Sunday, May 17, 2009

May 17 2009: It's time to pay

G.G. Bain Figaro Figaro Fiiiiiigaaaroo 1920
Italian baritone Giuseppe De Luca, who for many years sang leading roles for New York's Metropolitan Opera

Ilargi: California has a vote on Tuesday, in which citizens will be asked for their preference: be maimed OR be crippled. Workers in the automotive industry, represented by their unions, face similar options. In Canada, negotiations between unions and carmakers don't go anywhere. And it's a largely impossible task for all parties to start with. Recently, just a few days after there was an agreement, the Canadian government sent the parties back to the table, telling them it was not good enough.

So what do they talk about? I'm not sitting at those tables (for which I’m very grateful, eye: meet sharp stick), but I do know that the main problem is that nobody knows what it is they're negotiating for. That may sound strange, but there's this simple fact: the North American automobile industry presently operates at 42% of its capacity, and I'm willing to bet that not nearly all of the produced vehicles are actually sold; we've all seen the pictures of endless lots full of unsold cars.

It would, therefore, be economically wise to cut more than half of all capacity, but that will not happen as long as Washington predicts 3.5% GDP growth daydreams for the latter half of 2009. The North American car industry in its present form has no future, but the consequences of admitting that are still considered too politically unpalatable. So you get a weird environment in which many of the workers are made to believe that they will still have a job, and even get a strong measure of control over their companies, while their benefits are hollowed out and their jobs will disappear regardless.

I've been talking about this a lot the past week, and I will do so in the next days: reality is hitting Main Street, and the results, though unpredictable, are certain to be devastating. We've been making choices, through our governments, in the past 2 years, that will now come back to haunt us. The money that would have been needed to cover essential services has been wasted on bankrupt carmakers and banks. And now it's time to pay.

Martin Feldstein: US uptick doesn't mean crisis is over
A few recent glimmers of economic hope emerging in the United States do not mean the global crisis is over, a top economist who advises US President Barack Obama said Saturday. The crisis "is certainly the worst that I have seen in my career," Martin Feldstein, a 69-year-old Harvard economist and member of Obama's Economic Recovery Advisory Board told a world tourism conference in Brazil.

"The evidence simply doesn't support" the conclusion that the United States is on its way to a sustained recovery, said the academic, who also served as an advisor under former presidents Ronald Reagan and George W. Bush. He added that Europe's economy is "equally bad if not worse than in the US," and "Japan has been hit even harder." While some US observers and media in recent weeks have struck an optimistic tone on the back of a rebound in the stock market and positive results from big US banks, Feldstein said that was "temporary" because the bad news far outweighed the good.

He stressed that a "one-time rise in GDP due to the stimulus package" implemented by Obama's administration was being extrapolated across the rest of the year. But he said that stimulus package, headlined as an 800-billion-dollar initiative spread over two or more years, in fact equated to just 300 billion dollars for this year. That, Feldstein said, was less than half the 750 billion he estimated had been sliced out of the US economy by dramatic stock market losses, home price declines and a drop in residential construction caused by the crisis. The package "is not strong enough, not targeted enough, to deal with these problems," he stated.

Feldstein noted that one-third of all mortgaged US homes were now worth less than the value of their loans, suggesting more owners would simply walk away and the rate of foreclosures would rise, further depressing house prices and causing a spiral. "It is a very dangerous situation," Feldstein said. A recovery was possible in 2010, the professor advanced, but added: "Frankly, that is just a hope." He also warned of an impending slide in the value of the US dollar after the crisis because of the massive US trade deficit, a scenario that would drive up the trade-weighted value of the euro, making European exports more expensive.

In the past three weeks, the bad news has piled up in the United States. Official data showed the economy shrank 6.1 percent in the first quarter of 2009, with unemployment climbing towards what analysts predicted would be nearly 10 percent by year's end. Auto giants General Motors and Chrysler are in distress, and US airlines have reported a seven-percent drop in travel for the summer vacation period. US industrial production continued to fall in April, by 0.5 percent, after a 1.7 percent decline in March. US consumer prices dipped on an annual basis at the steepest pace in nearly 54 years.

Orszag: Economy's Freefall 'Seems to Have Stopped'
The White House's top budget official, Peter Orszag, said on Sunday that the decline of the U.S. economy appears to have slowed but that the country wasn't yet in the clear. "The freefall in the economy seems to have stopped," Mr. Orszag said during an interview on CNN's "State of the Union." "The analogy is there are some glimmers of sun shining through the trees, but we're not out of the woods yet." Mr. Orszag, director of the White House Office of Management and Budget, said the administration would update its budget assumptions in the coming months, as planned. He urged patience when it came to seeing results from the government's $787 billion economic-stimulus plan, noting that only $100 billion has been allocated since the legislation was enacted three months ago. "It takes time to get money out the door wisely," he said.

Mr. Orszag suggested that there was no time to waste when it came to overhauling the country's health-care system, however. Rather than study the issue further, the administration plans to get it done this year, he said. "If you look at the deficit in Social Security, it's a fraction of the deficit in Medicare. We're trying to deal with the big problem first." House Republican leader Rep. John Boehner of Ohio took issue with that approach on the Sunday morning news show and said there was a better way to tackle health care. "Scrapping our current system and putting together this big government option, I don't think isn't the answer," he said. Instead, a private-sector solution targeting those who don't have access to "high-quality" and "affordable" health care is the answer, said Mr. Boehner. He also said he wasn't counting on support from the health-care industry, which he characterized as adopting a "hang-me last strategy."

If the Government Can Fairly Value Its "Troubled Assets," Why Not the Banks?
A very interesting story in Friday's USA Today notes a number of federal agencies, including HUD, own a lot of houses that they're having trouble selling. Sound familiar? In many ways, the government's situation parallels what thousands of other homeowners are confronting: The houses it owns are harder to sell, they typically sit empty longer, and in many cases, their values cratered as the real estate market collapsed. Since 2007, the Department of Housing and Urban Development has acquired at least 110,000 foreclosed houses, its records show, spending about $12.2 billion to reimburse lenders after the owners defaulted on government-backed loans. So far, HUD has been able to recover only about $5.5 billion by reselling them. It has about 38,000 homes still for sale.

The government's houses are divided among a handful of agencies. Most came into federal hands when borrowers defaulted on government-backed mortgages; in some cases, the government foreclosed on loans it wrote, or took over foreclosed properties from private lenders. The list doesn't include homes repossessed by federally chartered mortgage giants Fannie Mae and Freddie Mac. I'm no expert in mortgage-backed securities, banking, finance, or math, but I do know this: when the government is unloading these houses, it's making a determination that it knows how much they're worth. When it chooses not to sell them in some enormous federal fire sale at Crazy Eddie low prices, it's saying there is a price it won't sell below. So if our bloated federal bureaucracy can figure how much its troubled assets are worth, why can't the bailout-munching banks?

In March and April you may remember, or perhaps you deliberately forgot, there was a whole fight between Wall Street and some in government over 'mark-to-market' accounting rules. Quick refresher: the Treasury and the bailout recipients were debating how to value the mortgages in the toxic securities they were holding on to.How much were they worth? Here's how the conversation went, in Mime:
Investment banker: [Stretches arms out as wide as he can]
Treasury official: [Hold hands very close together]

Translation for those of you who don't speak Mime: the banks were saying they were worth A LOT, and some in government were saying the securities were only worth a little bit. The good folks at NPR and Planet Money offer a good recap of how this all went down, but basically, the Financial Accounting Standards Board eased 'mark-to-market' rules that would have forced the banks to take steep losses. Instead, the holders of the mortgage-backed funny money were given flexibility that allowed them to value the assets as though they were being unloaded in an 'orderly sale.' Which is funny given how orderly everything appears these days. The government assented in this cockamamie scheme, agreeing that the market was in a funny state. And this angers a lot of people because it makes it look like the government was allowing the banks to say their toxic assets were worth more than they really are.

But the government, with its sales and non-sales of distressed mortgages it now owns, is showing us that there's another way. It's not the way that Goldman Sachs-linked Treasury officials would approve of; it's a method devised by the bureaucratic drudges at HUD and the VA and the USDA. Not financial rocket science engineering, just a creditor saying what it actually thinks an asset is worth. It seems like everyone could win in the bailout if Treasury just took the methods being used in other agencies and adopted them. It would allow the banks to say, "we won't sell below this price," and the Feds to say, "you only have to lose as much money as we do." It might not be financial services industry best practices (whatever those were), but it could be a "best we can do during these sour times" practice.

Ilargi: Tyler Durden uses a David Roche idea to explain what many people keep forgetting. Most of the "money" that makes our world go round is beyond the control not only of ourselves (no surprise there), but also of our governments and central banks. This leads to two conclusions: 1) injecting a few trillion dollars will not cause inflation and 2) once the shadow system starts falling apart, or even just deleveraging, debts become impossible to pay off, because they are far too big to be paid with "real" money. Mind you, the shadow system is closely linked to our banking system, which means the trillions dumped in there so far haven't solved anything. Those toxic assets we talk about so much are all in the top layers of the pyramid, which outnumber the bottom layers many, many times over.

The Exuberance Glut Or The Dollar-Euro Short Squeeze Race
Much speculation lately focuses not so much on what the stock market will do (the answer to that should be self-evident, especially once shorting stocks again becomes a practical reality), but what the impact of recent economic policies will be not just on inflation (regional or global), but also on that most sacrosanct piece of paper, the U.S. dollar.

In order to approach this question from a different angle than the conventional theoretical wisdom of Quantitative Easing being the end all be all explanation for the mid- and long-term fate of the U.S. currency, an approach that has much more practical credence is that presented by David Roche of Independent Strategy, which demonstrates overall liquidity, defined as claims on goods, services and assets, as an inverted pyramid.

At the bottom of this pyramid is the power money of reserve cash - liquidity created on the balance sheet of central banks. As noted, it accounts for a mere 1% of global liquidity, and thus the impact that the Fed and other world central banks will have with existing policies that address merely this aspect of liquidity will be, at best, massively muted. Above this is the liquidity bank loans liquidity, created through the conventional credit multiplier mechanism of commercial banks. Above that still is the liquidity created by securitization of debt. This experiment, gone horribly wrong, allowed claims on illiquid assets to grow further relative to the reserve money in the system. This is precisely the layer that the Fed and Treasury are trying to revive with the various TALF iterations, so far unsuccessfully. And at the very top of the pyramid is the layer of interest rate and credit derivatives: a means whereby institutions were able to maximize claims on physical and financial assets, by insuring against losses, without increasing precautionary reserves either of capital or reserve money.

In order to fully understand currency and price movements, one has to realize that the securitization of debt, and creation of derivatives amounted to a huge virtual printing press, primarily fueled by a massive increase in risk appetite which allowed for a huge expansion in the value of claims on financial assets and goods and services. It is worth pointing out, that the Fed has little to no control over this "printing press" at this point, which at last count was responsible for over 90% of the liquidity in the system.

Show me the money

In a fiat currency system, as previously pointed out, money is nothing more than a claim on assets, goods and services, and, most dangerously, money created at the top of the pyramid, in electronic form or otherwise, is just as real as the coins and physical dollars held at the basement of the Federal Reserve. The propagation of money higher in the liquidity pyramid explains why all traditional measures of money supply are not only inadequate but likely flawed: orthodox measure of money supply only include the first two pyramid tiers and completely ignore the major ones at the top. This is a major problem as analysts and economists who rely on these traditional "money metrics" only get a glimpse of 7% of the global liquidity in circulation. As for the the balance? The effect of creating an overabundant supply of money (that was not figuring into any monetarist policies) was that the price of money fell relative to assets, commodities and goods, services and labor. Therefore not only did generalized price inflation accelerate, but so did the increase in asset prices as well as the 6 year commodity bull run over the past 6 years.

Now hide the money

The liquidity pyramid's expansion was left unchecked for many years, as a result of loose regulation, low interest rates and a variety of other factors. At the core was the pro-cyclical risk appetite increase accompanying economic booms. Now that we are either in a recession or depression, this appetite has vanished (absent a few pockets of precisely orchestrated equity follow-on cluster bombs). Risk pooling and credit insurance, central to easy money creation, have essentially ceased (accentuated by the Lehman bankruptcy): one need only look at the total CDS notional in circulation which has collapsed from over $60 trillion at the end of 2007 to less than $30 trillion currently (according to DTCC). In short, 2008 was characterized by a massive destruction of money, and this process will likely continue well into 2009 and 2010.

Where does the dollar fall into all this?

The dollar's long decline from 2002 to 2008, most evident with its comparison to its recent rival, the Euro, reflected that the creation of money through securitization and derivatives was mostly denominated in U.S. dollars. And, very usefully, the U.S. current account deficit, which peaked at $844 billion in Q3 2006, recycled these dollars into the global economy, which coupled with the current account surpluses of Europe (only recently moving to deficit) and Japan (surplus for every year of the past decade), made the dollar pervasive. A "superabundance" of synthetic dollars had the effect of depressing its price relative to other fiat currencies in the same way it depressed their values relative to goods, services and commodities.

This process started to unravel last July. Much more than explanations provided by economic and rate expectations, the move has been too sudden and too large, and the most likely "real world" explanation is that the dollar has been caught (does this ring a bell) in a massive short squeeze as the liquidity pyramid has started to shrink. Dollars have been destroyed on the supply side much faster than any currency as i) more had been created and ii) the trust collapse occurred first and most with regard to financial institutions' dollar claims. As dollar supply has shrunk (and will continue to shrink massively) and price has risen, the dollar has appreciated versus all other fiat currencies.

In truth, it is not just a question of supply: as risk tolerance and trust have both collapsed, the demand for dollar cash has expanded.

As the dollar was the funding currency of choice for the entire world, everyone had gone short the dollar: the liquidity pyramid's growth meant that dollar funding was easily available and cheap. As long as loans could easily be rolled over and interbank borrowing was cheap this was not an issue (real LIBOR, not the manufactured number that the member banks provide BBA currently, offloading funding risk from themselves onto their sovereign, with the expectation that the Fed or BoE will constantly bail them out). All promptly ended with the failure of Lehman. Ever since then, banks have been scrambling to cover dollar short positions and replace them with increasing holdings of dollar cash: the rapid increase in the dollar price has been merely the confluence of a contracting supply and an increase in demand. Econ 101.

So what is next

At some point in the not too distant future, this process will end. Frighteningly for the Fed, as more dollar claims are destroyed (the collapse of asset prices in dollar terms, better known as deflation) the speed at which dollar liquidity is shrinking will slow relative to its next most popular cousin - the euro.

It is difficult to predict at what point we will reach the dollar/euro inflection point. As the QE results imply, the Fed is running out of arrows to even manipulate the first two tiers of the liquidity pyramid, and as deflation accelerates, it is very feasible that the dollar's appreciation will soon be limited. One thing that is certain, is that market participants will soon move from focusing on dollar claims to those denominated in euros, leading to a squeeze in the euro (granted of less violence and strength than the dollar's).

Of course it is difficult to evaluate the real state of the liquidity pyramid, especially since there is no way to track the true state of the money supply/demand in the 3rd and 4th tiers. Therefore, the only way to test any hypothesis is by looking at the behaviour of actual outcomes to discern if the underlying premise is in fact getting traction. The best that can be done is to look at leading indicators being tracked and determine when the money being destroyed becomes denominated primarily in euros than dollars. A major question here is whether the dollar and euro respond more to interest rate than risk.

Currently risk seems to dominate. Negative US events translate into dollar strength not weakness even when US rates and yields falls relative to those overseas. This must change before there is a switch in the dollar-euro outperformance behavior. And comparably for the euro, it needs to decouple from negative econ news in the same was the US currency has in the last several months. Once that occurs, and accounts start amassing euros, the dollar's drop will be just a matter of time.

In subsequent articles, we will examine the impact of liquidity on inflation, the unprecedented onslaught in UST issuance which at last check has gone parabolic, the impact of monetary policy on government borrowing, and also the greatest unknown of all: China.

Which 'flation should we fear more?
When the global economy began its dive eight months ago, one of Wall Street's biggest fears was that a deflationary spiral would kick in -- falling prices for goods and services leading to falling wages, in a vicious circle that governments and their central banks would be unable to stop. Yet so far, the worst-case deflation scenario has failed to materialize. In fact, depending on how you spend your money, you may be suffering much more from higher prices in this deep recession than you're benefiting from lower prices.

On its face, the government's main inflation gauge, the consumer price index, mostly has been pointing lower since October. The CPI was flat in April compared with March and fell at a 3.9% annualized rate, seasonally adjusted, over the previous six months, the government reported Friday. That sounds like deflation. But the decline was largely the result of a plunge in energy costs. Gasoline prices fell at a 63% annualized rate in the six-month period, for example, even though they have rebounded in recent months. Prices of many other goods and services have continued to rise despite the recession. Within the CPI, medical expenses rose at a 3.8% annualized rate over the last six months. Clothing costs were up at a 1.2% rate; personal-care products such as toiletries jumped at a 5% rate.

Nobody likes to pay higher prices, but the lack of deflation in many CPI categories counts as good news if you're worried about a worse economic calamity. Price cuts in moderation are wonderful for consumers. But actual deflation -- broad-based and persistent price markdowns -- would imply that the economy was falling into a black hole. Some analysts, however, say it's just a matter of time before deflation takes hold in a world where the jobless rate is soaring, massive wealth has been lost to the stock and housing markets' crashes, and a huge swath of manufacturing capacity is sitting idle. "I think people in general are underestimating the deflationary forces that are out there," said Brian Bethune, an economist at IHS Global Insight in Lexington, Mass.

If he's right, investors could be put through the wringer again. Forced discounting of goods and services by desperate companies could cause more severe damage to their earnings, which could be disastrous for the stock market. In that environment many investors probably would run back to the safety of government bonds, as they did last fall during the credit meltdown. If inflation is negative for an extended period, the current 3.1% annualized yield on a 10-year Treasury note could be a spectacular return. For the moment, it's clear that financial markets overall don't buy the deflation scenario. The stock market has rallied sharply since early March and Treasury bond yields have been rising for most of this year. Prices of many commodities, including oil, also have jumped in the last two months.

The markets have been taking their cue from the massive amounts of money that governments and central banks worldwide have been pumping into the financial system. "The aggressiveness of this response is unprecedented," said Paul Kasriel, chief economist at Northern Trust Co. in Chicago. And he believes it will do the trick, underpinning an economic turnaround that will keep deflation at bay. "I don't think we're at risk for a significant deflation," he said. Indeed, in recent months, the opposite concern has come to the fore: Flooding the financial system and economy with money, many economists believe, sows the seeds of a future jump in inflation. Central bankers wouldn't mind that so much, because they believe that subduing inflation would be a far easier task than halting a deflation spiral. As Japan's deflation experience showed in the late 1990s, a major risk is that falling prices breed more of the same as consumers figure it's smarter to wait to buy.

"There's more of an incentive to postpone spending if prices are going down," Bethune notes. In that context, it's easy for Federal Reserve policymakers to look at the recent trend in the CPI to justify keeping the money spigot wide open for the time being. The CPI was down 0.7% in April from a year earlier. Before this year, the last time the index went negative year-over-year was in 1955. And although the steep drop in energy prices has been the driving force behind the CPI's decline, food costs in the index have fallen overall for the last three months, and the index's clothing and housing components have been negative the last two months. Still, some analysts say it's surprising that price declines haven't been broader and deeper, considering how the global economy fell of a cliff beginning in September.

Joe Carson, economist at money manager AllianceBernstein in New York, says many companies appear to have forestalled the need for severe price discounting by quickly slashing production as the recession deepened. "Technology has given them a faster feed on sales trends," he said. Also, services -- including housing costs -- account for 60% of the CPI. Prices for many services historically have been notoriously "sticky." And the way the government calculates housing costs, including rents, has long frustrated economists who say it doesn't truly measure what is happening in the housing market. That has been a glaring deficiency in the CPI amid the housing crash, Bethune said. Despite the props under the CPI, Lacy Hunt, economist at Hoisington Investment Management in Austin, Texas, asserts that deflation hasn't been defeated -- just delayed.

"The greatest deflation threat is ahead of us, not behind us," Hunt said. Inflation is a lagging indicator; since 1950, inflation has reached its lowest points on average 29 months after recessions, Hunt said. And this time around, "We've got huge amounts of excess capacity in labor markets and everywhere else," he said. Coupled with consumers' need to save money to rebuild their finances, that's a recipe for deflation despite the tidal wave of money that central banks are making available, he said. For investors, the lack of clarity on the inflation issue suggests that a middle ground is still the best place to be, wimpy as that will sound: Keep some bet (probably stocks) that governments can beat deflation, but have a hedge (like Treasury bonds or cash) in case they're too late.

Another California Tax Revolt?
'I think it's going to be a tough summer, and I'm not sure of the solutions yet." So said California Republican Assembly leader Mike Villines last week as he announced that he was stepping down from his leadership post. California Republicans have been adrift in recent years, and this quote is one indication why. The state is facing a massive deficit, talk of bankruptcy is in the air, and polls indicate that on Tuesday voters will reject the legislature's Band-Aid budget fixes. GOP leaders aren't able to challenge the Democrats who run the state legislature by offering viable solutions. The drift, however, may be coming to an end. Mr. Villines is the second GOP legislative leader to fall this year. State Senate Republicans ousted their leader, Dave Cogdill, in February after he negotiated a budget deal that raised taxes. Something is brewing in California, and it looks a lot like the mix of politics that led to the recall of Democratic Gov. Gray Davis in 2003.

The driving issue is a budget deficit that won't go away. Several months ago, lawmakers were forced to tackle a $42 billion deficit that stems from a 35% general fund spending increase since Republican Arnold Schwarzenegger replaced Mr. Davis. The deficit is $4 billion larger than the one that helped end Mr. Davis's political career. After wrangling over what to do, the governor and legislature struck a deal that raises income and sales taxes as well as car-registration fees. In all, the tax increases will cost Californians some $13 billion over the next three years. The lawmakers punted the decision to enact much of the budget deal to voters in six ballot initiatives -- most of which are behind in the polls by nine percentage points or more. According to a recent Field Poll, 72% of voters agreed that rejecting the measures "would send a message to the governor and the state legislature that voters are tired of more government spending and higher taxes."

Voters are upset at the budget games lawmakers have played: One trick employed this year to balance the books was to send taxpayers IOUs instead of tax refunds they were owed. In an editorial, the San Diego Union Tribune captured the consensus on the budget deal by calling it "a sham, an utter sham." With the GOP's grass-roots ablaze in anger over taxes, Republican leaders are being forced to either come out against the initiatives or be driven from positions of power. Mr. Villines is lucky he only lost his leadership post. There are four recall efforts underway aimed at wayward Republicans. Assemblyman Anthony Adams is being targeted because he voted for the budget despite taking a no-tax pledge. Assemblymen Jim Silva and Jeff Miller are facing a recall effort because they refused to go along with an earlier coup attempt against Mr. Villines. And recall petitioners are taking aim at state Sen. Bob Huff because he voted to put one of the initiatives on the ballot.

Even Democratic activists are keeping the tax hikes on the ballot at arm's length. At the state's Democratic Party convention last month, delegates voted against endorsing several of the initiatives, notwithstanding pressure from party leaders to get in line behind the budget deal. Commentators of all political stripes are mocking the measures as buck-passing frauds. The core initiative is Proposition 1A, which would extend by two years the tax increase passed in the budget deal. State officials know that voters would never approve direct tax increases, so they dressed them up as a budget-control measure that increases the size of the state's rainy day fund and imposes spending caps. But those caps are a "fantasy," as Jon Coupal points out. He's the president of the Howard Jarvis Taxpayers Association, a watchdog group founded three decades ago as part of the state's last major tax revolt. The caps, he points out, allow spending to go up with state tax revenues, and they also allow the rainy-day fund to be raided on the say-so of the governor.

The remaining measures include a $9 billion earmark to the public schools that the Los Angeles Times calls a payoff to the California Teachers Association. Other initiatives propose to divert funds from previously passed state initiatives dealing with children's health services and mental health into the general fund. Another would expand the state's lottery enterprise. The only initiative that's ahead in the polls would deny pay raises to legislators and state constitutional officers in years when the state is running a deficit. That initiative is meant to gin up support for the others by convincing voters that the initiative package really means business. But voters are smarter and have longer memories than politicians give them credit for. They seem ready to approve the last one and say "no thanks" to the others in part because there is a general feeling that taxpayers have been taken one too many times.

After all, voters gave Mr. Schwarzenegger approval to borrow $15 billion back in 2004. He promised then that the new debt and accompanying reforms would permanently solve Sacramento's fiscal problems. He said he was taking the state's "credit cards, cutting them up and throwing them away." He's now campaigning for the initiatives using scare tactics. This week, he threatened large state layoffs, budget cuts, and a sell-off of state-owned properties if the initiatives come up short. Fiscally irresponsible legislators will likely blame "irresponsible" voters for the mess that's left after the budget initiatives get rebuked. But California has a history of tax revolts that remake the state's political landscape. Thirty-one years ago, the state's voters ignored a scare campaign and voted for Proposition 13, which placed strict limits on property taxes and helped ignite a nationwide tax revolt. That antitax movement played a role in electing Ronald Reagan, a former governor of California, president in 1980. Some politicians may not know what to do in a fiscal crisis, but California voters often do.

Schwarzenegger's doomsday message may be too late
Arnold Schwarzenegger unleashed Armageddon last week. No, not the sequel to the movie where the giant asteroid threatens Earth, but rather his proposed budget, which seemed to menace California. There were two budgets, actually. One, which assumed voters would pass state ballot measures on Tuesday, would cut deeply into state services to address a $15.4-billion deficit. The other assumed the measures' defeat. It would lay off thousands of workers, cut billions from schools, strip poor children of healthcare coverage, slice money for child welfare services, swipe billions from cities and send tens of thousands of convicts to county jails or federal custody, all to fill a yawning $21.3-billion hole.

Immediately, critics howled that the governor was stoking the fears of citizens. They implied that the governor was hoping fearful voters would storm polling places on Tuesday and reverse what surveys suggest is the looming defeat of the ballot measures. Although politics was undeniably on the governor's mind, that scenario ignored a California reality: Many of the state's most reliable voters had already cast ballots by the time the governor released his doomsday options. As of the close of last week, according to state voting officials, almost 2 million ballots had been collected at registrars' offices across the state, a huge chunk of the vote for an election where turnout is otherwise expected to be paltry. Indeed, many voting officials expect that this will be the first statewide election in which mail-in ballots make up more than half of those cast.

The mail-in ballot has radically reshaped politics in California. The traditional political calendar, in which a campaign seeks to roar like a tsunami onto the beach on election day, flattening the opposition on momentum, is of little use when voters can cast ballots on any of the 29 days before election day. Even television, the device most used by California campaigns to reach voters, loses some of its utility. Some campaigns -- particularly those that, like the ballot measure advocates, are strapped for cash -- figure their money is better spent appealing by phone and mail to reliable mail-in voters than lofting expensive ads to an audience dominated by people who won't show up. The demographics of mail-in voters, too, can alter the outcomes in races where turnout otherwise is expected to be low. Although the margins are narrowing, mail-in voters still tend to be older, more conservative, more white, more Republican and more Bay Area by residence than traditional precinct voters.

Part of the reason for each of those characteristics is the exceptionally low proportion of mail-in voters in the state's biggest county, Los Angeles. According to statistics gathered by the state elections officials, 17% of the county's registered voters will be eligible to vote by mail on Tuesday, compared with the state average of 39%. Although officials elsewhere have beaten the bushes to attract mail-in voters, Los Angeles has undertaken no special effort. The reason, county Registrar-Recorder Dean Logan said, is the numbers. Los Angeles County has 4.3 million registered voters. A little more than 750,000 are eligible to vote by mail in Tuesday's election. That is more than the number of registered voters in 51 of the state's 57 other counties. As it is, county elections officials are swimming in a sea of mailed ballots. "We're getting anywhere from 12,000 to 25,000 ballots back in the mail each day," Logan said. "It literally takes up a floor in our building."

Once retrieved from the post office, mail-in ballots need to be sorted by precinct, verified against voter signatures on file and prepared for counting. And this has to be done as workers are gearing up for the traditional precinct election, which in Los Angeles County on Tuesday will involve more than 3,000 polling places. "It's really the equivalent of two different elections at the same time," Logan said. In Los Angeles, as in the state, the numbers of mail-in voters are growing with each election. And they are having an intriguing effect on the task of getting California's blasé voters to vote. In November's presidential election, turnout beat 80% in each of the 10 counties with the highest percentage of mail-in voters. Sonoma County, one of the success stories in mail-in voting, saw more than 93% of its voters cast ballots in November. Of the 10 counties with the lowest percentage of mail-in voters, by contrast, only three counties hit 80%.

"Making it easier to vote tends to increase turnout," said Joe Holland, the Santa Barbara County clerk-recorder and assessor. In his county, Holland said, up to 70% of mail-in voters take part, about double the proportion of non-mail voters. Los Angeles County had its own experiment on the subject earlier this month, when San Marino voted on a parcel tax. In the mail-only election, more than 50% of voters cast ballots, a huge percentage for a special election. By contrast, a traditional April election in Arcadia drew less than 14%. And Los Angeles' mayoral primary drew a bleak 17%. For those trying to boost voter turnout, there is a central question about mail-in voters: Are they taking part because of the ease of voting from home, or are they signing up to vote by mail because they already are civic-minded? If the former is true, the numbers will grow exponentially; if it's the latter, growth may at some point slow. "I think both those dynamics are true," said Logan, the Los Angeles voting czar. "There certainly are voters who are just very highly civically engaged, who signed up because they want to be sure they are voting in every election. . . . And there are others who are driven by the intuitive: Because it arrives in the mail, they are more likely to cast that ballot."

Fiat's New Prospects Dazzle Italy

Almost overnight, Fiat Group has transformed itself from a bit player into a global titan in the auto industry, effectively taking over Chrysler and possibly a big chunk of General Motors. And nobody is more surprised than the Italians. "If you had asked me four years ago whether I could imagine that Fiat would be able to restore itself and become a hunter, instead of the hunted, I would have said you were crazy," said Sergio Chiamparino, the mayor of Turin, the northern Italian city that Fiat has called home for more than a century. "Practically speaking, it was a badly run company."

In 2005, Fiat was struggling to overcome chronic losses and recover from the death of its legendary chairman, Gianni Agnelli, who had ruled for decades with a feudal lord's touch. The company's future was so dim that it couldn't give itself away. General Motors, afraid it might get stuck with an Italian basket case, paid Fiat $2 billion to abandon a partnership. Today, the tables have turned. Under a chief executive with no prior experience in the car business, Fiat has stabilized its finances and is pursuing an ambition that most Italians would have laughed at only a few months ago: to become the third-largest manufacturer of automobiles in the world, behind only Toyota and Volkswagen and ahead of a fading GM.

Without spending a dime of its own money, Fiat has cut a deal to take over management of Chrysler, the bankrupt U.S. automaker. It is expected to acquire a 20 percent equity stake that could lead to majority ownership in a few years. Fiat is also negotiating with ailing General Motors to absorb GM's European and Latin American operations. If successful, Fiat will oversee a new company with the capacity to build almost 6 million cars a year -- triple what Fiat produced last year. That prospect has led to a surge in national pride in Italy, where many people remain awestruck that the White House has pinned its hopes on little Fiat to save Chrysler. Italians are also dazzled by the idea that Turin, a city with a population of 1 million and the Alps as a backdrop, could reverse Italy's steady economic decline and host a global industrial power.

At the same time, anxieties are growing over the potential downside. If Fiat takes over GM's European operations, it could cut up to 18,000 assembly-line jobs in an effort to restore profitability. Worse, Fiat's basic strategy could fail, given the inherent difficulty of combining three money-losing companies in a star-crossed industry. "We're worried that Fiat will internationalize itself and leave Italy in the dust," said Giorgio Airaudo, the regional general secretary of the Italian metalworkers union, which represents thousands of Fiat workers in Turin. "The big questions we ask are: What role will Italy play? What role will our factories play? What will we produce?" Doubts also linger over one of Fiat's main assumptions: that a quarter-century after abandoning the North American market, it will succeed at selling its small, fuel-efficient cars to U.S. consumers. "I hope that Americans will want to drive around in Alfas and Cinquecentos," Airaudo said, referring to Fiat's stylish, if tiny, sedans. "But I'm not so sure."

Fiat's workers and shareholders, as well as U.S. and Italian government officials, are pinning their hopes on Sergio Marchionne, 56, an accountant who was named Fiat's chief executive five years ago. Marchionne is credited with engineering Fiat's comeback by modernizing its fossilized management ranks, revitalizing its product line and cutting costs -- all while keeping the peace with organized labor. He returned the company to profitability in 2006, although it sank back into the red during the first quarter of this year, posting a $550 million loss. Since the onset of the recession last year, Marchionne has predicted that the auto industry is ripe for consolidation and that a handful of global manufacturers will dominate the market. An Italian by birth who was raised in Canada and lives in Switzerland, he has become a favorite of the Obama administration, which has agreed to let him run Fiat and Chrysler simultaneously.

"I guess what the question hangs on is how much of a miracle worker is Mr. Marchionne," said Marina Whitman, a former economist at General Motors and a professor at the University of Michigan. "In his ambition to become one of the big players in an increasingly consolidated marketplace . . . he's trying to bite off an awfully big chunk." The past offers some painful lessons. Daimler AG, the German automaker, paid $37 billion for Chrysler in 1998 but virtually gave it away nine years later to Cerberus Capital Management, a private equity firm. Fiat's partnership with GM between 2000 and 2005 was also a disaster, culminating in GM's decision to pay $2 billion just to get out of the deal.

Martin Leach, a longtime auto executive who served as president of Ford's European operations and managing director of Mazda in Japan, said Marchionne's plan to pull off a three-way merger is "extremely ambitious." In addition to ironing out differences in corporate cultures, he said, Marchionne will have to overcome logistical challenges and, quite literally, standardize nuts and bolts. "It is a massive undertaking," said Leach, now chairman of Magma Group, an automotive technology and consulting firm based in London. "Most people would put it on the too-hard-to-handle list."

But he said Fiat's key conviction -- that it needs to grow to survive -- is sound. "Most people might be skeptical of whether Marchionne can pull it off, but if anybody can, he can," Leach said. Matteo Colaninno, a member of the Italian Parliament, said Fiat has little choice but to accept Chrysler and GM Europe as partners. "It's very risky, but it's the only path for them to follow," said Colaninno, a member of the opposition Democratic Party. "It's much better to ensure that Fiat is in a strategic position to determine its own fate. It's probably not the perfect situation. But a perfect situation doesn't exist in the automotive industry today."

Fiat is banking on substantial help from the U.S. and German governments to fuel its expansion. The Obama administration has already approved a total of $12 billion in public financing for Chrysler. It has also forced private creditors to write off more than $4.5 billion in debt as the Detroit automaker goes through bankruptcy proceedings. Fiat will pay nothing for its 20 percent stake in Chrysler, but it will have to ensure that some of the U.S. government loans are repaid and meet other benchmarks before it can take majority ownership.

Similarly, Fiat is seeking up to $9 billion in loan guarantees from European governments, primarily Germany's, to help it run GM's European operations. GM Europe's crown jewel, Opel, is based in Ruesselsheim, Germany, and employs about 25,000 people in that country. GM is trying to shed Opel and its other money-losing European divisions as part of its restructuring. Although negotiations are ongoing, analysts said it is unlikely that the Italian firm would have to invest money up front. "The idea is that for two or three years Fiat can keep on relying on public funding," said Francesco Zirpoli, a management professor at the University of Salerno. "Which, if you put yourself in the shoes of Fiat shareholders, is very appealing and very smart. It's really managing to build up an empire with no cash."

Fiat, however, has run into hurdles in Germany. The proposed deal has become a hot campaign issue as Germans gear up for elections in September. Organized labor, a powerful political constituency, is seeking assurances that Fiat will not close any of GM's auto-assembly or engine plants in Germany. Some German politicians have openly questioned whether Fiat is the right choice to take over Opel, noting that the Italian firm has $9 billion in outstanding debts. "Fiat is not the European automaker that is doing the best at the moment," Guenther Verheugen, a German who serves as the European Union's industry commissioner, said last month. "I ask myself where this indebted company will get the means to support two such operations at the same time."

Verheugen's comments struck a nerve in Italy; Fiat executives and politicians in Rome accused him of trying to scuttle a deal. "I understand that for a German politician it could be annoying to have to accept the aid of an Italian business like Fiat to save a German-American one like Opel," said Italian Industry Minister Claudio Scajola. But the German government, which is eager to preserve jobs at Opel, has few options. The only other confirmed bidder for GM's European divisions is Magna International, a Canadian auto-parts supplier. Analysts said Magna lacks resources to invest in Opel and would also need public aid to make the deal work. A decision on Opel's fate is expected by the end of the month.

Fiat is an acronym for Fabbrica Italiana Automobili Torino, or the Italian Automobile Factory of Turin. The company was founded in 1899 and led by Giovanni Agnelli, a former cavalry officer. Fiat grew quickly and made the Agnellis one of the wealthiest families in Europe, akin to Italian royalty. "When the Italians voted out the monarchy, Agnelli understood that deep down they were monarchists, and so he crowned himself king of Italy," said a senior executive at a major Italian company who asked for anonymity to protect his business relationships. Agnelli's grandson, Gianni, took over the company in the 1960s and continued to manage the firm in regal style. Named by Esquire magazine as one of the five best-dressed men in the history of the world, he would arrive fashionably late to work, and if the weather was good, he might take the company helicopter to a nearby ski resort.

By the time Gianni Agnelli died in 2003, however, Fiat's management had grown staid and ill-equipped to compete in a globalized marketplace, said Giuseppe Berta, a professor of industrial history at the University of Bocconi in Milan. "The real fecklessness of the history of Fiat is its absence of corporate governorship," he said. "It acted as a court. It had a king, a very magnificent king, in Gianni Agnelli. The relationship with the king was more important for corporate managers than getting economic results." Fiat burned through a succession of chief executives until 2004, when Marchionne was appointed. He quickly overhauled Fiat's leadership ranks, hiring scores of foreign-born executives in an effort to change the insular culture at headquarters in Turin. "He admitted there was bad management and that if Fiat had to be rebuilt, it should start from top management," said Zirpoli, the University of Salerno professor.

Although Fiat has already received a financial boost from Washington and is hopeful of receiving one from Berlin, it may be harder to get help at home. The Agnelli family, which still holds a 30 percent stake in Fiat, has traditionally maintained good relationships with the Italian government, no matter which party has held power. But it has a complicated relationship with Prime Minister Silvio Berlusconi, a billionaire businessman who, in the minds of many Italians, succeeded Gianni Agnelli as Italy's unofficial king. Although Berlusconi has paid homage to the Agnellis in public, he has never been enthusiastic about giving state support to Fiat or the auto industry, analysts said.

"There was really no great love between Berlusconi and Gianni Agnelli when he was alive," said Sergio Romano, a former Italian diplomat and columnist for Corriere della Sera, a leading newspaper. When Fiat faced a cash squeeze in 2002 and looked to Berlusconi for a bailout, "there was no indication whatsoever of his desire to help," Romano said. Like Germany and other European countries, the Italian government approved a cash-for-clunkers subsidy this year to encourage car buyers to trade in old models for new ones, a program that has benefited Fiat. But officials in Rome have said the automaker should not expect any direct handouts. "At the moment, I think we can say no to that," said Benedetto Della Vedova, a member of Parliament from Berlusconi's party.

Italy's Fiat workers march in Turin to defend jobs
Thousands of workers from Italy's auto group Fiat marched through the streets of Turin on Saturday shouting for job guarantees as the company moves to create what would be the world's second-biggest auto maker. Blowing whistles, sounding horns and waving banners, the protesters from factories around the country vented their fears that ambitious deals planned by Fiat with Chrysler and General Motors could lead to plant closures and job losses. Trade unions claimed 15,000 workers gathered at Fiat's headquarters in the northern Italian city, while police put the total nearer 3,000. The most vociferous groups came from the Pomigliano plant in Naples, which has a history of militancy. "We've been at home on reduced pay for almost a year," said Pomigliano worker Milena Giammattei. "Fiat has never answered any of our concerns."

The Italian car maker is seeking alliances with Chrysler and General Motors Corp's European unit Opel in an expansion strategy to weather the downturn in global auto markets. Many workers appeared more angry with Silvio Berlusconi's centre-right government for not calling on Fiat to begin talks with unions than with the group's Chief Executive Sergio Marchionne, who won some praise for his expansion strategy. Marchionne said on Friday he was ready to talk with Italian unions after making more progress in negotiations with Opel, but workers fear that will be too late. "We want a meeting now between the prime minister, Marchionne and us, not when they have already decided everything," Giorgio Cremaschi, the head of Fiat's main trade union, the FIOM, told Reuters. U.S. and German unions have so far appeared to be putting up stronger opposition to the deals, fearing they have more to lose than the unions in Italy.

Marchionne, who took the helm in 2004, got rid of many white collar workers at the group when he arrived in 2004 and saved blue collar workers, leaving him respected with a less antagonistic relationship with unions. In newspaper interviews on Saturday, Economy Minister Giulio Tremonti and Industry Minister Claudio Scajola both said they had received commitments by Fiat not to cut jobs in Italy, but the marchers seemed far from convinced. "Fiat's planned alliances are positive... but we need to know about our future and how central to Fiat Italy is going to be," said Marco Roselli, a worker at the southern Melfi plant.

"Marchionne is far-sighted but we don't just need the brains (of the group) in Italy, we also need the arms and the legs." Ernesto Gado, from Turin's Mirafiori plant where the march began, said the factory now employed just 15,000 blue collar workers compared with some 70,000 in the 1960s and '70s. A Pomigliano worker who gave his name as Mimmo said if the plant closed the livelihoods of 25,000 families would be at risk and the only alternative for many of them in the poor southern region was offered by organised crime. "After Fiat the only thing left is the Camorra," he said, in reference to the notorious Neapolitan mafia.

Volkswagen Cancels Porsche Merger Talks for Indefinite Time
Volkswagen AG, Europe’s largest carmaker, cancelled talks with Porsche SE about the merger of the two automakers for an indefinite length of time, citing the absence of a “constructive” atmosphere. “We want to make it clear that there is currently no atmosphere for constructive talks, and that it’s completely open when talks can continue,” Volkswagen spokeswoman Christine Ritz said today in a telephone interview. “We are under no time pressure at all.” She declined to comment further. Both companies earlier in the day said a merger meeting due to occur tomorrow had been called off. Stuttgart, Germany-based Porsche, however, also said that talks between the two companies were continuing and further meetings will be held.

Volkswagen Supervisory Board Chairman Ferdinand Piech said last week that Porsche must trim debt before it can complete a merger with Volkswagen. Volkswagen “won’t solve” Porsche’s net debt, which tripled in six months to 9 billion euros ($12.2 billion) as of Jan. 31, Piech said. Porsche owns about 51 percent of Wolfsburg, Germany-based Volkswagen. The Porsche family is upset over Piech’s comments and concerned they may hurt the value of the carmaker, Der Spiegel said on its Web site yesterday, without saying where it got the information. When asked about whether Volkswagen would pay 11 billion euros for Porsche AG, Piech said the figure was “definitely a few billion too high,” according to the German magazine.

Porsche has fallen 21 percent this year, valuing the company at 7.21 billion euros. Volkswagen has declined 12 percent, valuing it at 69.6 billion euros. Porsche said yesterday it will hold a supervisory board meeting of its own tomorrow. The Piech and Porsche families, who control the maker of the 911 sports car, agreed May 6 to create a combined company with Volkswagen. Porsche workers will hold their first-ever strike tomorrow to protest Piech’s plans for a takeover by Volkswagen, Focus reported yesterday, without saying where it got the information. Porsche spokesman Albrecht Bamler said the situation may become clearer tomorrow. He declined to provide more details.

Paulson’s Complaint
Lehman Brothers disappeared with Hank Paulson's reputation. He wants it back

Hank Paulson, former master of the universe, sits in a nondescript office in northwest Washington, D.C. He is trying to work on his memoirs, but he is struggling. He doesn't seem like the onetime All-Ivy tackle at Dartmouth, the Harvard M.B.A. who ran Goldman Sachs, the prince of Wall Street who went on to be come secretary of the Treasury. He comes across more like an athlete who has lost a game and can't stop talking about the dropped pass, the missed shot. He is trying to explain the weekend last September when Lehman Brothers went down—and the financial world collapsed. The conventional wisdom, he admits, congealed quickly: it was a mistake for the government to let Lehman die, and the blame rested squarely with Hank Paulson. On the day that Lehman filed for bankruptcy, Paulson had tried to get out ahead of the story. If Lehman couldn't save itself, he told reporters, then he wasn't about to ask the taxpayers to step up. "I never once considered it appropriate to put taxpayer money on the line," he said. The message was that the government would no longer bail out failing companies—that would just invite more foolish risk-taking. It would create a "moral hazard."

But of course, in the weeks and months since the fall of Lehman Brothers, the government has gone on to bail out banks and other financial firms to the tune of hundreds of billions of dollars. So why didn't it save Lehman? If only the government had rescued Lehman, a financial panic could have been averted. Or so the story goes. The narrative was set from the beginning by Paulson's moralizing tone, followed by a market crash—and, as the once mighty bankers crawled out of the wreckage, the anguished testimony before Congress of Dick Fuld, the CEO of Lehman, who portrayed Paulson as a backstabbing Judas. "Until they put me in the ground," Fuld said, leaning into the microphone and baring his teeth, "I will wonder." Paulson insists that he did not turn his back on Lehman. "There's no company that I spent more time with and worked harder to save. That's sort of the irony of the narrative that we wanted them to go under," he told NEWSWEEK in one of his first extended interviews since leaving office. He also dismisses the argument that the fall of Lehman provoked a panic. "It is absolutely a fiction that Lehman was anything more than a symptom." He says a perfect storm of other near failures caused the financial crisis—the troubles at Fannie and Freddie, the news that AIG faced huge liabilities from its financial insurance gambles, the teetering of giant mortgage lender Washington Mutual on the edge.

All this is true enough, but it doesn't mean that Paulson knew what he was doing when Lehman went down. The panicked scenes that played out between bankers and policymakers during Leh-man's last days were recounted in the newspapers in the weeks that followed. But now, more than half a year later, and with the most acute moments of the financial crisis behind us, the key players are better able to reflect on the decisions they made. Perhaps no one has spent more time reconstructing the events than Paulson. In retrospect, it appears that Paulson was not the callous titan of Wall Street, but rather an earnest, sometimes bewildered man caught in a whirlwind he could not tame or even fully understand. He did the best he could, reaching, sometimes lurching for answers, but in the end he was rescued by the sort of nerdy professor type who might have been devoured on the trading floors of Wall Street. To the extent that there was a hero during those weeks, it was arguably Ben Bernanke, the quiet, shy chairman of the Federal Reserve, whose problem-solving and salesmanship before a skeptical Congress were critical to avoiding financial disaster.

Paulson was known as "the Hammer" as a 6-foot-1, 200-pound tackle on the Dartmouth football team because he seemed to explode at the snap of the ball. Tenacity and drive, more than brainpower, have distinguished his career. He has been a champion arm-twister and shrewd enough: when he rescued Goldman's IPO in the wake of the Russian financial crash in 1998 he made hundreds of millions for his partners and shortly thereafter became their leader. Yet Paulson can be oddly inarticulate for such a powerful man. He is not a Wall Street smoothie: no trophy wife (he remains married to his college sweetheart), and at Goldman he was known for wearing penny loafers, not handmade Italian shoes. He's an avid bird watcher. A nonsmoking, nondrinking Christian Scientist, he did not head for the Hamptons on the weekend but visited his mother in Barrington, Ill. Yet, physically imposing, radiating a confident forcefulness, he came to stand for the dominating Goldman brand. In the Wall Street hierarchy, Goldman is the smartest and most confident of them all: the firm makes bets, but only ones it feels sure to win.

The Lords of Goldman, who tend to come from Ivy League schools, looked down on the hustlers at lower-ranked firms like Lehman, who came out of state schools and the trading pits. Lehman was an old firm, but its modern incarnation was built in the image of its scrappy CEO, Fuld, who came from the trading floor and liked to make big, risky bets. Fuld was called "the Gorilla," a nickname some might have resented. Fuld kept a toy gorilla in his office. His ethos was us (the public-school guys—Fuld went to the University of Colorado) against them (the Harvard know-it-alls like Paulson of Goldman Sachs). Paulson and Fuld have known each other for years. For the record, as well as in private, Paulson describes Fuld as a "good guy" and even as a "friend." (Fuld declined to speak to NEWSWEEK). But knowledgeable Wall Streeters and government officials who asked to remain anonymous in order to speak more freely say that Paulson regarded Fuld as a gambler who lost sight of reality.

Paulson began having his doubts about Fuld—and the future of Lehman—as early as October 2007, when Lehman made a big bet on commercial real estate even though there were signs the deal was unwise. Paulson remained dubious about Leh-man's rosy earnings reports for the first half of 2008, and when the red ink began to show in June, he began urging Fuld to scale back Lehman's leverage and find a buyer or a fresh infusion of capital. He was frustrated, say these knowledgeable sources, when Fuld stubbornly demanded terms that were too favorable to Lehman to attract any buyers or investors. Fuld's 31st-floor midtown office had sweeping views of the Hudson River and the New York City skyscrapers. In early September, the executive suite of Lehman Brothers became a kind of war room; day and night, Fuld's lieutenants padded about, munching M&M's and chugging Diet Cokes, as they searched, with growing desperation, for a solution. A South Korean bank had seemed interested in investing, then backed off.

Fuld and his men tried to stay hopeful. Six months earlier, in March, JPMorgan had rescued the failing investment bank Bear Stearns—with the help of a loan from the federal government. In early September, the Feds seized control of Fannie Mae and Freddie Mac, the two mortgage giants sucked down by the collapsing real-estate market. Surely, the Lehman team believed, the Feds would step in to help—if Lehman could only find a buyer. Paulson does not seem to have grasped the urgency of the looming disaster. Although top financial experts were warning about the housing bubble back in 2006, Paulson—by his own admission—was not paying much attention to the way banks were slicing and dicing mortgages and selling them as complex securities. "I didn't understand the retail market; I just wasn't close to it," he told NEWSWEEK. But while he was at Goldman, he had lobbied Congress—successfully—for new rules allowing investment houses to at least double the amount of leverage they could carry.

In September, Lehman reported huge third-quarter losses, totaling nearly $4 billion. Two days later, the Feds stepped in. On Friday, Sept. 12, the heads of the Wall Street investment banks were summoned to an emergency meeting at the New York Federal Reserve. The black Town Cars began pulling up to the fortresslike Fed, which sits atop much of the nation's gold reserve, around 6 p.m. Paulson was there, along with Tim Geithner, president of the New York Fed. The century-old building was going through asbestos removal, so Paulson had to set up his command center in a makeshift conference room. "The furnishings were like a Ramada Inn in Toledo," recalled one of the participants, who, like the others who were there at the time, would not speak for the record because of the sensitivity of the negotiations. Paulson told the assembled Wall Street chieftains that it was up to them—not the taxpayers—to find a solution to the Lehman mess.

Back at Lehman, no one really believed that the Feds would stay on the sidelines. They thought Paulson was bluffing. But he wasn't. Paulson would later say that he was powerless—that under the laws governing the Federal Reserve, the government could not make a loan to an investment bank that lacked the necessary collateral. Paulson believed that Lehman had a multibillion-dollar hole in its balance sheet. There was not nearly sufficient collateral. Federal Reserve chairman Bernanke took the same view. To this day, former Lehman officials insist to NEWSWEEK that Paulson and Bernanke never told them that the Fed was required by law to stay out of the game. Speaking not for attribution (because of pending lawsuits from disgruntled former shareholders), these Lehmanites recall a lot of talk from Paulson about moral hazard, which they regarded as posturing from a Goldman stuffed shirt.

Fuld did not attend the summit meeting at the Fed; the Lehman board instead sent his No. 2, Bart McDade. Fuld refused to accept the signs that the end was near. He stayed in his office at what he called "the Mother Ship," working the phones, searching for a white knight. On that same weekend, he was reaching out to Ken Lewis, chairman of Bank of America. B of A was big enough to buy Lehman, and Lehman offered the giant bank a chance to get in the Wall Street game with a veteran player. But as Friday night dragged into Saturday, Lewis was not calling back. "Dick didn't understand," recalls a colleague who was there. According to this person, Fuld kept asking, "What's the story? Why is he not calling me? What's happening here? I don't understand it." Even in the cutthroat world of dealmaking, calls are usually returned, if only to say no. Fuld thought Lewis was being rude. Unknown to the Lehman team, Lewis had been buying a Wall Street firm that day—just not Lehman Brothers. The chairman of the Bank of America had been secretly closeted with John Thain, the chairman of Merrill Lynch, at B of A's corporate apartment in the Time Warner Center. Merrill, like Lehman, was in deep financial trouble. But Merrill employed a vast network of retail stockbrokers that made it an attractive target for B of A.

Another important person was not returning Fuld's calls that day: Hank Paulson was suddenly nowhere to be found. (Fuld was calling "every 10 minutes," according to a former Treasury official who was present.) Later, the Lehmanites suspected that Paulson had quietly encouraged Thain of Merrill to meet with Lewis of Bank of America, and they saw a plot. Thain, like Paulson, is a Goldman Sachs alumnus. Some on the Lehman team later groused that the Goldman men had gotten together to stab Lehman in the back—to ruin Lehman's courtship of Bank of America by secretly arranging the marriage of Merrill and B of A. To NEWSWEEK, Paulson rejected this notion, though he acknowledged that he did encourage Thain to speak to Lewis—simply because Merrill was in trouble, too.

Never known for giving up, Fuld had one more card to play—with Barclays, a well-known British bank. Indeed, as late as Sunday morning, some of Fuld's lieutenants believed they had a deal. But complications arose: the British government was balking, and Barclays shareholders had not been given a chance to meet. Time was running out. Sunday evening, Lehman's McDade returned from all-day meetings with other Wall Street barons and top government officials at the Fed with some very bad news: the government wanted Lehman to declare bankruptcy—that night, before the markets in Europe and Asia opened. "I can't believe it," Fuld said when he learned the Barclays deal had fallen through, according to someone who spoke with him about Lehman's position late Sunday. A call came from Christopher Cox, the head of the Securities and Exchange Commission. Over the speakerphone, Cox informed the Lehman bosses, "You have a grave responsibility." The Lehman executives were aghast. They knew that the consequences of a bankruptcy would be severe—that Lehman would default on debts owed to big Wall Street players. Paulson also knew the consequences would be serious. But none of the top federal officials foresaw just how bad it would get—money markets so severely hit that, for a time, it seemed that massive, global bank runs were a real possibility.

They were saved by the quick thinking of the chairman of the Federal Reserve. Ben Bernanke is so mild, his voice is gentle and sometimes quavery. He grew up in a small South Carolina town and spent his life as an academic. But Bernanke's academic specialty was the Great Depression, and the lesson he learned, above all, was that the federal government could not afford to wait to step in. In the days after the fall of Lehman, Bernanke basically threw open the banking window of the Fed and poured out $1 trillion in loans. "People are referring to you as 'The Loan Arranger,' with your faithful companion Hank," Barney Frank, the irrepressible chairman of the House Financial Services Committee, told Bernanke. The frontman remained Paulson, who seemed to stumble about through late September and early October. It was Bernanke who persuaded Paulson to go to Capitol Hill for massive bailout money, but it was a very tough sell, and Paulson nearly blew it. Congress originally rejected the bailout and approved it only with last-minute revisions—and after the stock market had plummeted.

Bernanke's low-key but incisive manner worked better with lawmakers than Paulson's bluster. With the House resisting Paulson's proposal to give him virtually unlimited authority to disperse funds to banks, House Speaker Nancy Pelosi announced that she was getting ready to leave town the weekend after Lehman's collapse and would be back Monday. Bernanke quietly but forcefully piped up, "We may not have an economy on Monday." Paulson is proud that he and Bernanke were able to prevent the entire global financial system from collapsing, through their emergency use of the Treasury's Exchange Stabilization Fund and Fed guarantees that kept money-market funds afloat. "If we hadn't come up with that, whoa," says Paulson.

At Lehman, the story is over—but not quite. Many of the Lehman traders found jobs at Barclays, where they trade today. The atmosphere is not quite the same. No one wears neckties, and there are no longer Brazilian shoeshine boys walking the rows of trading consoles, offering a shine for $10. But when the traders answer the phones, they sometimes still defiantly shout, "Lehman!" Paulson's book, which will be published in October by Business Plus, will play down Lehman's fall and play up the steps taken by the government to save the economy. And in some ways, he's right. Though Lehman's collapse traumatized policymakers and banks for months—no one talks about moral hazard any more— it was mainly a sideshow to a larger crisis. Off the football field, the Hammer, it appears, was sometimes more of a nail.

Bankers Bounce Back
There are probably good reasons to give Richard Fuld a job at the hedge fund Matrix Advisors. He is familiar with byzantine financial products: Lehman Brothers, the bank he used to run, gorged on them until it collapsed. He might know them enough to be more careful around them the next time. Still, I can’t get over just how flawlessly bankers bounce. Charles Prince, fired for steering Citigroup toward financial collapse, found a new job as vice chairman of Stonebridge, a consultancy firm. Stanley O’Neal, who was given a $161 million parachute before being dumped for leading the toxic asset binge at Merrill Lynch, just joined the board of American Beacon Advisors, a financial advisory company. I wonder whether it wouldn’t be a better choice for these men to take a break.

People’s sense of justice is anchored to an expectation that providence will ultimately mete out retribution to those who wrong us. It doesn’t necessarily require an eye to be taken for an eye. But the public outrage over the multimillion-dollar bonuses paid to the financial wizards at A.I.G. suggests that people have trouble absorbing bankers’ uncanny ability to keep landing in finance’s glittering fold while regular mortals are left to suffer from the economic fallout they unleashed. Sure, the United States prides itself on being the land of second chances. But the desire to punish wrongdoing runs deep. Evolutionary biologists suggest it was necessary for the flourishing of altruism — the willingness to share resources even at personal cost — which otherwise would have been driven out of the gene pool by egoists who would have hogged all resources and starved the selfless.

Today, public anger requires government officials to publicly excoriate bankers every time the government gives the banks more public money. If the banks need even more, President Obama will have to figure out a way to brave that fury. Given the raw feelings, it wouldn’t hurt if one or two of the current crop of jobless bankers went off to distribute malaria nets in Africa or teach math in an inner-city high school. They could even use some of their money. Michael Milken set up a foundation and started a think tank, and today a lot of people think of him as a philanthropist rather than as the junk bond king who was jailed for securities fraud. For the next couple of years, maybe, I would also stay away from shorting G.M. or cornering oil futures.

Ilargi: Bill Black takes far too much time to explain the core of what he has to say. That's a shame, because his point is very interesting. In his defense, they flew him all the way to Iceland for the talk, and while 10 minutes would be enough for the essentials, it undoubtedly wouldn't have sufficed for those who paid to hear him speak. His message: Economists don't recognize fraud as a factor in how their field functions (and fails to). Which, given the prevalence of fraudulent activities, is so silly as to makl their models obsolete.

William K. Black: Why economists must embrace the "F" word

There's worse to come and jobs do not spring up like green shoots
I am not sure that David Cameron's former boss knew what he had started when he referred to the "green shoots" of economic recovery. The reference, of course, is to former Chancellor Norman, now Lord, Lamont at the Conservative party conference in 1991. Hardly an article on the economy these days is complete without a reference to Lamont's "green shoots". This is not just the case in England, with its magical spring. "Green shoots" crop up in much overseas coverage of the world economic situation. Lamont believes to this day that he got his timing right with the phrase, although not everybody agrees with him, and it was slightly unfortunate that he claimed to see green shoots unseasonably in the autumn. In fact firm evidence of recovery did not appear until 1993, with the boost to the economy from the devaluation and lower interest rates that ensued after Black Wednesday in September 1992.

The green shoots phrase is more appropriate to the present season, at least in the northern hemisphere. But I fear that, seasonal though it may be, it is dangerously misleading in the present economic context, both with regard to the UK and much of the developed world. Indeed, much of the present debate seems to me to be missing what is probably the most important consequence of the concatenation of economic and financial misadventures which has led us to where we are. That consequence is that on both sides of the Atlantic and English channel there is a serious unemployment problem which will almost certainly get a lot worse and which could have disturbing social and political implications. Of the two sessions I witnessed with leading central bankers last week, the prospect was alluded to by our own Mervyn King, and referred to more specifically by Professor Axel Weber, president of the Bundesbank.

King, no stranger to publicity these days, received plenty of coverage for his downbeat assessment of the economic prospect when he unveiled what is still called the quarterly inflation report but is in fact an economic document covering a lot more than its title suggests. I have no idea whether the governor believes in an afterlife, but on the economic outlook he did his best to present himself and his Bank colleagues as agnostics when it comes to telling whether the British economy will be expanding or contracting next year. Yes, there were solid reasons for expecting a rebound in the short term - there is the huge fiscal and monetary stimulus, a devaluation which is encouraging what economists call "import substitution" and an expectation that, having met dwindling demand from stocks rather than production, manufacturers should now be gearing up.

"On the other hand," said King - we economists love our other hands - "there are also solid reasons for supposing that a sustained recovery will take considerably more time. This recession is different in nature from earlier downturns in the postwar period". Banks, businesses and "consumers" are rebuilding their balance sheets. Debts are being paid, and there is not much credit around. "The supply of credit will continue to be restricted for some while, with banks being risk-averse and aiming to raise capital ratios." There are many other reasons for pessimism. There is the general mood of "austerity" that now seems to pervade the nation. There is the fact that wage earnings are being squeezed, which does not exactly assist purchasing power and demand, and the rather telling statistic that a reduction in City bonuses has had a dramatic negative impact on average earnings in the country as a whole.

This brings me to an interesting study by Dick Sargent, a former Treasury adviser and economics professor, who recently asked "Were we too beastly to the unions?" in reference to what happened in the 1970s and afterwards. Sargent's thesis is that it is not surprising that the unions became restive in the 1970s, because their real wages were being heavily squeezed after two decades of comfortable growth. He highlights the strong trend of business investment in the 1950s and 1960s, and the slowdown in the 1970s. Fast forward to today, and there is great concern at the Bank of England and elsewhere about the negative impact that the shortage of credit and the dim prospects for consumer demand is likely to have on research and development and new investment, essential elements in economic growth. Which brings us back to unemployment, and the grim warning from Professor Weber in the Mais Lecture last week at the City University's Cass Business School.

Having contradicted those US and UK economists who argue that Germany has not taken much fiscal action - he said the fiscal stimulus in Germany amounts to 6% of GDP this year and next - he nevertheless claimed that policymakers "cannot offset the downturn" adding that "at best it can be mitigated". But Weber warned that "the major bad news is still to come" . He said that the main challenge facing policymakers was how to manage the employment (ie, unemployment) impact of the largest postwar recession. I agree. As a result of the recession of the past two quarters, unemployment in the UK and continental Europe is likely to go on rising for the rest of the year. And if the "recovery" is as anaemic as both the Bank of England and the Bundesbank seem to expect, unemployment will be the big issue well into next year. The Conservatives should be facing up now to what they are going to do about it. Cutting public spending, their current obsession, is certainly not the answer.

Bailed-out bank directors hit the pensions jackpot
More than 20 former bank directors are benefiting from staggering retirement plans, with actual or potential pension pots worth a combined total of more than £111m. These are paying out yearly pensions of £6,430,000 between them. The findings are part of a damning new exposé of some of Britain's top bankers to be broadcast on Channel 4's Dispatches programme tomorrow. The select group of wealthy bankers will remain unaffected by the economic catastrophe facing millions of Britons. Many have already been able to give up work years ahead of state retirement age. Experts have analysed the pensions of a number of former directors of British banks, many of which were only saved from collapse by state bailouts. The biggest beneficiary is former Royal Bank of Scotland director Larry Fish, who has a pension pot of £18m, paying out £1.5m a year. Unlike the former RBS chief executive Sir Fred Goodwin, he has managed to maintain a low profile up to now, as he used to run the bank's American operations.

Other bankers with pension pots of more than £1m include: Richard Banks, Richard Pym and Chris Rhodes (Alliance & Leicester); Steve Crawshaw and Chris Rodrigues (Bradford & Bingley); Peter Cummings, Colin Matthew and Phil Hodkinson (HBOS); David Baker, Robert Bennett, Keith Currie, David Jones and Andy Kuipers (Northern Rock); and Johnny Cameron and Mark Fisher (RBS). The analysis also established that the true value of Sir Fred Goodwin's pension pot could be, in fact, almost double the previously stated figure of £16m. According to pensions expert John Ralfe: "The official numbers that Royal Bank of Scotland has come out with is that his total pension pot from the age of 51 to the expected death is about £16.9m. I think that is a gross understatement. If I wanted to go along to a third-party pension provider and get the sort of pension that Fred Goodwin is on – £700,000 and that goes up in line with inflation, of course, each year – I would have to pay something in the order of £28m."

The contrast with the pensions given to rank-and-file banking staff could not be greater. Dennis Grainger, who worked at Northern Rock for a decade, is entitled to only £700 a year. "I'm so disgusted with this I've turned it down," said Mr Grainger. Vince Cable, the Liberal Democrat Treasury spokesman, has attacked the scale of the rewards: "What makes people really, really angry is that these people were exceptionally well paid, got enormous pension pots and other payments, despite the fact that they have failed and they have failed their shareholders, failed their employees and failed the taxpayer, and they are walking away with their millions." The large payments are not limited to pensions. Bank bosses have seen their average salaries rise from £800,000 in 2006 to more than £1m in 2008 – 20 per cent more than the average pay packet of chief executives in other sectors. They now earn £255,000 a year more than their FTSE-100 counterparts. Fees paid to non-executive directors of banks have also risen. In the case of the RBS, non-executive directors have seen their fees almost treble in less than a decade, from £25,000 a year in 2000 to £73,000 a year in 2008. Mr Cable has denounced bankers' pay and perks as "the kind of things you would associate with absolute monarchies in the days of the Bourbons in France".

Sir Fred Goodwin
Even after cashing in £2.7m of his pension, he gets £550,000
Sir James Crosby
Will start reaping rewards of £10.4m pension pot in 2011 £572,000
Lawrence Fish
£18m pension fund yields over a million every year £1.5m
Adam Applegarth
In 2022 he will be able to claim his full yearly pension £305,000
Andy Hornby
The former HBOS chief can take his pension at 50 £240,000
Michael Fairey
Opted to take his entire £7m pension pot as a lump sum £280,000

New reality dawns in eastern Europe
Eastern Europe's heady economic "miracle" may never return, leaders from the region were warned this weekend, at a sombre meeting of the European Bank for Reconstruction and Development, the London-based lender that funds development in the former communist states. Thomas Mirow, the EBRD's president, and a former German deputy finance minister, told ministers and central bankers at its City headquarters that it would be "unrealistic" to expect a repeat of the "double-digit growth, record levels of investment and readily available finance", of recent years. From fizzing along at an average rate of about 7% GDP growth in 2007, the EBRD predicts that the countries on its patch will suffer a painful 5% contraction on average this year - and cash-starved banks could slow recovery.

Before the credit crunch, private capital was flooding into Hungary, the Czech Republic and the tiny Baltic states, as investors banked on an inevitable "convergence" with mature European economies. Now several, including Hungary, have been forced to turn to the International Monetary Fund for emergency bailouts, and few see much hope of an imminent upturn. Grim news from Germany on Friday, where GDP contracted by 3.8% in the first quarter of the year - more than twice as fast as the UK - underlined the challenge facing nearby exporters. Delegates in London strolled past posters hailing EBRD investment projects across the region, from waste plants to power stations, to country briefings extolling the virtues of the region's economies as safe havens for investment. But there was also plenty of soul-searching about how much of the prosperity of recent years was a mirage.

The EBRD has been a champion of privatisation, public-private partnership and capital market liberalisation, and non-governmental groups claim that it is continuing to push this free-market agenda without learning the lessons of the credit crisis. Bankwatch, a thinktank that monitors the development lenders, last week accused the EBRD of "seeking to bail out corporate casualties and entrench failing development models", using taxpayers' cash. However, Mirow insisted that governments in the region would now have to re-examine how to build a successful economy. "A fundamental question is the future role of the state in the economy." Erik Berglof, the EBRD's chief economist, said the crisis had revealed major holes in the framework of rules and regulations in financial markets. "The gaps were just staring out at you."

Tim Besley, the LSE professor who sits on the Bank of England's monetary policy committee, said during a debate about the future for the region's economies, "We're going through a period of really quite striking de-globalisation in both goods and capital markets, and it's impossible to know whether this is a temporary blip or the beginning of a more protracted reversal." Not so long ago, the future of the EBRD, which was set up in 1991 to help rebuild the shattered economies that had emerged from behind the Iron Curtain, looked uncertain. Some of its shareholders, including the US, were sceptical about the advantages of propping up competitive economies in eastern Europe, and there was even a suggestion that it should pay out dividends to its investors - governments around the world - and start scaling down operations.

"There will be no discussion this year about how long the bank will be needed," Mirow said. It expects to make loans worth €7bn this year, and there are growing suggestions that an injection of fresh capital from its shareholders might be required, so that it can boost its operations in the years ahead. The IMF saw its resources tripled at Gordon Brown's G20 summit last month. The EBRD's most recent intervention was a €430m loan to support Unicredit, the largest bank in the region, replicating the banking bailouts in western economies and allowing it to keep up the flow of loans to businesses. Other financial institutions are expected to join the queue for help. At a briefing to reporters, Mirow said: "Looking at the mechanisms of financing, and at the balance sheets of banks, and taking into account stronger regulation and more demanding capital requirements, I would assume that it will take three or four years before we might see capital flows, if at all, that we have seen before the crisis."

Privately, EBRD experts admit that with funding from banks and investors likely to remain scarce for years to come, it could be propping up firms across the region for up to a decade. Mirow said many of the lessons to be learned in eastern Europe were similar to those in the rest of the world: "Take care not to have too much credit growth; look for a sustainable loan-to-deposit ratio; don't take too many credits in foreign currencies if you have a currency that is vulnerable and can come under pressure in crisis times; take care of your real estate sector and take care that you don't get a bubble."

European unions protest in Prague against crisis
About 20,000 labor unions members from the Czech Republic and other European countries rallied in Prague on Saturday to demand better protection for workers during the economic crisis and protested proposed measures against it. The protesters, joined by colleagues from Germany, Italy and France and eight other countries, gathered outside Prague Castle. "We have to do the maximum, including staging demonstrations to prevent the economic crisis to be misused against those who are not responsible for it, that is common citizens," said Milan Stech, who heads the country's major trade union umbrella organization. The speakers targeted recently proposed changes to the country's labor code, which were meant to help the economy combat the crisis, and claimed they were not acceptable for them as well as a reform of the pension system.

The proposed changes in the labor code, among others, they said would make it easier for employers to fire workers. The protest was part of coordinated efforts by European labor unions organizations to demand more action to protect their jobs during the economic downturn. Similar demonstrations took place in Madrid and Brussels earlier this week and another was planned for Saturday in Berlin. The export-oriented Czech economy has been hit hard as its major trading partners, including Europe's biggest economy, Germany, face deep recession. Unemployment grew to 7.9 percent in April and the economy contracted by a record 3.4 percent in the first quarter of 2009. "A responsible person has to do something," said Vlastimil Jura, 53, who traveled from the northern town of Varnsdorf to attend the rally. "We do mind that someone wants to harm working conditions."

Singapore firms turn to bartering
In northern Singapore, among many residential flats, there stands a huge six-storey building called Northlink. It houses more than 500 small to medium sized businesses, or SMEs. They are the backbone of Singapore's economy, and yet they are the hardest hit by the current recession. Since the global credit crunch spread to the city state, banks became nervous to lend - especially to SMEs. Alarmed by the situation, the government has announced that it will spend almost $4bn (£2.6bn) to stimulate bank lending in the budget. But Singapore is experiencing its worst downturn in its history, with the economy forecast to shrink by much as 10% this year. And the freeze in credit markets is not yet thawing. So businesses are turning to alternative methods to pay their bills, a tactic once considered a last resort, namely the age old practice of barter trade.

On the top floor of Northlink building, manager Malvin Khoo is busy finalising deals with his clients. He owns a Singapore based printing and packaging firm that employs 15 people. "The greatest thing about bartering is I could be ordering a jumbo jet, or a yacht tomorrow," he quips. Obviously, that is "quite unlikely", he laughs, though he has managed to use a property in Malaysia to barter with. "It is the cheapest way to expand my business." Mr Khoo joined Barterxchange, a network of 600 businesses in Malaysia and Singapore, 18 months ago. Instead of simplistic one-to-one direct exchange of goods and services, members go online. Forget cash. They have their own universal currency. Companies earn credits by offering their services and skills. They can then use them to get what they need from other members.

"I had some customers that I did packaging for, who had surplus plates," explains Mr Khoo. "So I structured to trade $20,000 worth of plates to restaurants. Some of them were just opening up so they needed new plates." In return, Mr Khoo scored free meals at various restaurants. One of them is Megumi Japanese restaurant, which has sold dining vouchers worth more than $10,000. "Not only did we get free webpage design and printing services by bartering, we also got some tremendous exposure to the business community," says managing director Hazel Hok. "We used to be a local neighbourhood restaurant, but we have seen a significant increase in corporate functions."

And there is no geographical boundary. Asia's biggest barter trade site is connected to more than a dozen global websites, where half a million companies participate. "We have even sent electronic goods to Nigeria," says Lee Oi Kum, executive chairman of Barterxchange. The industry is now worth over $8bn annually, according to the International Reciprocal Trade Association. And its popularity is rising. Barterxchange has seen a 30% jump in its membership since 2007. Companies cannot operate solely by bartering. But it definitely offers alternative methods to make things a little easier.

Hands off our Arctic, Canada tells Europeans
In London, the lions of Trafalgar Square share space with the towering image of an Inuit woman and her child. In Paris, an inukshuk greets people leaving the Metro. In Oslo, Ottawa is opening an Arctic political office. And in Brussels, officials are fanning out to promote the image of a cold, northern Canada. The Harper government has launched an aggressive campaign across Europe to brand Canada as an "Arctic power" and the owner of a third of the contested land and resources of the Far North. Ministers and ambassadors have been instructed to deliver a strong message, through every channel available: Canada owns it; hands off.
This new assertiveness has caught European and Russian officials off guard as Ottawa pushes to fend off attempts by other northern powers and the European Union to claim stakes in the Northwest Passage and the open seas of the High Arctic.

While this involves hard diplomacy, such as Canada's leading role in a move to exclude the EU from sitting on the Arctic Council, Mr. Harper's officials have also ordered embassies abroad to mobilize their cultural resources to deliver this policy message, to create a visual image of a fully Arctic Canada. The stakes are high. Yesterday, Russia released a report arguing that Arctic resources could spark military confrontations, and Canada recently released a major atlas of the Arctic, the result of research intended to back claims of Arctic land ownership under the United Nations Convention on the Law of the Sea. "Canada is an Arctic nation and an Arctic power," Foreign Minister Lawrence Cannon told European leaders in Tromso, Norway, at the end of April, while directing his diplomats to adopt an assertive new language around Canada's Arctic possessions. Under his instructions, the new phrase "Arctic power" has begun appearing in communiqués and speeches.

The message for Europe's leaders and citizens is simple and abrupt: The Arctic is not up for grabs. "Through our robust Arctic foreign policy," Mr. Cannon said, "we are affirming our leadership, stewardship and ownership in the region." The word ownership is key. As Arctic jurisdictional disputes make their way through the United Nations, Ottawa wants to assert its claim to be owner of a third of Arctic land, ice and water, as well as any oil and minerals that happen to lie below. That is by no means a settled matter. The European Parliament recently stated that it is interested in an international treaty on the Arctic, like the one that governs the Antarctic. The United States and Europe both dispute Canada's claim that the Northwest Passage is purely in Canadian territory. France now has a polar ambassador, former prime minister Michel Rocard, even though France's northernmost point is 1,500 kilometres from the Arctic Circle.

And Canadian officials believe that Europeans are hearing a far stronger message from Russia, which has aggressively industrialized and militarized the Far North and claims ownership of the North Pole, than they are from Canada. Mr. Cannon led the fight to deflect the EU's attempt to become a "permanent observer" on the Arctic Council, which includes the eight Arctic nations: Canada, the United States, Iceland, Norway, Denmark, Sweden, Finland and Russia. While Europe's ban on Canadian seal exports was the excuse, officials said there are worries that the 27-nation EU will try to interfere with agreements among the Arctic nations. Ottawa is also about to open a Canadian International Centre for the Arctic Region in Oslo. This will be an overtly political institution, designed to counter the messages being sent by Europe and Russia. Mr. Cannon announced that the centre, which will also play a research role, will primarily serve to "promote Canadian interests" and "influence key partners" on Arctic-sovereignty issues.

Behind closed doors, Canada's relations with its Arctic neighbours are actually fairly co-operative these days, in large part because all the Arctic nations agreed last year to settle their disputes using the UN Convention on the Law of the Sea. While Mr. Harper and Mr. Cannon have used Cold War-style rhetoric to publicly excoriate Russia for its expansionist ambitions, in private Canada's diplomats have begun meeting again with Russia, after a period of silence, albeit to a limited degree. And Nordic and Canadian diplomats say that the Arctic Council members agreed on most important matters last week. That is partly because the Arctic has become a closed club, and the new threat to its integrity comes from outside. "Europeans need to learn that the Arctic is not terra incognita, it is not like the Antarctic," said Peter Harrison, who until last year was the senior federal bureaucrat responsible for Arctic affairs, and now holds a position at Queen's University.

"Many people in Europe believe they should take a role in governing areas that are not anyone's territory. Well, the Arctic happens to be owned by the countries around it, and a third of it is in Canadian territory,"
To get that message across, Canada is devoting a sizable share of its European cultural-diplomacy resources on highly visible projects designed to persuade Europeans that Canada is, and always has been, a northern-oriented country with a human presence in the Arctic. This is partly intended to correct the image of an open and up-for-grabs Arctic that Mr. Cannon believes is held by many European citizens and leaders. But it also helps establish a "use it or lose it" principle under international law: If sovereignty is challenged in parts of the Far North, Canada needs to show that it has had an active state and citizen presence there. By displaying images of Canadians living and working in the Arctic, Canada establishes a "boots on the ground" reality in European minds.

This is the new public face of Mr. Harper's northern strategy, a government-wide campaign to expand and defend Canada's ownership of its share of the Far North. At home, this involves setting up military bases in the Arctic, patrolling the territory with aerial, satellite and human surveillance, and expanding into the thousands the size of the Arctic Rangers, a semi-volunteer force that sends "sovereignty patrols" into the Far North. And overseas, it involves publicizing this human presence on the ice as widely and strongly as possible, making it appear to be established Canadian territory. At a meeting in Copenhagen last year, the major Canadian embassies in Europe agreed to launch co-ordinated Arctic-oriented cultural campaigns to deliver Canada's message of assertive Arctic proprietorship. Under the rules of the Harper government, cultural programs abroad must be used to advance policy goals, and Arctic sovereignty is considered a top goal at the moment.

This has led Canada to sponsor or organize a bonanza of polar events in Europe, beginning this season. In Trafalgar Square, Canada House has been given over to a widely publicized exhibition devoted to the art, people and general Canadian-ness of Nunavut; similar exhibitions are taking place in France, Belgium, Germany and Norway. The message isn't subtle. Visitors are told explicitly that the Inuit dancers, sculptures, photographs and tapestries are being shown to "promote Canada's Arctic foreign-policy priorities." It also means inserting those priorities into museum exhibitions. Later this month, the London high commission is sponsoring a major exhibition at the Royal Maritime Museum in Greenwich devoted to exploration of the Northwest Passage. The sponsorship is meant to deliver the message that the passage is now fully Canadian territory, not international waters.

Paris is one of several cities to play host to Canadian government events commemorating the 10th anniversary of the territory of Nunavut, including art shows and numerous visits to European countries from Inuit leaders. Governor-General Michaëlle Jean has recently completed a tour of Norway, and several other Arctic programs will be under way this summer across Europe. These projects risk clashing with Canadian tourism and investment campaigns designed to show that Canada is a modern, urban country with close ties to U.S. markets, and with arts organizations that are discovering that non-Arctic projects are not a priority in Europe at the moment. But the policy goal is considered paramount. The Russians have taken a leading stand in claiming ownership of contested Arctic territory, with President Dmitry Medvedev telling his country's military leaders last fall that Russia's "first and fundamental task" is to "turn the Arctic into a resource base for Russia in the 21st century."

While Russia and Norway have sizable populations living in the Arctic and considerable industrial and military developments, Canada needs to make a more creative claim of its presence there, officials say. To that end, they have borrowed a strategy from Norway, whose Arctic agenda, beginning in 2002, set out to promote the Nordic country as a predominantly Arctic place. Norway devotes considerable diplomatic energy to promoting its Arctic image, bringing foreign visitors for tours of its highly populated cities above the Arctic Circle, and building institutions to bring Arctic nations together. The reason, Norwegians say, is that there is a worry that if they don't claim the North, other nations will do it instead. "After the end of the Cold War, the relevance of the Arctic really fell to a minimum with many administrations," said Kristine Offerdal, a fellow with the Norwegian Institute for Defence Studies. "That's why Norway really began pushing the Arctic agenda so much: when our allies didn't have eyes on the region, there was a fear in the Norwegian government that our country would be marginalized."

The best way to secure its ownership of its Arctic regions, Norway's government realized, was to broadcast that ownership as widely and loudly as possible. "Norway felt a need to make itself more visible in the North, and to put Norway's High North region on the map in Washington and Brussels and other major cities." Mr. Cannon's new language is, in some ways, modelled after Norway's. On the other hand, it often takes on aggressive, threatening, even militaristic tones, such as on Thursday, when he rebuffed Russia's study about military confrontation over the Arctic by declaring on a visit to Asia that he would do anything to protect Canada's Arctic sovereignty. But much more of his money and energy are devoted to fending off possible challengers who don't own a piece of the Arctic.

"Much to my astonishment, there are still among some European member states people who think that there's nobody who inhabits the North, so therefore I've made a point of going to any international meeting, whether it be on Antarctica, the one that we had in Washington not long ago," Mr. Cannon said on Wednesday, in an interview with the Ottawa magazine Embassy. "Everybody previously said, 'Oh yeah, that's nice, it's the North.' Well, we're out there doing something about it, and, personally, this is one of my priorities." Because they see this international attitude as a problem, the Harper government, and all its ministers, diplomats and officials, have begun a program to send the world a message. In part it is an encouraging, positive message, designed to contrast Canada with Russia and make us sound like a credible voice on Arctic affairs. Canadian officials say they want to project an image of Canada as a responsible, more ecologically careful and aboriginally oriented steward of the Far North. But at its core is a far more simple and relentless message: It may be empty and cold and inaccessible, but it's got a red-and-white flag on it.


VK said...

So I gather relations between the Arctic power of Canada the EU just became a little frostier!

That Newsweek article on Paulson was blatantly trying to portray him as a better person. You don't become CEO of Goldman Sachs by being nice. Lehman was set up to fail by the boys at Goldman, it's amazing how everything always works out for them. Add power, money and influence and you have the recipe for luck.

Frank said...

@VK You nailed the two biggies in the list. Canada joining Russia in telling the EU to butt out, to the quiet applause of the other four arctic powers. (See, Obama is not dumb. He's letting Putin and Harper do the heavy lifting.)
And Newsweek whitewashing Hank Paulson. But notice, the best they can do is make him out a bumbler rather than a scoundrel.

Anonymous said...

@Frank re:rural vs. urban.

hemenway has refuted the types of claims that people make about his reasons for leaving the country life... he got along just fine with his rural neighbors-- and so do i... you are mis-characterizing his reasons for leaving...

one reason we will leave is shoddy education-- which permeates the local community--- we homeschool now simply because the science teacher at the local high school does not believe in dinosaurs... this sort of backwards/religious undertone in almost all aspects of rural life is a bit too much for me as life is too short to be spending time worrying if i am offending someone because i do not attend their church...

i understand the fact that when people hear the word city, it conjures up visions of tenements, crowdedness, and chaos... stoneleigh used the word tenements today in her comments... and stated that it would be hard to grow food there...

believe it or not there are cities in the US that offer different visions of the one described by stonleigh... cities that offer alot of the same things that rural life provides- except for the extra added bonus that in the future, as fuel prices soar, these cities will be the focus of activity, economy, and survivability -- not rural areas--

i have only recently come to this conclusion as it is clear that the rural outpost which i currently occupy is highly unsustainable going forward--- and likely, so are most rural enclaves......

el gallinazo said...

Anon 10:06

The word "city" covers a very broad area. In the USA a large town becomes a city at roughly 35-50,000 people. There are cities on this planet with over 15M people. So there are many different species in this word. Stoneleigh was specifically referring to **major** cities with populations well over a million. As the country sinks back into general poverty, tenements will become the norm because it is cheap if unpleasant form of housing. Angela's Ashes, as mentioned by Stoneleigh, is a well written account of what life is like in these environments. Hopefully, you will find the life style you seek in one of the minor cities. Attacking Stoneleigh will not make that outcome any more likely. It just accentuates your fear that you will not.

Anonymous said...

Rural areas easily become 'inbred'.

Psychologically, intellectually and physically.

Their isolation reinforces a tradition of 'group think'. My father and grandfather, and great grandfather all did 'It' this way, and by God, that's the way I do it, blah,blah,blah!

Some of the most virulently racist people I've ever encountered were Northern rural people who have never even had a member of a racial 'minority' live in their community.

Also, marrying your cousin for generation after generation also takes a toll on rural creative thinking.

Yes, inbreeding as a concept is like vital oxygen to the rural populations anywhere in the world.

RC said...

The default mode: rural, urban or suburban, is the unsustainable one.
Oases of sustainability just are not going to be present in a world gone mad. If the overall sum is derived from systems that fail by design, how can any of the parts be whole?
All of us have to settle for being damaged. I do. But I have placed myself where the least damage has been done and will be done. That is what my choice is. Yet, I am hard pressed to see how those that live in a city like Manhattan {as I did 30 years ago} could feel any security at all. That's a very fragile and isolated place, and not much in the way of crops nearby. Raleigh NC, Harrisburg, PA, even Albany, NY, would be better. I have a deep prejudice about surviving in cold climates. I very much detest that experience having done it. I'll take my chances in the tropics. It's all a gamble at this point but freezing to death is not on my agenda.

lineup32 said...

Thanks very insightful post and links.

Anonymous said...

@el g:

how does referencing what stoneleigh says in a previous comment amount to an attack?

seems like we need some thicker skin around here...

Anonymous said...

I did not read any insult directed toward Stoneleigh; I read a very articulate post on the potential merits of the urban lifestyle--as opposed to some experienced pitfalls of rural living.

Nonetheless, if things get as bad as many around here seem to think--I noticed Starcade used THSHTF and TEOTWAWKI in the same sentence earlier today--it might all come down to what an individual brings to the group table. Carpenters, plumbers and electricians as well as other tradesmen will always provide viable services to communities. Of course, farming acumen will be on the top of any survival list. The white collar worker might not fare so well. Certain medical types will shine like gold and the high-class Neijia adept who can teach the ailing how to restore their own health will never go without food. The laid off Govt and muncipal worker will be in for a very steep uphill climb.

Tyr said...

So is Canada going to take on Russia alone ? Some people never learn from history.

Starcade said...

This is not meant as a threat to make people vote for the initiatives in California tomorrow (Tuesday), but to state the reality of the situation:

Those who vote No on these initiatives had better be ready to leave the state for good at a moment's notice.

Starcade said...

My point is that we went past TEOTWAWKI last fall.

When TSHTF, it is all over.

ccpo said...

@ Anonymous 10:39

You are making very broad statements of what seem to be fact in your mind when reality is that what is sustainable and what is not is highly variable and not dependent on size.

I would no more want to be in Seoul when TSHTF than in Hades because the population density in Korea will never support Seoul's population no matter how well Koreans cooperate. By the same token, a city like Chicago at the center of transport, in the middle of the Great Plains (possible to contract for food), water plentiful, etc., might just be a decent place to live when TSHTF.

29 Palms, California? Probably not a good place. A small city on a river in a northern border state with railroad? Maybe so.

One size does not fit all.

Fear messes with our vision. Let go of the fear.

Persephone said...

One small oversight in the "green shoots" / "light in the forest" spin - the U.S. economy is consumer driven.
With U6 unemployment approaching 20% and slashed credit lines - the U.S. consumer has less buying power and is slowly exiting. The current economic model cannot be sustained in the U.S.
I am sensing a collective pathology emerging out of fear and tension. Consumers are scared of losing their jobs, the reduction in their buying power, and the shrinking availability of credit. Middle Class U.S. Americans are realizing they have descended to a lower socio-economic class. It is TEOTWAWKI.

Frank said...

@Tyr Canada is not 'taking on Russia'. It is joining Russia in reminding the EU, that the Arctic is not the EU's business.

Of the Arctic powers, only Denmark is an EU member, (Norway and Iceland are sort of half in.) And Greenland is separately administered rather than part of Denmark proper.

Leona said...

Anon 10:06

Interesting characterization of rural/urban. Makes me appreciative of the isolated, rural, low population density area I live in. Democratic voting, writers guilds, the highest ranking school in the state (in a high quality state) for graduating college prepared kids. All this even though there are less than 200 kids from 5 towns and two religious colonies in our consolidated elementary.

But we are mostly 3rd to 5th generation immigrants from Norway... So still clinging to agrarian populism/socialism. We would, however, freeze to death in our nearly 7 month winters. But hey! My people came here from north of the Arctic Circle in Norway so it's still an improvement.

Like CCPO says, hard to say what will make for sustainability. My neighbors are interesting folks- commercial bee keepers, draft horse and old time farm machinery fanatics, pasture raised pork experts, artists, etc... And poor to start with so maybe that will be an adaptive benefit too.

Stoneleigh said...


My people came here from north of the Arctic Circle in Norway so it's still an improvement.

Finnmark (northern Norway) isn't so bad climatically, thanks to the Gulf Stream. I remember standing at Nordkapp (1400 miles from the North Pole) in a T-shirt in late spring. Of course the growing season would be very short, the long arctic night would be a bit hard to take for most people, and the dependence on crashing fish stocks would make it difficult to sustain much of a population in the future. The experience would be very different from continental North America though. That's more climatically comparable to Siberia in many places.

Bukko Boomeranger said...

When I read the bit about Fiat becoming the third-largest auto company on the planet by absorbing the fibrillating remnants of Chrysler and GM, it made me think of something called "cardiomyopathic hypertrophy." (I'm a medical professional. We use terms like that on the wards. Don't utter this at home.)

What is means is that when you've had high blood pressure all your life, your actual heart gets all large and swollen up from the effort of trying to pump blood against the resistance of that BP. You might think "Great big heart -- good thing!" But it's a bloated, flabby heart -- not tight and strong. That's what Fiat's gonna be after it swallows all this U.S. auto junk -- sprawling, flabby and weak. "Car"iopathic myopathy. Buona fortuna Fiat.

Stoneleigh, no doubt you know that one of the reasons Finnmark is liveable at all is because of the North Atlantic conveyor current which brings warm Gulf Stream water up to the Arctic Circle. If Al Gore and the warming globalists are even half right, and the thermohaline circulatory system collapses when the North Polar ice cap melts, Finnmark is farked.

Stoneleigh said...

Anon @10:06,

one reason we will leave is shoddy education-- which permeates the local community--- we homeschool now simply because the science teacher at the local high school does not believe in dinosaurs... this sort of backwards/religious undertone in almost all aspects of rural life is a bit too much for me as life is too short to be spending time worrying if i am offending someone because i do not attend their church...

That would be a show-stopper for me in that particular area. Fortunately it's not like that where I live, but then we're not that isolated. My older kids go to a very good school in the city, and the youngest goes to a reasonable middle school on the edge of it.

i understand the fact that when people hear the word city, it conjures up visions of tenements, crowdedness, and chaos... stoneleigh used the word tenements today in her comments... and stated that it would be hard to grow food there...

When I say things like that I am not thinking so much of cities as they are (although many are indeed already like that in part), but as they are likely to be in a future where socioeconomic complexity cannot be sustained and dickensian slum poverty is the norm.

believe it or not there are cities in the US that offer different visions of the one described by stonleigh... cities that offer alot of the same things that rural life provides- except for the extra added bonus that in the future, as fuel prices soar, these cities will be the focus of activity, economy, and survivability -- not rural areas--

I have spent quite a bit of time in Toronto and Montreal recently and know that such places are currently stable and prosperous. If they stayed that way, then growing some food locally would be achievable. I don't think they're going to stay that way though.

There will be economic opportunities there that rural residents will not have, as areas close to a centre that concentrates wealth from its periphery may be able to feed off that wealth concentration potential. IMO access to necessities will be all about connections though. If you are interested in the politics of the personal during economic collapse, you might enjoy Alena Ledeneva's work on the blat economy (economy of favours) in Russia.

i have only recently come to this conclusion as it is clear that the rural outpost which i currently occupy is highly unsustainable going forward--- and likely, so are most rural enclaves......

There are big differences between rural areas, as there are between cities. As I have said before, I think both have their benefits and risks. Urban and rural life will be very different going forward, and people must decide which set of risks they are prepared to accept for which set of benefits.

Stoneleigh said...


Stoneleigh, no doubt you know that one of the reasons Finnmark is liveable at all is because of the North Atlantic conveyor current which brings warm Gulf Stream water up to the Arctic Circle.

So I said ;)

If Al Gore and the warming globalists are even half right, and the thermohaline circulatory system collapses when the North Polar ice cap melts, Finnmark is farked.

Very true. I was merely pointing out that anyone used to northern Norway as it has been for a long time would not be prepared for life in the interior of the North American continent where it is very much colder.

el gallinazo said...

Re The Exuberance Glut Or The Dollar-Euro Short Squeeze Race

Great article from Zero Hedge. I went to the original to blow up one of the graphs and wound up reading many of the comments. Jeez, their readership has a lot of technical knowledge in matters such as money / credit supply. Stuff I am still trying to get a handle on. Very productive debates and dialogues.

Unfortunately, for reasons of graphic presentation, the inverse triangle of money is totally out of scale. If done to scale you would barely be able to see the power money at the bottom. The power money held at the CB's amounts to less than 1% of the derivative money. When you realize this, it becomes obvious why the central banks are essentially powerless to control the outcome.

It also gives a hint at what Max Keiser was driving at the other day. I enjoy Max and Stacy, but sometimes Max is not careful to define his terms. I think his "hundred trillion of counterfeit treasuries" is really referring to the fact the world's money supply is primarily made up of securitized debt and derivatives. TPTB can't cancel the derivatives through fiat as it would implode the credit / money supply overnight. But it must happen over months and years.

The author, Durden, a brilliant guy, makes the claim in the article that to the central banks derivative "money" is just as real as power and bank loan money. Their money all gets commingled. As Stoneleigh points out, money and credit will only get separated through deleveraging and debt default, a process we are just entering. Durden also
points out that this process is analogous to a currency short squeeze, and since the dollar denominated assets are much further along than the Euro ones, eventually the Euro will rise against the dollar as the process accelerates in Euroland. I think the inevitable sovereign defaults in Eastern Europe will turbocharge this.

Re the city / rural thing. After reading the comments again, I think my comment that the anon "attacked" Stoneleigh was inaccurate. I still believe though that it was an invalid criticism of her position.

el gallinazo said...


It also just occurred to me that Hankenstein's bailout of AIG was not only designed to transfer taxpayer money to the investment banks. Without the transfer, after the Lehman bankruptcy, AIG's CDS's would have paid off zero cents on the dollar instead of 100%. CDS derivatives would have been regarded as valueless overnight resulting in the instant disappearance of the vast bulk of the world's money/credit supply. Comments?

Anonymous said...

Of course the grab for arctic (water covered) lands is a direct result of the global warming (hoax). Without the disappearance of the arctic ice sheets, the oil underneath would be technically unexploitable. Now we can reach the oil so we can further accelerate global warming. Warms your heart.

Chaos said...

Karl Denninger's been working hard this weekend, and it shows...his latest is a nice summary of his position.

Anonymous said...

Mr. Vulture,

“CDS derivatives would have been regarded as valueless overnight resulting in the instant disappearance of the vast bulk of the world's money/credit supply. Comments?”

Starting with the f***s that got the money, including the stalwart Goldman Sachs. Tell me again why no law restrains finance artists?

Ahimsa said...

I think we'll face many challenges in the future, whether one lives in a hot climate region or a cold northern region. Catastrophic climate change will bring extremes of temperatures -- heat and/or cold -- to all regions, as well as periods of drought and then possibly floods.

I live in inland South Florida and the heat here from May to November has become unbearable without air conditioning. This area was not so hot when I was growing up in the 1960s without a/c. The temperatures were not so hot then and we would get daily afternoon rainfall (downpours) on hot days, which would immediately lower temperatures up to 20 F degrees. Now, we seldom get those wonderful afternoon downpours.

To be environmentally friendly, we built our well insulated small house without a/c 15 years ago in inland So. Florida. Well, everything went well until the 1998 summer of drought and extreme heat when I experienced heat exhaustion (BTW, I was taking all recommeded precautions and I'm very healthy). The ambient temperature inside our home was 90 F degrees and outdoors it was 116F. Of course, we reluctantly purchased a room a/c for our family of four after that event.

In the past decade in So. Florida, extremely hot temperatures (over 100F) arrive earlier in the year and have become more frequent and longer lasting. Lately, it's been 107 F degrees by noon on most days. I know many people will die from heat stroke if the grid was not to function normally.

James Lovelock is probably right when he asserts that most regions of the world will become scrub and desert. I already see this happening in inland So. Florida. The canal that drains our land does not have a drop of water. I've never seen it without water. Throughout the years, it has had 6 to 8 ft. of water. I worry about the wildlife, especially the black bears. Where do they go to drink water now? If our well runs dry, I won't be able to put out water for them.

Anonymous said...

an act of fraud

“The claim has been made that AIG, for example, fell outside of the federal regulatory
apparatus and thus their near-failure and the more than $170 billion “given” to rescue
them was both inevitable and unforeseeable, absent major regulatory changes. This claim
is categorically false. The systemic risk does not come from AIG, it comes from their
counterparties which are all regulated banks. If the regulators had been doing their jobs
the CDS and other instruments that banks purchased from AIG would have been
considered unsecured assets exactly as would be a credit card loan to a consumer, as AIG
could not (and did not) have sufficient assets behind the liability taken on in those CDS.

Again, the failure was caused by regulatory malfeasance and misfeasance within the
banking system in that the banks were permitted to hold CDS written by AIG as “money
good”, that is, secured assets, when in fact they were not. This misrepresentation was in
fact an act of fraud as the inability of AIG to cover those bets was blatantly obvious, yet
the fiction of their coverage being “money good” was allowed to remain for an extended
period of time.”

From Chaos’ Karl Denninger (pdf) above.

jal said...

Next, Karl Denninger, needs to include the operating cost in his example.
1. Little thing like operating within the spread. (Borrow at 0% and lend at 6%).
2. Long term effect of compound interest.


Anonymous said...

Steve Keen’s Debtwatch, ... some interesting depression related graphs

Anonymous said...

Three Month Dollar LIBOR Falls to 79 basis points ... Calcujlted Risk

"Meanwhile the TED spread has decreased further over the last week, and is now at 61.97. This is the difference between the interbank rate for three month loans and the three month Treasury. The peak was 463 on Oct 10th and a normal spread is around 50 bps."

Last week, FDIC Sheila Bair said "the liquidity crisis is over for good". That might be a little optimistic (some ARS markets are still frozen), but it does appear the Fed has eased the liquidity crisis for now. The Treasury is still working on the solvency issues.

Oh shyte, no mountains gonna be laid low by the mighty winds of deleveraging? Oh well, this time again next week, guys?

Anonymous said...


i suppose we have different ideas about what makes a place rural... i consider myself to be rural-- we are 2.5 hours from a metro area of 500,000...

you send your kids to the city for school... maybe by definition this would be considered rural--- or maybe you just live in a 'rural setting' as opposed to an urban setting... but if you are that close to a city- how would you differentiate between being rural and being suburban-- and further- wouldn't the problems associated with suburban areas post collapse (high oil price etc) be similar to the problems you are likely to experience at your current, rural location?

you mentioned toronto and montreal-- toronto has 5.5 million people in the greater area- 2.4 million in the city proper... montreal has a population of 3.6 million in the greater area- 1.6 in the city proper... cities of that size will have a very hard time when crises hit... and i believe that areas in close proximity to these types of behemoths will feel the shockwaves of chaos sure to happen in these urban nightmares...

i am talking about cities and metro areas of under 500,000... i think these sizes of cities are your best bet... especially ones that are somewhat isolated from metro monstrosities... and ones that have a tradition of agriculture...

Mike said...

So I guess being in a region where I live with about 10 Million people within 25 miles is a bad thing...


nice knowing you all...

John Hemingway said...

I was born in Miami and grew up there and I know what you mean about the afternoon showers in the rainy season (hurricane season). You could almost set your watch by them, every day at 3pm!

I think that what is happening in So Fla is tragic. It was once such a beautiful place.


memphis said...

@Anon 10:06 pm
one reason we will leave is shoddy education-- which permeates the local community--- we homeschool now simply because the science teacher at the local high school does not believe in dinosaurs... this sort of backwards/religious undertone in almost all aspects of rural life is a bit too much for me as life is too short to be spending time worrying if i am offending someone because i do not attend their church...

i understand the fact that when people hear the word city, it conjures up visions of tenements, crowdedness, and chaos... stoneleigh used the word tenements today in her comments... and stated that it would be hard to grow food there...

believe it or not there are cities in the US that offer different visions of the one described by stonleigh... cities that offer alot of the same things that rural life provides- except for the extra added bonus that in the future, as fuel prices soar, these cities will be the focus of activity, economy, and survivability -- not rural areas--

i have only recently come to this conclusion as it is clear that the rural outpost which i currently occupy is highly unsustainable going forward--- and likely, so are most rural enclaves......
Wow. That's a pretty broad swipe at the rural population. I guess small-mindedness can exist anywhere, and the above is one of the most sanctimonious postings I've read on TAE. It strikes me as being narrow to extrapolate a personal experience with a teacher and apply it broadly to rural school districts. Maybe the folks in Washington and some of the large urban money centers really DO know what's best for the rest of us, what with us po' rural residents being so inbred and all. People have learned to settle for mediocrity, regardless of where they live.

Having grown up in a rural area, living here is all I know. And it's a good life. Is it perfect? No. No place is.

And please don't confuse whether or not someone believes in dinosaurs with being religious. That'd be a real stretch. I don't intend to drag the discussion of religion into a conversation on TAE, but "dinosaurs' hasn't been a topic for discussion in my church lately. As far as offending someone because you don't attend their church, I don't think you've anything to fear.

But, perhaps I can understand your viewpoint about rural education: here in this "rural" area, we begin each sentence, name, and personal pronoun with a capital letter. You must be writing from a more enlightened positon.

el gallinazo said...

Anon 12:51pm

Yes happy times are here again. Ever occur to you that the Libor is way down because the central banks and treasuries are underwriting the loans? Totally artificial.

Instead of preaching to us doomsters, you should be leveraging long on financial equities. Give it all you have and more.

BTW, with the exception of Starcade who is a story unto himself, none of the regular commenters are deriving any pleasure from the pain we see coming. All of us would far prefer business as usual with perhaps rapid evolutionary improvements in the fairness of the system. It's just that we see the crest of the tsunami and we are trying to figure how to get ourselves and our families to higher ground.

Live long and prosper. Don't forget to leverage long in financial equities. You will do exceptionally in the fall.

Anonymous said...

It drives me crazy to see Paulson portrayed as anything except a gold-plated bucaneer,or a corpration hack...He is not good people.As was said do not get where he is by being "nice".

That he went into the treasury dept"With his hair on fire"bespeaks of prior knowledge that the essentialy "criminal" activity that had taken place at the higest levels of world finance had put all at risk.

..... He [we]lost...

He can retire to well-guarded ,well-provisioned estates w/o a care in the world as to his physical well being while the rest of the world goes to hell.His only payback may be seeing his favorite songbirds on a spit over a fire feeding starving citizens.

The AIG bailout still has be blue with rage.We made good the bad bets of one of themeanest companies around..and I still have not seen some corp. heads roll on that one.

I am pretty sure that there will be war in the artic,sooner or later,as soo as the resources are known,or suspected.Its the way we are built,at least this time around

Lots of discussion on the benefit of rural/urban in coming troubles.I am at the edge...I am 18 miles outside of the city proper [portland ore],with layer upon layer of smal farms between me and town,but 2 miles from the begining of the Salmon/Huckleberry wilderness area,which means visits from coyote-bear-cougar-racoon-eagle,and just about every other thing that likes chickens,or bee hives.Farm/farmett/rural homes are anywhere from 100-500 yards apart,on land from 2-200 acres,with good roads,and med care [urgent care]within 10 minutes.I am in the center of 2 small towns,Sandy ore,,and Estacada,ore.I would agree with some comments about rural schools,[Estacada comes to mind]but Sandy has a excellent [brand new] highschool...and is a wealthy community.I live off of two roads,and at the end of 3/4 mile of gravel road in rough shape.The privacy is wonderful.I hope that the advantages of both worlds rural and urban,with access to the advantages of the city,and the security of low population...and yes,I know all my neighbors...

Time to be productive...


Weaseldog said...

I have inlaws in Florida and have been out there now and then over the years.

At one time, the everglades and a lake were on fire. My bother inlaw waxed on and on about how fire was part of the natural order of things.

He talked about pine forests needing fire to open the pine cones and release the seeds.

Everyone agreed that he was very wise...

Except me, I blurted out, so the everglades have always burned down in the summer? The lakes always dry and the beds catch fire?

Florida seems to suffer from a confluence of factors, from the sugar industry diverting water, to the destruction of wetlands... And finally, all of the added pavement and drainage.

Florida once had plenty of water because it was swamp. Drain the swamp and the water goes away. Cover it in concrete and the temperature rises. Higher mid day temps mean no rain.

Florida is victim of it's own success. But it's simply one of the latest victims. We've lost so much in the pursuit of growth, yet we remain driven to lose more.

Stoneleigh said...

Anon @1:02,

i suppose we have different ideas about what makes a place rural... i consider myself to be rural-- we are 2.5 hours from a metro area of 500,000...

Your place is more rural than mine. I wouldn't want to be too remote.

you send your kids to the city for school... maybe by definition this would be considered rural--- or maybe you just live in a 'rural setting' as opposed to an urban setting...

I live on a farm. My kids don't go to the local school because they're both interested in the arts (visual art and vocal music) and auditioned for an arts school that's an hour's bus ride away. Such things won't be possible in the future, but it's a nice option to have now. My youngest will go to the local high school as she's interested in carpentry, and that's what they specialize in.

but if you are that close to a city- how would you differentiate between being rural and being suburban-- and further- wouldn't the problems associated with suburban areas post collapse (high oil price etc) be similar to the problems you are likely to experience at your current, rural location?

There are suburban homes in our area that are quite dependent on centralized services. We are less dependent by design, since we make our own power, heat with wood, have a well and septic and can get around in all seasons without fossil fuels (albeit not all that far). Our area has both rail and river connections. We have an orchard and a large garden, as well as raising our own meat. We hope to have enough people here one day to look after it properly, as it could support far more than the 6 of us who live here now.

you mentioned toronto and montreal-- toronto has 5.5 million people in the greater area- 2.4 million in the city proper... montreal has a population of 3.6 million in the greater area- 1.6 in the city proper... cities of that size will have a very hard time when crises hit... and i believe that areas in close proximity to these types of behemoths will feel the shockwaves of chaos sure to happen in these urban nightmares...

I don't live particularly close to either Toronto (4.5 hours) or Montreal (2 hours). The nearest city has a population of about 750,000. My local village (within cycling, sledding or walking distance) has about 4000 people.

i am talking about cities and metro areas of under 500,000... i think these sizes of cities are your best bet... especially ones that are somewhat isolated from metro monstrosities... and ones that have a tradition of agriculture...

I agree that smaller is better.

Anonymous said...

el gallinazo

Nice to see you are not gormless in your comments , possibly off the mark, but that's okay, gives a talking point. I am afraid that my view and position leave me in the cleft stick of 'hope' and 'remorse'. Remorse, as my occupation and joy is very very tied to things working out and going on and on the way they were. Hope, only in that the end will be with a bang and not a whimper. If you think about it at all deeply, and not merely as to how the old oak chest of yours fares then,to be succinct, the faster the destruction we are causing, as a species, to this planet ceases the better.

I don't think I could class you as a doomster, more of a survivalist and to that end I would suggest humour as an aid to survival. Just to give you a starting point in that, you might start by watching one of the few American moves worth watching more than once, The treasure of the Sierra Madre. Watched it in the theatre and still get a kick out of it. Of course, if you did see it , din't you love the way the the Mexican Bandito says, "I don't need no steenking financials, I got my rose garden"

-Sr. Huevos-

Oh almost forgot about this:

Yes happy times are here again. Ever occur to you that the Libor is way down because the central banks and treasuries are underwriting the loans? Totally artificial.

Well of course they are you big silly, and now all they got to do is get everyone smiling on the same frequency and we will bubble on for another decade and degrade the world just that much more before the mounains are laid low;)

Anonymous said...


your place sounds great... i wish that the US had the same attitude towards medicine and education and transportation as our northern neighbors...

Ahimsa said...

Weaseldog said:

"Florida seems to suffer from a confluence of factors, from the sugar industry diverting water, to the destruction of wetlands... And finally, all of the added pavement and drainage.

Florida once had plenty of water because it was swamp. Drain the swamp and the water goes away. Cover it in concrete and the temperature rises. Higher mid day temps mean no rain."
Agree, though, the catastrophic climate change we're witnessing in So. FL (and worldwide) is the primary cause of today's extremely high temperatures in So. FL. Two weeks ago, I-75 was closed for a week due to a 30,000 acre fire in the Everglades.

el gallinazo said...

Anon 12:51pm

Yes happy times are here again. Ever occur to you that the Libor is way down because the central banks and treasuries are underwriting the loans? Totally artificial.

Instead of preaching to us doomsters, you should be leveraging long on financial equities. Give it all you have and more.

BTW, with the exception of Starcade who is a story unto himself, none of the regular commenters are deriving any pleasure from the pain we see coming. All of us would far prefer business as usual with perhaps rapid evolutionary improvements in the fairness of the system. It's just that we see the crest of the tsunami and we are trying to figure how to get ourselves and our families to higher ground.

Live long and prosper. Don't forget to leverage long in financial equities. You will do exceptionally in the fall.

Anonymous said...

Anon @ 1:42PM Wrote:
"Carpenters, plumbers and electricians as well as other tradesmen will always provide viable services to communities. Of course, farming acumen will be on the top of any survival list. The white collar worker might not fare so well. Certain medical types will shine like gold"

Carpentets, Plumbers, etc will be worthless come a collapse. With No electricity, there is no power and most homes are unlivable without power. Don't believe me. turn your power and water off for a week during the winter or summer.

Second Modern medicine is dependant on Pharmaceuticals and complex electronic imaging equipment. Doctors can't treat 99% of illness without a supply of drugs and electricity to run the equipment.

RC Wrote:
"Oases of sustainability just are not going to be present in a world gone mad."

Rural regions off better changes of self-reliance. Perhaps you simply lack the skills to survive on your own without a functioning industrial complex. However, 200 years ago, America was populated by homesteaders living on the frontier with little or no outside help.

A city, even a small one can not survive beyond a week or two before bad things happen. First the power goes out causing homes to become unlivable in deep winter or hot summers. No Power means no water (required to run water pumps that fill roof tanks needed to deliver water in high rise buildings). No AC for the summer and no Heat in the winter, since all HVAV system need electricity to operate. No power means the gas pumps don't work either.

Garbage will pile up in the streets and Sewers will back up with human waste. Food supplies will quickly disapear. Cities are a death trap without constant source of energy and supplies.

APC said...

Anon at 1:02pm

"cities of that size will have a very hard time when crises hit..."From Withnail and I:

"I loathe those Russian plays. Always full of women staring out of windows, whining about ducks going to Moscow."