Saturday, January 17, 2009

January 17 2009: Barbarous Reflections

Lewis Wickes Hine The mill wanted me May 1912
Rock Hill, South Carolina. Arthur Newell, 12 year old doffer in Manchester Mills. Three weeks at it. 70 cents a day. His father in the mill gets $12 a week, mother $9, sister $4.80, he gets $4.20, total $30 a week. "I had ruther go to school but the mill wanted me."

Ilargi: On the one hand you have the data, on the other hope springs eternal. It's apparently too hard for many to realize that to get out of debt deflation, spending needs to grow. And not just by the Fed or the Treasury, but by consumers. And that sort of recovery is a long way off. After a decade of getting increasingly into debt, people now have to borrow about every penny they can spend. Even those that still do have jobs. And their numbers are shrinking fast.

However, not only is the financial system very reluctant, and outright unable, to provide more credit, most people simply cannot afford to dig themselves deeper into their underwater holes. The fact that Fed and Treasury have spent $8 trillion more of their money doesn't exactly make matters easier going forward. So it's maybe a good thing that hope springs eternal, because the deflation conundrum won't be solved tomorrow. Or next month. Or next year.

Home prices will need to come down, probably at least another 50%, to get back to trendline levels and for home purchases to be attractive and affordable. The flipside of that, of course, is that that kind of plunging values will put tens of millions of Americans, British, Irish, Dutch, Spanish etc. etc. citizens a mile and a half below sea level on their mortgages. That is, opting to let real estate prices come down, which they must anyway, will mean a prolonged and painful period of bottom scraping. Going the other way, trying to keep home prices high, means that no-one can afford to buy a house. Except when they go into levels of debt that will bankrupt them down the line.

So on the one hand prices need to plummet to make homes affordable, but on the other this will raise debt levels through the ceiling and beyond. Meanwhile, it doesn't help that governments refuse to help their citizens, but instead elect to put them deeper into debt by handing their money to banks, a move that doesn't just not aid the public, but is utterly contradictory to the public's best interest. What we see coming out of parliaments, government cabinets and presidential residences today doesn't just not solve anything, it makes it all much worse.

Still, the data don't lie. After receiving trillions of dollars from their respective governments, the large banks in the US and UK are in worse shape than ever. Much worse. And there is only one option left in the minds of the people's chosen representatives: take away the money, even more money, from those that elected them. If they admit to having made a mistake, it's one and one only: not enough money has been spent.

In the first two weeks of 2009, the losses the big banks go public with have risen on an exponential basis. What would have been unthinkable just a few months ago has now become a new government mantra: the world will come to an end without the creation of bad banks. The sole remaining way to save the banking system is to use public funds to buy up all the toxic debt paper in the various vaults. Nobody talks about the fact that the banks -in all likelihood- have far too much of the paper than any government can afford to buy, provided at least they wish to have a functioning economy. The idea is that if they succeed in hiding what it is they buy, how much it is, how much it's truly worth, that they can get away with this. For the time being.

We are looking at the essence of present day politics: focusing on the short term means votes, power and financial rewards. And politicians will ignore the best interests of their people if that's what it takes to keep their jobs. But it doesn't stop there. A politician who would advocate going through the inevitable bad times now, rather than tomorrow, would not be (re-)elected. People want their good times now, not next year. If you promise them that, they will vote for you. People want that hope that springs eternal, no matter what the data says. If you use their grandchildren's money to keep your voters -seemingly- rich today, you are the one who will get elected.

The only conclusion you can draw from this is that people care more for their own comfort than they do for their grandchildren's well-being. The hope that springs eternal allows people to deceive themselves into believing and thinking whatever it is that will allow them to do what they want, for their own short-term selfish reasons. And they don't know that it's a hopeless cause, they don't know how broke the system is, and their communities. The media don't report it, because it would hurt sales, and politicians don't talk about it because it would cost them votes.

And so here go billions of bloated ego's blindly into the night. It's a fate embedded in the character of the species. It makes no difference that the data doesn't lie. You can always make data that suit you better, data that provide eternal hope, even if they vanish forever beyond receding horizons. We don't volunteer to take a step back, not even if that would benefit our children. We can only learn about ourselves by hitting that brick wall at high speed. Until we do, we ignore there is a wall. Compared to other animals, we humans have one true distinction: we are the most tragic species. We can see what we do, but we can't help ourselves from doing it.

The Lint Age
When Ben Bernanke gave his speech to the London School of Economics on Tuesday, our reporter was on the scene. Terry Easton put a tough question to America’s central banker: aren’t your interventions just making the situation worse, he wanted to know. Amid the blah...blah...blah...of Bernanke’s response was this: “The tendency of financial systems to boom and bust a very long-standing problem... but I think it’s very important for us to try to put out the fire...then you think about the fire code.”

In his 1988 book, The Collapse of Complex Societies, Joseph Tainter argued that all societies – like all organisms – are doomed. Tainter studied ancient Rome as well as the Mayan civilization. He noticed that problems always blaze up. Each one – whether climatic, political or economic – rings the firehall bell. And each solution – and readers may substitute the word “bailout” for solution – brings more challenges and takes more resources. Finally, the available resources are worn out. Tainter observes that when the costs become high enough, people seem to give up. By the end of Roman era, for example, the burdens of empire were so heavy that people sold themselves into slavery to get free of them. So many people did so at one point that the authorities had to come up with another solution; they outlawed the practice. Henceforth, Roman citizens were required by law to remain free!

Another philosopher, Giambattista Vico, writing in the 18th century, put the beginning of the decline of Rome roughly at the time of the Great Fire during Nero’s reign. Nero, partly to pay for his post-fire reforms and reconstruction, began taking the gold and silver out of the coins. All civilizations go through three stages, Vico said – divine, heroic, and human. The divine period is ruled by the gods. The heroic period is adorned with victories and statues. Then, comes the human era. (Here, we permit ourselves to add a footnote to Vico’s oeuvre: the coin of the realm in early periods is the gods’ money – gold. Later, people switch to money of their own invention – the kind of money you make from trees.)

This last stage, says Vico, is when popular democracy arises, along with rational thinking and what Vico delightfully calls the “barbarie della reflessione” [the barbarism of reflection]. In earlier eras, people do what their gods and leaders ask of them. In the final era, they ask, “what’s in it for me?” Even as late as the early ’60s, John F. Kennedy could still appeal to heroic urge without drawing a laugh. “Ask not what your country can do for you,” he said in his inaugural address, “ask what you can do for your country.” But 11 years later, Richard Nixon, like Nero before him, began the process of debasing the country’s money. That was a solution too; the United States had spent too much. Nixon could worry about the fire code later. First he opened up with the fire hose; he defaulted on America’s promise to exchange dollars for gold at the statutory rate.

Barack Obama tried a Kennedyesque appeal to civic high-mindedness last week. We need to “insist that the first question each of us asks isn’t ‘what’s good for me’ but ‘what’s good for the country my children will inherit,’” said the president-elect. But now, like Doric columns in a trailer park, the words are ornamental, not structural. They are the homage that one age pays to a better one. We are in the 21st century now. Barbarous reflections rise up like swamp gas. The whole place stinks of them. Bernanke and Obama offer solutions. But their plans to save the world from a correction are little more than a swindle. They offer to bail out the mistakes of one generation with trillions of dollars’ worth of debt laid onto the next.

“Regarding the current financial meltdown,” writes Rony Teitelbaum, “it is very clear that two main factors underlie the political reactions to the crisis, the first being pressure originating from ties between the financial and the political elect, manifested by taxpayer bailouts of large institutions that continue to deliver bonuses to the executives and donate to political campaigns. For those of us who are not blind, these are clear signs of political corruption which would have made the worst Roman emperor blush. The second factor is political pressure originating from the mass public. The kind of solutions offered so far, and I may add which were received with very warm enthusiasm, were tax rebates and gasoline tax holidays.

These are actions aimed at a public who “impatiently expected quick and obvious results,” to quote Cary’s description of Roman society in AD300. (A History of Rome).” Circa 2009, there is hardly a soul in the entire world who has not been corrupted by the barbarie della reflessione of the late imperial period. Both patricians and plebes are for bailouts. Both business and labor back stimulus programs. The taxpayers and the politicians who rule them are of one mind. Liberal, conservative, rich, poor, Republican, Democrat all speak with a single voice: ‘Screw the next generation!”

The golden age is over, in other words. In the space of 40 years it passed from gold, to silver, to paper...and is now somewhere between plastic and navel lint.

Obama Financial Rescue May Revive Effort to Resolve Bad Assets
President-elect Barack Obama is likely to back a bank-rescue effort that combines fresh capital injections with steps to deal with toxic assets clogging lenders’ balance sheets, according to people familiar with the matter. Obama’s economic team will use another portion of the $350 billion remaining from the Troubled Asset Relief Program to help homeowners avoid foreclosure. It may also assist cash-strapped cities and states that are having trouble selling bonds, the people said. This week’s sell-off in financial stocks and the continuing decline of the U.S. economy put pressure on Treasury Secretary- designate Timothy Geithner and Obama’s economics chief Lawrence Summers to unveil a comprehensive program. Without a radical new effort, soaring credit losses could prolong and deepen a recession that is now more than a year old.

“We have a deteriorating real economy and deteriorating financial sector feeding on each other,” said Raghuram Rajan, a former chief economist for the International Monetary Fund who’s now a professor of finance at the University of Chicago. “It may be distasteful but we need to put more money in the banks.” An Obama adviser, who declined to be identified, said the incoming administration has yet to settle on a plan for using the TARP money to aid financial institutions. Regulators are advocating a government-backed “bad” or “aggregator” bank to acquire hundreds of billions of dollars of troubled securities now held by lenders. Treasury Secretary Henry Paulson and Federal Deposit Insurance Corp. Chairman Sheila Bair praised such an approach today, backing up comments earlier in the week by Federal Reserve Chairman Ben S. Bernanke.

“A lot of work has been done on an aggregator bank” and other ways of using the $700 billion financial-rescue fund to “go further when it comes to dealing with illiquid assets,” Paulson told reporters in Washington. An alternative would be to provide guarantees for the assets while they remain on the banks’ books. The Treasury, Fed and FDIC took that approach today when they provided a backstop of $118 billion for Bank of America Corp. The company also received a $20 billion capital infusion. “Moving these problem assets off banks’ balance sheets may open the market to new capital, both to purchase the troubled assets and to recapitalize the banks,” said Brian Olasov, a managing director at the McKenna Long & Aldridge law firm in Atlanta. “Credit won’t flow in material ways until bank portfolios are cleansed and collateral values are re- established.”

The U.S. economy showed further signs of buckling under the weight of the credit crisis, according to reports today. Consumer prices fell 0.7 percent in December, capping the smallest annual increase since 1954, the Labor Department said. Industrial output shrank 2 percent, and the capacity-utilization rate slid to 73.6 percent, according to the Fed. A private survey showed consumer sentiment little changed in January. Obama is set to take office on Jan. 20 and his advisers have been working to craft a comprehensive blueprint for overhauling the bailout. Summers, speaking to business executives on a recent conference call, said that the new administration wanted to have its financial recovery plan work in tandem with the $825 billion economic stimulus it proposed. Summers, according to one person on the call, said Obama would have a significantly different approach to implementing the TARP.

Paulson and Bernanke sought to end a series of ad-hoc interventions with financial companies last September, by urging lawmakers to approve the TARP legislation. While the initial proposal was to use the rescue funds to purchase illiquid assets, Paulson instead bought stakes in banks. The Obama administration’s “principle advantage over Secretary Paulson is that they are not acting on an ad-hoc basis,” said William Sweet, a partner at the Skadden, Arps, Slate, Meagher & Flom law firm in Washington who represents financial institutions. The Senate yesterday approved the release of the second half of TARP. A Bernanke-led oversight panel issued a report today calling for Treasury to “continue to take actions under the TARP to stabilize financial markets, help strengthen financial institutions, improve the functioning of credit markets and address systemic risks, given the disproportionate consequences that instability of the nation’s financial institutions and markets may have for the broader economy.”

While Summers told Congress Obama’s Treasury would use between $50 billion and $100 billion for a mortgage modification program, a good chunk of the rest of the funds could be used to buy the illiquid assets from banks. The FDIC, which has authority to take “any action” with insured deposit-taking firms deemed necessary to counter “adverse effects on economic conditions or financial stability,” could also play a role. “We think by leveraging TARP funds in this way, you could have a significant capacity to acquire troubled assets,” Bair, who is set to stay on under Obama, said. Officials could “require those institutions selling assets into this facility to contribute some capital cushion themselves.”

Rescue of Banks Hints at Nationalization
Last fall, as Federal Reserve and Treasury Department officials rode to the rescue of one financial institution after another, they took great pains to avoid doing anything that smacked of nationalizing banks. They may no longer have that luxury. With two of the nation’s largest banks buckling under yet another round of huge losses, the incoming administration of Barack Obama and the Federal Reserve are suddenly dealing with banks that are “too big to fail” and yet unable to function as the sinking economy erodes their capital.

Particularly in the case of Citigroup, the losses have become so large that they make it almost mathematically impossible for the government to inject enough capital without taking a majority stake or at least squeezing out existing shareholders. And the new ground rules laid down by Mr. Obama’s top economic advisers for the second half of the $700 billion bailout fund, as explained in a letter submitted to Congress on Thursday, call for the government to play an increasing role in the major activities of the banks, from the dividends they pay to shareholders to the amount they can pay executives.

“We are down a path that this country has not seen since Andrew Jackson shut down the Second National Bank of the United States,” said Gerard Cassidy, a banking analyst at RBC Capital Markets. “We are going to go back to a time when the government controlled the banking system.” The approximately $120 billion aid package on Thursday for Bank of America — including injections of capital and absorbed losses — as well as a $300 billion package in November for Citigroup both represented displays of financial gymnastics aimed at providing capital without appearing to take commanding equity stakes. Treasury and Fed officials accomplished that trick by structuring the deals like insurance programs for big bundles of the banks’ most toxic assets.

Instead of investing tens of billions of taxpayer dollars in exchange for preferred shares in the banks, which has been the Treasury Department’s approach so far with its capital infusions, the government essentially liberated the banks from some of their most threatening assets. The trouble with the new approach, analysts say, is that it is likely to conceal the amount of risk that taxpayers are taking on. If the government-guaranteed securities turn out to be worthless, the cost of the insurance would be much higher than if the Treasury Department had simply bailed out the banks with cash in the first place.

Christopher Whalen, a managing partner at Institutional Risk Analytics, said the approach also covers up the underlying reality that the government is already essentially the majority shareholder in Citigroup. “There’s nobody else out there to invest in them,” Mr. Whalen said. “We already own them.” Ben S. Bernanke, chairman of the Federal Reserve Board, outlined the elements of what could become the Obama administration’s new approach to bank rescues in a speech on Monday. Speaking to the London School of Economics, but addressing American audiences as much as European ones, Mr. Bernanke warned that the federal government had no choice but to put more money into banks and other financial institutions if it had any hope of reviving the paralyzed credit markets.

Known officially as the Troubled Asset Relief Program, or TARP, the rescue program has infuriated lawmakers in both parties, who complain that Treasury Secretary Henry M. Paulson Jr. has doled out money to banks without demanding accountability in return. Mr. Obama and his top economic advisers convinced enough lawmakers that shoring up the banks was essential to preventing a broader financial collapse, and offered written assurances that they would address the lawmakers’ biggest complaints. But Mr. Bernanke proposed an array of alternative approaches to dealing with the banks in the months ahead, and all of those options reflected a fundamental shift from the original assumptions of the Bush administration.

Mr. Paulson had insisted that the government would be investing only in healthy banks, some of which might take over sicker rivals. The Treasury would invest taxpayer dollars in exchange for preferred shares, which would pay a regular dividend and come with warrants that would allow the government to profit from increases in company stock prices. By contrast, Mr. Bernanke proposed various ways to fence off the troubled assets, from nonperforming loans to mortgage-backed securities that investors had stopped buying at almost any price. Mr. Bernanke’s options included guarantees for bank assets, which was at the heart of the rescue packages for Bank of America and Citigroup. Citigroup received its rescue package in November, but it is expected to report additional losses on Friday that could top $10 billion.

In both of those deals, the federal government set up a complicated arrangement that would limit the banks’ losses on hundreds of billions of dollars worth of their worst assets. Citigroup’s deal in November covered $300 billion in assets. Citigroup agreed to absorb the first $29 billion in losses. The Treasury agreed to take a second round of losses up to $5 billion, and the Federal Deposit Insurance Corporation agreed to take a third round of losses of up to $10 billion. The Federal Reserve then agreed to lend Citigroup money at low interest rates for the value of the remaining assets. As a second option, Mr. Bernanke and other Fed officials have proposed putting a bank’s impaired assets into a separate new “bad bank.” The effect would be much the same as providing a federal guarantee: the bank would be able to free itself from the need to set aside reserves for extra losses.

Both the idea of a government “wrap” and a government-backed “bad bank” have the virtue of protecting the bank’s common stockholders from being wiped out by the government. By contrast, the Bush administration’s original approach to recapitalizing banks — injecting capital in exchange for preferred shares with warrants to convert to common stock — had the effect of squeezing out the common shares. That was because any losses would have to first wipe out common stockholders before the bank could stop paying dividends on preferred shares.

“One of the problems with TARP has been a result of the government not wanting to own the banks,” said Fred Cannon, chief equity strategist at Keefe, Bruyette & Woods. “If you get losses, there is less common stock. What we are hopefully moving toward, to the extent that the government guarantees some of the assets, is a structure that protects common shareholders and allows the company to go out and raise common shares through the market.” But a growing number of analysts warned that the approach may be too clever, because it gives policy makers too many ways to conceal true problems at banks and true risks to taxpayers.

“What we have is a weird, shadow nationalization,” said Karen Shaw Petrou, managing partner at Federal Financial Analytics, a consulting firm in Washington. “The government does not want to and should not want to own banks. But if they get forced into that situation, they should resolve that situation. Here, what you have is a huge diversified financial services industry with recognized losses and looming losses in every aspect of its operations. There’s nothing straightforward about it.”

Time to take the banks into full public ownership
The Irish government just nationalised the third largest Irish bank, Anglo Irish Bank. Even an Irish government guarantee of all the liabilities of the Irish banks was not enough to keep Anglo Irish afloat. Bank of America has just received a second injection of capital from the US government - $20bn this time. It has also received a guarantee from the US Treasury, the FDIC and the Fed on all but the first $10bn of $118bn of potential losses on toxic assets. Governments all over the world (including the British government with Northern Rock and Bradford & Bingley, the Dutch government with ABN-AMRO) seem to resort to full nationalisation only after everything else has been tried and has failed.

Looking ahead it seems likely that all British high street banks, RBS, HBOS, Lloyds Banking Group, Barclays and HSBC will end up in (temporary) public ownership within the next year or so. RBS is already 57 percent government-owned and the soon-to-be-merged HBOS and Lloyds Banking Group are 43 percent publicly owned. All three need additional capital. None of the three is likely to be able to get it from the market. Barclays has so far avoided a public capital injection, but has raised additional capital at a much higher financial cost to the shareholders (although presumably not to the management) than the cost of an equal size state-funded capital injection would have been. HSBC may seem to be in a different league, because its share price has fallen by ‘only’ 43 percent over the past two years because it has raised very little new capital, and all of it from the market. I believe that this view is too optimistic.

HSBC’s writedowns have been about the same size as that of the other four banks combined. During the early stages of the crisis it has managed to offset a disastrous performance in the US with a strong performance in emerging markets, especially the Far East. With the emerging markets now suffering very badly as a result of the global credit crunch and global economic slowdown, the prospects for profitability over the next few years are dismal. Barclays too is heavily exposed to the economic fortunes of the emerging markets. So, incidentally, is Santander, the Spanish owner of Abbey and of Alliance & Leicester. Even if you do not share my view that all UK high street banks are dead banks walking, held up both by actual government financial support (directly through capital injections and indirectly through such facilities as the Special Liquidity Scheme and the Treasury’s guarantee on new bank debt) and through the anticipation of future government financial support, these banks do act like zombie banks.

They have enough capital to stay on their feet and stumble around a bit, but they are doing rather little of what banks are supposed to do: lending to the non-financial private sector - households and non-financial enterprises. There are many factors contributing to this reluctance of the banks to engage in new lending. Normal, sensible commercial prudence in the face of a severe cyclical downturn is one reason. In a recession, lending is riskier. Irrational fear and near-panic, resulting in excessive caution and risk aversion is another reason for low volumes of new lending, for higher interest costs and for more stringent loan conditions. The balance of power inside banks has shifted dramatically to the risk controllers and bean counters. Loan officers are being kept on a very short leash. ‘When in doubt, don’t lend’ is the motto above the employee’s entrance at our high street banks.

Contradictory messages from the authorities are a third reason. The Treasury and the PM shout ‘lend, lend!’. They also shout ‘pass on all rate cuts fully to the borrowers’ thus ensuring that new lending won’t be profitable. The FSA admonishes: ‘reckless lending is part of what got you into trouble! De-leverage and raise your capital ratios. And if you have any money to invest, put it into Treasury Bills and Bonds, to ensure adequate liquidity in the future‘. But I believe that costly partial state ownership and the fear of future state ownership (partial or complete) are themselves discouraging banks from lending. To minimize moral hazard, capital injections into the banks by the state and other forms of financial assistance by the state should be priced punitively and have other conditionality attached to it that is unpleasant for current shareholders and management (the dismissal of the incumbent top executives and the board; restrictions on dividend payouts and share repurchases until the state has been repaid; restrictions on executive pay and on bonuses etc.).

But if the state’s financial assistance is priced punitively or has other painful conditionality attached to it, existing shareholders and management will do everything to avoid making use of these government facilities. If a bank has no option but to take the government’s money, it will try to repay it as soon as possible - to get the government out of its hair. Such a bank will therefore be reluctant to take any risk, including the risk of lending to the non-financial private sector. Such a bank will hoard liquidity (sometimes in the form of deposits/reserves with the central bank) to regain its independence from the government. Still independent banks will hoard liquidity to stay out of the clutches of the government. I believe that this mechanism is at work in a powerful way both in the UK, the US and in continental Europe. Hans Werner Sinn in a recent Financial Times OpED piece pointed out that the German rescue package for banks was fatally flawed for precisely this reason: the acceptance by banks of an injection of public sector capital brings with it a cap on managerial salaries. Rather than accepting a cap on their salaries, managers would prefer to totter along with an under-capitalised bank and restrict the scope and scale of their lending operations.

There are two ways of resolving this problem and of incentivising the capital-deficient banks to lend again. The first is to make the capital cheap (gratis, in the limit) and to minimize the onerousness of the rest of the conditionality. This is the road taken in the US. The US Treasury injected capital into Goldman Sachs at less than half the cost to Goldman Sachs of a capital injection by Warren Buffett a few days earlier. AIG got a tough deal from the Fed and the US Treasury at first, but obtained much sweeter terms less than a month later. The latest capital injection into Citi by the US Treasury (preferred stock with a dividend yield of eight percent) is very cheap. By throwing cheap money with little conditionality at the banks, the Fed and the US Treasury may get bank lending going again. By subsidizing new capital injections, they reward bad porfolio choices by the existing shareholders. By letting the executive leadership and the board stay on, they further increase moral hazard, by rewarding failed managers and boards that have failed in their fiduciary duties. All this strengthens the incentives for future excessive risk taking.

There is a better alternative. The alternative is to inject additional capital into the banks by taking all the banks into full public ownership. With the state as sole owner, the existing top executives and the existing board members can be fired without any golden handshakes. That takes care of one important form of moral hazard. Although publicly owned, the banks would be mandated to operate on ordinary commercial principles. Managers could be incentivised by linking remuneration to multi-year profitability. The incentives for excessive liquidity accumulation and for excessively cautious lending policies that exist for partially nationalised banks and for banks fearing nationalisation would, however, be eliminated. In addition, full public ownership of the banks would greatly facilitate the creation of a ‘bad bank’ that would hold on its balance sheet all the toxic assets (illiquid assets of highly uncertain value) currently held by the high street banks. The key problem with any bad bank proposal is the price it pays for the toxic assets it acquires from the banks.

If all the banks, and the bad bank, are publicly owned, this problem goes away. The toxic assets are simply moved to the balance sheet of the bad bank. They could be valued at anything from zero to their notional value or historic cost (or even higher). It would be a redistribution of wealth from one state-owned entity to another state-owned entity. Note that the guarantee component of the Bank of America package (like the earlier insurance of/guarantee for $300bn worth of Citigroup toxic assets provided by the US Treasury) does not avoid the problem of valuing the toxic assets. The problem of determining a price or value for the illiquid assets stopped the TARP from being used as originally intended - for buying toxic assets from banks and in the process becoming a price and value revelation mechanism for illiquid assets.

There is a valuation embedded in the guarantee or insurance offered to Bank of America and Citigroup: the state will compensate the banks if the value of the securities falls below a certain level. But the valuation is rather well hidden, and may not be revealed unless the guarantee is actually invoked. Also, guarantees are off-balance sheet, and politicians, like bankers, like that. The bad bank would hold the toxic assets and collect the cash flows associated with it until a liquid market for these assets is re-established. This may never happen, in which case the bad bank would hold the toxic assets to maturity. The publicly-owned banks would be reprivatised when financial markets stabilise and the economy recovers. It would be good if a better regulatory and supervisory regime for banks and other highly leveraged entities were in place by that time.

Ironically, by partially nationalising some of the banks, by making this injection of public capital expensive financially and as regards other conditionality, and by holding the threat of possible future (partial) nationalisation over the remaining banks, the authorities created an incentive structure that is biased strongly against bank lending, and against bank risk taking generally. The best escape from this unfortunate halfway house is to go to temporary full public ownership of all the banks. It would be cheap. It should not cost more than £50bn for the state to buy the rest of the UK high street banks. It could wait a while and get them even cheaper - possibly for nothing. But time is more precious than money in this case.

The Real Problem With Geithner for Treasury
Tim Geithner is an awful choice for Treasury secretary, but not for the reasons other objectors are suggesting. Geithner is accused of employing an immigrant with an elapsed work visa. From my perspective, this is a complete nonissue. If Geithner wants to hire an illegal immigrant to mop his floors, nobody’s rights are violated. He wants his socks laundered, an immigrant wants a job, and they make a mutually beneficial trade. Geithner also reportedly failed to pay self employment taxes from 2001 to 2004, a shameful oversight for a man responsible for spending hundreds of billions of taxpayer dollars over the past year in various bailout schemes. While he certainly should have been aware of his obligations, given the subjective, contradictory and virtually impenetrable tax code, it’s easy to get lost amid a sea of paperwork.

The Tax Foundation estimates over $250 billion is spent in compliance costs, simply figuring out how much we owe each year. Why is it that even college-educated professionals need to spend hundreds of dollars simply figuring out their tax obligation? He has since paid his obligations – with interest. No, the problem with Geithner is, well, Geithner himself. In an age of bailouts, Geithner is the original Bailout Czar. It was Geithner, after all, who was the instrumental figure in arranging JP Morgan’s takeover of Bear Stearns, a deal in which $29 billion of taxpayer money was pledged as a backstop against illiquid and toxic assets.

It wasn’t Hank Paulson, but rather Tim Geithner who put together the plan to have the government rescue AIG, to the tune of $85 billion and growing. It has been widely noted Geithner was in favor of stepping in with taxpayer dollars to save Lehman Brothers. I guess it’s pretty easy to spend taxpayer dollars when you aren’t even paying your own taxes. If you are unfamiliar with Geithner, simply go the Federal Reserve’s web site to see a line-item balance sheet of his work: billions of tax dollars for AIG, Bear Stearns (look for “Maiden Lane LLC”; it’s the corporation created for Bear Stearns’s liquidation), commercial money markets and loans to primary dealers. Of course, the financial deterioration at most of the large banks now begging for bailouts occurred under Geithner's watch as president of the Federal Reserve Bank of New York.

One could argue he missed the credit storm despite being in the catbird seat for more than five years. He has, according to The Wall Street Journal, been looking for “as much firepower as possible” as Treasury secretary. Take note: That “firepower” is your tax dollars. There is uniform agreement that the TARP -- along with all the trillions in bailouts and backstops that have gone along with it -- has been a complete disaster, as we predicted it would be from the start. Now Obama seems poised to rely on the guy who was responsible for getting this bailout train underway. Wealth is not created because of a bailout, backstop or government stimulus plan. Geithner’s history suggests he believes government intervention is key to growing the economy. It hasn’t worked since Bear Stearns. Eight trillion dollars later…why would it work now?

Battered Wall Street tops Obama inaugural donors
Wall Street may be bruised and battered, but it still donated more money than any other U.S. industry to President-elect Barack Obama's inaugural festivities on Tuesday, a study has found. The Center for Responsive Politics said executives of finance, insurance and real estate companies and their family members gave $7.1 million to Obama's inaugural committee. Top donors from the world of high finance included George Soros, Ronald Perelman and David Shaw, the center said.

Bankers and hedge fund managers will mingle with Hollywood stars and Silicon Valley high-technology titans at the swearing-in ceremony for the 44th president, the parade down Pennsylvania Avenue and the balls and parties that follow. Special access and tickets are reportedly available to those who contributed $50,000 to the inaugural committee or who helped "bundle" larger sums from multiple individual donors, the center said. The committee refused to accept money from corporations, registered lobbyists, unions or political action committees.

Entertainers such as Halle Berry, Samuel Jackson and Sharon Stone donated heavily, as did behind-the-camera moguls including Steven Spielberg, George Lucas and Jeffrey Katzenberg, the center said, citing data downloaded from the Presidential Inaugural Committee's Web site. "While Americans are hoping for real change in Washington, many deep-pocketed donors are hoping money still buys them access and influence," said Sheila Krumholz, executive director of the nonpartisan money-in-politics watchdog group.

"If history is any guide, these wealthy individuals, as well as the corporations and industries they represent, may more than recoup their investment in Obama through presidential appointments, favorable legislation and government contracts," Krumholz said. People with Wall Street ties -- 118 of them -- gave $3.6 million; lawyers gave $2.5 million; and donors from the TV, movie and music businesses gave $1.7 million, the center said. The center's analysis of inauguration donors was posted on its Web site at

Americans say: TARP not working, stop spending
The government's financial bailout for troubled banks has not worked so far, a majority of respondents to a national poll say, and six in 10 don't want Washington to spend more money on the rescue. Sixty-one percent of those questioned in a CNN/Opinion Research Corporation survey released Friday oppose providing more government money in the financial bailout. There are some supporters, however -- 38% said the government should provide more assistance to ailing banks and other financial institutions. Most of the 1,245 adult Americans who were questioned for the poll were surveyed before Thursday's Senate vote to release the remaining $350 billion in the financial bailout program.

"One reason for the opposition to more money being spent may be that more than eight in 10 said that the first $350 billion of taxpayer money for the bailout didn't work," said CNN Polling Director Keating Holland. "Only 14% say that the money accomplished what it was supposed to do." Regardless of the apparent public opposition to the bailout, the Senate voted 52 to 42 to release the remaining funds. "Barack Obama may have something to do with the vote," said Holland. "Democratic leaders in the Senate may not have been eager for a showdown with the president-elect. The public would have been squarely on Obama's side. Sixty-two percent in the poll say they trust Obama more than Democratic Congressional leaders."

That compares to only 25% of those questioned in the poll indicating they would be more likely to trust Democratic Congressional leaders over Obama when they disagree on an issue. The poll also suggests that 50% of those questioned believe Republicans are more responsible for the economic problems facing the country right now. Less than a quarter of the respondents said Democrats are more to blame, and one in five said both parties are equally at fault. "Democrats may also have recognized that the public still blames the GOP for the bad economy. That suggests that the public may give the Democrats some leeway, at least for now," Holland added.

The 61% who oppose proving more taxpayer money for the financial bailout is up from 56% who opposed the initial bailout in mid-October. The CNN/Opinion Research Corporation survey was conducted Monday through Thursday by telephone. The survey's sampling error is plus or minus 3 percentage points for some questions and plus or minus 4.5 percentage points for others.

Treasury extends another $1.5 billion to Chrysler
In one of the Bush administration's final acts, the Treasury Department late Friday granted another $1.5 billion in emergency loans to Chrysler Financial. Chrysler, the most sub of the nation's subprime auto makers, no doubt appreciates the cash, which comes three weeks after it received $4 billion in bailout money, part of the initial $17.4 billion rescue package it shares with General Motors. Today's package gives much-needed liquidity to Chrysler's financial-services business so it can write more loans for car buyers caught in a tight credit market. Read full story on Chrysler. But it doesn't bridge the financial shortcomings facing Chrysler itself. Last week, Chrysler CEO Bob Nardelli told reporters in Detroit that the company still needs another $3 billion to survive, leaving open the possibility of bankruptcy if Nardelli's estimates are right.

With sales down 53% from a year ago, Chrysler knows it's in deep financial trouble, which means all of its assets are at risk. Nardelli used this argument when he asked Congress for money from Treasury Secretary Henry Paulson's Troubled Assets Relief Program. Paulson succeeded John Snow as head of Treasury in 2006, when Snow left the Bush administration to become chairman of Cerberus Capital Management, the private capital partnership that bought Chrysler the following year. Connecting dots between the Treasury Department and Chrysler naturally raises suspicions of political favors. But set suspicion aside. If we let the numbers tell the story, they still don't add up. Last month, Standard & Poor's cut its rating on privately held Chrysler to CC, which puts the company's debt deep in junk territory with "little prospect for recovery." The next step down is D, which stands for default.

Put another way, if Chrysler were to apply for a home mortgage, it wouldn't qualify. None of the big Wall Street banks propped up with TARP funds would be willing to give Chrysler a dime with a credit rating like that. Which is why Uncle Sam is the lender of last resort. If the same banks that bundled and marketed risky subprime mortgages around the world won't touch Chrysler, anyone outside the automotive industry must be scratching their heads over the Treasury's latest actions. The socioeconomic argument for saving Chrysler is compelling and the likely impact on an already weakened economy would be enormous. But at some point, something's got to give. Meanwhile, for investors searching for a bottom in this bear market, the flow of federal money to subprime industries obscures the view and further blurs the line on sound risk assessment.

FDIC shuts down banks in Illinois and Washington
The Federal Deposit Insurance Corporation and state regulators on Friday shut down banks in Illinois and Washington - the first bank failures of the year and the 26th and 27th since the start of the current credit crisis. Berkeley, Ill.-based National Bank of Commerce was shut down and he FDIC said Republic Bank of Chicago will assume all of National Bank of Commerce's deposits. The two locations of National Bank of Commerce will reopen Saturday as branches of Republic Bank, the FDIC said. The last Illinois bank to fail was Eldred-based Meridian Bank, in October, the FDIC said.

National Commerce Bank had total deposits of $402.1 million as of Jan. 7, and total assets of $430.9 million, the FDIC said. Republic Bank has agreed to buy roughly $366.6 million in National Commerce Bank's assets at a discount of $44.9 million. The FDIC estimated that the cost of National Commerce Bank's failure to the Deposit Insurance Fund will be $97.1 million. Also on Friday, the Bank of Clark County, Vancouver, Wash. was shut down and the FDIC was named receiver. The FDIC said Umpqua Bank, based in Roseville, Ore., will assume the insured deposits.

Bank of Clark County had total assets of $446.5 million and total deposits of $366.5 million. At the time of closing, there were approximately $39.3 million in uninsured deposits held in approximately 138 accounts that potentially exceeded the insurance limits. This amount is an estimate that is likely to change once the FDIC obtains additional information from these customers. Umpqua will not assume the approximately $117.8 million in brokered deposits. The FDIC will pay the brokers directly for the amount of their insured funds.

83 of 100 largest US corporations have tax havens, including bailed out banks
Eighty-three of the nation's 100 largest corporations, including Citigroup, Bank of America and News Corp., had subsidiaries in offshore tax havens in 2007, and some of the companies received federal bailout funding, a government watchdog said Friday. The Government Accountability Office released a report that said Bank of America Inc., Citigroup Inc. and Morgan Stanley all had more than 100 units in countries that maintain low or no taxes. The three financial institutions were included in the $700 billion financial bailout approved by Congress. Insurance giant American International Group Inc., which has received about $150 billion in bailout money, had 18 subsidiaries. JPMorgan Chase & Co. had 50 units and Wells Fargo & Co. had 18; both financial institutions received government bailout money.

Sens. Carl Levin, D-Mich., and Byron Dorgan, D-N.D., who requested the report, have pushed for tougher laws to fight offshore tax havens around the globe. Levin, who leads the Senate Permanent Subcommittee on Investigations, has estimated abusive tax havens and offshore accounts cost the U.S. government at least $100 billion a year in lost taxes. "I think we should take action to shut down these tax dodgers and we will be introducing legislation to do just that," Dorgan said. General Motors Corp., which received $13.4 billion from the federal rescue package, had 11 offshore subsidiaries while GM's financing arm, GMAC LLC, had two offshore units. GMAC, whose majority owner is private equity firm Cerberus Capital Management LP, received $5 billion from the Treasury Department in late December. Citigroup said in a statement that it has more than 4,000 subsidiaries around the globe "which enables us to serve hundreds of millions of individuals and institutions in more than 100 countries." A News Corp. spokeswoman declined comment. Messages were left with several of the companies identified in the report. Separately, the GAO said 63 of the 100 largest federal contractors maintain subsidiaries in 50 tax havens.

Levin noted that many competitors use the tax havens to varying degrees. PepsiCo Inc. has 70 subsidiaries while the Coca-Cola Co. has eight units. Caterpillar Inc. had 49 while Deere & Co. had three. "We need to put an end to the use of offshore secrecy jurisdictions as tax havens," Levin said. The GAO said the subsidiaries could be established in the countries "for a variety of nontax business reasons" and said having a business unit in one of the countries "does not signify that a corporation or federal contractor established that subsidiary for the purpose of reducing its tax burden." Citigroup had 427 units in 23 countries, including 91 subsidiaries in Luxembourg and 90 in the Cayman Islands. Morgan Stanley had 273 units, News Corp. had 152 and Bank of America had 115. Procter & Gamble Co. had 83 subsidiaries and Pfizer Inc. had 80 in the jurisdictions. Several major corporations have announced plans to leave Bermuda, a leading offshore business center, amid the global financial crisis and fears of tighter tax rules. Tyco Electronics Ltd., which makes electronic components, and Foster Wheeler Ltd., an engineering and construction company, are reincorporating in Switzerland -- which has a tax treaty with the U.S. -- for tax and other reasons. Covidien Ltd., a health care products company, is heading to Ireland.

Big losses intensify turmoil for banks
The turmoil in global banking intensified on Friday as Citigroup and Merrill Lynch reported huge losses, and shares in Britain’s Barclays plummeted amid fears it might need more capital. After the close, Barclays, whose shares fell 25 per cent to 98p – their lowest level since 1993 – said it knew of no reason for the plunge. The bank, which had a market value of £8.2bn ($12.1bn) at on Friday’s close, added that its full-year results, due out next month, would beat the analysts’ consensus of £5.3bn in pre-tax profits. Nevertheless, the grim news from some of the biggest names in global finance stoked investor fears of another round of capital-raisings, triggering another sell-off in bank shares.

The disclosure that Merrill Lynch – owned by Bank of America – had suffered a $21.5bn operating loss as the value of mortgage-backed assets plunged in the past three months of 2008 came as BofA secured a $138bn bail-out from the US government. The US bank, which finalised an $18.8bn all-share takeover of Merrill two weeks ago, received a $20bn capital infusion and a backstop on $118bn of troubled assets. BofA told the government in December that it would not be able to close the deal without help. Shares in BofA, which reported a $2.4bn loss in a quarter marred by Merrill’s disastrous performance, fell nearly 14 per cent.

Citigroup underlined the depth of banks’ problems by reporting an $8.3bn net loss, its fifth consecutive quarter in the red. The troubled financial group suffered nearly $28bn in writedowns and loan loss provisions in the quarter as the price of mortgage securities plummeted. Citi’s loss for the year was more than $18bn. The company confirmed its plan to isolate some $800bn-worth of unwanted assets and businesses into a non-core unit called Citi Holdings. Citi’s key businesses of commercial, investment and retail banking will be housed in a unit called Citicorp, a sign of the company’s desire to unravel the 1998 merger between Citicorp and Travelers that created Citigroup.

Bad loans jump at Citigroup, Bank of America
Citigroup Inc. and Bank of America said Friday that bad loans jumped during the fourth quarter as the recession deepened and unemployment increased. Commercial loans, which had held up better than consumer loans, began showing signs of stress too as more companies struggled to repay debt. Non-performing corporate loans at Citi jumped to $9.57 billion in the fourth quarter, versus $2.67 billion in the third quarter and $1.76 billion a year earlier. Citi said it set aside $1.2 billion in reserves to cover bad debt from the bankruptcy of LyondellBassell, one of the world's largest chemical companies, which went bust earlier this month.

Non-performing commercial loans at Bank of America climbed to $6.5 billion in the fourth quarter, up from $4.9 billion during the previous three months. Non-performing consumer loans, including mortgages, rose to $12.73 billion at Citi during the fourth quarter. That was up from $10.88 billion in the third quarter. Troubled consumer loans at Bank of America reached $9.9 billion in the fourth quarter, versus $6.8 billion during the previous three-month period. Analysts say bad debt will likely continue to climb in 2009, adding a second punishing leg to the credit crisis that began in 2007 with the implosion of the mortgage market. Such concerns are pushing the U.S. government to consider more support for the banking system, including the possible creation of a state-funded "bad bank" to separate and liquidate troubled assets, The Wall Street Journal reported late Friday.

Bank crisis reignites as US giants post massive losses
Hopes that the global banking crisis was past its worst were dashed yesterday when Bank of America was forced to accept $138bn (£94bn) of government support and Citigroup unveiled new losses of $8.3bn. The US announcements led another day of turmoil in the international financial sector, with Barclays' shares plunging 25 per cent in the last hour of trading on the London Stock Exchange. Bank of America, the biggest US lender by assets, posted a $1.79bn loss for the last three months of 2008 – its first quarterly loss since 1991 – and slashed its dividend to one cent. The bank was forced to seek government support to prop up its acquisition of Merrill Lynch, which suffered a record $15.3bn quarterly loss.

The federal government will inject $20bn into Bank of America in return for preferred stock paying a coupon of 8 per cent. The government will also guarantee $118bn of assets to ease the strain of absorbing Merrill's battered balance sheet. Citigroup, another stricken US banking giant, posted a bigger-than-expected fourth-quarter loss and said it would split itself in two to shelter its key businesses from risky operations. Bank of America was relatively unscathed by the financial crisis before the acquisition-hungry bank agreed to buy Washington Mutual and Merrill last year in what it believed were cheap deals. Merrill suffered massive losses in December, prompting Bank of America to consider calling the deal off, but the government insisted it must go through and offered assistance.

"The loss materialised late in the quarter and presented us with a decision," Ken Lewis, the chief executive of Bank of America, said. "We went to our regulators and told them we could not close the deal without their assistance. We believe those actions [by the government] were in the best interests of Bank of America and the financial system by limiting the downside." The losses and government bailout will put extra pressure on Mr Lewis, who said in late 2007 that he had had "all the fun I can stand" in investment banking but then changed course by acquiring Merrill in the wake of the Lehman Brothers bankruptcy.

Bank of America wrote off $5.5bn of loans in the final quarter and took a bad-debt provision of $8.5bn, with "market-disruption" hits of $4.6bn. Merrill's losses included $1.9bn of writedowns on leveraged loans, $1.2bn on investment securities and $1.1bn on commercial property. Citi's chief executive, Vikram Pandit, announced plans to break up the empire created by Sandy Weill by separating the conglomerate's core commercial banking business from its brokerage and asset management divisions. The bank announced its fifth straight quarterly loss, with Mr Pandit blaming the results on "unprecedented dislocation in capital markets and a weak economy".

Investors had hoped that Government bailouts at the end of last year had stabilised the banking sector after more than a year of massive writedowns on toxic debts. But the World Economic Forum warned last week that more asset falls, both in credit markets and ordinary loans to customers, would make this year just as painful for lenders as they pay the price of the global debt binge. Some analysts in the US now believe that Citi and possibly Bank of America may have to be nationalised to draw a line under their woes. Ireland announced the nationalisation of Anglo Irish Bank late on Thursday to stop a run on its deposits and shares. Bank of America shares shed 13.7 per cent in New York yesterday, and have lost nearly half their value this year. Citi shares fell 8.6 per cent.

Jitters about the banking industry spread to Britain's lenders yesterday afternoon as speculation mounted about the Government's plans for supporting the sector. New guarantees on mortgage bonds and other securities could be announced as early as next week, but the market was hoping the authorities would set up a "bad bank" to take illiquid assets off lenders' books. That idea is said to have dropped down the Government's list of priorities because of the complexity involved in valuing the assets. A meeting between the banks and the Treasury, scheduled for last night, was called off, suggesting that the Government is taking longer to come up with its plans than expected. But bank executives were said to be on alert for weekend meetings with the Treasury.

Barclays was the biggest faller in the FTSE 100, losing a quarter of its value in late trading as rumours swirled that the bank, which has resisted taking state funding, had applied to the Treasury for a capital injection, or that one of its top directors had quit. The slump in the shares, which closed near a 15-year low, forced Barclays to issue a statement after the market closed saying it knew of no reason for the drop. The bank's plunge coincided with the lifting of the Financial Services Authority's ban on short-selling financial stocks. Barclays, without the explicit backing of the Government, would have been more vulnerable to rumours spread by short sellers hoping to drive the bank's shares down. Industry sources suggested that even without the end of the shorting ban the sector may have been hit by a combination of bad news from the US and uncertainty about the Government's plans, prompting investors to close long positions in anticipation of a potentially dilutive new bailout plan.

UK banks 'technically insolvent' and 'living on a prayer'
Work is beginning this weekend on a fresh help package for Britain's banks following yesterday's dramatic stock market falls.
Treasury officials are working through the weekend to come up with a multi-billion pound bailout solution, amid a dramatic warning that the country's banks are effectively bust. The share falls were triggered by fears that the banks still had further losses to declare. This has prompted an intensification of efforts, which have been under way for some weeks, to agree a second massive taxpayer-funded cash injection. Today sources played down suggestions that the banks were  being summoned to the Treasury for crisis talks - as happened before the original bailout in October.

However RBS today acknowledged that there were 'ongoing meetings' with the Treasury, although they declined to give details. Barclays refused to comment. A Treasury spokesman said: 'We have been working with the banks for the past couple of weeks. We will be making an announcement on additional measures soon.' Earlier, Prime Minister Gordon Brown made clear that the banks would have to reveal the full extent of the 'toxic assets' still on their books as a result of the collapse of the sub-prime mortgage market in the US. 'One of the necessary elements for the next stage is for people to have a clear understanding that bad assets have been written off,' he told the Financial Times. 'We have got to be clear that where we have got clearly bad assets, I expect them to be dealt with.' The paper said that he refused to rule out a full-scale nationalisation of the banks or a further injection of taxpayer funding in order to restore lending to business.

Mr Brown and Chancellor Alistair Darling met yesterday with the Governor of the Bank of England, Mervyn King, and Financial Services Authority chairman Lord Turner of Ecchinswell to discuss the way forward. Restoring confidence in the banks is seen as essential if they are to resume to flow of lending to business vital to the prospects for economic recovery. Suggestions that the Government could use billions of pounds of public money to buy up 'toxic' assets from banks were however being played down in Whitehall. Experts warned UK banks  -  traditionally the powerhouse of the economy  -  are 'technically insolvent' and are ' living on a prayer'. Government sources said a huge loan guarantee scheme  -  with taxpayers' cash used to underwrite at least £100billion of mortgage lending, car loans and borrowing by big firms  -  could be announced as early as Monday.

Shares in major lenders fell sharply yesterday amid fears that more financial institutions will need to be bailed out by the Government. In just five days some £29billion has been wiped off the value of the five biggest banks  -  Royal Bank of Scotland, Barclays, HSBC, HBOS and Lloyds TSB. Barclays was the biggest loser. Its shares have almost halved in value since Monday, including a dramatic 25 per cent fall in a few hours yesterday, as rumours circulated about problems at the banking giant. Chancellor Alistair Darling is preparing for a frantic weekend as he tries to hammer out another multi-billion pound package aimed at kick-starting Britain's failing economy. The round of guarantees for mortgages and corporate loans would be designed to help boost bank lending. The guarantees are expected to exceed the £100billion that Sir James Crosby, the former chief executive of HBOS who is advising the Treasury, recommended was needed to stabilise the mortgage market.

Banks and firms look set to be allowed to swap assets which have effectively become untradeable since the onset of the credit crunch for Treasury bonds that can be used to raise money. Balance sheet requirements could be eased to allow lenders more freedom to raid reserves. But those are likely to be only the first steps, with fresh direct injections of cash into the banks and full-scale Government guarantees of their toxic assets also being considered. Last year's unprecedented £37billion bail-out of leading lenders by the Government has signally failed to kickstart lending. The Government now insists that the main aim of that package had been to save the banks from complete collapse, and new measures are needed to try to unfreeze credit. The scale of the crisis was underlined by a warning from analysts for the Royal Bank of Scotland, which is already majority state-owned.

In a shocking assessment on the health of the most important part of the British economy, they said: 'On our calculations, assets are worth less than liabilities.' The experts suggested a further bailout of £36billion would be necessary simply to make the banks technically solvent. They predicted the Government would be forced to announced 'further initiatives to improve credit availability', and said a state-owned 'toxic' bank, taking on all the sector's bad assets, was the preferred option. Bank of England deputy governor Sir John Gieve said yesterday Britain was facing its worst downturn in decades and issued a red alert that the Government and the Bank may need 'to do more'.

£200 billion to save British banks from bad debt
The taxpayer will be forced to underwrite up to £200 billion of bad banking debt under a government plan to take control of assets belonging to Britain's major high street lenders, The Daily Telegraph can disclose. In an attempt to restore confidence within the financial sector, the Treasury will tell the banks of its plan on Saturday. It aims to announce details of the rescue package publicly early next week. The bad bank plan has climbed the political agenda in the past couple of weeks as the Government has become aware of the extent of the lenders' bad debts. Sources said that a bad bank would have to take on about £200 billion of toxic assets. That would take the Government's total commitment to solving the banking crisis to almost £1 trillion in taxpayers' money that has either been spent or pledged.

That equates to about £33,000 per taxpayer. The total sum is equivalent to more than two-thirds of Britain's annual GDP of £1.4 trillion. The £1 trillion figure includes the £500 billion announced in October to buy shares in the banks and to guarantee their debt. It also includes a further £100 billion fund, which will also be announced next week as part of the rescue package, to provide the banks with cash to lend to ordinary customers and businesses. As well as creating a bad bank, the Government is planning to use Northern Rock as a "good bank" which can dramatically increase lending to individuals and businesses. The banking crisis has deepened in recent days on both sides of the Atlantic. Barclays shares fell by 25 per cent yesterday on fears that the Government would force it to take part in the bad bank.

Citigroup said it was to split itself in two to ring-fence its failing assets after disclosing £20 billion of losses in the past 15 months. Bank of America received a £14 billion cash injection from the US government. In the US, similar government measures are being discussed, with officials looking at either the prospect of a "bad bank" scenario, or extending individual guarantees to banks that need them. The situation has been being assessed by members of outgoing President George W. Bush's administration in recent weeks, in close contact with members of President-elect Barack Obama's transition team, who will take over the US Treasury and other key departments after his inauguration on Tuesday. As he finalises the details of the rescue plan with the Treasury, Gordon Brown will this weekend attack the "irresponsible" lending of British banks to foreign nationals and overseas companies.

City sources said last night that the talks over the setting up of a bad bank were "highly complex" and that there was still strong opposition among banks to the Government enforcing a compulsory seizure of their assets. A more attractive option for the banks would be to keep the assets on their own balance sheets but ring-fenced. The Government could then offer a guarantee on those assets in order to provide confidence to investors. The more likely option – which is favoured by the Treasury and City regulator, the Financial Services Authority – is to create a toxic bank. They see this as the best way to cleanse the banking system and set it on a path to recovery. Banking sources said they expected to be given an outline of what the Government plans to do on Saturday afternoon. There will then be intensive negotiations between the Treasury and individual banks over which assets must be put into the bad bank and at what price. The process could take several weeks to complete.

The major users of the toxic bank will include Royal Bank of Scotland, in which the Government already has a 60 per cent holding. RBS is understood to have been forced to write off a £2.5?billion loan to a Russian oligarch. Lloyds TSB, which has bought rival HBOS, will also take part in the scheme. HBOS was forced to sell itself to Lloyds last year after buckling under massive losses in its corporate lending book. The Government owns 43 per cent of the enlarged Lloyds bank. More controversial will be the position of Barclays and HSBC. Neither bank took cash from the Government as part of the October bail-out, and Barclays instead raised money from a group of Middle Eastern investors. However, it is believed that they will be forced to join the bad bank so that the entire banking system can be shown to be purged of problematic investments.

The Government will keep the toxic assets in the bad bank and, when the economy improves, will hope to sell them off over time. The other key aspect of the rescue plan is the £100 billion in Government-backed loans that will be offered to banks. The money will be used by banks to fund new loans for home owners and businesses. The package is effectively a way of underwriting bank lending. Taxpayers' money could be at risk if home owners or businesses fail to repay their debts to the banks and the banks therefore struggle to repay the Government. The latest rescue package comes after Mr Brown introduced a £500 billion package of aid for the financial sector in October. Despite the scale of that package, business leaders say banks are still not lending freely, threatening many companies with collapse.

Government insiders say the banks are refusing to lend because of the scale of their toxic assets – loans based on properties whose prices have collapsed – and face further major losses in the coming months. Downing Street has been angered by the mounting evidence that there was widespread reckless lending by the high street banks that precipitated last year's financial crisis. Mr Brown is understood to be concerned that up to 80 per cent of the bad debts at some banks were to foreign companies or individuals. There were signs last night that America was looking at a similar "toxic bank" scheme. Advisers to Barack Obama, the President-elect, are reportedly considering such proposals.

Brown orders Britain's banks to come clean
Gordon Brown yesterday told the banks to come clean over the extent of their bad assets, admitting the scale of the banking crisis could threaten the global economy with a new phenomenon: "financial isolationism". With speculation growing that the government will be forced to stage another bank rescue, the prime minister told the Financial Times he had been urging the banks for almost a year to write down their bad assets. "One of the necessary elements for the next stage is for people to have a clear understanding that bad assets have been written off," he said.

Speaking amid mounting market concerns that banks face further heavy losses, Mr Brown said: "We have got to be clear that where we have got clearly bad assets, I expect them to be dealt with." Mr Brown's team is looking at options to keep the banks afloat as new writedowns threaten to eat through the £50bn in capital injected in October, of which £37bn was provided by the taxpayer. Officials are working on plans possibly to underwrite the toxic assets or buy them outright and place them in a "bad bank".

Mr Brown declined to rule out the possibility that the banks may end up being fully nationalised or may need a further injection of taxpayer capital. Meanwhile, the prime minister met Mervyn King, Bank of England governor, to finalise plans to help Britain's biggest companies bridge a yawning credit gap. That package, to be announced next week, is expected to see a series of government guarantees over corporate lending, including measures to reopen the frozen securitisation markets in areas such as housing and car finance.

"It's the same problem of access to the banks and to funding," Mr Brown said. "Obviously, the sooner the corporate bond market moves more effectively, the better." The prime minister repeatedly stressed the need for international co-operation to revive the global credit market and identified a new risk of "financial isolationism" as big banks retrench into domestic markets. The British Bankers Association says that even if UK high street banks were to lend more, many overseas banks have pulled out or reined back on lending in the UK market, including Icelandic banks, European banks such as Fortis and Irish banks.

Mr Brown said that pattern was being reflected around the world, admitting that the part-nationalised RBS was among those pulling back from overseas investments. The prime minister, who hosts a summit of the G20 leading industrial and developing nations in London in April, did not have a prescription but said: "The greatest risk after the events of the last few months is a retreat into what I would call financial isolationism".

Final denouement approaches as crisis enters new phase
It was one of those defining remarks of the early stages of the banking crisis. Asked in October 2007 whether he saw opportunity in the chaos for acquisition-making, Ken Lewis, chairman of Bank of America, said "never say never, but I've had all the fun I can stand in investment banking". As well as being amusing, it was also instructive, or was taken to be. Here was Mr Lewis apparently quashing stock market speculation that he was lining up to buy one of Wall Street's bulge-bracket investment banks, which, though they were by that stage already struggling, weren't yet the busted flush they were later to become.

Lo and behold, a year later up pops Mr Lewis to buy the great big granddaddy of US investment banking, Merrill Lynch, in a deal valued at what today looks like the fabulous price of $50bn. Mr Lewis should have stuck to his earlier, self-denying ordinance. Yesterday he admitted to being so dismayed by Merrill's mounting losses and difficulties – final-quarter net losses were a jaw-dropping $15.3bn – that he had had to threaten regulators with non-completion of the deal unless the government could be persuaded to give additional support. Sir Victor Blank, chairman of Lloyds Banking Group, should take note. Mr Lewis has managed to get an additional $20bn of capital out of the federal authorities on reasonable terms, as well as federal guarantees on $118bn of Merrill's toxic assets, as the price for saving Merrill's from oblivion.

The Lloyds TSB takeover of HBOS, similarly framed as a helping hand to public authorities desperate to avoid having to nationalise Britain's largest mortgage bank, has now completed, but that's not going to stop Sir Victor reminding the Treasury in terms that he's done the taxpayer an enormous favour by taking HBOS off their hands. He needn't have done this deal. Lloyds TSB would arguably be much better off today if he hadn't. As with Bank of America and Merrill Lynch, the decision to push ahead was as much about the public service of trying to re-establish stability in the banking system as adding to the Lloyds TSB franchise. The Prime Minister owes him, and if there is to be a further round of recapitalisation among the British banks, Sir Victor will expect similar terms to the ones secured by Mr Lewis.

Over the last week, the banking crisis has taken a new, and frightening, lurch downwards. No sooner have the authorities managed to quell one fire than another one breaks out. The Bank of America/Merrill crisis may have been addressed, temporarily at least, but now there's Citigroup. In any case, there will be no rest for US Treasury officials this weekend. With results for the final quarter of last year to be announced across the banking sector, investors, depositors and regulators are again in a heightened state of nervousness. Front runners in the reporting season show no let-up in the red ink. As for UK domestic banks, Royal Bank of Scotland issued a circular yesterday predicting that rising impairment charges and declining, pre-bad debt profitability would ensure that they all remain loss-making for the year to March 2010.

More scary still, RBS remarks that, on a fully mark-to-market basis, all the UK domestic banks are already technically insolvent. In a bank, insolvency occurs when the liabilities – depositors and wholesale funding – exceed the value of the assets, which are the bank's loan portfolio. Such an event occurs when you get a severe bad-debt experience, impairing the value of the assets, and there is an insufficient capital buffer to make up the difference. As RBS points out, it is actually not unusual for banks to be insolvent at this stage of the economic cycle. What makes it different this time is that this dire state of affairs is much more transparent than it has ever been in the past. The banking system's greater reliance on wholesale funding also makes it considerably more vulnerable to withdrawal of funds on the liabilities side of the balance sheet.

Fast-back to the recessions of the early 1990s and 1970s, and the UK banks were similarly insolvent, but supervisors just chose to ignore it or shovel it under the carpet, knowing that eventually the downturn would end and the value of the assets would recover. Banking is all about confidence. In the past, regulators have conspired with banks in covering up the unpalatable truth. In today's world of instant mass communication and analysis, the illusion of calm stability is much harder to maintain. I warned the Financial Services Authority against lifting the ban on shorting banking stocks, but instead the regulator chose to listen to the "grown-up" voices of the financial press and the City that argued the ban was oppressive and ineffective.

Well , what do you know? The moment the ban is removed and the stock price of Barclays, which with the other UK banks part-nationalised is the only one left where it makes any sense to take short positions, loses 25 per cent of its value, with all manner of malicious rumours planted around the bank for maximum negative impact. These variously ranged from the resignation of John Varley, the chief executive, to the idea that the bank had been forced to go cap in hand to the Government for a bailout or that the Government was planning deliberately to exclude Barclays from any further measures to help the banks on account of its refusal to participate in the first recapitalisation. None of them seem to be right, and indeed a bewildered Barclays issued a statement last night saying it knew of no reason for the renewed plunge in its share price.

There is, however, one plausible enough explanation, and that is that the Government has been shamed into agreeing a substantial reduction in the cost of the preference capital it has injected into RBS, Lloyds TSB and HBOS. The prefs carry a coupon of 12 per cent, which looks positively usurious with interest rates now so low and is much higher than the cost of similar recapitalisations in the US and Europe. Any such adjustment in the terms will in turn make the price paid by Barclays for alternative recapitalisation with Arab money look even more excessive. Barclays' pride in rejecting UK Government money may end up costing it dearly. Shareholders have still to forgive the board for riding roughshod over pre-emption rights in agreeing the injection of Middle Eastern money.

So what is the Government about to announce in the way of more assistance to the beleaguered UK banking sector. There was much disappointment in the City this week with the limited package of guarantees on small business lending announced by the Business Secretary, Lord Mand-elson. On the other hand, this seems to have been just the hors d'oeuvre, with much more to come over the next week or two. A part of that package may be the aforementioned reduction in preference capital terms. The Government is also likely to follow the US, with a humongous programme of government guarantees for new mortgage and corporate lending. Also under consideration is a new scheme to issue banks with tradable government securities in return for UK mortgage and corporate lending assets. This would be similar to the Special Liquidity Scheme (SLS) already operated by the Bank of England, only the assets would be bought outright from the banks, rather than simply borrowed as they are at the moment under the SLS.

Yet if the City hopes to see the wider concept of a "bad bank" introduced, under which the Government would relieve the banks of their bad debts, it may be disappointed. The Troubled Asset Relief Programme (Tarp) in the US has encountered intractable problems in identifying which assets to buy and at what prices. UK Treasury officials believe the concept might prove similarly unmanageable in the UK. In any case, the situation is still fluid. Nothing has been ruled out or in. The only thing we can be certain of is it will cost one hell of a lot of taxpayers' money. In the US, a committee of top- drawer policymakers, including the incoming deputy Treasury Secretary, Larry Summers, has recommended that commercial banks in future be banned from proprietary trading and other such speculative use of banking capital.

If enacted, this would be very much like the reintroduction of Glass-Steagall, the legislation introduced in the 1930s to enforce a rigid separation of commercial from investment banking, so as to prevent the snakeoil salesmen of Wall Street squandering the deposits of ordinary Americans on bonus-driven speculation and high-risk, transactional-based lending. This is perhaps the least the banking system can expect by way of regulatory backlash. Bankers will never again be allowed the freedoms they have enjoyed over the last decade and a half, or not in our lifetimes anyway.

Governments eye new tools for credit crisis
When governments in Europe and the US unveiled co-ordinated bail-outs of their banking industries last October, politicians and regulators rightly believed they had narrowly avoided a collapse of confidence of the financial system. But this week it became clear governments will have to take on even more risk from the private sector if they are to restore the flow of credit to the economy. Citigroup’s $8bn loss for the fourth quarter offers a vivid illustration of how the government bail-outs have failed to stabilise flailing markets and a deteriorating economy that continues to undermine the value of banks’ assets. The US government’s decision, finalised late on Thursday, to insure Bank of America against “unusually large losses” on $118bn (€89bn, £80bn) of loans on its balance sheet underscores the sheer scale of the commitments taxpayers are being forced to make to shore up confidence.

If government intervention were limited to mopping up the residual mess left over from last year, this would represent little more than a minor headache. But the real problem facing policymakers is that, despite spending or committing hundreds of billions of dollars, the banking system is still not distributing credit to the economy. Consumers and companies are being starved of credit, raising the prospect of a continuing downward economic spiral. As a result, governments are reaching for several new tools to tackle the crisis. British officials were on Friday putting the finishing touches to measures that will attach government guarantees to instruments such as mortgage-backed securities and corporate debt. This represents an effort to stimulate the financial markets to again accept loans that would otherwise have to sit on banks’ constrained balance sheets. Yet these measures are limited to encouraging new lending.

They do not deal with the continuing problem of legacy loans that are still on banks’ balance sheets. These loans are rapidly turning bad as companies and consumers struggle to service debts they took on when credit was cheap and plentiful. What is more, new banking regulations are making matters worse. The Basel II framework for measuring banks’ capital, adopted by much of the world at the beginning of last year, was supposed to provide a more sophisticated way for measuring the risks attached to different loans. As losses mount, however, bankers are concerned they will be forced to hold ever-increasing amounts of capital to support existing assets. Until they have a clear idea of how much capital they need for old loans, banks are understandably reluctant to commit to new lending. As a result, policymakers have changed tack.

Bank capital ratios are essentially a fraction where the numerator is the total amount of capital a bank holds while the denominator is the sum of a bank’s assets, adjusted for their perceived riskiness. Wholesale bank recapitalisations launched last autumn were an attempt to improve the ratio by increasing the numerator. Now, governments and regulators are attempting to achieve the same result by shrinking the denominator. In other words, they want to reduce banks’ risk-weighted assets. Since most banks cannot sell assets without incurring huge losses, this can be achieved in two ways. The first is for governments to buy bad assets from banks in return for cash. This was the US government’s original plan under the troubled asset relief programme. The alternative is for bad assets to remain on banks’ balance sheets, but for the government to insure them against large future losses. The US took this approach with both Citigroup and BofA, and other governments are expected to follow suit.

Whatever the approach, removing bad assets from banks’ balance sheets should end the uncertainty about future capital requirements, allowing the banks to resume lending. Nobody is willing to say for sure whether this will work. However, most observers agree that the only alternative is for governments to seize full control of their banks by nationalising them. This is already beginning to happen. On Thursday, the Irish government nationalised Anglo-Irish bank – a move it had striven to avoid last September when it took the controversial decision to guarantee fully all Irish banks’ loans and deposits. On both sides of the Atlantic, governments are hoping the markets will not fully test their commitment to stand behind their banking systems. On the evidence of the past few week, that hope may be in vain.

Eurozone exports plunge as slowdown bites
Eurozone exports fell almost 5 per cent in November as a result of the slowdown in global growth, with Germany particularly exposed. Meanwhile, Spain’s finance minister warned the country faced its deepest recession in 50 years, amid more gloomy data. Exports from eurozone member countries dropped 4.7 per cent month on month, extending a 2.8 per cent fall in October, according to Eurostat, the European Union’s statistical office. November’s fall was the biggest monthly drop for more than eight years. The data highlighted the severe industry downturn that followed the collapse of the Lehman Brothers investment bank in September. With the scale of the recession becoming clear in only recent days, the European Central Bank announced a further half percentage point cut in its main interest rate this week to 2 per cent.

Germany, the eurozone’s largest economy, has proved particularly vulnerable. Jacques Cailloux, European economist at Royal Bank of Scotland said its performance in recent years had hinged largely on the global trade cycle and its huge exposure to the capital goods sector. Now “there is pretty much no escape”, he said. German gross domestic product is likely to have shrunk up to 2 per cent in the fourth quarter of last year, the country’s statistical office has estimated. France appears to be faring a little better, supported by domestic demand. The Banque de France on Friday estimated GDP in the eurozone’s second largest economy fell 1.1 per cent in the final quarter of 2008. Details of Friday’s figures showed German exports to countries outside the eurozone fell 4 per cent in November compared with October. Spain saw a 4.5 per cent fall but France a drop of only 1.5 per cent. The eurozone grew to 16 member states at the start of the year with the entry of Slovakia. Pedro Solbes, Spain’s finance minister, said on Friday his country’s economy would shrink 1.6 per cent this year.

Some independent economists think ministers are still too optimistic and predict a contraction of as much as 3 per cent. Even as the economy weakened last year following the collapse of the Spanish housing market and the worsening of the global financial crisis, Mr Solbes tried to limit government spending and control a budget, which he had helped turn from deficit to surplus after the Socialists won power in 2004. But Mr Solbes has now admitted defeat, predicting in parliament on Friday that this year’s budget deficit would reach the previously unthinkable level of 5.8 per cent of GDP after the announcement of billions of euros of government spending to stimulate growth. The number of jobless claimants jumped by almost 1m last year, sending unemployment to 13.4 per cent by November, compared with Mr Solbes’ July forecast for 10.4 per cent. Mr Solbes said the crisis had “drastically” changed the situation. Standard & Poor’s, the credit rating agency, says it may downgrade Spain’s sovereign debt ratings because of the deterioration in public finances.

Barclays shares in new collapse as bank crisis enters second phase
Shares in Barclays and Royal Bank of Scotland plummeted as huge losses at two of America's biggest financial institutions sparked fresh fears for the future of Britain's banking industry. In a frantic hour of trading, Barclays lost almost a quarter of its value - marking the second wave of a banking crisis that has already dragged the industry to the edge of collapse. The dramatic fall, which also shook the newly merged Lloyds TSB and HBOS, forced banking chiefs to cancel a planned summit in the City and triggered a flurry of emergency meetings in Whitehall.

Alistair Darling, the chancellor, met Adair Turner, the chairman of the FSA, the main financial regulator, while Gordon Brown met Mervyn King, the governor of the Bank of England, to assess the damage after a week of devastating news for the banking industry. Barclays denied it faced financial problems and rushed out a statement to the New York stock exchange before trading closed. The bank, which is due to report its figures next month, said profits before tax for 2008 after all charges and costs should be well above forecasts of £5.3bn. The bank's tier one capital ratio should be 6.5% at the end of the year and the total capital ratio will be 9.1%, putting it in line with many of its peers.

Analysts said Barclays had suffered a severe loss of confidence following speculation that it faces further losses on hundreds of billions of pounds worth of toxic investments. Concerns that the main City regulator had added to the bank's woes by lifting a ban on short-selling was dismissed by the government, but were leaped on by opposition MPs as an indication of government incompetence. Some City traders said the dive in Barclays shares had been fuelled by rumours of the bank's imminent nationalisation spread by short- sellers who profit from falling prices. Vince Cable, the Liberal Democrat treasury spokesman, said it was "absolutely extraordinary" that the ban had been lifted.

"Another wave of speculative pressure is the very last thing that is needed," he said. But Barclays shares have been falling all week, along with those of the other major banks, as investors come to terms with further bailouts by the US government and a raft of gloomy predictions for the UK economy. Citigroup, Bank of America and Merrill Lynch revealed losses over three months of $25bn (£17bn) between them yesterday.Citigroup sought extra funds from the US treasury and is being forced to break itself up as the price of its rescue. Bank of America, which bought the largest mortgage lender in the US last year at the height of the sub-prime crisis, also announced large write-downs on its assets, mainly sub-prime home loans. The US government has promised $800bn of extra funds after the Senate released the second tranche of a $750bn bailout yesterday.

The scale of the support for the US banking system has shocked even the hardened operators in the City and triggered soul-searching among investors, many of whom have seen the value of their holdings sink by 90% since a peak in early 2007. Many investors expect the banks' 2008 results next month will involve multi-million pound write-downs in a wide range of assets caused by the credit crunch. Auditors have already told the government they are reluctant to sign off the accounts of banks and many other companies because of funding worries. Analysts at RBS predicted banks would be unprofitable until 2011.

The Treasury has become aware in recent days of a general loss of confidence in the banks' capacity to escape from with credit crunch. Last night it indicated that plans to bolster the industry would be brought forward, possibly to early next week. A range of options to kick-start lending, including a scheme ring fence $200bn in toxic assets, will be discussed with the big banks at a meeting on Sunday.

Reviving the world's burst-bubble economy seems further away than ever
In the US and in Ireland, governments have been scrambling again to support their banks. For the economic prospects of these countries, and the world economy, that is troubling. Recession is only just beginning and yet many banks are holed. Governments are being obliged to pour in more capital, adding to the huge liabilities they now face. This vicious circle augurs poorly for recovery. It is not that governments should avoid intervening in banks. They are obliged to. To put public money into the banking system is the right thing to do because neither national economies nor the world can afford the collapse of large financial institutions.

Moreover, fresh losses at banks will make them more risk-averse and less inclined to lend into the economy, excerbating the recession. Economic recovery needs credit and the banks need economic recovery. To restore their financial positions, banks must continue the retreat from high leverage and risk. But the large amounts of public money poured into them do not automatically mean they will be quick to lend more. At present, neither is in a strong position to help the other. On the contrary, recession and low-growth risk are creating further asset losses for banks - and further recourse to government budgets already under huge strain. Had Anglo Irish Bank become insolvent, the Irish government, whose fiscal deficit is already heading towards double digits, would have been liable for some 100bn euros in deposits - about half of Ireland's GDP.

The Irish government has guaranteed deposits in all its banks but could not afford to honour that guarantee without issuing debt that would far exceed the country's GDP. It is improbable anyone would want to buy it. Nor can Ireland resort to the money printing press for funding, as the US and UK governments may eventually do. Ireland no longer has its own pounds to print. The worst afflicted banks are in countries which have experienced property price bubbles, like the US and Ireland. But as recession bites, more loans in more sectors and in more countries may turn bad. All this makes it likely that governments will be forced to print more money. At present, central banks are buying financial assets but not directly funding governments. Before long, however, they may be forced along that sorry path - the same one traveled in the past from Argentina to Zimbabwe. It's not yet the time. But monetising bad debt and devaluing paper money may in the end be the only way of reviving the world's burst-bubble economy.

Global economy to shrink; deflation greatest threat, says UN
The deepening global recession means that the world economy as a whole could shrink next year and will battle to avoid destructive Thirties-style deflation, the United Nations said yesterday. The UN alert over what threatens to be the worst year for the global economy since the Second World War came as fears of deflation were stoked when US producer price inflation slid into negative territory, registering an annual fall of 1.5 per cent last month. In a bleak assessment of world prospects, the UN said that the global economy was now deteriorating at such a pace that its main projections in yesterday’s grim report were already out of date.

Rather than its main published forecast for world growth this year of a meagre 1 per cent, the UN said that its more pessimistic scenario of zero growth, or outright global decline by 0.4 per cent, was now more realistic. Heiner Flassbeck, director of globalisation and development strategies at the UN Conference on Trade and Development (Unctad), said: “There is nothing unfortunately at the moment where we can say ‘this is positive’ or ‘this is giving a positive stimulus’ . . . For the world as a whole, the outcome could be zero, or even slightly below zero [growth]. I do not say this will go on for ever, but the coming months will get extremely tough.”

Mr Flassbeck said that the greatest threat now came from deflation of the sort suffered during the Great Depression, when falls in wages of 10 to 15 per cent in some economies triggered a drastic slump in consumer demand and brought world growth to a virtual standstill. With official interest rates across the West tumbling towards zero, the UN issued a call for coordinated fiscal stimulus packages in countries around the world, such as that being planned by the incoming Obama Administration in the US. The European Central Bank yesterday stepped up its efforts to combat the eurozone recession, cutting interest rates by a further half-point to 2 per cent, equalling previous record lows for the single currency era.

The ECB has now cut rates by 2.25 percentage points since October. Jean-Claude Trichet, the ECB president, signalled that the bank was set to cut eurozone rates still further, but indicated that the next move would probably come in March. “We didn’t say that it was now the limit and we would not move any more,” he said. Anxieties over deflation taking hold were multiplied, meanwhile, by yesterday’s US producer prices figures. The cost of goods leaving factories fell for a fifth month in a row, dropping by 1.9 per cent, or 1.5 per cent down on a year earlier.

Headline US inflation, for consumer prices, is also widely tipped to turn negative in further official figures today. However, these trends still fall short of full-blown deflation of the destructive sort suffered in the Thirties, since they are so far driven almost entirely by the rapid reversal of the past surge in oil prices. These have now plummeted from record highs above $140 a barrel in July last year to reach levels yesterday just above $35. So-called “core” US inflationary pressures, which strip out food and energy costs, remain far higher than headline inflation. Core producer price inflation in December climbed to an annual 4.3 per cent rate in yesterday’s figures, for example.

— The Russian rouble sank to historic lows against the dollar and euro yesterday as a growing threat of recession forced Moscow to further devalue the currency. After the Russian central bank widened the rouble’s permitted trading band for the fourth time in recent months, the currency fell to its lowest levels against the dollar since Russia opened up its economy in the Nineties, allowing the dollar to climb to 32.35 roubles. The euro also hit a record high of 42.55 roubles. The move came with the once-booming Russian economy sliding as demand for its oil and gas slumps.

US to blame for financial crisis, says China
US mistakes are the root cause of the global financial crisis, a senior Chinese central bank official said overnight, rejecting criticism of China's high savings rate and booming trade surplus. "Errors made in US economic policy-making, financial supervision and markets are the ultimate causes of the crisis," said Zhang Jianhua, research head at the People's Bank of China, in an opinion piece carried by the People's Daily. Some observers in the West are blaming China and other nations' high savings rate and trade surplus for fuelling excess consumption and asset bubbles in the United States, he said.

"Such views are ridiculous and irresponsible in the extreme," Mr Zhang wrote in the harshly worded piece in the Communist Party's mouthpiece. China's trade surplus rose by $US39 billion ($59 billion) in December, the second largest monthly growth yet recorded, after exports fell but imports fell even sharper. The figure suggests China's full-year trade surplus was $US295 billion, up about 13 per cent from 2007, rising to a level comparable with the entire economies of Iran or South Africa. The trade surplus was a main factor in boosting China's forex reserves, the world's largest, which stood at $US1.95 trillion at the end of December, up from $US1.91 trillion three months earlier, official data showed.

China spends a large part of its forex reserves buying US debt, keeping interest rates down and creating the conditions for more spending by American consumers, economists have argued. But Mr Zhang said China's forex reserves as well as investment in US Treasury bonds started to grow fast only from 2003 while household savings and the long-term interest rate in the United States have been falling since the 1980s. It was the loose monetary policy, lax supervision and huge fiscal deficit in the United States that caused the financial turmoil, he argued. The big US trade deficit is a result of its own economic structure, according to the article. "Theories that try to shift the responsibility for the crisis to countries with high savings are severely lacking in self-criticism, which is urgently needed if we are to... prevent similar crises," Mr Zhang said.

After US meltdown, the China Syndrome
The China Syndrome was a theory in the twitchy cold-war 1970s that a meltdown in a US nuclear reactor could burn through the floor of its containment building and spread radioactive infection. The hypothetical result was molten material would melt through the Earth to China. Last year saw the US economy encounter its own China Syndrome as plunging financial markets and splintering bank-created derivatives contaminated the real American economy and its counterparts in the developed world. Then, in the closing months of 2008, deteriorating economic data from the world's biggest factory and last bastion of boom-time growth showed contamination had indeed reached China.

This week, fresh figures showed trade falling for the second month in a row, the worst performance since 1999, with exports down 2.4 per cent for December and imports falling 21 per cent. The question that has world markets on tenterhooks is: how bad is this economic China syndrome? As one analyst warned, if it's bad, it may lead the world into depression. "In 2009 it is not the mounting risk of depression in developed economies that will come as a major surprise," Societe General analyst Albert Edwards wrote in a note this week, "it is economic implosion in China and the global and geopolitical risk thereof." So far, he is the worst of the bears. Plenty of others have faith in China's ability to manage the situation, as it did during the Asian economic crisis of 1997-98. The problem is that the rest of the world is triggering problems in China, not the other way around.

Underscoring all of this is the unhealthy trade imbalance that has developed between the US and Chinese economies, with the Asian giant effectively funding America's debt binge. It now holds the world's largest stash of greenback reserves. Even so, with the US embarking on a trillion-dollar stimulus drive, it will still need China to keep helping by buying its bonds and the like. The World Economic Forum, which commences its annual get together in the Swiss town of Davos on January 28, rates a very sharp slowdown in China as one of three key risks to the world economy in 2009, along with the deteriorating fiscal positions of developed countries and the emerging spectre of deflation.

"The decline in export demand has led to a substantial reduction in China's overall economic growth, increasing considerably the risk of a hard landing that would stress the financial system and could generate social tensions within China and beyond as other economies face similar declines," the World Economic Forum's Global Risk Report said this week. The global financial crisis that began in 2007 and entered full poisonous bloom in 2008 has demonstrated that globalisation has inextricably interlinked the world's economies, exploding the myth that Asia has decoupled from the western world. The world's most populated nation and third largest economy now sits squarely in the centre of fading hopes for a swift recovery from economic malaise.

China's notoriously reticent leaders have remained upbeat, reiterating their GDP growth target of 8 per cent for 2009. "Policy implementation and co-ordinated actions are targeted with (an) 8 per cent growth rate, at least for right now," China Reserve Bank governor Zhou Xiaochuan says. This is slower than the revised 13 per cent in 2007 (up from 11.9 per cent in new figures released this week) and 9 per cent for the last quarter of 2008. But only two weeks into the year, signs of uncertainty in the commentary are emerging. "China's economic slowdown reflects weakening external demand for manufactured exports, but also stems from the collapse of the domestic housing market, which has had ripple effects on industries like steel and cement, and indirectly on consumer sentiment," JP Morgan China equities chief Jing Ulrich says.

She notes that the country's macro-economic policy is now fully focused on stimulating the economy and maintaining growth to reach its target amid fears of rising unemployment, which is already a problem in the south of the country. But others are less positive, with some analysts tipping growth in China could fall more sharply -- as low as 5 per cent. This week the Reserve Bank's Zhou cast doubt on the target publicly for the first time. "Most people believe (8 per cent GDP growth for 2009) is a reasonable goal but we know we need to watch the international situation," Zhou said at the Bank of International Settlements conference in Switzerland. "No one really has good enough empirical data to show how to predict (in) the crisis period. There will certainly be risks to both sides.

"This is only a prediction, forecasting data. It's a moderate slowdown. Certainly we will keep a very good vigilance to prevent a sharp slowdown but up to now I think we can see, in comparison with many other countries, it is a moderate slowdown. We still have GDP growth, industrial production growth ... a very small decline in export growth." His comments follow pledges last weekend by Chinese Premier Wen Jiabao -- the country's second in charge -- for further economic stimulus packages to bolster an initial $US586 billion promised at the start of November last year. The World Bank has already pegged back its estimates of Chinese growth to 7.5 per cent last year and the World Economic Forum warns that the consequences could be dire if Chinese growth falls further. "Given the importance of China in terms of its potential to be a source of global growth and given its massive net creditor position, mainly with respect to the US, a slowdown to 6 per cent or below in China's growth rate would have significant impact on the already weak global economy," the World Economic Forum report says.

More worryingly, the crisis of confidence that has gripped the western world now appears to have seeped into China. This week, Hong Kong's South China Morning Post reported that mainland business confidence in the final three months of 2008 fell to an eight-year low. The National Bureau of Statistics said the business confidence index fell 29.2 points in the fourth quarter to 94.6, the lowest reading since the start of 2001 when figures were first issued. Like other economies around the world, China has promised a enormous stimulus package and is slashing interest rates to boost domestic demand to cover falling exports growth, sagging trade figures and a property slump. "Given how quickly things are deteriorating in both countries, with rising unemployment likely to cut further into consumption, I suspect that this isn't the last of the poor export numbers," Peking University's Professor Michael Pettis wrote.

As recently as three months ago, most economists were forecasting export growth of over 15 per cent in 2009, but now most seem to be forecasting a contraction of over 10 per cent. Exports make up only 18 per cent of China's GDP figures -- about the same as Japan -- with net exports contributing about 25 per cent of GDP in recent years. UBS analyst Tao Wang says that focusing on the size of the fiscal stimulus may miss the most important part of the economic picture. "Whether or not the governments package will boost growth in a sustainable way depends crucially on what the rest of the economy would do," he says. "That question for China is whether it will deleverage, and how. "In the last few years China grew rapidly, running a savings-based investment surplus -- its economy reduced leverage as the western world ramped up debt levels. Credit as a share of GDP fell, and profit rose strongly to help the corporate sector to reduce borrowing," Tao says. He now says China needs to increase leverage to sustain growth.

"Without re-leveraging, we do not think China can achieve GDP growth of 7-8 per cent in 2009," Tao says. "Government spending makes up only a little more than 20 per cent of GDP and government investment spending accounts for about 10 per cent of total investment, so non-government borrowing and spending is also crucial." The Chinese are not just using old-fashioned Keynesian fiscal stimuli to help stave off a sharper fall in growth. On December 13 the State Council announced a range of measures to boost investment in the property sector. Further signs that the Chinese property market is in a prolonged slump emerged this week in the shape of ballooning vacancy figures in China's biggest business centre, Shanghai.

"The Grade A office market in Shanghai was riding a roller coaster throughout 2008. Vacancy rate soared from below 5 per cent at the beginning of the year to 15.4 per cent by the end of the year," Albert Lau, managing director with Savills Property Services, Shanghai, told Xinhua news agency. Still, the slowdown in exports and possibility of tighter consumer demand have already seen more than 50,000 businesses in the Pearl River Delta of Guangzhou, Shenzen and Hong Kong shut their doors, sending millions of people looking for new jobs. UBS believes that overall effect across the export and construction sectors could be the loss of up to 15 million jobs in 2009. "Job losses from the export and related sector could reach 10 million in 2009," Mr Tao said. Initial job losses from the construction sector could be more than 5 million, though fewer by the end of the year after infrastructure and housing construction picks up.

Ford confirms credit unit talks with government
Ford Motor Co. on Friday confirmed its credit unit has been in talks with the Treasury Department on ways to help restore liquidity to markets to help spur new financing. "We have been maintaining ongoing dialogue with the government on ideas to help unfreeze the credit markets," the automaker said in a statement. Ford stressed that it is not seeking a bailout for its automotive operations at this time. The company has said it may seek a federal line of credit if its finances worsen more than expected this year. Ford Credit already has taken advantage of the Federal Reserve's Commercial Paper Funding Facility and has sought FDIC approval of its application to establish an industrial loan corporation.

ConocoPhillips to Take $34 Billion Charges, Cut Staff
ConocoPhillips, the third-largest U.S. oil company, said it will write down an estimated $34 billion of previous acquisitions including a stake in OAO Lukoil, and cut 4 percent of its workforce, after energy prices plunged. The company plans to reduce the value of its equity investment in Russia’s Lukoil by $7.3 billion, Houston-based ConocoPhillips said today in a statement. Other asset writedowns totaling $1.3 billion will be recorded. The biggest writedown, a $25.4 billion impairment charge in the oil and gas business, amounts to 87 percent of all the goodwill the company had on its balance sheet as of Sept. 30, according to Bloomberg data. The company plans to report its actual fourth-quarter results Jan. 28.

“It’s a pretty big number,” Jason Gammel, an analyst at Macquarie Securities USA Inc. in New York, said in a telephone interview. “It sounds like they’re writing almost the whole thing off.” ConocoPhillips’s writedown exceeds the $30.2 billion in combined losses incurred by General Motors Corp. and Ford Motor Co. during the first three quarters of 2008, according to data compiled by Bloomberg. In the third quarter of 2007, Detroit-based GM posted a record $39 billion loss after it wrote down the value of future tax benefits. Oil futures in New York have fallen more than $110 since topping $147 a barrel in July, after recessions in some of the world’s largest economies crimped demand for diesel, gasoline, furnace fuel and chemicals.

“We are positioning ourselves in the current business environment to live within our means in order to maintain financial strength,” Chief Executive Officer Jim Mulva said in the statement. ConocoPhillips had about 33,800 workers at the end of 2008, said Becky Johnson, a company spokeswoman. Four percent of the company’s workforce is 1,352 employees. The company also expects to reduce its contractor headcount, Mulva said in the statement. The announcement was made after the close of regular trading on U.S. stock markets. ConocoPhillips fell 40 cents, or 0.8 percent, to $48.98 at 5:44 p.m. in after-hours trading. ConocoPhillips said it will have a 2009 capital expenditure budget of $12.5 billion, 18 percent less than the $15.3 billion authorized for 2008. The new budget includes loans to affiliates and contributions to a venture with Canada’s EnCana Corp. The budget includes about $10.3 billion for exploration and production and some $2 billion for refining and marketing. ConocoPhillips and EnCana are expanding an Illinois refinery to boost Canadian heavy-oil processing.

Irving, Texas-based Exxon Mobil Corp., the world’s largest energy company, plans to increase capital spending by 20 percent this year to about $30 billion, Chief Executive Officer Rex Tillerson said in a Dec. 11 meeting with reporters in Chicago. Chevron Corp., the second-largest U.S. oil company, probably will maintain spending on rigs and refineries at the same $22.9 billion level as 2008, Mickey Driver, a spokesman for the San Ramon, California-based company said on Dec. 1. Chevron plans to formally announce its 2009 budget later this month. ConocoPhillips also said today that the drop in commodity prices will affect its reporting of reserves. Some reserves, primarily in North America and Lukoil’s, will be removed from proved reserves based on prices at the end of the year.

Circuit City to shut down
Bankrupt electronics retailer Circuit City Inc. said Friday it will close its remaining 567 U.S. stores and sell all its merchandise. The company said it has 34,000 employees. "We are extremely disappointed by this outcome," James Marcum, acting CEO for Circuit City, said in a statement. "We were unable to reach an agreement with our creditors and lenders to structure a going-concern transaction in the limited timeframe available, and so this is the only possible path for our company." In a filing with the U.S. Bankruptcy Court for the Eastern District of Virginia, which a judge approved late Friday, Circuit City - the No. 2 electronics retailer after Best Buy - said it had reached an agreement with four companies to start the liquidation process.

The company said the sale would begin Saturday and run until March 31, pending court approval. The retailer's Web site and call center will cease to operate after Jan. 18. Circuit City said employees will receive 60 days' notice of the termination. Employees who are laid off earlier will get pay and benefits for the 60-day period beginning Friday, the retailer said. Those who remain with the company to assist with the liquidation, will receive pay and benefits. Circuit City also operates about 765 retail stores and dealer outlets in Canada. The company said its Canadian operations, which employ 3,000 workers, will continue to operate. The company said it will redeem its gift cards through the liquidation sale, but the cards will have no value once the stores are closed.

"This is very significant. It shows you how bad things are for the retail industry," said George Whalin, president and CEO of Retail Management Consultants. Whalin said management mistakes over the past few years combined with the recession brought down Circuit City. "This company made massive mistakes," he said, citing a decision to get rid of sales people and other mismanagement. What's more, given the credit market freeze, Whalin added that no manufacturer wants to sell to any retailer who doesn't have money to pay for the merchandise. At the same time, Whalin said there's still a very slim chance that one or more firms that have expressed an interest in buying Circuit City could still buy it out of bankruptcy over the next few days. "I wouldn't say it's completely over yet for Circuit City, but it's almost over," Whalin said.

Love Goel, CEO of Growth Ventures Group, a private equity firm focused on retailers, agreed with Whalin. "Circuit City isn't a viable business in its old incarnation when half of electronics sales have moved online," Goel said. "CompUSA and Tweeter also didn't make it for the same reason," referring to two stores forced to close most or all of their locations. However, Goel speculated that Circuit City could still find a lifeline if Golden Gate Capital, one of the reported lead bidders for the merchant, bought the company and restructured it primarily as an online business with very few physical stores. "This would eliminate overhead costs, vendor conflicts and other issues," he said. "Circuit City has an almost $1 billion online business. So there is a future for it in that regard." NPD Group's retail analyst Marshal Cohen warned that no retailer is "sacred" in this environment unless "you have a service model that differentiates you from the competition and keeps pace with changing needs of the consumer."

He said Circuit City was late to the game with its Firedog customer service business, and it didn't resonate with customers as well as Best Buy's Geek Squad was business. What's more, Cohen said Circuit City found itself in the unfortunate position of becoming the "monkey in the middle" as Wal-Mart aggressively moved into the electronics market with its low prices model, and Best Buy continued to widen the gap with its competitors and dominate as the industry leader. "Circuit City just got stuck in the middle for too long," said Cohen

Germans Full of Angst about the Future
Germans are more worried about the future than their European neighbors, reveals the latest Eurobarometer survey. But they seem to be more optimistic about the European Union, with 64 percent saying membership is a good thing for Germany. The Germans have a reputation of being an angst-ridden nation. No matter how much prosperity they enjoy, so the stereotype goes, the Germans are still more worried about the future than their European neighbors. Now a new European Union-wide survey has confirmed that the stereotype does have some basis in reality. According to the latest Eurobarometer survey for Germany, seen by SPIEGEL ONLINE ahead of publication, 57 percent of German citizens believe the economic situation in their own country will get worse, compared to 51 percent of Europeans as a whole. Regarding the economic prospects for the European Union, 47 percent of Germans believe the situation will worsen. Forty-one percent of Europeans as a whole share their view.

Germans' expressed pronounced pessimism despite the fact that the survey was carried out at a time when the global financial and economic crisis was only just beginning to affect Germany -- the poll was conducted between Oct. 6 and Nov. 6 last year. A total of 1,526 Germans and 26,618 EU citizens in the bloc's 27 member countries were surveyed. The latest results show that Germans are not, however, plagued merely by concern about the current economic situation. In response to the question "Will the lives of today's children be harder than those of your own generation?", 73 percent of Germans answered yes, compared to just 62 percent of Europeans as a whole. But even if the Germans are more fearful than other Europeans, they are also happier with their lot: 85 percent said they were satisfied with their lives, compared to the European average of 76 percent. The survey also reveals that Germans are more likely to trust their own system than the average European: 38 percent of German respondents feel that things are moving in the right direction in Germany, compared to only 28 percent in Europe. Germans are also more likely to believe that the European Union is moving in the right direction (41 compared to 35 percent).

European Commission Vice President Günter Verheugen welcomed the German results. "For me, the survey shows that the majority of Germans understand that no country needs the European Union more than Germany and that no other country has benefited more, both politically and economically, from European integration than Germany," Verheugen, who is German himself, told SPIEGEL ONLINE. The confidence of the Germans in the EU is also reflected in other questions. Some 47 percent of German citizens believe that the European Union will protect them from the negative effects of globalization, compared to only 43 percent of Europeans as a whole. According to the Eurobarometer survey, the EU enjoys high approval ratings in Germany, with 64 percent of Germans believing that membership of the bloc is a good thing, 11 percentage points more than the EU average of 53 percent.

European Commissioner Verheugen sees this as a positive sign. He feels that Germany has a special responsibility for Europe because of its history and because of its role as the largest and economically strongest member state. "It is good that the Germans themselves see things this way," said Verheugen. However, German enthusiasm for the European project does have its limits. The Germans are not so keen on EU enlargement, with only 26 percent supporting the admission of new member states, compared to 44 percent of Europeans. The Eurobarometer survey was first conducted in 1973. Since 1978, it has been used by the European Commission to track public opinion in the member states. The survey includes both standard questions and questions on topics of current concern.

Dutch government support package
The Dutch cabinet is to implement a new series of measures totalling 1.5 billion euros in order to strengthen the economy, finance minister Wouter Bos has announced. This latest stimulus package consists of government guarantees to large businesses, support for hospitals and the housing market and an export credit insurance. "We are now taking measures which affect the heart of the economy," Bos said. He said the measures are necessary, as the current credit crisis means that companies have difficulties in gaining acess to credit.

So far the Dutch government has stepped in by nationalising the Dutch operations of Fortis and ABN Amro banks and offering a 20 billion euro emergency fund for financial institutions facing difficulties, such as ING, Aegon and SNS Reaal. In November it presented a 6 billion euro package of measures to stimulate the economy with the re-introduction of accelerated write-offs on investments for businesses, an extension of the shorter working scheme (wtv), extra tax deductions on investments and better loan guarantees for smaller firms. In response to criticism that the government is not doing enough Bos said: "The Netherlands has taken measures to support the financial sector which amount to about 15 percent of the gross national product, which is 80 to 90 billion euros". Bos said consumers and businesses will benefit, in addition to banks.

Obama Adviser Urges More Rigorous Global Financial Regulation
A top economic adviser to the incoming Obama administration unveiled a plan Thursday to radically rethink the global financial system, including measures that would dramatically expand government control over banking and investment in the United States. The report -- which recommends limiting the size of banks, monitoring executive pay and regulating hedge funds -- offers the first hint of the kind of change to the financial system that President-elect Barack Obama may push for in coming months.

Obama has pledged to present a package of reforms to prevent another round of the financial crisis that began in the United States, ahead of a summit of world leaders in London this April. Observers saw in Thursday's report potential building blocks of Obama's plan. Although issued by the Group of 30 -- an organization of international economists and financial policymakers -- its lead author is Paul Volcker, the chairman of the Federal Reserve during the Carter and Reagan administrations who will serve as a special adviser to the Obama White House. Part of Volcker's role is to help mastermind what could become the biggest overhaul of the U.S. financial system in decades.

"I think this is a clear sign that the new administration is going to push for a major overhaul, for major structural reforms of the regulatory system," said Steven Schrage, the Scholl Chair in International Business at the Center for Strategic and International Studies. "Having this highly esteemed group backing that proposal is going to put pressure to present those changes before [the] April summit." The report's recommendations may find support among those in the United States and Europe who have called for tighter regulation over the financial system in the wake of the current economic crisis. But elements of the plan were already opposed Thursday by some in the financial industry, where some worry that the push for tighter government regulation may go too far.

The report offered 18 recommendations that would insert government regulators into the boardrooms of financial institutions as never before. The plan calls for vastly increased oversight of major banks, going as far as to recommend the end of an era of mega banks whose size makes their failure potentially catastrophic to the global financial system. To limit their size and scope, banks, the document states, should be prohibited from managing private-equity or hedge funds. And deposits should not be concentrated in the hands of too few banks. "Keep them small, so that any failure won't have systematic importance," Volcker said at a news conference.

Money-market mutual funds that offer services similar to banks, including dollar-for-dollar withdrawal at any time, should be subjected to increased government oversight, the report said. Currently, most do not operate that way. But those bank-like mutual funds that want to avoid tighter regulation should sell relatively safe financial instruments and clearly state to customers that the value of their funds may or may not remain stable. The proposal suggests that the U.S. government should clarify the status of mortgage giants Fannie Mae and Freddie Mac, either making them government agencies or regulating them as independent mortgage brokers. Credit-rating agencies would also be subjected to greater scrutiny. Volcker said he would press the new administration to consider the measures, saying major changes are imperative because the financial system is "broken." "It's a four-letter word," he said. "It's a mess."

Elements of the plan -- such as imposing regulation on hedge funds -- echo calls for closer supervision made by policymakers in the United States and abroad in past months. But Thursday's report was more specific and aggressive in imposing government restrictions on the financial system than a broad outline of changes agreed to by the Bush administration during a meeting of leaders representing the Group of 20 economic powers in Washington last November. The Obama administration is expected to work closely with key congressional leaders including Rep.  Barney Frank (D-Mass) on legislation that could restructure existing regulatory agencies and impose new guidelines on U.S. financial institutions. The scope of Volcker's proposal, analysts say, suggests that Obama's plan may contain highly ambitious reforms.

Although financial industry officials concede that more regulation is likely needed to prevent a repeat of the current crisis, they also said that some of the measures in the report appeared to go too far. For instance, they opposed the suggestion that banks limit their deposits and size. "You want to apply the appropriate amount of regulation to address the concern that this kind of crisis never happens again," said Scott Talbott, senior vice president of government affairs for Financial Services Roundtable, which represents the largest financial institutions in the United States. "But at the same time, you don't want to stifle innovation, creativity or the allocation of resources to take appropriate risks."

Although the report calls for global reform, it acknowledged charges that flaws in the U.S. financial system were to blame for starting the current global economic crisis. Thusly, it noted that "several of the issues and recommendations have a direct U.S. focus." The report renewed calls for greater international cooperation on regulation, and new laws to oversee exotic financial derivatives, made during the November summit in Washington. With cautious support by President Bush, plans are moving forward, for instance, to enhance international cooperation in overseeing major banks through the Financial Stability Forum in Switzerland. But European leaders have eagerly awaited a signal from Obama on his ideas for new rules for the global financial system.

It is unclear how many of the recommendations will make their way into Obama's final plan, but the report could lift the spirits of Europeans who have called for tighter government oversight on executives' pay and risk management in financial institutions -- an area where the Bush administration has offered tepid support. The report urges the government to enforce systematic board reviews of executive pay as well as new guidelines to measure the level of risk a firm is taking with exotic investments.

Ambac, MBIA Eye TARP
With Congress releasing the next $350 billion of funding for the Troubled Asset Relief Program at the request the Bush administration and the incoming Obama administration, bond insurers Ambac Financial Group Inc. and MBIA Inc. are hoping their efforts to get a piece of the pie pay off. Working with regulators and lobbyists, Ambac has asked the government for a $1.5 billion capital injection through preferred equity that it would use to recapitalize muni-only insurer Everspan Financial Guaranty Corp. - the old Connie Lee Insurance Co. But given the difficulties the companies have had, critics - including the insurers' healthier competitor, Assured Guaranty Corp. - say equity injections would be inappropriate.

Ambac executives say that along with $500 million put in by their firm, a $2 billion insurance company could support between $25 billion and $30 billion in public finance issuance its first year. "By putting it into Everspan, Ambac's muni-only guarantor, you're assured that 100% of the money that goes in is going to help the municipal market," Everspan chief executive officer Douglas Renfield-Miller said. But Assured has told federal officials that the companies don't deserve the equity injection they're asking for. The company says using the capital purchase program to aid the monolines is not in line with Treasury's objectives. "It's not clear that additional equity would address investors' lack of confidence in these companies, given that they continue to have significant exposures to troubled asset classes," it said.

"We don't think it's appropriate for CPP money to be made available to bond insurers because it's contrary to what the program is intended to do: provide otherwise healthy companies with the liquidity and funding so that they can make loans," Assured Guaranty president Michael Schozer said. "It's not there to resuscitate companies who are financially impaired, which is the situation in our industry." What both sides can agree is that the market demands credit enhancement. Insurance penetration fell to 18.4% in 2008 from 46.8% in 2007 as insurers were downgraded, a number below investment grade. But Assured said that the market has responded well to the troubles at the bond insurers. Other providers credit enhancement have stepped up - letters of credit use increased 240.2% in 2008 - and companies such as Berkshire Hathaway Assurance Co. and Municipal and Infrastructure Assurance Corp., co-sponsored by the Macquarie Group and Citadel Investment Group, have entered the market.

Others, though, say letters of credit are not a perfect substitute for bond insurance. And Berkshire has maintained a low profile in the market, while MIAC is not yet rated and writing business. Further, Ambac executives said that although the company expects a municipal-only insurer could achieve steady returns in the "low teens," the time required to earn them could deter private equity firms from starting a new insurer. "You can't readily extract capital it once it goes in, as Blackstone learned with [Financial Guaranty Insurance Co.]," Renfield-Miller said. "It also takes a very long time to really build up returns, because the capital must all go in up front while the portfolio builds gradually over time. Once the book is built up it's a great business, but it takes five to seven years to achieve this steady state."

Ambac has for months planned to recapitalize Everspan. It wanted to begin writing business as early as Oct. 1, but delayed an $850 million injection into the company when Standard & Poor's placed Ambac Assurance Corp. - now rated Baa1 by Moody's Investors Service and A by Standard & Poor's - on review for downgrade in September. Ambac has worked in a coordinated effort with MBIA and insurance regulators from New York and Wisconsin, where the two insurers are based, to ask federal officials for assistance. Everspan would leverage the public finance experience at Ambac, executives say. The company will have about 40 to 45 employees, including the origination and underwriting team from Ambac along with certain risk management and general management staff. Everspan will also have access to Ambac's 60 to 70 person surveillance team through an arms-length service contract, much like it will have for accounting and other functions.

Everspan is taking steps to convince investors and rating agencies that it will have independence from Ambac. Its risk management team has brought in people outside the financial guaranty industry to provide a new perspective, including chief risk officer Judy Slotkin from Citigroup. Its board will also have a majority of independent directors, primarily drawn from the public sector, with super-majority decisions needed. In addition to giving investors the assurance of the timely payment of interest and principal, bond insurance has helped provide liquidity to the market. With the economic downturn putting pressure on municipal issuers, the guarantee of bond insurance and the extra set of eyes it provides could attract investors, executives said.

Ambac believes Everspan - which already has licenses in 49 states as Connie Lee - could be up and running within 30 to 45 days of receiving TARP money. Everspan is a separate muni-only insurer beneath Ambac Assurance in the corporate structure, and profits would benefit existing Ambac policyholders before accruing to shareholders. "Market has higher risk than it did a while ago, so we think this is great timing," Renfield-Miller said. "The need for a financial guarantor is probably greater than it's been in a very long time." It's not yet clear, though, whether investors will actually accept a new insurer linked to Ambac in any way. Even on debt backed by Assured and FSA - which trades at premiums - investors are taking a closer look at the underlying credits, market participants said. "Retail loves insurance, but more and more retail is getting accustomed to the concept of focusing on underlying ratings and ignoring insurance," said Janney Montgomery Scott LLC fixed-income strategist Guy LeBas. "It's one they've sort of been burned once [by the insurers], and don't want to go back."

Ambac is trying to generate demand for Everspan guarantees. It has held more than 50 face-to-face meetings with investors to convince rating agencies there is an interest. It plans to increase its marketing efforts and offer "real-time accountability" through transparency efforts, such as posting its entire book of business online. "Investors are naturally cautious; however, they also said if Everspan's a highly rated and stable financial guarantor, yes, they'd certainly look at it," Renfield-Miller said. "At the end of the meetings, they said we're rooting for you, we need capacity." But some say the federal government has better options for using the TARP money in the guarantee space. Matt Fabian of Municipal Market Advisors said the current market needs bond insurance, but that Treasury or Federal Reserve would be taking risks by propping up the "out-of-favor" monolines.

By giving money to MBIA and Ambac, the federal government risks that their credit profiles continue to deteriorate, he said. In addition, the companies face credibility problems, and it's unclear investors would be interested in the paper minus a complete federal guarantee, Fabian said. He added that helping the existing monolines would also undermine healthy competitors and deter new companies from entering. A report recently released by an industry commission convened by the National League of Cities suggested that local issuers investigate starting their own national mutually owned credit enhancer. Oklahoma Treasurer Scott Meacham wrote in a letter the governor that the state should consider creating its own guarantee fund, modeled after the Texas Permanent School fund. In a hearing with the House Financial Services Committee, Federal Reserve vice chairman Donald Kohn told representatives who had asked him about aiding the downgraded insurers that it was one option for helping the municipal market, but he didn't "know that that particular way is the best way."

House Financial Services Committee chairman Barney Frank and Rep. Gerald Connolly, D-Va., earlier this week suggested the federal government provide some form of credit enhancement. Connolly said the government could directly provide the credit enhancement or form a national insurer. LeBas said aiding Ambac or MBIA would not fit with what the federal government's TARP plans. He said his firm puts a low probability on a recapitalization because any systemic damage that has occurred because of problems at the firms has already happened. It appears as though the firm has too damaged a name to write new business, even through a new muni-only subsidiary, LeBas said. "So at this point it's kind of throwing money at something that will help the companies, it would help the customers, but it doesn't really help the financial system or the economy," he said. "And clearly the government's motivation is to do just that."

Others avenues of support could include splitting off the guarantees on toxic assets with enough capital to placate bank counterparties and then recapitalizing the existing public finance book, supporting current policyholders, and, ideally, new public finance business. The insurers' regulators say they could support some form of support to the bond insurers that way. New York insurance commissioner Eric Dinallo said the insurers already have the expertise to write new business and that helping them would aid all tax-exempt credits, rather than just local municipalities. "Of all of the proposals I've heard, I think it offers the biggest bang for the buck," Dinallo said. "For several billion dollars, you could have two underwriters back in the market at triple-A doing wraps for all these municipalities that are trying to get off the ground. And that's remarkable and could have a huge impact on helping unthaw the credit freeze."

If Ambac does not get TARP money, it still plans to capitalize Everspan, albeit it with less capital. It believes it can survive, but thinks it can better service the municipal market with the money. "We are a viable institution with or without the TARP money, but we would be a lot more effective with the TARP money," said senior managing director Diana Adams, who has led the efforts in Washington.

Community Colleges Get Squeezed
These should be good times for Monroe Community College in Rochester, N.Y. While enrollment at a number of other colleges is rising marginally, Monroe's enrollment rose a school-record 3.6% this year, to 18,210 students. But given the sour state of the economy, this blessing is fast becoming a curse. On Dec. 16, New York Governor David Patterson recommended cutting the state's contributions to higher education, including an 11.2% reduction in state funding to Monroe, as part of his recently proposed budget. Juggling record growth and steep cuts in state resources is no easy task for Monroe's interim president, Larry W. Tyree, who took the office in September. "We know we have a mission to serve students who might not have alternatives other than Monroe Community College," he says. "How are we going to do it in light of these revenue shortfalls? I don't have a crystal ball to answer that."

Tyree's problem is not unique. The rapid growth in enrollment in community colleges nationwide will only be exacerbated by the current economic crisis, which is pushing hordes of new students to community colleges. With many states cutting back on funding, schools like Monroe are struggling to keep up. A recent study by the Delta Cost Project, a group that monitors income and spending habits at colleges and universities, indicates that enrollment at community colleges is on the rise while their revenues, mainly from state governments, are dwindling. Despite a 6.1% growth in enrollment for the period 2002 to 2006 at community colleges, spending per student fell 5.9%. During the same period, public universities were able to increase spending per student by 2.9%. "These schools are really stretched to the limit," says Jane Wellman, executive director of the Delta Cost Project.

Community colleges are not only being fed by a new wave of high school graduates, more eager than those of their parents' generation to earn a degree, but by transfers from universities where rising tuition, coupled with a recession that is crippling many parents' ability to pay, is pushing many to find more affordable alternatives. Tyree says the state of the economy is largely, if not entirely, responsible for the 15.1% increase in transfer students Monroe saw in the fall of 2008. This influx of new students makes the cuts in state spending on community colleges all the more harmful. Making matters worse is the general inability of community colleges to attract the endowments or other private funding that most major public and private colleges and universities can fall back on during hard times.

Tyree describes private revenues at Monroe as "minuscule," and Wellman notes that this is a common trait among community colleges. According to the Delta Cost Project study, as of 2006, private funding accounted for $268 of revenue per student in community colleges, whereas in public research universities it accounted for $2,208 per student and private research universities drew $37,755 in revenue per student. "There's almost no private money in community colleges," says Wellman. "The institutions themselves and state governments are both going to have to step up." Because of the lack of significant funding from private donors, community colleges tend to lean heavily on tuition fees and state government subsidies.

Tuition hikes can't be pushed too far because high fees can alienate the low-income students that community colleges work so hard to attract. Tyree does concede that tuition increases are unavoidable, and that Monroe's current $2,900 tuition will likely jump 10% in the fall of 2009. "One of the hallmarks of community colleges is to maintain accessibility," he says. "Every time we think about increasing tuition fees, we ask ourselves, are we pricing some of our potential students out of our market?" Budget cuts would help alleviate some of the financial tension, but they come at a price. Administrators at large and small schools alike are wary of cutting any programs or amenities that serve their students. All feel obligated to maintain their faculty and key educational programs, but on-campus facilities and student services will likely suffer.

Tyree notes that to combat the economic woes, Monroe has left 18 staff positions unfilled, and the school's technology budget has been cut in half, but he is adamant about not cutting faculty. Though with an impeding state budget cut coupled with pressure to keep tuition low, he and other community college administrators like him may face tough choices. "Painful decisions are going to have to be made," says Robert H. Atwell, president emeritus of the American Council on Education. "They're going to have to cut back."

Big US Firms Deepen Job, Wage Cuts
Strapped U.S. companies, while continuing to slash their work forces, are deploying a once-rare tool to trim labor costs -- pay cuts. On Friday, microchip maker Advanced Micro Devices Inc. in Sunnyvale, Calif., said it would temporarily cut pay between 5% and 20% for workers and executives. The chip maker also said it would eliminate 1,100 positions. That news was part of yet another round of large job cuts by big-name businesses. ConocoPhillips said Friday it would lay off 4% of its work force -- about 1,350 workers -- in the largest hit to the job market to date from plunging oil prices. Pfizer Inc. is planning to lay off a third of its sales force, as many as 2,400 positions, according to a person familiar with the situation. The announcement came days after the pharmaceutical giant cut some 800 research jobs. Car rental firm Hertz Corp., a subsidiary of Hertz Global Holdings Inc., will cut 4,000 positions, and Insurer WellPoint Inc. announced 1,500 layoffs.

Electronics retailer Circuit City confirmed Friday its plans to liquidate, putting more than 30,000 jobs in jeopardy -- potentially one of the largest single blows to the labor force so far in the recession. In addition to layoffs, companies are increasingly trimming wages, a tactic economic historians said hasn't been wielded broadly since the Great Depression. Heavy equipment maker Caterpillar Inc. announced in late December it would cut executive pay by half, and many salaried employees would see cuts of as much as 15%. Hutchinson Technology, a Hutchinson, Minn., maker of disk drive components, cut salaries 5% for employees who remained after a round of layoffs concluded this week. In Galveston, Texas, police and firefighters unions agreed to a 3% pay cut as the city grapples with the recession and the aftermath of Hurricane Ike.

The Federal Reserve reported this week in its survey of economic activity that companies around the U.S. are considering freezing or cutting pay. The Fed's survey of 12 districts, known as the Beige Book, cited examples in the Boston, Chicago and San Francisco regions. In a recent poll by human-resources consulting firm Watson Wyatt, 5% of 117 companies surveyed said they had reduced salaries to cope with the recession; 6% plan to do so in the next year. Meanwhile, 7% of 805 small businesses surveyed recently by the National Federation of Independent Business said they had reduced salaries. The percentage of companies cutting salaries has never been higher than 4% since the survey began in 1973, said William Dunkelberg, chief economist for the NFIB. Wage pressures are mounting as U.S. consumers are finding some relief in falling prices.

The Labor Department reported Friday that consumer prices inched up 0.1% in 2008, compared to about 4% a year earlier. That represents the slowest pace in a half-century. It also points to especially steep price declines over the past few months since prices, especially of oil and other commodities, soared mid-year before falling. Energy prices dropped 8.3% in December alone, the fifth-straight monthly fall, as crude-oil prices have slumped about 75% since July. But falling prices bring their own troubles, as employers make up for revenue declines by trimming wages. Employers in recessionary times always feel compelled to squeeze more from less. But with the job market so weak, employees appear more willing to work for less pay than leave behind pensions and health care coverage to brave the worst job market in a generation. For companies with a unionized labor force, the very real prospect of bankruptcy has eroded much of the remaining power of collective bargaining.

Trucking firm YRC Worldwide recently negotiated a 10% pay cut with drivers represented by the International Brotherhood of Teamsters, as well as pay cuts for non-union employees. After layoffs over the past year that have reduced the work force by 15%, the firm is now looking to cut costs without reducing employees. "It's forced people to look at things differently than they have in the past," said Bill Zollars, chief executive of the trucking firm. "We've kind of cut down to the bone because of the severity of the economy downturn." Jim Price, a Yellow truck driver from Sewell, N.J., recently saw his pay fall 10% to $20.45 an hour, part of the concessions his union made to YRC. Mr. Price, who voted against the pay cut, said the cut will reduce his check by about $100 a week. He anticipated stripping his household budget of such extras as the occasional baseball game or dinner out with his wife. "It's kind of a kick in the teeth," he said.

What's making it easier for employers to cut wages -- and for workers to accept them -- is that jobs are getting harder to find. Production at the nation's factories, utilities and mines fell by 2% in December from the previous month, the Federal Reserve said Friday. Manufacturing production fell 2.3% and was down just under 10% from December 2007 -- the worst yearly drop since 1975. Manufacturers are using just 70.2% of their current capacity, as of December, suggesting further plant closings, lay-offs and other cost-cutting measures in the coming months. Small businesses also are resorting to cutting wages. Sarah McGee, owner of Visual Changes Salon and Spa, in Ellicott City, Md., has seen sales fall 10% from the summer, as their customers stretch out hair appointments and do their nails at home.

Labor represents about half of Ms. McGee's costs, so she recently cut wages for two of her nine employees. A nail technician's wage fell to $9 an hour from $10; another who performs facials and body waxing fell to $14 an hour from $17. Ms. McGee said employees had the choice of working fewer hours at their old rates, but they favored a pay cut, anticipating more tips and a chance to build their client base. "We need to have the employees," she said, "but we also have to be able to pay the bills." While average wages are still on the rise nationally, wage cuts have become an instant way for companies to save cash at a time of tight credit. The last time the U.S. had widespread wage cuts was during the Great Depression, when benefits were a smaller slice of overall compensation. Manufacturing production workers saw their wages fall 10 cents to 49 cents an hour between 1929 and 1933, which would be a fall from about $29 an hour to $18 an hour in today's dollars, according to the Historical Statistics of the United States. "In general, since the Great Depression you haven't seen nominal wage cuts," says Price Fishback, an economic historian at the University of Arizona.

Today, most employees are not in a position to argue. The U.S. shed almost two million jobs in the last four months of 2008, with most sectors losing ground. The rate at which employees quit their jobs has also been falling, indicating that workers are finding fewer opportunities. The quit rate was 1.4% in November, compared with 1.8% a year earlier, according to the Bureau of Labor Statistics. With the quit rate so low, companies are less worried about losing their best workers. Kulicke & Soffa Industries Inc., a Fort Washington, Pa. designer and manufacturer of semiconductor equipment, laid off about 240 employees last year as demand dropped for its line of wire-bonding equipment. The company has since announced more layoffs, and also instituted a 10% wage cut for salaried employees. Executive salaries were cut between 15% and 20%.

C. Scott Kulicke, the company's chief executive, said some employees told managers they would prefer pay cuts over a deeper round of layoffs. The recession is bad enough that Mr. Kulicke isn't as worried about the company's hard-to-train engineers leaving for another job. "You're balancing cost-cutting against retention issues," said Mr. Kulicke. But when everyone seems to be cutting jobs, he said, he is less worried about losing top employees. Other companies are resorting to measures just shy of wage cuts and layoffs. On Wednesday, Gannett Co . Inc, the largest U.S. newspaper publisher, said it would force workers to schedule a week off without pay.

New York Fed Nears Pick
William Dudley, who runs the markets desk at the Federal Reserve Bank of New York, is the likely front-runner to become next president of the bank after another leading candidate for the job, Fed governor Kevin Warsh, withdrew from the race. It wasn't immediately clear why Mr. Warsh fell out of the running so late in the interview process. People familiar with the search had seen him as a leading candidate. New York Fed board members interviewed several candidates for the job last Saturday and have met again this week. Once they make a final choice, the Federal Reserve Board in Washington needs to sign off on the decision, which it is expected to do quickly. The process has been slowed by the uncertain status of outgoing New York Fed president, Timothy Geithner.

Mr. Dudley has helped to design and implement many of the new facilities that the Fed has launched in recent months, giving him an intimate inside knowledge of the changes the institution has gone through and the problems plaguing markets. He is a career economist, who spent a long stint as the chief U.S. economist for Goldman Sachs and who earned a PhD in economics at the University of California at Berkeley. Mr. Warsh, a Fed governor, has been deeply involved in many of the key decisions the Fed has made in handling the crisis in the past year and a half. A person familiar with the matter said he withdrew. At 38, he was viewed by some on Wall Street as too inexperienced for the job. But Mr. Warsh has impressed officials at the Fed and is close to the chairman of the New York Fed's board, Stephen Friedman.

One outsider who has been interviewed by the board is Paul Calello, the chief executive of Credit Suisse's investment bank. The Swiss bank has been hit less hard by the financial crisis, which made Mr. Calello a potentially appealing candidate. Fed officials also have looked closely at Terrence Checki, head of the New York Fed's international affairs group, and David McCormick, Treasury undersecretary for international affairs.

Japanese Machinery Orders Dive
Japanese machinery orders fell at their fastest rate on record in November as the global slowdown severely curbed manufacturers' spending -- the latest indication that the nation's economy weakened in the final months of 2008. Data released Thursday by the Cabinet Office showed that core private-sector machinery orders dropped a seasonally adjusted 16.2% in November from the previous month to 754.2 billion yen ($8.47 billion). The decline in core orders -- which don't include often-volatile orders from electric-power companies -- was the largest since April 1987 when comparable data were first made available, a Cabinet Office official said.

The latest figure marked the second consecutive month of decline following October's 4.4% decrease. Japanese exports and industrial production also posted the worst drops on record in November. The grim numbers prompted a number of economists to cut their growth forecasts for Japan's export-dependent economy. Some say the economy may have shrunk by double-digit numbers on an annualized basis during the October-December quarter, compared with a decline of 1.8% during the July-September period. Thursday's data darkened the outlook for Japan's economy in early 2009 because machinery orders are seen as a reliable gauge of future business investment. The decline in machinery orders was more than double the 7.5% drop expected by economists surveyed by Dow Jones Newswires and the Nikkei.

A record 33.2% drop in manufacturers' orders was behind the weak demand for machinery. Investors responded to the data by selling Tokyo stocks and buying safe-haven Japanese government bonds. The benchmark Nikkei 225 Stock Average fell 4.9% to 8,023.31. Data released by the Bank of Japan reinforced worries of a return to deflation -- a period of declining prices that hurts corporate profits and causes consumers to delay spending. The central bank said prices of domestically produced goods traded among Japanese firms rose 1.1% in December on falling costs of imported oil and raw materials. That was the slowest pace since May 2004 and well behind the 2.8% gain in November. The figure also marked the 58th straight month of increases.

Declines in natural-resource costs might initially appear to be good news for Japan, which isn't rich in energy sources. However, the drops don't necessarily benefit the country's economy because cheaper energy costs mirror deteriorating global demand, economists said. "The chances are high that deflationary pressure will grow in Japan," said Hirokata Kusaba, a senior economist at Mizuho Research Institute.

The trick is confidence
Say what you like about Sol Trujillo's globe-trotting ways, and plenty of people do, they give the Telstra chief executive a unique perspective on the state of the world. While most people's experience of the global financial crisis is confined to their homeland, which may or may not be in recession, and what they can pick up from the media, Trujillo has seen its effects first-hand on his travels through Australia, the US, Europe and Asia. And the word that comes most to mind is sombre. In the past few months, he says, there is no doubt a sense of dread has spread from the financial epicentres of Wall Street in New York and The City in London.

He felt it on his trip to the US last week, particularly in the once high-growth states such as Arizona and California, where real estate prices are tumbling and unemployment rising. He felt it in Britain and wider Europe, where he fears government action to stimulate the economy is not as comprehensive or co-ordinated as in the US. Last month he felt it in China, where he has more confidence in Beijing's vast stimulus package. "It's not just Wall Street and people in major metro (centres)," he tells Inquirer. "It's mainstream." ANZ chief executive Mike Smith is also well placed to comment. British-born and Melbourne-based, he travels frequently through ANZ's expanding Asian operations, maintains close ties to Europe (he had a brief break in France during Christmas) and is in constant touch with associates in the US. For Smith, the present crisis is not exactly the recession we had to have but "the adjustment that had to happen".

Wall Street and London, he agrees, remain "very gloomy places" as job cuts and restructuring continue to rip through the banking sector. There is no doubt that the US economy, the key to the world's fortunes in the coming year, faces very significant challenges, and continental Europe looks like entering a prolonged downturn. But, he says, there are signs of hope, particularly in Asia and Australia. In any event, the current round of pain should be viewed as a return to normal in the financial world after 15 years of "great times" that sent market valuations to crazy, unsustainable levels. "It's going to be rocky, there's no doubt about it," Smith says. "But I think this is more of a normalisation than anything else. We are going through an adjustment, but good companies will still succeed and bad companies will go under."

Talk to economists and business leaders and the prognosis for the coming year is, to say the least, uncertain. But there is a grim consensus building: the last quarter of 2008 was among the worst on record worldwide and this quarter will be little better. The US, Europe, Britain and Japan are already in recession; the global economy will grow at less than the 2 per cent rate the International Monetary Fund considers the benchmark under which recessionary conditions exist and any recovery will not start until later this year at the earliest. Governments will certainly be called on to do more to stimulate their enfeebled economies. We haven't seen the last of the corporate asset write-downs by a long shot, bruised stock market investors and superannuants face another anxious year and the myth that a "decoupled" China would protect Australia from the rot has been busted.

In fact, Australia may only just avoid falling into recession. In basic terms, the key to the coming year is whether the trillions of dollars thrown around by governments to stabilise the financial system and stimulate spending will be enough to shield the real economy, that is, households, investors and businesses, from the crisis that grew out of the collapse of the sub-prime, or low-quality, mortgage market in the US in mid-2007. Trujillo says the painful lesson the world has learned in the past year is that "we truly are in a global economy". "We are at a point in time, globally and economically, where finger-pointing is no longer productive but it's rapid learning, rapid co-ordination and the alignment of currencies, policies ... and other things that become more critical," he says.

Westpac managing director of economics and research Bill Evans warns, however, "It may be that no policy response is effective in warding off the powerful negative forces emanating from collapsing wealth, dismal confidence, shrinking liquidity and the evaporation of foreign capital." For 18 months the world has watched as a spike in defaults among overextended American homeowners morphed first into a credit crunch and then into a global systemic crisis that left banks, companies and households gasping for capital. The impact on the financial system has been horrific, with banks (even countries) failing, Wall Street suffering its worst year since the 1929 crash that ushered in the Great Depression and an unfathomable $US30 trillion ($44.4 trillion), more than 40 times the annual value of the Australian economy, wiped off global stock markets. Westpac estimates that Australian household wealth fell by close to 10 per cent last year.

Governments across the world have moved, with varying degrees of alacrity, to stem the damage. Interest rates, which just months ago were being held high to tackle inflation, have been slashed to record lows, often in swingeing cuts of 100 basis points. Trillions of dollars have been spent propping up or nationalising failed institutions, boosting liquidity in frozen debt markets, buying toxic assets off bank balance sheets, guaranteeing bank debt and lining consumers' pockets to stimulate faltering economies. In retrospect, however, there was no way that the real economy - main street to Americans - was going to be shielded from the carnage. For the fourth time since the early 1970s, the world is entering a global recession. But with most advanced economies simultaneously in recession for the first time since World War II, this one is shaping up as a bad one. The danger is that the world economy, just 12 months after confronting an inflationary threat as energy and food prices soared, will enter a deflationary spiral.

A recession is defined as two consecutive negative quarters of economic growth, a fall in real gross domestic product. Even a modest fall of 0.1 percentage points each quarter can have dire consequences for an economy. A depression, on the other hand, is an economic slump of 10 percentage points or an economic contraction that lasts three years or more. For now, at least, it appears the world is not entering another Great Depression. Another definition of a recession, according to ANZ chief economist Saul Eslake, is a spike in unemployment of at least 1.5 percentage points in 12 months or less. This is where Australia may get caught, with many economists predicting the jobless rate will rise from 4.5 per cent to 6 per cent by the end of the year. In any event, the not-very-funny joke in financial circles is that even if Australia avoids a technical recession, it will still feel like one. (A recent paper by Eslake recalls another joke used by Ronald Reagan in the 1980 US presidential campaign: "A recession is when your neighbour loses his job; a depression is when you lose yours.")

The problem, says commonwealth bank chief economist Michael Blythe, is that recessions preceded by a period of financial distress are typically larger and longer than normal recessions. "The type of financial stress also matters," Blythe says. "Recessions related with banking system stress are typically more painful than those following periods of securities markets or foreign exchange markets stress." The latest forecast from the IMF, made in early November, has the world economy growing at 2.2 per cent this year. That is considered wildly optimistic, with this week's figures from the Organisation for Economic Co-operation and Development showing a steep decline in global output in the past three months, suggesting global growth forecasts should be pared back to 1 to 1.5 per cent. Investment bank UBS is forecasting zero growth.

The advanced economies - including the US, Japan, Britain, much of the eurozone, Singapore and New Zealand - will shrink this year, while the emerging economies of India and China will continue to grow but at significantly reduced rates as their trading partners falter. Australia's GDP, which rose an anemic 0.1 per cent in the September quarter, is forecast to grow between zero and 2 per cent this year, compared with 2.4 per cent last year. Whether Australia avoids recession depends largely on the prospects for the economies of the US, the world's biggest, and China, the third-biggest and Australia's No1 trading partner. As Blythe points out, the Australian economy has survived recent bumps and swings in the US largely untouched but the impact of a Chinese downturn is harder to quantify because we've only ridden the dragon on the way up.

The US National Bureau of Economic Research, a semi-official body made up mainly of academic economists, which uses a looser definition of a recession, believes the US economy entered a recession in December 2007. This means it has already been in recession longer than the post-war average of 10 months. With no recovery expected until later this year, the current slump is likely to be the longest since the Depression of 1929-34. Barack Obama takes over as US president on Tuesday US time facing the most serious financial threat to the nation since that time. Economists, noting the loss of almost two million jobs in the past four months and a housing market in free fall, expect the US economy to crash 5 per cent in the December quarter, with GDP falling 1.3 to 1.8 per cent in the coming year. How Obama deals with what he characterises as a "very sick" economy will determine the length and depth of the downturn.

At least, says Smith, there is a feel-good factor about Obama, "more hope than reality" that his election could be the catalyst for a change in the nation's fortunes. Already, the president-elect is lobbying for the release of the second tranche of the $US700 billion Troubled Assets Relief Program to bail out companies in strife and he remains committed to his campaign promise of a record $US600billion to $US800 billion stimulus package to get the economy moving. Trujillo says the trick for the US and other countries with big stimulus agendas is to make sure none of the money is wasted and that it is targeted to get results in the short term (jobs growth) and longer term (nation-building infrastructure investment in partnership with key companies). "We have got to make sure there is not a lot of pork involved, because at this point in time you have to make sure that everything is stimulative," he says.

In a speech to the London School of Economics this week, US Federal Reserve chairman Ben Bernanke lent his support to the US package but suggested that more, multibillion-dollar steps were needed to prop up the financial system, most likely by taking on more distressed assets and providing more government guarantees for bank debt. With interest rates at close to zero, robbing the Fed of further ammunition, any recovery by the US economy will depend on fiscal policy. In particular, it will rely on how quickly the Obama stimulus package - short-term tax breaks and longer-term public spending plans - takes effect. And it will rely on how quickly the US banking system returns to any sense of normality, reopening lines of credit to businesses and households.

London-based Westpac senior economist James Shugg believes the US should be able to "eke out modestly positive growth" by the second half of the year but warns in a recent report that the risks to the economy are "skewed heavily to the downside". "A resurgence of protectionism that stifles the global recovery; a move by households to raise saving that more than offsets the US Government's political and budget capacity to spend; a shell-shocked banking system that refuses to do its job. (These) are all factors with the potential to stretch this contractionary episode into a deflationary one that lasts well into the next decade," Shugg says.

Recession will also grip much of the European Union this year, with the European Central Bank, which was accused of prevaricating on rate cuts early in the crisis, hoping to inject E200billion ($390 billion) into the 27-nation bloc as it continues to reduce rates to record lows (possibly zero). Smith fears the rise in the euro will hinder the continent's recovery by making its exports less competitive, leaving it "bumbling along" as Japan did in the '90s while other countries, such as Britain with its weaker pound, recover more quickly. "Who, for example, is going to buy Airbuses?" he asks. Britain is pursuing its own emergency measures, including an unprecedented, temporary cut in its goods and services tax, in an effort to revitalise an economy that relies more heavily than any other major nation on its financial services sector. Prime Minister Gordon Brown, who won kudos for leading efforts to bolster the international banking system, is still expected to watch Britain's economy contract by at least 1 per cent this year, with the loss of hundreds of thousands of jobs in all corners of the country, before a modest recovery later this year.

While Japan and parts of Asia will wallow in recession, China and India will continue to grow strongly, albeit at rates well below what was expected just months ago. The concept of decoupling, under which economies such as China carried enough momentum to escape the problems of the Western world, to the great benefit of major trading partners such as Australia, has fallen out of favour. In recent weeks China has confronted a marked downturn as its major trading partners entered recessions. "Given its massive net-creditor position mainly with respect to the US, a slowdown to 6 per cent or below in China's growth rate would have a significant impact on the already weak global economy," warns the World Economic Forum, which later this month holds its annual gathering of world business and political leaders in Davos, Switzerland.

One of the unquantifiable risks facing the global economy is that China and other Asian investors, perhaps in response to a new wave of American protectionism, refuse to keep buying US Treasury paper to fund the colossal $US1trillion-plus annual deficits Washington will need to spend its way out of the current mess. That could trigger a crisis in bond markets and a devastating collapse in the US dollar. China last month unveiled a two-year $US585 billion stimulus package representing an astonishing 15 per cent of GDP. As a result, most economists still expect the nation's economy to grow at close to 8 per cent this year, down from 9.3 per cent last year. However, those forecasts are based on the package delivering a significant improvement in the second half of the year from the current level of 6 to 7 per cent growth.

Smith remains confident about the outlook for Asia and China, noting that some of Beijing's spending is already filtering through the economy. "We are still anticipating growth of 7 per cent from the region," Smith says. "It's not decoupling (from the West, especially the US) but it's better than it would have been 10 years ago." Still, expectations of a global recession and fears about Chinese growth have helped puncture the commodities bubble that in recent years has swollen Canberra's coffers, giving it the budgetary ammunition to fight the financial crisis. Prices for key Australian exports such as iron ore and coal are expected to fall sharply when long-term contracts with Asian customers are renegotiated in coming months.

But the Commonwealth's Blythe, who puts himself in the "less pessimistic" camp, believes other prices are close to their lows and the accumulated gains from the earlier years of the boom "will help support activity for a while yet". He says it can take up to three years for the full impact of a commodity boom, worth an average of 1 to 2 per cent of GDP a year, to work through the economy. The benefits of the boom, represented in the forecast budget surpluses that the Rudd Government has turned into likely deficits to stimulate the economy, are just one reason why many believe Australia can ride out the storm better than other Western nations. The Government, with its willingness to embrace modest deficits, and the Reserve Bank of Australia, with its interest rate at 4.25 per cent, still have plenty of scope to combat the economic downturn using fiscal and monetary policy. There are calls for the Government to do more than its initial, pre-Christmas $10.4 billion injection into the economy, possibly by bringing forward tax cuts. The Reserve Bank is expected to cut its interest rate to 3.25 per cent or lower, taking mortgage rates to their lowest since the early '70s.

The nation's banking system, armed with a new government guarantee on its debt, remains among the most robust in the world. Despite some high-profile failures and a squeeze on financing, the corporate sector, too, has remained resilient. The weaker Australian dollar is shielding the economy by making exports more attractive and offsetting US dollar falls in commodity prices. House prices, although forecast to fall up to 5 per cent this year, are holding up better than in the US and Britain, boosted in part by the Government's increased first homeowner grants. And figures released this week reveal many shoppers heeded Kevin Rudd's call to the malls, spending an economy-boosting $37 billion during the Christmas period. The fall in petrol prices and interest rates, and the rise on the stock market, have helped bring consumers out of their shells.

The key risks to the Australian economy and most developed economies are a crisis of confidence among consumers, investors and businesses, and an escalation of job losses. "Confidence is a significant issue," Blythe says. "Perception is reality and there is a real risk that the general doom and gloom produces worse outcomes than can be justified based purely on the economic fundamentals." Confidence is already fragile, with many Australians choosing to bank their recent windfall from Canberra or use it to pay down debt, a process economists call deleveraging. Job security is many households' No1 concern amid signs, including this week's employment figures, that redundancies are growing. Any further signs of corporate Australia losing confidence and winding back investment as conditions worsen and twitchy banks withhold funding will raise fears of widespread job losses, with a devastating impact on household confidence.

JPMorgan chief economist Stephen Walters expects unemployment to peak at 9 per cent late next year, suggesting more than one million Australians would be out of work for the first time since 1994. Others are far less pessimistic, suggesting a peak of 6 per cent, or 650,000 out of work compared with the current 500,000. But if Australians genuinely fear for their jobs, they are likely to save more money than spend it, cutting debt in a process that would fuel the economic downturn, possibly turning inflation into deflation, when prices and values fall. At worst, widespread job losses could trigger forced property sales and deleveraging, sending Australia well into recession. It is almost certain that the coming six months will be grim in Australia and around the world. Economists and business leaders are warning households, businesses and battered share investors not to expect any upswing until late in the year at the earliest and to try to ride out further shocks. Above all, Australians should not talk themselves into a recession. "Confidence is a fickle thing," says Smith, "(but) if we can just keep our calm, we should come through this."

The Deflation Battle Rages On
For the first time since 1955, the consumer price index fell on a year-over-year basis. Last month's seasonally adjusted CPI slipped 0.1% for the 12 months through December, the Labor Department reports. On a monthly basis, the decline in CPI is more pronounced, falling by 0.7% last month--the third straight monthly decline.

Deflation, in short, is here. It's been expected for some time, as we've been discussing in recent months. The great question, of course: How long will it last? Team Fed is working overtime trying to keep the visit relatively brief. By dropping the central bank's key interest rate to virtually zero and otherwise buying up assets that no one else wants, Bernanke and company are pulling out all the stops to engineer inflation back into the system. So far, the policy has yet to show results. But such actions take time to work. Eventually, and perhaps quite soon, signs of progress will emerge for keeping consumer prices on an even keel.

The Fed, in sum, will win, and then the real work will commence. But that's a problem for another day. Today, the central bank can't afford to lose this battle. Lower prices are nice, of course. More importantly, falling prices give consumers some relief from the ill winds otherwise blowing in the economy, and that's stimulative generally. But there's a limit to stimulus delivered in this form. If continually lower prices endure, the trend becomes toxic for growth and business expansion. And the bottom line is that the only way out of this mess is through growth and expansion.

In some respects, the Fed's raison d'etre is on the line here. If deflation persists, at some point one can imagine Congressional hearings and the like calling for a major reordering of the Federal Reserve. The institution, after all, is a creature given life by Congress and so the Fed ultimately exists and operates at the mercy of politicians. As such, the Fed's war on deflation is also a fight for survival to keep the central bank as it now stands intact.

Changes in banking generally are now being discussed openly. The prospect of nationalization, or something close, regarding several large private banks is topical these days. “We are down a path that this country has not seen since Andrew Jackson shut down the Second National Bank of the United States,” Gerard Cassidy, a banking analyst at RBC Capital Markets, tells the New York Times today. “We are going to go back to a time when the government controlled the banking system.”

Maybe, although for the moment a true nationalizing of such institutions as Citigroup is still unlikely. Yes, one can argue that a quasi-nationalization is already taking place, given the rising influence that Washington has over the finance industry via all the bailout money being extended to private institutions. But outright control and management of the banking sector by the federal government still looks improbable. Then again, we don't know what 2009 will look like and so one can never say never, especially these days. Perhaps we're idealists, but the lessons of modern economics insure that policymakers won't turn the clock back to the Age of Jackson in banking. More regulation and oversight is coming, but direct ownership and unfettered management of banks is doubtful.

As for the Fed, it's not too difficult to imagine that if deflation runs on for an extended period, and inflicts havoc on the economy, the incoming Obama administration and Congress may feel pressed to take even bolder actions to stem the tide of financial implosion. The front line of this battle is winning the war against deflation. It's not clear that if the Fed fails on this front the Congress can fare any better, but that wouldn't stop politicians from trying.

But we're fairly confident that the Fed won't fail. Deflation, we believe, will be slain and inflation will return. Timing, of course, is unknown, and since timing is increasingly the politically and economically sensitive variable in 2009, there's risk ahead—lots of risk, with predictions as well as with economics. Still, there's reason for hope. Keep in mind that the CPI needs only to flat line for a while to keep deflation at bay. Stability seems likely in the months ahead if you expect, as we do, that the bulk of the decline in energy prices—gasoline in particular—is now behind us.

The energy component of CPI has fallen now for five months straight. It's too soon to say for sure, but it looks like November was the climax of the decline, with the CPI's energy index tumbling a hefty 17% that month. In December, energy fell again, although the pace slowed considerably to an 8.3% decline. Since gasoline makes up most of the CPI's energy index, we can look to the fuel for signs of what may be coming in future inflation reports.

On that note, the March '09 gasoline futures contract appears to be stabilizing, suggesting that perhaps the great energy selloff has passed. No guarantees, of course. Yes, gasoline demand over the past 6 months has taken a hit and so have prices. But unless you really are expecting the apocalypse, energy prices generally are set to stabilize.

Demand for fuel won't keep dropping by leaps and bounds month after month after month. Or so we believe. That's not to say that energy prices won't go lower still. But on a percentage basis, the big declines are behind us. That'll go a long way in helping battle deflation, and letting the Fed keep its fancy offices on Constitution Ave.

What George Orwell would make of our financial 'apocalypse'
A flick through the great author's work soon puts paid to self pity, argues Michael Deacon. As we stagger helplessly into the swallowing fog of financial apocalypse , allow me to float an idea. It's not a solution so much as a palliative. Every one of us, man, woman and child across the land, should read or re-read The Road to Wigan Pier by George Orwell. Urgently. Let us rise as one and buy our copies today. (If we actually go to a shop, rather than ordering it online, we might even save a couple of high street chains in the process.) Yes, these are bad times. Businesses are failing and falling. Thousands of people are being laid off every week. We read that this is the worst slump since the Great Depression. But that doesn't mean it's the same as the Great Depression. We know because The Road to Wigan Pier tells us so. In this glowering monolith of reportage, Orwell records in grotty detail the living conditions of innumerable families in northern English towns in the mid 1930s. It's always made for unpleasant reading – until now. All of a sudden, in a strange and shameful sort of way, it's quite comforting.

Admittedly, some of Orwell's opinions in the book are a little eccentric. "We may find in the long run," he declares, "that tinned food is a deadlier weapon than the machine gun." I suppose it depends how hard you throw it. But the information he compiles is as engrossing as it is grim. He visits houses in which 10 people sleep in two small, squalid rooms. Houses that have no hot water and are 50 yards from the nearest lavatory. Houses in which there are no bedclothes because the occupants can't afford them ("…just a heap of old overcoats and miscellaneous rags on a rusty iron bed"). These houses, in such towns, were not exceptional. They were normal. Orwell observes that the number of the underfed in England at the time was between 10 and 20 million. When we're at our local bookshops later, squeezing our way through cheerily plump droves of fellow consumers, we may reflect that under-nourishment is not quite so harrowingly widespread at present. On the drive home we may also ponder the question of what living standards a modernday Orwell would find if he were to repeat his investigation. If he were to visit Bolton, Blackburn or Manchester at around two o'clock this afternoon, he might experience some difficulty negotiating a path through the tens of thousands of men who are about to pay £30 or more a head to spend 90 minutes watching men on £60,000 a week play football. By the time he reached the houses in the less affluent end of town, he might discover their occupants enjoying the Hull v Arsenal match on widescreen televisions.

The Road to Wigan Pier was published 72 years ago. For a fair number of our readers, no doubt, that's within living memory. Look at how our idea of financial hardship has changed since then. If the citizens of working-class Wigan in the Thirties had a time machine with which to visit the present, they'd think even the shabbiest of us were living like Persian princes, and probably lead a murderous revolt against us and our pampered ways. Thankfully they didn't have a time machine. Would you believe the poor dears didn't even have cars? We're not quite as badly off as those luckless millions in the Thirties. We may well be watching the collapse of Western life; but, chin up, we're watching it in fabulous HD. Financial disintegration, though, must be harder to take today. When you've been spoilt by years of prosperity and comfort, any reduction in living standards is bound to seem terrifying. To find yourself suddenly unemployed in the City nowadays is probably more bewildering than it was in a Thirties mining town. We haven't been here before. We don't know what to do. We feel powerless either to halt or to escape our troubles. But when we scuttle back to bed and hide under our bedclothes, we can at least thank heaven that they are bedclothes, and not old overcoats and miscellaneous rags.


Anonymous said...

The banks have not been nationalized so much as the Treasury has been privatized. The model I am loath to say is National Socialism.

Setting that aside there is no one true story about complex events. I do think my story about the Treasury being privatized is just as accurate if not more so than the obverse.

On another matter, again, the Treasuries guarantees of BAC's and C's debt is a sham. The money will never be forthcoming. Not unless the Fed prints it because congress will never appropriate it. It's just a con, a con game. Trying to instill some 'confidence' in the bankrupt banks. Dressing up their books by allowing their shitty assets to be declared rich dark luxury chocolate.

Bigelow said...

It would be less expensive for the government to take over failed bank savings and checking deposits than guarantee all the toxic waste held by the banks themselves. As has been pointed out here, if the government back-stops the banks why not eliminate the middleman the banks? One consequence would be collapse of lines of credit for small business and as small business is supposed to generate most of our employment, that would have definite side effects. What about requiring private banks to only finance businesses that make or do real economy jobs? Can't do that now, it would infringe corporate "rights".

Anonymous said...

Ilargi --

The WSJ is reporting that the Obama administration is discussing a plan to create a government bank to take on all the bad debt. You say that there isn't enough money to do so. However, it seems that some sort of legerdemain will be used to accomplish this chicanery.

What impact do you think this will have on the markets and economy both short and long term?

Thank you

Greenpa said...

"But when we scuttle back to bed and hide under our bedclothes, we can at least thank heaven that they are bedclothes, and not old overcoats and miscellaneous rags."

See what I mean about delusional personalities? The writer is saying; see, we're not doing so badly!

When, in fact- there are many thousands, in the UK, who do, already, go back to piles of overcoats and old rags. More, daily.

Anonymous said...

So, wait...

I don't like the bank bailouts, either, but if we don't bail them out, then what? We have to bail out their depositors through the FDIC.

That might cost less, but then what? We have two banks left in the country? And what kind of collateral damage (no pun intended) would result from that? And who ELSE, in addition to depositors, would we be bailing out?

Let's say banks as a whole have, say, $1 trillion in assets and $10 trillion in debt. If we let them go under, well, we pay the $1 trillion right off the top through the FDIC, but what about the other $9 trillion? Who is it owed to? And wouldn't we just end up bailing THEM out, instead of the banks?

Jan Steinman said...

Deflation is inevitable.

John Michael Greer notes the difference between a "problem" and a "predicament" -- problems have solutions, but predicaments don't, they only have coping strategies.

Deflation is inevitable precisely because the real backing of our fiat currencies is limited to energy, the driving force of growth.

The religion of perpetual growth will end, not because we want it to or work toward that goal, but because (as Tainter hints) the stuff that underlies growth will go away.

So let's stop arguing about what the Fed or the Treasury should do, What each of us should be doing is coming up with coping strategies for a low-energy future.

Plant a garden! Walk to work! Better yet, work at home! Better yet, work three jobs at home! (A single job or career is nothing but fiscal monoculture.) Don't buy anything non-essential! Join together with neighbours and support each other! Produce your own energy! De-consume! Starve the beast!

Anonymous said...

@Ilagri: That was a nicely done intro.

@rapier: "The Treasury has been privatized". That's an interesting point; it has been and seems headed more that way.

It seems the first $350 Billion in TARP funds bought us 3-4 months, as the main banks were ready to hit the wall this week. That's not counting the additional $8 Trillion.

One has to ask how much time the next $350 Billion is going to buy us? I notice that absolutely no one is claiming that it will fix the problems.

It looks to me that things will be over by this summer at this rate. Or Helicopter Ben will try to pull some other stunt and delay the inevitable a few more months.

But it's pretty clear that time is running out, and the wall that we're headed towards is approaching fast.

Dan said...

@ Rogue

The banks default, they file for bankruptcy, they have the majority of their liabilities discharged, there is tons of suffering the nation and the world struggle to feed and clothe and house the unemployed and desperate. And then we rebuild, we work to create a world in which the system of fractional reserves cannot be defrauded with such ease, we elect representatives from the rank and file of the American public, and we begin anew.

If we continue to bailout the banks with more debt upon debt, we never have the chance to suffer legitimate suffering: instead, we collapse into chaos and anarchy.

Anonymous said...

Some of the optimistic articles/ comments were borderline delusional. The ones with 8% growth in China, that the Brits have bedclothes instead of old clothes and the one about Australia just escaping recession. In the next few years we are going to see a 30% fall or more in global GDP, 20%+ unemployment in most OECD countries and this without the effects of peak oil!

What happens when the decline phase really starts kicking in around 2012 onwards. There's a 1:1 corelation between growth and oil use according to the Hirsch Report. 6.1% forced global contraction on an annual basis is going to shatter any remnants of the system that remain due to peak credit.

Some of the articles and comments are disgusting, the MSM is making no effort to educate people and make them aware of the harsh physical wall that the world economy has banged into. According to them if we think happy and smile than all will be right and well. That we can wish ourselves away from cold, hard reality.

It would be worthwhile having a deep depression just to make these people stop spewing nonsense and for their corrupt ideologies and illogical thinking to be exposed.

How can people be so utterly blind? The truth is literally one google search away...

Anonymous said...

@ Orion

Why the Bush White House is trumpeting 0.6% GDP Growth in 2009 and forecasting recovery! They foresee a solution. It was on CNN this morning! Have you any reason to doubt them, has the Bush white house ever deliberately lied? ;-)

Anonymous said...

What we have today is the building blocks of fascism. Mussolini would be proud.

Banks pay millions to elect politicians, who in turn bail out the banks and other corporate interests.

And the money they use in their orgy of power and debt is not their money, it is the money of the taxpayers in both cases that the leaches use to feed each other in their cesspool of lies,deceit and imagined self importance.

Greenpa said...

Rogue- yeah, it's a big fat mess, ain't it? I&S can give you lots of details on where the bailout money actually goes- but "away" is the short version.

Ok, folks, in my half assed way, I've been toying with this idea today- feel free to expand, or nuke, or sing hallelujah.

How about- for every dollar we give The Financial Sector, in bailouts (we're not going to stop that happening any time soon, let's face it) - we also make one dollar available for citizen loans.

How? The old fashioned way- through the Post Office. Direct loans of taxpayer dollars to taxpayers. Gosh- we'd only cut out 280 middlemen, and their ill-gotten profits that way.

The banks couldn't scream "no, the gov't can't compete with private business! It's uncapitalist!" Um; since the banks are totally non-functional at the moment, they can just shut up.

So; you need $100 to pay your rent, and think you'll have the money to pay it back in 6 months? Fine- the Postmistress knows you- and this kind of loan carries 0.5% interest. Default rate? Highish- but always VASTLY cheaper to society than any of the alternatives.

You need money to buy a used car to get your breadwinner to work? Here's the loan; the Postoffice keeps the title to the car; 1% interest over 3 years.

You want money to buy a second car for your family, which you don't so much need as want? Fine. Here's the money (see, we're keeping the economy going.) Title stays with the PostOffice - loan is at 15% interest, for 2 years.


Why shouldn't governments: ie. USA, UK, D, PRC - start making direct loans? And just as soon as the banks can get their shitheads together, so they can offer competitive consumer services- fine. Competition is good, yes?

Ok; fire away.

Anonymous said...


Heh. Personally, I think the Bush administration has been more honest than people realize. Someone else pointed out that they have managed to achieve their goals of destroying Medicare, Social Security, high labor wages, the environment and just about every other thing wanted by the Liberals.

The real touch of a master is that they may end up pinning this on the Liberals.

I think we underestimated King George.

Anonymous said...

There's an interesting article over at the Economist:
World Economy: Accelerating downhill

What's interesting is the overview of the numbers worldwide. Good luck with their conclusion though (which is basically "spend more").

Falletta said...

First post. I'd like to thank everyone that contributes to this site, especially Ilargi and Stoneleigh. It is hard enough to write an essay, let alone to do so day after day and keep it fresh and interesting. I am a young student and I've learned a great deal, and not just about economics. You are both humanists in the broadest sense.

My question concerns wealth destruction. Calculated Risk is calling for about 1 trillion in losses for banks in the States. I know that this is only one sector of the economy in one country, but if I recall correctly, you put global losses at about 50 times that. How do you come up with such a large number? I know there is a simple answer here, but could you, or anyone else, please spell it out for me. Many thanks.

Dan said...

@ Falletta

my 2 cents...

Derivatives! CDS!!!


Anonymous said...

Nobody wanst to live in the conditions that the pictures of the early 1900s that Ilargi has been showing.

For years, I have seen people living the “middle income” lifestyle. I could never figure out how they could do it because their income was lower than our family income and we could not do what they were doing without going into debt.

The economists are basing the recovery of the economy upon the middle income Americans getting back into spending mode.
In order for me to get into the middle income class, I could not do the spending of the “PRETEND MIDDLE INCOME CLASS”.
I certainly will not go into a spending spree and lose what I have accumulated and then wake up in the early 1900s.

There is a large portion of Americans who are in a “PRETEND MIDDLE INCOME CLASS”.

The middle class is in reality a lot smaller than what is being stated and the truth is about to be revealed.
The real middle class will not go into a spending spree to save the economy.
The lower income class will wake up to 1900s with a lot of “PRETEND MIDDLE INCOME CLASS” people that have joined their ranks.

Now ... what was it that the romans did to keep the population calm ... something to do with lions and bread lines???

Anonymous said...

Jim Kunstler coined the term "Formerly Middle Class"

The expression for keeping the populus asleep (patterned after Rome) while they were sold down the river into desolation and debt slavery was "Bread and Circuses"

Stardate: 2009

"Cheez Doodles and Cable TV"

and from

Star Trek Episode:

Bread and Circuses (1968)

"...the Enterprise discovers a planet whose oppressive government is a 20th-century version of Earth's Roman empire.."

Welcome to the Future.

Anonymous said...

Since there has been recent mention of Yoga and Plyometrics I offer this analogy/metaphor, and a question. One of the key principles of internal Chinese Martial Arts (Tai Chi, Hsing-I,Pa Qua) is the practice of Kai and He--to open and close. Or to store and release. Compress and expand. To jump in the air (release) one first needs to bend their knees in order to store energy to release/jump. Bend the bow to release the arrow. The universal rhythm of life is to open and close: a heart pumping; a flower closing; a fist opening. Are the economic solutions( bailouts and prop ups) offered to date the physical equivalent of bending the knees to leap again while still in the air?

I sense that Krugman-- and others offering Keynesian solutions-- think of the stalled economy as a car parked on a hill in San Francisco; turn the wheels away from the curb and watch a mighty down the backside momentum take over. But I sense we have an uphill pull ahead and some bending of the knees and storing of energy will be required to enable steps up a steep mountain. Belief in endless arrows out of an already released bowstring sounds like a glorious kite in the windy month of March, but this is the season of inert, listless air.

To fly again is going to require a mighty leap and the preceding requirement of bending the bow to store the energy. But before that can occur feet will need to first land back down on the ground. And come to think of it, I will pass on flying for a while. Down in the valley of rich beautiful dirt isn't so bad. And what about a view from the top of a peak? No problem, one honest step at a time.

Anonymous said...

I see another has figured our "Dear leader George"was truthful when he said he had had a successful presidency.The sick bastard has destroyed the most advanced nation on earth for a ideology.He cut the heart out of the .gov ability to care for the citizen...unless you are a corporate citizen with the ability to fund a army of lobbyists to ensure your place at the feeding dish
Its the same gig Regan[may he burn in hell]did...spend the money on .mil and plead fiscal responsibility when the other bills,like foodstamps are due.

We are at the cusp of the "Age of Default".Order your garden seeds early...they will be at a premium very soon..

I hope the ones who decided to send us down this path are the same who will lose everything...unfortunately this is rarely the case.

I do not think it will take much more for the whole of the citizenry to figure our that what we had is gone.

There is a story floating around that the comptroller of California has stated as of feb 1st,no further Welfare,un-employment,or/and any other payment will be made by the state of California.

If this is true,how long before the riots start?


scandia said...

Ilargi wrote of " hitting the wall". I've encountered another wall in conversation about financial decisions to make in current conditions. In one my friend started to cry. On reflection the high wall that keeps her from seeing reality is " previous psychological investment". She has worked like an immigrant dog for 15 years to acquire the condo that she intends to retire in. She is very happy returning to it at the end of each day.It is her safe haven. To even suggest she sell it brought tears.It is simply impossible for her to conceive a 40+percent drop in value.
In the second conversation with a mutual friend of the woman I was stopped short with a pervasive " everyday garden" type home truth. " EVERYBODY KNOWS YOU DON'T SELL IN A DOWN MARKET"! End of conversation,end of story.

SanderO said...

A bank is a business. The sell money (loans) and buy money (deposits) and they gamble (trade "instruments:"). And of course they have expenses, like rent and supplies and workers.

So when a bank is in the whole it means it owes more than it can pay. Got it.

So when we give them tens of billions - what are they doing with it? Are they payng off their debts? Are the keeping it for a rainy day? Are the execs taking it home and partying?

Anonymous said...

Jan S.

"Deflation is inevitable, precisely because the real backing of our fiat currencies is limited to energy, the driving force of growth."
I would add that energy is not the exclusive backing: innovation and/or more productive usuage of that energy contibutes a significant portion.
"The religion of perpetual growth will end, not because we want it to.... but because (energy?) goes away"
There is no question that the era of "cheap" energy (if one does not factor in the externalities, such as pollution, health, military prowess, etc.) is over. However, the present deflationary period provides us with a window of opportunity to transition to more benign and ultimately, cheaper sources of energy. And the rate at which at which our existing cheap energy dissapears off our radar screen is well within our control: demand can be altered instantaneously (prodding by "leaders" is the biggest catalyst, as grade-school experience would vindicate);more lastingly by innovation.
And here's where Greenpa's "half-assed way" of giving loans directly to consumers comes into play. But instead of shotgun loans, direct the application of these loans only to the innovations that lower energy usuage:solar,wind, micro-hydro,weatherization,hybrids,electric cars,etc.,etc..
If growth is inevitably tied to the availibility of "cheap" energy,why not embark on a program that provides "free" energy after the initial payback?
And creates instant, well paying jobs besides. With a better multiplier to the economy than tax rebates or unemployment checks.

Starcade said...

rapier: Everything, at this point, is a con game. Every bank in the world is insolvent -- money, as a _concept_, is about to go away -- and the entire social fabric may go backwards at least three centuries.

Bigelow: You're right -- but there's one problem. You still have to account for how you are going to deal with bad bets 30X the value of the entire world's worth (or some estimate close). Until you do that, the money based on that worth is, well, worth-less.

ca: The government doesn't even have enough money to _service_ _it's own debt_. How is it going to do anything about an amount of bad debts that might be two orders of magnitude greater, and try to put THAT on the federal books? Come on...

Greenpa: And I used to live on the streets for years too. I'm basically one broken spirit of a friend away from the same experience -- and, given what I've seen in the news, it can't be that far off anymore.

Rogue: How about having zero banks left? None of them are solvent. You *MIGHT* end up with just Wells Fargo, for a time...

Jan Steinman: I would even assert it already has gone away, and the brutality is about to start. There could even be American hot-spots within the next two weeks.

Orion: BoA needs another $20B for a month or two. UK banks are gone. Citibank is a joke. California is about to pull the plug on welfare payments and tax refunds. You know where this all goes... Riot.

Dan W: The only reason you propose that letting it all go now will actually work as you propose is that you don't believe that there are Powers That Be which openly want chaos, disorder, and culling of the herd to massive proportions.

VK: And go further: Most models for the very survival of China as a nation require double-digit growth as a base-point.

And I say it again: Truth = Riot. If people actually understood what was going on, they'd start killing each other in direct competition to be one of the few(er) left when equilibrium is reached.

Anon 1638: And, if present conditions prove out, Martial Law in parts of America should be in force by sometime in the next six weeks. California sounds like a starter.

snuffy: It depends. If the Controller says that February state SSI payments, etc. are impacted, the riots start before Feb. 1. But the riots start basically about 5 minutes after enough street people realize their checks aren't coming.

And then, it mushrooms with all the other services shut off and the tax refunds. Mayhaps Arnie is trying to force a martial law scenario through mass (un)civil unrest?

Anonymous said...

It is true, Ilargi, that people will vote for politicians who claim that they will guarantee their affluent lifestyle. Pres. Carter who called for sacrifice and described a malaise in American culture was easily defeated by Ronald Reagan.

Empires are corrupt and decadent, but so are most residents and citizens who reside in the belly of the beast.

Indeed, we are a tragic species. I also find tragic the fact that we are part of Western Civilization whose degree of greed and lust for power are unprecedented in the history of humanity. F. Nietzsche and Oswald Spengler described us well.

Anonymous said...

Morning In America was a reaction to Carter's malaise. Carter was correct morally, ethically but not politically. Everybody wants more for less work and since we are Americans we deserve it.

So we had Morning In America which was comprised entirely of credit. The result was global warming, peak oil and their daughter, financial collapse. Not to be forgotten is that our elites gained power and wealthy beyond the imagining of king of old. Well that was the idea all along. Unlimited wealth and power.

D. Benton Smith said...

There may seem to be a lot of talk recently about the legacy of George H.W. Bush, but it’s just a bunch of publicists trying turn another trick before the vice squad sweeps them up. His legacy has already written itself.

In every instance, when given the opportunity to call upon us to dig down and contribute our strengths George W. Bush instead voted ‘no confidence’ in the character, toughness and underlying good will of the American people. When he could have encouraged us to think better of ourselves and of our History-tested institutions, he instead undermined a great nation’s self image with lies and the expedient of appealing to fear.

With our troops in Iraq dutifully risking and losing their lives defending what they believe to be America’s values, Bush voted his opinion that all the rest of us were cowards who would rather throw the Constitution into the garbage than take any personal risk of being harmed by invisible (but omnipresent) terrorists. There was not then and there is not now any threat so grave as to justify passage of the repugnantly named ‘Patriot Act’ or the creation of the new Gestapo, the Department of Homeland Security… which between them rip a gaping hole in the heart of our freedom loving people.

I want to inform our ex-president, along with all of his cohorts. I and most other Americans prefer taking the risk of harm to self (just as a soldier does), if by so doing we help preserve the guarantees of basic human rights expressed in our Founding documents. Freedom from torture… no matter what. Freedom from secret closed door trials… no matter what. Freedom from interminable imprisonment without charge or trial… no matter what. Freedom from warrantless wiretaps, silencing of dissent, unprovoked wars, rigged elections, and government sponsored fear mongering and lies… NO MATTER WHAT.

Time after time, when there was a choice between trusting in the integrity, grit and kindness of Americans, versus pandering to our fears, insecurities and selfishness… he chose the latter. Not only chose it, but pumped it up, played it to the hilt, and made the once loved America belittled in the eyes of the world.

Do we as a people have human flaws? Of course we do, but we chose to brave the risk of exposure to harm by aspiring to higher and more dangerous values such as freedom of speech, the rule of law, and protection from the unrestrained exercise of raw power.

Thanks to two terms of rampant neo-conservatism and unbridled corporate greed under George Herbert Walker Bush we stand at the precipice of ruin, guilty, shamed and impoverished. Instead of the opportunity to rise to greatness we must now pay for our collective failure, aspiring only to a slow and uncertain redemption.

We were once a nation that stood for something unique and special. There was a price and we paid it willingly. Now we are just another country.

Bigelow said...

Our collective spending decisions have been made as if during a long session of binge drinking. Now the deflationary hangover is here and we are sick. The elites have worked assiduously to completely loot the public purse and have taken the all aspirin with them.

Anonymous said...

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Anonymous said...

Is this writer correct that the credit crunch was a hoax and scare?

Anonymous said...


Energy extraction/capture is far more important than you give it credit for, and far less likely to be a solvable problem as you imply. It is one of a few elephants stomping around the room that few people really understand...

Anonymous said...


@ Anon 21.23 who wrote:
"Are the economic solutions(bailouts and prop ups) offered to date the physical equivalent of bending the knees to leap again while still in the air?"

Interesting image. I recently wrote a piece on the current futility of stimulus with a different analogy. I compared the economy to a swimmer sinking into about three metres of water. If the swimmer lets himself sink, he will reach the bottom from which he can push vigorously in hopes of reaching the surface.

I find the image works because downward motion (sinking economy/swimmer) is generally perceived as negative. In this case, where we are confronted with deflation, an informed swimmer must counter-intuitively accept the necessity of sinking (going through deflation) and reaching the bottom before he can effectively (i.e. without wasting energy/money) push off from the bottom (stimulate) with a legitimate hope of reaching the surface.

The remaining question, of course, is what the swimmer will find at the surface. A deflation will probably last a few years, peak oil is already or will soon have kicked in, if only because of the current drop in investment.

We will see,

el gallinazo said...


Excellent post, except that you refer once to our miscreant, soon-to-be ex-president as George W. Bush, and twice to him as George H.W. Bush. At first I thought you were referring to Bush Sr., but then you referred to GHWB as a two term president, which of course George the First was not. I agree with everything you stated but the nomenclature.

Gravity said...

There are thought-criminals who maintain that Gravity is not real.
Believe me, Winston,
it is very real.

Perhaps you're not familiar with how it operates?

Indeed, then perhaps you imagine
a huge network of mass,
prepared to commit any atrocity
in order to demoralize and weaken the order of our society.

The reality is infinitely
more subtle.

If Gravity itself fell into
the hands of the Paulson,
it could not give them a list
of its agents.
Such a list does not exist.

It is not an organization in
the sense that we know,
nothing holds it together but
an Idea. There is no possibility
of change in their lifetime.

In the face of the Pyramid they cannot act collectively.
Individually, they cheat, forge, blackmail, corrupt children,
spread disease and prostitution,
in the name of spreading knowledge from generation to generation,
until, in a thousand years...

scandia said...

Question for all the posters on California... do you expect the Feds to bailout California, other bankrupt states?
FB, thanks for the definition of ZOG the other day. Who knew? Must be many extreme positions out there that I haven't heard of!

Anonymous said...

I am one of the slow guys, who despite patient response from I & S, still does not believe the future is deflation. Not that I don't want it to be. I am no debt, half cash, half land (always have a place to live). Deflation, on balance, would be much better for me and my family than Zimbabwe. But ...

To me, the key phrase in Ilargi's introduction is: "the banks -in all likelihood- have far too much of the paper than any government can afford to buy, provided at least they wish to have a functioning economy." That has seemed always to be the catch -- deflation is inevitable because inflationary policies would ruin the economy. And our leaders wouldn't do that would they?

Exhibit 1) our leaders have been running policies that ruin the economy for many years. Why stop now?

Exhibit 2) as Ilargi says clearly and accurately, politicians always take the course that involves the least pain in the short term. In the very short term, inflationary policies always cause less pain than facing the music. That is how Zimbabwe got where it is.

Exhibit 3) the picture painted here at TAE of a deflationary world is so bleak that it doesn't seem that different from Zimbabwe. So what do our leaders have to lose by buying a delay through printing of (heretofore unthinkable) amounts of money?

Inflation is possible in any circumstance if the government is shameless enough. Economic ruin can come in many forms.

Most of us here have one big advantage over the hapless residents of Zimbabwe -- our savings are in currencies that are still "hard" enough to convert into hard assets of some sort. I hope I&S are right about deflation, but I am scared.

Stoneleigh said...


Deflation, on balance, would be much better for me and my family than Zimbabwe. But ...

Be careful what you wish for ;)

Deflation is far worse than Zimbabwean hyperinflation because it pulls the rug out from under people's feet so quickly. So many people end up abruptly destitute that social unrest is very likely. California is already threatening to cut the most vulnerable people off from benefits, and this is only the beginning.

To me, the key phrase in Ilargi's introduction is: "the banks -in all likelihood- have far too much of the paper than any government can afford to buy, provided at least they wish to have a functioning economy." That has seemed always to be the catch -- deflation is inevitable because inflationary policies would ruin the economy. And our leaders wouldn't do that would they?

It's not that they wouldn't inflate, it's more that they'll try and fail. The scale of the losses that are still hidden vastly exceeds the scale of all proposed bailouts. Everything that they throw at the credit crunch is disappearing into a giant black hole of credit destruction, being hoarded by banks and doing nothing to increase the velocity of money. Nevertheless, eventually the bond market will punish them for it, and that will precipitate a far worse spiral of default and deflation.

...the picture painted here at TAE of a deflationary world is so bleak that it doesn't seem that different from Zimbabwe. So what do our leaders have to lose by buying a delay through printing of (heretofore unthinkable) amounts of money?

They will eventually lose access to international debt financing through the bond market, at least at an affordable rate. They will also lose their reputations, and some may lose their heads when ordinary people realize that the bailouts only benefited a few well placed insiders at great cost to everyone else.

Inflation is possible in any circumstance if the government is shameless enough. Economic ruin can come in many forms.

Once a vast amount of credit has been created, it will eventually be destroyed. People will realize the extent of the excess claims and attempt to press their own while they can. It is the mob panic nature of such an occurrence that causes it to unfold as a cascade.

Economic ruin can indeed come in many forms, but we set ourselves on the path to ours a long time ago, when we began to inflate the credit bubble.. N one can monetize debt as quickly as credit can be destroyed once confidence is gone.

Most of us here have one big advantage over the hapless residents of Zimbabwe -- our savings are in currencies that are still "hard" enough to convert into hard assets of some sort.

I would say that the purchasing power of cash will increase greatly over the next few years, although some hard goods you may want to purchase will also cease to be available. I generally suggest purchasing that sort of thing now, but waiting to buy larger items such as land until the price falls further. I wouldn't hold out for a bottom though.

I hope I&S are right about deflation, but I am scared.

Welcome to the club. Anyone who isn't scared at the thought of deflation doesn't understand the implications.

Ilargi said...

"I am one of the slow guys, who despite patient response from I & S, still does not believe the future is deflation."

The present is deflation. We have always maintained that the future will bring inflation, but that it is years away.

"deflation is inevitable because inflationary policies would ruin the economy."

Deflation ruins it much faster.

"Exhibit 2) as Ilargi says clearly and accurately, politicians always take the course that involves the least pain in the short term. In the very short term, inflationary policies always cause less pain than facing the music. That is how Zimbabwe got where it is."

Mugabe can do what Bush and Obama cannot, since it operates in isolation, undeterred by international bond markets.

"Inflation is possible in any circumstance if the government is shameless enough"

Absolutely not. Bloomberg estimates from late 2008 state that $30 trillion was lost from world stock markets, and $60 trillion in overall global wealth. That is, the world lost more than it produced in total GDP. This loss rate will continue into '09-'10. Inflation is impossible against this background.

Perhaps the best way to put it is in the simple question: If printing money were so easy, why doesn't everyone do it? Yes, I know they try, some, but I mean printing enough to make up for the losses? The reality is that governments can't just print, they have to sell their debt, and are therefore dependent on buyers willing to purchase.

Greenpa said...

The news from Minnesota, today; in the Sunday Minneapolis Star-Tribune:

"Loans threaten Minnesota community banks

Commercial real estate loans are going bad at increasing rates in Minnesota. Some say bank failures are possible.

By CHRIS SERRES, Star Tribune
For much of the past two years, Minnesota's community banks have seemed to escape the credit crisis engulfing the nation's largest banks.

Until now.

Dozens of Minnesota banks have entered the new year on shaky footing, hobbled with millions of dollars of commercial real estate loans going sour at an alarming pace. Several analysts predict that some community banks could fail in the state this year, as the slump that began in the housing market spreads to business loans backed by land and buildings."

And, there's a nice punchline. The Star Tribune, Minnesota's biggest, longest established newspaper (think Chicago Tribune) -

Filed for chap. 11 bankruptcy on Thursday; just announced today.

Anonymous said...

Rapier said:

"Carter was correct morally, ethically but not politically."

Carter was not so correct morally and ethically in his foreign policy. He is responsible for the Carter Doctrine which stated that the United States would use military force if necessary to defend its national interests in the Persian Gulf region.

Anonymous said...

Ahimsa- oh, fuff. And which US president, ever, was going to say publicly -"Go ahead, bad guys, do whatever you want, we're going to sit on our butts and just let you!"

Jimmy has a good heart. But like others I could name- he expected people to just understand him, since the logic was clear. To him. So he ticked a lot of people off by seeming bossy. Not good leadership, there.

Bigelow said...

“Good Bank, Bad Bank Shell Game

The aggregator bank idea is nothing more than a shell game with a twist. I wrote about such shell games once before in Super SIV Bailout Plan Doomed To Fail.

Don't Ask - Don't Sell
• The plan boils down to this: Don't Ask - Don't Sell.
• Don't Ask what the asset is worth.
• Don't Sell or you will find out and not like the result.

Paulson's Super SIV idea did indeed die on the vine, in failure.

The idea now is to separate out all the bad assets and place them under one shell in a don't ask, don't sell plan, keeping the good assets in a good shell, and pretending the bad shell does not exist. The "twist" is that taxpayers will be on the hook for most of the assets hidden under the bad shell, footing the bill over time.

Somehow this scheme is supposed to inspire confidence.”
Fed and BOE Shell Games to Bailout Insolvent Banks MISH'S Global Economic Trend Analysis

bluebird said...

Stoneleigh says "eventually the bond market will punish them for it".

What does this mean? What does the bond market do? Are these U.S. Treasury Bonds or foreign bonds? Will short term bonds (Treasury Bills) have a higher interest rate than long term Treasury bonds, say 10-year bonds? What should we look for?

bluebird said...

Stoneleigh says" some hard goods you may want to purchase will also cease to be available."

What do you mean by hard goods? What should be purchased now before they disappear vs the hard goods we should wait to purchase in a few years?

Thank you Stoneleigh.

Anonymous said...

Ilargi you say "$30 trillion was lost from world stock markets,"

Is this actual loss or is much of it merely moved to cash and other valuables?


Anonymous said...

This slide show is worth a look at Unsold cars piling up all over the world

The four horseman of the apocalypse

- Overpopulation
- Climate Change
- Peak energy
- Fractional Reserve Banking

People at large can not see that they are hurting the future of their children by taking on debt that is unsustainable.

Our brain's discount rates simply can't see very far. It's very hard to think 10,20,100 years into the future. Usually I like most people think on a daily/ weekly basis, maximum maybe a year maybe.

The future is just not accounted for properly in our simple brains. If it was, than we would have taken huge steps to mitigate peak oil, climate change and this exponential debt based money system.

We have a built in genetic optimism bias and that shows in most of the articles and words of economists. Something like 90% of all analysts recommend buying shares most of the time.

There are many times I find myself talking to friends and family about future plans and ideas etc and my response is usually in line with a BAU scenario half the time, the other half I incorporate peak oil, deflation etc into my thinking. It's very surreal to live in a world which seems so "normal" but is changing for the worse so rapidly.

The elusive obvious is what most humans struggle with.

Anonymous said...

D. Benton Smith said:

"We were once a nation that stood for something unique and special."

This sounds like a patriotic American myth. This is how history is taught in the US, as propaganda. On paper the US stood for something unique and special, but not in reality. Just ask Native Americans, Blacks, Mexicans, Guatemalans, Cubans (not in Miami!), Chileans, Vietnamese, Iraqis, ad nauseum.

My eyes were opened years ago by Howard Zinn's The People's History of the United States, Morris Berman's Dark Ages America: The Final Phase of Empire, William Blum's Killing Hope: US Military and CIA Interventions Since World War II (see and Rogue State: A Guide to the World's Only Superpower.

SanderO said...

So $60TT of wealth disappeared in the last year.

If I understand correctly if it can disappear into thin air, it wasn't really there.

Tangible hard assets cannot dissolve into thin air, but perhaps go up in smoke.

The wealth created and disappeared essentially comes down to flooding the world with "money" which then chased after assets both real and "constructed" such as intellectual property.

So we have this notion of a rising tide rasies all ships. So when my neighbors get more for their house the "value" of mine has increased. I have supposedly become wealthier. If I sell I can take the cash the wealth and spend it or put it back into the game.

The game is fueled by the ever rising perceived value of assets and "financial instruments". But in fact there is no change in what the value or the utility of the asset is. The house I live in doubled in value but it still only can house 4 people. The wealth created by the bubble was completely illusory.

Those most affected by this slight of hand are those with skin in the game, people with "assets" and investments where they park their "wealth".. But those with no skin in the game are employed by those who do and lose their jobs when the boss feels the draft. One guy can't party hearty so all the workers take a pay cut. And so it ripples through the middle class stake dand the working class, whose stake was their pensions - their skin in the game - to the poor who have only a job to eek by on.

Lots of the heat in the USA was the frenzy of spending both illusory wealth and the idea that you can buy now and pay later... a scheme for the banks to make money on every consumer transaction in America/world.

Even with all the cards stacked for the wealthy/property owers/oligarachs they still needed to game the system because their greed knows no bounds.

Why is an income of $500K not enough to live very very comfortably? Why do people feel they have a right to unlimited wealth? If there is a aggregation in the hands of the oligarchs doesn't it make sense that this is removed from everyone else?

Why do our leaders always look for top down / trickle down economic policy solutions every time.. bailing out banks instead get jobs and money to the people? Why do they worry so much about shareholder confidence and fear of their flight?

When a companies share value tanks to a few dollars a share it obviously has as little to do with the value of the company as when it soars. This value is really no different than the value of "art". it's value is what someone will pay for it,. not the cost of the canvas and paint and frame.

Can we please have some sort of reality based economy without the smoke and mirrors and the "need" to create wealth from asset bubbles.

Stoneleigh said...


I agree completely.

Anonymous said...

@scandia: Regarding State bailouts by the Feds.

The Governors met with Obama about 2 weeks ago, hat in hand. They were delighted to meet with him, but came away without any promises.

Obama might have since promised them a pittance, but at this time I don't know of any bailouts that are on the table.

California at least is such an incredible dysfunctional mess that any bailout would have to be repeated later. There is no fiscal constraint, and has not been for years (and at least for two different administrations).

One key insurmountable problem is that you have extremely powerful lobbies (E.g. the Prison Guards Union) who have no compunction about bankrupting the State as long as they get what they want. Multiply that several times over across many different special interests who do control the Legislature.

Something has to give, and it will. It's only a question of when. A State bailout would only delay the problem.

BTW - delaying has been the entire name of the game for the past 5-10 years, and repeated every summer (when the budget is due).

In short, we're in a new economic reality now, and the States are just waking up to this fact. The Feds will be next, IMO.

Martin_B said...

Something doesn't add up...

Assume High Street Banks lend $10 trillion to Deadbeats for mortgages.

Now we have Agents and Salesmen, $1 trillion in commission; HS Banks $1 trillion in fees; Builders and Previous Owners, $8 trillion in sales (which they will put back into HS Banks); HS Banks 10 trillion in paper, -$10 trillion cash.

The banks bundle the mortgages, get them rated, and onsell them to Hedge Funds and Investment Banks for a profit.

Now we have HS Banks $11 trillion (incl $1 trillion profit) for paper sales; Rating Agencies $1 trillion for rubber stamping; and Hedge Funds and Investment Banks $12 trillion in bundled and rated paper (worth only $10 billion unbundled), -$12 trillion cash.

The Hedge Funds and Investment Banks expect a steady repayment of their $12 trillion with interest over the next 30 years. Just to be safe, they insure with AIG.

Consternation! The Deadbeats don't pay up!
No problem. AIG will pay out.
Devastation! AIG has run out of cash!
Oh shit. So between them the Hedge Funds, Investment Banks, and AIG have invested $12 trillion in something worth $4 trillion at today's prices.
They could take the hit now, or hang on and hope things improve over the next thirty years (which they surely will). They're big boys. They can sort it out among themselves.

But meantime back at the High Street Bank, they loaned out $10 trillion, and got back $1 trillion fees and $11 trillion for sale of the paper. Plus that $8 trillion that went to Builders and Previous Owners must be deposited back with them.

So the High Street Banks should be doing very well right now ($2 trillion profits and fees, $8 trillion new deposits). Why the credit crunch then?

Stoneleigh said...


What does the bond market do? Are these U.S. Treasury Bonds or foreign bonds? Will short term bonds (Treasury Bills) have a higher interest rate than long term Treasury bonds, say 10-year bonds? What should we look for?

The bond market is where the countries (and other parties) borrow money to fund their needs. Developed countries are mostly debt junkies - needing to borrow constantly in order to fund the level of spending to which they have become accustomed.

If the bond market participants become worried that 'money printing' is going on, then they will insist on a higher risk premium (ie a higher interest rate), especially on long bonds. A long bond is a long term bet on a country's finances. Either it has to be held to maturity or the owner has to find a buyer, but if yields (interest) go up, the price will fall. Long bonds are therefore not a good capital preservation instrument in times such as these.

Higher rates on government bonds will translate into higher interest rates on all other borrowing, as everything else is seen as inherently riskier than government debt. In deflationary times, even low nominal rates can be high in real terms. The high nominal rates that would come from a bond market dislocation would be cripplingly high in real terms against a backdrop of a collapsing money supply. This is why we emphasize that you need to carry no debt.

My view is that long term rates will be significantly higher than short term. Placing money in short term treasuries is not a way to earn a high yield, but it is a way to preserve capital, and remember that the return OF capital is more important than the return ON capital.

What do you mean by hard goods? What should be purchased now before they disappear vs the hard goods we should wait to purchase in a few years?

Some very useful things are only available as imports, or are made in certain locations and depend on shipping to reach other places. They can be obtained easily now with only the internet and a credit card, but that is unlikely to be the case in the future.

I would have a look at water filters such as the Big Berkey or a small grain mill. Lehmans Non-Electric Catalogue (an Amish company) is a good place to look for all manner of very interesting things that make self-sufficiency more realistic. The Country Living Grain Mill site is another good spot to find things. It wouldn't hurt to have some spare warm clothes, rechargeable batteries, perhaps a solar cooker, a wind up radio, solar battery charger, perhaps some cast iron cookware designed to last, etc.

Anonymous said...

You guys notice the creeping totalitarianism on the finance blogs?

Mike Shedlock's rag requires email registration, just for the favor of putting up with his crass (and depressingly ironic) ideology of Ayn Rand style libertarianism ... Those who disagree need not participate. But isn't Corporatist Authoritarianism the very altar that Ayn Rand and her devotees promoted. Isn't Alan Greenspan a fellow member of the clique (a particularly funny irony).

Let's hope TAE can stand to promote a more robust democratic civil society.... The world desperately needs it!

bluebird said...

Thank you Stoneleigh :)

Stoneleigh said...


We are not libertarians, even though libertarianism usually seems to go with the Austrian school economics that we espouse here. TAE has a progressive bent, reflecting the facts that we value what can be achieved through cooperation and would like to see the needs of ordinary people taken care of.

Sadly, that doesn't mean that we think it will happen that way though. All too often progressive rhetoric is only a means to achieve power, or to dress up a bailout of the wealthy as help for the little guy in order to win support for it.

Cooperation will also be difficult to achieve in the era of pervasive distrust that we a rapidly moving towards. Keeping the cooperative mindset through think and thin, while not being unwary enough to be fleeced, will be a difficult balancing act, but well worth the effort. No man, or family, is an island.

Anonymous said...

The Country Living Grain Mill is superb. Be certain to get the handle extension though. It's well worth the money and makes grinding a lot easier.

the key thing about using a hand mill is learning the right technique. I haven't seen this published, and had to learn the hard way. Use *both* hands at the same time, with emphasis on one during one half of the cycle, and on the other for the other half.

I can do about 4-5 cups of finely ground flour in about 10-15 minutes.

Also, the single best preparedness book that I've seen can be obtained free. This is put out by the Mormons, and is called "LDS Preparedness Manual". It's a compendium of the best advice around, and is extremely complete.

Just do a google search for it.

The Religious stuff is in the first dozen pages. After that, it's golden.

Anonymous said...

Stoneleigh wrote:
"Deflation is far worse than Zimbabwean hyperinflation because it pulls the rug out from under people's feet so quickly. So many people end up abruptly destitute that social unrest is very likely."

There is massive civil unrest in Zimbabwe. Lots of people there are starving and fleeing the country.

Hyperinflation buys a bit of time, bit doesn't protect the population from hardship. It is equalivent to burning the furiture and the woodwork to stay warm for a bit longer. It a one way trip to ruin.

Stoneleigh wrote:
"It's not that they wouldn't inflate, it's more that they'll try and fail. The scale of the losses that are still hidden vastly exceeds the scale of all proposed bailouts."

You grossly underestimate the will to print tens or hundreds of trillion or even quads of dollars. The US gov't is insolvant. It only has one choice left, and that is to print money. There is nothing that is preventing the gov't from hyper-inflating the currency.

Stoneleigh wrote:
"They will eventually lose access to international debt financing through the bond market, at least at an affordable rate."

That will be the beginning when they turn to the printing presses. For now, the US gov't has been lucky that investors have supplied more than ample cash. This will change over the next 9 to 18 months as gov't spending soars, and unemployment soars globally. A global recession will remove the supply of foriegn savings that are invested into the US.

Stoneleigh wrote:
"I would say that the purchasing power of cash will increase greatly over the next few years, although some hard goods you may want to purchase will also cease to be available."

The purchasing power of the US dollar will dimish over the next few years. The US economy has been utterly dependent on foriegn imports and capital to sustain the value of the dollar for decades. For the US dollar to remain stable or apprieciate in value, foriegners will have to invest even greater amounts of savings than they currently have. If americans are buying less foriegn made goods, there will be less US dollar reserves to be dumped into US treasuries. Plus unemployed workers will probably take there money out of the US to pay for non-discreationary items, Foriegn Central banks need to invest capital into their own banks because of trillions in bad loans.

As foriegn goods cease to arrive on American shores, shortages will appear. This will lead to higher prices as inventories deplete, even if consumption falls by 99%. Consider that much of the stuff consumed in the US, originates in overseas factories, which are closing down and laying off workers. Much of the leading manufacturing countries are deep in debt because of over-capacity investments, and are facing civil unrest. Available Capital will be used domestically instead of being re-invested in US treasuries and credit for americans to go on consuming.

The most probabe out-come is asymetic inflation\deflation. Some goods and services will collapse in price. Home prices and high end luxury goods will be at the top of list for deflation. Non-discretionary goods and services will likely rise, Food prices will probably remain flat or rise. A lot of farmers got burned this season, and are planting for failure this season. Its too risky for them invest in crops when they can plant for failure and collect the gov't handout for crop failures. Local and state taxes will also go up as states deep in the red need to raise capital. Expect higher property, income, sales, and fuel taxes. Gov't stimulus construction programs will also drive up costs, as they gov't overpays for everything. Healthcare may also go up when the gov't expands healthcare programs.

Ilargi wrote:
"I know they try, some, but I mean printing enough to make up for the losses? The reality is that governments can't just print, they have to sell their debt, and are therefore dependent on buyers willing to purchase"

No they don't. Zimbabwe doesn't need to sell its debt on the global market. it just prints new currency to meets its obligations.
The US gov't will continue play its ponzi game, by selling its debt to investors, only as long as the suckers show up to play. In the not so distant future, there will be a bond crash, and the US gov't will have to pay much much higher interest on its debt. When this happens, the interest payment will consume too much revenue, and the gov't will change the rules, as they always do.

The gov't would either have to shutdown 80-90% of its spending to balance is budget with much higher interest rates on its debt. Or they can bypass the bond market by printing money.

Which politicians in power are going to agree to shut-down federal spending to make sure that bond investers are paid in full? Which politicians are going to commit political suicide? Which politicial wants to be the next Herbert Hoover? None.

When the time comes Congress will wholeheartly agree to print rather than permit a deflationary crash. A deflationary crash would also result in a abupt end of the United States as the country falls to pieces in civil unrest and anarchy. During the Rodney King trial, LA went nuts over a police brutality case. Cutting off federal spending and allow deflation would causes 10,000 rodney kings all over then country.

Its not a matter of "if" hyper-inflation will happen, just a matter of "when" it will begin. Most likely it will begin in the next four years.

bluebird said...

anonymous @ 2:29 says "unemployed workers will probably take there money out of the US to pay for non-discretionary items"

There are homeless people who are not employed, have no money, no other income, no savings. Nothing with which to purchase the necessities in the US. So I don't see how they could buy anything anywhere else. Maybe I missed what you intended?

Starcade said...

scandia: California will default -- one way or the other, they will default. The government has to step in and either backstop it or watch the entire shit-fest go to Martial Law levels very quickly. They won't be able to fix this alone.

Mugabe: It not only isn't that different than Zimbabwe, but think of this a moment:

A pussified people, beaten into submission, is easier to control than one which believes it has freedom.

One thing some of you are going to have to keep in mind is that, for there to be a debt on your children, you would a) have to have children, and b) expect there to be a world still around when they mature. Chances are, for a lot of people, that is not their way of thinking.

SanderO: There's no way that much wealth could really disappear -- for if that were the case, it would wipe out the entire worth of the planet in one fell shot. The entire worth of the planet has been last estimated at about $50-55T.

But here's the problem: To have a reality-based economy, a certain percentage of the population must die unless you believe the current population can be supported, in reality. I don't think we are prepared to make that kind of decision, though I know there are those who would like to make that decision (and the one on who lives and dies) for us.

Orion: You've got two choices (CA and USA and world):

You can either repeat the bailouts until you can't anymore...


you lose all social order immediately and the whole thing begins to degenerate about three centuries, with not enough places to bury the bodies.

We _may_ well be within a couple weeks or months before that decision has to start being made as to the retention of social order in at least some of the states -- starting, as one can expect, right here in California.

The problem is simple: The moment that Social Security and welfare default, the prison guards are going to get a lot of company that won't give a shit until bullets are put in all their heads. I can guarantee you that. If they go through with this, flee California while you still can (and, word is, more than a few people _are_!).

And it won't take but one missed payment: The amount of street theft out there even now is MIND-BOGGLING.

D. Benton Smith said...

D. Benton Smith said:
"We were once a nation that stood for something unique and special."

To which Ahimsa replied:
"This sounds like a patriotic American myth. This is how history is taught in the US, as propaganda. On paper the US stood for something unique and special, but not in reality. Just ask Native Americans ...(etc.) "

Hi Ahimsa,

Yes, it does sound a bit mythical, doesn't it? Yet I assure you that for the greater part of my lifetime the vast majority of my fellow Americans subscribed to the principles expressed in our Constitution and Bill of Rights as best they could. Some still do, perhaps naively.

As a nation we have always fallen grievously short of the ideals we espouse, but that is precisely the point. We aspired to high ideals, and we had the courage to actually write them down, invest them with the power of law, and kept on trying.

When I said that "We were once a nation that stood for something unique and special." I chose the words quite carefully. That something which we stood for was, indeed, what we stood for ... even when we fell short of actual accomplishment.

That America even dared to express those truly revolutionary ideas was such a tectonic act of defiance against the powers of that day that it changed the world forever.

That change is not just on paper. It is as real as the world we live in. The effects are reverberating still, as I firmly believe they will continue for as long as humans walk the earth.

Is history in the US taught as propaganda? To be sure, it is. Are the ideals false, or should I abandon them because some greedy little pissant from Texas wanted to be President just like his Dad?

Absolutely not.

I would point out to America's critics that the very criteria they use in judgement, are the ones that America first placed upon the world stage.

Fair enough. That's what they are there for. Please continue.

Stoneleigh said...

Anon @2:29,

There is massive civil unrest in Zimbabwe. Lots of people there are starving and fleeing the country.

I'm sure there is, but it too a long time to get there. deflation takes much less time than that and is equivalent to having the rug summarily pulled out from beneath your feet. There's hardly any time to adapt, unless you see it coming in advance and prepare in advance, which is what we are trying to get people to do here. We couldn't sleep at night if we didn't warn people.

Hyperinflation buys a bit of time, bit doesn't protect the population from hardship. It is equalivent to burning the furiture and the woodwork to stay warm for a bit longer. It a one way trip to ruin.

I know. Still, it plays out as a slow squeeze in comparison with deflation. I do think we'll see hyperinflation after the deflationary impulse is spent, but we have to live through the inevitable deleveraging first.

You grossly underestimate the will to print tens or hundreds of trillion or even quads of dollars. The US gov't is insolvant. It only has one choice left, and that is to print money. There is nothing that is preventing the gov't from hyper-inflating the currency.

I think you underestimate the scale of the losses, and the ability of the government to stay one step ahead in the confidence stakes. I think whatever bailouts they try it will always be too little and too late to inspire confidence, as the government is reactive, not proactive. Credit destruction will outpace them.

A global recession will remove the supply of foriegn savings that are invested into the US.

Agreed. I think borrowing costs will rise, especially long term borrowing costs.

The purchasing power of the US dollar will dimish over the next few years. The US economy has been utterly dependent on foriegn imports and capital to sustain the value of the dollar for decades. For the US dollar to remain stable or apprieciate in value, foriegners will have to invest even greater amounts of savings than they currently have.

The purchasing power of the USD will appreciate relative to goods and services domestically. It should also appreciate versus other currencies for a while as the flight to safety continues. After that I expect currency relationships to become chaotic. I wrote a primer on this recently. It's called The Special Relativity of Currencies and you can find it on the right of the main page.

As foriegn goods cease to arrive on American shores, shortages will appear. This will lead to higher prices as inventories deplete, even if consumption falls by 99%.

Prices will not rise if the money supply collapses, and with it price support. Deflation decreases prices across the board, while simultaneously rendering almost everything less affordable. The essentials will be the least affordable of all, as a much larger percentage of a much smaller money supply chases them, offering relative price support.

Consider that much of the stuff consumed in the US, originates in overseas factories, which are closing down and laying off workers. Much of the leading manufacturing countries are deep in debt because of over-capacity investments, and are facing civil unrest.

Agreed. Exporting countries will see demand for their products collapse due to a lack of purchasing power, which will create considerable unrest in countries accustomed to growth.

The most probabe out-come is asymetic inflation\deflation. Some goods and services will collapse in price. Home prices and high end luxury goods will be at the top of list for deflation.

Inflation and deflation are monetary phenomena, not relative price movements. Either the money supply is rising in comparison with available goods and services or it is falling. Both cannot happen at the same time, although prices movements in different directions can and will occur.

A lot of farmers got burned this season, and are planting for failure this season. Its too risky for them invest in crops when they can plant for failure and collect the gov't handout for crop failures.

That is a sad state of affairs. Farmers who try that further down the line when entitlements are disappearing will get very badly burned if they expect continued handouts.

Local and state taxes will also go up as states deep in the red need to raise capital. Expect higher property, income, sales, and fuel taxes.

Agreed, but you can't get blood from a stone. They won't be able to fill the massive holes in their budgets, but they'll certainly try. Even people who own their homes free and clear need to budget for much higher property taxes, at least in real terms.

Healthcare may also go up when the gov't expands healthcare programs.

I think the healthcare system in the US will collapse. It's a monstrosity that serves a few quite well, albeit at great cost, but leaves far too many out in the cold. The cost of it will be completely unsustainable in deflationary times.

Zimbabwe doesn't need to sell its debt on the global market. it just prints new currency to meets its obligations.

The US is not Zimbabwe. It is very dependent on the bond market.

In the not so distant future, there will be a bond crash, and the US gov't will have to pay much much higher interest on its debt.

Agreed. This will cause a massive wave of default, with resulting destruction of credit, and is therefore deflationary.

The gov't would either have to shutdown 80-90% of its spending to balance is budget with much higher interest rates on its debt. Or they can bypass the bond market by printing money.

They will have to do both. They need the bond market. Eventually international debt financing will die though, and that's when I think we'll see hyperinflation. For the time being we're stuck with deflation and depression, which are mutually reinforcing.

Which politicial wants to be the next Herbert Hoover?

Apparently Barack Obama and John McCain, as they were both competing for exactly that title.

When the time comes Congress will wholeheartly agree to print rather than permit a deflationary crash.

They have no choice. Deflation is already underway and will proceed until the (small amount of) remaining debt is adequately collateralized to the (few) remaining creditors. And yes, I do expect the process to lead to violent unrest, and consequent repression.

Its not a matter of "if" hyper-inflation will happen, just a matter of "when" it will begin. Most likely it will begin in the next four years.

I think it likely to be considerably further off than that, but even if the timescale is relatively compressed, we still have to live through credit deflation first.

Greenpa said...

Mr. D Benton Smith- very nice.

Part of the history/propaganda, which has always served us very ill, has been to obscure our founders' frailties - and doubts and reservations; disappointments and bitternesses. They had plenty; all around.

I still find them astonishing; and hope I can do a fraction as well with my life.

Warts and all. Beats a lot of the alternatives.

Anonymous said...

bluebird wrote:

"There are homeless people who are not employed, have no money, no other income, no savings. Nothing with which to purchase the necessities in the US. So I don't see how they could buy anything anywhere else. Maybe I missed what you intended"

I was refering to overseas investors that lose thier jobs or thier business fail and they will pull thier savings out of the US. I was not refering to the unemployed that don't have any savings. There are large numbers of foriegners that invested savings in the US instead of domestically because of taxes, regulations, or they just believe the US was a "safer" place, or had better returns.

Stoneleigh wrote:
"Apparently Barack Obama and John McCain, as they were both competing for exactly that title."

Neigher person understood the situation, especial McCain. Obama thinks that he can run Trillion dollar deficits for ever, which shows his lack of understanding of economics.

Stoneleigh wrote:
"we still have to live through credit deflation first."

The deeper the credit contraction occurs the shorter the period to hyper-inflation. The US gov't is the Top Dog of credit. The quicker the credit contraction happens the quicker investors will take away the US gov't credit punch bowl. When this happens, that gov't will resort to print money. The US gov't simply can't survive without cheap and abundant credit. Perhaps is will start slowly and quietly, but it will end in a bang.

Stoneleigh wrote:
"Eventually international debt financing will die though, and that's when I think we'll see hyperinflation."

It is already dying. All over the globe, big projects are being canceled and terminated. Only gov't debt financing persists on the international market.