money from Arab investors, too. The Abu Dhabi Investment Authority, one of the largest of the world’s sovereign wealth funds, with assets estimated earlier this year to be approaching $700 billion, wound up in the same boat as Jewish charities in New York: caught in the collapse of Bernie Madoff. In early 2005, the investment authority had invested approximately $400 million with Mr. Madoff, by way of the Fairfield Sentry Fund, according to a profile of the firm that it prepared for a prospective buyer in 2007. Fairfield Sentry had more than $7 billion invested with Mr. Madoff and was his largest investor; now, it says, it is his largest victim. The investment authority, in turn, was one of Fairfield Sentry’s largest investors. Even after the investment authority took two significant redemptions from the fund, in April 2005 and 2006, its stake the following year of $132 million made up 2 percent of the fund’s assets under management.

The 2007 report lists Philip Jamchid Toub, one of Mr. Noel’s sons-in-law, as the firm’s "agent" with the Abu Dhabi investors, presumably meaning the person who manages the relationship with the particular clients. Mr. Toub, a Fairfield Greenwich partner, is married to Alix Noel and is the son of Said Toub, a wealthy shipping executive from Switzerland. Other investors for whom Mr. Toub is listed as the agent include the Safra National Bank of New York and the National Bank of Kuwait. And Fairfield was finding new fields for Mr. Madoff to cultivate. In 2004, the firm turned its eyes to Asia, forming a partnership with Lion Capital of Singapore, now Lion Global Investors, to create Lion Fairfield Capital Management, a joint venture meant to introduce Asian investors to the firm. "Many investors believe that Asia holds the best global opportunities for hedge funds over the next two to five years, as compared to the U.S. and Europe," Richard Landsberger, a Fairfield partner and director of Lion Fairfield, told HedgeWorld in 2006. Yet it appears that Sentry remained Fairfield’s chief focus in this new vineyard. Among the institutions that had invested in the fund are Korea Life Insurance, which has about $30 million to $50 million in the fund; a Taiwanese insurer, Cathay Life, with about $12 million; and Samsung Investment and Securities, with about $6.3 million.

As Fairfield moved into Asia, another feeder fund, Stellar US Absolute Return, was incorporated in Singapore in 2006 to funnel investors’ capital into Sentry. According to data from Bloomberg News, Stellar borrowed $3 for every dollar of investor money it received, in an effort to extract higher returns. Last year, Jeffrey Tucker went to Asia to educate potential investors in Beijing and Thailand about hedge funds, seeking to allay their concerns about previous blow-ups in the industry like Long-Term Capital Management, a Connecticut hedge fund that had been rescued under the supervision of the Federal Reserve Bank of New York when its exotic derivative investments brought it to the brink of a costly collapse. "China is moving slowly as the reformers become familiar with what we do," Mr. Tucker told HedgeWorld in November 2007. "It’s the same thing in Thailand. There are misunderstandings about hedge funds." But even with all the money pouring in, it was not enough, not in a year in which financial markets were plunging. Suddenly, people wanted cash — even the people who had trusted their cash for so long to Mr. Madoff. Time was running out for history’s first worldwide Ponzi scheme. But he maintained a brave face at the family firm that he had founded before his sons Mark and Andrew were born, and where they now worked, the firm where his brother Peter had labored at his side for decades, the firm that remained a stock-trading powerhouse on Wall Street.

But that trading business lived on the 18th and 19th floors of the Third Avenue tower, called the Lipstick Building, that was home to Bernard L. Madoff Investment Securities. Mr. Madoff operated his vast but largely unseen "asset management" business from the 17th floor, aided by a small staff that had been with him for years and a computer system separate from the trading business. His family knew Mr. Madoff had an investment management business, but Mr. Madoff had always kept it separate. Moreover, he explained that he placed his trades through "European counterparties" rather than use the trading desks his sons oversaw. But Mark and Andrew felt their father had been under increasing tension as the markets grew increasingly difficult this fall. In early December he remarked to one of them that he was struggling to raise $7 billion to cover redemptions. He seemed tired and drawn, but so was just about everyone else during the turbulent weeks of late November and early December. Then, early on Dec. 10, he shocked his sons by suggesting that the firm pay out several million dollars in bonuses two months ahead of schedule. When pressed by his sons for a reason, he grew agitated and insisted that they all leave the office and continue the conversation at his apartment on East 64th Street.

It was there, at midmorning, that he told his sons that his business was "a big lie" and, "basically, a giant Ponzi scheme." There was nothing left, he told them — and he fully expected to go to jail. The questions have piled up since then: Could Mr. Madoff have sustained this worldwide fraud for so long by himself? Why didn’t regulators, in Washington and abroad, catch him sooner? And will anything be recovered for investors, some of whom have lost every penny? But when the news of his arrest began to spread on Dec. 11, the first thought that struck an old friend who had known him as a pioneer on Wall Street, was, "There must be an error. It must be another Bernie Madoff." Then he added, "But then, there is no other Bernie Madoff."

UBS seeks to deny duty over Madoff funds
UBS sought to absolve itself from any duty to safeguard investor assets in a $1.4bn fund that channelled money into Bernard Madoff’s alleged $50bn Ponzi scheme. The Swiss bank used an agreement that denied it was responsible for the assets – even though its marketing documents claimed it would be. The move came as a US judge changed the terms of Mr Madoff’s $10m bail, confining him to his New York apartment.

UBS’s wording of subscription documents for the Luxalpha Sicav, a Luxembourg mutual fund registered for sale across Europe, may set it in conflict with the Luxembourg financial regulator. The Commission de Surveillance du Secteur Financer said: "The provisions of the sales prospectus are binding." So-called feeder funds which invested their money with Mr Madoff are coming under increasing scrutiny. As well as the Luxalpha fund, at least one other Madoff feeder fund was registered for sale in Europe. The Irish-domiciled $1.1bn Thema International Fund had HSBC as custodian.

Subscription documents for the Luxalpha Sicav explicitly remove UBS’s liability if the fund’s assets are lost. Under European rules, custodians such as UBS must take responsibility for "safekeeping" of a regulated mutual fund’s assets. But the Luxalpha subscription form states that UBS "is not the safekeeping agent of the assets of the fund as the assets are safekept by the US registered broker-dealer". UBS acted as manager, custodian and administrator of Luxalpha until this year, when Access Management – thought to be part of New York’s Access International Advisors – took over. Four of the six directors of the fund still work for UBS, according to the latest prospectus.

UBS said it could not comment on Luxembourg law, but said: "We established fund of fund structures on clients’ request. Bernard Madoff was not on the bank’s wealth management recommended list as a direct investment option." Mr Madoff not only acted as manager of assets – never mentioned in the Luxalpha documents – but also insisted on being custodian and broker. HSBC confirmed it acted as custodian to several Madoff funds but said it "does not believe that these custodial arrangements should be a source of exposure to the group".

Ethics investigation
The firm that audited the books of Bernard Madoff, the broker accused of a $50bn fraud, is under an ethics investigation by the industry’s main trade association. The firm, Friehling & Horowitz, was not subject to a professional review in 15 years, though it was enrolled in a peer review programme, because it said it was not conducting audits for any company, Mr Roberts said. The firm, a tiny operation in Rockland County, New York, with only three employees, could not be reached for comment Friday. Several potential investors in the "feeder" funds – which channelled money into accounts at Mr Madoff’s New York brokerage – said the size of the auditor had raised a "red flag" and contributed to their decision not to invest. Jim Vos, chief executive of Aksia, a hedge fund consultancy, said the feeder funds put "substantially all" their assets in the custody of Madoff Securities.

Fred Thompson has it right, for once
We don’t know what Thompson would have done if he had, God forbid, been elected as president, but he nails it in this little video. And it ain't that hard.

Oil at $40 a barrel will cause 'price explosion' in future
The oil cartel OPEC is right to warn that sharply falling oil prices will create a "price time-bomb for the future", experts have warned. Saudi Arabia's oil minister Ali al-Naimi and Abdalla El-Badri, secretary-general of OPEC, said low demand was "wreaking havoc" by halting investment in the sector. Oil prices in London fell near to $40 per barrel this week – down from a spike of $147 in July– prompting OPEC to cut supply by 2.2m barrels a day. Prices were closer to $35 in New York. If the low prices stop investment in exploration and production, there will be a shortage of oil in years to come, the producers said at a global summit in London. Prime Minister Gordon Brown called for an end to oil trading volatility, acknowledging prices could jump sharply if investment faltered. However, energy minister Ed Miliband insisted that low oil prices were good for consumers and the world economy.

OPEC called on Western governments to cut fuel tax to help push prices back up to the "fair and reasonable" sum of $70 per barrel. Inenco, the UK's largest energy analyst, agreed that slumping demand would ultimately cause prices to rocket. Oil exploration and production projects in the Canada, USA, Mexico, Damman have recently been shelved because they have become uneconomical. "The oil price would need to be in the range of $70-$80 a barrel to make these projects economically viable," said Inenco consultant Ian Parrett. Sources close to BP said the oil company feared current lack of investment would create an undersupply in three to five years' time. Barclays Capital said global spending on production will shrink 12pc to $400bn in 2009.

Glut of oil creates short-term storage problems
Traders locking up storage space for crude created a huge rift in prices Friday between oil that must be delivered in several weeks and oil that can be taken in February. The January contract for crude expired Friday and with stockpiles rising at the key storage facility in Cushing, Okla., the price dropped close to a five-year low as brokers and traders attempted to unload supply for whatever price they could get. "If you could find storage for it, it's a way to get rich real quickly," said Peter Beutel, an analyst with Cameron Hanover. With space tight amid a glut in supply, light, sweet crude for January delivery fell $2.35 to settle at $33.87, a level last seen in early 2004. Most traders focused on the February contract, however, which rose 69 cents to settle at $42.36 a barrel on the New York Mercantile Exchange. Because crude contracts bought for February also bought more time to find storage, it sold at a premium of more than $7 a barrel compared contracts expiring Friday.

While the January price was largely discounted because the volumes were so low, analyst Jim Ritterbusch, president of energy consultancy Ritterbusch and Associates, said it did provide a downside target for future sales. The market is sending strong signals that an oversupplied market will remain in place for some time, he said. "I think it's going to work its way down to today's lows in the January futures," Ritterbusch said. Consumers and industries are consuming much less energy than they had before the United States went in to Recession last December. That has led to enormous volatility in crude markets, a topic of discussion Friday from the trading floors of New York to a gathering of world leaders in London. At an energy summit Friday on London, British Prime Minister Gordon Brown warned that a failure to stabilize oil prices could cost the global economy trillions. "Wild fluctuations in market prices harm nations all round the world," Brown said. "They damage consumers and producers alike."

OPEC Secretary-General Abdullah El-Badri acknowledged the problem. "We all know that extreme oil prices whether too high or too low are as bad for producers as they are for consumers," El-Badri said. Meanwhile, Zeljko Bogetic, the World Bank's chief economist in Russia, told investors that the oil-rich nation would come under crippling financial pressure and may need to take out loans if crude prices do not rebound. "If oil prices in 2009 and 2010 average $30 a barrel, that would be a nightmare scenario for a global economy," Bogetic said. Russia, which has used oil profits during the past eight years to pay down most of its foreign debt, could turn from creditor to borrower if current trends continue. At $50 a barrel, Russia could drain much of its reserve funds and run budgetary deficits, Bogetic said. Earlier this week, the 13-nation Organization of Petroleum Exporting Countries slashed its output quota by 2.2 million barrels a day in a bid to bolster prices that have slid about 70 percent since July. Still, crude prices tumbled this week amid a bevy of dour economic reports suggesting demand for energy will continue to erode.

Beutel said the oil market should be growing more bullish after such huge declines, but the steady stream of bad economic news has made everyone skittish. "Until people can just take their eyes off of the demand for five seconds, it doesn't seem like this market is going to have an easy time moving higher," Beutel said. There was word Friday that OPEC may meet again in Kuwait on Jan. 19 to discuss further production cuts. Meanwhile, the national retail average price for a gallon of regular gas rose three-tenths of a penny to $1.673 a gallon overnight, according to auto club AAA, the Oil Price Information Service and Wright Express. That is about 37 cents a gallon below what it was a month ago and more than $2.43 below where it was in July when prices peaked at $4.11 per gallon. Before Friday, retail gasoline prices had fallen for 86 straight days. In other Nymex trading, gasoline futures rose less than a penny to settle at 96.93 cents a gallon. Heating oil gained nearly 2 cents to settle at $1.392 a gallon while natural gas for January tumbled 21.4 cents to settle at $5.334 per 1,000 cubic feet.

Don't destabilize Russia, Putin warns foes
Prime Minister Vladimir Putin warned Russia's foes on Friday against trying to destabilize a country facing broadening economic crisis, Russian news agencies reported. Putin did not specify who might pose a threat to Russia's stability. But in the past, he has often blamed Western security services of trying to destabilize the country using opposition groups and non-governmental organizations as their instruments. "Any attempts to weaken or destabilize Russia, harm the interests of the country will be toughly suppressed," they quoted ex-KGB spy Putin as telling an annual meeting of top spies and security officers ahead of their professional holiday. Putin, who was the Russian president in 2000-08, has contributed greatly to the growth of influence of Russia's FSB federal security service, a successor of the Soviet-era KGB.

Many ex-KGB officers became key government and regional officials during his presidency forming his power base, which largely remained intact after Putin handed over powers to his successor Dmitry Medvedev in May. Critics say that under Putin, security services have become excessively influential and expressed fears Russia could one day become a police state. Rights campaigners have urged Medvedev to veto a cabinet bill ordering that professional judges rather than juries run trials involving terrorism, civil unrest and several other serious crimes. They also urged Medvedev to block government attempts to impose high treason charges on people accused of "harming the constitutional order," which critics believe could lead to a political witch-hunt. Analysts say the role of the security services is likely to grow even further as Russia plunges into an economic crisis marked by rising unemployment and financial woes that threaten the popularity of the government. Avoiding civil unrest and maintaining political stability is viewed by the government as a top priority.

The Day of Security Officers is marked annually on December 20, a day when in 1917 Bolshevik rulers created the CheKa secret police to suppress their foes. After a string of transformations, the Cheka became the KGB. As president, Putin always personally attended the holiday meetings of security officials. Medvedev, a former corporate lawyer with no security background, stayed away and sent his chief of staff Sergei Naryshkin to deliver his greetings. Medvedev, who faced the challenge of a brief war with Georgia soon after becoming president which soured Russia's ties with the West, said security concerns remained paramount. "In the past 20 years the world has changed but has not become a quieter place," Naryshkin said, reading out his letter, according to Interfax.

Charities fight for survival as donations dry up because of economic crisis
Vital services to help the most vulnerable children are being closed as charities face big cuts in donations as a result of the economic crisis. The NSPCC has had to close two key services, in Derbyshire and Norfolk, because of lack of funds, The Times has learnt. Smaller voluntary bodies such as Woking and Sam Beare Hospices face having to shut completely rather than provide a threadbare service with their dwindling funds. The charitable sector also has £150 million tied up in the collapsed Icelandic banks, with little hope of getting much of it back. Naomi House Hospice, hit by that bank fiasco, has also had to close some of its services.

Most charities contacted by The Times yesterday said that they were trying their utmost to save programmes and services by making redundancies and cutting adminstrative costs. Shelter, Oxfam and the disability organisation Scope have already announced redundancy programmes and are building up trading enterprises to help to recoup costs. But things are getting worse every week. In October a Charities Commission survey suggested that one in 12 charities was having to make redundancies to avoid service cuts. But the latest figures show that one in three is laying off staff and half are unable to meet increasing demands.

Despite the recent highly publicised child abuse cases such as the death of Baby P, even the NSPCC plans to make 150 of its 2,500 staff redundant and is starting to close services because of substantial reductions in corporate and legacy donations. The family support team in Norfolk helps dozens of dysfunctional families where intervention by social workers could save children from abuse. "We try to identify parents who might have anger difficulties which could spill over to abusive situations," an NSPCC spokesman said. The second service to close is a therapeutic service in Derbyshire, where a child protection team last year helped 67 children who had been sexually abused. "The staff help children aged 5 to 18 to recognise serious changes in their behaviour as a result of their experience and support them in retrieving their own personalities," the spokesman said.

The NSPCC admits that it has lost £2 million from reduced legacy payments, which has led to the service cuts. Many charities rely on being given a percentage of an estate, or occasionally an entire estate, when someone dies. But after the collapse of the housing market the value of these estates is dropping by 20 to 30 per cent, resulting in big reductions to charities. The difficulty in selling homes, which can take six months or more, has been causing big cashflow problems. "Previous downturns in the economy have not adversely affected the NSPCC's income because the public are aware we need their support more than ever in such circumstances," said Giles Pegram, the NSPCC's director of fundraising. "However, this time we are already noticing an impact in some areas of fundraising. It is becoming more difficult to recruit new donors and to upgrade existing supporters.

"We are also noting that some individuals and organisations can no longer afford to give so much. We know that legacy income is down because of its dependence on house prices and there has been a downturn in ticket sales for some events." Other charities such as Shelter, the charity for the homeless, say that corporate donations are "falling off the edge of the cliff". Adam Sampson, Shelter's chief executive, told The Times that five big corporate donors, including Bradford and Bingley, had cut donations by £400,000 this summer, a fifth of their corporate funds. Legacy donations, usually £3million a year, had also halved. Shelter is making 43 redundancies, including senior management staff, but Mr Sampson said that services had so far been protected. He disclosed that the charity had lost up to £2.5 million out of a predicted income of £45million from corporate donations, legacies, individual donations and government or local authority grants.

"We have about 100,000 standing orders from individuals of £5 a month or more which are standing up well," Mr Sampson said. "But we are losing from corporate donations and legacies as the house market collapses. We will have to be more innovative and rethink how we raise money." Mr Sampson said that Shelter would now start exploring "ethical business" with commercial partners. He mentioned Age Concern, which sells travel insurance for elderly people. Oxfam, which is losing up to 45 staff, says that its priority is to protect its overseas services, so it is cutting back costs in Britain by 10-15 per cent. Its biggest losses are due to the falling value of sterling, with each pound buying fewer goods abroad. But Oxfam's trading income in Britain is holding up well, with more people buying clothes from charity shops as the recession bites. The charity said that it was also raising income through a new partnership with Marks & Spencer. Anyone bringing M&S clothes to an Oxfam shop will be given a £5 voucher to spend on goods over £35 at the company's stores.


Erin Winthrope said...

Dear Ilargi and Stoneleigh,

I’ve been an avid reader of your website since July, having stumbled upon it by chance after reading commentary by James Howard Kunstler. I never cease to be amazed by how clear-headed and prescient your analysis has been. The two of you have been so far ahead of the curve, you’ve revealed all of the other pundits and talking-heads to be nothing but a bunch of blabbering children.

So my basic question is: who are you? I don’t mean to pry for nitty-gritty personal details. I’m just really curious, are the two of you renegade elites, clued into the nature of our political-economic system by years of upbringing within the exclusive club? Renegade in the sense that you’ve decided to break the code of silence and reveal the workings of the system to a few peons curious enough to listen. Or, are you instead, peons yourselves, who carefully observed the world around you, applied logic, and reached the appropriate conclusions about where we are and where we are headed as a civilization? If you emerged from the ranks of the peons, which ranks: academia, industry, government?

Anonymous said...


Someone suggested we set up a world map indicating where readers are located.

Does anyone have the know-how to do that?

Simply set it up and let us know where it is so any willing persons can plug in their data.

It would be fun.


el gallinazo said...

"Credit Suisse has hatched a cunning plan to avoid public condemnation over executive bonuses this year: it is going to pay top managers not in cash, but in the toxic mortgage assets that caused the credit crisis. Thousands of managing directors and directors will be handed a slice of a new internal hedge fund, into which the bank is transferring some of its $5bn (£3.3bn) in illiquid investments. "

On their bonus envelops, "Eat shit and have a Merry Christmas"

I wonder how Credit Suisse accountants are going to handle these bonuses? Mark to model or mark to market? I wonder where the $5B evaluation comes from? Must be nominal value.

Erin Winthrope said...

To my fellow commentators on the discussion board,

I'd love to hear how you became aware of Peak Credit/Peak Oil/Peak Civilization.

For me, the last few months have been incredibly eye-opening. My life has turned upside down as I evaluate the slim likelihood that my current career path (academic microbiologist) will workout. I once considered myself very well informed about current events. Each morning I digested the New York Times and the Washington Post. I looked forward to Op/ed pieces by Tom Friedman. Like a well-behaved and thoroughly brain-washed peon, I read a lot of politics and obsessed over the constant ebb and flow of drama and scandal. Every once in a while, I'd ask myself how different all this reporting was from a television soap-opera; but I'd quickly banish the thought, secure in my bubble-world that I was becoming a real intellectual. Things began to change in June of this year when, while reading an article about the oil price spike, I came across the name James Howard Kunstler. I soon discovered his website and realized how much I'd been missing. How could I have been so clueless about EVERYTHING! I read The Long Emergency on my honeymoon in August and drove my new wife crazy obsessing about what was going to become of all the Hawaiians in their jacked up pickup trucks when the tourist trade collapses. Anyway, as I mentioned above, Kunstler led me to the Automatic Earth and the rest is history. I've concluded that Chomsky is correct: The elites sure do know how to herd the peons, even the seemingly well informed ones, into various thought-pens, where they can be fed a daily diet of he-said-she-said bull****.

bluebird said...

Ed - About our hosts - Stoneleigh is not shy and she has commented on her background a few times. Check the comments section from the Rattle for September 12, 2008.
Ilargi is mysterious. I don't recall that he has mentioned his background, unless it was before summer.

I came to TAE from a different forum who recommended Ilargi and Stoneleigh.

The TAE is my favorite. I am most grateful for all that I have learned here. Time for another donation.

el gallinazo said...

Ed Gorey

Great (though sad) posting. I have circulated it on my email group along with a warning that I will cease and desist my gloom from Wed through Fri in honor of Navidad. Your royalty check is in the mail :-)

I had the same question regarding the locals in the US Virgin Islands (where I have lived the past 12 years) though they tend toward spiffy new and giant SUV's with all the trimming. I am bailing St. John at the end of July. I think there is going to be a lot of rage here with black kicking white ass. I'm too old to go to the nude beach so my ass is very white. Already burnt my bridges behind me. Can't change my mind.

St. Stoneleigh,

Mish has a really interesting analysis of Elliott waves today. He is quite certain that we are in leg 4 - the suckers' rally. Going to dump my SDS on Monday at a small loss. Haven't made up my mind whether I want to try to ride it up with SSO or just stay out until the leg 5 collapse. Going short is so much safer than long if you have no danger of a forced sale.

Erin Winthrope said...
This comment has been removed by the author.
Anonymous said...

My local news is reporting the high hope of a new airport runway as a result of Obama's stimulus package. This airport is dying. It is one hour from a larger airport and this past year it lost much of its business. What are they thinking? Seems nothing makes sense anymore.

Anonymous said...

The labor fight you are predicting, Stoneleigh, has been made more intense by the election of Obama and his new labor secretary appointee.

ExRanger said...

Excellent post!
I work in the auto industry (for a little while yet) and our wages have gotten where they are not because of large raises over the years but mostly helped along by a COLA (cost of living allowance). My pay has not been eroded by inflation over the last 30+ years. The flip side of the coin is that in a deflationary economy money automatically gets taken away by the same formula.

el gallinazo said...

Anon 12:57

The stimulus package will divide the work force up into two groups. One will dig holes and the other will fill them. Since it is harder to dig a hole than fill it, the first group will be larger.

Anonymous said...

A note to all those critizising
our decisssion makers. (Obama's team)

1. They know what you know. They probably read TAE. (we are in deep poo)
2. They know the consequences of the implementation of scenarios that you have not even considered.
3. They know that the old days are gone. They want to see a new day, just like you.
4. If you think that they are overlooking some facts then present them at
All of the info that I get is 3rd hand and opinionated and so are your sources of information.
The efforts of the decission makers will or will not prevent us from reaching the "bottom".

Just get prepared.
The following have been posted before and deserve reading again.
A Nightmare Before Christmas
by Pete Schiff December 15, 2008
Where did all the money disappear? Liquid fantasies
by Satyajit Das December 15, 2008
I'm glad that I only need to decide my own fate and that I'm not a decission maker.

el gallinazo said...


But being a decision maker (or a decider) makes it so much easier to " to decide my own fate." Stealing a billion here and there can change one's own fate quite a bit, as well as the fate of others. What evidence do you have for your four numbered statements beyond being an article of your own faith?

You still don't "get it," and you probably never will no matter how many times you get hit on the head with their hammer. This is my last comment vis-a-vis your comments. I would doubt that saddens you :-)

scandia said...

Ed Gorey, who are Ilargi and Stoneleigh?
Strangely I prefer the anonimity. I can be overly influenced by authority/wealth/power etc. The record here on TAE demonstrates that they are very good at connecting the dots, that they know how the real world works.
They also reveal a far reaching knowledge base in several fields( Economics,the Arts,Science,History....) I think of Ilargi and Stoneleigh as rare Renaissance people.

Anonymous said...

el gallinazo
"You still don't "get it," and you probably never will no matter how many times you get hit on the head with their hammer. This is my last comment vis-a-vis your comments. I would doubt that saddens you :-)"
I do "get it".
I'm not following your path.
I'm following my path.
Our path have been narrowly defined by others.
There are herders doing the herding.
It's not us.

Anonymous said...

el Gallinazo

In realtiuon to your St John Comment:

What is going to happen if a karge hurricane hits a major population center in the next 2 or 3 years?

Where is all of the clean up money going to come from. How will the Insurance companies survive without a bailout?

Where does the aid come from since so many private aid groups are going out of business?

Bigelow said...

So if your wages would have had to increase by 50% since year 2000 just to maintain purchasing power lost to inflation, add the extra tax you would have paid on all that imaginary increase in your pay grade and you will find you would have had to make even more than a 50% increase. Conversely with deflation wage must decline to have steady purchasing power, but shouldn’t the government pay you back all those extra taxes it took on the inflating way up? Of course not. We are screwed coming and going.

There is no legitimacy for a government loosing control of the economy, but on a more fundamental level there is a people loosing control of their money; all that U.S. Constitutional stuff about no coin but gold or silver went away. Trace the decline right back to 1913 in the U.S. with the creation of Income Tax and the Federal Reserve.

The work of The Automatic Earth is awesome, however chances of the general public eventually finding out what happened to their pensions or money are nil. Thought control will continue via the main stream media and the internet will be muzzled as a public forum to save use from terror or pedophiles.

el gallinazo said...


I assume these are rhetorical questions.

However, we have a public holiday here, namely, Hurricane Supplication Day, when we supposedly all go to church and pray to our respective gods that any upcoming hurricane should hit another island and miss us. This actually works, proof of which was Omar, heading right at us at Cat 4 and doing a slight hop and shuffle to the east and passing between us and St, Maarten. Never underestimate the power of prayer, It is quite cost effective.

We also have an estimated 500 feral donkeys on our small island, which were released with the introduction of paved roads and the infernal combustion engine. I have been pushing for a holiday to commemorate this - namely Donkey Emancipation Day. However, my efforts have come to naught, and it is probably for the best. In the Greater Depression, they will shortly be either placed back in bondage or eaten, making my proposed holiday a cruel mockery,

Anonymous said...

Ed gorey.

This is a reply/comment written by Stoneleigh before the collapse at sept. 15. I think it is worth reposting so I'll take the freedom of doing so (hope I don't spam)...

Stoneleigh said...

Anonymous critic,

I think you'll find that what I said about a lack of downgrades by rating agencies was correct when I wrote it (August 2007). Indeed rating agencies had been major bubble cheerleaders for a long time and only began their raft of downgrades after the writing was on the wall. They even pushed companies like Ambac and MBIA to extend their insurance business into exotic instruments some time ago by threatening to downgrade them as uncompetitive if they didn't. I fully expect them to create self-fulfilling prophecies by over-reacting on the way down to the same extent that they under-reacted on the way up, as that is the nature of herding behaviour.

I don't regard subprime lending as helpful at all. It generally enables people to take on levels of debt that they will be unable to service if circumstances change. The era of low interest rates (especially in real terms) has been a trap for the unwary who are concerned only with the size of their monthly payment and not with the level of their indebtedness. Not that subprime borrowers were the only ones to over-extend themselves by any means. The addiction to easy credit runs very deep, even in high income brackets.

Default rates may currently by low, but that is not the point. Defaults are accelerating exponentially, even before we see the majority of resets on option ARMs. Negative equity will be a huge burden in years to come, especially for those who refinanced themselves into recourse loans. As house prices continue to fall, as they inevitably will, more and more people will find themselves in difficulties.

Personally I think home prices will fall by 90% on average (with significant local variation), reflecting the negative added value nature of much of suburban over-build. With credit making up the vast majority of the effective money supply, but evaporating by the day, plummeting purchasing power will drastically reduce the pool of buyers. Such falls have happened locally before, as our Texan readership reminds us from time to time.

As for the concentration of wealth, in years gone by there was not the indebtedness that is now so pervasive. It was possible to live on one moderate salary, whereas many households are now drowning in debt with two incomes. Granted people own far more stuff, but their wealth is largely illusory given their liabilities.

Markets (and empires) act as wealth conveyors, sending wealth from the periphery to the centre where its concentration confers considerable power. That power is bought with the debt slavery of the masses (comparable to international debt slavery for the third world).

As for your point regarding financial background, there is a line to be drawn between training and knowledge, in that the former does not necessarily lead to the latter. In fact, training can actively inhibit the acquisition of knowledge by placing mental limits on intellectual curiosity. This is particularly true in terms of an understanding of complex systems, as academic training is generally very narrow. In my experience, training is unlikely to provide an understanding of the big picture. Individuals have to come up with that by themselves.

I have plenty of formal qualifications, but thankfully not in economics. Otherwise I might have been burdened with the efficient market hypothesis, rational utility maximization, and assumptions like perfect information and perfect competition ;)

My background is in science and law, and by far the most useful subject for understanding markets has been psychology. Markets are not rational. Instead they reflect human herding behaviour, and as such are to some extent predictable.

The herd climbed to great heights on the back of easy credit, the rediscovery of leverage, and the collective delusion that credit and wealth amount to the same thing. Now that mistaken perception is being stripped away, as people discover that credit only acts as a money substitute during the expansion phase.

Unlike currency inflation, credit hyper-expansion has created multiple and mutually exclusive claims to every scrap of underlying wealth. Most of those claims will be extinguished during the coming credit collapse, as the true size of the underlying real wealth pie is revealed. Much of our complex economy is based on nothing more than a pile of worthless IOUs wrought by 'financial innovation'.

I share your opinion of the importance of trust and confidence, and your view of what the loss of trust will mean for the financial system. Our entire banking system is 'faith-based', and in a very real sense, confidence IS liquidity. The herd is now stampeding straight into the liquidity trap, where collective actions will magnify the underlying circumstances to the downside to the same extent as the power of the collective magnified them on the way up. The only difference is that humans feel that feel a virtuous circle is right and proper, while a vicious circle is unnatural and evil. In fact both are equally natural and equally part of the human condition.

Incidentally, Ilargi is one of the most intelligent people I know. Even after spending a considerable amount of time as an Oxford academic, I don't know of anyone else who has assimilated the breadth of knowledge that he has (in his third language). I am proud to work with him.

Stoneleigh said...

Ed Gorey,

As the quoted post said, I am a former academic from Britain, now living in Canada. I left the UK eight years ago, because I felt it's prospects were exceptionally poor, due to its precarious energy situation and its unbelievable housing bubble (far worse than in North America). I came to Canada for family and because a much greater degree of self-sufficiency was possible here.

I have spent 15 years avidly studying everything I could get my hands on across a wide range of fields, including biology/environmental science, psychology/neuroscience, international law and finance. I concentrate on finance here because the time frame is the shortest, so that people must navigate this crisis successfully if they are to have any remaining freedom of action to tackle the other challenges headed our way.

I now live on a farm and raise sheep, alpacas, sled dogs and chickens (with a bonus cat thrown in for good measure). I work in the energy sector, trying to get at least some renewable electricity generation connected to the grid before financing becomes impossible.

As always, I'll let Ilargi speak for himself.

Dan said...

RE: Ilargi: "...For one thing, that means interest has to be paid. And also, it's still a continuation of living on borrowed money and borrowed time..."

What I am finding as I poke around a bit is that people---lots of people---are now "choosing" to stiff the credit card companies. Yes some cannot pay, but many with whom I have spoken are basically saying screw it. I think this trend will grow as more and more folks come to see banking in general as totally corrupt and destructive.

This is yet ANOTHER reason why I think the whole "debt as money" game is up. Over.

Anonymous said...


Carolus Obscurus

Stoneleigh / Ilargi

Great stuff. I would like to comment a lot more but all this scrolling down to the bottom of the webpage really bugs me.

There is something uncanny about the accuracy of your predictions.

Woe, woe ...

bluebird said...

Karl Denninger's latest...He talks about the largest bubble ever, how the bubble grew, the bubble has popped, and what needs to be done. And lots more, 7 pages long.

Greenpa said...

Dan W "What I am finding as I poke around a bit is that people---lots of people---are now "choosing" to stiff the credit card companies."

You have any links you can offer? I've thought for some time there should be a "credit strike" - just like a rent strike when the landlord won't fix the building.

If a few million people refused to pay, when there interest rate jumps to 35%, because they were 2 days late on a payment (usually because the card company sent them a bill 1 day before it was due) - do you really think the card companies could run several million law suits at once?

Some organization would help. Anybody organizing yet? For those who are afraid of consequences- you put your payement in escrow- and send the company a letter telling them they'll be paid when they fix the problem- ie., when they treat you like a customer buying and paying for a service, instead of krill.

Hey! That's a better name than "consumer".

Krill, folks. We are all krill to them. :-)

I vote we all become toxic krill.

el gallinazo said...

Re Bluebird's linked Denniger article:

Really good rant. Covers the same ground as Ilargi.

One thing that confuses me is that most Austrian school economists appear to be Social Darwinists. They favor the elite, and hold Greenpa's krill in contempt. Scrooge McDuck was certainly a Libertarian of the Austrian persuasion. One of the wonderful things about I&S is that they can combine Austrian analysis with a humanist approach.

Even Denniger cannot enter this Christmas season entirely playing the Scrooge McDuck role. In his rant:

"Our Declaration of Independence lists the following rights that are endowed to us by our creator:
Life, Liberty and the pursuit of Happiness.
Note that nowhere in this list are:
Free anything, including wealth, food, health care, shelter or even a job.
Happiness itself (only the right to pursue, but not achieve, happiness is endowed"

However, near the end:

"The human suffering that is and will occur will be tremendous no matter what we do. The one place we can and should spend is on essential human needs; that is, food, shelter and clothing. We can provide barracks-style shelter, cafeteria-style food, basic medical care and donation-based clothing for millions of Americans for a song compared to these "bailouts" and we both can and must. Every state should have these centers established in major cities and at least one at or near its geographic center (or the closest reasonable place to it) in which all United States Citizens (but no illegal aliens) can come, reside, eat and obtain basic clothing and medical care at no cost to them. This can be done at a cost of single-digit dollars per day per person, and we must. This is a social imperative and we simply have to be prepared to provide it."

Perhaps the Ghost of Christmas Future visited Karl while he was writing this piece.

Anonymous said...

I normally don't comment on this blog because I don't think anyone reads the little people's opinions, however when I saw Fred Thompson sputtering his words of wisdom thru his penis sized cigar I had to comment....and this comment is directed to Freddie, the wonderful acting politician, "who really gives a shit what you think after the have been smoking way to many of those blunts to know anything about our current mess....just keep your arse in that little country hick town you live in, so that when the fit hits the shan we can find your fat arse real easy.....

scandia said...

Greenpa, I love your idea! A krill...
Love it and could be extremely effective. What do we want as a result? Might just be the way to negotiate a public look at the books.
I am becoming obsessed with seeing the ledgers!

Anonymous said...

Greenpa, well said! I do like instigators ... :)


Tyr said...

Speaking of Belgium, you wouldn't believe how uninformed people are here. The media are still referring to Fortis as "the crown jewel of Belgian finance" and people talk of Fortis as a basically sound company. It really borders on delusional.

Apparently the powers that be are aware of the seriousness of the situation (though they are keeping stum about it) because the PM's cabinet has been accused of trying to reshuffle the judges appointed to a court case by the shareholders of Fortis to halt the sale of Fortis to BNP Paribas to get it to fail. Presumably these shareholders think they stand a better chance getting their money back from the government than from another bank.

To be fair though this instability is nothing new here as we've lurched from institutional crisis to crisis in the past year. (Well, the last 50 years with the last one being especially bad.)

Anonymous said...

Hi scandia !
I am becoming obsessed with seeing the ledgers!
I pulled a few number out and I cannot make out anything. Are there any accountants wanting to give their opinions?
Treasury International Capital System

Securities (page 1), special data series
Part A -- U.S. Securities
(mfh) Major Foreign Holders of U.S. Treasury Securities. Includes data from survey of holdings at end-June 2007.
Treasury bulletin
Current Issue: December 2008
Treasury International Capital System
U.S. Banking Liabilities to Foreigners by Country
U.S. Banking Claims on Foreigners by Country
How do you interpret the data?
Liabilities to Foreigners/ Claims on Foreigners
Cuba $93m minus $70
Haiti $619m minus $76
Iceland $486m minus$0
Canada $78,981m minus $85,654
China $183,609m minus $10,497
China-Taiwan $33,750m minus $1,135
China-Hong Kong $61,322m minus$11,094

scandia said...

Jal, thanks for your efforts. I found the info on US Treasuries held by foreign gov'ts of interest. for instance Mexico holds almost double(33B) than Canada(18B).I don't have enough knowledge to grasp what this means except to wonder how 33B might help the desperately poor in Mexico.
It is the ledgers of the banks specifically that keeps me awake at night...

Anonymous said...

Scandia,my workload changed like a light switch last week..cut to 16 hrs,partly weather,partly light/no work.I have changed gears and am starting to focus on my land and all the stuff I need to get up and operational If things really go haywire next year,as it looks they will.A foot of snow does not help.I have a 66x14 trailer that I need to move/rework to make a couple of apts[bed and bath]and a bunkhouse[in the middle]for the "refugee' family & tribe I expect to show up when it starts to get for real bad.And get the new water system in the rabbits...and get the greenhouse up,and the new irrigation system laid out,and and and
You don't think of collapse to a lower energy state to be as complicated as it is in reality. {may be 'cause I want to make sure me and mine stay eating,and get to the other side.}

dark matter,I run around all over the Portland metro area ,all day long.I talk to a LOT of people.They are all hip to whats going on,in various ways.And they are ALL scared.

Everybody knows we are screwed.

Last post was the result of spend some quiet time thinking out strategy.I have to stay away from here a night or 2 to clear my head,as the information sometimes pisses me off so bad I feel ill.

On another discussion I am having,the topic of the "elites"and their games were spotlighted,as is the case here.I am starting to get a gut feeling that this [get your tinfoil hats out]was planned.

This was planned as a way to nullify everything since the new deal in our society,get rid of a mountain of debt,cut the knees off of the Chinese,establish us .mil troops here in the CONAM,as well as ,on a side note,put into power a man who would install the worst of the bad to break the fed gov so badly it could never threaten corp. power again.

"The shock doctrine"on steroids

the use of a[financial] catastrophe to ram thru societal changes that would never have been tolerated if "the system "had not been smashed first.Social security,medicare,un-employment insurance.....everything will be swept away.

Cheny would do it.In heartbeat.He has been described as the meanest guy to ever make senator.And so would Bush.He is a certifiable sociopath,as far as I can tell.the mask has slipped too far on that boy...he don't care what anyone thinks now...and I will fear for my country until the day he is replaced.


Anonymous said...

After many years of debt servitude I purposefully defaulted on my credit cards. Some had balances near $5,0000. I have not been sued in over three years. My credit score is poor but I don’t plan on dealing with the money changers again.

The only drawback is that the money changers have manipulated opinion through the mass media to have credit scores associated with integrity and in our fascist system employers are encouraged to examine credit scores to evaluate the worthiness of potential employees. Unless the head is removed from this beast soon, it may be impossible to find employment without wearing the shackles and chains of interminable debt.

el gallinazo said...


Krill is a bit too aquatic IMO to describe our debt slave situation most accurately.

I prefer:

pissant |ˈpisˌant| vulgar slang
an insignificant or contemptible person or thing.
worthless; contemptible.
ORIGIN mid 17th cent.: from the noun piss + -ant .

Anonymous said...

Friedman says China needs 8% growth or it all goes down.

I think he's a doofus myself, but he says all we have to do is give them all our credit cards, so they can buy all the unnecessary crap.

Stoneleigh said...

The intro for today's Debt Rattle is now a Daily Kos diary.

Greenpa said...

El Gallinazo - I think you give the elites too much credit. The have no contempt for us- they do not know we exist.

The point to the krill image is that they are higher animals, which happent to be small, exist in the billions, and are mainly consumed by vast whales and factory ships which consider them to be only a "resource." When a fin whale takes a gulp and swallows 3 million lives in one instant- the whale's only feeling is "ah, belly full."

No awareness- none- of lives. The credit card companies have passed out of the predator phase of business, and evolved into filter feeders. Wholesale resource devourers, on such a different scale of existence they are no longer even aware of us.

Greenpa said...

Oh, and; you are may not be aware there in the islands- but children today know a great deal about krill, both from school and from several very popular movies- they are no longer obscure.

Greenpa said...

Different topic; the mainstream pundits are, in fact, starting to catch on.

"This wholesale loss of confidence is a catastrophe that not even the new president’s most costly New Deal can set right."

The phrase "depression is a real possibility" now occurs commonly.


Unknown said...

Talk of building new runways as a part of a stimulus package reminds me of the cargo cults in the Pacific islands that sprang up after WWII.

Anonymous said...

RE; Jubilee

How far must things deteriorate before this idea becomes palatable to decision-makers or failing that, becomes a necessary alternative to the masses?

2009 will be 'a really bad year' - IMF

Furthermore, how would something like this work? Limit it to large-scale sectors such as housing? Hit the reset button for everything?


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


Good points. I agree. Krill is a more accurate descriptive. However, I am still fond of pissants in other contexts :-)