Thursday, January 1, 2009

Debt Rattle, January 1 2009: Friction comes to have its machine

Lewis Wickes Hine Straw Berries May 1910
"Mother and children hulling strawberries at Johnson's Hulling Station, Seaford, Delaware. Cyral (in baby cart) is 2 years old and works steadily hulling berries. At times Cyral would rest his little head on his arm and fall asleep for a few minutes and then wake up, commencing all over to hull berries.

Ilargi: Welcome to the new year, dear friends and readers. May peace walk with you, and the road rise.

And may you find the strength and wisdom to lower your expectations when it comes to money and material possessions. A lot of dreams will be shattered in 2009, a lot of things once taken for granted will disappear and never return. My biggest fear looking forward is probably that many of us will not be able to adapt to the vision of a future with less of almost everything. The reactions of younger generations to the realization that the vast majority among them will not be able to do as well as their parents could be rough and violent. Millions upon millions in the western world who are today reasonably well-off, and expect to retire with a nice pension, will find when the time comes that that dream is gone too.

They may feel entitled to comfort after a life of work, but their children will feel entitled to jobs and wealth and health care and schools for their own children. And there will simply not be enough to go around. Those who have been lucky enough to live the good life in the past decades will need to share, to give up a large part of what they have, or societies and communities will implode. But will they understand the problems and their implications in time to make the necessary adjustments? I am not very optimistic. Politicians, generally speaking, will be useless in processes such as these. They will give the majority of voters what they want: more of the same, or at the very least promises of more of the same. The outcome could give a whole new, and not too kind, meaning to the term 'generational conflict'.

Things that will start to play out in the world at large in early 2009 all have to do with how to cut a shrinking pie. In particular, individuals, companies and governments all will find it much harder to finance their day to day dealings. And we will find out that many parties are in much worse positions than they have let on until now. Many levels of government have hidden a lot of trouble from their constituents, and most will now have to come clean. The only feasible ways to get their books in order are raising taxes and issuing bonds.

But tax increases are a short and narrow dead-end street when people lose their jobs and homes. And the bond markets will soon be so bloated with the excess in offerings that the price to sell them will be too overwhelming across the board. The same, of course, is true of corporate bonds. The LA Times series Hooked on Debt paints a chilling picture of the financial past and future of California, and there is no way others haven't done the same things.

Internationally, we will see trade wars of many varieties, protectionism, debt defaults and entire countries simply going bankrupt. Once a country is sufficiently isolated in trade, it may attempt to inflate its way to happiness, even though that is clearly impossible. There will be governments that point beyond their borders to guilty scapegoats next door. In many places, troops will be gathered on both sides of borders. Inside countries, governments will be tested, tried and sometimes overthrown, with many an army and police force acting against their own citizens. Athens and Bangkok will be replayed on a 1000 stages across the globe.

In the US, government lending and spending has broken through all previously set limits. The Treasury hands taxpayers’ money to the bankrupt financing arms of defunct carmakers, who use the money to offer 0% loans to people who should never not be buying new cars or homes. Literally everything the Treasury and Fed have done in the past year has been utterly wrong, and guaranteed to make matters much worse. For the man in the street, that is. Not for the wealthy.

The next steps are undoubtedly long since on the table: massively more, and more massive, "rescue" operations, funded with your children’s ability to repay, and all focused on making you consume, no matter how broke you may already be. Remember, even with a 0% interest rate, a debt is still a debt. Don’t go there. From the point of view of democratic politics, the US turns more into a farce each passing day. The Treasury has no qualms spending more than Congress provided. Yeah, so what, what is anybody going to do to stop them? The Treasury makes public money available to Cerberus, a private company that doesn't even have to open its books. So what are you going to do?

In this new world, we think there most certainly is a place, and a function, for The Automatic Earth. 2009 will be a whole lot worse than 2008, and the ugliness will increasingly rear its head a theater near you. What was troubling but distant in '08 no longer will be distant in '09. Many among you will lose their jobs, and perhaps their homes, and certainly most of their pensions. And don't forget health care. 2009 will change your world way, way faster and stronger than 99% of you can even imagine.

We will be here to make you better understand the events as they unfold, to help and support you. In exchange, please help and support us. We simply can't do it without you.

PS: Today's title comes from Thoreau's Civil Disobedience

Investors' big question: Will stocks' slide get even worse?
Wall Street on Wednesday closed out its worst year in more than seven decades, battered by a devastating credit crunch that smashed investor and consumer confidence and fueled fears of another Great Depression. The Dow Jones industrial average plummeted 34% for the year -- the steepest drop since the blue-chip index crashed 53% in 1931, the second full year of the Depression. Many broader market indexes lost more than the Dow did in 2008 as nearly $7 trillion of the country's stock-market wealth was wiped out. Despite widespread belief among experts that the U.S. isn't on the verge of a 1930s-like economic collapse, the mammoth market loss taunts the optimists. And it has left many individual investors understandably wary.

Rodney Punt, a 63-year-old Santa Monica retiree who has less than 20% of his investment portfolio in stocks, expresses interest in buying beaten-down shares as the new year begins, but isn't yet sure about risking his money. "There is still a downward spiral in the real economy," he said. "Is it a recession? Is it a depression?" As Punt tries to gauge the depths of the economy's woes, what he and other investors decide to do with their money in 2009 could foretell the return of growth: Typically, stocks begin to rally four to seven months before the end of a recession, as investors anticipate a recovery in corporate earnings.

With the current recession already a year old, most economists expect a turnaround in the second half of 2009. If the market follows the usual script, stocks should show a significant pickup beginning in the first quarter of the new year. A rising market could be a confidence builder for the economy, including for corporate executives who are wrestling with how many more jobs to pare as they cope with sinking sales. Paul Hickey, a partner at Bespoke Investment Group in Harrison, N.Y., noted that stocks have a track record of rebounding in the year after a harrowing sell-off. The Dow's 10 worst yearly losses since 1896 were followed by rallies the next year in eight of those instances. The glaring exceptions: 1930 and 1931.

Some investment professionals caution against putting too much faith in historical trends. This recession has been different from most, rooted in the bursting of the housing bubble and magnified by a credit crunch unlike anything the world has experienced in modern times. Paul Desmond, president of Lowry Research Corp., a stock-research firm in North Palm Beach, Fla., says predictions about the economy and the market should be taken with more than the usual dose of salt -- given that almost no one foresaw the severity of what transpired in 2008. "What makes you think their projections for 2009 are going to be any better?" he asked.

Investors know too well how we got here: What began as a U.S. housing market crash two years ago spread like a wildfire through the global financial system in 2008, as losses on mortgage-related securities toppled pillars of the banking industry and caused survivors to simply stop lending. For the economy, already weakened by soaring energy prices in the first half of the year, the shutdown of the debt markets in the second half was a body blow that caused many consumers and businesses to halt spending. As the economy fell off a cliff beginning in September, stock markets worldwide went too -- taking countless nest eggs with them.

The average U.S. stock mutual fund lost 38% for the year; the average foreign stock fund lost 46%. In recent weeks, however, many world stock markets have stabilized and moved modestly higher. The Dow, which closed at 8,776.39 on Wednesday, is up 16% from its five-year low reached Nov. 20. The now well-hewn argument against the risk of economic catastrophe on the scale of the early 1930s is that the federal government, and the Federal Reserve, have thrown trillions of dollars into the fight to bolster the financial system, get credit flowing again and revive confidence. President-elect Barack Obama has promised to add a huge fiscal stimulus program. Large-scale government intervention was missing as the Depression unfolded in the '30s, until President Franklin D. Roosevelt took office in 1933.

As things worsened, the stock market fell for four straight years from 1929 through 1932, for a total loss of 89% on the Dow from peak to trough. This time, the Dow's decline from its all-time high reached in October 2007 is a far more modest 38% -- so far. Yet many stocks are at or near their lowest levels in a decade or more, and are selling at low prices relative to per-share earnings. Optimists believe that long-term investors won't be able to resist depressed stocks in the new year, particularly with so much cash sitting in short-term accounts paying virtually no interest. The panic selling of the last few months "has created massive sidelined buying power," said James Paulsen, chief investment strategist at Wells Capital Management in Minneapolis. Assets of money market mutual funds, for example, hit a record $3.76 trillion this week, according to iMoneyNet Inc. Yet investors in money funds are earning an average annualized yield of just 0.76%.

Analysts who remain cautious about stocks believe that that cash hoard sends a troubling message: Many investors would rather earn a near-zero return on their money than risk it in stocks even at slashed prices. "If stocks were real bargains, we ought to be seeing people rush in to take advantage, and we're not," Desmond of Lowry Research said. One key issue is that there still is little confidence that the housing market is bottoming. "Stabilization in home prices would mark a major turning point in the crisis," economists at Goldman Sachs & Co. said in a report to clients Wednesday. "Unfortunately, such a stabilization does not look imminent." Goldman projects that U.S. home prices, on average, will drop 15% more over the next year. That could worsen the spiral of mortgage defaults and foreclosures, undermining the government's attempts to restore the banking system to health and make credit easier to get.

Some investment pros say that, even if U.S. stocks don't fall much more, any rebound from here could be anemic. The odds of a rip-roaring new bull market soon are slim, they say, because the economy -- and corporate earnings -- could struggle for years as consumers work down the mountain of debt that helped drive spending over the last two decades. Demographics also may be a weight on the market: Many aging baby boomers are likely to be selling stocks to fund their retirement or to shift to less volatile investments such as bonds, said Ed Clissold, senior global analyst at Ned Davis Research Inc. Clissold says his firm believes stocks could rally in the first half of 2009 on optimism about an economic turnaround, then slump again in the second half as weak growth disappoints investors.

Gail Dudack, a veteran analyst and head of Dudack Research Group in New York, says the market may be in a long stretch that "isn't a bull or a bear, but a workout period." With the dive in share prices in 2008, the bull market gains of this entire decade already are gone: The Dow is down 24% since Dec. 31, 1999. That, too, is likely to deter some buy-and-hold investors from wanting to take a chance on stocks now: They've already gone nine years with nothing to show for their trouble. Wall Street has been through these periods before. From 1966 through 1981, the market overall experienced many sharp rallies and steep declines, but the Dow ultimately saw no net price appreciation over those 16 years. Such a period requires a different approach to stock investing, Dudack said. "It's not about growth," she said. "It's about survivorship."

Will Banks and Financial Markets Recover in 2009?

Global financial markets in 2008 experienced their worst crisis since the Great Depression of the 1930's. Major financial institutions went bust; others were bought up on the cheap or survived only after major bailouts. Global stock markets fell by more than 50%; interest-rate spreads skyrocketed; a severe liquidity and credit crunch appeared; and many emerging-market economies staggered to the International Monetary Fund for help. So what lies ahead in 2009? Is the worst behind us or ahead of us? To answer these questions, we must understand that a vicious circle of economic contraction and worsening financial conditions is underway.

The United States will certainly experience its worst recession in decades, a deep and protracted contraction lasting about 24 months through the end of 2009. Moreover, the entire global economy will contract. There will be recession in the euro zone, the United Kingdom, Continental Europe, Canada, Japan, and the other advanced economies. There is also a risk of a hard landing for emerging-market economies, as trade, financial, and currency links transmit real and financial shocks to them. In the advanced economies, recession had brought back earlier in 2008 fears of 1970's-style stagflation (a combination of economic stagnation and inflation). But, with aggregate demand falling below growing aggregate supply, slack goods markets will lead to lower inflation as firms' pricing power is restrained. Likewise, rising unemployment will control labor costs and wage growth. These factors, combined with sharply falling commodity prices, will cause inflation in advanced economies to ease toward the 1% level, raising concerns about deflation, not stagflation.

Deflation is dangerous as it leads to a liquidity trap: nominal policy rates cannot fall below zero, so monetary policy becomes ineffective. Falling prices mean that the real cost of capital is high and the real value of nominal debts rise, leading to further declines in consumption and investment - and thus setting in motion a vicious circle in which incomes and jobs are squeezed further, aggravating the fall in demand and prices. As traditional monetary policy becomes ineffective, other unorthodox policies will continue to be used: policies to bail out investors, financial institutions, and borrowers; massive provision of liquidity to banks in order to ease the credit crunch; and even more radical actions to reduce long-term interest rates on government bonds and narrow the spread between market rates and government bonds.

Today's global crisis was triggered by the collapse of the US housing bubble, but it was not caused by it. America's credit excesses were in residential mortgages, commercial mortgages, credit cards, auto loans, and student loans. There was also excess in the securitized products that converted these debts into toxic financial derivatives; in borrowing by local governments; in financing for leveraged buyouts that should never have occurred; in corporate bonds that will now suffer massive losses in a surge of defaults; in the dangerous and unregulated credit default swap market. Moreover, these pathologies were not confined to the US. There were housing bubbles in many other countries, fueled by excessive cheap lending that did not reflect underlying risks. There was also a commodity bubble and a private equity and hedge funds bubble. Indeed, we now see the demise of the shadow banking system, the complex of non-bank financial institutions that looked like banks as they borrowed short term and in liquid ways, leveraged a lot, and invested in longer term and illiquid ways.

As a result, the biggest asset and credit bubble in human history is now going bust, with overall credit losses likely to be close to a staggering $2 trillion. Thus, unless governments rapidly recapitalize financial institutions, the credit crunch will become even more severe as losses mount faster than recapitalization and banks are forced to contract credit and lending. Equity prices and other risky assets have fallen sharply from their peaks of late 2007, but there are still significant downside risks. An emerging consensus suggests that the prices of many risky assets - including equities - have fallen so much that we are at the bottom and a rapid recovery will occur.

But the worst is still ahead of us. In the next few months, the macroeconomic news and earnings/profits reports from around the world will be much worse than expected, putting further downward pressure on prices of risky assets, because equity analysts are still deluding themselves that the economic contraction will be mild and short. While the risk of a total systemic financial meltdown has been reduced by the actions of the G-7 and other economies to backstop their financial systems, severe vulnerabilities remain. The credit crunch will get worse; deleveraging will continue, as hedge funds and other leveraged players are forced to sell assets into illiquid and distressed markets, thus causing more price falls and driving more insolvent financial institutions out of business. A few emerging-market economies will certainly enter a full-blown financial crisis. So 2009 will be a painful year of global recession and further financial stresses, losses, and bankruptcies. Only aggressive, coordinated, and effective policy actions by advanced and emerging-market countries can ensure that the global economy recovers in 2010, rather than entering a more protracted period of economic stagnation.

Markets Limp Into 2009 After a Bruising Year
There was almost no place to hide from the crash of 2008. When the New York Stock Exchange bell rang out the year on Wednesday, it tolled for virtually anyone with money in the stock market. The final, grim tally only confirmed what investors had known for months: it was a very bad year to own stocks, any stocks — indeed, one of the worst ever. In a mere 12 months, the Dow Jones industrial average plunged 4,488.43 points, or 33.8 percent, its most punishing loss since 1931. Blue chips like Bank of America, Citigroup and Alcoa lost more than 65 percent of their value. The broader Standard & Poor’s 500-stock index sank 39.5 percent, almost exactly matching its decline in 1937. All told, about $7 trillion of shareholders’ wealth — the gains of the last six years — was wiped out in a year of violent market swings.

But what is striking is not just the magnitude of the declines, staggering as they are, but also their breadth. All but two of the 30 Dow industrials, Wal-Mart and McDonald’s, fell by more than 10 percent. Almost no industry was spared as the crisis that first emerged in the subprime mortgage market metastasized and the economy sank into what could be a long recession. As the new year dawns, Wall Street is looking to Washington, where the balance of financial power has tipped in recent months. Analysts and investors are focusing on what the incoming Obama administration and the Federal Reserve will do to revive the economy and the financial system. It is a remarkable turnabout from the mid-1990s, when Wall Street traders helped drive economic policy. Back then, bond investors flexed their financial muscle and urged the Clinton administration and a Republican Congress to reduce the federal budget deficit.

These days, the market in ultra-safe United States Treasury securities seems like a refuge, even as the deficit balloons from the cost of bailing out banks, insurers and the Detroit auto companies. Many investors, having lost stocks and other investments, are buying up Treasuries that offer little or no return. They are content simply to get their money back. “The only willing risk taker is the government," said William H. Gross, the chief investment officer of the Pacific Investment Management Company, or Pimco, the giant bond trading firm. Speaking of the epicenter of the financial world, he added: “It is no longer New York, it’s Washington."

Like many money managers, Mr. Gross is a conservative — he describes himself as a “Reagan fan from way back" — who generally prefers limited government involvement in the markets. But he and others say that the government’s sweeping intervention into private industry and in the markets, though sometimes flawed, is necessary to prevent a collapse of the financial system. They are hoping that policy makers do even more to stimulate the economy and revive moribund financial markets. Given the damage in the markets, however, policy makers face daunting challenges. “When we have bear markets, they usually take twice as long to get down this far," said Robert C. Doll, vice chairman of BlackRock, the big investment firm. The markets have become incredibly volatile, especially since Lehman Brothers sank into bankruptcy in September. Since then, the S.& P. has moved more than 5 percent in either direction on 18 days. There were only 17 such days in the previous 53 years, according to calculations by Howard Silverblatt, an index analyst at S.& P.

Diversification — the idea that it is unwise to put all your eggs in one basket — did not pay off for investors in 2008, casting doubt over this cornerstone of modern investing. The American market was far from the worst hit in 2008. Stocks fell 55 to 72 percent in the so-called BRIC economies — Brazil, Russia, India and China — that were darlings of the late, great boom. Stocks in developed European and Asian markets also fell sharply, though less than their emerging counterparts. Many commodities like oil and copper crashed. Losses in the credit markets, which are at the heart of this financial crisis, appear small relative to the devastation in other markets. The International Monetary Fund estimated in October that banks and other investors would suffer $1.4 trillion in losses on loans and securities, a loss of just 6 percent. Financial institutions globally have already reported $1 trillion in write-downs, according to Bloomberg.

The I.M.F.’s estimate, however, does not count losses on derivatives, those complex instruments that derive their value from other assets. Losses on these instruments could outstrip those in the so-called cash markets because they are much bigger than their underlying assets. A spokeswoman for the I.M.F. said the fund’s estimates did not include those losses because they were transfers of wealth from one party of a transaction to another. For example, when the insurer American International Group loses $1 billion on a credit-default swap, a type of derivative, it makes payments to customers like investment banks. These complex financial instruments will pose one of the biggest challenges to policy makers in the year ahead. Many investors have lost confidence in banks, insurers and other financial intermediaries, in part because they do not know whether these companies are valuing opaque instruments properly. Some firms may be carrying enough toxic sludge to sink them, while others may be relatively unscathed.

“Until those assets can be removed from the balance sheets of the bank, or until the owners get a better understanding of what these assets are worth, we will have uncertainty," said Douglas M. Peta, an independent market analyst. A broader focus for policy makers will be reviving the economy. Most financial and political analysts expect the Obama administration to enact a stimulus package that could approach $1 trillion. The effort will aim to create three million jobs by spending money on infrastructure, green energy technology, aid to states and other initiatives. Many analysts say such an effort will help revive the economy, but not immediately. Infrastructure spending, for instance, can have a powerful impact by stimulating demand and creating jobs but, like much else in the economy, it often takes years to work.

Some are looking to efforts by the Treasury and Fed to jump-start lending by lowering mortgage rates and improving the market for bonds backed by small-business, auto and credit card loans. A recent drop in mortgage rates has already set off a refinance boom, but analysts say home prices in many parts of the country are still too high for many would-be buyers. Furthermore, employment and household savings will most likely have to climb for some time before consumers have enough confidence to buy homes and enough money for down payments. “Across the board, they can potentially prevent a further slide, and they deserve a lot of credit if they achieve that," Martin S. Fridson, chief executive of Fridson Investment Advisors, a bond trading firm, said about policy makers. “I just don’t think that they can push a button and have the economy and the stock market turn around."

Thomas J. Lee, the chief equity strategist at JPMorgan Chase, said a recovery early in the year could give way to another sell-off before the stock market finally bottoms later in the year. Mr. Lee said his forecast reflected “how unconventional the current recession is." Unlike in the past, policy makers cannot rely on consumers to push the economy ahead by borrowing and spending, he said. “This is a recession where households are net debtors," he said. “They have lost money on houses and equities. That has rarely happened, at least since the 1950s." Mr. Doll of BlackRock agreed that consumers would not “run back and power the economy ahead." But he nonetheless contends that several important markets, including stocks, may be close to their bottom. The Fed, he argued, has taken on a more activist role in the markets and the new administration is likely to push through a huge stimulus. Such sentiments have probably helped drive the S.& P. 500 index up by 20 percent since Nov. 20 and investment-grade corporate bonds up by nearly 10 percent since October. “Perhaps we have seen a bottom," Mr. Doll said. But he added that like the economy, “the stock market recovery will be more muted as well."

U.S. Stocks Post Steepest Yearly Decline Since Great Depression, Dow Plunges 34%
U.S. stocks plunged the most in 2008 since the Great Depression as financial shares collapsed, energy and metal producers tumbled and the world’s biggest economy suffered a yearlong recession. Citigroup Inc., Bank of America Corp. and Goldman Sachs Group Inc. retreated more than 60 percent as 80 out of the 84 financial institutions in the Standard & Poor’s 500 Index declined. Exxon Mobil Corp. and Freeport-McMoRan Copper & Gold Inc. fell as the Reuters/Jefferies CRB Index of 19 raw materials dropped a record 36 percent. Caterpillar Inc. sank 38 percent as the U.S., Europe and Japan experienced the first simultaneous contractions since World War II. "They will write about this year for a long time," Duncan Niederauer, chief executive officer of New York Stock Exchange owner NYSE Euronext, said in an interview. "It’s been, in one word, tiring."

The S&P 500 decreased 38.5 percent, the most since the 38.6 percent plunge in 1937, to 903.25 and sank to an 11-year low of 752.44 on Nov. 20. Volatility increased, with the index rising or falling 5 percent in a single day 18 times. The Dow Jones Industrial Average slumped 34 percent to 8,776.39 for the steepest drop since 1931. The market gained yesterday, with all 10 industries in the S&P 500 advancing, after fewer Americans filed for jobless benefits and the Treasury said it will expand aid to more companies in the car industry. The Chicago Board Options Exchange Volatility Index, known as Wall Street’s fear gauge, jumped 78 percent to 40. The so- called VIX, a measure of how much investors are paying for insurance from stock declines in the options market, had never exceeded 50 before October. Its close of 80.86 on Nov. 20 was the highest in its 19-year history.

At its lowest closing level of 2008 on Nov. 20, the S&P 500 was down 49 percent for the year and 52 percent from its Oct. 9, 2007, record of 1,565.15. The plunge came as more than $1 trillion in credit-related losses at global financial companies triggered a global recession. The S&P 500 has rebounded 20 percent since Nov. 20. The gains were propelled by the government’s rescue of Citigroup Inc., President-elect Barack Obama’s pledge to spend the most on infrastructure projects since the 1950s and the Federal Reserve’s reduction in its benchmark interest rate to as low as zero. "What’s going to determine the equity market is how deep the recession is going to be," said Noman Ali, a money manager at MFC Global Investment Management, which oversees $20 billion of U.S. stocks in Toronto. Policy makers "are going to throw everything at it to prevent a deep recession, but it’s still going to be pretty bad because credit markets are still closed and investors are not taking any risk."

Tunisia was the only market out of 69 in MSCI Inc. indexes that rose in 2008. Twenty-eight national benchmarks lost more than half their value, including Russia’s 67 percent drop, China’s 66 percent retreat and India’s 52 percent decrease. The U.K.’s FTSE 100 Index posted the smallest decrease among the world’s 20 biggest markets, slumping 31 percent. China’s CSI 300 Index fell for an eighth straight day yesterday, capping the gauge’s first annual decline since it was introduced in April 2005. The index tracking yuan-denominated A shares tumbled as economic growth cooled and exports shrank. Stock indexes in the other three so-called BRIC nations --Brazil, Russia and India -- fell as the global economic slump cut demand for commodities and investors shunned riskier assets.

"Most of us in the market are going to be very happy for the calendar to tick over to 2009," said James Gaul, a money manager at Boston Advisors LLC, which oversees about $1.5 billion in Boston. "I’m slightly optimistic on 2009, but I think there’s still some major hurdles to get through, not the least of which is investor psychology. It’s been so bad, and people have gotten burned in such a severe way." Financial companies tumbled the most among the 10 main industries in the S&P 500, falling 57 percent collectively for the worst drop in the 19-year history of the index tracking the group. The retreat was driven by banks racking up asset writedowns and credit losses stemming from the 2007 collapse of the subprime-mortgage market. Lehman Brothers Holdings Inc., once the nation’s fourth- biggest securities firm, filed the largest U.S. bankruptcy in September after its shares lost almost all their value. Its rivals Merrill Lynch & Co. and Bear Stearns Cos. were forced into takeovers to avoid collapse, while Goldman Sachs Group Inc. and Morgan Stanley converted to bank holding companies as investors lost confidence in firms that depend on debt-market financing. Morgan Stanley shares slid 70 percent in 2008, while Goldman Sachs fell 61 percent.

"Credit markets really set the tone for market behavior in 2008. ‘‘We expect that to continue to be the case in 2009,’’ Craig Peckham, equity trading strategist at Jefferies & Co. in New York, told Bloomberg Television. ‘‘I’m not convinced that we’ve seen the lows for the market yet" as the recession "is going to be more prolonged than the consensus believes at this point." Insurers crippled by losses on investments and contracts protecting against debt defaults were among the market’s biggest losers this year. American International Group Inc., the world’s largest insurer before it was put into government conservatorship, lost 97 percent. Citigroup dropped 77 percent to $6.71. Bank of America lost 66 percent to $14.08. The S&P 500 Energy Index slumped 36 percent, while the measure of raw-material companies fell 47 percent. Exxon fell 15 percent to $79.83, and Freeport tumbled 76 percent to $24.44. Crude oil futures retreated a record 54 percent to $44.60 a barrel in 2008. They reached an all-time high of $145.29 in July.

Automakers slumped as the slowing economy pushed General Motors Corp. to the brink of bankruptcy, sending the nation’s largest car company down 87 percent and prompting the government to issue emergency loans to keep the company solvent. GM’s U.S. sales tumbled 22 percent during the first 11 months of the year, which the company blamed on buyers’ dwindling access to credit. Companies that sell discounted goods posted some of the only gains after consumers reined in spending as the yearlong recession deepened. Family Dollar Stores Inc. jumped 36 percent for the biggest advance in the S&P 500 in 2008. Wal-Mart Stores Inc., the world’s largest retailer, climbed 18 percent and fast- food chain McDonald’s Corp. increased 5.6 percent for the only 2008 gains in the 30-stock Dow average.

Corporate profits have fallen seven straight quarters, according to the U.S. Bureau of Economic Analysis. Should earnings fall through the first half of 2009, as analysts surveyed by Bloomberg project, it would be the longest streak since the government began tracking quarterly data in 1947. Takeovers and initial public offerings dwindled as falling share prices and frozen credit markets made terms more onerous. Announced takeovers plunged 43 percent in 2008 to $873 billion from the record $1.54 trillion in 2007, according to data compiled by Bloomberg. Only 43 IPOs raised more than $50 million this year, the fewest since 1979, according to Renaissance Capital’s The S&P 500’s decline in 2008 was the first that exceeded 30 percent since the 39 percent plunge in 1937. The benchmark gauge for U.S. equities lost 23 percent in 2002 and 29.7 percent in 1974, losses that were followed by annual gains of 26 percent and 32 percent, respectively.

Ten of the 11 investment strategists surveyed by Bloomberg expect the S&P 500 to rise next year. The forecasts range from a drop to 874 at Barclays Plc to a gain to 1,300 at UBS AG. The average is 1,056. While the global economic slowdown weighed on stocks in 2008, U.S. government bonds posted their best year since 1995 amid speculation the recession will extend into the first half of 2009. The dollar completed its biggest annual decline against the yen in more than two decades, while the euro had its best year against the British pound since its 1999 debut. Even as the S&P 500 capped its worst year since 1937 and the Dow its worst since 1931, traders on the floor of the New York Stock Exchange paid homage to a decades-old tradition by singing 1905’s "Wait ‘Till the Sun Shines, Nellie.’’

Treasury Has Pledged More Rescue Funds Than Authorized
The Treasury Department has committed nearly $10 billion more than the $350 billion Congress has authorized to date for the financial-sector rescue package, which could constrain how the incoming Obama administration deploys the rest of the fund. Treasury's announcement Monday that it is directing $6 billion to auto-finance company GMAC LLC brought to $358.4 billion the total funds from the Troubled Asset Relief Program that have been pledged to a variety of programs and guarantees. That suggests Treasury is tapping into the second half of the $700 billion set aside in October before it has been released by Congress. "They are pushing the envelope here," said Sen. Bernie Sanders (I., Vt.), a critic of the bailout. "What they are trying to do is create a situation to put pressure on [President-elect Barack] Obama and the Congress to provide the next $350 billion."

Under the legislation that approved the bailout funds, Treasury received $350 billion and was required to request access to the rest by providing a detailed plan of how the money would be spent. The goal was to provide a check for lawmakers wary about Treasury's broad authority under the legislation. Treasury says the agency has complied with the rescue legislation. A Treasury official briefing reporters Monday said that "from a short-term cash-flow basis," the department hasn't come close to the $350 billion limit because not all its commitments have been fulfilled. As of Tuesday, roughly $207 billion had been disbursed. 

Treasury's actual commitments include $250 billion for capital injections into banks, $40 billion for insurer American International Group Inc., $20 billion for a Federal Reserve consumer-finance program, $25 billion for Citigroup Inc. and $23.4 billion in aid to the auto industry. A Treasury spokeswoman declined to comment Tuesday on whether the newest commitments were based on the assumption that Congress would release the second installment, or would require reallocating money that had been promised to others. A spokeswoman for Mr. Obama's transition team declined to comment.  Treasury Secretary Henry Paulson, in announcing the auto-rescue plan Dec. 19, said "it is clear" that Congress will have to release the second $350 billion tranche to maintain financial-market stability.

Treasury Defends Its Actions to an Oversight Panel
Early on the afternoon of Dec. 31, just as many Americans were beginning to tune out and focus on New Year's Eve celebrations, the Treasury Dept. issued its response to a blistering Dec. 10 report from the congressional panel established to oversee the agency's actions. The 13-page Treasury report broke no new ground, strongly echoing recent comments and testimony from Treasury Secretary Henry Paulson and Neel Kashkari, his deputy managing the crisis response.

At the same time, it sidestepped some of the most pointed questions and observations raised by the Congressional Oversight Panel in its initial report. In that report, the COP criticized the Treasury for failing to monitor what the banks and others actually did with billions of dollars in federal funds they had received, and questioned whether the Treasury had an overarching strategy or could show concrete results. In its response, the Treasury effectively responded that it knows what it's doing, things could have been a lot worse, its efforts should improve matters in time, and the programs are working even if results are difficult to measure.

Throughout its report, the Treasury offers summary for explanation, recapitulating the events of late September and early October to account for its abrupt changes of course—injecting capital instead of buying toxic assets, then abandoning toxic-asset purchases altogether; ignoring the automakers only to aid them later—and describing why its programs ought to work instead of providing the evidence of results the COP members clearly sought. (Or most of them, anyway: The lone Republican on the panel at the time, Texas Representative Jeb Hensarling, declined to sign the report.)

The report also left unclear how aggressively the Treasury is seeking to determine how banks are using federal funds—a central criticism of both congressional leaders and the COP's initial report. In Dec. 10 testimony before the House Financial Services Committee, Kashkari said his team was "working with the banking regulators to develop appropriate measurements" to track the flow of federal funds through financial institutions, "and we are focused on determining the extent to which the [federal investment] is having its desired effect." No further detail emerged in the Treasury's report Wednesday, which echoed Kashkari's testimony in nearly identical language.

Central to many of the agency's answers in the report—and echoing Paulson and Kashkari in recent weeks—is the argument that, without Treasury's actions, worse could have happened: "The most important evidence that our strategy is working is that Treasury's actions, in combination with other actions, stemmed a series of financial institution failures," the report says. In other words, Treasury seems to be saying, Citigroup (C) teetered on the brink even after receiving an initial $25 billion capital infusion from the Treasury; but after a second bailout, it survived.

The Treasury said it also continues to "monitor lending"—responding at least in part to criticisms by Democrats and others that it never actually required banks to lend the government funds they received. Again echoing Paulson and Kashkari, the agency notes that it hasn't distributed much of the $250 billion allocated to shoring up bank capital. (As of Dec. 29, $172 billion was out the door.) "Clearly this capital needs to get into the system before it can have the desired effect," the report says. But if lending is in fact not measuring up, the Treasury report continues, Congress should blame "low confidence" rather than the agency's strategy. "As long as confidence remains low," the report says, "banks will remain cautious about extending credit, and consumers and businesses will remain cautious about taking on new loans. As confidence returns, Treasury expects to see more credit extended."

Overall, some of the more challenging questions asked by the COP remain unanswered, including whether increasing consumer lending will really have a concrete effect on the financial crisis. "Efforts to increase the availability of credit assume that the fundamental problem is a lack of liquidity," the oversight panel wrote on Dec. 10. "But if Americans are more worried about their own economic security—their employment prospects, their current expenses, and their debt levels—then increasing liquidity will have little impact on consumer spending."

And, while the Treasury outlines why it thinks its efforts have worked—a tough task, given how interwoven its actions have been with those of the Fed, the FDIC, and other bodies, and how many outside factors influence the financial markets—it doesn't address a fundamental suggestion by the COP, echoing an earlier Government Accountability Office report: Treasury should "define what the Department itself [believes] constitutes success." Instead, the Treasury mostly addresses concerns about its effectiveness by recounting its actions: "Is the [Treasury's] strategy helping to reduce foreclosures?" the COP asked. "Yes," the Treasury responds. "Treasury has moved aggressively to keep mortgage financing available and develop new tools to help homeowners."

Specifically, the agency adds, it prevented Fannie Mae and Freddie Mac from failing, it established a voluntary coalition of mortgage servicers and others in October 2007 to modify some homeowners' loans, it set up a protocol to make loan modifications under Fannie and Freddie's control simpler, and Fannie and Freddie are putting foreclosures on hold for 90 days. But just one statistic is offered on the actual effects of these moves: The housing-industry coalition, HOPE NOW, "estimates that roughly 2.9 million homeowners have been helped by the industry since July 2007," and an estimated 200,000 homeowners a month more are being aided. It remains unclear from the report how many of the assisted homeowners were facing foreclosure but avoided it with industry help, or how much of that help was the result of the Treasury's actions.

"What have financial institutions done with the taxpayers' money received so far?" asked the COP. It's hard to say, the Treasury responds. Much of the money hasn't been handed out. What has been handed out over the last two-plus months "must work its way into the system before it can have its desired effect." Confidence remains low. Injecting capital into banks should make them stronger and less likely to tighten credit further—and things could have been a lot worse. The Treasury report says lending "won't materialize as fast as anyone would like, but it will happen much faster as a result of having used the TARP to stabilize the system and to increase the capital in our banks."

The exchange between COP and the Treasury isn't over; panel chairwoman Elizabeth Warren is likely to thank the Treasury politely for its yearend report. But chances are good that she and her fellow panel members will get the last word. In its earlier report, they made clear that they see their job as evaluating the Treasury's performance themselves, and won't rely on information from the agency alone to evaluate its success. And within a few weeks, Paulson and his deputies will be replaced by an Obama Administration more closely aligned with the COP's congressional sponsors.

US Treasury: No Way To Insure TARP Firms Follow Executive Comp Rules
The Treasury Department still has no way of ensuring that firms receiving billions of dollars from the federal government are complying with executive compensation rules, the department said in a report released Wednesday. The report to the congressional oversight panel overseeing the $700 billion Troubled Asset Relief Program said Treasury hasn't finalized a system to make sure firms are actually imposing restrictions on executives' salaries. Treasury said it is committed to "rigorous oversight" on firms that receive TARP funds but acknowledged that it is "continuing to develop a comprehensive compliance program to ensure that institutions adhere to executive compensation provisions." 

The revelation is unlikely to sit well with critics of the department's implementation of the rescue plan who have faulted Treasury for frequent changes in the scope and direction of the rescue effort. The Government Accountability Office, in a report released Dec. 2, found that Treasury had no way of measuring whether the TARP program was a success, whether firms were complying with restrictions imposed by the government, or evaluating potential conflicts of interest.

Treasury Opens Door to Array of Companies, Industries to Help Automakers
The U.S. Treasury threw the door open to taxpayer financing for a widening array of companies and industries by drafting broad guidelines on aid to the auto industry. The Treasury’s guidelines, published yesterday, would let officials provide funds to any company they deem important to making or financing cars. That leaves room for the government to provide money from the Troubled Asset Relief Program beyond loans already committed to General Motors Corp., GMAC LLC and Chrysler LLC.

“There are going to be other industries that are going to have just as good a case," as the auto companies, former St. Louis Federal Reserve Bank President William Poole said in an interview on Bloomberg Television. “We don’t know what those other industries are going to be. Where does this process stop?" Shares of auto suppliers including American Axle & Manufacturing Holdings Inc. and Lear Corp. jumped yesterday after Treasury announced the guidelines. The Motor & Equipment Manufacturers Association has been lobbying for the use of federal funds as a backstop in case parts makers can’t collect money the auto manufacturers owe them.

Analysts have speculated that companies such as GM’s bankrupt former parts unit Delphi Corp., might be eligible for assistance. The Treasury guidelines may encourage more guessing on what companies and industries are next, said Vincent Reinhart, resident scholar at the American Enterprise Institute in Washington. Treasury officials “much prefer discretion, and so they would view the statement as being constructively ambiguous," Reinhart said. “It’s appropriate that they end the year the way they spent most of it -- that is, adding uncertainty into an environment in which there’s a lot of uncertainty."

The guidelines don’t bind the government, so the lack of specifics gives President-elect Barack Obama plenty of leeway to decide who succeeds and fails when he takes office in three weeks. The bailout was originally designed to buy assets from banks and has instead become a fund for Treasury to prop up lenders, insurers, carmakers, auto-finance companies and, now, any firm that may be important to those industries. “The further you go, the slipperier the slope becomes, the more you open the door to anyone who says, ‘Look, my firm is in trouble, I need help too,’" said Lyle Gramley, a former Fed governor and now a Washington-based senior economic adviser for Stanford Group Co. “We don’t want to go any further down that road than we absolutely have to."

The Treasury already has provided $6 billion in aid to GMAC, the financing arm of GM, and up to $17.4 billion in financing for GM and Chrysler, using funds from the $700 billion bank-rescue package. “Treasury will determine the form, terms and conditions of any investment made pursuant to this program on a case-by-case basis," the Treasury said in the new guidelines. “Treasury may consider, among other things, the importance of the institution to production by, or financing of, the American automotive industry." The government will weigh “whether a major disruption of the institution’s operations would likely have a materially adverse effect on employment and thereby produce negative spillover effects on economic performance" or on credit markets, the Treasury said.

Shares of American Axle, GM’s largest supplier of axles, and Lear, the world’s second-largest maker of auto seats, both leapt in the minutes after the Treasury’s announcement yesterday. Detroit-based American Axle rose 56 cents, or 24 percent, to $2.89 in New York Stock Exchange composite trading. Southfield, Michigan-based Lear, which gets almost a third of its revenue from GM, rose 26 cents, or 23 percent, to $1.41. This week’s funding agreement between the Treasury and GMAC opened a new rescue program for the auto industry as part of the TARP. Treasury said then that the GMAC agreement was “part of a broader program to assist the domestic automotive industry in becoming financially viable." A Treasury official said there’s no cap or deadline for aid to the auto industry under the TARP. “We would not be surprised to see additional government funds to GM to support a Delphi solution," JPMorgan Chase & Co. analyst Himanshu Patel said in a report Dec. 30.

With this week’s funding for GMAC, the Treasury has now earmarked $358.4 billion out of the $700 billion bailout. Its actual spending has been less -- for example, the department so far has handed out only $172.5 billion out of the $250 billion designated for bank capital injections. When Congress approved the TARP in October, it gave the Bush administration the first of two $350 billion tranches. After injecting capital into GMAC on Dec. 29, the Treasury reiterated its call for legislators to release the rest of the money. The auto-rescue program could range anywhere from full bailouts of specific companies to merely keeping others going while in bankruptcy to ensure production isn’t interrupted, said Kirk Ludtke, an analyst at CRT Capital Group Inc. in Stamford, Connecticut. “The Detroit three are still at risk," Ludtke said, referring to GM, Chrysler and Ford Motor Co. “The government is acknowledging it needs to assure at least an orderly restructuring of the key players in the auto industry."

Hank's Deals on Wheels
Hurry to your local GM dealer, because Hank Paulson has a deal for you. Within hours of receiving a $5 billion lifeline from the U.S. Treasury on Monday, GMAC -- the financing arm of General Motors -- slashed its car-loan rates and lowered its lending standards to help GM sell, sell, sell.   As of Tuesday, GMAC was offering 0% financing on several models -- hey, if 0% is good enough for Ben Bernanke, it's good enough for you -- and said it would extend credit to buyers with credit scores as low as 621 -- right on the edge of subprime territory. The median credit rating is 723.  Once Washington got into the business of owning car makers, it was only a matter of time before Hank Paulson & Co. started trying to sell cars too. It's now the American public's investment in Detroit that's on the line, after all. But Monday's bailout of GMAC, inevitable as it was, shows that the federal government has now waded so far into auto maker business that it's easier to keep marching forward than to pull back.

Take GMAC's capital structure. GMAC hasn't said whether it has secured the approval of enough of its bondholders to convert their debt into equity and to satisfy the demands of federal regulators that they do so. As of late last week, it was far from obvious that GMAC would clear this hurdle. But the Federal Reserve blinked anyway and approved its application to convert into a bank holding company. That conversion, in turn, is supposedly necessary to make GMAC eligible for the Troubled Asset Relief Program funds it received Monday night. But if the auto makers are themselves eligible for the TARP, why should Mr. Paulson stand on ceremony when it comes to GM's financing arm? A healthy GMAC is, we are told, essential to a healthy GM, and a viable GM is needed to avert auto Armageddon, so a little thing like reducing GMAC's debt load isn't going to stand in Mr. Paulson's way. 

This is not to say there aren't other awkward questions for our new public-private automobile complex. For example, Treasury has now twice driven to the rescue of Cerberus, the huge private-equity group that owns 51% of GMAC. Under the terms of the bank conversion, Cerberus will have its ownership diluted and will have to sell down its stake in GMAC to 33%. GM, which owns the other 49% of its formerly captive financing arm, will have to sell all but 10% of GMAC and give up its seats on the board. But Cerberus's 33% of a bailed-out GMAC is still worth more than 51% of a bankrupt GMAC. As with the Chrysler bailout, taxpayers have a right to ask why Cerberus is being saved without having to contribute more to the rescue.

Meanwhile, some of the vehicles on which GMAC is offering its 0% financing are those nasty, gas-guzzling SUVs that Washington loves to hate. Will Nancy Pelosi stand for this when Congress returns next week? Will those car designers at the Sierra Club insist that the best terms go to the most environmentally conscious vehicles? On second thought, forget we asked.  With taxpayer interests now welded to Detroit at the axle, Mr. Paulson is only doing what every auto dealer in America does six days a week. GMAC says the best incentives end January 5, so don't delay -- you'll be paying for those cars one way or another. As the best car salesmen like to say, what can we do to put you in this car today? We'll just check with Hank over in finance . . .

Auto dealers offer cash back, low rates, 2-for-1 sales
As the worst sales year in more than a decade draws to a close, auto dealers are sweetening deals this week in a last-ditch effort to unload acres of cars. Cash back, 0% interest rates and even wackier deals, such as buy-one-get-one-free, are being tried to squeeze out a few last sales. "For bargain hunters, it's probably the best time in the last 10 years at least," says Philip Reed, senior consumer advice editor for

General Motors added a last-minute inducement Tuesday by offering 0% to 4.9% financing through Monday on some remaining 2008 models. Financing arm GMAC said the loans were made possible by a $6 billion infusion from the federal government's bank rescue fund. In another a move toward normalcy, GMAC said it will extend its low-rate loans to those with less-than-perfect credit. The widespread deals result from pressure on automakers to move inventory. New vehicles are averaging an "exceptionally high" three months at dealerships before selling, the longest for a December since Power Information Network started keeping track in 2002, analyst Tom Libby says. "It's a buyer's market," he adds.

The backlog is so deep that major automakers, including import brands, are cutting production this month and next to try to let demand catch up to supply. Ford Motor analyst George Pipas says too many would-be buyers still are being kept out of the market by tight credit. Many can't get a loan even as Ford runs an employee-pricing promotion, through Monday, that Pipas says offers the deepest discounts of the year. Besides low interest, GM is offering incentives up to $10,000 on some remaining 2008 models. With gas prices down, pickups are hot at Prestige Ford in Garland, Texas. "We've been busy," says John Thull, the general sales manager. "Good deals to be had on just about everything."

Sales are brisk — helped by a 0.9% interest rate — at Bob Smith BMW/Mini in Calabasas, Calif., says Tim Smith, president. All these discounts have some dealers getting creative to try to stand out in the crowd. Peterson Super Center in Boise, for instance, has a "two-for-the-price-of-one" sale this week: Buy a full-size Cadillac or Chevy SUV or Chevy diesel pickup at full price and get a free 2009 Chevy Cobalt sedan. Interest in the deal has been "really good," ad director Sharon Potter says.

Gazprom Cuts Gas Supply to Ukraine After Failure to Agree on Export Price
OAO Gazprom, Russia’s state gas exporter, called for a resumption of talks on a dispute with Ukraine that led to a cutoff of Russian supplies of the fuel today to the country, the second interruption in three years. Price was not the main issue in negotiations broken off yesterday, Gazprom spokesman Sergei Kupriyanov told a press conference in Moscow today, adding that the Ukrainian delegation had no mandate to sign a deal. He said Gazprom has cut 110 million cubic meters of gas a day in supplies to Ukraine. Gazprom is waiting for the Ukrainian energy company, NAK Naftogaz Ukrainy, to respond on the offer of new negotiations, Kupriyanov said.

Talks broke down shortly before midnight after Ukraine rejected an offer from Gazprom to sell it the fuel this year at $250 per 1,000 cubic meters, and insisted that Russia also pay higher transit fees. Ukraine said it is seeking a price of $201. Russia halted gas deliveries to Ukraine at 10 a.m. Moscow time today, raising the threat of a disruption to natural-gas shipments to Europe. Both Russia and Ukraine said they would guarantee the stable transit of supplies to European consumers. Gazprom, which supplies a quarter of Europe’s natural gas, mostly through Ukraine, cut Ukrainian deliveries in January 2006 amid a similar pricing dispute. The shutdown reduced gas flows to Europe and led to questions over both countries’ reliability as energy suppliers.

The Dismal Economist's Joyless Triumph

I have long been forecasting that it was only a matter of time before America's housing bubble - which began in the early days of this decade, supported by a flood of liquidity and lax regulation - would pop. The longer the bubble expanded, the larger the explosion and the greater (and more global) the resulting downturn would be. Economists are good at identifying underlying forces, but they are not so good at timing. The dynamics are, however, much as anticipated. America is still on a downward trajectory for 2009 - with grave consequences for the world as a whole.

For example, as their tax revenues plummet, state and local governments are in the process of cutting back their expenditures. American exports are about to decline. Consumer spending is plummeting, as expected. There has been an enormous decrease in (perceived) wealth, in the trillions, with the decline in house and stock prices. Besides, most Americans were living beyond their means, using their houses, with their bloated values, as collateral. That game is up. America would be facing these problems even if it were not simultaneously facing a financial crisis. America's economy had been supercharged by excessive leveraging; now comes the painful process of deleveraging. Excessive leveraging, combined with bad lending and risky derivatives, has caused credit markets to freeze. After all, when banks don't know their own balance sheets, they aren't about to trust others'.

The Bush administration didn't see the problems coming, denied that they were problems when they came, then minimized their significance, and, finally, panicked. Guided by one of the architects of the problem, Hank Paulson, who had advocated for deregulation and allowing banks to take on even more leveraging, it was no surprise that the administration veered from one policy to another - each strategy supported with absolute conviction, until minutes before it was abandoned for another. Even if confidence really were all that mattered, the economy would have sunk. Moreover, what little action has been taken has been aimed at shoring up the financial system. But the financial crisis is only one of several crises facing the country: the underlying macroeconomic problem has been made worse by the sinking fortunes of the bottom half of the population. Those who would spend don't have the money, and those with the money aren't spending.

America, and the world, is also facing a major structural problem, not unlike that at the beginning of the last century, when productivity increases in agriculture meant that a rapidly declining share of the population could find work there. Nowadays, increases in manufacturing productivity are even more impressive than they were for agriculture a century ago; but that means the adjustments that must be made are all the greater. Not long ago, there was discussion of the dangers of a disorderly unwinding of the global economy's massive imbalances. What we are seeing today is part of that unwinding. But there are equally fundamental changes in the global balances of economic power: the hoards of liquid money to help bail out the world lie in Asia and the Middle East, not in West. But global institutions do not reflect these new realities.

Globalization has meant that we are increasingly interdependent. One cannot have a deep and long downturn in the world's largest economy without global ramifications. I had long argued that the notion of decoupling was a myth; the evidence now corroborates that view. This is especially so because America has exported not just its recession, but its failed deregulatory philosophy and toxic mortgages, so financial institutions in Europe and elsewhere are also confronting many of the same problems. Many in the developing world have benefited greatly from the last boom, through financial flows, exports, and high commodity prices. Now, all of that is being reversed. Indeed, it is the ultimate irony that money is now flowing from poor and well-managed economies to the US, the source of the global problems.

The point of reciting these challenges facing the world is to suggest that, even if Obama and other world leaders do everything right, the US and the global economy are in for a difficult period. The question is not only how long the recession will last, but what the economy will look like when it emerges. Will it return to robust growth, or will we have an anemic recovery, à la Japan in the 1990's? Right now, I cast my vote for the latter, especially since the huge debt legacy is likely to dampen enthusiasm for the big stimulus that is required. Without a sufficiently large stimulus (in excess of 2% of GDP), we will have a vicious negative spiral: a weak economy will mean more bankruptcies, which will push stock prices down and interest rates up, undermine consumer confidence, and weaken banks. Consumption and investment will be cut back further.

Many Wall Street financiers, having received their gobs of cash, are returning to their fiscal religion of low deficits. It is remarkable how, having proven their incompetence, they are still revered in some quarters. What matters more than deficits is what we do with money; borrowing to finance high-productivity investments in education, technology, or infrastructure strengthens a nation's balance sheet. The financiers, however, will argue for caution: let's see how the economy does, and if it needs more money, we can give it. But a firm that is forced into bankruptcy is not un-bankrupted when a course is reversed. The damage is long-lasting. If Obama follows his instinct, pays attention to Main Street rather than Wall Street, and acts boldly, then there is a prospect that the economy will start to emerge from the downturn by late 2009. If not, the short-term prospects for America, and the world, are bleak.

Journal of a Plague Year: Faith in Markets Cracks Under $30 Trillion Loss
It has been a year of record misery: the largest bankruptcy, bank failure and Ponzi scheme in U.S. history; $720 billion in writedowns and losses by financial institutions; $30.1 trillion in market valuation wiped out. The biggest loss and the hardest thing to recover, though, may be something that can’t be precisely measured -- confidence in the markets and the firms that rely on them. "The wholesale funding model lost its credibility," said David Hendler, senior analyst at New York-based CreditSights Inc. "That started the semi-nationalization of funding in the financial markets. It’s a real chink in the armor of capitalism as supposedly the best process for allocating capital. The government is now deciding who gets access to capital."

For Paul DeRosa, a principal of Mount Lucas Management Corp., a $1 billion hedge fund in Princeton, New Jersey, most unnerving was that the credit crisis revived something that, like the bubonic plague, was supposed to be a relic of the past. "We had what was for all intents and purposes a systemic bank run for the first time in 70 years," said DeRosa, whose fund is up 25 percent this year. "This ended our belief that financial panics were a thing of the past. That’s why this is a transcendent event." The price tag has been transcendent, too. Global stock markets lost about half of their value in 2008, or $30.1 trillion dollars. In the U.S., $7.2 trillion of shareholder value was wiped off the books, as the Standard & Poor’s 500 Index fell 39 percent through Dec. 30 and the Nasdaq Composite Index dropped 42 percent.

And if market losses weren’t bad enough, as much as $50 billion went up in smoke when New York money manager Bernard L. Madoff confessed to authorities this month to what may be the biggest swindle in history -- an alleged Ponzi scheme that spanned the globe, claiming victims from Alicia Koplowitz, one of Spain’s richest women, to filmmaker Steven Spielberg. Institutions that seemed as solid as their Manhattan headquarters buildings crumbled. Lehman Brothers Holdings Inc., with assets of $639 billion, filed the largest bankruptcy in U.S. history on Sept. 15. Its creditors may have lost as much $75 billion, the firm’s chief restructuring officer said. Bear Stearns Cos. was taken over by JPMorgan Chase & Co. in March after a funding crisis triggered by losses from subprime- mortgage investments. Merrill Lynch & Co., facing a crisis of its own, sold itself to Charlotte, North Carolina-based Bank of America Corp. And the last two major investment banks, Goldman Sachs Group Inc. and Morgan Stanley, converted to bank holding companies and got capital injections from the U.S. government.

In the largest U.S. bank failure, Seattle-based Washington Mutual Inc. collapsed in September with $307 billion in assets. There were 25 bank failures in 2008, the most in 15 years, according to the Federal Deposit Insurance Corp. The combined assets of lenders that failed in 2008 exceeds the total of those that collapsed in the preceding six years. New York-based Citigroup Inc., whose shares lost 78 percent of their value this year, needed $20 billion in U.S. bailout funds in November on top of an earlier $25 billion infusion of capital. The government also guaranteed $306 billion of the bank’s troubled assets.

The wave of writedowns and losses that swamped financial institutions around the world reached $720 billion this year. It also eroded employment: 221,360 job cuts in the financial- services industry were announced. Wall Street bonuses became so rich in recent years that $1 million was referred to as "a buck." This year, chief executive officers including Lloyd Blankfein of Goldman Sachs and John Mack of Morgan Stanley have said they will get no bonuses at all. The Amex Securities Brokers/Dealers Index hit a high of 267.69 on June 1, 2007; as of Dec. 30, it stood at 74.26.

The U.S. government was forced to rescue the world’s largest insurance company, American International Group Inc., with a $152.5 billion package of investments, loans and capital infusions. It had to start purchasing corporate commercial paper to give companies the capital they needed to meet payrolls and conduct routine business. Overall, the federal government has committed $8.5 trillion in trying to jumpstart a shrinking economy. General Motors Corp. and Chrysler LLC will get $13.4 billion in federal loans to stay afloat until President-elect Barack Obama’s administration can devise a rescue plan of its own. The paralysis of credit markets sent ripples through many of the businesses that had flooded Wall Street with profits over the past decade. U.S. corporations raised $4.54 trillion issuing securities in 2008, down from $5.14 trillion in 2007. Global merger activity fell to $2.5 trillion in deals announced from a record $4.1 trillion the previous year.

Hedge funds lost 18 percent of their value for the year through November, the worst year since record-keeping began in 1990, according to Chicago-based Hedge Fund Research Inc. Morgan Stanley estimated that, by year end, at least 620 hedge funds will have closed. At bottom, the debacle amounted to a loss of faith, especially for individual investors. They pulled $215.7 billion from stock mutual funds in the first 11 months of the year, according to Investment Company Institute, a Washington-based association. That compares with a $91 billion inflow of funds for the same period of 2007. As a result of those withdrawals and market losses, the total net assets in all types of mutual funds fell by $2.67 trillion in the first 11 months of 2008, the institute reported.

While the fear may pass, it will leave permanent changes in its wake. Few believe Wall Street will emerge as anything like the freewheeling industry it was over the past few decades. "I see this as a Darwinian event," said Mount Lucas Management’s DeRosa. "You find out which specimens of the species are genetically fit. I’m reasonably sure that things in 2009 will get better, but they’ll get materially worse before they start to look up."

Jobless claims data paint bleak picture for 2009
The number of laid-off workers continuing to draw unemployment benefits bolted to 4.5 million in late December, and even more Americans are expected to join the ranks of the jobless in 2009. While first-time applications for jobless benefits dropped last week, economists mostly attributed that to the Christmas holiday and cautioned that a more accurate picture of new layoff filings won't become clear until the holiday season is passed — around mid-January. All in all, though, the picture that emerged Wednesday was largely grim and is not expected to improve any time soon. "It wasn't a very merry Christmas for most of the labor force and it doesn't look like it will be a very happy New Year, either," said Richard Yamarone, economist at Argus Research. The Labor Department's report showed that people continuing to draw unemployment benefits jumped by 140,000 to 4.5 million for the week ending Dec. 20, the most recent period for which that information is available.

The larger-than-expected increase underscored the difficulties the unemployed are having in finding new jobs. That left continued claims at their highest since early December 1982, when the country was emerging from a deep recession, though the labor force has grown by about half since then.  A year ago, the number of people continuing to draw jobless benefits was 2.7 million. The report also showed that the number of newly laid-off workers filing first-time applications for jobless benefits dropped by a seasonally adjusted 94,000 to 492,000 for the week ending Dec. 27. That decline, however, didn't signal any improvement in labor conditions. The drop — while bigger than economists expected — was mostly related to seasonal adjustment difficulties and reflected some out-of-work people not making it to unemployment offices to file claims over the Christmas holiday, analysts said. Even with the drop, new filings remained elevated. A year ago, claims stood at 339,000. Similarly, the four-week moving average of first-time jobless claims, which smooths out week-to-week fluctuations, fell last week to 552,250, a decrease of 5,750 from the prior week. A year ago, this figure was 344,500.

Economists expected so-called "continued" claims to rise to around 4.38 million, and that first-time applications for unemployment benefits would drop to around 550,000.  On Wall Street, investors took some comfort in the drop in first-time unemployment claims. The Dow Jones industrials added nearly 110 points on the last trading day of a tumultuous 2008. Next week's jobless claims report also is likely to be distorted by another shortened holiday week because of New Year's Day, analysts said.  The bottom line here is that it probably won't be until mid-January that we begin to get a clear picture of what claims are saying," said Abiel Reinhart, economist at JPMorgan Chase Bank. 

Economists predict the jobs situation will get worse before it gets better.  Brian Bethune, economist at IHS Global Insight, predicts first-time filings for jobless benefits will climb back up to 550,000 or higher in the middle of January and stay in that elevated range for some time.  Meanwhile, the nation's unemployment rate — which zoomed to a 15-year high of 6.7 percent in November — is expected to rise to 7 percent in December when the government releases that report next week. If that proves correct, it would be the highest level since June 1993. Economists also are predicting employers eliminated another 478,000 jobs in December alone. In November, 533,000 jobs vanished.  Many economists believe the unemployment rate will keep climbing — hitting 8 percent or close to 10 percent at the end of 2009.

Employers have slashed payrolls as they scramble to cut costs. The deepening recession, disappearing jobs, shriveling nest eggs and tanking home values have forced consumers to cut back, which is hurting businesses. Atlanta-based Interface Inc. on Tuesday said it will lay off about 530 employees to cope with weakening demand for its carpet products. Other companies that announced mass layoffs recently include: technology services provider Unisys Corp., pharmaceutical company Bristol-Myers Squibb Co., International Paper Co. and Bank of America Corp.  Since the recession began in December of 2007, the economy has lost nearly 2 million jobs.  Spurring job creation is a key priority for President-elect Barack Obama, who takes over on Jan. 20. He is contemplating a massive package of government spending and tax cuts to stimulate the economy.

Unemployed workers accept pay cuts to find jobs
Happy new year and welcome to your new job. One that pays 30%, 50%, 70% less than your old one. That's right: With more than three job seekers for every opening, more workers are having to take significant pay cuts to find employment. "For people who have been laid off, this is obviously a buyer's market," said Ravin Jesuthasan, a managing principal at Towers Perrin. "We're seeing pay levels in new positions coming down."   In fact, 63% of unemployed workers said they would be willing to accept a job offer that pays less than their previous job, according to a recent survey conducted by the National Employment Law Project. Still, only 37% of respondents expressed high confidence in finding a job in the next four months despite being willing to make such a sacrifice. Nearly 2 million jobs were lost in 2008 and economists say the unemployment rate, which stands at 6.7%, will continue to rise into 2010.

"People realize that this is a different environment, said Jeff Joerres, chairman and CEO of employment services firm Manpower. "People are more anxious and are willing to secure something even if it is less." Shaun Chedister, 30, is one of those people. Chedister was laid off from his job at Washington Mutual at the end of last year. After eight months of actively looking for work to help support his wife and four children, he accepted an offer from Ernst & Young even though the new position as an executive administrator paid less than half of what he was making before. "My unemployment had run out, and I had to get something," he explained. But the adjustment to making $66,000 a year from $125,000 has been hard. "For the last four to five years I'd been making six figures," Chedister said. "My lifestyle had been at a certain level." Now Chedister said he's looking for a more affordable home. Last week one of the family's cars was repossessed after he got behind on the payments. "It could be worse," he said, I could still be unemployed." 

Often the hardest part of accepting a pay cut is the change in lifestyle that goes along with it, says Manpower's Joerres. "When you recalibrate your earnings expectations that means you have to recalibrate your lifestyle as well." And for those living paycheck to paycheck, that can mean having to move, sell possessions or give up everyday extravagances such as cable TV or phone service. After Jarrod Posner, 34, was laid off from his $110,000-a-year job as a mortgage lender for D.R. Horton, he had to change careers to find employment. After months of looking he took a job as an enrollment counselor at the University of Phoenix - a position that paid $33,000. "I was actually thankful because I was getting a job, but at the same time my wife and I realized we had to make a lot of lifestyle changes," Posner said. Since then, the Posners, who have two children, foreclosed on their home, moved into a rental property, downgraded from two cars to one and learned how to budget, he said. They've also given up their telephone and cable TV package. "All the little luxuries we don't enjoy anymore," he said. Despite the dramatic downsizing that came with a 70% salary reduction, "I'm kind of happy," Posner said. "It's nice to know that I have pretty steady employment."

After dramas of 2008, prepare for unemployment to take centre stage
Sunday, September 14, 2008, symbolises for me the year when the unimaginable happened. Over a few frantic – and I have to admit at time surreal hours on that Sunday – we ripped up our business section time-and-time again as the night unfolded. First to tell the breaking story of the failure of Lehman Brothers; then the collapse of Merrill Lynch into the arms of rival Bank of America; and finally a last ditch private-equity bid to rescue AIG from the brink. In the period of just a few hours we witnessed three events that in any "normal" year would have been among the biggest stories of the year. In the taxi home at the end of the night I remember texting the night's headlines to my father (a former Merrill employee). I started my text by assuring him I was sober (and still sane). It will, I suspect, be years before we discover quite how close we came in September to a full blown credit crisis. (I hope to have retired by the time the Cabinet papers are released in 2038 – but given the current dire state of my pension fund I fear I may still be scribbling away).

Few expect 2009 to be as unprecedented as 2008. What we now face is a hard, relentless grind as the fallout from the credit crisis spreads into the real economy. While the collapse of financial institutions dominated 2008, I believe unemployment will dominate 2009. The dire data of recent weeks is worth repeating. More than 75,000 extra people claimed Jobseeker's Allowance in November – the largest monthly increase for more than 17 years. If the forecasters are to be believed the picture will get a lot worse in the coming year. The Chartered Institute of Personnel and Development (CIPD) forecasts that 600,000 workers face redundancy this year – the equivalent of 1,600 people a day. As I have written before, don't underestimate the effect of unemployment – not just on those unfortunate enough to have been laid off, but also on the confidence of friends, family and neighbours. The fallout from redundancies spreads: hitting the confidence of everyone – no matter how secure their own jobs. With economists now predicting that unemployment could now hit 3m, jobs look set to become the a major headache for the Government in 2009.

Unfortunately there is no quick solution. No bail-out would be large enough to fix the economy and avoid us all paying the price for the excesses of the last decade. How long will the recession last? Listen to some commentators and we face years of stagnant growth with a Japanese-style downturn that could last up to a decade. New Star economist and strategist Simon Ward is more upbeat predicting on his blog – – that we could see the bottom of the curve as soon as February (although we will have to wait until 2010 until we return to growth). G7 industrial output has already contracted 7pc since peaking in February 2008, according to Ward who has crunched the November and October output data for the G7 members. The speed and depth of the downturn mean that we have already exceeded the 2000-2001 downturn and look set to exceed the 1980-1982 recession with the current decline heading towards 10pc. That would make the current recession the second worst since the Second World War, beaten only by the 1974-75 recession when output plunged 12pc from peak to trough.

List of Troubled Banks
Ready to see where your bank stands? A few days ago, a friend of mine called me to ask if I had any idea how to figure out which banks would be the next to fail. Some extensive googling revealed that while lists of troubled banks obviously exist, none of them seem to be readily available to the public. Why? Because the bankers do not want you to have this. Just watch the president of the American Bankers Association in this interview talk about how important it is to keep this private.

This is a list of all of the banks in the United States and the corresponding Texas Ratio for each one. Developed by Gerard Cassidy, the Texas ratio is a measure of a bank's credit troubles. Basically, the higher the ratio, the worse the situation is for that particular bank. Banks with a ratio of 100 and higher are in very serious danger of collapse, and banks with a ratio of 50 or higher are vulnerable.

This is the formula I used: 100 * ((Non-performing Assets - U.S guaranteed loans) + Other REO) / (Equity + Loss Reserves)

All of this information is available on the FDIC website, but it's extremely difficult to gather in a meaningful way. In fact, I don't think you'll find a list like this anywhere else on the internet.

Almost 3,000 UK home owners falling into negative equity every day
Almost 3,000 home owners are falling into negative equity every day, according to new research which underlines the scale of the housing slump. More than half a million households start the year living in a home worth less than the loan they took out to pay for it. This number could surpass the 1.7m total reached in the early 1990s by the end of this year. The warning came after the UK endured one of its most torrid years in recent memory, with London shares sliding by the biggest amount since the 1970s and the pound falling at the sharpest rate since Britain abandoned the Gold Standard in 1931. Calculations by The Daily Telegraph, based on research from Standard & Poor's, reveal that the number of people facing negative equity has risen from 350,000 in October to around the 500,000 mark by the year-end. The calculations chime with a warning from the Bank of England that around that number of households could already be facing negative equity.

The phenomenon is widely regarded as among the most painful of all financial difficulties, since it effectively traps households in their homes, since they would have to pay a hefty surcharge to their mortgage company to move house. Mortgage experts added that many millions more families would be directly affected, since the fall in house prices has brought many house prices down to levels where they are worth only slightly more than the mortgage financing them. In such circumstances, lenders whose mortgage deals are soon to expire will have little option but to move onto a more expensive deal on the standard variable rate. Simon Ward, chief economist at New Star, said: "The problem with negative equity is the fact that it interacts with rising unemployment, causing more repossessions. That is the scenario we're facing at the moment." Economists expect the number of people out of work to rise towards 3 million this year, leaving many of the most over-extended with little choice other than to sell their homes or give them up to their mortgage companies. Mr Ward said: "I think this is broadly comparable to the early 1990s. However, a further problem is this will obviously makes the situation facing the banks even worse. If they are forced to foreclose on further loans it could intensify the banking crisis being faced at the moment."

The Bank of England warned recently that one in 10 mortgage holders - 1.2 million households - are likely to be trapped in a home worth less than the loan they took out to pay for it, though many independent forecasters, including Standard & Poors, suspect the eventual total could near 2 million - the greatest number on record. Ray Boulger, of mortgage advisers Charcol, said that all homeowners should be vigilant about the dangers posed by falling house prices. "Negative equity is not just a problem for anyone who needs to move home - although it clearly affects them directly," he said. "It is an issue for anyone intending to renew their mortgage in the coming years. If your mortgage is worth more than 80 per cent of your property, it will be significantly more difficult to find a cheap deal in the coming years."

It means many families will face a "mortgage shock" in the coming months as they are refused a new loan and have to take up the significantly more expensive standard variable rate. Coming at a time when unemployment is rising and workers are bracing themselves for a fall in their incomes, the warning will be of serious concern for many homeowners. Mr Boulger said that although most mortgage companies had the right to force their customers to repay their loans in circumstances of dire emergency - a so-called "armageddon clause" - he added that they were unlikely to trigger it because a household has slipped into negative equity. City economists have predicted that house prices will tumble further this year, as the UK faces its worst economic performance since the Second World War. The FTSE all-share index dropped by a third in 2008 - its worst year since the early 1970s - while the pound has slid by around a third against the euro, and is close to parity with the single European currency. Although the drastic efforts to pump cash into British banks last October helped avert an outright collapse in the financial system, many analysts suspect that further amounts of taxpayer money will have to be funnelled into the system in the coming months. The only alternative, they say, is for banks to cut back their lending even more dramatically in the coming months, causing further economic gloom as a result.

The Great Real Estate Bust of 2008

What brought on the collapse of home prices in 2008 that is the root of the financial crisis now enveloping much of the world? Home prices in the United States, as measured by the Standard & Poor's/Case-Shiller Home Price Indices, have plummeted more than 40% in real inflation-adjusted terms in some major cities since the peak around the beginning of 2006. Nationally, including all cities, the fall is over 25%. The futures market at the Chicago Mercantile Exchange is now predicting declines of around 15% more before the prices bottom out in 2010. These are the market's forecasts - and it is not a very liquid market. But those who make these forecasts are implying real declines, from peak to trough, of more than 50% in some places.

Why are we seeing such big price drops? And why does the housing market in so many other countries now reflect similar conditions? The answer has both proximate and underlying causes. The proximate answer for the US is that a decline in lending standards helped people buy houses at ever-increasing prices before 2006. Freer lending meant that people were freer to bid up prices of homes to ridiculous levels. Shacks were selling for a million dollars. After the peak, lenders tightened their standards. When buyers find it difficult to finance home purchases, sellers have to cut the asking price. The up and down of lending represents a credit cycle, and credit cycles have played a major role in economic fluctuations for centuries. In his 1873 book Lombard Street, Walter Bagehot, the British businessman and editor of The Economist, described these cycles perfectly.

The boom just before the depression of the 1870's that he described sounds a lot like what happened just before the current crisis. When credit expands, he wrote, "The certain result is a bound of national prosperity; the country leaps forward as if by magic. But only part of that prosperity has a solid reason...this prosperity is precarious." But the credit cycle was not the ultimate cause of the 1870's depression or the crisis we are seeing today. Ultimately, one must always ask why lending standards were loosened and then tightened. The credit cycle is an amplification mechanism. The instability in the lending sector is always there, and the crisis manifests itself only if some precipitating factor triggers it. Moreover, the extreme weakening and then tightening of credit standards seems particularly prominent only in the US, while the housing boom-bust cycle is prevalent throughout much of the world.

The precipitating factor that led to the current situation has to do with our evolving world culture, spread rapidly through enhanced media outlets and the Internet, and its perceptions of the markets. It has to do with the deep admiration of markets that has developed during the boom, in line with the "efficient markets theory" in academic finance. It became widely believed that financial markets are such sublime poolers of information that they represent a collective judgment that transcends that of any mere mortal. James Surowiecki's bestselling 2004 book, with the outrageous title The Wisdom of Crowds, pressed this idea forward at the very height of the real estate boom. The boom in the world's housing markets and stock markets between 2003 and 2006 was caused by this faulty idea, and the idea that investments in homes and equities are a sure route to wealth.

It had become an article of faith that the value of both types of assets only goes up in the long run, and that it is foolish to try to "time the market." It was sincerely believed, and supported by deep intuitive judgment, that interruptions in this upward trajectory could only be small and transient. People seemed to think that rapid appreciation in these markets had become a universal constant, like the speed of light. Nothing else ultimately explains lenders' immense willingness, in the boom up to 2006, to lower their credit standards on home mortgages, regulators' willingness to let them do it, rating agencies' willingness to rate mortgage securities highly, and investors' willingness to gobble them up.

There is no theory in economics that provides a reason to think that prices in these markets can only go up. On the contrary, economic theorists have been puzzled by the historical rate of increase in the stock market, which they call "the equity premium puzzle." They do not have a corresponding name for the behavior of the housing market, because, historically, its prices (correcting for inflation) have not generally gone up very much on average, until the post-2000 bubble.

The booms in these markets can be traced substantially to the growth of the idea that one should always continually hold as many of these assets as possible, just as that you should drink green tea or eat dark chocolate every day for antioxidants. Such ideas create artificial demand - but only for a while. After all, we no longer smoke cigarettes to prevent infections. People will believe many things if they have the impression that the rich and famous believe them, too. But their belief can suddenly be disrupted if plainly visible events contradict it. That is what is happening now, and 2009 will shape up as a year of even more profound disenchantment.

The euro's bitter-sweet triumph at 10
If the purpose of the euro is to confront US dollar hegemony and turn the European Union into a monetary superpower, it is a signal triumph. But politicians should be careful what they wish for. On its tenth birthday, the single currency is an unquestioned part of daily life for 330m people in sixteen states (Slovakia joins on January 1st), spreading almost as widely as Rome's denarius -- the first truly Pan-European coin. There has been no "tissue rejection" by the public, even if Eurobarometer data shows that the euro is more accepted than loved. Shoppers blame it - unfairly -- for inflation. Half the French still think in francs. Oddly, a slew of regional currencies have begun to circulate in German regions since the launch of EMU. Sociologists are baffled.

Market eagerness to push the euro to sterling parity, and to defiant highs against the dollar, yuan, rouble, and rupee, is an undeniable stamp of confidence. But success is bitter-sweet. The eurozone itself is in deep recession. A currency surge at this juncture is a cruel blow for export industry. The full damage will hit in late 2009 as the time-lag effects work their curse. The point of monetary union -- at least for Paris -- was to stop this happening. EMU was supposed to shield Europe against the fall-out from Anglo-Saxon "casino capitalism" and to ensure a stable currency. Stable it is not. The Élysée never imagined that it would be a currency on steroids, spiking so high that it hollows out the French industrial core and drives Airbus to the brink. As President Nicolas Sarkozy put it in a moment of fury, "we didn't create the euro so that we could no longer build a single aircraft in Europe".

Otmar Issing, ex-High priest of the European Central Bank, says half the states of West Europe would now be facing currency storms akin to the early 1990s were it not for the fortress strength of EMU. The yield spreads on Italian, Greek, Portuguese, Spanish, Austrian, and Irish debt would be even higher than they are already, amplifying the effects of the credit crunch and probably making it too dangerous for governments even to think of fiscal rescue plans. "People do not seem aware of this. They are now taking the advantages of the euro for granted," he said. This is true in one sense, although the 1990s ructions stemmed from a fixed link to the D-Mark, a recipe for disaster. But such claims and counter-claims hardly touch on the deeper question of whether EMU is a viable undertaking over the long run -- or an "optimal currency area" (OCA) in economic jargon. Ten years on, the controversy rages. Both sides have enough evidence to say with equal vehemence, "I told you so". It all depends which part of the picture you look at.

Let us not forget that the euro is a revolutionary construct. Never before have sovereign states of equal weight agreed to abolish their currencies -- some dating back to the Middle Ages -- and tied their destiny to a supranational bank. The franc -- minted in 1360 to celebrate the end of Jean Le Bon's captivity in England -- evoked France itself, and French voters were not easily persuaded to give it up. The Maastricht Treaty passed by a wafer-thin margin in September 1992. We will never know how the German people would have voted if allowed to decide on the fate of their beloved D-Mark, the symbol of national renewal. Currency unions come and go, typically revolving around one dominant power. The euro is a different animal. It has no political anchor. It is a leap into the unknown without a state, treasury, debt union, or EU social security net to back it up.

For arch-critics at Germany's universities, the decision to press ahead with the euro before the creation of a full-fledged EU state was to put the cart before the horse. America had forged its union before issuing a currency, as had 19th century Germany. This is the bigger question to be tested over the euro's second decade. Currency unions can mask risk for a while. They shield sinners long enough to let imbalances get out of hand, storing up trouble for a more traumatic crisis later. Eurosceptics say this is exactly what is happening. The gap between North and South has grown ever wider as Europe's nations hold true to type, and as the ECB's one-size-fits-all policy has vastly different effects on different cultures. Italy has lost 40pc in labour cost competitiveness against Germany since the currencies were fixed in 1995, and Spain has lost about 35pc.

The reasons are complex, rooted in the wage-bargaining structures, the protected guilds, and the banking systems of countries refusing to give up their traditions. In Spain, 70pc of wages are indexed to inflation, and over 98pc of mortgages are linked to floating Euribor. Is it any wonder that Spain's property boom mushroomed out of control when the ECB held rates at 2pc (to help Germany, then in trouble)? Latin Bloc states could have taken drastic steps to make their economies more compatible with Germany. They failed to do -- despite heroic efforts by officials, especially at the Bank of Spain -- because the political class never understood the implications of EMU. Nor did Germany's leaders, for that matter. The shining exception is Finland.

Current accounts tell the sorry tale. Germany has a surplus near 7pc of GDP, while deficits have reached 10pc in Spain and Portugal, and 14pc in Greece. Club Med extravagance can continue only as long as foreign investors are willing to plug the gaps with fresh capital. Italy's debt headache is different, but no less serious. As Europe's most indebted state, it must roll over €200bn of bonds this year in hostile markets. It will not be easy for victims to claw back competitiveness within the constraints of monetary union. They will have to "deflate" wages relative to Northern Europe, but there lies the risk of a self-feeding debt trap. We are shifting into the political realm in any case. Spain's unemployment has jumped from 8pc to 13pc in little over a year, and some analysts are predicting 18pc by 2010. When does civic patience snap? Nobody knows, but the ferocity of last month's riots in Greece is a warning.

As Europe's slump deepens this year we may find out if it matters whether or not the euro is a stateless currency. In dollar land, Washington disburses a fifth of GDP. A system of "fiscal transfers" automatically shifts stimulus from healthy regions to bust zones. This is how an 'OCA' self-adjusts. We may find out too whether euroland enjoys the solidarity of a nation, "all for one and one for all", when the chips are down. German body-language so far does not suggest that it does. For now, the eurozone is basking in glory as the world's ultimate safe-haven. Icelanders are eyeing the currency longingly, and Denmark has paid a high price (two rate rises into the crisis) for its semi-detached role in the Exchange Rate Mechanism. The Poles are trying to rid themselves of the zloty as fast they can.

Berkeley Professor Barry Eichengreen says the euro is the "great winner" of this financial crisis, confounding those in the Milton Friedman camp who thought EMU would blow apart in the first bad storm. The nature of this banking drama has played -- unexpectedly -- to EMU's strengths, he argues. Banks in European states outside EMU mostly lack a domestic currency used for international dealings, so they have borrowed in euros (and dollars). This has proved to be an Achilles Heel. "The implication is clear. National banking systems need a lender of last resort. In small countries, where a significant share of bank liabilities is in someone else's currency, the national central bank lacks this capacity. The only options are then to slap draconian controls on the banking system or join the euro area," he says. His verdict is that every country except perhaps Britain will have to join Euroland. "The writing is on the wall", he said.

So the debate goes on. For defenders of sterling - and the Swedish and Norwegian crowns -- the precipitous slide against the euro over recent months is broadly a boon, unless you work in the travel industry, or ski a lot. It acts as a shock absorber at a crucial moment, helping to cushion the economy against debt deflation. Export profits may hold up long enough to give a lifeline to UK manufacturing and service firms as banks shut off credit lines. It is the difference between survival and failure for thousands of healthy companies. This is what an independent currency is for. It preserved social stability in 1931 when Britain left the Gold Standard, and again in 1992 on leaving the ERM (from which the pound later roared back to a higher level, at the appropriate time). We are too close to events to draw any definitive conclusions about the workings of EMU or the crash in sterling. There will be many twists and turns before this great debacle has played itself out across the world. When the Chinese leader Chou-en-Lai was asked what he thought about the French Revolution, he replied "too soon to tell". To judge the euro revolution on just a decade is frivolous.

Almost three quarters of Britons opposed to joining the euro
Almost three quarters of Britons remain opposed to joining the euro 10 years after it was introduced. A new poll reveals that 71 per cent of people are against Britain entering the European single currency, with only 23 per cent in favour. It comes amid the plunging value of sterling against the euro, which has almost achieved parity with the pound. This week the euro climbed to a record high of 98p against the pound, leaving tourists receiving less than a euro given for each pound once commission charges are taken into account. It comes as William Hague, the Shadow Foreign Secretary, reiterated that a Tory government would never adopt the euro.

There are fears that the pound may fall further amid speculation that the Bank of England may deliver another cut in interest rates next week to stave off a prolonged recession. Sterling is less attractive to foreign investors if rates are coming down as they will typically get a lower return on their money. The ICM survey for BBC Radio 4's The World At One also revealed that just 15 per cent said that the pound's fall made them more keen on ditching sterling for the euro. Martin Ellis, chief economist at Halifax, said: "The euro has risen strongly against the pound in 2008, with an almost parity being reached between the two currencies over recent days. The financial markets appear to be reacting to the belief that the already record low bank rate of 2 per cent could be cut further in the New Year."

Last month, European Commission President Jose Manuel Barroso said the UK was "closer than ever" to joining the euro and that the "people who matter" in British politics were contemplating giving up the pound. Business Secretary Lord Mandelson said the Government maintained the long-term policy objective of taking the UK into the euro, though he insisted: "It's not for now." When the euro was launched 10 years ago it became the official currency for 11 member states of the EU, marking an end to Germany's Deutschmark and the French franc. It began trading on January 4 1999, at just 71p against the pound and has since traded at an average of 67p against the pound. The euro hit an all-time low against the pound of 57p in May 2000 but recovered to reach this week's record high. Also today, Slovakia became the latest member of the euro area, taking the number of countries where the euro is official currency to 16.

Commodity Boom Turns Bust in 2008 as Worldwide Economy Crumbles
Commodity prices in 2008 plunged the most in five decades as demand for energy, metals and grains tumbled in the second half because of the recession. From July to December, the slumping economy drove crude oil, gasoline, copper, corn, and wheat down from records in the first half. In 2008, the Reuters/Jefferies CRB Index of 19 raw materials fell 36 percent, the most since the gauge debuted in 1956, to 229.54. It rose to a record 473.97 on July 3. On Dec. 5, the measure dropped to the lowest since August 2002. The worldwide economy crumbled last year. Home prices plummeted, investment banks collapsed and credit froze. U.S. consumer spending plunged, pushing the nation’s automakers to the brink of bankruptcy. Growth in China and other emerging markets withered.

"Macroeconomically, we’re in a free fall," said John Brynjolfsson, the managing director and chief investment officer at hedge fund Armored Wolf LLC in Aliso Viejo, California. "There’s a complete destruction in industrial production and demand, and this is likely to keep pressure on the commodity sector in general." In 2008, 15 prices dropped in the CRB, led by gasoline and nickel. Only four climbed, paced by cocoa. "The recession will stretch for at least the next six months," Marc Faber, the managing director of Marc Faber Ltd. in Hong Kong and publisher of the "Gloom, Boom and Doom Report" said in an interview on Bloomberg Television on Dec. 26. "2009 will be a write-off in terms of economic activity."

In 2008, gasoline dropped 59 percent, the most among CRB components. Cocoa climbed 31 percent, the biggest increase. Sugar, gold and hogs were the only other commodities to post gains. Gasoline futures declined to $1.0082 a gallon last year on the New York Mercantile Exchange. The price climbed to a record $3.631 on July 11. The 2008 low was 78.5 cents on Dec. 24. Crude oil futures tumbled a record 54 percent to $44.60 a barrel last year on the Nymex. The price rose to an all-time high of $147.27 on July 11. On Dec. 19, it touched $32.40, the lowest since February 2004. Oil may rebound to average $60 in 2009 as the Organization of Petroleum Exporting Countries makes record production cuts to counter the deepest economic slump since World War II. Copper futures declined 54 percent to $1.41 a pound in 2008 on the Comex division of the Nymex. The price rose to a record $4.2605 on May 5. On Dec. 26, the metal touched $1.255, the lowest since October 2004.

"Things are going to be a lot better next year than people think," Lars Steffensen, the founder and managing director of Ebullio Capital Management LLP, a commodity hedge fund based in Southend-on-Sea, U.K., said yesterday. "The U.S. is going to print the dollar to get out of the recession, and anything tangible, like industrial metals, is going to be worth more." Cocoa futures in 2008 jumped 30 percent to $2,665 a metric ton on ICE Futures U.S. in New York. A smaller crop in Ivory Coast, the world’s biggest producer, eroded inventories, contributing to a global deficit. "Cocoa has the best fundamentals of any commodities, except maybe tin," Steffensen said. "They share a low- inventory story, straight deficits and limited ability for production increases, along with supply problems." Gold futures rose 5.5 percent to $884.30 an ounce last year on the Comex division of the Nymex, marking the eighth-straight annual increase. The metal reached a record $1,033.90 in March. Gold may benefit as U.S. government policies result in inflation in the long term, said Chip Hanlon, the president of Delta Global Advisors Inc. in Huntington Beach, California.

The Federal Reserve "believes it has to prop up the financial system," Hanlon said. "The move toward quantitative easing to fight what they perceive as deflation ultimately will lead to higher rates of inflation." The U.S. government has pledged more than $8.5 trillion to help ease the credit crisis. The Fed slashed its benchmark interest rate to near zero to help stimulate the economy. Hog futures climbed 5.2 percent to 60.875 cents a pound last year on the Chicago Mercantile Exchange. The global economic slowdown set the stage for cutbacks in supplies. "We’re going to have 3 percent to 4 percent less pigs next year, and that should be very supportive to higher pork prices," Mark Greenwood, who manages about $1 billion of loans and leases to swine producers for AgStar Financial Services in Mankato, said last month.

Street looks to '09 with relief after terrible '08
The last trading day of 2008 on Wall Street provided a merciful end to an abysmal year -- the worst since the Great Depression, wiping out $6.9 trillion in stock market wealth. Six years of stock gains disappeared as the economy crumbled and markets crashed around the globe, shaking the confidence of professional and individual investors alike. But the year's chaos went far beyond the stock market. Credit markets that drive lending became paralyzed, plunging the country further into recession and touching off an unprecedented rush for the safety of Treasury bills, notes and bonds. Commodities markets, usually ignored by most investors, soared on speculative buying and then collapsed when it became clear that the world economy was in trouble and that record high prices, including oil's peak above $147 a barrel, were unjustified.

"It was a feeling of flailing," said Jerry Webman, chief economist at Oppenheimer Funds Inc. "People couldn't get a grasp because there were not obvious historical precedents." By the year's end, many market analysts were predicting that 2009 would be better, but that recovery would be slow as investors, shaken by the devastation to their portfolios, U.S. companies and the overall economy, remain reluctant to buy. "I think this may be much more of a show-me market than we're used to. The market is going to be looking for some stabilization, increases in earnings, a few more positives before it begins to recover," said Webman. Wall Street's stats for 2008 provide evidence of how stunningly terrible the year was:
  • The average price of a share listed on the New York Stock Exchange plunged 45 percent to $41.14 by the end of the year from $75.01 a year earlier.
  • The Dow Jones industrial average fell 33.8 percent for the year and 38 percent from its record close of 14,165.53 in October 2007, making it the Dow's worst year since 1931, when the country was in the midst of the Great Depression.
  • The Standard & Poor's 500 index, the indicator most watched by market pros, slumped 38.5 percent in 2008 and 42.3 percent from its 2007 high of 1,565.15.
  • Investors lost $6.9 trillion as relentless selling reduced the value of stocks across the market. That amount, measured by the Dow Jones Wilshire 5000 Composite Index, represented 38 percent of the total value of U.S. stocks at the start of 2008.
Yet the last week of the year was almost serene. On Wednesday, the Dow rose 108.00, or 1.25 percent, to 8,776.39. Broader stock indicators also rose. The Standard & Poor's 500 index gained 12.61, or 1.42 percent, to 903.25. The Nasdaq composite index rose 26.33, or 1.70 percent, to 1,577.03 and ended the year down 40.5 percent. It's down 44.8 percent from its recent peak in October; the Nasdaq's record high close of 5,048.62 came in March 2000 just before the end of the dot-com boom. The Russell 2000 index of smaller companies rose 16.68, or 3.46 percent, to 499.45. The tranquility was a welcome change in a year that was rocky from the start as worries about the financial system were fed by reports that banks had suffered billions of dollars in losses on securities tied to defaulting mortgages.

The forced-sale of Bear Stearns Cos. in March unnerved Wall Street, yet it still managed to right itself through the spring. The surging price of oil and other commodities dealt another blow to the market. As a barrel of crude leaped from $112 at the beginning of May to a once-unthinkable $147.27 on July 11. With retail gasoline prices soaring above $4 a gallon, stocks fell amid fears that consumers would have to cut back their spending because of higher energy prices. But the market again stabilized -- until the September bankruptcy of one of the most venerable Wall Street investment firms, Lehman Brothers Holdings Inc., set off a panic on Wall Street and in the credit markets. Banks, fearing that other financial institutions would be unable to repay, stopped lending to each other. The market for short-term corporate debt known as commercial paper was frozen. Interest rates soared. The only thriving part of the credit markets was government debt. Investors desperate for safety poured money into Treasury issues, particularly short-term bills. The yield on the three month bill plunged to zero, and briefly to a negative return, as investors decided no return or a slight loss was better than the losses on Wall Street or in commodities.

Wall Street's crash in 2008 didn't come in one day like the famous 22.6 percent plunge of Oct. 26, 1987. In many ways it was more nightmarish than Black Monday because there wasn't a quick end to the selling and record volatility. From Sept. 15 to Nov. 20, when the Dow fell to a close of 7,552.29, the depths it had reached in the bear market of 2002, the blue chips rose or fell by triple digits 41 trading days out of 49. Relative stability returned to the market during December. But Wall Street's horrific performance has cast a new mold for modern bear markets, often defined as a decline of more than 20 percent, and made expectations for 2009 so low that any reduction in the economic bloodletting would be considered a victory. "Everyone is so down in the dumps about everything that I do think it gives you the opportunity to have a positive surprise if maybe the economy does turn quicker," said Bill Stone, chief investment strategist at PNC Wealth Management.

Wall Street is hoping for signs of recovery by the second half of 2009, including evidence the housing market has hit bottom, increased lending by banks and a drop in unemployment accompanied by increased consumer spending. But for the near future economists and market experts predict more bad news. "I have yet to see anyone who anticipates that the first half of next year is going to be rosy," said Dean Junkans, chief investment officer at Wells Fargo Private Bank. But even a modest improvement in the economy, which has been in recession since last December, could help stocks extend their recent run. "If you're standing still, walking is a pickup of speed," said Alan Levenson, chief economist at T. Rowe Price Associates Inc. The government has helped calm markets with a $700 billion rescue of the financial sector and by agreeing to provide financing to the major U.S. automakers. The Federal Reserve slashed its benchmark interest rate to near zero to reduce borrowing costs. Cheaper oil prices -- it settled at $44.60 a barrel on Wednesday -- are expected to help bolster the economy, draining less money away from consumers and businesses.

The declining prices of other commodities, which have come down in response to rapidly waning demand for raw materials around the world, should also help. In addition, some analysts believe the market will improve because so many investors have pulled out, leaving little room for more selling. "Given the nasty carnage how much further risk is there?" said David Darst, chief investment strategist for Morgan Stanley's global wealth management group. Still, the credit markets remain nearly stagnant as banks continue to be anxious about lending. Corporate forecasts in January could help shape investor sentiment, even as expectations are modest. David Kelly, chief market strategist at JPMorgan Funds, said the prospects for the market are "exceptionally uncertain." For the market to hold its advance from November he contends the calmer trading of the past month must continue and president-elect Barack Obama's plan to boost the economy with spending on infrastructure must show it is working quickly. "The great risk is we are in a wait-and-see economy," Kelly said. "What Obama needs to do is turn this into a do-it-now economy, give people a reason to buy."

Banks 'feel remorse' for downturn
The chairman of one of the world's largest banks has told the BBC that bankers must take some responsibility for the global economic downturn. Sir Win Bischoff, from Citigroup, said his industry was "partly to blame" and some within it did feel "remorse". He said forthcoming bonuses would be "way down" at his bank, which received a £35bn bailout from the US government. Sir Win and other senior Citigroup executives have said they will forgo their 2008 bonuses. In a memo to employees, Sir Win, along with chief executive Vikram Pandit and senior adviser Robert Rubin, said it was fair for them to give up their bonuses - and to cut those of other executives - in light of the "harsh realities of 2008, primarily our earnings results".

Citigroup lost $10.42 billion (about £7.2bn) between January and September 2008, and plans to cut 52,000 jobs by early this year. Sir Win, who was guest editor of BBC Radio 4's Today on Thursday, told the programme that banks "ultimately do carry some of the responsibility" for the economic downturn. "I think it's very important for banks not to deny that they carry some of the can," he said. "My view is that they are partly to blame and there are people who feel remorse about this. "Do they all? I don't know." Sir Win said it was "a really painful period" for everyone involved in the banking industry. He said bankers did not have "their heads in the sand" - but no-one had foreseen the severity of the current crisis.

Sir Win said the "root cause" was the widespread use of financial products "which appeared to have sufficient safety factors built in," but were, in fact, too risky. "That then led down a slippery path… [it] actually led to this kind of confidence that asset prices could not possibly fall, commodity prices could not fall," he added. Sir Win said some bonuses would still be paid to those working in "very useful and very profitable" sections of his company. Overall, however, he said rewards would be cut "substantially". "For a lot of people there are not going to be bonuses. Bonuses are going to be way down. "Finance used to be a profession which was very attractive financially. I think it's going to come back much more into the mainstream in terms of remuneration." One of Citigroup's Wall Street rivals, Goldman Sachs, has cut its pay bill by half this year, although its 30,000 employees still earned an average of £250,000.

Municipal Bond Sales Drying Up Just as States Face $42 Billion Shortfall
The worst year for municipal bond investors since 1999 may further reduce demand for tax-exempt debt just as state governments face the biggest budget deficits in at least a quarter-century. State and local borrowers sold $385 billion of long-term bonds through yesterday, down 9 percent from 2007, according to data compiled by Thomson Reuters. Next year, sales will drop more than 6 percent to about $364 billion, the least since 2004, based on an average of estimates from London-based Barclays Plc, Merrill Lynch & Co. and Loop Capital Markets LLC. The combination of the worst financial crisis since World War II and the collapse of the $330 billion auction-rate debt market will leave 41 states and the District of Columbia with shortfalls just as financing sources diminish. Merrill Lynch’s Municipal Master Index, which tracks 14,000 bonds, fell 4.6 percent this year, the first decline since a 6.34 percent drop in 1999. The biggest underwriters are merging or leaving the business.

"It’s been an absolutely horrible year," said Robert MacIntosh, a money manager at Eaton Vance Management in Boston, who oversees $17 billion in tax-exempt bonds. He said he’s never seen such turmoil in the $2.67 trillion municipal debt market during more than 25 years in the business. A freeze in global credit markets this year drove municipal borrowing costs to unprecedented levels. Yields on AAA general obligation bonds due in 30 years rose to a record 2.2 times Treasury yields from the historical average of about 0.96 times, according to Concord, Massachusetts-based Municipal Market Advisors. That represents an extra $2.93 million a year in interest on every $100 million of debt sold.

The lowest-rated borrowers were hit hardest. Merrill Lynch’s index tracking debt ranked BBB, the bottom tier of investment- grade, fell 22.3 percent, the most since the firm began compiling the data in 1989. Five of the 12 largest municipal-bond underwriters, including New York-based Merrill Lynch and Zurich- based UBS AG, agreed to merge or have exited the business. Budget analysts are increasing their estimates of state deficits as the U.S. economy enters its second year of recession. The Center on Budget and Policy Priorities in Washington, a nonpartisan budget and tax analysis group, said last week that states faced a combined budget shortfall of $42 billion this fiscal year, up from $8.9 billion on Oct. 10. "It’s going to be very hard to get refundings done, at least in the first part of the year," said Evan Rourke, part of a team that manages $7 billion in municipal bonds at New York- based M.D. Sass Associates.

This month, top-rated Harvard University in Cambridge, Massachusetts, sold tax-exempt bonds due in 2036 at a yield of 5.8 percent, or 1.31 percentage points more than similar securities it issued in June. New York City offered investors 6.25 percent on bonds due in 20 years, up 1.65 percentage points from December 2007. Cascade Healthcare Community’s yields shot up more than 3 percentage points in seven months to 8.5 percent, as the Bend, Oregon-based hospital’s ratings were cut, in part because of higher debt costs.Rising bond expenses are forcing municipalities to postpone projects. Merrill Lynch estimates the backlog of offerings to fund public works has grown to more than $120 billion. The school district in Fort Bragg, California, a town of 6,600 located 170 miles (273.5 kilometers) north of San Francisco on the Pacific coast, put off construction at its high school and delayed a solar-power project after shelving a $7 million bond sale when interest rates jumped following the collapse of Lehman Brothers Holdings Inc. in September.

"It got really crazy right about the time we wanted to sell," said Kathryn Charters, the district’s business manager, who hopes to issue the debt next year. A total of $390 billion of bond sales are anticipated in 2009, said analysts Ivan Gulich and Chris Mier of Loop Capital, a Chicago-based underwriter. "Interest rates are the most important predictor of municipal bond volumes," they said in a Dec. 18 report. This year’s turmoil is a reversal from 2007, when sales reached a record $430 billion as hedge funds, banks and other institutions borrowed money to buy municipal securities and boost returns, according to Thomson data. Analysts at New York-based Citigroup Inc. led by George Friedlander estimated in a Dec. 19 report that the amount being used by investors in that type of strategy fell to about $12 billion from a peak of $120 billion.

Losses started in February, when the auction-rate market collapsed as dealers who supported it for two decades abandoned the weekly and monthly sales where rates were set on the long- term bonds. Interest costs soared to 20 percent for issuers such as the Port Authority of New York & New Jersey when dealers stopped buying securities that went unsold. At the same time, bond insurers that guaranteed more than 50 percent of all new municipal debt began suffering credit rating downgrades after standing behind the same subprime mortgage-related securities that have triggered $1 trillion in losses and writedowns at the world’s biggest financial institutions. "Everything you thought was not possible in the muni market basically has come to fruition," said Peter Hayes, head of the municipal product group at asset manager BlackRock Inc. in Plainsboro, New Jersey.

Instead of selling bonds to finance public works, issuers from California to New York were forced to refinance auction-rate and other adjustable-rate securities with fixed-rate debt. With demand drying up among institutions, state and local governments are turning to individual investors. A marketing campaign by California, the biggest municipal borrower, helped draw a record of more than $3.9 billion of orders from retail investors in a $5 billion short-term note deal in October, according to the state treasurer’s office. "Issuers should not presume that market access will necessarily be available on demand," underscoring the need to cater to individuals, Phil Fischer, a municipal strategist at Merrill Lynch, said in a Dec. 8 report. California officials said Dec. 11 the state’s shortfall will reach a record $41.8 billion over the next 19 months, and the state may run out of cash as soon as February.

A day earlier, Standard & Poor’s said it may lower the rating on California’s $46.6 billion of general obligation debt and $7.8 billion in bonds backed by lease payments. S&P reduced to "SP-2" from "SP-1" its ranking on $5 billion of short-term notes that the state sold to cover its tax shortfalls. Public officials are pinning their hopes for a turnaround on a stimulus plan of as much as $1 trillion being developed by President-elect Barack Obama. New York Governor David Paterson wrote in a Dec. 29 letter to Obama that he "strongly" supported spending $300 billion for "ready-to-go projects to rehabilitate and construct" infrastructure. "We have got a huge infrastructure problem that will start to be funded in 2009," said Kevin Giddis, a managing director of fixed-income trading with Morgan Keegan Inc. in Memphis, Tennessee, in a Dec. 29 interview with Bloomberg Television.

Hooked on Debt: Creative borrowing catches up with California cities
Oxnard was in a bind, facing a $150-million bill to fix cracking and crumbling streets and no way to pay for the work without cutting other services. The city had tried, and failed, to get voters to approve a bond measure for street repair. And it had borrowed money against almost all of its public property, including a soccer stadium, three fire stations and its library -- even the Police Department's evidence-storage building. With virtually nothing left to hock, the city came up with an ingenious way to take on more debt: It borrowed against future revenue by "selling" its streets to a city-controlled financing authority. "We had way too much construction work to do and way too little money," said Ken Ortega, Oxnard's public works director. "We really pulled every creative financing string we could to come up with the money."

Desperate for cash in a sputtering economy, local governments throughout California are digging themselves deeper into debt, and many are doing so through exotic financing schemes designed to sidestep the need for voter approval. California cities, counties and other agencies borrowed $54 billion last year, nearly twice as much as in 2000, and governments are straining under the load. Statewide, 24 cities and public agencies missed scheduled debt payments this year or were forced to tap reserves or credit lines to stay current, records show. That's up from nine in 2006, according to the bond industry's self-regulatory agency. The city of Vallejo, burdened with huge debt obligations, in May became the largest city in California history to file for bankruptcy protection. Chula Vista, Orange County and Palmdale are among the other cities and counties staring at red ink.

Much of this borrowing binge was made possible by complex financial schemes such as the one Oxnard used. These nontraditional debt vehicles cost more over the long run because they are considered riskier than general-obligation bonds, which governments stand fully behind. Investors therefore demand higher interest rates. "There are many cities and counties engaging in complex financial deals that they don't really understand," said Michael Greenberger, former head of the trading division of the Commodity Futures Trading Commission. "And now it's starting to catch up with them."

Government officials say such measures were necessitated by Proposition 13, the 1978 initiative that limited property taxes and required a two-thirds vote for future property tax hikes. Local governments can raise various fees or cut costs to reduce their need for borrowing, but many are reluctant to do so, fearing a voter backlash. "Instead of saying we don't have enough income to do what we need to do, we've resorted to debt," said Jean Ross, executive director of the California Budget Initiative, a nonpartisan group that studies the state's budget priorities. "It's time for elected officials to have an honest conversation with voters about what their tax dollars can buy."

Oxnard's sale of its streets in December 2007 was a variation on a borrowing technique known as a lease-back. In a typical example in the private sector, a business sells a property to raise money, then leases it back from the buyer. In the public sector, lease-backs are more a financial sleight of hand. A city council that needs to raise money might sell its city hall to a council-controlled finance authority. The council would then rent, or lease back, the building from the finance authority. The authority, meanwhile, would issue bonds using the city hall as collateral. It would pay back the bondholders with the "rent" it collects from the city. The sale of the building is a legal abstraction, a shuffling of paper whose purpose is to keep the debt off the city's books. That way, officials can circumvent the state Constitution's requirement of voter approval for government borrowing.

"The reason they enter into these leases is so that they don't have to get the debt voter-approved," said John Kim, an advisor with Los Angeles investment bank De La Rosa & Co. who has set up lease-back deals for a number of California cities. "They're so popular that a lot of cities then run out of assets to lease." Oxnard is one of Kim's clients. In 2007, the city wanted to issue bonds to finance part of its $150-million street repaving project, using its share of state gas tax revenue to repay the debt. But the state Constitution says local governments can't issue debt against that revenue. That's where Kim came in. His plan: The Oxnard City Council would sell the streets to the Oxnard Finance Authority, which consists of the council and mayor. The Finance Authority would issue bonds to raise money for the improvements and repay the bondholders by selling the streets back to the city. Where would the city get the money to buy the streets? From its gas tax revenue. "If you had to get a vote on everything, it would take a lot of time and there would be no guarantee that the voters would approve the debt," Oxnard financial services manager Michael More said. "Otherwise we would have to use a pay-as-you-go approach to every project, and we could never come up with enough money."

Recognizing the novelty of the approach, and facing some local opposition, Oxnard ran the strategy past state Atty. Gen. Jerry Brown. Brown gave the green light, and De La Rosa & Co. -- which collected $300,000 in fees from Oxnard -- had a winning formula. The investment bank has since helped the cities of Santa Ana, Coachella and Indio come up with similar street deals, none of which went to a public vote. "They're circumventing the intent of the law," said Larry Stein, an Oxnard accountant and longtime city activist. "They're indebting the taxpayers using future revenue streams that may or may not pan out in the long run. But the taxpayers have no say." Of more than 10,000 bonds and other debt vehicles issued between 1998 and 2007, fewer than 700 went to a public vote, according to the state treasurer's office.

It isn't just voters who are often left in the dark. The investors who lend to local governments are not always given a clear picture of the borrower's finances. In April, the Securities and Exchange Commission accused the city of San Diego of misleading investors about its finances when selling more than $260 million in bonds. The SEC has asked a federal judge to fine the city, without specifying an amount. San Diego officials have denied the charges and are fighting the case in federal court. "The fictions that are put together to fund the construction of public buildings and to cover these budget gaps are astounding," said Mattie Scott, a Monterey attorney who was hired by the Richmond School District to help it untangle its legal problems before it filed for bankruptcy protection in 1991.

Many cities pass their bond funds through technically separate public financing authorities, housing authorities, utility authorities or special taxing districts. The use of such entities makes it difficult for the public to assess a city's debt load. Whether it's such a pass-through deal or a lease-back, bond buyers demand a higher rate of return for complicated deals. The California Legislative Analyst's Office has estimated that the state government's use of lease-back deals costs as much as $370 million more for every $1 billion in debt than the use of general-obligation bonds. The report was issued in 1995, and finance experts say the added cost is probably greater now because the deals have become more complicated.

Chula Vista is an example of what happens when a city gets hooked on debt. Between 2000 and 2007, the city in San Diego County took on $648 million in new and refinanced debt to build a city hall, a police headquarters and other projects, including a segregated dog park to keep the terriers from nipping at the Dobermans. None of this debt was issued with voter approval. The City Council presumed that rising revenue would allow it to pay the debt. Then came the economic downturn, and Chula Vista now is cutting furiously to meet its obligations. It has shrunk the budget by $30 million, or 17%, since mid-2006. Lost were library hours, senior programs, 200 jobs. Even the popular Fourth of July festivities were crossed off the calendar. More cutbacks may be on the way. The city is looking at a $20-million shortfall in the current fiscal year. "We were growing so rapidly that the need to build these facilities happened quicker than people had anticipated," said Maria Kachadoorian, the city's finance director. "But now the growth has stopped, and we don't have the money coming in to cover a lot of our costs."

'Original Sin' Returns as Emerging Markets Plan Bonds
Developing nations plan to sell the most dollar-denominated bonds since 2005, reversing a shift into local debt, as commodities prices fall, foreign reserves diminish and emerging-market currencies weaken. International sales may rise 68 percent to $65 billion next year, according to estimates by ING Groep NV. Mexico raised $2 billion in a Dec. 18 offering. Peru’s Finance Minister Luis Valdivieso met with investors in New York, Boston, London and Madrid this month to drum up interest for the country’s first foreign sale in almost two years. Governments are growing more dependent on international markets after the six-month drop in raw materials reduced earnings from exports and caused budget deficits to widen.

Dollar borrowing will increase foreign-exchange risk, a pattern that led countries across Latin America to default in the 1980s, said Ricardo Hausmann, director of the Center for International Development at Harvard University in Cambridge, Massachusetts. "Countries will be forced to issue in dollars," said Hausmann, a former Venezuelan planning minister who called developing nations’ reliance on foreign markets the "original sin" in a 1998 article in Foreign Policy magazine. "Debt structures will deteriorate again." Dollar bond sales fell 43 percent in the past three years from $68 billion in 2005 as a 134 percent surge in commodities, as measured by the UBS Bloomberg CMCI Index, helped countries repay foreign obligations, according to Amsterdam-based ING. Local-currency debt offerings rose 23 percent annually since 2005, according to the Bank for International Settlements in Basel, Switzerland.

Colombia moved 71 percent of its debt into peso-based securities, up from 48 percent in 2002, according to Finance Ministry data. Eighty percent of Mexico’s obligations were in pesos in 2007, up from 55 percent seven years earlier, according to government figures. The combination of slumping commodity prices since July and the worldwide credit crunch dried up dollar inflows, pushing down emerging-market currencies and draining foreign reserves. Oil, the biggest export from Mexico, Russia and Venezuela, plunged 71 percent from a record $147.27 a barrel. Russia’s central bank used a quarter of its $598 billion of reserves in less than five months to limit the ruble’s slide against the dollar, according to Bank Rossii. Mexico’s $2 billion sale of 10-year bonds came after its central bank used $15.2 billion, or 18 percent, of foreign reserves to prop up the peso when it fell to a record low in October.

Budget needs are swelling. Russia will post its first deficit in a decade next year, Finance Minister Alexei Kudrin said Dec. 27. Mexico forecasts a shortfall equal to 1.8 percent of gross domestic product next year, a gap that UBS AG says would be the biggest since 1990. The forecast is based on an oil price estimate of $70 a barrel, 63 percent higher than today’s $42.90. Venezuela, which gets about 90 percent of export receipts from oil, may have a deficit in the current account, the broadest measure of trade, equal to 4.3 percent of GDP in 2009 after posting a surplus of 12.5 percent of GDP this year, according to Standard & Poor’s. "Pressures are mounting," said David Spegel, head of emerging-market strategy at ING in New York. "Most budgets will be in deficit. They’re going to have to be financed."

Borrowing costs in dollars rose this year as the credit squeeze triggered by $1 trillion in losses and writedowns at the world’s biggest financial companies eroded demand for all but the safest securities. Investors demanded an average 12 percent yield on emerging-market dollar bonds on Oct. 24, up from 6.92 percent on Aug. 29, according to data compiled by New York-based JPMorgan Chase & Co. Yields on Argentine bonds due in 2033 have soared to over 22 percent from 11.2 percent four months ago after the government seized private pension funds, a move analysts said was aimed at cobbling together financing. Ukraine, Hungary and Pakistan, strapped for cash amid the crisis, reached loan agreements with the International Monetary Fund in November. Ecuador’s President Rafael Correa defaulted this month on $3.9 billion of foreign bonds, calling the debt "illegal."

The average emerging-market yield fell back to 8.96 percent as the Federal Reserve took unprecedented steps to support the U.S. economy. The Fed cut its target interest rate for overnight loans between banks as low as zero, helping push yields on Treasuries, the benchmark for emerging-market rates, to a five- decade low. Emerging-market local bonds have also rebounded, posting a 8.3 percent gain in dollar terms this month, as investors anticipate interest-rate cuts in Brazil, Indonesia and India, according to Merrill Lynch & Co.’s LDM Plus Index. Gerardo Rodriguez, head of public credit at Mexico’s Finance Ministry, said in an interview Dec. 18 that he used a "window of opportunity" to sell the $2 billion of 10-year bonds at a yield of 5.98 percent. Valdivieso, Peru’s finance minister, said Dec. 22 in Lima that meetings with investors suggested there’s demand for at least $600 million of notes. Russia is also considering an international sale, Arkady Dvorkovich, an economic adviser to President Dmitry Medvedev, said in a Dec. 24 telephone interview. The increase in dollar bonds is unlikely to lead to a wave of defaults like those in the 1980s because developing nations have reduced spending and curbed inflation, Spegel said.

Brazil trimmed its budget deficit to the equivalent of 1.2 percent of gross domestic product from 8.8 percent a decade earlier. Inflation fell to 6.4 percent from a high of 6,821 percent in 1990. "They are coming into the crisis in better shape," said Igor Arsenin, an emerging-market strategist at Credit Suisse Group in New York. "Increased dollar issuance only poses a risk if we see a protracted period of global slowdown." This month’s rebound in emerging-market local-currency bonds left them up 1.2 percent for the year, according to Merrill’s LDM Plus index. The bonds returned 13.9 percent in 2007 and 12.7 percent in 2006 as currencies rallied. Brazil’s real strengthened 62 percent against the dollar in the four years through 2007, the best performance among the 16 most-traded currencies, while Poland’s zloty rose 52 percent and Colombia’s peso climbed 38 percent.

Currency gains combined with yields of more than 10 percent in countries including Brazil, Turkey and Philippines proved irresistible to investors, said Jonathan Binder, who manages more than $2 billion of emerging-market assets at INTL Consilium LLC in Fort Lauderdale, Florida. "It was a double whammy that was highly lucrative," Binder said. "But it took a short time to reverse" gains, he said. The real weakened 33 percent from a record high in August. Turkey’s lira slid 24 percent against the dollar over the same period while Hungary’s forint dropped 22 percent. "You’ll see investor reluctance to fund locally," said Michael Atkin, who helps oversee $12 billion of fixed-income assets as head of sovereign research at Putnam Investments in Boston. Countries may "find it much more difficult to issue locally and might find it more attractive to issue internationally," he said.

Bond Dealers, Hedge Funds Will Face Penalty for Failed Trades
Bond dealers and hedge funds that fail to complete trades in Treasury securities face a penalty of as much as 3 percent on the proceeds of transactions, according to a Federal Reserve-backed industry code to be implemented in the next six months. The plan, which strengthens official oversight of trading, will be unveiled as soon as Jan. 5, said Thomas Wipf, chairman of the Treasury Market Practices Group and the head of institutional securities group financing at Morgan Stanley in New York. "It seems quite obvious that the Fed and Treasury cannot and will not accept the status quo for much longer," Wipf said in an interview.

Demand for Treasuries is so great that investors are lending cash for next to nothing to obtain the securities as collateral through repurchase agreements, or so-called repos. The problem is market participants haven’t always delivered the bonds, causing "fails" to exceed $5 trillion at their peak, according to the New York Fed. Because the penalties will be imposed across the government debt market, unregulated investors like hedge funds will be held to the same standard as banks and bond dealers. Failures impair trading in a range of debt markets, exacerbating the worst credit crisis in 70 years. The Treasury Department needs to keep the bond market working smoothly to meet the government’s financing needs, which may reach $2 trillion next year, according to Goldman Sachs Group Inc. economists.

The Fed this month lowered its target rate for overnight loans between banks to between zero and 0.25 percent. Rates on repos in the market for borrowing and lending government debt opened at 0.15 percent today for general collateral. Securities that can be borrowed at interest rates close to the Fed’s target rate are called general collateral. "The fact that participants can choose to fail when low rates distort the incentives is unacceptable," Wipf said. The Treasury Market Practices Group, which the New York Fed helped assemble in 2007, includes managers, lawyers and compliance officers from bond dealers, banks and institutional investors. Treasury Department and Fed officials take part in its discussions. The Fixed-Income Clearing Corp., a unit of the New York-based Depository Trust & Clearing Corp. that nets and settles government securities trades among bond dealers, will help enforce the penalties.

With interest rates so low, bond market participants have less incentive to solve settlement problems because they’re forgoing less return than usual on a failed trade. The Practices Group, which released a draft of the guidelines in November, will also address margin requirements and conditions that would require cash settlement of failed trades. The recommendations also deal with trade netting, a method of consolidating trades that is an important part of untangling unsettled transactions. "We appreciate the new policies and guidelines," Treasury Assistant Secretary Karthik Ramanathan said in an e-mail to Bloomberg News on Dec. 29. When failed trades surged to a record in October, he put bond markets on notice that the Treasury would step in unless the industry took quick action. "We clearly stated that private sector participants should take additional steps from a monitoring, compliance and supervisory perspective to ensure that settlement fails do not reach levels that impact financing markets," Ramanathan said.

Treasury officials have voiced concern about failed trades since at least 2003. Fails climbed in the weeks following the Sept. 15 collapse of Lehman Brothers Holdings Inc. as demand for the relative safety of Treasuries increased. Failures to deliver or receive securities rose to a record $5.311 trillion in the week ended Oct. 22. While the amount fell to $891 billion by Dec. 17, that’s still above the average of $165 billion before credit markets seized up in August of last year, according to Fed data dating to 1990. "This is one of those issues that festered a while," said Dino Kos, managing director at Portales Partners LLC, New York, and the former manager of open market operations at the New York Fed. "It’s time to stop dithering and get on with it." "Interest rates are essentially zero, and they’re going to stay here for a really long time," Kos said. "Market efficiency will degrade with time if this situation is not addressed."

Primary dealers’ average daily trading volume fell to $356.4 billion in the week ended Dec. 17, the smallest amount of government securities changing hands in about a year, according to Bloomberg data. The Fixed-Income Clearing Corp. told customers last week that it expects to adopt the new policies in the second quarter of next year. Such a move would require approval by its regulator, the Securities and Exchange Commission. FICC’s step puts dealers on the hook for all failed trades, giving them an incentive to pass the charges through to investors. In October, when fails peaked, members would have received net penalties of $110 million, with $14.8 million the biggest charge to a single firm, FICC said.

"A member will be responsible for the fails charge regardless of whether the fail to deliver was ultimately caused by the member’s non-FICC member counterparty," the clearing group said in a note to members. Hedge funds say they’re already affected by failed trades, noting fewer opportunities to trade with foreign investors reluctant to lend securities while fails are high. "It’s a counterparty risk they just don’t want to take," said Mark Spindel, chief portfolio manager at Potomac River Capital LLC, a Washington-based hedge fund that trades and invests in Treasuries. Hedge funds doubled their share of U.S. bond trading to 30 percent in the 12 months through April 2007, according to the most recent data from Greenwich, Connecticut-based research firm Greenwich Associates.

GMAC: Bank Holding Companies Do Go Bankrupt
Springtime for G.M. will lead to:

(a) a slippery-slope series of industrial bailouts exceeding $100 billion
(b) a "pre-pack bankruptcy" auto rescue sweetened by federal pension protection and guarantee of new-car warranties
(c) a multinational merger with troubled Toyota

William Safire, New York Times, December 28, 2008

In the New York Times this past Sunday, Bill Safire picked "b" among the three unsavory choices facing GM in the New Year, as excerpted above. Would that our political class in Washington had the wit and financial savvy to understand that option "b" is pretty much a given with a forward auto sales estimate for 2009 of 10 million units in North America. Just about every vendor we know is cutting back on headcount and services, part of a generalized deflation not just of asset prices, but of services. Following that line of thinking, the Fed's 4-1 approval of the GMAC application to become a bank holding company ("BHC") is, to us, the latest evidence that our central bank badly needs a change in leadership. Providing the enablement for this ersatz BHC to access $6 billion in TARP funds will not change the firm's problematic financial picture, a picture colored heavily by exposure to the mortgage, consumer and auto sectors of a shrinking US economy.

What a shame that Fed Chairman Ben Bernanke and the other members of the Federal Reserve Board lacked the courage to say no to the Congress and the automakers when it came to approving the GMAC application. This was a great opportunity to show leadership in favor of a "Prime Solution." But alas, not this time. Thankfully one member of the Fed Board of Governors was willing to vote against the application, which juxtaposed expedited approval or a GMAC bankruptcy as the two stark choices. Voting for this action: Chairman Bernanke, Vice Chairman Kohn, and Governors Warsh, and Kroszner. Voting against this action: Governor Duke.

Whether or not GMAC is a BHC or no, we have grave doubts that this entity or GM will escape a restructuring in 2009. As in the case of the Washington Mutual resolution, we can foresee a still low-probability scenario where GMAC's bank unit is resolved and sold by the primary federal bank regulator, the FDIC, and the remaining business is placed into bankruptcy. Or GMAC might file and the GMAC Bank would continue to operate under the bankruptcy, as in the case of Lehman Brothers Bank FSB and the Aurora Loan Servicing units today. And don't cry for Cerberus in the event of a GMAC default. We hear that the buyout fund more than extracted its equity investment in GMAC via dividends and fees, thus the bond holders are the true economic owners. Wonder if the folks at the Fed realize that the imposition of ownership of limitations on Ceberus may really be no imposition at all! Or put another way, does an independent GMAC as envisioned by the Fed's approval order make sense as a stand alone business?

Let's start with a review of the latest SEC filings for GMAC LLC using the IRA SEC Catalog. At the end of Q3 2008, the $211 billion asset business was imploding, to put it generously. Revenue and assets were down from a year ago, and GMAC LLC showed an operating loss of $2.6 billion in Q3 and $5.5 billion for the nine months ended September 30, 2008. Add $6 billion in fresh TARP funds and you buy a couple of quarters more operating losses - maybe. GMAC's FDIC insured bank, GMAC BANK, rates a "C" on the IRA Bank Monitor's safety & soundness benchmark at the end of Q3 2008. With an overall stress index of 3 vs. 1.5 for the industry average stress level, to us GMAC Bank is headed in the wrong direction in terms of financial trends. The $32 billion asset bank has decent efficiency in the 60% range and above peer capital, but the defaults at 97bp (annualized) and low ROE drag the bank's score up to 2x the industry average.

While the Fed is allowed to give BHC applications accelerated processing, we'd like to see a more detailed explanation from the Board as to just how GMAC meets the statutory financial strength requirements for a BHC, even with the $6 billion in TARP funds. The Board's written order refers to business plans and other future actions, but the approval of the GMAC application seems to violate the safety and soundness requirements of 12 CFR. How can the members of the Board who voted for this application say that GMAC is able to serve as a source of financial and managerial strength to GMAC Bank?

Again, think of the Fed approving this BHC application by GMAC with a bank unit that may, in our humble opinion, rate a "3" at best on the CAMELS scale. GMAC Bank is by no means ready to fail, at least looking at the Q3 2008 financials, but a "C" rating on our safety and soundness Bank Stress Index is a very bad place to be and close to the border of those institutions that are being resolved by the FDIC. Would it not be better to first restructure GMAC and leave a stronger parent to then become a BHC!?

Article I, Section 8 of the US Constitution provides Congress grant of authority to "establish... uniform laws on the subject of Bankruptcy throughout the United States." The Founding Founders included this explicit enumeration of a federal bankruptcy process, above and beyond the reach of state law, to embed in our system the purifying and self-healing mechanism of public liquidation. The supervision by the federal courts assures a transparent, public process to handle insolvencies and afford fairness to all claimants. At the time, merely having such mechanisms placed exclusively under the federal courts largely isolated insolvencies from politics, but not in the age of systemic risk and "too big to fail."

Today the public bailout financed by Washington has circumvented the quaint checks and balances of the Founding Founders, part of which included the very public resolution of insolvencies. So it is that with American International Group and GMAC the opaque, bailout model of political economy prevails, with public subsidies provided to private corporations under the rubric of supporting the collective good, and all with minimal public disclosure or debate.

As in the case of the conversions by Goldman Sachs, Morgan Stanley and American Express, the GMAC transformation into a BHC does not solve the underlying business issues that somebody, at some point in time, must address. To get the US economy moving again, we all must make tough judgments about the viability and global competitiveness of businesses large and small. In the New Year, we look forward to contributing to that "Prime Solution."

Unspoken Link Between Credit Cards and Colleges
When Ryan T. Muneio was tailgating with his parents at a Michigan State football game this fall, he noticed a big tent emblazoned with a Bank of America logo. Inside, bank representatives were offering free T-shirts and other merchandise to those who applied for credit cards and other banking products. “They did a good job," Mr. Muneio, 21 and a junior at Michigan State, said of the tactic. “It was good advertising." Bank of America’s relationship with the university extends well beyond marketing at sports events. The bank has an $8.4 million, seven-year contract with Michigan State giving it access to students’ names and addresses and use of the university’s logo. The more students who take the banks’ credit cards, the more money the university gets. Under certain circumstances, Michigan State even stands to receive more money if students carry a balance on these cards.

Hundreds of colleges have contracts with lenders. But at a time of rising concern about student debt — and overall consumer debt — the arrangements have sounded alarm bells, and some student groups are starting to push back. The relationships are reminiscent of those uncovered two years ago between student loan companies and universities. In those, some lenders offered universities an incentive to steer potential borrowers their way. Here at Michigan State, the editors of the student newspaper wrote this fall that “it doesn’t take a giant leap for someone to ask why the university should encourage responsible spending when it receives a cut of every purchase." At Arizona State University, students set up a table on campus last spring to warn of the danger of debt and urge students to support limits on on-campus marketing.

The contracts, whose terms vary but usually involve payments to colleges or alumni associations that agree to provide lists of students’ names, have come under harsh criticism in Washington. “That is absolutely outrageous, the sharing of students’ information with the banks," Representative Carolyn B. Maloney, Democrat of New York, who oversaw a June hearing on campus credit card marketing, said in a recent interview. “That should be outlawed." College campuses are one place that young Americans are introduced to credit and the possibility of spending beyond their means, a problem now confronting the nation as a whole. For banks, the relationships are a golden marketing opportunity. For colleges, they are a revenue source at a time of declining public funding. And for students, they help pay the bills and allow more shopping.

But debt incurred in college becomes a serious burden at graduation, especially in a recession in which jobs are scarce. A survey of more than 1,500 college students by US PIRG in Washington found that two-thirds had at least one credit card. Seniors with balances had an average debt of $2,623 on their cards. University officials say that their agreements with card issuers comply with the law and bring in valuable revenue. “It provides money for scholarships and other programs," said Terry R. Livermore, manager of licensing programs at Michigan State. He said that the program was aimed primarily at alumni and the university would not include sharing student information in future credit card contracts. “The students are such a minuscule portion of this program."

Jennifer Holsman, executive director of the alumni association at Arizona State, said the association tried to teach students about responsible uses of credit. “We work closely with Bank of America to provide educational seminars to students in terms of being able to get information about how to pay off credit cards, how not to keep balances," she said. Credit card issuers say that they try to educate students to use cards responsibly and that the cards they offer on campus have more restrictive terms than cards offered to alumni. “The available credit for undergraduates is capped at $2,500," said Betty Riess, a spokeswoman for Bank of America. “We want to take a fair and responsible approach to lending because we want to build the foundation for a longer-term banking relationship."

Ms. Riess said the bank had agreements with about 700 colleges and alumni associations, making it one of the biggest, if not the biggest, card issuer on campuses. She said that only 2 percent of the open accounts under those agreements belonged to students, but also said it was not possible to determine what percentage of program revenue resulted from fees and charges on those student cards. Stephanie Jacobson, a spokeswoman for JPMorgan Chase, wrote in an e-mail message that the bank had fewer than 25 contracts with colleges or alumni associations and that while some of the contracts gave it the right to ask for and use lists of student names and addresses, the bank had not done so since 2007.

That may be because football games present a marketing opportunity that requires no address information. Abigail D. Molina, a second-year law student at the University of Oregon, applied in 2007 for a Chase Visa offered at a tent outside a football game. In exchange, she received a blanket. “I mostly wanted the blanket," Ms. Molina said. She added that this was her second university credit card. In 1994, when she was an undergraduate at the university, she applied for a card at a booth on campus and then accumulated about $30,000 in debt, almost all of it on the card. In 2001 she filed for bankruptcy. Looking back, she said it was “shockingly easy" to get the card, even as a first-year student. Mr. Muneio, the Michigan State student, said he did not apply for a Bank of America card because he already had two Visa cards. “The last thing I need is another account to keep track of."

Many students are unaware of the contracts that universities have with credit card issuers and do not question the presence of marketers on campus or applications in their mailboxes, despite recent protests on a few campuses. Sometimes, the contracts have confidentiality provisions. Universities may try to distance themselves, stating that the contracts are only between alumni associations and banks. But the universities provide alumni groups with lists of current students’ names, addresses and telephone numbers, which the groups pass on to banks. The New York Times obtained information about and, in some cases, copies of contracts between lenders, public colleges and their alumni associations using open records requests. Because private colleges are not subject to open records laws, they are not included.

While most universities contacted for this article did not provide detailed financial information on the contracts — the University of Pittsburgh, for example, confirmed only that it had an agreement — two did share numbers. The alumni association of the University of Michigan is guaranteed $25.5 million over the term of its 11-year agreement with Bank of America. Under the agreement, the association agreed to provide lists of names and addresses of students, alumni, faculty, staff, donors and holders of season tickets to athletic events. Much of the money goes toward scholarships, said Jerry Sigler, vice president and chief financial officer of the alumni association. He was unsure what students were told about the program. “Students are generally told how they can opt out of having their information publicly displayed in directories or provided in response to requests like this," Mr. Sigler added. “But it’s not to my knowledge specific to the credit card program."

Michigan State University gets $1.2 million a year but is guaranteed at least $8.4 million over seven years, according to its agreement. The contract calls for a $1 royalty to the university for every new card account that remains open for at least 90 days, $3 for every card whose holder pays an annual fee, and a payment of a half percent of the amount of all retail purchases using the cards. For cards that do not have an annual fee, the bank pays $3 if the holder has a balance at the end of the 12th month after opening an account, a provision that appears to give the university an incentive to get cardholders into debt. A few schools have adopted policies that prohibit sharing student contact information. Ball State University’s alumni association, which has a contract with JPMorgan Chase, does not provide information on students, said Ed Shipley, executive director of the association. “Who we market to is our alumni because that’s our purpose," he said. However, the bank is permitted to set up marketing tables at athletic events.

The University of Oregon, whose alumni association also has a marketing agreement with Chase, stopped providing student addresses as concern grew about student debt, according to Julie Brown, a university spokeswoman. The university still permits marketing booths at athletic events. Some research suggests that students may be using credit cards less frequently, in favor of debit cards linked to their bank accounts. A survey last spring by Student Monitor, a Ridgewood, N.J., company that tracks trends on campus, found that 59 percent of undergraduate students had debit cards, up from 51 percent in 2000. But universities have arrangements with banks that offer debit cards too, perhaps raising some of the same issues that the credit card deals do. At New Mexico State University, for example, students are given the option of opening a bank account with Wells Fargo if they want to convert their campus identification into a debit card. The accounts are not mandatory, said Angela Throneberry, assistant vice president for auxiliary services at the university. But, she said, “There’s some revenue sharing that happens as part of this."

Madoff’s Asset List Won’t Be Made Public
The U.S. Securities and Exchange Commission, which sued Bernard Madoff last month for allegedly directing a $50 billion fraud, won’t make public a list of his assets filed yesterday, the regulator said. A federal judge ordered Madoff to provide the SEC an accounting of all investments, loans, lines of credit, business interests, brokerage accounts and other holdings. The court hasn’t authorized its public disclosure, said SEC enforcement official Andrew Calamari, who confirmed receipt of the list. “I think one of the fears here is that much of this money may be in offshore funds," Columbia Law School Professor John Coffee told Bloomberg Television, adding that the SEC wants to keep the assets secret to protect them. “There is the danger that foreign regulators and foreign creditors may seek to seize that money if the names and sources are made public."

Madoff, 70, was charged in December by federal prosecutors with directing an alleged Ponzi scheme through his New York investment firm. Defense lawyer Ira Sorkin has said Madoff’s company is cooperating with the government. His client met with prosecutors last month, according to people familiar with the case. Shortly before he was arrested, Madoff allegedly told employees that he had $200 million to $300 million left, according to an FBI complaint. Sorkin declined to comment yesterday on the amount of Madoff’s remaining assets. Madoff’s firm collapsed after he was arrested Dec. 11. He told his sons that he directed the Ponzi scheme, in which old investors are paid off with money from new ones, according to a lawyer for the brothers. The firm is liquidating under the Securities Investor Protection Corp., whose funds cover securities and cash claims of as much as $500,000 per customer, including as much as $100,000 in cash.

The Dec. 18 court order that Madoff disclose his assets required the list be given directly to the regulator, Calamari said. It “does not authorize public release of materials related to the SEC’s ongoing investigation," he said. The effort “seeks to preserve and recover money for investors and hold wrongdoers accountable." The catalog of Madoff’s assets may be attractive to angry investors including hedge funds, universities and charities as they sue to recoup lost money. Madoff’s investment advisory business may have had more than 4,000 customers, people familiar with investigation said last month. Losses disclosed by some clients may have been inflated by purported gains in their accounts with Madoff. Yeshiva University, which had previously valued its holdings with Madoff at $110 million, said on Dec. 30 that its net investment was about $14.5 million before inflation by “fictitious" profits.

“Madoff may very well have given money to other persons or other entities," said Fred Longer, a lawyer suing hedge fund operator Tremont Group Holdings Inc. over Madoff-related losses. He said the SEC list will be useful primarily to investors suing Madoff directly. “Those are the rabbit trails. They’ll need to trace all of them to find the cash and it will take a lot of forensic efforts." Longer filed a lawsuit in Manhattan federal court yesterday against Tremont Group Holdings Inc., a hedge-fund firm owned by Massachusetts Mutual Life Insurance Co. The complaint seeks the recovery of losses suffered through the hedge fund firm’s investments with Madoff. The lawyer represents Group Defined Pension Plan & Trust, a Jersey City, New Jersey-based investor. Also sued was Tremont’s auditor, Ernst & Young LLP. Longer claims the accounting firm missed warnings about the alleged scheme. The complaint seeks class-action, or group, status.

Congress is set to hold hearings next week on the Madoff scandal. Witnesses scheduled to appear before the House Financial Services Committee on Jan. 5 include David Kotz, the SEC’s inspector general, Stephen Harbeck, president of the SIPC, and Harry Markopolos, a former investment firm employee who flagged suspicions about the alleged Ponzi scheme. Madoff’s firm was the 23rd-largest market maker on Nasdaq in October, handling an average of about 50 million shares a day, according to exchange data. It took orders from online brokers for some of the largest U.S. companies, including General Electric Co. and Citigroup Inc. Madoff, who hasn’t formally responded to the securities fraud charge, may have to appear in Manhattan federal court by Jan. 12 unless he is indicted before then. On Dec. 30, the trustee now in charge of Bernard L. Madoff Investment Securities LLC obtained court approval to use $28.1 million out of its accounts as it unwinds the firm.

“The estate requires the funding to get to the sale of certain assets," said Richard Bernard, an attorney representing Irving Picard, the trustee appointed by the SIPC to supervise Madoff’s company. The SIPC said that the use of some of the Madoff firm’s funds won’t diminish customer returns, according to a statement from the agency and Picard. Picard reached a deal with Bank of New York Mellon Corp., which holds the funds, to have them released. U.S. Bankruptcy Judge Burton Lifland in Manhattan said the court papers outlining the agreement were very basic and asked the lawyer for more information on the accounts. Bernard said there are more funds and accounts, without being specific. Bank of New York is holding some funds because it may have “set-off rights" on certain claims, he said, adding he was limited in what he could say in open court because of ongoing criminal investigations. Picard is tasked with maximizing assets for the firm as investors that had about $36 billion with Madoff seek the return of their money. Lifland last week gave him authority to share confidential information, such as proprietary trading programs, with potential buyers of the Madoff firm’s market-maker unit.

Connecticut Bank Is Drawn Into Madoff Scandal
Lawyers in Florida say they are investigating the role that a Connecticut bank may have played in steering money to Bernard L. Madoff, the Wall Street trader accused of operating a $50 billion Ponzi scheme. According to the lawyers, their clients believed for more than a decade that they had an account at the Westport National Bank, a division of Connecticut Community Bank in Westport, from which they had received statements for many years. Early last week, they learned their money had actually been entrusted to Mr. Madoff, the lawyers said. A number of wealthy investors and institutions have already filed lawsuits complaining that money they put into prominent hedge funds or private partnerships had actually been passed along to Mr. Madoff without their knowledge.

But this time, that complaint is being made against a federally regulated bank, which is subject to much more rigorous oversight than the other investment vehicles through which money has flowed to Mr. Madoff. The bank disputes the allegation. It said on Wednesday night that its only role had been to maintain “a custodial account for a number of individuals and entities" who invested with Mr. Madoff. It did not say how many customers were affected, or how much money was involved. “As custodian, Westport National Bank served in a ministerial capacity only," said its president, Richard T. Cummings Jr., in a statement. The bank gave no investment advice to its custodial customers and did not invest any of its own money with Mr. Madoff, the statement concluded.

Mr. Madoff, the founder of Bernard L. Madoff Investment Securities, was arrested on Dec. 11 and charged with a single count of securities fraud. On Wednesday he provided a report on his personal assets and liabilities to the Securities and Exchange Commission, which would not disclose the report. According to court documents, Mr. Madoff was arrested after telling two senior executives at his firm — later confirmed to have been his two sons — that the investment advisory business he had run for years was “a lie" and “a giant Ponzi scheme" whose losses could run as high as $50 billion. Since then, a growing roster of prominent charities, schools and celebrities have reported losing money they had knowingly entrusted to Mr. Madoff.

But other investors caught up in the scandal have said they actually thought they were investing with someone else — in this case, Westport National Bank. The lawyers handling the Florida investigation said their clients are a middle-aged professional couple in South Florida who had dealt with Westport National since at least 1996. They had been solicited to open an account at the bank by a promoter, whom the lawyers also declined to name. The couple told their lawyers that they had always believed their money was being held and invested by the bank. They received regular statements from the bank showing deductions for “custodial fees" and “record-keeping fees" that totaled 4 percent a year, according to Adam T. Rabin, a partner at McCabe Rabin in West Palm Beach.

Craig Stein, his co-counsel and a partner in Stein, Stein & Pinsky in Boca Raton, said that a bank statement from January 2005 showed that the custodial fee had been paid through the sale of “5.3 shares of BLM," while the record-keeping fee, paid to the promoter, had required the sale of “31.26 shares of BLM." Mr. Madoff’s firm does not have any publicly traded shares, and the couple thought these transactions involved investments the bank had made on their behalf, Mr. Stein said. “The couple told us that they had seen the terrible news about the Madoff victims and said ‘Oh, those poor people,’ " he added. “They had no idea that they were among those victims."

Then, a few days after Mr. Madoff’s arrest, the couple came home to find a Federal Express envelope at their door. It contained a letter from Westport National Bank, a copy of which was provided to The New York Times. The letter, dated Dec. 12, opened: “Dear Custodial Services Customer." It stated that the couple had given “full discretionary authority" over their custodial account at the bank to the Madoff firm. “You may have learned of the recent allegations involving Bernard Madoff and his firm," the letter continued. It then asked the couple to notify the bank if they wanted it to request that Mr. Madoff’s firm “return assets of yours to the bank."

The bank is one of five divisions of Connecticut Community Bank, formed in 2004 by the merger of Greenwich Bank & Trust Company and Westport National. It is supervised by the Office of the Controller of the Currency. A spokesman for the agency said it did not disclose details of bank examinations. In 2005, other public records showed that the bank’s parent, Connecticut Community Bank, had assets of $252 million. State records show that it had about $370 million in assets earlier this year.

Wells Fargo’s Purchase of Wachovia Tested by Economic Crisis
Wells Fargo & Co.’s $12.7 billion acquisition of Wachovia Corp. faces immediate stress as economists predict home foreclosures will keep rising and some forecast unemployment in 2009 to reach a 26-year high. Wells Fargo, the biggest bank on the U.S. West Coast, closed the purchase yesterday, nine days after it was approved by Wachovia shareholders, the companies said in a Business Wire statement. The combination creates the country’s second-largest bank by deposits and the top coast-to-coast branch network with more than 6,600 offices.

Since the acquisition was announced in October, an already bleak economic picture has gotten worse as carmakers neared bankruptcy, companies slashed jobs and home prices continued to drop. Economists on average expect U.S. unemployment to reach 8 percent by the third quarter, up from their September estimate of 6.2 percent, according to Bloomberg surveys. RealtyTrac’s Rick Sharga says more than 3 million homes may be in foreclosure this year, up from 2.8 million in 2008. "We’re entering into an economic cycle where unemployment is likely to drive foreclosure activity," said Sharga, executive vice president at the Irvine, California-based seller of default data. "With what’s going on with the auto industry, we could see a pretty nasty trickle affect." Wells Fargo Chief Executive Officer John Stumpf said as recently as Dec. 10 that Wachovia’s $482.4 billion loan portfolio will produce $60 billion in losses over the next three years, with about 60 percent coming from option adjustable-rate mortgages. Wells Fargo, based in San Francisco, is the second- biggest U.S. mortgage lender, behind Bank of America Corp.

Wachovia brings added housing risk in California, home to its Golden West Financial Corp. unit, and Florida, which claims the second-highest foreclosure rate in the country. Unemployment rates in California and Florida were 8.4 percent and 7.3 percent, respectively, in November, compared with 6.7 percent nationwide. Among economists surveyed by Bloomberg, the highest estimate for U.S. unemployment in the third quarter is 9.5 percent, a level not seen since 1983. "There are a lot of unanswered questions that will take time to play out," said Jennifer Thompson, an analyst at Portales Partners in New York, who recommends holding Wells Fargo shares. "How quickly will they be able to write down the value of loans, how aggressive are they going to be and how are the loans that they’re acquiring going to perform in this type of environment?"

During the housing and construction boom, Wells Fargo avoided most of the riskiest loans that plagued rivals like Citigroup Inc. and caused the failures of Washington Mutual Inc. and IndyMac Bancorp. That enabled Wells Fargo to stay profitable, while the industry worldwide has surpassed $1 trillion in losses and writedowns. Wells Fargo rose 68 cents to $29.48 yesterday on the New York Stock Exchange. The shares lost 2.4 percent in 2008, compared with the 50 percent plunge in the 24-company KBW Bank Index. Wachovia shareholders received 0.1991 share of Wells Fargo stock for each share held, valuing Wachovia at $5.87 a share. That’s down from $7 in October, when Wachovia canceled a plan to sell its banking business to Citigroup and agreed to sell the entire company, including the investment bank and securities brokerage, to Wells Fargo.

With the biggest U.S. carmakers needing government assistance to stay afloat, more employees in the auto industry are going to be out of work and struggling to pay their home loans, said David Lykken, a consultant at Mortgage Banking Solutions in Austin, Texas. General Motors Corp., Ford Motor Co. and Chrysler LLC will close about 59 factories over the next month as sales plunge. "They thought they were anticipating the worst," said Lykken, referring to Wells Fargo’s loss estimates for Wachovia. "The problem is the worst got a whole lot worse." Wells Fargo spokeswoman Julia Tunis Bernard said company executives were unavailable to comment for this story. She pointed to recent investor presentations on the "benefits of the merger."

The company has said it expects to trim $5 billion in annual expenses with the deal. Wells Fargo also said it’s bolstering liquidity by adding Wachovia’s $370 billion of core deposits and will have the third-largest retail brokerage in the country with close to 22,000 brokers. "When the dust settles, they’re going to have a pretty powerful franchise," said Joseph Morford, an analyst at RBC Capital Markets in San Francisco, who recommends buying Wells Fargo shares. "There’s a tremendous opportunity." Still, Morford says the critical issue is housing and he isn’t convinced that Wells Fargo’s projections reflect the worst- case scenario. "A lot of it’s going to come down to how the economy plays out," Morford said. "If we see a more dramatic downturn from here, than it may not be enough."

China 2009: The Confidence Deficit
It's a question that has economists worldwide scratching their heads: What will happen to growth in China in 2009? While some are predicting economic expansion in the mainland will slow to less than 7%, others are still hoping GDP gains will be 9%-plus. The optimists assume China will be able to buck collapsing U.S. and European demand for its phones, TVs, sneakers, and myriad other products. Their biggest hope is Beijing's $586 billion stimulus program, announced in November. Just as important—though perhaps less likely to pay off quickly—are China's consumers. With more infrastructure spending, expanded social welfare programs, and directives ordering banks to lend, China's consumers and companies will rise to the occasion and spend more—or so the theory goes.

A quick perusal of the latest Chinese economic indicators doesn't bolster one's faith. In November, China registered a 2.2% drop in exports. That's the first decline since 2001, and the trend is likely to continue throughout 2009. Industrial production growth slowed to 5.4% in November, the lowest level since February 2002. And manufacturing activity continued to slide for a fourth consecutive month, with a PMI (Purchasing Managers' Index, a monthly survey measuring China manufacturing activity, compiled by CLSA Asia-Pacific Markets) of 40.9 in November, down from 45.2 in October. After months of worry about inflation, China now may be heading toward deflation, with prices up only 2.4% in November.

Reversing the decline will depend on confidence. Even as the world economy will likely continue to struggle in the New Year, China is counting on consumers to lift still-strong retail sales. Confidence, however, is just as rare a commodity in China as in the rest of the world. China's city dwellers aren't looking back at 2008 with fondness. Chinese stock markets fell some 65%, ripping a hole in many a nest egg. Real estate prices have slid by as much as 10% in Shenzhen and other cities, and are flat at best in Beijing and Shanghai, says China's National Bureau of Statistics. Throw in continuing worries about rising health-care and education costs and it's no surprise that the national data collecting organization recorded a 4%-plus drop in consumer confidence in October, as compared to the same month a year earlier. As recently as July, consumer confidence was growing, but those days now seem long ago.

And for China's vast legions of rural residents and migrant workers, confidence in the future is also in short supply. As millions of migrant workers head back to the countryside early for Chinese New Year (Jan. 23), many will likely arrive without the mountains of gifts or cash-filled envelopes they typically bring home for the holiday. That's because as the export downturn rips into provinces such as Guangdong, factories are shutting their doors, often leaving workers unpaid. As many as 70,000 small and midsized companies may have gone bankrupt in the past year, estimates Jeongwen Chiang, associate dean of the Cheung Kong Graduate School of Business in Beijing. Overall, Chiang thinks the bankruptcies could grow to 20% of export-oriented manufacturers in southern China. "Someday the growth engine was going to stop, and they weren't ready for it. They don't know how to handle a recession," warns Chiang.

The bankruptcy trend is expected to lead to a surge in unemployment in 2009. And there aren't many agricultural jobs waiting for laid-off migrant workers either. McKinsey & Co. estimates that another 300 million rural residents must come to Chinese cities over the next seven years. Already, this year's 5 million university graduates are struggling to find whit-collar jobs. "The current employment situation is still grim," Yin Weimin, minister of human resources and social security said at a November press conference in Beijing. "In the first quarter of next year there will be even greater difficulties," he said, citing bankruptcies affecting migrant workers as one key factor.

In a demonstration of weakening consumer confidence, tens of thousands of migrant workers have taken to the streets in southern cities like Dongguan and Shenzhen, blocking traffic and demanding they get paid back wages. Strikes by taxi drivers have flared in Guangzhou and the southwestern city of Chongqing. That has local officials taking steps to contain the unrest. In Dongguan, the local labor office has stepped in to pay some worker wages. And in Chongqing, former Commerce Minister Bo Xilai met for three hours in November with representatives of the striking cabbies to address their concerns.

Beijing, of course, is hoping that its planned vast infusion of spending—over half a trillion dollars into infrastructure including roads, railways, and low-cost housing—will create jobs and keep consumers spending. The government also has ordered banks to lend more, with a goal of $588 billion in total loans for 2009. And money-supply growth next year is targeted at 17%, up from a November rate of 14.8%, year on year. In mid-December the State Council issued a series of policies aimed at encouraging that expansion, including expanding corporate bonds related to infrastructure and giving banks more freedom to set lending rates. And on Dec. 22, China's central bank cut interest rates for the fifth time since September, lowering the benchmark one-year lending rate and deposit rates to 5.31% and 2.25%, respectively. "When the central government mandates a certain growth rate, the locals [governments] jump," says David Li, director of Tsinghua University's Center for China in the World Economy. "That's the easiest way to create growth."

That may indeed ensure growth in infrastructure-related investment, which in China makes up 25% of total fixed-asset investment, according to Jing Ulrich, managing director of China equities at JPMorgan (JPM) in Hong Kong. But the challenge will be seeing the same boost in investment tied to the property and manufacturing sectors, which make up 24% and 32% of total investment, respectively. Both are reeling from excess capacity. Sales of commercial real estate fell by 19.8% in the first 11 months, while residential sales declined by 20.6%. Meanwhile, industrial sectors from steel and autos to electronics, toys, and textiles are all facing massive inventory gluts and falling prices. Indeed, China's fixed-asset investment growth through November already declined to 26.8% as compared to 27.2% for the first 10 months. "We expect lower investment in the near term as the export sector grapples with weaker demand and property developers focus on clearing their existing inventories," Ulrich wrote in an analysis on Dec. 16.

So don't expect confidence to start infecting companies in China, either. And even if they were inclined to boost their spending, it is unlikely China's lenders will suddenly start shoveling capital to all of them. When it comes to making loans, China's state-owned banks continue to favor larger, state-owned enterprises to the detriment of China's private companies, a habit unlikely to change in an ever more uncertain economic climate rife with bankruptcies, too. "Households cannot expand demand, businesses cannot expand demand—so it is left to the government to do it," says Michael Pettis, professor of finance at Guanghua School of Management at Peking University.

That worries Pettis: He cites both the slowing pace of appreciation of the yuan and the reinstatement of a host of export rebates as signs that Beijing instead may try to support economic growth by boosting exports, a move that could spark waves of global protectionism. "If China makes the same mistakes the U.S. did, and thinks they can export their way out of this problem and don't have to massively boost domestic demand, then we have a repeat of the 1930s. So far China is acting like it thinks it can export its way out of this problem. I am very, very worried," says Pettis, who is predicting that China's growth will fall below 7% in 2009.

As Trade Slows, China Rethinks Its Growth Strategy
At the docks here, the stacks of shipping containers that used to loom above the highway overpass are gone. Logistics managers say they negotiate deeper discounts every week on ships that are leaving half empty. In nearby Guangdong province, so many factories are shuttering without paying employees that some workers are resigning pre-emptively and demanding immediate pay before their employers go bankrupt. In Sichuan and other interior provinces, municipal officials are desperately searching for ways to provide jobs for millions of out-of-work migrant laborers whose families no longer need them for farming.

Those are the effects of millions of Americans losing their confidence in the economy, feeling poorer and, as a result, pulling back on their spending. American retailers, after suffering a dismal holiday shopping season, are delaying payment for Chinese goods 90 or even 120 days after shipping, in contrast to the usual 30 to 45 days, forcing their suppliers to try to borrow more money to cover the difference. Some Chinese suppliers who cannot raise the money — many already operate on thin margins — are going out of business. At the same time, retailers are demanding that exporters show that they have strong balance sheets and will not go bankrupt before completing orders. Exporters, worried the retailers will fail before paying for their purchases, are reluctant to let goods be loaded on ships. And banks, for the same reason, have cut back on guaranteeing retailers’ payments to exporters.

“Trade finance is collapsing," said Victor K. Fung, the chairman of the Li & Fung Group, the giant supply chain management company that connects factories in China with retailers in the United States and Europe. “We’ve got orders we can’t ship right now." Mr. Fung estimates that 10,000 of the 60,000 factories in China owned by Hong Kong interests have closed or will close in the coming months. Other business leaders say the toll may be even higher and that factory closings are an even bigger problem among mainland Chinese businesses because these tend to be smaller and more poorly capitalized than those owned by Hong Kong businesses. Government statistics show that Chinese exports slipped 2.2 percent in November when calculated in dollars, after seven years of rapid growth. But figures in dollars do not come to close to capturing the real depth of the downturn.

Convert the export figures into China’s own currency, a much better measure of the effect on China’s economy, and exports plunged 9.6 percent last month. Factor in inflation over the last year and the plunge was 11.4 percent. Indications are that the December data will be even worse. Consumer electronics manufacturers have been hit the hardest, according to customs data. “No one has any money any more, so demand for our mini hi-fi systems has declined a lot," said Lion Yuan, the sales manager at the Shenzhen Yidashi Electronics Company, where exports have dropped 30 percent in the last year. In the last two weeks, Chinese officials have announced a series of measures to help exporters. State banks are being directed to lend more to them, particularly to small and medium-size exporters. Government research funds are being set up. The head of the government of Hong Kong, Donald Tsang, plans to seek legislative approval by late January for the government to guarantee banks’ issuance of $12.9 billion worth of letters of credit for exports.

Particularly noteworthy have been the Chinese government’s steps to help labor-intensive sectors like garment production, one of the industries China has been trying to move away from in an effort to climb the ladder of economic development with more skilled work that pays higher wages. But now China has become reluctant to yield the bottom rungs of the ladder to countries with even lower wages, like Vietnam, Indonesia and Bangladesh. China has been restoring export tax rebates for its textile sector, for instance, which it had been phasing out. Municipal governments have also stopped raising the minimum wage, which doubled over the last two years in some cities, peaking at $146 a month in Shenzhen. “China will resort to tariff and trade policies to facilitate export of labor-intensive and core technology-supported industries," Li Yizhong, the minister of industry and information technology, said at a conference on Dec. 19.

Increased export incentives by China have the potential to create a trade issue for President-elect Barack Obama, particularly regarding textiles. American quotas on the import of a wide range of Chinese garments are set to expire on Thursday. Even before the Chinese began announcing their latest programs for exporters, the United States filed a legal challenge on Dec. 19 at the World Trade Organization, accusing China of having already provided illegal subsidies to exporters in a long list of industries as part of a program of trying to build recognizable export brands. China denied on Dec. 23 that there were any illegal subsidies, saying that many countries tried to help exporters and that its actions were no different. In a letter to the National Council of Textile Organizations on Oct. 24, Mr. Obama stopped short of promising any protection from Chinese imports but said that he favored close monitoring of China imports. “China must change its policies, including its foreign exchange policies, so that it relies less on exports and more on domestic demand for its growth," he wrote.

But shifting toward a greater reliance on domestic demand is not easy. Chinese households have one of the world’s highest savings rates because the country’s social safety net is in tatters, with families receiving scant government help with education costs, medical care and retirement; the average hospital stay costs the equivalent of two years’ wages for the average Chinese worker. Important bureaucratic obstacles also exist. Chinese factories are allowed to import equipment while paying little or no duty, provided that the equipment will be used only to produce goods for export. Obtaining approval to switch the same equipment to making goods for the domestic market can take two years and require the payment of much of the import duties that were previously avoided, a payment that many factories cannot afford.

China’s measures to help exporters are starting to cause concern in other Asian countries that compete with it, and raise the risk of a protectionist reaction against China. Indonesia, one of Asia’s largest markets, is preparing to impose a series of administrative measures on Thursday that are meant to reduce smuggling but will have the practical effect of making it harder to import Chinese goods. In Indonesia, the third most populous country in Asia after China and India, the government is already acting to limit imports of garments, electronics, shoes, toys and food — five large categories in which Indonesian producers are struggling to compete with China. Starting in the new year, importers of these products will have to be registered with the government, use only five designated ports for their shipments, arrange for a detailed inspection of goods before they are loaded on a ship or plane bound for Indonesia and then have every single container exhaustively inspected on arrival by Indonesia’s notoriously slow customs bureaucracy.

The plan, intended to comply with W.T.O. rules, was adopted after heavy lobbying by Indonesian manufacturers and labor unions. Boediono, the governor of Indonesia’s central bank, who uses only one name, said that Indonesia would be watching China’s policies but added that he hoped Indonesia could stay competitive. At less than $120 a month, industrial wages in export zones near Jakarta, Indonesia’s capital, are slightly below those in coastal regions of China, and have not shown the same steep increases in wages. “I’m not sure they can compete with us again by moving down the ladder," Mr. Boediono said, “because I think they have already moved up the ladder."

Wikipedia's plea pulls in flood of user-generated cash
Someone forgot to tell Wikipedia there's an economic crisis afoot. Conventional thinking says that in times of economic turmoil, consumers sit on their wallets and spend cash only on essentials. Free online encyclopedias don't generally enter the conversation. This year, the Wikimedia Foundation - a non-profit organization that operates the Wikipedia family of websites - set a goal of $6-million in donations, enough to cover its 2009 expenses, while hoping to buck the global financial slowdown.

At first, it appeared the fundraising drive that began on Nov. 3 would fall short of its goal, even though the group was running banner ads soliciting donations at the top of each of Wikipedia's 11 million pages. Then, on Dec. 23, Wikipedia founder Jimmy Wales wrote an impassioned plea to the site's users, imploring them to put their faith in the foundation and to "imagine a world in which every single person on the planet is given free access to the sum of all human knowledge." In the next 24 hours, the number of donations rose 892 per cent, from about 800 the day before Mr. Wales's letter went public to 8,186 the day it began appearing on Wikipedia pages. Before his appeal to users, the foundation was receiving about $30,000 (U.S.) a day in donations. Now the foundation is averaging more than $215,000 in donations every day.

The explosion of support is further proof of how important Wikipedia has become to the 275 million people who visit it every month, and it underscores the power of the Internet to quickly raise money through small increments and grassroots initiatives. "We're really thrilled that people have come out in force and made a clear statement that they care about this cause and they care about Wikipedia, even though we were kind of nervous after the economic news became really clear," said Jay Walsh, a spokesman for the Wikimedia Foundation.Last year the site brought in just over $1.5-million in its yearend fundraising drive. As of yesterday, Wikimedia had already collected more than $5.5-million, placing it on track to reach its goal two weeks before the end of the campaign, Jan. 15, the site's eighth birthday.

The foundation - which has only 23 paid staff members - relies on an army of 150,000 volunteers to keep the site running and as accurate as possible. Wikipedia, an online encyclopedia that can be edited and updated by anyone, is the eighth most popular website in the world and is also the most visited non-profit site on the Web. Unlike other high-flying Web 2.0 success stories such as Facebook and MySpace, Wikipedia has eschewed the millions of dollars in advertising revenue pouring onto the Internet, instead relying on the financial support of its ever-expanding user base. Although the foundation has received a handful of "major gifts" of between $5,000 and $10,000, most of the donations coming in are from individuals pledging an average of just $30. "You multiply that effect thousands of times you see the pattern that emerges. It's really fitting because it echoes the framework of Wikipedia; lots of people all over the world making small contributions, which is what created Wikipedia." The result is remarkably similar to the online fundraising efforts of U.S. president-elect Barack Obama, who raised an unprecedented campaign war chest by collecting thousands of small contributions from supporters over the Internet.


*** said...

Ilargi, Stoneleigh and all, happy new year.

On December 30, you wrote:

Every level of government needs to look long and hard at where the food for its people comes from. If it is possible to feed every one of your citizens, action needs to be taken to make sure that self-sufficiency is established. A national government will be mostly useless in these things, you need smaller entities to be efficient. Increasingly empowering lower levels of government has another advantage: it’s much easier for everyone to track where their money is going.

You see, I can write all this, and much more, and know that every word I write is true. But I don't think any of it will be done while there is still time.

Do you know about Mexican ejidos? From the WIKI page:
The ejido (from latin exitum) system is a process whereby the government promotes the use of communal land shared by the people of the community. This use of community land was a common practice during the time of Aztec rule in Mexico.
(links: WIKI
about ejidos in general, and this link about Tolantongo
illustrates the principle of creative collective use of ejidal land.)

Yesterday we met with a certain Mexican notario who has set up many socially beneficial groups and organizations working here in Mexico. We have verified that while it is not possible to be a member of an ejido as a foreigner, it is very possible to invest resources in one, particularly as part of a Mexican association.

In particular, it is possible to work with ejidos in allowing non-Mexicans to build/lease on their property. They would love to collect the rent, perhaps best pre-paid come the collapse of capital. For they wait in vain for the government’s fiscal support of their agriculture most of the time. The potential for mutual benefit is infinite.

Just for whoever doesn’t know: Mexico is mostly NOT like the set of a Clint Eastwood movie. Central Mexico, once above about 4,000 feet, has the most idyllic climate you can imagine, temps ranging from 50-85 F year round. People never seem to tire of asking me if we’re suffering from temps in the 100’s. Never. For a look at the architecture of this particular vicinity, visit here.

The extremely mountainous terrain, and the aquifers we see while hiking which ooze water year-round, are perfect for terraced farming, something we haven’t seen here yet. In fact Mexico, in her boom now, has enough waste of food (e.g., fruit unpicked on trees) that we could probably fill a boxcar a month with it all. The land here is eager to produce, very volcanic and rich, and as for terraced farming (picture a reservoir above terraces), why the industrialists overlook the ready cooperation of gravity in water supplies, I’ll never understand. Were I to idealistically reinvent the US, I’d put terraced farms on the foothills of the Rockies and leave the plains – which should never have been farmed – for grazing. I have agriculture experience, ask away anyone.

In our two years of living here, we’ve made friends with certain Mexicans we trust very much (including a surgeon who saved my life – living in Mexico IS our health insurance. Anyone, ask away.). Through this aegis we look forward to doing certain things which I’m not going to fully outline at length on the internet, but I think you can see the possibilities.

While perhaps some would object that investment in the “democratic communism” ejido system of Mexico is iffy, we can see for sure that Hellmurriker is not “iffy” at all – its agricultural and infrastructural catastrophe is certain.

With new years’ best wishes for all, let’s see how we can work together. I’m here for your questions.

el gallinazo said...

Anon 10:16

"How much is it normal to donate to a site such as this?"

Tithing is appropriate as well as your first born female child.


Thanks for the Orlov link. I love Orlov, except it's depressing that a man born and raised in Russia should write better English than I. But my ego (and dictionary) managed to survive Vladimir Vladimirovich Nabokov, so I can live with Orlov. Orlov shares with Nabokov that uniquely funny Russian sense of sardonically mundane realism which goes back to Gogol and Dead Souls (and beyond).

favorite quotes form the article:

"It's easy to be green!" says Kermit the frog in an SUV commercial; I would beg to differ, but then who am I to disagree with a hand-puppet?

It is to be expected that we will run out of fossil fuels before we run out of optimists, who are, along with fools and madmen, a renewable resource.

An inboard diesel is available as an option for those who enjoy unnecessary expense, water and oil in the bilge, dragging a propeller when under sail, and soot.

Anon 12:12

The first thing I found reading The Long Emergency by Kunstler that stuck in my craw was his strong anti-Arab and anti-Islam prejudices. The product, like with many of my friends, of growing up in an urban, USA Jewish community where your parents where traumatized by Hitler. The fact that the IDF is duplicating the SS's strategies of Yugoslavia and elsewhere cannot penetrate their paranoia. Orlov, a Russian Jew, with his preceding generation suffering incalculably more than any in the USA, doesn't suffer from this. Amy Goodman of Democracy Now has also escaped the fate and remains impartial to these prejudices,

My second criticism is his touting of nuclear energy.

Third is that his knowledge of physics and chemistry is rudimentary. His book described methane by an incorrect chemical formula. I have my copy of the book lent out, but from my memory, it was something like C2H3 or CH3. To a chemist this is like a purported biologist calling a whale a fish.

Finally, in his epilogue, he describes his personal preparation for the purported apocalypse as buying a Leatherman. My Core is like a third hand, but give me a break.

Finally, I suspect that he is a rather obnoxious person to know personally. The Long Emergency has value but I regard Kunstler pretty much as a one trick pony and certainly not a guru.

January 1, 2009 12:57 PM

Stoneleigh said...

Johanna wrote (yesterday):

About commodity prices falling ... (Oh I just know this is a really stupid question) ... If the retail prices of essentials (food etc) are expected to go up significantly over the next few years, does that mean that commodity prices will soar again at the same time?

Don't worry - it's not a silly question at all. Deflation causes prices to fall, as the evaporation of credit, and consequent collapse of purchasing power, undercuts price support. Falling prices do not equal greater affordability though, as purchasing power falls faster than price for most people.

People typically associate things becoming unaffordable with inflation, but deflation can achieve the same thing much more abruptly. Credit can disappear very quickly once a tipping point is reached, and without credit, people will find that there is very little actual money available. Prices for many things (homes included) could easily fall by 90% or more, but the remaining 10% could be far more out of reach then for most people than 100% is now.

We have already seen commodity prices fall substantially, first as a result of speculative flows of money shifting into reverse, and subsequently with declining demand. The effect of China's economic difficulties has been significant, since they were by far the largest source of commodity demand, and the on-going collapse of shipping, due to the breakdown of the letters of credit system, has also been a factor.

Demand collapse has much further to go, and for many things this may mean that prices also have much further to fall. However, for essentials such as food an energy, where a much larger percentage of a much smaller money supply will be chasing them, there will be greater price support. Unfortunately, that means that in a world where everything is rapidly becoming less affordable, the essentials will be the least affordable of all.

In the case of commodities such as oil, demand collapse is very likely to be followed by supply collapse, as many projects will become uneconomic. Both the financial and physical risks will be too high in a capital constrained world where governments are prepared to fight over access to the source of their power (and in a very meaningful sense, oil IS hegemonic power).

I would expect oil, and quite possibly gold, to bottom much earlier in a depression than other things. In the case of real estate, it's possible that none of us will live long enough to see a lasting bottom, although some places will do better than others.

*** said...

Just a little more about agriculture:

There is no reason electricity should be used to pump water. Gravity will do that. One simply has to arrange for the reservoir/water source to be uphill from the agriculture. On the contrary, pushing water around in sheets on the plain is about as dumb as it gets if any electricity must be involved.

Note this masterpiece (and don't miss seeing the home website).

I had quite some experience farming in Shell, Wyoming, a desert which freezes solid in winter.

1) by protecting a peach tree by wind with a combination of a fence surrounding a small area, plus a lot of terracing to "trip" the wind in its killing spree, plus weed-guarding beneath it then covering it in deep gravel to retain moisture during the 115F+ summer months, I achieved a yield of over 300 baseball-sized peaches. An old Mormon farmer who came by for the harvest said if he had not seen it he never would have believed it.

Same periodically hellish environment: by mixing 50/50 compost/earth in a 5 gal sized clay pot, covering around a tomato plant with weedguard and inserting six inches of rock cover, I was able to leave said plants in 105 degree weather for a week between watering.

People just don't realize: rock is our friend. But no, everywhere I went in the US I'd see orchards being watered with electrically-pumped water on bone dry earth, half of it at times probably evaporating before it hit the ground.

Another rock function: thermal. What kills roses in such an environment is not how cold they get, but how quickly. Therefore I put rock berms around the bases of the roses to about a foot up. When sudden chills came (temps can drop 60 degrees in an hour there), the stone continued emitting warmth, allowing the bases of the roses to gradually adjust to the cold. I never lost another rose over winter after learning that.

Diversity. Plenty of you know about that. Lack thereof brings disease and pestilence. Only by personally attending agriculture can on really have the diversity necessary. But hey, how many of these now homeless mortgagees dreamt of a retirement gardening in their back yard?

Fertilizer: oh for crying out loud this is so stupid, burning up petroleum for it all. Idea one: off and on let livestock roam. They do excrete. It can be gathered and mixed with dirt to eventually yield rich compost. But no. Gotta burn oil. Idea two: green tea. Take one 50 gallon rubber barrel with tight-fitting lid. Fill with any manner of green waste (grass cuttings, branches etc.) then add water to the top. Place tightly fitting lid on, leave in sunlight for two weeks. Upon opening it, watch out, the odor could singe your eyebrows off. But man, do your plants prosper from this mix. It will feed your garden if you add green tea every week. You'll never taste better tomatoes.

Image: an hectare of land, studded with 100 rubber barrels of green tea cooking away at all times. You get the idea.

Pesticides: see diversity. Add a lot of garlic planted around things and bugs will not invade. Smoke is the third trick. Native Americans smudged with soot did it for a reason: bugs hate smoke. Their body painting functioned as insect repellent. In fact Indians smoked areas to rid them of bugs. They practiced a lot of agricultural methods, unbeknownst to the idiotic English-style system which supplanted them. The US forest service, in its 95 years, is DIRECTLY responsible for the ruin of forests due to pine bark beetle in particular, due to which the Rocky Mountain pristine areas are turning red and burning up with a vengeance.

How? They assumed the Indians did nothing, thus they would "leave it natural" too. Call it the "dumb Indians" philosophy of arrogant presumption. The FS has it coming.

Indians constantly gathered firewood. They thinned the forests. They did selective burns to rid overgrowth. The forest service on the other hand allowed trees to grow in fine and thin, like the hair on a boars back. You can't walk into them. THEY have ruined the forests.

Together with the BLM, the FS guard a public trust of nearly a half billion acres. Could be for la gente, but no, it goes to the oil ponzi kings. Forests? Ah that's for corporations. These two gummnt entities are ripping off la gente, big time, and selling off resources to those who are ruining the earth. One could voice protest, but they literally have ruined the rocky mountain forests. It is too late.

Gets worse: post 1988 Yellowstone fires, a little town cradled in Park boundaries saw the wrath of the stupid elitist country club who run the parks. First, during the fires, the gummnt wanted to "let it burn naturally" for they wanted Cooke City to live up to its name and be gone. Some divine quirk forestayed the fiery wrath and Cooke City survived. Meanwhile the green meanies cut down the burned timber and piled it up. When a friend of mine moved there post-fires, he eyed the piles and thought "great, there's my winter's firewood supply." Not. He was sternly adjured by locals that if he laid a finger on it, the forest service would imprison him for felony theft. So the stacked wood laid around some years and rotted until the FS burned it all up.

Heh. The forests could have been groomed all along to provide pulp for paper. Not. The bureaucratic issue of the FS could have been printed on the effects of its labor, but this is an elitist class of doorknob turners who mostly get up in the morning to protect the public assets FROM the people, not preserve it for them. Therefore the taxpayer buys the FS its paper while wood is left to rot for the most part. I could go on forever about how they've now fatally ruined the Rocky Mountain forests, but hey. It's new years day.

*** said...

Sorry to sound so mad. Just that I am. The forest in beautiful Shell Canyon (Big Horn Mountains, WY) is ruined, as are most of the other forests in the Rockies where I was born/raised. There literally is nothing to do anymore except burn it all down (pine bark beetle) and start again. Yes it's bitter. I don't ever want to go back and see it again, preferring to remember it as it was. (link, link, link, link)

el gallinazo said...

Thank you, St. Stoneleigh, for leading us by the hand like teetering toddlers along the labyrinthian pathways of miasmically shrouded financial mine fields. You are, indeed, a master teacher.

Anonymous said...

Wis. man accused of stealing $625 in lobster, beef
15 hours ago

RACINE, Wis. (AP) — A suspected grocery thief still has a taste for finer cuisine, even in the struggling economy.

Police in Racine, Wis., say 43-year-old Brian A. Rubenstein tried to steal $625 in groceries. The total included $365 in lobster and $213 in ribeye and beef roasts.

Workers told police they saw Rubenstein fill his cart with lobster tails and beef cuts, as well as a smoked ham, apple pie and fruit platter. He was arrested Dec. 23.

Rubenstein was charged Friday with misdemeanor retail theft, which carries a maximum penalty of nine months in prison and a $10,000 fine.

Rubenstein didn't immediately return a message left Wednesday evening.

Police say he told investigators times are tough.

Information from: The Journal Times,

Kosher ham and kosher shell fish no doubt !

Starcade said...

2008 was TEOTWAWKI.

2009, I truly believe in my heart, is when TSHTF.

And, as I've said before, that starts, for me and a lot of other people, the clock towards our end.

Anonymous said...

I & S:

I have to wonder if TAE isn't generating enought revenue, then perhaps it's due to the format? I.e. perhaps you've hit the maximum of what blogspt can provide? It strikes me that repackaging and remarketing would be effective if done right.

Today's superb collection of articles is a case in point. I'd swear that one could spend hours commenting upon each and every article. But we have this non-threaded way here which seriously limits the bandwidth of information exchange.

It also limits the social networking. And one of your excellent pieces of advice is to make friends. It strikes me that a more appropriate platform would allow the opportunity for people to make friends here.

Clearly the donation scheme isn't working. People seem able to pay for their Internet connections, and yet can't afford something smaller? Perhaps you should encourage people to click on the ad links, like someone mentioned yesterday, if they can't afford to send in even $5.

I know you've got something new in mind. I hope works, as I'd really like to see TAE continue.

Anonymous said...

Ok, there's something else which I really don't get. Perhaps someone can help me out here.

We constantly hear about the toxic assests on the Banks books. Yet, no one ever explains how these are going to go away.

One of the articles was a case in point. They mentioned them in one paragraph, and in the next they jump to a completely different subject. But in all of the mainstream media, no one ever explains how these toxic assets are actually going to be fixed.

So, is the Grand Plan by TPTB really just to create 2 Million low-paying jobs, and expect that will be enough to fix all of these troubled assets? While extinguishing any higher paying jobs by the importation of tens of millions of cheaper foriegn workers?

And/or is it the plan for the Government to aquire the Banks, and take on the trillions of dollars of this debt?

And/or is it the plan to extend Credit to Consumers who are already deeply in debt, and afraid for their jobs?

So forgive me if I seem confused here. I really don't understand what exactly the Plan is, or how it's going to work. And I don't understand how exactly the economy is going to be restarted. I just see people saying things are going to get better in late 2009, and I really don't understand how.

If anyone can clear this up for me, I'd be really appreciative.

SanderO said...

I did a paypal donation but it took me half an hour to remember my password since I have stopped most internet transactions.

I agree that perhaps a better format with LINKs and threads bring in more support and participation.

AE is a valuable (if depressing) and sobering read. More people need to stop by.

What is interesting about the collapse we are experiencing is how fast it is unraveling.

Although there were many factors which contributed to the bubble bursting or perhaps many bubbles bursting and even the entire system was set to destruct because of it's fatal flaws, I wonder if someone can identify one event which cascaded and really began taking capitalism as we know it down? If not one event was it two or three at the same time?

Stoneleigh said...


Those toxic 'assets' are just losses that haven't yet been realized. There's nothing anyone can do to breathe life (or value) back into them. They represent the excess claims to underlying real wealth that credit expansions always create, and that are always extinguished when expansion morphs into contraction.

Most of these 'assets' will simply be wiped out as virtual wealth attempts to map on to real wealth. The ratio of the former to the latter is at least 100:1, as the vast majority of the effective money supply is credit. The process of credit deflation will therefore not go smoothly, to put it mildly.

Stoneleigh said...

El Gallinazo,

Thanks :)

Anonymous said...


in deflationary times what kind of economic policy could work/improve the situation. You often write about securing the essentials for everyone - but the current social economic theories (often based on Keynes) seem to be based on low and stable inflation. Would these theories apply to deflation too, or do we need to think in a new way?

adiosababilonia said...

I would love to dialogue, btw.

Here, I'm a friend in Mexico.

I know it's controversial. But I think everyone here knows that a feature of the bailout was the permission for the Chinese to come over and call bluff on foreclosure material.

I'm just suggesting that with gummnt like that, it may make more sense to go rent some land from your "communist" neighbors to the south. There is nothing more fungible on this blessed earth than a goat in Mexico.

*** said...

I wrote what's under "K". Still having ID problems with blogspot. Sorry.

Anonymous said...

Get your own Economic Advisers. Exclusive offer: contribute just whatever you can afford. Act today and start saving your friends. If you act now we will include a portfolio of commenters at no extra charge! Do it today.

Submit your advice said...
This comment has been removed by the author.
Anonymous said...

Orion, I'd like to see a threaded forum here too.

Having been involved in several free Internet projects, I know how hard it is to get donations (to cover host machine expenses and similiar). Getting 500 USD a year is pretty hard as most users seem unwilling to pay for Internet services and publications. The fact that TAE has gathered almost 10 grands i hugely impressive and show how much the readers appreciate the work of Illargi and Stoneleigh and friends!!!

Still I'd recommend a format that allows for more advertisements. It is possible to get a buck each time this site is opened in a browser (probbaly 1000s of times every day) and additional fees for advertisement clicks.

Personally I hate getting flooded with advertisement, but as for my experience with the Internet that is the way to go. Donations is not an on-going thing and needs to be pushed all the time too...

el gallinazo said...

I can't comment about revenue, but I have regularly used two threaded news groups that deal with troubleshooting Mac computer problems for the last 15 odd years, so I am familiar with that format. A threaded format would definitely permit more in depth discussion of individual articles, but IMHO would seriously detract from the virtual community that TAE is generating in its comment section.

Stoneleigh said...

Anon @3:02,

There are different ways that deflation can play out in practice depending on the political culture in which it takes place. In an individualistic culture with a history of laissez faire, the most likely response if unfortunately a free-for-all where the powerful will claim whatever they can and leave the rest with nothing, thereby planting the seeds of revolution.

A more collectivist culture might institute a programme of rationing, perhaps similar to what the British did during and after WWII. That was arguably quite successful, but it occurred after the bottom when a more constructive mood was developing. Now such a thing would be more difficult, as we are rapidly moving collectively towards a much less constructive frame of mind and a pervasive state of distrust.

That will make cooperative efforts much harder to institute as people will have a predisposition to feel cheated by others whether or not that is in fact the case. Where they can convince themselves (likely with 'help' from populist politicians) that the 'others' who are cheating them belong to some identifiable minority, they are likely to look for vengeance in a horribly unfair and vindictive manner. This would be a national, and international, tragedy.

My recipe for dealing with deflation would start with halting the bailouts which only ever benefit a handful of insiders, although they are sold as help for the common man. The losses have already occurred and the toxic 'assets' must see the harsh light of day, and be valued at pennies on the dollar at most, before trust can begin to build again. this will be incredibly painful, but cannot be avoided. It can only be postponed at even greater cost.

My prescription would definitely involve rationing of essentials rather than allowing the rich to price the poor out of the market for food, heat, light etc. I say this even though I know that it would require a far greater degree of central control, and that such a thing has its own clear and present dangers. Central powers once gained are always abused, perhaps not by those to whom they were given, but always by their successors. I think under the present circumstances, however, a rationing programme is by far the least of various evils.

The problem is that even under rationing, there simply may not be enough to go around, since we are so far above the carrying capacity of the Earth. It is therefore very likely that there will be widespread morbidity and mortality, no matter what anyone does.

I prefer to focus on local solutions, since those have a far greater chance of succeeding than anything organized at a national level. Within localities, it is more likely that the necessary trust can survive a downturn, especially if people begin building community ties now. I would certainly consider local currencies, as these can be remarkably effective, although they will be seen as a threat by central authorities and will therefore be difficult to maintain.

Ilargi and I have often championed the communal living strategy that we ourselves have used for the past year. Sharing what you have with othe, as we do with our farm, is ironically likely to be the best way of keeping it. A working farm requires a wide range of skills to maintain and defend it, and no nuclear family by themselves is likely to be able to cover all bases. A small community has a far better chance.

Essentially, no one can save the system we have known. It's day has come and gone rapidly, somewhat like a supernova that briefly outshines entire galaxies then collapses to a pale shadow of its former self. While we can't save what we have known, we can do our best to save families, friends, neighbours and our companions on the internet who are following our communal journey.

Stoneleigh said...


I quite agree. There is always more to be gained from cooperation. All too often people forget that during hard times though. For those who remember, the rewards are significant.

Anonymous said...

el gallinazo says:

"Thank you, St. Stoneleigh, for leading us by the hand like teetering toddlers along the labyrinthian pathways of miasmically shrouded financial mine fields. You are, indeed, a master teacher."


Anonymous said...

RE: Roubini

This guy must have someone behind him in the office, watching every word he types. First he says "...Deflation is dangerous as it leads to a liquidity trap: nominal policy rates cannot fall below zero, so monetary policy becomes ineffective..."

And then 2 paragraphs later he says: "...Only aggressive, coordinated, and effective policy actions by advanced and emerging-market countries can ensure that the global economy recovers in 2010, rather than entering a more protracted period of economic stagnation..."

We know that monetary policy is not gonna work in a regime in which the velocity of money is so low that printing and "liquifying" the economy only makes things worse---the money disappears, and the debt just GROWS!

So what the heck does Roubini mean in the last statement when he talks about 'aggressive' and coordinate policy actions?!? What I think he means is that some guy in a dark suit is telling him to lighten up....or else.

Bigelow said...

I have never had a lot of money but a fortune cookie said I would die wealthy --so there you go. And in the spirit of fake-it-till-you-make-it, to try to understand what is going on, for years I've taken a handful of investment newsletters that you pay for ... The Automatic Earth is the least expensive and has been stunningly accurate. I've gladly quadrupled my contribution to TAE, just because the guilt of not doing so beat out the fear of spending has nothing to do with it.

BTW I do not like threaded discussions.

Stoneleigh said...

Dan W,

Maybe Roubini can't quite face the logical consequences of his own predictions. If so, he wouldn't be the first to be in denial.

Anonymous said...

@ stoneleigh

Perhaps that is so...but he ends up sounding really nutso, like a great intellect who is afraid of his own thoughts.

by the way, happy new year.

Bigelow said...


Maybe Roubini's relatives were threatened.

Anonymous said...

@ Bigelow

It simply cannot be ruled out: Roubini, Krugman???

Anonymous said...

@ Roubini

The powers that be will do ANYTHING to win. Lest we forget the words of Woodrow Wilson:

"I am a most unhappy man. I have unwittingly ruined my country. A great industrial nation is controlled by its system of credit. Our system of credit is concentrated. The growth of the nation, therefore, and all our activities are in the hands of a few men. We have come to be one of the worst ruled, one of the most completely controlled and dominated governments in the civilized world - no longer a government by free opinion, no longer a government by conviction and the vote of the majority, but a government by the opinion and duress of a small group of dominant men."

And these men will eliminate anyone who threatens their wealth....

Anonymous said...

The writings of Pastor Sheldon Emry (pdf's):

Billions For The Bankers
Debts For The People

Bible Law On Money

Greenpa said...

And/or, maybe Roubini's man in the dark suit is- himself. He IS a Perfesser of Economics. They do have some core teachings which he had to absorb. It may just be impossible for him to abandon them altogether. Think of the classic problem of the priest confronted with evil in the world- the most common response is either renewed piety; or complete apostasy. He's not looking apostate, so far.

Anonymous said...


My uninformed impression concerning Roubini is that he finally made it mainstream and is now not willing to risk that recognition by continuing with non-mainstream predictions.

His shift to "things will be better in 9 to 12 months" would seem to date back just a few months, i.e. coincident with the vast increase in his public appearances and that famous NYT article.

Too bad, though his site still offers a lot of useful information.


Anonymous said...

RE: Roubini, Krugman, et al

I feel silly. Of course these guys have to temper their doom-speak and have to point to recovery. They have become the mainstream, and the mainstream makes a living by remaining mainstream. Roubini would get a smaller paycheck if he told the truth. Silly silly me.

Unknown said...

Regarding GMAC Parent company Cerberus:

The Treasury makes public money available to Cerberus, a private company that doesn't even have to open its books. So what are you going to do?

I am always mindful of the fact that the Chairman of the Board of Cerberus is John Snow. You know... the John Snow who signed those dollar bills in your pocket right now? That one.

Regarding Roubini:

I am fortunate to have subscription to RGE -- and most of the researchers and writers tell a different story. I agree with those who have noticed Roubini's recent econobabble. It is odd and it bothers the hell out of me.

Anonymous said...

Happy New Year 2009!

1,600+ retailers expected to go bust in 2009
The downturn in consumer spending will drive over 1,600 retailers out of business in 2009, triggering thousands of job losses and leaving more than one in ten shops empty, a report said Thursday.

*** said...


You mean, kind of like that phony letter Caroline Kennedy wrote, saying Obama might be a president like her father?

I think a lot of people are being forced to play roles for "Shadow Hollywood."

Anonymous said...


Concerning Kunstler, I too was surprised by his superficial treatment of the Arab world in "The Long Emergency". My impression was that in scanning the world, he felt he needed to say something about the Arabs, so he did.

But I do not feel it would be fair to criticize the book on that basis. It is not about the Arabs, the Chinese or even the developed world outside the U.S. It is about a worldwide problem and how that problem applies to and affects the U.S. and a set of factors specific to that country (notably suburbanisation).

Furthermore, it is not intended for a scientific journal. It is a primer, a useful introduction for people (like me two years ago) who need that type of book simply to start thinking about everything that is coming our way. And it does that job pretty well.


Unknown said...

Hey Babilon:

I'd prefer to believe that someone is pulling his strings. What I don't want to believe is the Dr. Roubini is "terrified." He comes from a school of thought that believes:

"If a nation's money supply is increasing; if it has massive foreign debt; and if its economy is shrinking -- it can still get by or get rescued. BUT... if the people should suddenly lose Confidence -- the whole thing could collapse in a matter of days."

I'm worried that Roubini thinks he's putting his influential finger in the dike of Confidence to save the Dollar. Oh brother. If I can pick up on his fear, so can investors see that the whole thing is hanging by a thread of shared and manufactured "confidence."

Anonymous said...

Follow up:
U.K. houses are now the most affordable in more than five years, HBOS Plc said Dec. 31.

U.K. houses are now the most affordable in more than five years, HBOS Plc said Dec. 31.
The ratio of house prices to average earnings fell to 4.56 in November, the lowest since July 2003 and down from a peak of 5.84 last year, the country’s biggest mortgage lender said in a statement. The number of regions where housing became more affordable for first-time buyers tripled.

Anonymous said...

Government aid could save U.S. newspapers, spark debate Reuters

Anonymous said...

reposted from the thread on TOD;

A short Tale of Trust (Confidence)

The Bank Bail Out Explained

Young Bob bought a horse one day from a farmer for $100.

The farmer agreed to deliver the horse the next day. Fair enough.

The next day he drove up and said, 'Sorry son, but I have some bad news, the horse died.'

Bob replied: 'Well, then just give me my money back.'

The farmer said, 'Can't do that. I went and spent it already'

Bob said: 'Ok, then, just bring me the dead horse.'

The farmer asked, 'What ya gonna do with him?

Bob said: 'I'm going to raffle him off.'

The farmer said, 'You can't raffle off a dead horse!'

Bob said: 'Sure I can, Watch me. I just won't tell any body he's dead.'

A month later, the farmer met up with Bob and asked,'What happened with that dead horse?'

Bob said: 'I raffled him off. I sold 500 tickets at two dollars a piece and made a profit of $998..'

The farmer said, 'Didn't anyone complain?'

Bob said: 'Just the guy who won. So I gave him his two dollars back.'

Bob has been appointed to be in charge now of all financial 'bailouts'

Anonymous said...

2009, The Year of the Parrot

Anonymous said...

Stoneleigh, great posts!

Re Roubini, perhaps he refuses to recognize the logical conclusion of economic collapse. Or, he may know what's coming but is afraid to diverge too drastically from the mainstream.

*** said...


Think about it. Like someone's saying, money's the only thing humans ever created from nothing. Purely thin air.

Click. A collective change of mind and it doesn't exist anymore.

That's witchcraft for you.

Roubini has been given his official pointy hat and some duct tape, no?

el gallinazo said...


I always called him Dr. Doom Lite. But I would listen to him because he is very smart and articulate, and he has a sexy Persian accent :-) I can probably out tin foil any one on this blog site, (if I got started Ilargi would ban me for my next three incarnations) but the chances that he is being threatened in any overt fashion are negligible. Now that he is a celebrity, Doom Lite just wants to have more taste and be less filling to go with all his free lobster newberg dinners. Krugman is just a deluded idiot and his pseudoNobel will make him worse - I wouldn't compare Doom Lite to him. Remember that Krugman is a Princeton asshole faculty buddy of Helicopter Ben. Roubini diagnoses as an Austrian and prescribes as a Keynesian - thus his schizo, Dr. Strangelove impression. Just watch the hand with the black, leather glove. Some day he will grab his own throat and strangle himself.


I agree that the Long Emergency has value and is a good (not great) primer for peak oil. I have been lending out my copy continuously (with caveats). And I can be a tough, sarcastic critic when people piss me off (which, unfortunately, is pretty constant). That said, I retract nothing from my earlier comment (until they bring out the water board).

Anonymous said...

Agree that Kunstler appears to be xenophobic. Remember in "The Long Emergency" he mentioned that the Pacific NW might not be a good place to relocate to because Asian pirates might threaten the area? Additionally, in his novel "World Made By Hand" he generally depicts women characters as shallow or mindless hookers. Sharon Astyk reviewed his novel on her website, followed by a lively discussion where most women who read "World Made By Hand" expressed disgust with the novel.

I think Kunstler has had his day already. He was instrumental early on popularizing Peak Oil on the film "End of Suburbia", etc. His fiction work I find disgusting.

Houyhnhnm said...

Dan W said: "So what the heck does Roubini mean in the last statement when he talks about 'aggressive' and coordinate policy actions?!? What I think he means is that some guy in a dark suit is telling him to lighten up....or else."

Roubini's last paragraph, one filled with pathetically unlikely events, got me too. Thanks for the explanation.

Some guy in a dark suit. Yup, that explains it.

Anonymous said...

The International Monetary Fund warns that worldwide losses from the U.S. subprime mortgage crisis could total $945 billion, according to a new report, which criticizes the excessive risk-taking and weak underwriting by undercapitalized banks. Any suggestions? The agency recommends that the ratings systems be reformed and that executives compensation structures at financial institutions be revised.

Looks like the TARP might just cover that and keep the dear old ponzi bubble from imploding? A bit of peace in our time?

SanderO said...

I'm thinking a few things. It appears that so much of the ponzi scheme we all have been living "under" for decades adn decades is like any other illusion of con game. It will not work without "confidence" at all. If every likes the emperor's clothes he CAN parade around naked and not get call crazy.

I suspect most economists who get to babble on TV and write columns believe that they have a role to play in the con game, whatever it is. We already heard the rubbish about banks not trusting and not lending and so forth. That sounds awful strange to me. I know the restaurant where I eat trusts I will pay the check after I have eaten, but this bank to bank trust thingy is pure lunacy.

Little people need to trust that their savings in banks is there for withdrawal... so uncle sam will insure it. But how do banks not trsut other banks.. unless they know that the all the banks are insolvent and when one folds they all do???? So all these econ guys have to show some sort of belief that the system can be made to work.

And now to the toxic assets we are not seeing. What the heck is a toxic asset? The only thingh that comes to mind is fraud.I call a mortage on my house for $500MM fraud cos it is worth no more than $200K. If they hold such "paper" it's not toxic, it would be fraudulent. I assume that toxic is jsut another word for fessing up to fraud and criminal activity.

If this is true, what WOULD be the impact of all the big guys dropping their pants and revealing that they were engaged in pure unadulterated criminal activity, I'm not talking weird ass bets on weather futures.or crazy CDSs.

If this is criminal fraud lots and loits and management would be in country club jails. And we would have NO banks except for janitors and tellers. So what they seem to have done is (our reps) is bribe these guys to keep their mouths shut and start playing again. But they don't even know how to do it fair and square anymore.

What did the banks actually do with the $350BB?

Don't banks lend money with deposits? (in addition to paying rent and salaries)

What is a toxic asset?

el gallinazo said...

houyhnhnm said...
Dan W said: "So what the heck does Roubini mean in the last statement when he talks about 'aggressive' and coordinate policy actions?!? What I think he means is that some guy in a dark suit is telling him to lighten up....or else."

He doesn't mean anything except that governments should do **something** with enthusiasm now that they have shot their wad with monetary policy. Doom Lite is rehearsing for a Delphic Oracle slot if he loses tenure at NYU. Viva la ouzo! Can anyone say that he was wrong?

timekeepr said...

The Fire Fiddler

"Now comes the test of one’s homesteading stamina: January. Might as well throw in February too except that by then the aconites and snowdrops have started to nose up through the ground or may even be blooming in sheltered places. But for now, hang in there and read garden catalogs."


"A banker friend of mine who is an avid fire fiddler, says that if you are short of paper and twigs with which to start fires, good, cheap substitutes right now are bank notes and stock certificates."

Honest John said...

In this environment just what is confidence? Confidence=Greed....It's the next bubble, what do we have left to blow this up with? I don't see much from where I'm sitting. I think we just ran out of "soap"......

Anonymous said...

Libor rates dropping quite nicely.

TED is pulling his spread together, maybe just by wrapping hisself in a good old Yankee TARP

Graph below on Shadowstats seems to be saying that M1, M2, even M3 which is slowing, are are still growing like little Topsy and not genuflecting which seems the only deflationary thing about those rates.

Anonymous said...

Thanks, Stoneleigh.

I do understand that part. "Yertle the Turtle all the way down" is how Ilargi once aptly put it, IIRC.

What I don't understand is what the "Official" plan is. Or perhaps the Official plan, and the one they are actually going to try to execute on. This is what is lacking in the media and the government.

For the media, this is especially gauling. They should be asking these questions, but they just keep ignoring it. It strikes me that this is one of the greatest questions impacting all of us, and it is simply ignored.

If I have I missed something, someone *please* correct me.

I'm on the hook for my share of $700 Billion to $8 Trillion, and I'd really like to know. Every taxpayer has a right to know.

How and when is what I'm asking. But it's as if the problem will magically go away if we ignore it long enough.

I also don't hear anyone who claims that things will get better in the next 9-18 months claiming the toxic asset problem is going to be solved by then. Have I missed something there?

Or, perhaps their not having a plan, and not discussing it, is an answer in itself?

Anonymous said...

from one of the articles posted:

"Shaun Chedister, 30, is one of those people. Chedister was laid off from his job at Washington Mutual at the end of last year. After eight months of actively looking for work to help support his wife and four children, he accepted an offer from Ernst & Young even though the new position as an executive administrator paid less than half of what he was making before. "My unemployment had run out, and I had to get something," he explained. But the adjustment to making $66,000 a year from $125,000 has been hard. "For the last four to five years I'd been making six figures," Chedister said. "My lifestyle had been at a certain level." Now Chedister said he's looking for a more affordable home. Last week one of the family's cars was repossessed after he got behind on the payments. "It could be worse," he said, I could still be unemployed."

Wow, 30 years old and making $125,000 per year in the financial sector. Is it any wonder kids these days don't want to get an engineering degree. Engineering school was damn hard and doesn't really leave a nerd like me time to go to clubs drinking every night of the week like some of the business majors I knew. I am 31 years old and am a mechanical engineer working at a power plant making steam and electricity, you know, things that have the potential to do actual work, and am making about as much as this guy is now with his pay cut in half.

I think I live pretty conservatively. Six years ago I put 20% down on my house which was no more than 2.5 times my salary (minus the 20% down) and am paying a 30 year loan off as a 15 year loan (I have been doing it that way since I got the loan 6 years ago in case I got in a bind, like a pay cut, I can just pay the loan off as a 30 year loan). I only have one other debt and that is my toyota corolla which will be paid off in a year, one year early. Anyway, what's my point? Just that I will be seriously pissed and might go postal if I get shit canned because of this mess caused by so many irresponsible people out there - irresponsible lenders, stupid home buyers, pushy realtors, etc.

Submit your advice said...
This comment has been removed by the author.
Anonymous said...

Got it. Thanks so much Stoneleigh!

el gallinazo said...


"For the media, this is especially gauling. They should be asking these questions, but they just keep ignoring it. It strikes me that this is one of the greatest questions impacting all of us, and it is simply ignored.

If I have I missed something, someone *please* correct me."

Fascism is never having to say you're sorry.

Anonymous said...

Happy New Year, Ilargi, Stoneleigh and all:)
Big thank you!

scandia said...

RE Roubini I recall something he wrote awhile back which indicated to me that he had looked into the abyss and was terrified. He responded by simply rejecting the possibility as too frightening. Since then the abyss of system collapse has been moved to the back burner. He is doing everything he can to increase confidence as a way to avoid the abyss,as a way to keep dancing until a stroke of luck comes our way.
Another reality is that many human beings respond to bad news by shooting the messenger.

Unknown said...


Thanks for the Fire Fiddler link. Although I was hoping it was about Nero, it was a good read.

Speaking of the original fire fiddler (or lyreist, more accurately) I wonder who best fits the description today. I nominate the US "news" media. What a silly, unserious song & dance they put on every day.

Dan said...

2 things...

1. I bet Roubini loves all of the attention he's getting...even here. Mo money Mo Money Mo Money....

2. LIBOR no longer stands for LONDER INTERBANK OFFERED RATE. It now stands for LEND IT BUDDY, OR else!!!

Like everything in this ponzi-world, nothing is as it seems anymore. Indicators such as LIBOR are just as susceptible to manipulation by TPTB as are the TARP, EESA, etc. et al ad infinitum.

Anonymous said...

"2. LIBOR no longer stands for LONDER INTERBANK OFFERED RATE. It now stands for LEND IT BUDDY, OR else!!!"

Cute! But like most rhetoric rather empty. You would be better off quoting figures,maybe for instance the ISM,- very not nice that one:)

Also very very doomer and self concerned is this site, you figure Roubini is walking down grannies garden path? Try reading between the lines amongst the occasional MSM thrown rose grow mighty thorns, of course that is for eyes that see.

Dan said...

@ ANON 1141


Sometimes 'cute' rhetoric gets to the heart of the matter without all of the extra bluster.

True or False: bankers make the numbers.

DaveW said...

Just FYI, I donated last month. But it was in US$ so it bought only a few Loonies. Sorry, that's all I got! Great site, though.

As for Orion's question about what happens to the toxic assets: when a bank recognizes that a loan (asset) has gone bad (won't be repaid), it writes it off as bad debt. Usually, a bank will try to collect on a bad debt, hoping that the borrower will pay something, anything. After a while, the work of collecting the debt becomes too much and the bank writes it off, offsetting that lost asset against a liability the bank holds, namely an allowance for bad debt. If it has anything left in that account!

The bank could try to sell the bad debt (the contract with the borrower that specifies what is owed) to a collection agency, who could try to collect a few pennies on the dollar from the debtor (barring the debt being discharged in bankruptcy).

If bad debts become too large, the bank's solvency could be threatened because more and more of its equity would be consumed by write offs for bad debt. That's very bad.

If a bank has no equity (assets minus liabilities), can it remain a going concern?

Weaseldog said...

DaveW said... "If a bank has no equity (assets minus liabilities), can it remain a going concern?"

If Henry Paulson, the USA's Money Emperor owns interest in it, then yes.