Friday, July 31, 2009

July 31 2009: It's a good idea, but it's wrong

Jack Delano Summer Brake March 1943
Summit, California. Brakeman opening the retainer valve on a car on the Atchison, Topeka and Santa Fe Railroad between Barstow and San Bernardino. From here to San Bernardino is one long downgrade of more than 2,700 feet

Ilargi: In 2006, a Bureau of Transportation report estimated that there were 250 million passenger vehicles on American roads. Five years before, a National Automobile Dealers Association study found that of vehicles in operation in the US, 38.3% were older than ten years, 22.3% were between seven and ten years old, 25.8% were between three and six years old and 13.5% were less than two years old. According to this study the majority of vehicles, 60.6%, of vehicles were older than seven years in 2001.

If we assume that relative numbers have stayed more or less the same between the studies, and into the present, we find that some 150 million US vehicles are over 7 years old, which probably makes them -potential- candidates for the Car Allowance Rebate System (CARS), or Cash for Clunkers, in which the government pays to get an old car off the road when a new one is purchased. While there are long and confusing lists of ineligible cars, something should still already be clear.

Germany has had a similar program running for a number of months now (as have other European nations). It's been a huge success from the start. The Germans reserved $7 billion for their Klunkers(?!), with the money set to run out soon.

So what does the US do? The administration proposed a $4 billion plan, which got cut to $1 billion by the House. At an average of $4000 per vehicle purchased, that takes care of 250.000 cars. The plan was supposed to run until November. Instead, it ran out of cash in one week. Today, another $2 billion was appropriated for the scheme.

Which will be good for another 500.000 cars, for a grand total of 750.000. By then it'll be August. 750.000 out of a total of 150 million potentially eligible vehicles Or are perhaps only 100 million eligible?. A great plan, but it's wrong. Maybe that’s what you get for listening to Alan Blinder. I smell someone making a lot of dough from skimming teh system. Anything that's so poorly organized is ideal for a scam or two. But I'm still wondering: how do you get anything THAT wrong? That must take a Herculean effort. Better take a summer break now.

Then again, it’s all mostly about appearances these days. I think the idea is to overwhelm us with phony numbers till we just give up. In my mind’s eye, I see a big black hole with a huge opaque soap bubble temporarily suspended over it. It'll pop when the days get short.

On the one hand you got your scars:
Recession Worse Than Prior Estimates, Revisions Show
July 31 (Bloomberg) -- The first 12 months of the US recession saw the economy shrink more than twice as much as previously estimated, reflecting even bigger declines in consumer spending and housing, revised figures showed.

On the other hand you got your shoots:
US Economy Shrank Less Than Expected in Quarter
(from BEA): Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- decreased at an annual rate of 1.0 percent in the second quarter of 2009, (that is, from the first quarter to the second), according to the "advance" estimate released by the Bureau of Economic Analysis. In the first quarter, real GDP decreased 6.4 percent.

You think it might be a good idea to wait for the revised numbers? It might also be worthwhile to see what causes the numbers to drop less:

On the one hand you got your greens:

The economy’s long, churning decline leveled off significantly in the second quarter, as stock markets started to recover, corporate profits bounced back, housing markets stabilized and the rampant pace of job losses tapered off.

On the other hand you got your scorched earth:

Declines in business investment leveled off, and the economy was aided by big increases in government spending at the federal, state and local levels.[..] But consumer spending fell by 1.2 percent as Americans put more than 5 percent of their disposable income into savings. Economists are concerned that consumer spending, which makes up 70 percent of the economy, will not rebound as long as employers keep cutting jobs and trimming wages.

Real imports of goods and services decreased 15.1%, real exports of goods and services decreased 7.0%. And everyone is talking about the recovery around the corner. Listen to them at your own peril. Watch AIG in the weeks to come. Remember, $180 billion went into it already. Turns out, thecompany is simply shifting funds around between subsidiaries to look not yet dead.

Come on, guys, everything that allegedly goes into this assumed recovery is organized along cash for clunkers principles. It's all just a dirty joke.

$2 Billion in New Cash Steered to Clunkers
Congress moved Friday to inject fresh funds into the wildly popular "cash for clunkers" program after it nearly ran out of money, threatening to become a symbol of government bungling. The House approved moving $2 billion from a program that backs loans to renewable-energy companies into the car-repurchase program, which apparently burned through its allotted $1 billion in just a week. The move came just before one of the biggest car-sales weekends of the summer. The House vote capped a chaotic few days in which auto dealers saw a huge surge in sales, but struggled to register their deals with a swamped Department of Transportation computer system. Unsure how to react, Obama administration officials sent mixed signals late Thursday about suspending the program just as dealers braced for heavy buyer traffic.

Even Friday, officials weren't able to calculate how much money remained in the clunkers' kitty, other than to say that the National Highway Traffic Safety Administration, which handles the rebates, has processed $250 million in vouchers. As late as Thursday morning, a NHTSA spokesman was brushing off concerns about the money running out as dealer "paranoia." President Barack Obama, during a brief White House address on the economy, said Friday that the clunker program "has succeeded well beyond our expectations and all expectations." His administration and Congress, he said, were "doing everything possible to continue this program."

Designed to last through October, the cash-for-clunkers program offers rebates of up to $4,500 to consumers who trade in old vehicles to buy new, more fuel-efficient models. What happens now isn't clear, in part because House efforts to expand the clunker fund may face a tougher ride in the Senate, where some Republicans oppose the additional spending and some Democrats hope to tighten the program's environmental standards. Despite its administrative failings, the clunkers program excited recently-flinty consumers and provided a quick jolt to the U.S. economy after 19 months of recession. Car dealers reported their highest weekly sales volumes in nearly two years as consumers appear to have used the program to buy as many as 250,000 new cars.

At Classic Buick, Pontiac and GMC in Arlington, Texas, sales director Will Carter stayed up until 2 a.m. Friday to finish processing the 29 cash-for-clunkers deals -- just in case the program ran out. A few months ago, the dealership was lucky to sell five cars a day. This week, the sales team has been closing 10 or more, putting the dealership on pace for a record sales month, Mr. Carter said. "If there is any part of the stimulus that absolutely needs to stay, this is it," he said.

So many dealers were trying to jam through sales Thursday night that the government's processing Web site,, crashed several times, said Chris Lemley, president of Sentry Auto Group, which owns three dealerships in Boston suburbs. "It was sort of like trying to buy U2 tickets in the first five minutes they go on sale." The roughness of the program's launch has provided fodder for Republicans who question the government's readiness for wading deep into other private-sector strongholds, such as health care.

"If this is how the government is going to handle billion- dollar programs affecting all Americans, I ask, whatever will we do if this administration takes control of our health care?" said Rep. Jerry Lewis, a California Republican. He and others complained that the program got underway with no public hearings and little debate. The original clunkers legislation called for putting $4 billion aside for consumers to trade in older cars for more fuel-efficient models. Despite pushback from environmentalists, the efficiency standards in the original bill were weakened under heavy pressure from U.S. auto makers and Midwest legislators. Lawmakers who were skeptical of the program's success, or opposed to the additional spending, also managed to whittle the funding down to $1 billion.

In Germany, with a population roughly one-third that of the U.S., lawmakers in January ponied up nearly $7 billion to entice drivers to get rid of older cars and buy new, more-efficient models. That program has been such a boon that it could run out of money by September. The U.S. program officially kicked off July 1, but the DOT needed nearly a month to put 130 pages of rules in place and to set up an elaborate computer and banking system to register dealers and handle transactions.

With $50 million in administrative funds, the department's National Highway Transportation Safety Administration set up a 250-person phone bank to take calls from consumers and hired Oracle Corp. to handle computer operations. Oracle declined to comment on the system's troubles.\ Not until July 24 were dealers able to register with NHTSA and process claims. Problems began to bubble up immediately. At Koons Automotive Companies, a large dealer chain around Baltimore and Washington D.C., it took three days to get its 16 dealers registered. Koons by early Friday had done 295 clunker deals. But the company had registered only a small fraction on the NHTSA site as vouchers were kicked back or Koons accountants struggled to log onto the system.

"This is a great program, but it's also the worst-run program I've ever seen," said Alex Perdikis, Koons's executive vice president. Earlier this week, fears mounted within the administration and among dealers that the sheer volume of sales could prove larger than the legislation -- or the government's clerks -- could handle. Wednesday, the National Automotive Dealers Association began an informal email poll of members to gauge the surge. By then, nearly 20,000 dealers had registered but official transactions numbered less than one per dealership.

The NADA poll found that actual sales were as high as 14 per dealership, suggesting that more than $900 million had already been used. The association sent its findings to NHTSA early Thursday morning. "That's when the alarms went off," said one DOT official. Concern spread to the White House and its Office of Management and Budget, where officials began to comb through the federal budget for money they might draw on to pay dealers should the program bust its budget. Early Thursday evening, OMB sent out word that there was none to be had.

Transportation Secretary Ray LaHood began briefing lawmakers Thursday afternoon, informing them that the fund was depleting rapidly. Around 4 p.m., Mr. LaHood called NADA President Phillip Brady and told him the department was "terminating" the program at midnight that night, according to NADA spokesman Bailey Wood. A spokeswoman said Mr. LaHood wasn't available to comment. As word spread, lawmakers said they were inundated by phone calls from car dealers and voters in their districts, expressing anger that such a popular program might die. Late Thursday, the White House scurried to announce that the program had not been suspended. Some Senators are expected to push for more aggressive environmental targets for the program as part of any extension.

U.S. Economy Shrank Less Than Expected in Quarter
The American economy shrank at an annual rate of 1 percent from April through June, the government reported on Friday, stoking hopes that the worst recession since the Great Depression was nearly over. The economy’s long, churning decline leveled off significantly in the second quarter, as stock markets started to recover, corporate profits bounced back, housing markets stabilized and the rampant pace of job losses tapered off. Declines in business investment leveled off, and the economy was aided by big increases in government spending at the federal, state and local levels.

“We’re in a deep hole, and now we’ve got to dig ourselves out of it, which is a very difficult task,” Diane Swonk, chief economist at Mesirow Financial, said. But consumer spending fell by 1.2 percent as Americans put more than 5 percent of their disposable income into savings. Economists are concerned that consumer spending, which makes up 70 percent of the economy, will not rebound as long as employers keep cutting jobs and trimming wages.

Friday’s report on gross domestic product — a broad gauge of the country’s output — is the government’s rough draft at measuring the economy, and can be revised sharply up or down. The Commerce Department revised its earlier assessments of the country’s woes, saying that the economy contracted at a pace of 6.4 percent in the first three months of the year, compared with an earlier figure of 5.5 percent. Economists had been expecting the second-quarter economy to contract at a pace of 1.5 percent.

Now, even with jobs still vanishing and wages flat, many forecasters expect the economy to touch bottom sometime in the next few months. Economists say that businesses from small manufacturers to big automakers are poised to rebuild their depleted inventories, which fell by an annualized $141 billion in the second quarter. That restocking could spur economic growth later this year. “We’re going from recession to recovery, but at least early on, it’s not going to feel like one,” said the chief economist at Moody’s, Mark Zandi. “For economists, this is a seminal part in the business cycle, but for most Americans, it won’t mean much.”

That is because the job market is expected to remain dismal even after the economy resumes growing. As business picks up after a recession and companies start receiving more orders and restocking their shelves, employers will still resist hiring new full-time workers, and instead pay overtime or rely on part-time employees. To make a dent in the 9.5 percent unemployment rate, economists say, the economy needs to grow at a 3 percent clip and add 300,000 to 400,000 jobs a month — a difficult task after so many months of a recession.

Many economists expect an arduous recovery marked by high unemployment and unsteady growth. Not only does the specter of a jobless recovery presage more pain for the country’s 15 million unemployed workers. It could pose a significant political challenge for President Obama, who has asked Americans to be patient as the government’s $787 billion economic stimulus plan takes effect. “The bar’s pretty high to make people outright happy about the economy,” said the chief economist at Action Economics, Michael Englund.

The Commerce Department’s quarterly assessment offered a tour through a bleak year. The economy withered during each of the last four quarters, its longest contraction since the 1940s. Businesses cut their investments and laid off millions of workers. Imports and exports tumbled. The country’s gross domestic product fell to $14.15 trillion in the second quarter, from $14.5 trillion in the second quarter of 2008.

In interviews, small-business owners across the country say the ground is slowly reforming under their feet, and that business no longer seems to be careening downward. Indeed, business investment in structures like new factories and office buildings fell at a rate of 8.9 percent in the second quarter after declining by more than 40 percent in the previous three months. And investment in equipment and software, which fell 36 percent this winter, dropped a more modest 9 percent in the second quarter.

But many employers who have laid off employees or scaled back say they are not about to increase their spending or start hiring. In Nashville, Jerry Robertson laid off one of his 15 employees, cut his budget for advertising and trade shows and moved into a smaller office space to cut costs at his company, which helps trucking companies manage their operations. His business is down about 10 percent from last year, and clients are still falling off his books. “We do see it not declining as fast as it was, but we don’t see any growth,” Mr. Robertson said. “We’re still going down.”

Falling Imports versus Falling Exports (GDP = -2.38%)
I noted earlier that the oddity of imports versus exports calculation would produce a positive contribution to GDP. Let’s look at the details of this, and find a way to understand what this means. First, off conceptualize the difference between what imports and exports are. At the most basic level, Imports represent our consumption of overseas production, i.e., We buy what they make. Exports are where overseas consumers purchase our production, i.e., They buy what we make. What were the specifics of the GDP data regarding import/export?

-Real imports of goods and services decreased 15.1%
-Real exports of goods and services decreased 7.0%

So in Q2, both consumption by us of overseas goods and services and by them of US made goods and serivces declined significantly. The Differential between imports and exports — who dropped fastest — was the key to this quarter’s GDP data. According to Bloomberg, Decreasing Exports subtracted 0.76% from GDP. At the same time, falling Imports added 2.14%.  Net contribution of the fact that Imports are free falling twice as fast as Exports are = 1.38%.

If they were both falling at the same rate — if Europe and Asia’s consumers were hurting as much as ours –  GDP would have been -2.38%. If it seems weird to you that the ratio of domestic and overseas shrinking economies and their reduced consumption somehow turned into a positive GDP contributor, well, welcome to the wonderful world of government statistics.

Thank God For Government Spending
Today's better-than-expected -1% GDP was tempered, somewhat, by the staggering 11% spike in Federal Government spending (hello stimulus!). Today's chart looks back at the Y/Y GDP change with the same number sans government spending. As you can see from the divergence, the government boost provides a big help.

Stimulus has yet to really boost GDP
The nation's economy is starting to rebound, but the Obama administration's massive stimulus package had little to do with it. The gross domestic product contracted at an annual rate of 1%, a significantly slower decline than the past two quarters. Economists had expected a drop of 1.5%. While government spending at all levels increased in the second quarter, only a small amount of the $787 billion stimulus package had trickled out by June 30.

As of July 3, only $60.4 billion of recovery funds had been distributed, the largest chunk of which went to help states cope with rising Medicaid costs. Much of the $43 billion in stimulus tax relief -- which includes the Making Work Pay tax credit for individuals -- also kicked in during the quarter. "I don't think the effect of stimulus has been very large," said Edward Lazear, an economics professor at Stanford's Graduate School of Business who advised former President George W. Bush. "Very little has gone out."

Non-defense federal government spending provided a 0.15 percentage point boost to GDP, while state and local government spending contributed 0.30 percentage points, according to the Commerce Department. Federal spending jumped nearly 11%, while state and local government outlays increased 2.4%. To be sure, stimulus spending had some effect. Some of the early components of stimulus to be distributed have allowed people to spend more, said Dean Baker, co-director of the Center for Economic and Policy Research. Those who received the $25 increase in unemployment benefits have likely already put those funds into the economy.

And states did put the money they received to use, which contributed to the fastest growth in state and local government spending since the middle of 2007, according to Josh Bivens, an economist with the Economic Policy Institute. Some economists say that the GDP numbers would have been worse without the stimulus funds. Bivens estimated the recovery act money may have contributed as much as 3 percentage points of annualized growth to the quarter.

But others expect the figures to be revised downward in the future. They point to an 8.9% contraction in business spending and a 7% decline in hours worked, which doesn't mesh with a mere 1% decline in GDP. The true test of the stimulus package will come in the fall, when the government reports economic activity for the third quarter. The administration is working to get the money out the door quicker, as complaints mount that stimulus is not having its promised effect. "The third quarter will be a critical time period for assessing the stimulus package," said Mark Thoma, an economics professor at the University of Oregon.

Friday's GDP report comes as some experts are calling for a second stimulus package to further juice the economy. They say the first was not enough to promote a recovery. "It is preventing a collapse," said L. Randall Wray, senior scholar at the Levy Economics Institute of Bard College. "I wouldn't say it is big enough to get us growing." Others, however, say that more government funding will not address the key issues -- such as the housing and financial markets turmoil -- holding back the economy. "You will feel better, but it won't really get at the heart of the problems driving the crisis," said Philip Levy, a scholar at the American Enterprise Institute who worked in the Bush administration.

Recession Worse Than Prior Estimates, Revisions Show
The first 12 months of the U.S. recession saw the economy shrink more than twice as much as previously estimated, reflecting even bigger declines in consumer spending and housing, revised figures showed. The world’s largest economy contracted 1.9 percent from the fourth quarter of 2007 to the last three months of 2008, compared with the 0.8 percent drop previously on the books, the Commerce Department said today in Washington.

“The current downturn beginning in 2008 is more pronounced,” Steven Landefeld, director of the Commerce Department’s Bureau of Economic Analysis, said in a press briefing this week. The revisions were in line with past experience in which initial figures tended to underestimate the severity of contractions during their early stages, he said. The updated statistics also showed that Americans earned more over the last 10 years and socked away a larger share of that cash in savings. The report signals the process of repairing tattered balance sheets following the biggest drop in household wealth on record may be further along than anticipated.

Consumer spending, which accounts for 70 percent of the economy, decreased 1.8 percent in last year’s fourth quarter from the same period in 2007, exceeding the prior estimate of a 1.5 percent drop. Purchases also began sinking sooner than previously projected, registering their first decline at the start of 2008 rather than in the second half. Treasuries headed higher after the report, while stock- index futures declined. Benchmark 10-year note yields were at 3.58 percent at 8:51 a.m. in New York, from 3.61 percent late yesterday. Contracts on the Standard & Poor’s 500 Stock Index were down 0.3 percent at 979.

Residential construction fell 21 percent during the period, almost 2 percentage points more than previously reported, aggravating what was already the worst slump since the Great Depression. The Commerce Department also reported today that the economy contracted at a 1 percent annual rate from April through June after shrinking at a 6.4 percent pace in the first quarter, the most since 1982. The decline in the first three months of the year was previously reported as 5.5 percent.

The National Bureau of Economic Research, the accepted arbiter of U.S. business cycles, last year determined the recession started in December 2007. The private group is based in Cambridge, Massachusetts, Today’s updates are part of comprehensive revisions that take place about every five years and are more extensive than the changes announced at this time each year. Figures as far back as 1929 can be revised.

Over the most recent period, the third quarter of 2008 underwent one of the biggest changes, going from a 0.5 percent decrease in gross domestic product to a 2.7 percent drop. The new reading better illustrates the effect the September collapse of Lehman Brothers Holdings Inc. had on the economy and credit markets. The deeper deterioration last year underscores why Federal Reserve Chairman Ben S. Bernanke and his colleagues at the central bank cut the benchmark rate to a record low and extended credit to non-banks for the first time since the 1930s.

The new GDP data also help explain why the unemployment rate shot up 2.3 percentage points last year, the biggest annual jump since 1982. The revisions showed that the 2001 recession was less severe than originally estimated, reflecting a smaller decline in business investment. The economy actually grew 0.1 percent from the fourth quarter of 2000 to the third quarter of 2001, erasing the 0.2 percent drop previously reported.

Personal income was revised up over the last decade, after the government boosted its adjustments for the underreporting and non-reporting of income using more recent data from the Internal Revenue Service. The increases in the most recent years reflect gains from rents, interest and proprietors’ income. The government changed the way it accounts for natural disasters, such as Hurricane Katrina, eliminating much of the prior volatility in income calculations.

Higher incomes and less spending translated into bigger savings. The savings rate for 2008 was revised up to 2.7 percent from 1.8 percent. The rate shot up to 5.2 percent in the second quarter, the highest level since 1998. The government revised corporate profits down for 2006-2008 and up for 2004 and 2005. Finally, Commerce shifted food services, which include meals purchased at restaurants or served in schools, out of the food category. As a result, the Fed’s preferred inflation gauge -- which tracks consumer spending and excludes food and fuel -- was pushed up by 0.2 percentage point for the three-year period from 2006 to 2008.

The costs of meals away from home are not as volatile as fresh food, the government said, and therefore services should be included in the measure commonly known as the core index.

Is This What's Coming Next?
In yesterday's CHART OF THE DAY we noted the similarities between this current rally and the famous rally between 1929 and 1930.

Today, David Rosenberg picks up on the same thing, and fills it out a little more.

Five more banks fail
Regional banks in Oklahoma, Florida, Ohio, Illinois and New Jersey fall, bringing the national tally up to 69 for 2009. The closures cost the FDIC $912 million.

Regulators shut down five regional banks Friday, the Federal Deposit Insurance Corporation said, bringing the total number of banks to fail in the United States to 69 this year. Friday's bank closures will cost the FDIC fund $911.7 million, bringing the total cost for failed banks to $15.13 billion this year. That compares with $17.6 billion in all of 2008. First State Bank of Altus, based in Altus, Okla., was shut down and Herring Bank, headquartered in Amarillo, Texas, will take over all of the deposits of the failed bank. As of June 19, the First State Bank of Altus had total assets of $103.4 million and deposits of $98.2 million. The failed bank was the first to go down in the state of Oklahoma in 2009.

Meanwhile, Integrity Bank, headquartered in Jupiter, Fla., was shuttered and Stonegate Bank, based out of Fort Lauderdale, Fla., will assume all of the deposits of Integrity Bank. As of June 5, Integrity Bank had total assets of $119 million and total deposits of $102 million. The failed Florida bank was the fourth to fail in the state so far this year. The third bank to go down Friday was the Peoples Community Bank, based in West Chester, Ohio. The First Financial Bank, National Association, headquartered in Hamilton, Ohio, will take over all of the deposits of the failed bank.

The failed bank was the first bank to be closed in Ohio in 2009, and as of March 31, had total assets of $705.8 million and total deposits of $598.2 million. The fourth bank to fall Friday night was the First BankAmericano, based in Elizabeth, N.J., and the Crown Bank, of Brick, N.J. will take over the deposits. As of July 16, First BankAmericano had total assets of $166 million and total deposits of $157 million. The failed N.J. bank was the second bank in the state to fall in 2009.

The fifth and biggest bank of the night to fail was Mutual Bank in Harvey, Ill., which had total assets of $1.6 billion and total deposits of $1.6 billion. Mutual Bank's 12 branches will reopen on Saturday as branches of United Central Bank of Garland, Texas, which has assumed all deposits from Mutual Bank. The number of bank failures so far in 2009 has almost tripled last year's total of 25. Smaller regional banks have been hammered in the downturn. Many of the banks failed because local residents and commercial real estate developers that took out loans have been unable to pay them back. 

FDIC tests toxic assets sale program
The U.S. Federal Deposit Insurance Corp launched the first test of its Legacy Loans Program that could eventually help banks rid their balance sheets of toxic assets so they can raise new capital and increase lending, the agency said on Friday. Officials at the FDIC, which insures the deposits of U.S. banks and acts as the receiver for failed institutions, said they will take final bids in late August or early September and declined to say which bank's toxic assets were involved in the test.

In the test transaction, a receivership will transfer a portfolio of residential mortgage loans to a limited liability company in exchange for an ownership interest in that entity, the agency said in a statement. FDIC spokesman Andrew Gray declined to comment on the size of the asset pool. He said bidders must sign a confidentiality agreement in order to participate. Royal Bank of Scotland and Deutsche Bank AG are the advisers to the FDIC on the program. In its early stages, the pilot program is soliciting interest for the transaction and potential bidders are going through a qualification process, officials said.

No open and operating institutions are currently participating, FDIC officials said. Accredited investors will be offered an equity interest in the limited liability company under two options. The first is an all-cash basis, which is how the FDIC has recently sold receivership assets, with an equity split of 20 percent to the investor and 80 percent to the FDIC. The other option is a sale with leverage, under which the equity split will be 50-50 between the investor and the FDIC.

The FDIC said it will be protected against losses by the limits on leverage amount, the mortgage loans collateralizing the guarantee, and the guarantee fee. "The FDIC will analyze the results of this sale to see how the Legacy Loans Program can best further the removal of troubled assets from bank balance sheets, and in turn spur lending to further support the credit needs of the economy," the agency said. FDIC officials did not rule out additional sales.

The test pilot differs from previous receiverships sales due to the inclusion of a leverage aspect that hasn't been utilized since the era of the Resolution Trust Corporation, a government trust that liquidated assets in the 1980s and 1990s during the savings and loans crisis. The FDIC is also offering two leverage ratios for investors -- 6-1, which comes with certain performance strings attached, and 4-1, which has no strings attached.

For example with a 6-1 leverage, if the transaction price is $700 million, a note will be issued for $600 million and the remaining $100 million will be split evenly between the investor and the FDIC.
An investor who opts into the 6-1 leverage ratio will be required to meet certain performance thresholds and redirect some cash flows to lower the note in order to protect the lender, which is the FDIC. For an all cash transaction, the investor would be liable for 20 percent, or $140 million, based on a $700 million price.

Investors might find the 6-1 leverage option too onerous, said University of Louisiana finance professor Linus Wilson, who questioned why investors would want to partner up with the government and put up a 20 percent stake equity without cheap leverage. "Thus, 4 to 1 leverage may be the more popular choice," Wilson said. Officials said the note could be structured so that it is marketable instrument, similar to a mortgage-based security.

If the test proves successful, open and operating institutions will be able to shed troubled loans as long as the manager follows certain loan-servicing requirements under either the Home Affordable Modification Program guidelines or FDIC's loan modification program. The Legacy Loans Program is part of the government framework called the Public-Private Investment Program, which also includes a separate program under the Treasury Department to sop up troubled securities. The Treasury unveiled PPIP last year with the goal of enticing private equity firms who were sitting on the sidelines awaiting rules on when and how they could participate.

Limits on Bank Bonuses Face Senate, Obama Skepticism
Restrictions on financial industry bonuses heading to a vote in the U.S. House may be rejected by the Senate and the Obama administration, which are reluctant to increase government’s role in deciding compensation. The House, emboldened by New York Attorney General Andrew Cuomo’s report yesterday that showed nine banks getting U.S. aid paid $32.6 billion in bonuses last year, started debate today and probably will pass a bill requiring regulators to ban pay practices that encourage “inappropriate risks.” A panel in the House, where Democrats hold a 256-178 advantage, approved the measure along party lines July 28.

The bill must pass the Senate and be signed by President Barack Obama to become law. White House press secretary Robert Gibbs, who hadn’t read Cuomo’s report, said yesterday the administration is concerned the measure may give regulators too much say on incentive pay. Michael Oxley, former chairman of the House Financial Services Committee, said senators are more likely to back the say-on-pay measure that gives investors a non-binding vote on compensation.

“It is difficult for me to believe that the Senate would be particularly interested in passing that version, despite the report,” Oxley, co-author of the Sarbanes-Oxley corporate governance law, said in an interview. “I don’t think it’s going to influence the Senate.” The House in March passed a bill to set a 90 percent tax on bonuses at companies getting at least $5 billion in aid. The legislation, responding to public outrage over retention bonuses at American International Group Inc., died in the Senate after Obama said the U.S. shouldn’t “govern out of anger.”

Public outrage over Wall Street compensation reignited after Goldman Sachs Group Inc. set aside $11.4 billion for compensation and benefits for the first half of this year, a 33 percent rise from a year earlier and enough to pay every worker $386,429 for that period. Cuomo analyzed 2008 bonuses at banks that received $175 billion in U.S. aid and found that 4,793 employees were paid more than $1 million in bonuses last year. The 51 members of Citigroup Inc.’s senior leadership committee got an average of $4 million each, according to Cuomo.

The report underlines “why we’re trying to pass this bill,” House Financial Services Committee Chairman Barney Frank said yesterday in an interview. “This is precisely the kind of thing that should be subject to legal restriction.” The House measure goes further than administration proposals to regulate compensation. It bars incentive-pay plans that “could threaten the safety and soundness of covered financial institutions,” or that “could have serious adverse effects on economic conditions or financial stability.” The Senate wouldn’t take up the measure until it returns from its recess, which begins Aug. 10 and ends Sept. 7.

“History teaches us that it is a lot tougher to stampede the Senate than the House,” said John Olson, a partner at the Gibson, Dunn & Crutcher law firm in Washington. “If Mr. Cuomo was playing federal politics and trying to influence the Senate, he would have released this report after Labor Day.” The rules, with details to be set later, would cover every U.S. financial institution with at least $1 billion of assets. In addition to banks, credit unions and other financial companies, it also may cover hedge funds.

“We should tread very lightly,” said Senator Mark Warner, a Virginia Democrat, speaking before Cuomo’s report was released. Banks might avoid congressionally mandated pay restrictions if they can set the “right standards” and then be willing to engage in self-policing, he said. Hedge funds and other money managers should be exempt from limits because “if you think you are paying too much you can take your money out,” said Phillip Goldstein, principal at Bulldog Investors in Saddle Brook, New Jersey. “It’s the same thing with baseball. You see the price on the tickets and if you think it’s too much, don’t go to the game. I can’t believe anybody who took Eco 101 could support this.”

Goldstein won a court decision in 2006 throwing out an SEC rule requiring fund managers to provide information such as their business address and assets under management. “If this is going to be an issue, then as soon as Congress started handing out the money they should have been there to say that when it comes to compensation, we want to be party to this,” said Peter Sorrentino, a senior portfolio manager at Huntington Asset Advisors in Cincinnati, which manages $13.8 billion including shares of Citigroup, Goldman Sachs, JPMorgan Chase & Co. and Wells Fargo & Co.

Regulators Are Getting Tougher on Banks
Federal regulators have escalated the number of wounded banks they have essentially put on probation, with some of the targeted banks complaining that the action is too harsh. The Federal Reserve and the Office of the Comptroller of the Currency, two of the primary U.S. banking regulators, have issued more of the so-called memorandums of understanding so far this year than they did for all of 2008, according to data obtained from the agencies under Freedom of Information Act requests.

At the current rate of at least 285 so far, the Fed, OCC and Federal Deposit Insurance Corp. are on track to issue nearly 600 of the secret agreements for the full year, compared with 399 last year. Memorandums of understanding can force financial institutions to increase their capital, overhaul management or take other major steps. Such sanctions typically aren't publicly disclosed to avoid possibly rattling depositors and shareholders. Institutions hit with memorandums this year range from giant Bank of America Corp. to regional bank Colonial BancGroup Inc., based in Montgomery, Ala., to Berkshire Bancorp Inc., a New York bank with just 12 branches.

The sharp increase comes as Congress considers changes proposed by the Obama administration that would overhaul the way the U.S. government oversees banks. Many bankers and analysts believe those changes would result in an even more assertive regulatory apparatus. Regulators have been criticized for going too easy on banks and securities firms. Regulators say getting tougher now could prevent some struggling banks from failing as borrowers fall behind on their payments and the U.S. economy slogs through recession. A total of 64 banks have failed this year, up from 25 in 2008. "Regulators' natural response is: Oh my goodness, we've got to toughen up," Charles Plosser, president of the Federal Reserve Bank of Philadelphia, said in an interview.

Some bankers counter that the regulatory squeeze is making it even harder for them to make good loans that would help them recover. Others say banks are being forced to meet arbitrary standards that exceed what regulators normally require. "It's frustrating and aggravating," said Pat Sheaffer, chairman and chief executive officer of Riverview Bancorp Inc., of Vancouver, Wash., which has $920 million in assets and 18 branches. In January, the Office of Thrift Supervision issued Riverview a memorandum of understanding that requires the bank to increase its total risk-based capital, a measurement of financial strength, to 12% from 10.7% as of Dec. 31. Mr. Sheaffer said there was little dialogue with the agency before the requirement was imposed.

James Miller Jr., CEO of Fidelity Southern Corp., said he was surprised to be hit with a memorandum of understanding in December because the Atlanta bank's exposure to residential real estate is low in comparison to other banks in the area. Regulators want Fidelity to reduce its residential real-estate construction lending to no more than 100% of total capital, down from about 120%. Since the agreement, the bank has lowered its exposure to 110%. "I am not about to say anything about my regulators," Mr. Miller said. The bank got $48.2 million in capital from the taxpayer-funded Troubled Asset Relief Program right after it signed the memorandum. "I concluded that regulators were satisfied with how we were running our bank," he added.

Steven Rosenberg, Berkshire's chief executive, disagreed when regulators approached him about a memorandum of understanding that would change how certain assets are classified and the amount of reserves set aside to cover potential losses. He relented and then disclosed the agreement publicly. "You don't fight with the guys who regulate you," Mr. Rosenberg said. The increase in memorandums of understanding has been especially sharp at the Fed. Through June 30, the agency has issued 99 memorandums, compared with 94 for all of 2008.

Fed governor Daniel Tarullo, a close adviser to President Barack Obama during last year's campaign, now heads a committee in charge of the Fed's bank-supervision division. Mr. Tarullo has pushed for the Fed's 12 regional banks to take a more harmonized approach to bank regulation, according to people familiar with the matter. In the past, the Fed has faced criticism that its regulation was too uneven, with examiners in some areas of the U.S. accused of being too easy on banks, while examiners in other regions were much tougher.

"There is an awful lot of talk among bankers that ... 8, 10 and 12 [percent] will be targets FDIC will want to see going forward, even for healthy banks," said Ted Awerkamp, chief executive of Mercantile Bancorp Inc., referring to three ratios of financial strength known as Tier 1 capital, Tier 1 risk-based capital and total risk-based capital. The Quincy, Ill., bank holding company entered a memorandum with the Fed earlier this year. A separate agreement with the FDIC last year for a Naples, Fla., bank owned by Mercantile required that bank to attain capital ratios that are well above the minimum levels usually required by regulators.

Memorandums of understanding can lead to sterner, public sanctions if a bank is seen as not doing enough to correct problems. Colonial, which has been battered by bad real-estate loans, disclosed in March that it received memorandums from the FDIC, Federal Reserve Bank of Atlanta and Alabama banking regulators. On Monday, Colonial announced it "consented" to a cease-and-desist order from Alabama and the Federal Reserve Board of Governors related to "the issues of capital, liquidity and allowance for loan losses."

After Rescue, New Weakness Seen at A.I.G.
The dozens of insurance companies that make up the American International Group show signs of considerable weakness even after their corporate parent got the biggest bailout in history, a review of state regulatory filings shows.

Over time, the weaknesses could mean trouble for A.I.G.’s policyholders, and they raise difficult questions for regulators, who normally step in when an insurer gets into trouble. State commissioners are supposed to keep insurers from writing new policies if there is any doubt that they can cover their claims. But in A.I.G.’s case, regulators are eager for the insurers to keep writing new business, because they see it as the best hope of paying back taxpayers.

In the months since A.I.G. received its $182 billion rescue from the Treasury and the Federal Reserve, state insurance regulators have said repeatedly that its core insurance operations were sound — that the financial disaster was caused primarily by a small unit that dealt in exotic derivatives. But state regulatory filings offer a different picture. They show that A.I.G.’s individual insurance companies have been doing an unusual volume of business with each other for many years — investing in each other’s stocks; borrowing from each other’s investment portfolios; and guaranteeing each other’s insurance policies, even when they have lacked the means to make good. Insurance examiners working for the states have occasionally flagged these activities, to little effect.

More ominously, many of A.I.G.’s insurance companies have reduced their own exposure by sending their risks to other companies, often under the same A.I.G. umbrella. Echoing state regulators’ statements, the company said the interdependency of its businesses posed no problem and strongly disputed that any units had obligations they could not pay. “There is absolutely no concern about the capital in these companies,” said Rob Schimek, the chief financial officer of A.I.G.’s property and casualty insurance business. The company authorized him to speak about these issues.

Nothing is wrong with spreading risks to other companies, a practice known as reinsurance, when it is carried out with unrelated, solvent companies. It can also be acceptable in small amounts between related companies. But A.I.G.’s companies have reinsured each other to such a large extent, experts say, that now billions of dollars worth of risks may have ended up at related companies that lack the means to cover them.

“An organization like this one relies on constant, ever-growing premium volume, so it can cover and pay for the deficits,” said W. O. Myrick, a retired chief insurance examiner for Louisiana. If A.I.G.’s incoming premiums shrink, he warned, “the whole thing’s going to collapse in on itself.” Mr. Myrick has not fully examined all the A.I.G. subsidiaries but said his own recent review of many state filings raised serious concerns, particularly about the use of reinsurance to “bounce things around inside the holding company group.” “That is a method used by holding companies to falsify the liabilities,” he said.

A.I.G.’s premiums have, in fact, been declining in important lines. Its ratings have fallen, and customers tend to steer clear of lower-rated insurers. To woo them back, A.I.G. has in some cases lowered its prices, competitors say. A.I.G. executives insist they would rather lose a customer than drive down prices dangerously. A.I.G. has also pledged a share of its life insurance premiums to the Fed, to pay back about $8 billion. Details have not been provided, but consumer advocates say it is not clear how the life companies will pay future claims if their premiums are diverted.

“Eventually, there’s going to be a battle between the policyholders and the feds,” said Thomas D. Gober, a former insurance examiner who now has his own forensic accounting firm that specializes in insurance fraud. “The Fed is going to say, ‘We want our money back,’ but the law says, ‘Policyholders come first.’ It’s going to be ugly.” Mr. Gober is a consultant for a lawsuit on behalf of A.I.G. policyholders, filed in California Superior Court in Los Angeles. The lawsuit seeks a court order requiring all A.I.G. subsidiaries doing business in California to put enough money to cover their obligations into a secure account controlled by the state treasurer.

The goal is to keep money from being moved out of California or used to finance A.I.G.’s other activities, said Maria C. Severson, a lawyer for the plaintiffs. The lawsuit also seeks to bar A.I.G. companies from soliciting new business without full disclosure of their financial condition. The condition of A.I.G.’s individual companies is hard to see in the parent company’s filings with the Securities and Exchange Commission. Those filings simply tally all the individual subsidiaries’ financial information.

The companies’ weaknesses emerge in their filings with state insurance regulators — particularly when several are reviewed together. But that appears not to happen often, because there are so many. A.I.G. has more than 4,000 units in more than 100 countries. Responsibility for A.I.G.’s 71 American insurance companies is spread among 19 state insurance commissions, which do not conduct examinations simultaneously. As a result, Mr. Myrick said, a conglomerate like A.I.G. “can keep moving assets around to clean up one company” at a time, when examiners were looking. He said that it would take a coordinated, multistate examination of all the insurance companies to catch this.

Mr. Schimek, speaking for the insurance companies, said that in 2005, a team of examiners had at least considered A.I.G.’s property and casualty businesses as a group. “It was a thorough examination,” he said. “I have absolutely no concern about the integrity of the financial information that’s been filed under my watch.” State regulators confirmed that they believed the A.I.G. subsidiaries under their authority were solvent.

Mike Moriarty, deputy insurance superintendent for New York State, said that while A.I.G. subsidiaries did not report all their reinsured obligations on their balances sheets, state regulators could “follow the trail of liabilities” and make sure they did not get lost in the holding company. Obligations “can’t be hidden from state insurance regulators,” Mr. Moriarty said.

One A.I.G. subsidiary, the National Union Fire Insurance Company of Pittsburgh, shows what can happen by heavily relying on affiliates. Its most recent regulatory filing in Pennsylvania said it had more than enough money to pay its obligations. But at the end of 2008, more than a third of National Union’s portfolio was invested in the stock of other A.I.G. companies, which are not publicly traded. National Union might not be able to sell all of these shares, and it is not clear what it could get for them. Many states bar insurers from investing that heavily in related companies.

Meanwhile, National Union has $42.1 billion in obligations looming off its balance sheet. These have been transferred to 56 other A.I.G. companies, through reinsurance. National Union will have to pay any of these claims and then collect from its relatives. But it is not clear that the affiliates could pay promptly. National Union’s biggest reinsurance partner is American Home Assurance, an A.I.G. subsidiary that has taken $23.1 billion of obligations off National Union’s hands. In a New York filing, American Home reports total assets of $26.3 billion, but part of that consists of assets that cannot be used to pay claims, like furniture. It too includes a number of investments in other A.I.G. companies.

In addition, American Home has “unconditionally” guaranteed the obligations of 16 other A.I.G. subsidiaries, bringing the total it might have to pay to $140.6 billion. Normally, when an insurance company weakens, regulators in its home state will first measure its capital. They may demand a weak company rebuild its capital, and if it fails, eventually bar it from selling new policies.
Like New York regulators, Pennsylvania regulators say they do not see a problem.

“The insurance companies remain strong and are probably the most valuable assets within the A.I.G. structure,” said Joel Ario, Pennsylvania’s insurance commissioner. “To the best we know it, we think the companies are sound.” But policyholder advocates said they feared state regulators were deferring to the wishes of the Fed and Treasury, to use the insurance operations to pay back the taxpayers. “The insurance commissioners, for whatever reason, are letting them do this,” Mr. Myrick said. “I’d be jumping out of my shoes.”

Bond Worry: Will China Keep Buying?
Shaky auctions of Treasury notes this week reignited concerns about whether the government can attract buyers from China and elsewhere to soak up trillions in new debt. A fuse was lit this week when traders noted China's apparent absence from direct participation in two Treasury bond auctions. While China may have bought Treasurys just before the auctions, market participants read the country's actions as a worrying sign that China and other foreign investors may be ratcheting back purchases at a time when the U.S. is seeking to fund a $1.8 trillion budget deficit.

This week alone, the U.S. deluged the bond market with more than $200 billion in record-size sales. The U.S. has had little trouble finding buyers in recent months. But that demand is fading, and the Treasury market has become volatile. Many are selling in favor of riskier assets such as corporate bonds, stocks or even higher-yielding debt of other countries. This portends higher interest rates for the Treasury, and it may need to find alternative sources of cash like issuing more inflation protected Treasury bonds.

Tension on Wall Street trading desks began building late last week when the Treasury surprised the market with plans for a record week of sales. A Monday sale of $90 billion in Treasury bills with maturities of as much as a year went well. But China appeared absent from the following two sales, which totaled $81 billion of debt, traders say. By Thursday morning, trading-desk heads were frantically working with clients to ensure a better fate for the $28 billion seven-year note auction. It did fare far better, allaying some concerns.

"We believe by maintaining the deepest, most liquid market in the world, we will continue to attract capital from a broad array of investors," said Andrew Williams, a spokesman for the Treasury Department. The seven-year Treasury note rose after the auction, gaining 3/32 point Thursday to 99 25/32, which lowered its yield to 3.285%. The 10-year Treasury also gained in price on the day, up 6/32 to yield 3.641%. Details about the auctions aren't revealed by the government until weeks later. Overseas buyers initially are lumped together into a category known as "indirect bidders," giving little insight into the origins of demand. It may be months until more thorough data on foreign-government buying are released by the U.S. Treasury.

Foreign investors had been substantial bidders in recent Treasury auctions, even though their holdings of Treasury debt had started to wane. But this week's auctions renewed worries that central banks and other buyers will start selling more aggressively. "If this trend continues, it could reflect foreign buyers' increasing concerns about the creditworthiness of the U.S.," said James Bianco, president of Bianco Research. The worries over China shine a light on the potential vulnerability of the U.S. as it tries to fund is budget hole. Last year, China led foreign investors in selling mortgage securities guaranteed by government entities Fannie Mae and Freddie Mac, according to Treasury Department data. They also sold corporate bonds as the global financial crisis ramped up. They have not dipped back into these asset classes despite a huge rally in corporate bonds and mortgage debt this year.

While no one at State Administration of Foreign Exchange, which manages China's $2 trillion, would comment on the latest Treasury auctions, the government has left little doubt it fears the portfolio is at risk. Clipped comments from government officials, amplified by state media editorials, point to a worry the U.S. will ultimately address its massive debt obligations by permitting inflation to rise or letting the U.S. dollar sink -- factors that would erode the value of Treasurys owned by foreign investors such as China.

At economic talks in Washington this week, senior Chinese officials gave their Obama administration counterparts an earful about the burgeoning U.S. budget deficit. China made clear it wants the U.S. to "protect its investment assets" for the good of the bilateral relationship, as the state-run Xinhua news agency reported. The gravity of Beijing's concern was reiterated with blanket coverage of the talks in Chinese newspapers, which generally praised Washington for treating seriously its concerns. Global Times, a nationalistic English-language paper, published a front-page photo showing U.S. Federal Reserve Board Chairman Ben Bernanke appearing anxious, perched on the edge of a chair and listening as Chinese Vice Premier Wang Qishan makes a point.

The Chinese are also in a bind. If they sow doubts about the solvency of the U.S. government, they risk driving down the value of the $800 billion in U.S. Treasurys they already own. The Chinese government's Treasury strategy is a closely guarded secret, and analysts were hard-pressed to identify any evidence that might suggest an adjustment was suddenly under way. "We worry about the devaluation of the U.S. dollar, but not at this stage," said Yang Hui, a bond salesman at Citic Securities Co. in Beijing.

The Federal Reserve's holdings in a facility set up to support the commercial-paper market fell to $67.3 billion in the week ended July 29 from about $106 billion last week, according to data released Thursday. This week, three-month paper was maturing, and companies likely took their funds out of the Fed's Commercial Paper Funding Facility. "We are seeing a significant improvement in sentiment around commercial paper, which is encouraging people to leave the Fed's protective custody," said Joseph Abate, money-markets strategist at Barclays Capital in New York. The facility held about $334 billion at the end of 2008.

Wall Street Analysts Keep Telling Big Earnings Lie
At a time when the financial industry’s credibility is at an all-time low, you would think Wall Street’s finest would break their necks providing transparency. Not so. Stock analysts continue to promote corporate earnings lies, insisting that net income isn’t really what investors need to know. Instead, their earnings estimates ignore often huge expenditures that can’t help but affect a company’s health. In analystspeak, Intel Corp. wasn’t hit with a $1.45 billion fine from the European Union in the second quarter for anticompetitive practices.

After setting aside funds to cover the fine, which Intel is appealing, the semiconductor-maker had a quarterly loss of $398 million, or 7 cents a share. Disregarding the fine altogether, analysts maintain the company earned 18 cents a share, beating their average estimate of 8 cents. As Wall Street tells it, the employee stock options Google Inc. granted in the second quarter didn’t cost its shareholders $293 million. Google, according to generally accepted accounting principles, earned $1.48 billion, or $4.66 a share, in the period. Not enough for Wall Street, which prefers to say the company earned $5.36 a share, leaving out the cost of stock options.

Business journalists know what’s going on and in their stories emphasize net income -- which accounting authorities say is where the focus should be. Still, if reporters want to show how the latest report compares with earnings estimates, they are stuck using analysts’ predictions. Viacom Inc., an entertainment company, this week reported second-quarter net income of $277 million, or 46 cents a share. Analysts had estimated profit as if money Viacom paid out in severance in the period wasn’t the real thing. On that basis, Viacom earned 49 cents a share, beating the average estimate by 1 cent.

Time Warner Inc., a rival of Viacom for entertainment dollars, said it earned $519 million, or 43 cents a share, in the quarter. Analysts insist Time Warner earned 45 cents, excluding, according to Bloomberg data, costs related to litigation and asset sales. Lawyers must work for nothing. By similar Wall Street reckoning, the expense of cutting jobs and selling an asset that reduced McGraw-Hill Cos. second quarter earnings per share by 10 percent was immaterial.

Analysts also say investors should ignore $129 million that Textron Inc., maker of small airplanes, helicopters and golf carts, charged against net income in the latest quarter. Included was the cost of shutting a plant for an eight-seat jet Textron decided not to build. General Electric Co., which makes jet engines and electric power equipment and has a financial services arm, had a second- quarter profit of 24 cents a share. GE and the analysts emphasized earnings from continuing operations, which at 26 cents a share, exceeded their estimate by 2 cents. A $194 million loss from discarded businesses was discarded.

Wall Street’s big earnings lies must exasperate investors. They already have lost faith in the reported earnings of banks that are the center of the financial system. Exactly how impaired are banks’ impaired loans? The Financial Accounting Standards Board, under political pressure, has ruled that the banks decide. Might as well ask a six-year- old who took the cookies.

The argument is that “adjusted” earnings make for a smoother picture of company performance. Cooking the books to smooth out earnings from quarter to quarter is what hoodwinked shareholders of Fannie Mae and Freddie Mac several years ago. The companies, which support the mortgage market by buying loans, ended up charging billions against earnings and executives were fired. Fannie and Freddie subsequently suffered from the collapse of the mortgage market, and are now wards of the government. Investors who bailed out after the fraud was revealed were the lucky ones.

Billions in Lehman Claims Could Bury an Elusive Insurer
Next to a Chinese restaurant in Burlington, Vt., lurks a quiet guardian of Wall Street — an obscure insurance company that is supposed to protect big-money investors in the event of a catastrophic failure of a major brokerage firm. A failure, for instance, like the one that brought down Lehman Brothers nearly 11 months ago. Now, after years in the shadows, the insurer, the Customer Asset Protection Company, could finally be put to the test, and questions are starting to swirl.

The worry is that the company, which has never paid out a claim, might be unable to cope with the Lehman bankruptcy. If it were overwhelmed by claims, the banks and brokerage companies that own Capco, as it is known, could end up owing billions of dollars. Capco representatives dismiss such concerns, but state insurance regulators are keeping an eye on the company. Officials at the New York State Insurance Department are concerned about the company’s ability to withstand the Lehman bankruptcy, the largest in history.

By some industry estimates reviewed by the insurance department, Capco could face nearly $11 billion in claims but has only about $150 million with which to meet them. The state is examining whether the company sold policies without the means to cover them, according to a person with direct knowledge of the inquiry who had signed confidentiality agreements. The issue has even reached Washington, where a member of the Senate Finance Committee, Robert Menendez, has sounded an alarm. Mr. Menendez, Democrat of New Jersey, wrote the Treasury secretary, Timothy F. Geithner, in June to express his concern.

“It has become clear that this entity is thinly capitalized,” Mr. Menendez wrote in the letter. Capco, he said, potentially posed “systemic risk.” Capco was created in 2003 by Lehman and 13 other banks and brokerage companies as a kind of marketing tool. The pitch was that while Capco would not insure customers against investment losses, it would compensate them if the firms failed. Capco promises to provide virtually unlimited coverage above the $500,000 offered by the Securities Investors Protection Corporation and its equivalent in Britain.

Capco is virtually unknown even in financial circles, but it is being thrust into the spotlight by the events at Lehman. Creditors and former customers are battling over who will get what and when from the fallen bank, including more than $32 billion of assets that have been tied up in Lehman’s London prime brokerage unit. Untangling the mess could take years. Some former Lehman clients, which include big hedge funds, are looking to Capco for answers — and money. Dewey & LeBoeuf, the law firm that represents Capco, said in a statement that Capco had no current policies outstanding and was “preserving all assets to address claims that might arise out of the insolvency of Lehman Brothers Inc. and Lehman Brothers International (Europe).”

The law firm called worries about Capco’s potential exposure to Lehman “speculation.” Capco, which is private, is something of a financial mystery. Its members include Wall Street giants like Morgan Stanley and Goldman Sachs, banks like JPMorgan Chase and Wells Fargo, smaller brokerage firms like Robert W. Baird & Company and Edward Jones, and Fidelity, the mutual fund giant. Capco was initially registered in New York but later moved to Vermont, where state law enables it to operate without disclosing much about its finances.

Capco’s owners referred questions about the company’s liability to Dewey & LeBoeuf. Since it stopped writing policies on Feb. 16, most of Capco’s owners have purchased account protection for their clients through private insurance companies like Lloyd’s of London. Pershing, a unit of Bank of New York Mellon, told clients in a December notice that their Capco insurance would expire and that the firm had a new policy with Lloyd’s to “provide our customers and their investors with extra comfort that their assets are safe.”

It’s unclear who actually serves as the current president of Capco, and the company’s main phone number connects to a recording that tells callers they’ve reached a “nonworking number at Morgan Stanley.” A unit of Marsh & McLennan, the giant insurance services company, is listed as Capco’s administrator, but no contact information is listed on Capco’s Web site. The unit is based in the same Burlington building as Capco.

Brokerage companies used to buy account protection insurance from large insurance companies like Travelers and the American International Group. But in 2003, those insurance companies stopped offering such policies, saying it was impossible to calculate their liability. Enter Capco. The Capco members played up their coverage when pitching their brokerage services to clients, especially large hedge fund customers who could lose billions of dollars if a firm went under. Although Capco’s finances were never disclosed publicly, the company was initially a given high rating by Standard & Poor’s.

That rating, however, was cut to junk status last December, and the ratings were withdrawn altogether in February. In its report, S.& P. said it was concerned about potential claims from customers of Lehman’s London unit, which “could create a liability for Capco that exceeds the insurer’s resources.” Charles Schwab, UBS and Merrill Lynch never opted for Capco, arguing that the arrangement seemed risky. Schwab requested the company’s financial statements from the insurance department through a Freedom of Information Act request in 2004, but was told the books were confidential.

The New York State Insurance Department later told Capco’s members that the company would eventually have to release the information. Before that happened, however, Capco relocated to Vermont, a haven for so-called captive insurance companies, whose owners are the ones buying the policies. “Right away, the whole Capco thing just did not pass the smell test,” said Robert Meave, an outside consultant for Schwab at the time, who evaluated the insurance company. “Schwab was not about to go to their clients and tell them we’re providing account protection and, oh by the way, they were owners of the insurance company.”

Firms who sought coverage elsewhere, mainly through Lloyd’s of London, could buy only up to $150 million of insurance per account and a maximum of $600 million for the entire firm. As a result, some customers moved their money to firms that offered Capco coverage. “Let’s face it, none of us could have foreseen an event like Lehman, but we didn’t feel the capitalization of Capco as it seemed to be forming was going to be adequate in the extremely unlikely event that something happened,” Mr. Meave said.

Owners of the assets tied up in Lehman’s London unit, including pension funds and university endowments, believe they may have claims against Capco if all of their money is not returned by Lehman’s liquidator. If Capco can’t pay out the claims and files for bankruptcy, several customers said they would bring lawsuits against the other brokerage houses. “The bottom line is, this insurance should have never been sold to clients, and it just shows how Wall Street again miscalculated the risks involved with one of their own going under,” said an adviser working on the Lehman bankruptcy who was not authorized to speak for the company.

The Road to Financial Serfdom: The Official Disconnect of Main Street from Wall Street and the Financial Mainstream Media
On Thursday with the S&P 500 inching closer to the 1,000 mark it is near impossible to silence the “recession is over” media hype.  Of course, this is the same media that missed the biggest economic collapse since the Great Depression but here they are predicting the end of the recession.  The problem of course is they do not define the end of the recession clearly.  In their mind’s eye, the end of the recession means Wall Street profits and largesse pouring into the banking coffers.  What about jobs?  What about $14 trillion in lost household net worth?  The U.S. Treasury and Federal Reserve are suddenly neo-Keynesians but only when it comes to saving themselves which is convenient.  If you think of the stimulus plan for example, it was passed in February and had a price tag of $789 billion.  This may seem gigantic but compared to the $13.5 trillion banking and Wall Street bail out it is relatively small.

Yet many people forget how that money was spent or will be spent:


Now the above gives you a general sense of the plan.  Much of the money sent to states is already spent.  Not much stimulus occurred here because states used the funds to patch up brutal deficits like those being experienced in California.  Also, a large portion of the money was in tax cuts.  That amount is $282 billion.  Much of that money is already factored into the current economy.  Yet the stimulus bill was more like a band aid and less of a stimulus plan.  The overall idea of a stimulus bill is to create jobs but when you dig into the bill, there really wasn’t much money dedicated to this.  However, let us now look at the Wall Street and banking bail out:


*Source:  Bloomberg

In fact, if we look at only two line items here, the Term Auction Facility and the Currency Swaps program, these two dwarf the 2009 stimulus bill.  So why is the stock market rallying yet 26,000,000 people are unemployed or underemployed?  Because Wall Street has become a casino and most of the “bail out” funds have gone to the rigged banking system.  Keep in mind this is the same banking system that created collateralized debt obligations trying to convert toxic waste mortgages into “solid investments” and sold them off to so-called investors.  This is the same industry that hungered for subprime mortgage debt and allowed the real estate industry to give loans to anything and everything.  This is the same Wall Street that held the American public financially hostage last September and October.  This is the same industry that offered wicked incentives to the real estate industry for finding any loan even if it was fraudulent to put into their mortgage-backed security portfolios.

So on the one hand, we have a stimulus bill of $787 billion that people can feel and then you have $13.5 trillion committed to the banking and Wall Street bail out with already $4+ trillion used.  And you wonder why the stock market is up 46.5 percent in four months?  The stock market is no longer connected to main street.  Take a look at some mainstream media analysis of this:



*Source: Futurnomics

What can be more telling than that CNBC screen capture stating the recession is over and then, right beneath it you see the Bank of America and Merrill Lynch logos?  The recession may be over for Wall Street and banks thanks to the $13.5 trillion committed but Main Street is still very much in a recession.

Keep in mind the U.S. Treasury and Federal Reserve have already committed this money and we still have the $3 trillion commercial real estate bubble that will burst and we have covert action like Plan C where they are preemptively getting ready to use taxpayer money to bail out more toxic financial waste.

Why is all this failing so miserably for the public?  We have the worst of Keynesian thought mixed in with the worst of free market thinking.  In a nut shell, Keynesians believe that in difficult economic times the government should step in to create an environment that will help economic conditions by stimulating work and demand.  In war, this works perfectly as it did after World War II and issued in 30 years of prosperity for the U.S.  Yet using too much of this during peacetime will create problems like the 1970s stagflation.  That is, politicians will use Keynesian mixed-market planning in times of political desperation like when Nixon stated, “I am now a Keynesian” and was re-elected for a second term in a very difficult economic climate.  An advisor to Nixon at the time Milton Friedman chastised his action but that is how politicians will operate in desperate times.

After that, the school of free market thought entered and de-regulation was put up on a mantle.  This led to economic recovery but also gave us the S&L crisis and was a precursor to our current financial de-regulated mess.  Unfortunately, it would seem that we are using the worst of both systems.  We are using Keynesian principals to bail out the so-called free market banks.  They are using both theories of Hayek and Keynes in completely unjustified ways.  We really have no idea how things will end but many Americans are feeling as if they are on path to financial serfdom.

We have bankruptcies rising at colossal speed.  The 30 year housing bubble has burst with deep consequences.  We keep borrowing money every day from our foreign lenders.  Unemployment is still rising with the real unemployment rate closer to 17 percent.  Keep in mind that even though we are not flying off the edge, companies are not hiring.  That is the second part of the equation that is leading to modern serfdom.  Sure, companies may not be laying off current employees at the peak levels of this recession but they are not hiring either:


*Source:  Gallup Poll

As usual, it pays to look at who is doing the hiring instead of clamoring around Wall Street and the mainstream media analysis like middle school girls.  As you can see from the above, those letting people go is still high.  We went from about 40 percent of those surveyed in February of 2008 saying they were hiring to the current 22 percent.  Those letting go was about 11 percent in February of 2008 and now it is near 27 percent.  But again, who needs a job when you have trillions funneling into Wall Street.  And what good is a tax cut when you are unemployed?

The road to financial serfdom is paved with bad intentions here.  The U.S. Treasury and Federal Reserve are operating under the premise of “what is good for Wall Street is good for America.”  It is not.  When are we going to investigate Wall Street with a strong arm?  And don’t you think it would make sense to investigate why things failed before committing $13.5 trillion to the cause?  Interesting how they already know how much money they need right?  That is why you shouldn’t be surprised when you get reamed with another trillion for commercial real estate, more trillions in bad toxic mortgage debt, and the government running to bail out Wall Street for bad bets.

You cannot be dogmatic in these cases but it is incredible what is happening.  Looks like the financial overlords on Wall Street want to make Americans into their financial serfs.  Who needs a job when you can watch CNBC all day and watch them drink champagne while they cheer big earnings for banks since trillions has been given to this industry?  Hard to lose money with a trillion safety net.

Don't Be Fooled
by Michael Panzner

I was originally going to write about something else, but after a loyal Financial Armageddon visitor alerted me to the following Financial Times commentary, "Insight: Learn to Love the Recovery," by Tim Bond, head of asset allocation at Barclays Capital, I changed my mind. Frankly, I couldn't believe this piece of propagandistic excretia was written by a senior financial industry executive who makes decisions about where to invest. Because some FT readers might be fooled into thinking Mr. Bond had something useful to say, I felt duty-bound to respond to his "insights" with a few brief comments of my own (interspersed with his italicized text):
Never has a bull market climbed a steeper wall of worry. In spite of a proliferation of positive economic indicators, the consensus remains gloomy. Bullish economists are than hens’ teeth.

The average forecast for third-quarter US gross domestic product growth is a weak 0.8 per cent, which would be by far the slowest first quarter of any recovery on record. Since 1945, the average annualised real US growth rate in the first two quarters of recovery is 7 per cent. History provides abundant evidence that the deeper the recession, the stronger the bounce. Even the recovery from the Great Depression conformed to this rule, real US GDP grew 10.8 per cent in 1934 and 8.9 per cent in 1935.

There are so many inconsistencies and logical fallacies in the above paragraph that it's hard to know where to begin. Among other things, Mr. Bond assumes that the consensus is correct in seeing a third-quarter uptick in GDP. That may or may not be the case, but given how wrong economists have been about every aspect of this downturn so far, I'd lean towards the latter. Even if they are right, what evidence does he have that a third-quarter rebound will be the turning point, rather than the equivalent of an economic dead-cat bounce? Moreover, his assumption that the postwar time frame is the relevant reference period when it comes to forecasting the kind of recovery we might eventually expect to see is laughably ignorant given the extraordinary upheavals of the past two years. Paradoxically, he also makes reference to the upturn that followed the Great Depression, conveniently ignoring the fact that the earlier downturn dragged on for more than twice as long as the current one has before things turned around.
Yet today’s consensus assumes this time things will be different. The persistence of such pessimism is striking given a strong Asian recovery is visible, with output, employment and demand all following V-shaped trajectories, and regional industrial production rapidly bouncing back above the previous peak. Yet this recovery is dismissed by western analysts, who appear unable or unwilling to believe the region is capable of endogenous growth. That 2009 will be the second year in a row in which the increase in Chinese domestic demand exceeds that of the US is a point roundly ignored.

Actually, anybody who's been paying attention knows that most mainstream forecasters still seem to believe that what we are going through right now is "more of the same" -- that is, the same kind of (admittedly severe) cyclical downturn we've seen in the decades since World War II, rather than a bursting-credit-bubble-induced secular unraveling. The fact that Mr. Bond fails to grasp that the alleged V-shaped rebound in China and its sphere of influence is anything other than a steroidally-inflamed mirage spawned by a government-ordered blast of reckless spending and an XXX-rated orgy of forced bank lending makes you wonder why he still has a job (oops, I forgot: competence is not a prerequisite when it comes to those who are paid to make "forecasts" for a living).
The fate of the Chinese economy is supposedly in thrall to the US consumer, in spite of clear and persistent evidence to the contrary. The US economy, which provides a home to 17 per cent of China’s exports, is still seen as the arbiter of growth in Asia. This obstinate adherence to an outdated assessment of economic dependence is not the only gaping intellectual flaw.

I suppose in one respect he's right: China is no longer as in thrall as it was to the US consumer; rather, the country now seems to be dependent on the whims of 1) panicky authorities, worried about the domestic social consequences of a global collapse in growth and trade; 2) corrupt and overextended lenders, who have apparently mistranslated the words "bad loan" and "malinvestment" into "any borrower will do"; and, 3) speculators, who've decided that all they need to do to get through these troubled times is to buy a lot of stocks, commodities, real estate, etc. -- using tons of borrowed money -- and they will invariably make a killing.
The 9.5 per cent US unemployment rate is also viewed as an obstacle to recovery. This objection ignores the many contrary examples of high unemployment rates and subsequent recoveries, not least in the US. Thus in 1982, US unemployment hit 10.8 per cent, yet GDP soared at an average annual pace of 7.7 per cent over the next six quarters.

Mr. Bond uses a baseless assumption -- the current unemployment rate is at or near its peak -- and a bogus comparison -- today's unemployment rate means conditions are similar to what they were back in 1982 -- to make a ridiculous argument. I wonder: Does this reflect the sort of analytical talent you need to manage other people's money?
Similarly, few commentators consider the possibility that the large post-Lehman rise in US unemployment was a mistake on the part of panicky managements. Yet this is precisely what trends in labour productivity growth, not to mention common sense, tell us occurred. In the first half of 2008, labour productivity growth averaged 3.3 per cent, while the unemployment rate rose to 5.6 per cent. At that point, there was no evidence US companies were overstaffed. Thereafter, output collapsed, yet business productivity growth remained positive, registering an average yearly pace of over 2 per cent, as companies shed labour at a faster pace than they reduced output. Businesses, like markets, panicked after Lehman went under. Employment and output were both reduced far more than it turned out to be necessary, as businesses temporarily and understandably assumed a worst case scenario.

Again, Mr. Bond makes a number of dubious assumptions and ridiculous assertions. Was it really "a mistake" that "panicky" managements slashed payrolls, or was it an entirely rational response to epic declines in global cross-border trade, orders, and revenues, a sudden seizing up of many traditional financing mechanisms, and a dramatic about-face in the spending habits of overleveraged consumers, among others? While Tim Bond and his fellow economic revisionists might have a different spin on things, my recollection is that much of corporate America -- not to mention Wall Street and Washington -- remained upbeat on the outlook for the economy up until the very moment the bottom fell out, sucked in by the reassurances of mainstream prognosticators who failed to see the meltdown coming until it was too late?
Just as global output is performing a V-shaped recovery, there is a big risk US employment will do the same, with monthly payrolls showing surprising growth by the end of 2009.

If Mr. Bond engaged in even a modicum of research that went beyond crunching massaged and mangled economic statistics and hobnobing with clueless policymakers and delusionists in the financial industry -- say, by reading a small town newspaper or talking to people on the streets about what is really going on, he would quickly realize just how out-of-touch and ignorant he sounds -- then again, maybe not -- when he makes statements like those in the paragraph above.
If unemployment is one half of the bearish consensus, de-leveraging is seen as the other main obstacle to recovery. Yet increases in private leverage never play a significant role in recoveries. Indeed, since 1950, US private sector borrowing ex-mortgages has declined an average 0.1 per cent of GDP in the first year of recovery, with non-financial business borrowing declining 0.6 per cent of GDP.

The fact that Mr. Bond is effectively discounting the role that leverage played in creating the mess we are in, and takes no real account of the fact that the financial industry is almost completely dependent on government largesse while many lending and market mechanisms are in disarray or have broken down, suggests to me that he is experiencing a degree of denial -- or, perhaps, incoherence -- that is breath-taking. The fact that total debt as a percentage of GDP is at record extremes and the overleveraged consumer, who represents about two-thirds of the U.S. economy, has neither the will nor the wherewithal to spend more or increase his borrowing appears not to mean much to Mr. Bond, who keeps insisting, bizarrely, that the postwar period is the correct frame of reference. Who in their right mind would argue that the events of the past two years bear even a passing resemblance to what has occurred over the past six decades?
A regression of the household savings rate on the wealth-to-income ratio tells us the former has made the appropriate adjustment to declines in the latter. In fact, the rally in the stock market, the low level of interest rates and the stabilisation in house prices all tend to limit the risk of a further sizeable increase in the savings rate. So over the rest of this year, the standard cyclical timing of a US economic turning point tells us pessimistic expectations are likely to collide with the economic reality of a strong recovery. The net result is almost inevitable, in the shape of an inexorable continuation of the equity rally.

In many respects, Mr. Bond's final paragraph is the pièce de résistance, a fitting climax to a stuporous journey through economic la-la land. In fact, some might say the collage of bogus relativistic comparisons, irrelevant details, distorted "facts," circular reasoning, and logical inconsistencies is like a WTF?-Wet Dream stoked with lashings of LSD. Is he really saying that a few months worth of a few seasonally-adjusted data points represents "stabilization in house prices"? Is he suggesting that current debt levels and the long-term trend of historical savings rates relative to disposable income are not all that important in assessing whether an "appropriate adjustment" has been made in the savings rate? Why does the "standard cyclic timing of a US economic turning point" matter when the events of the past two years have been neither standard nor cyclical? And since when is a "rally in the stock market" a driver for "an inexorable continuation of the equity rally"?

Great job, Mr. Bond. Can't wait to hear what you have to say next.

Causes of Depression Yet To Be Addressed
More disruptions for the US dollar and UK Pound, international financial system too weak, GDP numbers are phony, more devaluation and default, Globalization a disaster, Purging the system still a good idea, Abolish the Fed, Gold and Silver your only safe haven, What can the market possibly do under such stress?....

As we enter August we are getting closer and closer to real disruptions with the US dollar, as well as problems with the British pound, as both economies feel the sting of rising inflation within a progressive depression. The stimulus package has exhausted itself for this year so the economy in the US can at best stay neutral at a minus 4% of GDP. The causes of our depression have yet to be addressed as the Treasury and the Fed flood banking, Wall Street and insurance companies with funds to keep them afloat. The deterioration continues unabated as Wall Street and banking report higher earnings by laying off workers and by playing accounting games.

US debt is on it way to causing a retest of USDX to 71.18. The will cause higher interest rates. There will be a furious effort to re-liquefy the US economy causing ever more inflation. The entire international financial system is in no condition to meet such a challenge. The US Treasury is so busy trying to find buyers for Treasuries they have little time to solve anything, as unemployment at 20.5% throttles the nation. The economy is not going to recover by saving the anointed few in banking and Wall Street. Americans and Brits are no longer buying the ridiculous fairy tale of green shoots.

People are catching on that the economy and the markets are being temporarily rigged. By the end of October we believe banks in the US, UK and Europe will be in serious trouble again. That should really knock markets and the world economy to new lows. It could also corrupt any improvement in GDP anywhere. The problems of 2007 and 2008 will return, because the façade of the public bailout of banking and Wall Street will crumble again. Further impoverishment is on the way. More and more will be laid off and they’ll be no new jobs available. Savings will be exhausted and most homes that have been financed will be under water.

You must put in dehydrated and freeze dried foods, a water filter and plenty of guns, ammo and clips. All stocks and bonds should be sold, except gold and silver shares and Canadian and Swiss Treasuries. All cash value life insurance policies and annuities should be sold. We’ll deal with pensions later. All IRA’s, Roth’s and 401(k)’s that you control should be in gold and silver shares, funds and coins. The phony GDP numbers won’t fool actuality. You cannot have a recovery without an expanding jobs market and we are going the opposite way.

Devaluation and default are in the air and it is only a matter of time before it happens. Be out of dollar and pound denominated investment except gold and silver mining shares and gold and silver coins. Convert as fast as possible. Following the collapse of both the US and UK economies, New York’s, Wall Street and the “City of London” will cease to be the centers of world financial powers. Then will come the real investigations and trials of those who stole from the people and committed treason. And, all the kings’ horses and all the king’s men couldn’t put the Illuminati together again.

Globalization has been a disaster for the US, Europe and the UK and Canada. It may have brought relative prosperity to the third world and transnational conglomerates, but overall it has simply been a method of redistribution of wealth. This deliberate policy by internationalists will eventually push us back into tariffs, a device that helped keep competition fair, not free. We found out in the late 1700s what damage British Colonialism, known as British mercantilism, visited upon our young economy.

The one-worlders who brought us free trade, globalization, offshoring and outsourcing brought us the collapse of our financial system. Due to their control of the Fed and the Treasury Department, Goldman Sachs and JP Morgan Chase brought about the demise of Bear Stearns and Lehman Bros., and caused Merrill Lynch to be bought out. It is handy when you have the power to destroy more than half of your competition. Not that they were not broke, they were, but so were GS and JPM. All these firms and banks and many others used 30 to 50 times leverage, which has and is insanity.

Making excuses for these players doesn’t wash. All they are doing is borrowing money at zero interest rates from the taxpayer, and these are the people who caused this disaster. Contrary to what the banks say, it will take a lot longer to work out from under their debts. They are just starting to get hit with credit card debt, commercial real estate debt and face three more years of foreclosures in residential real estate. We might add that former Treasury Secretary Paulson, on loan from Goldman Sachs, made sure that banks and Wall Street were rescued along with a cluster of insurance companies. Very little was done to assist some of the deserving public.

Those who were saved were the ones who approved subprime, no-doc and option ARM pick-and-pay loans, along with the rating services, which committed fraud jointly in the sale of collateralized debt obligations. In addition, Paulson, who threatened Congress with insurrection in the streets if his demands were not met, raised $700 billion from Congress. This is the same Paulson who strong-armed the FASB to change the accounting rules from mark-to-market from mark-to model to allow financial institutions to falsify their books. We might also add that while he led Goldman he allowed 50 to 1 leverage and he was a major player in securitizing loans.

Banking leverage over the past ten years has risen form 19% to 50% versus tangible equity and is currently about 45%. In England it is 55%. UK bank assets are 5 times GDP, whereas they are 2 to 1 in the US. It is not cavalier to demand a purging of the system. No matter what is done by the Fed and the Treasury the music must be faced with a deflationary depression. Yes, unemployment would go to 40%, but it is going to go there anyway. Little effort is being made to deleverage the banking system and that is one of the major problems. Remember, those banks and those on Wall Street and in insurance that were rescued by the taxpayer were all elitist firms.

U6 unemployment minus the birth/death ratio is 20.5%. Job losses are now equal to or greater than at any time since WWII. All job growth since 2002 has been totally wiped out. The average workweek is 33 hours as more and more companies request employees to take unpaid leave. That government says amounts to more than 9 million people, or 5.8% of the workforce. Those figures are greatly understated as factories work at 65% of capacity utilization. The average length of official unemployment is 24.5 weeks, the longest since stats began in 1948.

Unemployment is spreading at an unprecedented rate: 92% of this year’s stimulus was spent to pay down debt, as savings jumped to 6.9%. That spells sufficiently scared. That should shortly send consumption to less than 70% of GDP. The corporate bottom line is being fattened by layoffs. These problems are going to get considerably worse before they get better. Homeland Security is going to change their program that allowed local police to enforce federal immigration laws. The law is very effective – catching some 60,000 illegal aliens annually, most of who are deported. Now we cannot have an effective law like that can we? Thus, it is being done away with. It increased deportation by some 24%.

There is no question that special inspector general Neil Barofsky’s quarterly report to Congress made intelligent heads spin. Our projection of the government’s financial exposure at $14.8 trillion was woefully short of Mr. Barofsky’s $23.7 trillion estimate. Incidentally, all of Mr. Barofsky’s figures are official releases of data. If we had the time we’d come close to the same numbers. Regarding our estimate, we saw only two similar estimates, one at $12.8 trillion and the other at $14.5 trillion.

It should also be kept in mind that all government figures are bogus, thus, Mr. Barofsky’s real figure could be $30 trillion. He said that the federal government has devoted $4.7 trillion just to save the financial sector. We ask, what is the real figure? Perhaps $8 or $10 trillion? We’ll never really know, will we? That is because the Fed, a private corporation, says it is a state secret and won’t release any information. That is why we desperately need HR 1207 passed. The Fed has to be abolished; otherwise it will totally destroy the world financial system. If you are curious Mr. Barofsky’s estimate puts every American $88,000 deeper into debt, essentially to rescue the shareholders of the Fed.

One of the things that deeply disturbs Congress and we suppose is one of the reasons Ron Paul’s HR 1207 has 276 sponsors, is that the Fed absolutely refuses in detail to discuss the quantity and quality of assets backing all of their programs. This means, at this time, losses to taxpayers could be upwards of $50 trillion. Worse yet, the Comptroller’s Office doesn’t – can’t account for $12 trillion in an audit of the Fed. They won’t even tell us who the TARP recipients are and how they used the funds. In the final analysis neither the Treasury nor the Fed have any credibility left. They either lie or stonewall on every issue. These are the people who are running the financial sector of our economy.

On Thursday, the S&P 500 broke out of a large head and shoulders reversal pattern, which dates back to last summer. The question is will the breakout persist or reverse. Industrial production and unemployment are at the lowest levels since the Great Depression. Commercial paper and bank credit have been collapsing for two years and bank non-performing assets continue to rise.

For the past year treasuries owned by foreigners has stayed steady at $1.7 trillion. T-bill holdings have increased from $226 billion to $586 billion. Custodial holdings of foreign central banks at the Fed of GSE, Agency and mortgage debt has fallen from $968 billion to $807 billion. T-notes have increased from $226 billion to $586 billion. T-notes and bond holdings rose from $412 billion to $618 billion and GSE mortgage debt has increased an eye popping $639 billion from zero. This is where the Fed is training for its demise. Could it be that foreign central banks are finally preparing for dollar devaluation and all that money the Fed and Treasury has been printing for banking and Wall Street?

The Reuters/University of Michigan Surveys of Consumers says July sentiment fell to 66.0 from 70.8 in early June. Expectations fell to 63.2 from 69.2 in June. The current conditions index fell to 70.5 from 73.2 in June. Our Illuminists, Treasury Secretary Geithner, says the Treasury is not in a position to give an estimate of taxpayer losses due to bailouts. Not only is the housing market not stabilizing, but it is getting worse. The housing crisis as bad as it is shows that rental vacancies are surging and rents are declining. The bottom is a long way off at the end of 2012. Housing prices will fall 20% to 30% more.

Capital One’s shares jumped as a result of better than expected earnings. This was accomplished by not declaring costs of paying back TARP funds and by not increasing provisions for loan losses. The income was created out of thin air, a fantasy. Their earnings were really flat, or less than declared. This bank, like many other banks, has serious problems and is to be a voided like all bank shares should be avoided. This is an example of the lies and chicanery being employed to deceive by almost all large banks, probably on orders from the Fed.

This week the Treasury will borrow $203 billion. If they do that each month that would aggregate $2.4 trillion. If this happens weekly that is $10.5 trillion a year.

World economies, particularly those of G-7 countries, excepting Canada and Germany, are so buried in debt that they cannot respond positively to further economic stimulus. The current debt driven crisis within the G-7 means the euro won’t survive if Ireland, Spain, Italy and Portugal default. The mainstream economists are finally realizing that the system has to be purged, something we believe the ECB-eurozone is already attempting. The growth of their M4 will determine which direction they will go in.

Next the mainstream will finally discover the manipulation of all markets by the Fed and the outrageous suppression of gold and silver prices. That is why gold and silver are so important. They are your only safe haven.

Last week markets were pushed upward by phony earnings reports, particularly by financial institutions. The Dow gained 4%; S&P 4.1%; the Russell 2000 rose 5.6% and Nasdaq rose 4.7% as the 2-year credit crisis wears on and the economy feebly chugs along. Cyclicals rose 10.1%; transports 6.7%; consumers 3.3%; utilities 5.5%; banks 0.6%; broker/dealers 6.7%; high tech 4.5%; semis 3.6%; Internets 5% and biotech 26.9%. Gold bullion gained $14.40 and the HUI gold index rose 3.8%.

Two-year T-bills rose 1 bps to 0.96%; the 10-year notes rose 1 bps to 3.66% and the 10-year German bund rose 8 bps to 3.48%. Freddie Mac’s 30-year fixed rate mortgage rates rose 7 bps to 5.20%; the 15’s gained 5 bps to 4.68% and the one-year ARMs rose 1 bps to 4.77%.

Fed credit fell 41.1 billion. Year-on-year it is up 128%. Fed foreign holdings of Treasury, Agency debt rose $4.8 billion to a record $2,787 trillion. Custody holdings for other central banks under a new secret formula has risen 19.3% ytd and is up 18.4% yoy. M2, narrow money supply, fell $15 billion, up 8.5% yoy. Total money market fund assets increased $8.9 billion to $3.656 trillion. Assets are up 8.2% annualized. Total commercial paper fell $3.4 billion having fallen 63% annualized. Asset backed CP fell 44.5 billion yoy, a fall of $313 billion. The dollar declined 0.7% to 78.77 this past week.

Most professionals and investors are surprised to see the Dow over 9,000 again. Stocks have again become totally divorced from reality and economic fundamentals that when the next drop comes, which it will, most will be caught flatfooted. There is a total disconnect between the equities market and the credit market. Of course, the summer’s thin volume has masked the upside moves.

The Treasury has borrowed last week and will this week some $235 billion, a colossal sum. The Rasmussen survey tells us 25% of those polled say the stimulus helped the economy; 31% said it has hurt the economy. The week before last the Fed pumped $80.2 billion into the bond market and other markets as well. Last week they removed $33 billion. The more important earnings releases are already history, so we ask what can the market do for an encore?

S&P Says It Can’t Be Sued Over Lehman Bond Ratings
Standard & Poor’s, Moody’s Investors Service and Fitch Ratings sought dismissal of a lawsuit by two California investors, claiming they weren’t responsible for the plaintiffs’ investment decisions. The investors spent $40,000 on highly rated Lehman Brothers Holdings Inc. bonds that turned out to be worthless. The ratings services issue their opinions at the request of bond issuers and to provide information to the public, said Floyd Abrams, an attorney speaking for the ratings services, at a hearing today in federal court in Sacramento, California. “Ratings go out to the world,” Abrams told U.S. Magistrate Judge Dale A. Drozd. “A rating is issued, and investors take what they need.”

S&P, Fitch and Moody’s face investor lawsuits and criticism by lawmakers for grading mortgage bonds too high and maintaining the ratings months after home-loan defaults surged in 2007. The California Public Employees’ Retirement System, or Calpers, the largest U.S. public pension fund, sued July 9 in a case in state court in San Francisco over $1 billion in losses it blamed on “wildly inaccurate” risk assessments. Ronald Grassi, a retired California attorney, and Sally Grassi, a retired teacher, sued the New York-based companies in federal court in January for negligence, claiming they gave high ratings to the Lehman bonds to curry favor with the investment bank, which filed the biggest bankruptcy in U.S. history in September.

The Grassis said in court filings that they had sought safe investments and bought the bonds because they held A ratings from the companies. Ronald Grassi, speaking in court today, said investors are a “limited group” to whom the ratings services owe a legal duty. “This is issuing false opinions for profit,” Grassi said. Credit ratings are statements of opinion protected by the Constitution’s First Amendment, the companies said in court filings. They noted the dismissal of claims brought by Enron Corp. investors who alleged that the companies published false and misleading credit information about the now-defunct energy trader.

The ratings companies said they can’t be sued for negligence because they had no direct dealings with investors and made no attempt to induce them to purchase the securities. The Grassis haven’t shown that the companies knew their assessments were faulty or acted with malice, lawyers said in court papers. “Generalized accusations of wrongdoing, no matter how harsh, cannot support a claim in this case,” lawyers for S&P argued in court papers. “Plaintiffs must allege who at S&P made negligent and/or fraudulent misstatements.” Drozd told Grassi that “the only thing that really matters” is whether he could show that the ratings services had a legal obligation to investors.

“Your brief is interesting and well-done but light in legal authority,” Drozd told Grassi. At the end of the hearing, Drozd said he will make a recommendation to a another judge who will issue a ruling on the request by the ratings services to dismiss the case. “I’m going to take the motion under consideration, but it’s not going to be quick,” Drozd told the lawyers. Calpers, in its state court complaint, said S&P, Moody’s and Fitch used methods to analyze medium-term notes and commercial paper that were “seriously flawed in conception and incompetently applied.”

Default Increase Curbs Bankruptcy Lending as Recoveries Dwindle
Companies on the verge of bankruptcy are finding it harder and more expensive than ever to get loans to help nurse them back to health. With corporate defaults at a six-year high, so-called debtor-in-possession financings dropped to about 23 percent of businesses failing to make debt payments so far this year, the lowest since at least 2003, according to a strategist at Bank of America Merrill Lynch. Lenders are charging those entering Chapter 11 reorganization a record 7.25 percentage points over benchmark interest rates, on average, even with borrowing costs for issuers of junk-rated bonds the cheapest since September.

DIP loans provide funds to continue operating normally while in Chapter 11. Less available financing will give fewer companies this option and drive more into liquidation, said Darin Schmalz, a director on the Fitch Ratings leveraged finance team in Chicago. “The playbook is changing,” said Steven Smith, global head of leveraged finance and restructuring at UBS AG in New York. “Very little new capital is flowing into restructuring and Chapter 11 reorganization right now, which is potentially a huge problem. It’s very hard to reorganize companies without new capital.”

The number of businesses filing for liquidation under Chapter 7 of the bankruptcy code rose 60 percent to 30,035 last year, the most since at least 2000, according to the U.S. Courts Web site. Retailers Linens ‘n Things Inc. and Mervyns LLC said last year that they would liquidate rather than reorganize. Richmond, Virginia-based Circuit City Stores Inc. announced it would go out of business in January after seeking court protection in 2008. The worst credit squeeze since the Great Depression has helped increase U.S. companies’ default rate on bonds to 13.2 percent for the last 12 months, the highest since it reached 16.4 percent in 2002, according to Fitch.

In the leveraged loan market, the trailing 12-month U.S. default rate rose to 8.2 percent at the end of the second quarter, from 2.1 percent a year earlier, according to New York- based Moody’s Investors Service. DIP financing helps companies to move through Chapter 11 more successfully, according to a 2000 study written by Sandeep Dahiya of Georgetown University; Kose John of New York University’s Stern School of Business; Manju Puri, now at Duke University’s Fuqua School of Business in Durham, North Carolina; and Gabriel Ramirez, now with Kennesaw State University’s Coles College of Business in Georgia. Those receiving loans are likely to exit reorganization more quickly, they found.

Creditors of Delphi Corp., the former General Motors Corp. car-parts unit that filed for Chapter 11 in 2005, won an auction for some of the company’s assets by bidding the value of the DIP loans they were owed. On July 30, a court approved the sale of the Troy, Michigan-based company’s assets to the lenders and the automaker. Elliott Management Corp. of New York and Greenwich, Connecticut-based Silver Point Capital LP were among investors making the so-called credit bid. Delphi owed about $3.3 billion on the three classes of its bankruptcy loan as of July 21, according to a regulatory filing. The two firms will lead a $750 million financing that will be offered through syndication to other lenders, said John Butler Jr., Delphi’s lead bankruptcy lawyer.

The DIP market may also be tested by New York-based CIT Group Inc., which received a $3 billion loan this month to stave off insolvency. The 101-year-old commercial-finance firm has $1 billion in notes maturing in August. CreditSights Inc., a New York-based debt researcher, said July 28 that the company “remains at risk” for filing bankruptcy even if a tender for the debt succeeds. The offer is “intended to provide CIT with liquidity necessary to ensure that its important base of small and middle market customers continues to have access to credit,” the company said in a July 20 statement.

CIT asked owners of the notes to agree to take a loss through a debt tender. If the offer is accepted, the company may start debt-for-equity exchanges, according to a person familiar with the matter. Providers of emergency credit to the company include Boston-based hedge fund Baupost Group LLC and Pacific Investment Management Co., which oversees $842 billion in Newport Beach, California. The money managers’ decision to lend to CIT at an annual interest rate of at least 13 percent may help protect their investment in its bonds. Businesses such as Eaton Vance Corp. are competing with traditional DIP lenders, including New York- based JPMorgan Chase & Co. and Bank of America Corp. of Charlotte, North Carolina, after financial companies worldwide ran up more than $1.5 trillion in writedowns and credit losses since the start of 2007.

Boston-based Eaton Vance, the largest manager of investments designed to minimize taxes, is raising $1 billion to invest in DIP loans, the firm said in May. Aladdin Capital Holdings LLC of Stamford, Connecticut, a hedge fund overseeing $15 billion, said in February that it began offering bankruptcy credit to take advantage of “massive dislocation” in the market. “You’re seeing disparate groups of hedge funds putting up competing proposals,” said UBS’s Smith. “You’re seeing more interest and a little bit more competition, which is having the impact of improving terms to the debtor.”

Increased competition isn’t pushing bankruptcy-financing costs down to pre-credit crunch levels, even after yields on speculative-grade bonds relative to benchmarks fell to below “distressed” levels, or 10 percentage points, on July 23. The decline marked the narrowest spread since Sept. 25, when the collapse of Lehman Brothers Holdings Inc. led credit markets to freeze, according to Merrill Lynch & Co.’s U.S. High- Yield Master II Index. The gap was 9.33 percentage points as of yesterday. The difference between the average cost of DIP loans and benchmark interest rates so far this year compares with 5.3 percentage points in 2008, according to the Bank of America Merrill Lynch report. It never exceeded 4 percentage points before last year.

While DIP financings have reached a record $16.2 billion this year, many are so-called roll-ups of borrowings that existed before the bankruptcy filings, according to the Bank of America Merrill Lynch report by strategist Jeffrey Rosenberg. Roll-ups now account for 64 percent of total bankruptcy loans, up from 36 percent in 2008, Rosenberg wrote. Before last year, the proportion of rolled-up loans never exceeded 10 percent. Lenders seek the feature to improve their standing relative to creditors who don’t participate in a debtor-in-possession transaction, Smith said. Doing so gives them a higher priority for getting repaid, creating a new set of “winners and losers.”

Lyondell Chemical Co., which filed for Chapter 11 on Jan. 6, received a record $8 billion in loans at an interest rate of 10 percentage points over the benchmark after the DIP market had “ceased to operate,” a lawyer representing the Houston-based company, Mark Ellenberg of Cadwalader, Wickersham & Taft LLP, said during a Jan. 7 bankruptcy hearing in New York, according to a transcript. Roll-ups, including commitments from borrowers, made up about 40 percent of the bankruptcy credit, according to Mark Cohen, head of restructuring at Deutsche Bank AG in New York. Last week, Lyondell’s DIP roll-up was trading at 83.5 cents on the dollar. The portion of the DIP that wasn’t rolled up was trading at 42 cents on the dollar.

DIP financing may recover as credit markets begin to heal, Cohen said. Eddie Bauer Inc., a unit of the Bellevue, Washington-based retailer that filed for Chapter 11 last month, received a $100 million loan costing 4 percentage points more than the London interbank offered rate, the common benchmark for such credits, according to Bloomberg data. Banc of America Securities LLC was the lead arranger of the deal. “Market pricing is coming down; new investors are coming in,” Cohen said.

Still, shrinking bankruptcy financing and rising defaults pushed 12-month recovery rates, or the amount of face value an investor can expect to receive from a loan after default, to 43.9 percent in June, down from 65 percent a year earlier, according to Moody’s. The level is lower than any annual average since the ratings company began compiling the data in 1990. “Recovery values tend to drop as bank lending standards tighten,” said John Lonski, chief economist at Moody’s in New York. “If you’re a creditor and you see the value of collateral falling, you are going to tighten credit.”

Canada's GDP shrinks in May
Canada's economy contracted at a faster pace than expected in May, according to figures released Friday. Statistics Canada said Canadian gross domestic product fell by 0.5 per cent in the fifth month of 2009 as the country's manufacturers and oil pumpers led the reverse economic charge. Analysts were thinking the national economy would slip for the month, but only by 0.3 per cent. "Over the last four months, the goods-producing industries have contributed the most to the decrease in real GDP, while the output of the service sector has remained essentially unchanged," said Statistics Canada in a press release.

By comparison, April saw Canada's economy contract by 0.2 per cent on a revised basis. Overall, Canadian GDP will tumble for the current year, according to the Conference Board of Canada. The Ottawa-based business think tank predicts that the country's economy will shrink by 2.7 per cent, after subtracting inflation, in 2009. But, the Conference Board said in its most recent forecast, that Canada will see an economic expansion of 2.8 per cent in 2010.

Canada's goods-producing sector continued a long-term losing streak in May as manufacturing activity fell by 1.6 per cent in May compared to April. Since May 2008, however, manufacturing GDP has contracted by a hefty 15.8 per cent. The automobile segment, hard hit by the recession, has decimated Canadian manufacturers. Statistics Canada noted that approximately half of the manufacturing decline in May was attributable to fewer cars and trucks getting built and sold in this country.

"About half of the decrease was due to a 21 per cent drop in motor vehicle manufacturing, following three months of recovery, and an 8.2 per cent decline in parts production. The temporary closure of two assembly plants, combined with the discontinuation of the production of a model line in Canada, contributed to this decline," the agency said. As North American car makers start up idle plants, the contraction in the automobile segment could moderate, experts have said previously.

Petroleum producers also did less work in May, according to Statistics Canada. Output in the sector dropped by 2.3 per cent, the fourth consecutive month in which activity among energy firms slipped in Canada. Comparing year-to-year, that portion of Canada's GDP attributable to oil and gas production was eight per cent smaller in May 2009 versus May 2008, Statistics Canada said. In fact, of all the segments followed by Statistics Canada, only non-durable manufacturing (0.2 per cent), health care (0.2 per cent), real estate and finance (0.4 per cent), retail (0.6 per cent) and government administration (0.1 per cent) posted gains in May.

Japan jobless rate up amid record deflation
Unemployment in Japan surged to a six-year high as the country set a new record for core consumer price deflation in June, data released on Friday showed. The 1.7 per cent year-on-year fall in consumer prices, excluding fresh food, and the 5.4 per cent jobless rate highlight the continuing troubles of the world’s second-largest economy, despite a sharp rebound in industrial output over the past four months.

While the falling energy prices that have been the main driver behind the decline are no bad thing for resource-poor Japan, analysts increasingly worry that deepening deflation – fuelled by job insecurity and massive manufacturing over-capacity – could undermine economic recovery. The fall in “core-core” consumer prices, excluding food and energy, accelerated to 0.7 per cent in June. More recent July price data for urban areas of Tokyo showed a fall of 1.1 per cent. Although there has been record growth in industrial production over the past quarter – including a 2.4 per cent month-on-month rise in June – output is still down by more than one-fifth since last year, leaving large excess capacity which will put pressure on prices.

Meanwhile, South Korea reported a 5.7 per cent month-on-month rise in industrial production, more than double the pace economists had expected, and Thailand reported a 3 per cent rise. In Japan consumer sentiment is likely to remain vulnerable to the continued rise in unemployment, already at a level last seen in June 2003, and expected to pass the 5.5 per cent record rate set then. Labour industry data released on Friday showed that work availability was already at a record low, with only 43 jobs on offer for every 100 applicants.

With the Bank of Japan’s policy interest rate already at 0.1 per cent, the central bank has little room to manoeuvre. The Organisation for Economic Co-operation and Development has called for the Bank of Japan to “fight deflation through a strong commitment to implement effective quantitative measures”.

However, the BoJ remains relatively relaxed. In a speech last week, Hirohide Yamaguchi, central bank deputy governor, said “large short-term” price changes could not be avoided after a shock such as that suffered by Japan, but that the BoJ expected deflation to moderate in the six months to March 2010 as the economy recovered. “The bank therefore thinks it unlikely at present that prices will continue to decline and thereby lead Japan’s economy into a deflationary spiral,” Mr Yamaguchi said.

Unemployment Rises and Prices Fall in Europe
Unemployment in the 16 countries using the euro rose to a 10-year high of 9.4 percent in June, according to data released Friday. The increase was less than expected, however, following measures by some governments to combat the economic crisis. The European Union’s statistics office also said on Friday that inflation in the euro area had moved much further into negative territory than forecast in July, with consumer prices falling at an annualized rate of 0.6 percent.

The drop raised worries about deflation and heightened expectations that the European Central Bank will maintain its loose monetary policy. The jobless rate for the euro region rose from the revised figure for May of 9.3 percent, as 158,000 people lost their jobs in the month, Eurostat said. With the preliminary reading of May unemployment at 9.5 percent, economists had expected June’s figure to be 9.7 percent, but the number was still the highest since June 1999.

The smaller-than-expected unemployment rate probably resulted from various state programs to preserve jobs through such means as subsidizing part-time shifts or training programs, analysts said. “Unemployment would have been much higher still if not for the short-time working schemes and related measures adopted in euro zone countries,” said Martin Van Vliet, an economist at ING. But, he added, “With the economy still in recession and any recovery likely to be sluggish, unemployment, unfortunately, looks set to continue to rise this year and next.”

Many analysts also said July’s deeper-than-expected fall in consumer prices increased the risk of deflation. Analysts had expected July inflation to be minus 0.4 percent because energy and food were more expensive a year ago and the crisis has eroded firms’ pricing power. July was only the second month of negative inflation since the creation of the currency area in 1999, after prices fell 0.1 percent in June. “We feel that the European Central Bank is underplaying the risk of deflation,” said Ken Wattret, an economist at BNP Paribas.

High joblessness and falling prices mean the E.C.B. could keep its lax monetary policy, with its main rate at 1 percent, and unconventional monetary measures in place. The E.C.B. has said consumer prices are likely to fall for a few months in mid-year, but that price growth will resume later. This view was echoed by the International Monetary Fund’s report on the euro zone, published on Thursday. The lower-than-expected unemployment, combined with a significant fall in prices, could mean more purchasing power for consumers. “Falling prices will provide a welcome boost to real incomes,” said Jennifer Mckeown, economist at Capital Economics.

But the depth of recession was underlined by Eurostat’s calculation that 3.17 million people in the euro zone had lost their job since June 2008, when unemployment was at 7.5 percent. The economy shrank 2.5 percent in the first three months of 2009 from the previous quarter, with a smaller contraction expected later in the year and a modest revival in 2010. Eurostat said since June 2008, the smallest increases in unemployment were registered in Germany, from 7.3 percent to 7.7 percent, and the Netherlands, from 2.7 percent to 3.3 percent.

In Spain, hit by the collapse of the construction sector, the jobless rate soared over the period from 11 percent to 18.1 percent — the highest in the euro zone. In the wider, 27-nation European Union, the unemployment rate was 8.9 percent in June, up from 8.8 percent in May and 6.9 percent a year earlier. Since June 2008, more than 5 million people have lost their job in the E.U., highlighting the severe crisis in non-euro countries such as the Baltic republics and Hungary.

Recession Robs Spain's Youth of Jobs and Hope
The ongoing economic crisis has pummelled Spain. Small businesses feel abandoned by the government, layoffs are swelling the ranks of the desperate, and a whole generation of recent college graduates is facing a future without prospects. It was early July when it finally happened and nothing came out of the ATM. With a sinking feeling, Iñigo Ortega went into his usual bank to print out his statements. The bank's maintenance fee had been debited from his account, and there was nothing left -- his savings were gone. It had taken only three months to go completely broke.

As recently as March, Ortega, 36, was employed as the head of a small but upscale architectural firm on La Castellana, Madrid's grand boulevard, making €3,000 ($4,280) a month. But the firm specialized in luxury restorations and renovating hotels in historic buildings, and it had been getting fewer and fewer lucrative contracts. It wasn't really a surprise, seeing that the worsening economic crisis was keeping millions of foreign tourists away. The most creative designer on the firm's six-person team was the last one to be let go. And it was Ortega's bad luck that he had been working for the last four years as a freelancer without a set contract that would have entitled him to claim unemployment benefits.

"My job's gone, my money's gone and so is my hope," Ortega says bitterly as he leafs nervously through his documents. He has sued the owner of the architectural firm for the social security contributions he never paid, overtime hours, holiday pay and a settlement. He doesn't want to accept the fate of being "in my late thirties and dependent on my parents again, like a kid still in school." Ortega got the job after eight years of university followed by internships with some of the best firms in the business. But now it was all for nothing. At first he was needed. Ortega created a hip Web site for his boss and taught him computer drafting. But now the boss doesn't need him. He doesn't know what the future holds and is trying to figure out how he can "scrape through from day to day."

Generación Ni-Ni

Tens of thousands in Spain are currently in the same dire straits as Ortega. As the country faces the worst recession since the Spanish Civil War ended 70 years ago, first-time jobseekers are being hit especially hard. No other country in Europe has as many young people out of work: almost 37 percent of people under 25 and a quarter of those under 30. Sociologists have already created a name for this group -- "generación ni-ni," the neither-nor generation. The term meant to describe young people who are neither studying nor working and don't have something in their lives that they can get excited about. It's a true zero generation -- zero jobs, zero prospects. A recent survey of Spaniards between the ages of 18 and 34 showed that 54 percent of those polled view themselves as neither-nors.

Take Eva Reina López, for example. She's 20; her father's an electrician and a widower. Reina did everything right. After getting her secondary school degree, she no longer wanted to be a burden on her father, who had raised her alone since she was six. So, instead of enrolling at one of Madrid's universities -- which had been her father's dream for her -- Reina followed her boyfriend to a small city in León Province nestled in the mountains of northwestern Spain. And there -- in her mother's hometown and where Spain's socialist Prime Minister José Luis Rodríguez Zapatero began his political career -- Reina learned how to weld. After six months of training at a company called Coiper, which manufactures towers for wind turbines, she secured an employment contract for six more months. The government in Madrid is promoting wind power as Spain's great industry of the future.

In January, it was all over. Coiper can no longer find buyers for its products. The government froze subsidies for sustainable-energy ventures after the economic crisis hit, which has caused wind-farm construction to stagnate. As a new employee, Reina wasn't entitled to claim unemployment benefits, and she only received welfare payments of €400 a month through June. Her boyfriend and other permanent employees have had their working hours reduced. Now they sweep the empty production rooms, waiting for the news that the company is shutting down for good. "There aren't a lot of choices here in Ponferrada," Reina says. "What will we do if everything here closes?"

"We've hardly even started our careers, and we're already disillusioned," says Noa Beade, 24. Like others her age, Beade gets upset whenever she gives some serious thought to her career prospects. A year ago, Beade received a journalism degree from San Pablo CEU, a respected private university. She has also completed four internships, speaks English fluently and spent six months in Paris learning French on Europe's ERASMUS student exchange program. But even with all these qualifications, she didn't land any of the several dozen jobs -- or unpaid internships -- she applied for directly out of college. A drop in advertising revenues has crippled the Spanish media. Instead of hiring, they're laying people off.

Beade's father, who lives in Galicia and also works in the wind energy industry, paid €4,057 to allow her to take a special course in financial journalism at Madrid's public Complutense University. He wanted his daughter to make it further in life than he and his wife, who works as a dietician in Vigo. The certificate helped Beade land another internship, this time working for a business news service for three months. She's not sure if she'll be paid while there.

The Building Bubble Bursts

It's a vicious circle. In the 10 years before the global credit and economic crisis hit, more jobs were created in Spain than in the rest of Europe put together. But after 14 years of uninterrupted growth, the crisis hit Spain harder than other countries.

Spain's boom was marked by an intoxicating degree of consumption resulting from demand pent-up during the almost four decades of the Franco dictatorship. But it primarily came in the construction industry. Around 800,000 new apartments were built every year, more than in all of Germany, France and Italy combined. Blue-collar workers were able to buy homes on credit, and middle-class families piled up debt in order to be able to pass an apartment on to every child. Even outside of the upper class, a second or even third home on the sea or in the mountains wasn't unheard of. And it was all on credit. People chased after quick profits by buying and reselling apartments, which could bring in double their initial price once they were ready for use. The value of property shot up twenty-fold as soon as a town zoned it for construction.
But last year, after the summer holidays, the real estate market's gigantic bubble burst. The same banks that had recently been handing out mortgages with abandon were now only reluctantly granting credit for building projects, and interest rates were skyrocketing. There are now a million vacant apartments. Likewise, people who piled up debt now have to pay off the absurdly inflated original price of their properties rather than the substantially lower current value. Many of them can no longer afford their loan payments. Of course, they would love to sell off their properties, but no one is buying.

Everything in Spain seems to be somehow connected to the construction industry. Even the soccer teams have real-estate speculators to thank for their world-class players. The real-estate market once generated an outsize proportion of Spain's GDP. But now that the building sector has collapsed, Spain's economic miracle is viewed as more of a curse.

Construction, the supply industry and tourism were primarily responsible for creating 7 million jobs. Most of these required very little specialized training, and at least 5 million immigrants were brought into the country to do the hard work. When the recession hit, foreigners were the first to be laid off. Next to go were the temporary workers, who could be let off with only a small compensation package. Out of a total of 19 million employees, 7 million have these "dirty jobs," and 12 million are "mileuristas," meaning that they work for under €1,000 a month. Over the last 12 months, almost 2 million people have lost their jobs. Unemployment has shot up from less than 8 percent in 2007 to today's 18.7 percent. The ranks of the unemployed have swelled to almost 4 million. That's more than there are in Germany, which has twice as many inhabitants as Spain.


At the beginning of the year, Ortega had just moved into a bright new apartment with a view of Retiro Park, Madrid's green lung near the Prado Museum. The architect shares the apartment with his sister. It's a blessing for him that she still has a job as an optician and can cover his share of the rent. In the mornings, when he jogs through the park and the nearby upscale neighborhood of Salamanca, Ortega notices more and more "For Sale or Rent" signs on the grand old buildings.

Many clothing and furniture stores in the once splendidly decorated shopping streets are also empty. Their windows are now plastered with posters bearing pictures of the prime minister and reading: "Thanks to Zapatero and his vision for the future." They've been placed there by political groups, such as the far-right Frente Nacional (National Front) party, that wouldn't have any following if it weren't for the recession.

Status-conscious people in Madrid used to like to show off in fancy cars. But now, even with the government's €2,000 subsidy for people buying new cars, sales have nosedived. Sales of BMW's, which are especially popular in Spain, dropped a further 39 percent in May. And trendy restaurants that used to require reservations a week in advance have started offering discounted daily menus just to get some lunchtime business on weekdays.

"We don't feel like celebrating anymore," says José Ignacio Recoder, 64, who owns a family business that makes diamond-cutting machines primarily for the construction industry. Like most companies in Spain, Recoder's has made drastic cuts in services. The company used to employ 60 people and boasted annual sales of €12 million, but now he's had to lay off a third of his workforce.

Small and medium-sized companies make up the bulk of Spain's business world. The prime minister has promised them tax cuts, but "that's no help to us if we're losing money," Recoder says. The federal government has provided local governments with €8 billion to create hundres of thousands of jobs building roads and renovating town halls and schools. But Recoder doesn't have much faith in this plan. "It would do a lot more good if the towns and the government would pay their invoices on time," he says.

Governments in Spain currently owe such businesses around €32 billion. While the average payment delay in Germany is 40 days, it's 94 days in Spain. The courts are overburdened, and larger companies are also able to delay paying their smaller suppliers by 180 days or more without consequences. "We have to pay value-added tax for income that we haven't received yet," Recoder complains. He speaks for many small employers who are being choked by the crisis because banks refuse to grant them short-term credit. Recoder is depressed about not having a better inheritance to leave to his five children after a long life of work.

A Fraying Social Safety Net

For the moment, most unemployed people in Spain are relying on their families for support. But there are still nearly a million households without a single regular income, and 600,000 people are already dependent on charity. Recoder's oldest son, who is a partner in the family's crippled business, must also support his grown daughters. Both of them have lost their jobs -- and become new members of the neither-nor generation. Beade needs a minimum of €700 a month to live in Madrid, where she shares a €1,200 flat with three friends. If she doesn't find a paid job in the fall, she'll have to move back in with her parents in the cheaper region of Galicia.

Eva Reina López would like to stay in the small village of La Rivera de Frogoso, where she shares a two-room apartment with her boyfriend for just €250. Her grandmother lives nearby, and she often invites the young couple over for meals. They've dropped any plans for vacations or going out in the evenings. Things have gotten even tighter because Reina's father just lost his job, too, and can no long support her. After more than 30 years of hard work, all he has left is 24 months of unemployment benefits.

The wind turbines let Reina down, even though Prime Minister Zapatero continues to preach "less oil and more renewable industry, less brick and more computers" as his country's new growth model. But the International Monetary Fund predicts a very slow recovery for Spain. "Who knows if I'll find something else," Reina says. In order not to waste away in the ranks of the neither-nors, she's registered for a correspondence course in social work. And Ortega, the architect, lost his lawsuit. In the judge's eyes, he was unable to prove that he'd been fired since he got his pink slip verbally and with no witnesses. "I feel bad," he says, "like a total failure." If Madrid gets to host the 2016 Olympic Games, maybe there will be work for him again.

Rural Medical Camp Tackles Health Care Gaps
It was a Third World scene with an American setting. Hundreds of tired and desperate people crowded around an aid worker with a bullhorn, straining to hear the instructions and worried they might be left out. Some had arrived at the Wise County Fairgrounds in Wise, Virginia, two days before. They slept in cars, tents and the beds of pickup trucks, hoping to be among the first in line when the gate opened Friday before dawn. They drove in from 16 states, anxious to relieve pain, diagnose aches and see and hear better. "I came here because of health care - being able to get things that we can't afford to have ordinarily," explained 52-year-old Otis Reece of Gate City, Va., as he waited in a wheelchair beside his red F-150 pickup. "Being on a fixed income, this is a fantastic situation to have things done we ordinarily would put off."

For the past 10 years, during late weekends in July, the fairgrounds in Wise have been transformed into a mobile and makeshift field hospital providing free care for those in need. Sanitized horse stalls become draped examination rooms. A poultry barn is fixed with optometry equipment. And a vast, open-air pavilion is crammed with dozens of portable dental chairs and lamps. A converted 18-wheeler with a mobile X-ray room makes chest X-rays possible. Technicians grind hundreds of lenses for new eyeglasses in two massive trailers. At a concession stand, dentures are molded and sculpted.
The 2009 Remote Area Medical (RAM) Expedition comes to the Virginia Appalachian mountains as Congress and President Obama wrestle with a health care overhaul. The event graphically illustrates gaps in the existing health care system. "We're willing to sleep in pickup trucks or cars and deal with the elements to at least get some kind of health care," Reece adds. He earned a six-figure income working for an international industrial supply firm until an accident five years ago left him disabled. Joining him for dental, vision and medical checks are his wife, daughter, son-in-law and three grandchildren.

"Tomorrow, I'm going to see the doctor to get my ear and my nose fixed!" grandson Jacob shouts excitedly. His nose appears battered and his ear has an oozing scab. Before the gate opened, Loretta Miller, 41, of Honaker, Va., got four hours' sleep behind the wheel of her parked minivan. She was No. 39 in line for her eighth RAM expedition. Her visit last year saved her life. "They done an ultrasound and told me that my gallbladder was enlarged and was ready to burst and it could kill me," Miller recalls. "They told me if I hadn't got help when I did, literally I could have died."

Medical, dental and vision help is often elusive for the 2,700 people seeking treatment during the three-day RAM event. Just over half of the people attending this year have no insurance at all, according to a survey of the patients conducted by RAM. Forty-seven percent could be considered underinsured, given unaffordable copays or gaps in coverage provided by Medicare, Medicaid and conventional insurance plans. Only 11 patients have dental insurance, and just seven have vision coverage.

"There's no doubt about it. There is a Third World right here in the United States," concludes Stan Brock, RAM's founder. Brock has organized similar medical expeditions in Asia, Africa and South America. "Here in the world's richest country, you have this vast number of people, some say 47 million, 49 million, that don't have access to the system and that's why [this] is necessary." About 1,800 volunteers provide the medical, dental and logistical help, including hundreds of doctors, dentists, nurses, assistants and technicians.

Miller is ecstatic when her number is called. The divorced hairdresser and mother of two is uninsured and in pain. But she had taken the time, even with little sleep, to put on makeup, braid her blond hair and dress in a white lace tunic. She walked briskly through the gate for what would turn out to be five hours in dental chairs, given the extraction of an abscessed tooth, three fillings and a root canal. More than half of those seeking help sign up for dental exams and procedures. They fill the more than 70 dental chairs while hundreds wait their turn under tents nearby. Hundreds more out in the grassy parking lot hope they'll get their teeth cleaned and fixed before the event ends.
Dental health greatly affects general health, says Dr. Terry Dickinson, who directs the Virginia Dental Association and the RAM dental effort at the Wise fairgrounds. "The infection in the mouth certainly has been shown to have an effect on systemic diseases," Dickinson explains. "So it's really critical that these folks be able to get infected teeth out and infection treated in the mouth because it's going to help them with their overall health." The extent of infections is staggering. Dickinson and his team pull 3,857 teeth in 30 hours of work spread over 2 1/2 days. Some patients lose all their teeth. A 4-year-old had cavities filled in every tooth.

Terrible teeth, obesity, smoking, high blood pressure and diabetes are common among the people seeking help here. That raises an important question. Are they at fault for their poor health? "There's enough blame to go around for everybody. I think patients certainly have to have personal responsibility for what they're putting in their mouth, but we are also trying to create a better access care system. How are you going to get providers, whether it be dentists or physicians or anybody else, into these areas where economically these communities are struggling?" Dickinson asks.

That's a reference to the costs of medical and dental schools and the debts that graduates incur, which can be $100,000 and more. There's pressure to practice in more lucrative places beyond rural regions like Appalachia. "There are areas of the country, and certainly Wise County is one of them, where there just aren't [enough] physicians," says Dr. Susan Kirk, an endocrinologist and diabetes specialist with the University of Virginia Health System, which provides specialists for the Wise RAM event. "We provide indigent care at the University of Virginia, but that's six hours away."

RAM founder Stan Brock is impatient with those who suggest the people seeking help in Wise are somehow at fault and unworthy of care given poor health habits. "The rest of the population is not exactly in the best of shape themselves," Brock asserts. "They're eating well and, therefore, they're putting on weight and, therefore, they've got heart disease and the rate of diabetes in this country is going up. But, in the case of the well-to-do and the well-insured, they can afford to take care of it." At the end of her long day with dentists, Loretta Miller was still numb with Novocain but grateful for the care she could not otherwise afford.

"It's well worth the drive and the wait," Miller said, close to 12 hours after her number was called. "You get tired and stuff. But you think about all the trips and the money it would have cost to have all this done. I couldn't have had it done." She then laughs about standing in line again at 5 a.m. the next day so she can get eyeglasses to "see what they've done." RAM organizers say they spent about $250,000 providing care worth about $1.5 million. In 10 years in southwest Virginia, they say, they've treated more than 25,000 people. They have eight more expeditions planned this year, from Virginia to California.

By the Numbers

A survey of RAM attendees by the event's organizers provides some insight into who is left out of conventional medical, dental and vision care.
What: Health care providers saw 2,715 patients and performed 2,671 medical exams, 1,088 eye tests and 1,850 dental exams. They extracted 3,857 teeth and put in 1,628 fillings.
Who: Patients came from 16 different states; 30 percent were repeat patients. Of the patients, 51 percent are uninsured, 40.3 percent are on Medicaid or Medicare, and just 7.3 percent have employer or private insurance. Fewer than 1 percent of patients have dental or vision insurance. Twenty-six percent of the people are employed, 40.6 are unemployed, 4.7 percent are retired and 4.8 percent are children.
Cost: The organizers paid about $250,000 out of pocket to run the event, and they provided an estimated $1.5 million worth of care.

Living in Tents, and by the Rules, Under a Bridge
The chief emerges from his tent to face the leaden morning light. It had been a rare, rough night in his homeless Brigadoon: a boozy brawl, the wielding of a knife taped to a stick. But the community handled it, he says with pride, his day’s first cigar already aglow. By community he means 80 or so people living in tents on a spit of state land beside the dusky Providence River: Camp Runamuck, no certain address, downtown Providence.

Because the two men in the fight had violated the community’s written compact, they were escorted off the camp, away from the protection of an abandoned overpass. One was told we’ll discuss this in the morning; the other was voted off the island, his knife tossed into the river, his tent taken down. The chief flicks his spent cigar into that same river. There is talk of rain tonight. Behind him, the camp stirs. Other tent cities have sprung up recently around the country, but Rhode Island officials have never seen anything like this. A tea kettle sings.

A heavily pierced young person walks by without picking up an empty plastic bottle, flouting the camp compact that says everyone will share in the labor. The compact may be as impermanent as this sudden community by the river, but for now it is binding. The chief speaks, the bottle is picked up. The chief, John Freitas, is 55, with a gray beard touched by tobacco rust. He did prison time decades ago, worked for years as a factory supervisor, then became homeless for all the familiar, complicated reasons.

Layoffs, health problems, a slip from apartment to motel room. His girlfriend, Barbara Kalil, 50, lost her job as a nursing-home nurse, and another slip, into the shelter system. A job holding store-liquidation signs beside the highway allowed for a climb back to a motel, but it didn’t last. Weary of shelters, the couple pitched a pup tent in Roger Williams Park, close to a plaque bearing words Williams had used to describe this place he founded: “A Shelter for Persons in Distress.” But someone complained, so Mr. Freitas set off again in search of shelter. The March winds blew.

Down South Main Street he went, past the majestic court building and the upscale seafood restaurant, over a guardrail to a gravelly plot beneath a ramp that once guided cars toward Cape Cod. Foul-smelling and partially hidden, a place of birds and rodents, it was perfect. He and Ms. Kalil set up camp with another couple in early April. Word of it spread from the shelters to Kennedy Plaza downtown, where homeless people share the same empty Tim Hortons cup to pose as customers worthy of visiting that doughnut chain’s restroom. The camp became 10 people, then 15, then 25. No children allowed.

“I was always considered the leader, the chief,” Mr. Freitas says. “I was the one consulted about ‘Where should I put my tent?’ ” By late June the camp had about 50 people. But someone questioned the role of Mr. Freitas as chief, so he stepped down. Arguments broke out. Food was stolen. “There was no center holding,” recalls Rachell Shaw, 22, who lives with her boyfriend in a tidy tent decorated with porcelain dolls. “So everybody voted him back in.” The community also established a five-member leadership council and a compact that read in part: “No one person shall be greater than the will of the whole.”

It is now late afternoon in late July, a month after nearly everyone signed that compact. The community remains intact, though the very ground they walk on says nothing is forever. Here and there are the exposed foundations of fish shacks that lined the river long ago. Some state officials recently stopped by to say, nicely but firmly, that everyone would soon have to leave. The overpass poses the threat of falling concrete, and is scheduled for demolition. The officials have shared the same message with a smaller encampment across the river.

For now, a game of horseshoes sends echoing clanks, as outreach workers conduct interviews and raindrops thrum the tent tops. The chief lights another cigar and walks the length of the camp to tell residents to batten down, explaining its structure as he goes. Here at the end, nearest the road, are the tents of young single people and substance abusers; this way, rescue vehicles won’t disrupt the entire compound.

Here in the center are a cluster of couples, including two competing for the nicest property, with homey touches like planted flowers. Here too are the food table, the coolers, the piles of donated clothes — what can’t be used will be taken by camp residents to the Salvation Army — and the large tent of the chief. Plastic pink flamingos stand guard. Farther on, the recycled-can area (the money is used for ice and propane); the area for garbage bags that will be discreetly dropped in nearby Dumpsters at night; and, behind a blue tarp hung from the overpass, a plastic toilet. The chief says the shared task of removing the bags of waste tends to test the compact.

Finally, near some rocks where men go to urinate, live a gay couple and some people who drink hard. Timothy Webb, 49, who says he used to own a salon in Cranston called Class Act, cuts people’s hair here. Then, at night, he and his partner, Norman Trank, 45, sit at a riverside table, a battery-operated candle giving light, the moving waters suggesting mystery. “It’s what you make of it,” Mr. Trank says. Dark clouds have brought night early to Providence. Heavy drops thump against tarp. Water drips from the overpass, onto the long table of food.

In the last couple of hours the chief has resolved a conflict about tarp distribution, hugged a pregnant woman who mistakenly thought she had been kicked off the island, conferred with outreach workers and helped with dinner preparations. He is also thinking about tomorrow. Tomorrow, an advance party for the chief will leave to claim another spot across the river that turns out not to be on public property. Many in the camp will decide it’s time to move on anyway, to a spot under a bridge in East Providence. Camp Runamuck will begin its recession from sight and memory.

At least tonight there is a communal dinner: donated chicken, parboiled and grilled; donated corn on the cob; donated potatoes. People line up with paper plates. The rain falls harder, pocking the river’s gray surface, surrounding the dark camp with a sound like fingers drumming in impatience. The chief hears it, but what can he do? He finishes his dinner and lights another cigar.