bizzXceleration: Performance, Value and Profit

The original plan was to put up a post over the weekend looking beyond the rescue package but as the news ebbed and flowed we got distracted more than a bit. And still headed into today with a relatively benign outlook which turned out to be mis-placed. There's been a change of plan since instead of containing the breakout from Stalingrad we've had an ideologically motivated sit-down strike on the part of the troops who're now sulking in their tents. So rather than our normal longish analytical post along with excerpts, charts, etc. we're going to focus on Steve Perslstein's latest column from the Washington Post which is as short, pithy, direct, accurate and honest a description, in ordinary English, as we've read. We've got a lot more to say but we're simply going to start here and pick up more tomorrow, depending on how tonight's drinking goes. BtW - how's your food, water, ammo, fuel and liquor stocks doing ? After you read Mr. Pearstein's elegantly direct assessment we also suggest you consult John Mauldin's latest newsletter for a more detailed explanation: Who's Afraid of a Big, Bad Bailout?

They Just Don't Get It

Oy vey.

That is the technical economic term that best sums up a day in which the House of Representatives refuses to pass a $700 billion rescue plan pushed by the White House and congressional leaders from both parties, Wachovia is taken over in a deal that will have the government potentially owning 10 percent of Citigroup, a few European banks fail, the Federal Reserve and other central banks are forced to inject an additional $300 billion into the global banking system, the Dow Jones industrial average plunges 777 points, and investors everywhere rush to the safety of gold and short-term Treasury bills. The basic problem here is that too many people don't understand the seriousness of the situation. Americans fail to understand that they are facing the real prospect of a decade of little or no economic growth because of the bursting of a credit bubble that they helped create and that now threatens to bring down the global financial system. Politicians worry less about preventing a financial meltdown than about ideology, partisan posturing and teaching people a lesson. Financiers have yet to own up publicly to their own greed, arrogance and incompetence. And leaders of foreign governments still think that this is an American problem and that they have no need to mount similar rescue efforts in their own countries. In the coming weeks and months, all of these people will come to understand how deep the hole really is and how we're all in it together. They'll come to understand that the giant sucking sound they hear is of a massive deleveraging of the global economy and the global financial system as households and governments, businesses and investment funds adjust to living in a world with less debt and more inflation.

And they will come around, reluctantly, to the understanding that the only way to get out of these situations is to have governments all around the world borrow gobs of money and effectively nationalize large swaths of the financial system so it can be restructured, recapitalized, reformed and returned to private ownership once the crisis has passed and the economy has gotten back on its feet.

In the next few weeks, the center of attention here in the United States will shift from the Congress and an exhausted Treasury to the Federal Deposit Insurance Corp., which will now have to rescue any number of failing banks, either by taking them over directly or managing their transfer into stronger hands. It will also shift back to the Federal Reserve and other central banks, which will have to step up their efforts to maintain liquidity in money markets and prevent the credit crunch from taking down hedge funds, businesses, and state and local governments.

These will, alas, be only holding actions. Restoring real stability to financial markets will require the kind of systemic approach and extraordinary government interventions that the public has refused to authorize and finance. In better times, the public might have put aside its reluctance in response to the strong and unified recommendation of political and business leaders. But it is a measure of how little trust remains in both Washington and Wall Street that voters are willing to risk a serious hit to their wealth and income rather than follow their lead.

Posted by dblwyo at 09:49 PM | Permalink | Comments (0)

Not sure about you but re-fighting Stalingrad and watching the Kabuki dancing of the political poseurs is wearing on my nerves. Call it the triumph of the lizard-brained. That's not a pejorative btw but a technically accurate description of how our brains are wired. The neuro-stack is Lizard-brain (ancient), Monkey (very....y old), and "Modern" (the part we think is new, in charge but who's primary purpose is to rationalize the primitive decisions already reached by Mr. Lizard and Madam Monkey). Of course James told us all that over a 100+ years ago and it's been confirmed by modern cognitive neuro-sciences and brain-scanning. For as simple a summary of where we're at that's relatively non-technical check this other post:This is a Rescue, Not A Bailout: And It's Your Life . And for my complete archives laying out the genesis and evolution of this crisis try a quick skim of these two archives:CreditMktsCrisis,Fed & Credit. You might be surprised at how much information has accumulated that's turning out prescient but grossly under-emphasized. That is, I didn't see it blowing up this bad either. Instead we'd like to remind you that beyond today's credit crisis du jour are a host of real economic problems, including a Housing market that has at least two years before recovery from excess and mounting inventories. And a real economy that we warned sometime back was in an accelerating downturn and was now crossing the tipping point all on it's own. (Be Afraid, Very Afraid: Five Things to Know About the Economy) Summarized in the accompanying table which dates from around Feb (we think). (Filtering the Non-Linearities: Sorting the Risk Factors) Take a minute and read it because you'll notice that there's a lot still qued up to be worked thru. A lot indeed. The point here is not to celebrate my own prescience but to highlight the fact that that the machinery available here allows one to be prescient within divine gifts of insight. So instead we're going to focus on recent economics news, which you'll find summarized and excerpted after the break. The two must-skim readings are Mark Faber's outlook which captures our own exactly and the huge warning shot from the Chinese government that it's lost all confidence in US investments. If you don't think that's critically important you need to educate yourself as to what happens if they start drawing down the flow of funds that have kept interest rates low.

First, a little sidetrip back to the crisis. As you no doubt know Th. saw the collapse of Rescue Package talks with more political posturing by some very mistaken Republican ideologs. Fortunately for all of us the markets, including the credit markets, are retaining their strong belief in a package getting passed. Given that short-term credit conditions are turning into a disaster area and already beginning to seriously crimp business and the economy that's amazing and good news. 

The top sub-chart is a short-term SP500 chart that shows us how resilient the markets were, even rising to positive territory today. On a day when many of us were expecting a 300 point drop. We may get a relief rally next week if the bill is passed as promised over the weekend. If you haven't already down so...sell into this and get out. There will be a major downturn in the works.

As you can see looking at the slightly longer-term and second sub-chart which shows the real trend in place. Our anticipation is that as soon as we get past this little excitement, presuming we do, that economic realities will slowly sink in and a real recession will start showing up. Which it hasn't as yet. We're not even down 20% as yet and typically downturns get you 30% and this is likely to be worse. Beyond that, as one of the excerpts points out and we've been saying, earnings expecations have moved from unreal to surreal. We're not sure what the analysts are smoking but we'd like some. So what is the economic news - all of which was bad this week and last, though we spent more time on the crisis than on that big picture ?

Economic Assessments and Outlook

Consumer Spending: Real consumer expenditures are slowing rapidly and are as low now as in '01 and dropping while real retail sales have been declining since Nov07 and recently started dropping faster and have been negative since Jan. Probably a good thing that these YoY numbers aren't reported as people would really get scared. Oh yeah - auto sales continues in the tank and we don't think the industry is prepared for how deep and long this downturn will be. When shorting is restored there's money to be made betting on some BK's in Detroit.

Investment: the next item up moving around the business cycle circle of life is investment. Which as you recall lags consumer spending because it's driven by it. The drop in New Home Sales continues though the good news is the decrease appears to be flattening off at -35% YoY ! Think about that for a minute. Afterwards notice that Industrial Production is headed over into the tank and the recent MtM headlines were a -4.5%. On our charts the downturn has been visible for months. New capital goods orders look much better until you notice that they went in the thank last summer and ask why they picked up ? The answer was a weak...k dollar and exports. A boon soon to be taken away. BtW that decline means that Tech spending is going to take it in the neck (Tech Trends II (Analysis): What're the Drivers and Outlooks).

Future Demand: the main drivers of future demand are growth in real wages and employment. Well guess what real wages have been dropping, not quite like a rock and we're now in our seventh month of employment declines. The net result is their sum is tipping over as well. And we're just started into the real downturn which is NOT visible yet because of normal cyclic patterns. Something that repeatedly escapes the pundits, talking heads and the MSM. We're starting to see some glimmers, e.g. Faber's got it right and more and more of the financial economist community is starting to see the world the way we've been seeing it for months. Halleluah - at long last. At least from an intellectual perspective. From a painful experiences to come perspective not so good. 

Wrapping Up

We'll leave you with this fascinating little chart that looks at some alternative extrapolations of GDP growth over the next ten years. The first is a mild downturn that's the best case we see, the 2nd a more severe downturn if the credit crisis worsens and the third is if it gets really bad, the package doesn't work too well and we catch the no-growth Japanese diseases. Factor these into your planning. We think we're being realistic and have deliberately ignored the Big-D scenario having a desire to keep our dinners down.

 

Credit Crisis and the Economy 

Debt Market Distress Spreads Short-term money markets remained in turmoil, heightening the likelihood the credit pullback will harm the broader economy. Short-term money markets remained in turmoil, heightening the likelihood the credit pullback may harm the broader economy. Inside markets that are hidden to most Americans -- the overnight Treasury repo market, the short-term commercial-paper markets and the floating-rate municipal bond markets -- action was unfolding that will soon affect how companies meet payroll, pay vendors and make investments. These markets allow companies with ample reserves to squeeze out a few extra dollars by investing the cash in securities with life spans of just days or weeks. All that cash helps keep the economy lubricated by distributing money to other firms that need short-term loans to buy inventory or meet payroll. Some distressing signs emerged Thursday from one of the most important of these marketplaces, the commercial-paper market, where companies borrow money for periods of just a day to up to a year. The market contracted by $61 billion in the week ended Sept. 24, its largest decline since August 2007, when investors fled over some of the first warning signs of the subprime-mortgage crisis. In the latest week, banks and other financial companies accounted for most of the decline, as they took $50.3 billion of paper off the market. The decline follows a $52.1 billion shrinkage in the week ended Sept. 17, which reduces the overall market to $1.702 trillion, according to Federal Reserve data. "The world is clearly saying this is a huge problem," said Harjeet Heer, who runs the Global Aggregate business at Baring Asset Management, which manages $17.8 billion in fixed-income assets. These changes already are having affects on a host of companies that are constantly managing their cash positions. Payroll processor Paychex Inc. transmits billions of payroll payments each day for 500,000 U.S. businesses. Last week, Paychex's chief financial officer, John Morphy, moved some of his working cash out of short-term municipal bonds and some money-market funds and into discount notes issued by government-backed Fannie Mae and Freddie Mac, called agency discount notes. "When you're talking about a company like ours, if you've got to be liquid, you'd rather make sure you're liquid and you might give up some return, but you'd rather be safe," said Mr. Morphy.

• Small Businesses Can’t Get Cash

Hey, what about my job? The credit crisis is taking its toll on financial firms, leaving many people on Wall Street out of work and many more uncertain about whether they will lose their jobs in the coming months. But the market meltdown is likely to have an even wider effect on the entire job market, which was weakening even before the historic meltdown of the past few weeks. More than 600,000 jobs have already been lost this year, according to the government. And there are currently over 9.4 million people looking for work in the U.S. Given the recent events roiling the economy, the prospects for job seekers are looking dimmer every day. "Everybody is at risk," according to John Challenger, chief executive of global outplacement firm Challenger, Gray & Christmas. Frozen financial markets mean that banks are putting the brakes on lending. With businesses finding it harder to get financing, that could hinder their growth and lead to more layoffs. That, in turn, compels consumers to curtail their spending, slowing economic activity even more...which leads to more layoffs, Challenger explained. It's a "negative spiral," he said. Beyond the finance industry, many companies have already started cutting back in order to cut costs, Eubank said. Since May, General Motors (GM, Fortune 500) laid off 19,000 hourly workers, Starbucks (SBUX, Fortune 500) cut 12,000 jobs and American Airlines (AMR, Fortune 500) announced it was cutting 7,000 jobs, according to Challenger, Gray & Christmas. Other companies have instilled temporary hiring freezes or put their hiring plans on hold altogether. "Employment expectations are down substantially," according to John Dooney, manager of strategic research for The Society for Human Resource Management. Meanwhile, the employers that are hiring are moving slower and being more selective. Instead of three rounds of interviews, there might be twice as many, Paris said. With the unemployment rate now at a five-year high, according to the latest figures from the Labor Department, experts say it may be a while before an economic turnaround takes hold. According to Challenger, "the economy is going to be very slow through 2009."

• Orders For U.S. Durable Goods Drop 4.5%, More Than Forecast, as Sales Slow Orders for U.S. durable goods fell more than twice as much as forecast in August, a sign that slower sales and tighter credit conditions prompted companies to cut spending.
• New-Home Sales in U.S. Plunged 11.5% in August to Lowest Level in 17 Years Sales of new homes in the U.S. fell in August to a 17-year low, signaling the housing market suffered another setback even before the latest turmoil in financial markets.
• U.S. Initial Jobless Claims Soar to Highest in Seven Years on Hurricanes The number of Americans filing first-time claims for unemployment benefits rose last week to the highest since September 2001 as hurricanes kept residents of Texas and Louisiana out of work.
• U.S. Economy Expanded 2.8% in Second Quarter, Less Than Previous Estimate The U.S. economy expanded more slowly than previously estimated in the second quarter, showing consumer spending was weakening before the credit crisis intensified

Asia Needs Deal to Prevent Panic Selling of U.S. Debt, Yu Says Japan, China and other holders of U.S. government debt must quickly reach an agreement to prevent panic sales leading to a global financial collapse, said Yu Yongding, a former adviser to the Chinese central bank. ``We are in the same boat, we must cooperate,'' Yu said in an interview in Beijing on Sept. 23. ``If there's no selling in a panicked way, then China willingly can continue to provide our financial support by continuing to hold U.S. assets.'' An agreement is needed so that no nation rushes to sell, ``causing a collapse,'' Yu said. Japan is the biggest owner of U.S. Treasury bills, holding $593 billion, and China is second with $519 billion. Asian countries together hold half of the $2.67 trillion total held by foreign nations. China, Japan, South Korea and others should meet soon to seal a deal, said Yu, a former academic member of the central bank's monetary policy committee. The talks should involve finance ministers, central bank governors and even national leaders, he said. Yu said China is helping the U.S. ``in a very big way'' and added that it should get something in return. The U.S. should avoid labeling it an unfair trader and a currency manipulator and not politicize other issues, he said. ``It is not fair that we are doing this in good faith and are prepared to bear serious consequences and you are still labeling China this and that, accusing China of this and that,'' he said. ``China knows what to do. We don't need your intervention.'' The U.S. financial crisis had taught China a lesson and that was: ``Why are we piling up these IOUs if they may default?'' China's economic expansion strategy, which emphasizes export growth that has led to trade surpluses and the accumulation of $1.81 trillion in foreign-exchange reserves, is the main problem, said Yu. ``Our export-growth strategy has run its natural course,'' he said. ``We should change course.'' China should stop intervening in the foreign currency markets and thus allow rapid appreciation of the yuan, he said. While this would cause pain for exporters, China could ease the transition by using its strong fiscal position to aid those who lose their jobs. It also should stimulate domestic demand to offset lower income from overseas sales.

Foreign Economic News

European Services, Manufacturing Shrink at Fastest Pace in Almost 7 Years Europe's manufacturing and service industries contracted at the fastest pace in almost seven years in September as the credit-market seizure intensified and companies scaled back production in response to slowing orders. Royal Bank of Scotland Group Plc's composite index dropped to 47, the lowest since November 2001, from 48.2 in August. Economists had forecast a decline to 47.8, according to the median of 21 estimates in a Bloomberg News survey. The index is based on a survey of purchasing managers by Markit Economics in London and a reading below 50 indicates contraction. Banks are hoarding cash as they struggle with the yearlong credit crisis that has claimed financial institutions including Lehman Brothers Holdings Inc. and with an economic slowdown that is curbing loan growth. Cooling demand is also hitting Europe's biggest manufacturers, with Germany's BASF SE last week announcing it will slash production of polystyrene in Europe. ``The flash PMI data for September make grim reading, showing recession-consistent activity data pretty much across the board,'' said Ken Wattret, an economist at BNP Paribas in London. ``Manufacturing has taken over from services as the main driver of weakness, reversing the pattern in the early stages of the downturn. This is linked to Germany's switch from boom to bust.'' The continued contraction in manufacturing and services industries suggests Europe's economy isn't recovering after shrinking in the second quarter for the first time in almost a decade. The European Central Bank on Sept. 4 cut its 2008 growth forecast to about 1.4 percent. The European Commission also lowered its outlook this month and predicts recessions in Germany and Spain, the region's largest and fourth-largest economies.

• French August Consumer Spending Falls as Slowing Growth Fuels Joblessness

• Ireland Is First in Euro Area to Enter a Recession as Investment Plunges Ireland became the first euro area economy to slide into a recession, as homebuilding and consumer spending slumped and the global financial crisis intensified.

Post-Olympic economic blues Hopes of a rapid recovery in the health of the Chinese economy after the Olympic Games are fading fast on weakening commodity as well as property prices, Citigroup said in a report released Wednesday. "All signs are pointing towards an across-the-board slowdown in the Chinese economy. The particular worrying signs are rapid cuts in steel prices, surging steel exports, deceleration in electricity consumption growth and weakening coal prices," Citigroup Lan Xue wrote in the report. Lan said an unexpected reduction in steel prices for November announced last week by Baoshan Iron & Steel Co., China's largest steelmaker, suggested steel companies weren't expecting any major rebound in economic activities. Baoshan last week announced a reduction of 800 yuan ($117) a ton, or more than 10% over October, in the prices of hot-rolled and cold-rolled steel coils for November, according to reports. China's economic indicators were expected to show an improvement after the Olympics, after industrial production weakened in the run up to the Games last month, partly because the government shut down several polluting factories in and around Beijing. Official data released earlier this month showed that the growth in China's industrial output slowed to 12.8% in August from the same month a year ago, the weakest pace in six years. In July, China's industrial production expanded 14.7%. Lan said "a significant deterioration in the property sector" was believed to be one of the key reasons behind the weakness in domestic demand.

Consequences and Delusions

Faber Says U.S. $700 Billion Rescue Plan Isn't Enough (Update3) The U.S. government's $700 billion bank rescue plan won't be enough to revive the finance industry, said investor Marc Faber, who forecast the so-called Black Monday crash in 1987. The government should buy out struggling home owners, Faber, managing director of Marc Faber Ltd. and publisher of the Gloom, Boom & Doom Report, told reporters on the sidelines of an investor conference in Hong Kong. He's also predicting Chinese economic growth to ``disappoint'' and Indian stocks to decline. ``The U.S. has many problems,'' Faber said. ``It's a period of hardly any growth in real terms in the economy for several years.'' Faber also forecast the Standard & Poor's 500 Index will rally to as high as 1,350 points following the approval of the bailout plan because stocks are ``oversold.'' That level is about 14 percent higher than the gauge's close yesterday. Still, ``I'm not playing that rally,'' he said. ``I'd rather think that stocks are not particularly cheap. We don't have a valuation bubble. We have an earnings bubble. In 2009, earnings will disappoint.'' Faber said he is ``negative'' on China's economic growth, which has slowed for four straight quarters. The economy expanded at 10.1 percent in the second quarter, down from the previous period's 10.6 percent, though still the fastest pace of the world's 20 biggest economies. Industrial production grew in July at the weakest pace since February 2007 and manufacturing contracted in August for a second month, according to an official survey, underscoring government concern that an economic slump is possible. ``Economies like China that grow very rapidly can have significant adjustments,'' Faber said. ``I'm not negative for the long term. It's just that from a cyclical point of view the Chinese economy could turn out to be weaker than what analysts are telling you.'' India is also ``not problem-free,'' Faber said. He forecasts the Bombay Stock Exchange's Sensitive Index, or Sensex, will fall below 10,000. The Sensex is down 33 percent this year. ``I think new all-time highs in markets are most unlikely for the time being,'' Faber said. ``So I'm not particularly interested to play the market at the present time.''

Earnings Reports: The Audacity of Hope Even as politicians remake the Street, its denizens remain optimistic. Collectively, analysts expect S&P 500 earnings to expand by 23.9% in 2009, and that figure has increased slightly since July. Remarkably, Wall Street's consensus on earnings is: "Fine in '09." Even as politicians remake the Street, its denizens remain optimistic. Collectively, analysts expect S&P 500 earnings to expand by 23.9% in 2009, according to Thomson Reuters. What's more, that figure has increased slightly since July, despite the recent intensification of the credit crunch. Such bottom-up analysis, however, will be crushed by top-down pressures. Despite concern about the government flooding the economy with dollars and stoking inflation, disinflation is the more likely near-term prospect, as the private sector deleverages. Consumer spending, which is 70% of gross domestic product, and corporate investment will necessarily suffer. Expecting a big profit rebound makes no sense. Take the financial sector, at the center of the storm. Its collective earnings for 2009 are forecast to be $156 billion. Not only would that represent more than double the expectation for this year, it would imply the sector actually making more in 2009 than in 2007 when, to paraphrase one of its more high-profile casualties, the music was still playing. Views on the consumer-discretionary sector are similarly bullish. Hopes for energy profits also remain strong, reflecting lingering hopes about global economic decoupling; that thesis appears to be coming apart as far as Europe is concerned, at least. As corporate management teams head toward the end of a turbulent year, expect budgets to be recast, reduced expectations to be communicated to analysts -- and the Street's enduring optimism to be dimmed.

Posted by dblwyo at 07:04 PM | Permalink | Comments (2)

Yesterday was a day of political kabuki in the US Senate as Sec. Paulson and Chairman Ben were raked over the coals, tripped, stripped and drug back over 'em again and again and again. It was truly a massive display of unusual bi-partisan unity by every Senator of both parties with nary a display of understanding, sympathy or constructive suggestions. As political theater it was entertaining to the extent that you admire the works of the Marquis de Sade. Whether it will turn out to be unavoidable and useful are really the questions. Put another way given how angry, ill-informed and torch-waving the electorate is was this 1/3 posturing and 2/3 preparation or 1/3 posturing, 5/6 dead serious and 1/6 who knows ? On the answers to that question hinges the fate of the economy, literally.

Market as Proxy

During the bulk of the day I had the chance to listen to the live testimonay and questions on-line while tracking the markets performance and it was amazing. After a very bad Monday Tue. started out flattish and then started falling apart as the level of objections became clear. Then when it looked as if some rationality was setting in and folks had calmed down the markets picked up considerably, much to the relief of the traders who'd bet on a relief rally following Mon's debacle. Alas it was not to be because around 3pm the the stories started to hit and the realities of the kabuki reached a wider audience....call it the kabuki kaboom. By close of business we were down 4+% in the worst 2-day drop in years. So far today things have been oscillating wildly as the Buffet Goldman put faded instantly to be replaced by apprehensive waiting for today's play.

Clearing the Air

Let's try and clear the air a little bit despite the fact that everything you're hearing, reading and people are talking about is largely distorted, serves an agenda that's not necessarily helpful or is just plain wrong. Sadly, for myself in particular, some of the financial journalists and bloggers for whom my respect has been the utmost are among those getting it wrong, being non-contributory or just terminally - implications intended - ideological. You should know who you are and it's rather sad that you don't. Let me give you two acid test questions for all of those "pontificating poobahs of pessimism": 1) if you don't like the proposal what's wrong with it and how would you fix it ? 2) in the timeframe we have before the markets crash and take the economy with it ? 3) if you don't like the plan at all what's your alternative proposal - let it all fail so the devil can sort out the hindmost ? Fortunately there are a few folks who are acting sensibly with names like Gross, Buffett, et.al. And our friends at BNN come thru again with a fair, balanced and reasonable interview.

First off it's not either a bailout or $700B. In fact none of the so-called bailouts are even that from Bear-Sterns to AIG to this "re-capitalization" plan. Nor are the Wall St. fatcats getting rich off of it. In fact many of them are getting wiped out, not to mention the ordinary folks being put on the street. There's a lot more secretaries than poobahs at Lehman or any of these firms. Dick Fuld sold his stock for something like $600K when last year it was worth about $170M. In the AIG case the $85B "bailout" is a loan, the Fed gets 90% of the stock, the CEO was fired and the stockholders were wiped out. And the Fed's getting paid 11% on the money - try and find that sort of return anywhere. When you take each one of these apart the details vary but they are variations on the same theme.

Take the giant bailout for example. The idea is to buy up the bad investments on the banks books because if they sold them at "fire-sale prices" the result would be many would be out of business and credit in the US economy would vanish. I'm not sure how to to make clear what that means - most companies in the US borrow money every day or every week to fund receivables, smooth out payables, finance payrolls while waiting to get paid and all that's just the normal course of business. Most people have car loans, many have mortgages, credit cards and so forth. THAT ALL GOES AWAY. The economy slows down and then stops completely...pretty soon no more car loans...no more auto manufacturing...no more auto jobs....well maybe that's a bad example but you get the idea. We're not talking about rescuing the fat cats we're talking about Joe Boilermaker's job, paycheck, healthcare, and everything else under the sun.

Objections and Consequences 

The major trotted out objections seem to be four: an equity stake, more oversight, help with foreclosure prevention and no golden executive comp. First off this was a proposal on three pages originally put together at Congress's request for them to turn into legislation, which they did, rather quickly and well. With the exception of the adders. Second off some speed was and is of the essence. As Sen. Dodd put it perfectly during his closing comments yesterday, "our legislative process doesn't lend itself to responding to crisis like this". They want weeks and months to carefully craft a package. I'd ask what's wrong with pushing something thru now to keep the markets from imploding while crafting a more meticulous package over the next 2-3 months. By the way for all those asking for fundamental strategic reform of financial regulation Sec. Paulson put forward a comprehensive proposal in March which the Congress has chosen not to act on. Be that as it may as a proposal it was supposed to be emended. As the Sec. testified he's not asking for no oversight and welcomes it. As for controlling executive compensation well enough, bargain that thru. An equity stake - that'd have to be thought thru but the precedents are already in place. Foreclosure prevention - that's populist pork-barrel-rolling at it's worst. First, until housing prices come down to reasonable levels this whole thing will keep breaking out. Second, everybody needs a haircut. And third that's a separate, major issue where the clock isn't ticking away in seconds.  

As a final point consider this - even if we lost every dime of the $700B plus all the prior investments but managed to get economic growth to stay higher than it would be we make money. Put another way we don't end up with 10-12% unemployment and an economy growing at 1% for ten years. Consider the last graphic which shows actual GDP vs Potentil - the gap between them is lost output. To make those differences bigger we also graphed (on the right-hand scale) the YoY growth rates. Now we have an $11T economy. Supposed we get a decline for the next two years of -3%/year (possible but optimistic in a credit collapse), so we have a minimal deadweight loss of -$333B x 2 = -$666B (accidental but meaningful numerology). And suppose we slowly recover for ten years at 1% instead of growing at potential. Let's close with a little worked out table: 

 

 

 At the end of ten years the difference between a mild downturn followed by a return over several years to potential growth and a slightly more severe downturn followed by a Japalaise decade is $2.6T in the last year alone. The total difference over all ten years is -$14T while the net present value is -$9.4T ! In either case that's a lot of lost jobs, people dying in emergency rooms, unbuilt houses and un-educated kids. And that's comparing a good case to a bad one...not the terrible one we're at risk of. Seems to me $700B is a pretty good investment for that kind of return.

Economic Consequences of the Bailout 

Bernanke Says Failure to Pass Bailout Threatens Financial Markets, Economy Federal Reserve Chairman Ben S. Bernanke warned lawmakers that failure to pass a rescue plan to take over troubled assets from financial firms would pose a threat to markets and the economy. ``Action by the Congress is urgently required to stabilize the situation and avert what could otherwise be very serious consequences for our financial markets and for our economy,'' Bernanke said in testimony prepared for delivery today to the Senate Banking Committee. ``Global financial markets remain under extraordinary stress.'' Bernanke and Treasury Secretary Henry Paulson are pushing Congress to quickly approve a $700 billion plan to remove illiquid assets from the banking system. Lawmakers have balked at rubber-stamping the proposal, with Democrats demanding it include support for homeowners and limits on executive pay, while some Republicans question the plan's reach and size. ``At this juncture, in light of the fast-moving developments in financial markets, it is essential to deal with the crisis at hand,'' Bernanke said. Bernanke endorsed the biggest federal intrusion into markets since the Great Depression after failing to stem the credit crisis by cutting the benchmark interest rate at the most aggressive pace in two decades. He has also opened up lending to securities firms and expanded loans to commercial banks. Along with the government bailout, Bernanke supports a regulatory overhaul for a U.S. financial industry upended by $523 billion in losses from the collapse of mortgage credit.

Paulson, Bernanke May Find Painful Parallels in 1990s Nordic Bailout, Bust He says the effort by Finland, Sweden and Norway to save troubled banks in the early 1990s is the closest parallel to the market-rescue plan being engineered by the U.S. Treasury secretary and Federal Reserve chairman. The Nordic effort -- similar in speed and scope to what the U.S. is planning now, though smaller in size -- did manage to end the financial crisis. At the same time, it didn't prevent a deeper recession and surging unemployment in all three countries. ``In the long term, there were benefits, but it took half a decade before they began to show in the economy,'' said Esko Ollila, a member of the Bank of Finland board from 1983 to 2000.

Buffett Calls Credit Crisis an `Economic Pearl Harbor,' Backs Paulson Plan Billionaire investor Warren Buffett, calling the market turmoil ``an economic Pearl Harbor,'' said Treasury Secretary Henry Paulson's $700 billion proposal to prop up the U.S. financial system is ``absolutely necessary.'' ``The market could not have taken another week'' like last week, Buffett told CNBC today, a day after saying his Berkshire Hathaway Inc. will buy a $5 billion stake in Goldman Sachs Group Inc. ``I think it was the last thing Hank Paulson wanted to do, but there's no Plan B for this.'' ``I am betting on the Congress doing the right thing for the American public and passing this bill,'' Buffett said. The economy is ``everybody's problem,'' he said, likening it to ``a bathtub -- you can't have cold water in the front and hot water in the back.'' Berkshire is buying the stake in Goldman, Paulson's former firm, after three of the investment bank's biggest competitors went bankrupt or were forced into emergency sales. He has already agreed to spend at least $25 billion this year to acquire companies, finance buyouts and purchase securities for Omaha, Nebraska-based Berkshire. ``I certainly have a vote of confidence in Goldman and vote of confidence in Congress,'' said Buffett, who is investing in the firm after it lost 40 percent of its market value in the past year.

Libor Rises as Funding Squeeze Worsens After Banks Pay Record Cash Premium Money-market interest rates increased as banks sought to bolster balance sheets amid deepening concern a bailout of financial institutions won't happen quickly enough to ease short-term funding constraints. The one-month London interbank offered rate, or Libor, for dollars jumped 22 basis points to 3.43 percent, the highest level since January, the British Bankers' Association said today. The corresponding rate in euros rose 7 basis points to 4.91 percent and the pound rate also advanced 7 basis points, to 5.91 percent. ``There's no real term funding markets except for central banks,'' said Meyrick Chapman, a fixed-income strategist in London at UBS AG. ``The Libor is meaningless. It's for unsecured lending and there is no unsecured lending as far as I can see.'' Money markets have frozen since the collapse of the U.S. housing market more than a year ago. Efforts by the Federal Reserve, along with central banks worldwide, to revive lending through emergency cash auctions have failed as banks hoard cash and balk at lending to each other on concern more institutions will go bankrupt.

Treasuries Lose Allure for Axa, South Korea Pensions as Bailout Costs Soar Investors outside the U.S., who own more than half of all Treasuries outstanding, say the government's $700 billion plan to revive the banking system will diminish the appeal of the nation's bonds. Treasury Secretary Henry Paulson's proposal, which seeks funds to rescue banks by purchasing devalued securities, would drive the country's debt to more than 70 percent of gross domestic product. The last time taxpayers owed as much was in 1954, when the U.S. was paying down costs from World War II. ``The image of U.S. Treasuries as a safe haven has been tainted by the ongoing financial debacle,'' said Kwag Dae Hwan, head of global investment in Seoul with South Korea's $220 billion National Pension Fund, which holds about $14 billion of U.S. government debt. ``A big question mark hangs over whether the U.S. can deal with an unprecedented amount of debt. That is unnerving all the investors, including me.'' The government depends on foreign money to finance the budget deficit, which UBS AG estimates will increase to $1 trillion next year from $407 billion if the bailout is approved. Investors outside the U.S. own 56 percent of the $4.8 trillion in marketable Treasuries outstanding, up from 42 percent of the $3.4 trillion outstanding five years ago, according to data compiled by the government. U.S. long-term interest rates would be 1 percentage point higher without demand from foreign governments and central banks, according to Professors Francis and Veronica Warnock at the University of Virginia in Charlottesville, who have done research for the Federal Reserve.

Bailout plan draws bipartisan anger in Congress The Bush administration urgently pressed Congress in public and private Tuesday for quick passage of a $700 billion bailout of the financial industry as Democratic and Republican lawmakers vented their anger over a crisis that slid the nation's economy toward the brink. But even before Paulson could speak, lawmakers expressed unhappiness, criticism of the plan and -- in the case of some conservative Republicans -- outright opposition. "I understand speed is important, but I'm far more interested in whether or not we get this right," said Sen. Chris Dodd, D-Conn., chairman of the Senate Banking Committee. "There is no second act to this. There is no alternative idea out there with resources available if this does not work," he added.Sen. Richard C. Shelby of Alabama, the panel's senior Republican, was even more blunt. "I have long opposed government bailouts for individuals and corporate America alike," he said. Seated a few feet away from Paulson and Ben Bernanke, the chairman of the Federal reserve, he added, "We have been given no credible assurances that this plan will work. We could very well send $700 billion, or a trillion, and not resolve the crisis." Dodd and other key Democrats have been in private negotiations with the administration since the weekend on legislation designed to allow the government to buy bad debts held by banks and other financial institutions.

• U.S. Stocks Drop in Worst Two-Day Decline Since 2002 on Bailout Concerns
• Housing Prices Tumble 5.3% in U.S. as Home Loans Become Harder to Get
• Congressional Leaders Push for Changes to Bailout Plan as Opposition Grows

A Day in the Shooting Barrel 

Administration's rescue plan hits speed bump in Congress The biggest financial bailout in American history hit a speed bump Tuesday on Capitol Hill as members of the Senate began to balk at quick action to pass the measure, saying such a massive proposal requires more careful discussion and consideration. While there was no sense that the plan, authored by Treasury Secretary Henry Paulson, was yet in peril, senators suggested at a hearing with Paulson, Federal Reserve Chairman Ben Bernanke and other top regulatory officials that the measure would not be completed by the end of the week and needed extra provisions.Senate Banking Committee Chairman Christopher Dodd said that the plan "is not going to work" in its current form. Sen. Richard Shelby of Alabama, the panel's top Republican, said the plan "is not going to be just rubber-stamped." Lawmakers grilled the two financial chiefs about the huge package and pressed both of them to include other elements such as aid for homeowners and caps on executive pay. Notes of skepticism crept into the statements of congressional leaders. But many legislators were walking a tightrope -- complaining about the plan while promising to take action. Dodd said the Paulson proposal was "stunning" in its lack of detail. "It would do nothing in my view to let a single family save a home. It would do nothing to stop a CEO from dumping billion dollars of toxic assets on the back of American taxpayers," said Dodd. "It is not just our economy at risk but our Constitution as well," Dodd said, because it would allow Paulson to spend $700 billion "with impunity." Paulson’s Testimony on C-Span, Entire Hearing (opening statements are worth listening to; a masterpiece of political theatre, posturing and disingenuousness by one of the principal agents responsible)

• Paulson Says Crisis Spreading; Delay of $700 Billion Plan Would Be `Grave'

Bernanke rides to rescue of Paulson plan The quiet unassuming professor of economics appeared just in time at the crest of the hill and rode to the rescue of the savvy Wall Street tycoon who had his wagons circled in the valley below desperately trying to hold off the opposition. Such was the story line of the extraordinary Senate hearing Tuesday examining the historic $700 billion bailout of financial firms proposed by Treasury Secretary Henry Paulson. Many Congressional hearings are carefully scripted, with both sides prepared well in advance and with the conclusion never in doubt. But other hearings, like this one, contain real drama. The hearing began with Federal Reserve Chairman Ben Bernanke and Paulson forced to listen in stony silence for an hour of withering criticism of the proposal by members of both Republicans and Democrats on the Senate Banking panel. "I haven't had a single phone call in favor of this proposal," announced Sen. Sherrod Brown, Democrat of Ohio. When Sen. Mike Enzi, Republican of Wyoming, vowed that the Paulson proposal would not pass, applause broke out in the audience. Sen. Jim Bunning, Republican of Kentucky, followed up by calling the plan "un-American." When it was the turn for the government officials to speak, Paulson fought back with a tough, take-no-prisoner statement that brought to mind the "the Hammer' nickname that he was given by his colleagues at Goldman Sachs. It didn't play very well with the senators and clearly there was a sense in the room that the plan might be in deeper trouble than expected. But then, Bernanke took the microphone, set aside his prepare remarks, and calmly laid out the benefits of the Paulson proposal in such a way that took the starch out of the opposition. A key point of the critics was that under the plan Treasury must pay more than the market value for the mortgage assets. But Bernanke explained that the mortgage securities have two prices - a "fire-sale price" if the mortgage asset was sold quickly today and a "hold-to-maturity" price if the mortgages were held to maturity. Banks have been paralyzed by this fire-sale price because their precious capital would evaporate overnight. The key to the plan, Bernanke said, was that if Treasury was able to buy the mortgages, it will be able to hold them to maturity. As a result, the fire-sale price could be avoided. This would remove uncertainty, return liquidity, and credit markets should be able to unfreeze, Bernanke said. "This is not an expenditure of $700 billion. This is a purchase of assets. If auctions are done properly...the American taxpayer will get a good value for his or her money and as the economy recovers, most, all, or perhaps more than all, of the value will be recovered over time," Bernanke said. Bernanke warned that the plan was a "pre-condition" for an economic recovery. He said there would be a severe economic downturn with no action. "I believe that if the credit markets are not functioning that jobs will be lost, the unemployment rate will rise, more houses will be foreclosed upon, GDP will contract, and the economy will not recover in a healthy way," he said. Bernanke’s Testimony on CSpan

• Bernanke Tells Congress U.S. Economy Will Shrink If Rescue Plan Not Passed

Americans Oppose Bailouts, Say Obama Would Best Handle Financial Emergency Americans oppose government rescues of ailing financial companies by a decisive margin, and blame Wall Street and President George W. Bush for the credit crisis. By a margin of 55 percent to 31 percent, Americans say it's not the government's responsibility to bail out private companies with taxpayer dollars, even if their collapse could damage the economy, according to the latest Bloomberg/Los Angeles Times poll. Poll respondents say Democratic presidential nominee Barack Obama would do a better job handling the financial crisis than Republican John McCain, by a margin of 45 percent to 33 percent. Almost half of voters say the Democrat has better ideas to strengthen the economy than his Republican opponent. Six weeks before the presidential election, almost 80 percent of Americans say the U.S. is going in the wrong direction, the biggest percentage since the poll began asking that question in 1991. After market chaos this month drove Lehman Brothers Holdings Inc. into bankruptcy and prompted federal takeovers of American International Group Inc., Fannie Mae and Freddie Mac, most survey respondents said financial companies shouldn't expect taxpayers to rush to the rescue.

Bailout battle: Where things stand The battle over the proposed $700 billion bailout of the U.S. financial system continued on Tuesday. Treasury Secretary Henry Paulson and Federal Reserve chairman Ben Bernanke defended the Bush administration's plan before the Senate Banking Committee, but new Democratic proposals have shifted the terms of the debate. Plus, some conservative Republicans have raised concern about the potential cost. The Bush administration's plan would allow the Treasury to buy up troubled assets from financial institutions. The aim is for the government to buy the assets at a discount, hold onto them and then sell them for a profit. The Democrats are considering several add-ons: They want the government to get an equity stake in the companies it helps; more assistance for those at risk of foreclosure; more oversight of the program; and curbs on compensation of executives of participating companies. Help for housing markets: Many experts are skeptical of the plan, especially in its indirect ability to help homeowners. Accordingly, the Senate Democrats' proposal would also require the government to include in the bailout proposal a separate systematic way to keep people in their homes. Democratic add-ons: Democrats have expressed concern about the lack of oversight in the Treasury's proposal. Both Sen. Dodd's and Rep. Frank's plans would create an oversight board for the Treasury program as well as regular updates on the plan's progress. Sen. Dodd would require the government to receive an ownership stake in the companies it helps. That idea would require companies who sell assets to the Treasury to give the government shares in the company.Curbs on executive pay were also proposed in the Dodd plan but not in the Frank plan. Dodd's proposal would set standards on compensation for big wigs from institutions that take advantage of the bailout, including limits on incentives and severance packages.

Non-intrusive Realities 

Cutting Back the Rescue's Price Tag In fact, there are a few reasons why the government's interventions probably won't be quite as expensive as people think. For starters, some experts say it's far from certain that the U.S. government will even need all the money it has budgeted. They say policy makers set their spending limits on the high side to make clear to investors that the government would do whatever it takes to make financial markets work again. And once the government's rescue program begins to establish prices for currently unmarketable securities, the hope is that the market will start functioning again before the U.S. actually has to buy $700 billion worth of them. Regardless of how much the government actually spends, the impact on the budget deficit will be further limited because budget rules allow the government to treat such debt as a "means of financing." Only the anticipated losses on the investments, plus interest costs, would show up as additions to the deficit. Ultimately, as Mr. Bernanke suggested, the government stands to get a lot of its money back on the securities it buys. It can sell them off or hold them as investments, depending on market conditions. Mark Zandi of Moody's Economy.com figures the government might pay out a total of $750 billion in all of its financial interventions -- about half the maximum $1.4 trillion total that has been allocated for the rescue package, the takeover of mortgage companies Fannie Mae and Freddie Mac, the bailout of insurer American International Group Inc. and the housing bill that Congress passed earlier this year -- and will be able to recover most of that. He estimates the total cost to taxpayers at no more than $250 billion, including the losses on the assets plus the interest on the government bonds that must be issued to finance the programs.

Posted by dblwyo at 12:51 PM | Permalink | Comments (0)

Well so much for the promised bailout saving the day. Hopefully you've noticed the Dow was down over 350 pts. today ? Oddly enough up until last We/Th a 350pt. day on the Dow would have gotten my adrenaline going but now...shrug. So, what's next ? That is the question, ain't it ? As usual the general reactions miss the whole point of the situation and the bailout, though fortunately the guys in charge continue to get it and do their best to do the right thing. We'll put it in context by continuing our Stalingrad analogy. We keep beating it to death, so-to-speak, for more than we like it. It's also because the relative timeline implied is probably pretty accurate.

After the break you'll find a bunch of readings to skim that totaled out at six pages just from today's news. The first section has long excerpts from some really key stuff, including Paulsen's editorial on what they're trying to do and an excerpt from his and Bloomberg's Meet the Press appearances. Also in the same section you'll find an excerpt by Ken Lewis on the future of the finance industry, from a speech he gave at the Black MBA association over the weekend. We happened to just catch it live on C-Span and tracked down the link. You'll make no better investment than listening to King Henry, Bloomie and Ken. If you think about what they're saying. We particularly liked Ken's speech because what he has to say about lack of discipline, the rushing consolidation in finance and the need for sound business models are drums we've been beating here for months. We won't bother to list the postings but if you'll skim the Finance Industry archives basically what you've got, or had, was a heck of an opportunity to make a lot of money. BtW - given how poorly the NDX has performed relative to the SPX in the last couple of weeks you could also have made a lot by going in on our negative Technology outlook. Both of which assessments during the times we made were cross-grain to the standard opinions. Among other cases where that's true. And oh yeah, as you'll read below, the Emerging Markets are really going in the crapper and  their troubles are getting worse fast. Again something we've  been flagging since Dec07 six months before the pundits were still talking them up.

Market Performances 

 The composite chart shows a 3Mo S&P on top and a YtD chart on bottom, thru last Friday so today's downturn isn't captured. What we see on the top chart was the swings low getting worse and worse, right up until the bailout rumors arrested what was looking awfully like a market collapse. Today's SPX downturn brings us well back into that down-channel. We'll have to see how it plays out.

Which gets us to the second component. Normally we disinclude the tails on our trendlines when drawing them on these candlestick charts on the theory that the body of the candles captures the main, central tendencies. In this case we added on a dotted red line to show what could have happened and what the downside risk still is.

IOHO what we're looking at is a fundamental shift in investor awareness and outlook, one that's still not completely settled in, but is nonetheless going to be increasingly important. And the reason the Stalingrad metaphor is so apt. You see while we've all been focused on the headline news what's lurking in the background is the continuing acceleration of the economic downturn, which is being ignored still. Despite the fact that we've crossed a tipping point which the present turmoil is all too likely to make worse. Some of the rest of the news excerpts will walk you thru some of the consequences from more reductions in consumer and business spending outlooks to tigether credit to the startling news that the last two major investment banks in the world converted themselves to commercial banks. On any other day that would have been earth-shattering news. Today it's, yeah, so.

Reactions and Outlooks

The reaction of blogospere commenters and authors, some media and the general public is, again IOHO, simply appalling. But given the apparent level of ignorance about how markets and economies work on the macro-scale not surprising given the level of fear and uncertainty. Where the blind rage and desire to blame anybody but them/ourselves could take us however is a very bad place. Because the popular and populist backlash could hamstring the ability to get quick passage of the bailout package. All we need to do right now is keep the wheels on the wagon, 'cause they're sure awfully wobbly. Without that bailout package we're in deep kimchee indeed. In fact we think a major reason for the downturn today was a) the fading of the relief rally as realities returned to the forefront of Mr. Market's consciousness and b) the awareness that the Congress critters are playing posturing games with the bill. The real problem is that they likely have little or no choice given the reactions of their constituencies. Let me quote Mayor Bloomberg: 

We've re-posted an earlier chart illustrating where we're at in business cycle. Like we said, we've started across the tipping point into a more severe downturn. The problem now is to get the Ebolatization of the credit markets halted so we can focus on keeping that downturn from sliding across the lower boundary into something truly painful. That is from slipping across the lower black line into the region bounded by the red one. That is the current clear and present danger...

...and too many people don't get it and aren't acting as if it couldn't happen.

Strategic Situation: King Henry, Big Ben and Ken the Jester

Ten Days Changed Wall Street as Bernanke Saw `Massive Failures'  Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben S. Bernanke had been thwarted all week in their efforts to stabilize U.S. financial markets. Now, early in the evening of Sept. 18, they had a bigger fix in mind, and they went to sell it to Congress. They sat in House Speaker Nancy Pelosi's office, at a wooden conference table adorned with pink roses and white hydrangeas, surrounded by more than a dozen congressional leaders. In the previous four days, Lehman Brothers Holdings Inc. had gone bankrupt. Merrill Lynch & Co. and Bank of America Corp. had rushed into a shotgun wedding. The regulators had pumped $85 billion into American International Group Inc., nationalizing the world's biggest insurer, and were trying to thaw frozen credit markets and prevent economic catastrophe. Earlier that week, lawmakers of both parties had talked about waiting until after the November election to take legislative action. Bernanke, a scholar of the Great Depression, let them have it. ``The credit lines in the American financial system, the lifeblood of the economy, are completely frozen,'' he said, according to Senator Charles Schumer of New York, a Democrat who was in the meeting. Banks had stopped lending to each other overnight, Bernanke said. That threatened to halt all lending in the U.S., forcing businesses to close and idling workers, the Fed chief said. The Fed also was seeing money being moved out of the country. ``You could have massive failures within days,'' he told the group, and it would go beyond the banking system to ``large name- brand companies,'' according to a congressional staff member who attended the meeting and took notes. Politicians leaving the meeting said they were shocked at these portents of Armageddon from the usually understated Bernanke. They left the 90-minute meeting looking shaken, and resolved to act before the election. It was ``as sobering a meeting as any of us have ever attended in our careers here,'' said Christopher Dodd, a Connecticut Democrat and chairman of the Senate Banking Committee. Thus culminated 10 days that rattled markets worldwide and changed the structure of the U.S. financial system. Wall Street firms are shuttering or selling themselves to the most stable bidders. Regulators and lawmakers are moving toward a rescue that could cost more than $700 billion and permanently step up regulation. President George W. Bush said as much in public remarks Sept. 20. ``At first, I thought we could deal with the problem one issue at a time,'' Bush said. ``The house of cards was much bigger and started to stretch beyond Wall Street. When one card started to go, we worried about the whole deck going down.'' The meltdown reached banks on Tuesday, Sept. 16, when the London interbank overnight rate jumped 3.33 percentage points to 6.44 percent. This signaled that banks didn't trust each other enough to make 24-hour loans -- except at a premium -- and overnight more than doubled the cost of borrowing in dollars. The rate was the highest since 2001. The fear gripping the market gridlocked the financial system, including collateralized debt obligations. ``The recent intervention in the markets, nationalization of financial services companies and systemwide RTC-like bailout being crafted in Washington are disconcerting to say the least,'' said Christopher Low, chief economist at FTN Financial in New York. ``Unfortunately, there's not much choice.''

Restoring the Strength of Our Financial System - We have acted on a case-by-case basis in recent weeks, addressing problems at Fannie Mae and Freddie Mac, working with market participants to prepare for the failure of Lehman Brothers, and lending to AIG so it can sell some of its assets in an orderly manner. And this morning we've taken a number of powerful tactical steps to increase confidence in the system, including the establishment of a temporary guaranty program for the U.S. money market mutual fund industry. Despite these steps, more is needed. We must now take further, decisive action to fundamentally and comprehensively address the root cause of our financial system's stresses. The underlying weakness in our financial system today is the illiquid mortgage assets that have lost value as the housing correction has proceeded. These illiquid assets are choking off the flow of credit that is so vitally important to our economy. When the financial system works as it should, money and capital flow to and from households and businesses to pay for home loans, school loans and investments that create jobs. As illiquid mortgage assets block the system, the clogging of our financial markets has the potential to have significant effects on our financial system and our economy. As we all know, lax lending practices earlier this decade led to irresponsible lending and irresponsible borrowing. This simply put too many families into mortgages they could not afford. We are seeing the impact on homeowners and neighborhoods, with 5 million homeowners now delinquent or in foreclosure. What began as a sub-prime lending problem has spread to other, less-risky mortgages, and contributed to excess home inventories that have pushed down home prices for responsible homeowners. A similar scenario is playing out among the lenders who made those mortgages, the securitizers who bought, repackaged and resold them, and the investors who bought them. These troubled loans are now parked, or frozen, on the balance sheets of banks and other financial institutions, preventing them from financing productive loans. The inability to determine their worth has fostered uncertainty about mortgage assets, and even about the financial condition of the institutions that own them. The normal buying and selling of nearly all types of mortgage assets has become challenged. These illiquid assets are clogging up our financial system, and undermining the strength of our otherwise sound financial institutions. As a result, Americans' personal savings are threatened, and the ability of consumers and businesses to borrow and finance spending, investment, and job creation has been disrupted. To restore confidence in our markets and our financial institutions, so they can fuel continued growth and prosperity, we must address the underlying problem.

Treasury Secretary Henry Paulson & N.Y.C. Mayor Michael Bloomberg

MAYOR BLOOMBERG:  Well, I think number one, Hank's the right guy for now.  He knows what goes on on Wall Street, he understands these complex financial instruments in a ways most people do not and most Treasury secretaries do not. So if I had to have one person at the helm today, I would pick Hank Paulson. But I think you got to step back and say what's the real problem here?  There are two crises.  One is the crisis in the financial market, a lack of confidence that almost closed down the financial system this past week and that Hank has to address.  And it's up to the Treasury with the acquiescence of Congress, but to do something quickly.  And nobody knows exactly what they should do, but anything is better than nothing.  You've got to restore the public's belief and the market's belief that we will go on.  And this is not just an American problem, it's financial markets around the world that are all interlinked and they're all collapsing.  The second problem, which is up to Congress, it's a much longer-term problem and may be the genesis of the problem that we have today in the financial markets, and that is that people are losing their homes, deserted homes are destroying neighborhoods, people are losing their jobs.  We have some industries that Congress tried to protect, and instead of protecting them they've caused them to not keep up in a competitive world with new products.  We have an education system that isn't preparing us for the future, and we have a retirement system that's just not going to be there when we need it.  So there's two things here:  One you got to do quickly; one you really need a lot more thought about and that Congress should spend that time debating.  But I don't know that there's time for a lot of the debate now. You can put some safeguards in, but you don't have time to build in the safeguards that you should have for long-term.  And we're paying the price for the last years where we all wanted something for nothing, where we took risks because we were convinced that we would never have to pay, somebody else would pay on the downside, but we'd keep the profit.  Congress has been unwilling to address the fundamentals of this country--an energy policy that makes sense, infrastructure, health care, all of these kinds of things.  So you want something that overnight we can do, what Hank Paulson's been arguing for a long time. Regulation's a good example.  Our regulation in this country is designed for the world of 50 years ago.  We have separate regulation for different industries, except today those industries all do the same thing.  Also, our regulation isn't consistent with regulation around the world.  And every company, every bank, your job, my job, all our jobs depend on commerce and what happens elsewheres in the world.  And we have to find a ways to, to pull together, in Congress not have all of the different oversight committees, in the executive branch not have all the different agencies, and not just think that we're the only ones that can do this, but pull it all together. Paulson's been talking about it for a long time.  But I think it, Tom, it comes out of this instant gratification.  We all were happy when the stock market was going up, we were all happy when there was all this money sloshing around in the economy, and everybody could get a loan whether they could pay it back or not.  When companies went out and bought other companies and people got great bonuses, it was great.  And nobody wanted to say, "Wait a second, this can't go on forever."

Netcast (Sun. meet the press netcast) 

Remarks to the National Black MBA Association Kenneth D. Lewis, Chairman and Chief Executive Officer, Bank of America. Our economy is suffering from several major shocks, and one major imbalance. The shocks include rising energy prices, which are contributing to inflation; and the crash in the housing market, which led to the credit crunch, our financial crisis and upward pressure on unemployment. The imbalance is the ratio of household debt…including mortgage debt… to savings. The crash in the housing market, in hindsight, was inevitable. There were a lot of factors that played a role… think of it as a “perfect financial storm.”  Today, the greatest source of imbalance is household finance. But in past crises, the source has been too much debt leverage in the commercial sector. Either way, as you can imagine, the problem of excessive debt poses a challenge to bankers, for whom interest income is an important source of profit. The banks best able to meet this challenge are those whose business models balance interest income with fee income from services… whose consumer offerings balance loans with investments…and whose wholesale business balances credit with other services like treasury management and investment banking. This week’s events have led some to wonder if we’re close to hitting the bottom of the market. I won’t make a prediction. I will say that the industry, homeowners and investors have been through a lot of pain… and it’s not over. There’s a lot of bad debt out there that still needs to get cleaned out of the system. But it will… and in the meantime… at the risk of sounding like a contrarian… I’d like to put this situation in perspective. There are some obvious lessons learned from this episode. No asset is immune to the bubble effect – even housing. Distribution of risk is not the same as elimination of risk. Maybe most important: There are limits to the positive effects of financial leverage. The ability to increase demand through rising financial leverage can stimulate the economy. But it cannot create unlimited wealth out of thin air. Eventually, economic fundamentals always come back to remind us what’s real and what’s not. To this point, in hindsight, I’d say that the decision to lift leverage limits on investment banks earlier in the decade was, at the least, a contributor to our current situation. We’ve also had some reminders about what’s important for survival. Capital strength and liquidity are important. Diversity of assets, revenues and geography are important. And, obviously, good judgment is critical. Everyone has been hurt by the housing crisis. But good judgment has, more often than not, meant the difference between those who will survive, and those who are already among the missing. What is changing – as I said earlier – is consolidation. The industry is getting smaller. And it should. Even as the number of banks in the country has fallen by half, the financial services industry for the past 20 years has been on a rapid growth spurt. Financial stocks’ share of the market value of the S&P 500 tripled over the past 17 years. And over the past century, financial workers’ share of U.S. income quadrupled. Now, I’m the first one to defend the value that my industry adds to the economy. And much of the industry’s growth comes from exporting financial services to other countries with less-well-developed financial sectors – which, obviously, should continue. But there are limits to how fast and how much the financial industry can grow without distorting market fundamentals. And I think it’s clear that we passed those limits some time ago. So those of us in the industry need to come to terms with a more rational view of the value we add to the economy… and more humility in understanding the limits of the magical powers of finance to create economic value. The result will be fewer overall institutions... but good growth opportunities for those with broad and deep capabilities.

Ken Lewis' Speech on the Future of the Finance Industry

Charting the Outlook

What Happened, What's Next Back from the brink. The U.S. financial system last week was rocked by the biggest crisis since the 1930s -- and the federal government responded with a multi-pronged intervention that is the most sweeping since the New Deal. Over the course of just three days, Americans were shaken to see venerable investment bank Lehman Brothers Holdings file for bankruptcy protection, Merrill Lynch abruptly sell itself to Bank of America and the U.S. hurriedly launch an $85 billion bailout of American International Group, one of the world's largest insurers. Just one week earlier, the government had bailed out mortgage giants Fannie Mae and Freddie Mac. The turmoil has people worrying about the safety of their brokerage accounts, their insurance policies and even their "safe" stashes of cash -- as the problems at Lehman produced losses for investors in at least one money-market mutual fund. In the midst of the financial-industry carnage, the Dow Jones Industrial Average was down more than 8% for the week at one point midweek. But stocks soared Thursday and Friday as the government announced a massive effort to try to keep the financial system from unraveling. Key components: a plan to help financial institutions unload toxic mortgage assets and new federal insurance for money funds. How did all this happen and where do we go from here? We tackle those questions and others below: Q: Will that intervention turn things around?A: The hope is that it will prevent the crisis from spinning out of control and will thus buoy the economy. A revival of the credit markets and a bottoming of the housing market are keys to a revival. The government's debt plan may reduce the level of fear in the market, enabling the credit markets to operate properly. But such a plan wouldn't do anything about the excess supply of homes and the large number of mortgage borrowers in dire straits. Q: So what's the outlook for the economy and the stock market over the next few months?A: Housing could take many months to bottom, and then rebound, analysts say. Meanwhile, economies around the globe could weaken dramatically, something many investors aren't counting on. Still, investors shouldn't get too gloomy. The stock market's decline of about 20% from last fall's peak is close to the average fall for the market in periods of recession, notes Citigroup strategist Tobias Levkovich. "One can suggest that a bottom is near," he says. Adds Peter Brodie, director of investments at a unit of Bryn Mawr Trust: "History has shown that it is crises such as these that create the extreme pessimism required to set the stage for meaningful market recoveries -- and we feel that the resiliency of our economy will again be exhibited as we enter '09." SEC's Cox `Asleep at the Switch' as Paulson, Bernanke Encroach on His Turf

Brave new world for financial markets Before it gets a chance to embrace another round of irrational exuberance, the U.S. financial system will undergo a complete makeover. Besides the cost to U.S. taxpayers, banks will find that the cost of the moral hazard provided by the past week's massive government bailout will be more and tighter regulations. This will occur regardless of who is elected president or which party controls the Congress. Coming down the pike is nothing less than a modification of our capitalist system. You remember capitalism; it says that you are free to enter -- and free to exit -- any business you may want to. It also says that with reward comes risk. It will first be noticed on Wall Street. Now that the chasm between commercial and investment banking is all but closed, look for much more of the Street to be subject to tighter controls. Commercial banks have a conservative business model and are closely regulated, in order to safeguard people's deposits. Besides the existing regulations, look for a slew of new rules to hit the Street, starting with more transparent accounting. The regulators will want to see how much leverage these firms employ and their sources of funding, to name two items at the top of their list. Off-balance-sheet activities will come under the regulators' magnifying glasses as well. Bank regulators may also seek to limit the use of such exotic instruments as credit default swaps, collateralized debt obligations, structured investment vehicles, mortgage-backed securities and other products dreamed up by the Street's financial engineers. And speaking of mortgage-backed securities, don't be surprised if the government puts limits on how many mortgages a bank can sell. Forcing the banks to keep more of their mortgage loans on their books is a great way to ensure that they lend more carefully, going forward. Don't be surprised if investment banks return to being agents (executing trades), as opposed to owners. This, of course, will require less capital. Most commercial banks will have little trouble funding themselves. But the rewards will come down from the stratosphere.

First Wave Ripples

U.S. Stocks Slump on Speculation Financial Bailout Won't Prevent Recession U.S. stocks tumbled, led by banks, retailers and technology companies, as oil jumped 16 percent and investors speculated the Treasury's plan to buy toxic mortgage assets will fail to prevent a recession. The Standard & Poor's 500 Index lost 3.8 percent, erasing almost half of its rally over the previous two days. Sovereign Bancorp Inc., Marshall & Ilsley Corp. and Washington Mutual Inc. sank more than 21 percent, sending the S&P 500 Banks Index to a record plunge, on concern the government bailout will lower the value of mortgage loans they hold. Apple Inc. and Cisco Systems Inc. dragged down computer stocks on expectations slower growth will reduce sales. The S&P 500 retreated 47.99 points to 1,207.09. The Dow Jones Industrial Average slid 372.75, or 3.3 percent, to 11,015.69. The Nasdaq Composite Index decreased 94.92, or 4.2 percent, to 2,178.98. Six stocks retreated for each that rose on the New York Stock Exchange in floor volume of 1.3 billion shares, 45 percent below last week's average. ``They really haven't changed the economic fundamentals at all,'' said Jeffrey Coons, co-director of research at Manning & Napier Advisors Inc. in Fairport, New York, which manages $18 billion. ``We still have a debt-laden U.S. consumer facing falling employment.'' Treasury bonds and the dollar tumbled on speculation the U.S. government is spending too much to save banks after the collapse of Lehman Brothers Holdings Inc., Fannie Mae, Freddie Mac and American International Group. Heating oil, gold and copper climbed as the dollar's biggest-ever slide against the euro heightened the risk of inflation. All 10 industry groups in the S&P 500 lost at least 1 percent.

• Oil Declines as Dollar Rebounds, Paring Record Gain on End-Month Squeeze

New York Loses More Jobs, London Homes Drop as Finance Hubs Race to Bottom The London-New York tug-of-war for bragging rights as the world's preeminent financial center is now a race to the bottom. Six months after Bear Stearns Cos. was bailed out by JPMorgan Chase & Co. and a week after Lehman Brothers Holdings Inc. filed for bankruptcy, both cities are bleeding. While it will take months to determine which will be hardest hit, New York has so far lost more financial-services jobs and London's luxury housing market has taken the first hit. The market value of London's publicly traded financial firms has dropped by 99.4 billion pounds ($182.3 billion) in the past 12 months, cutting their worth by about 25 percent. Their counterparts in New York have lost $477 billion in market capitalization, or 37 percent. In New York, Vincent Alessi, general manager of Bobby Van's Steakhouse on Broad Street, says the same. ``It's tense,'' he says. ``But my bar business is doing great.''

Shaken Consumers, Wary Companies, Banks Stifle Growth, May Extend Slowdown The U.S. economy might be moving from the acute stage of the credit contagion to a chronic one. Even with hundreds of billions of dollars from Washington to keep them solvent, banks facing the prospect of more loan losses may still curb new lending. Debt-laden consumers look set to rein in spending further as job cuts take their toll. And profit-pinched companies are turning cautious on investing and hiring as the rest of the world slows. The plan the Bush administration and Congress are racing to enact is designed to alleviate the crisis in the markets rather than stimulate a sluggish economy. The credit squeeze is prompting some economists to lower their forecasts for the economy. Mark Zandi, chief economist at Moody's Economy.com in West Chester, Pennsylvania, now expects the economy to contract next quarter and in the first quarter of 2009. That would be the first recession since 2001. The consensus forecast calls for growth of 0.7 percent in the fourth quarter and 1.1 percent in the first quarter, according to a Bloomberg News survey of economists completed Sept. 9. The economists saw a 51 percent chance of a recession in the next 12 months. For all of 2008, growth is forecast to be 1.8 percent, the slowest since 2002. Analysts at Merrill Lynch & Co. said Sept. 18 that U.S. retailers may suffer their slowest holiday sales since 1991 as households grappling with higher food and fuel costs cut back. ``Consumers are starting to get the idea that they've got to de-leverage,'' says David Wyss, chief economist at Standard & Poor's in New York. Companies may also be turning more cautious. Industrial production fell in August by the most in almost three years as slower consumer spending prompted automakers to cut back. Almost half of large companies across the globe have curbed technology spending for the next year, according to Cambridge, Massachusetts-based Forrester Research Inc. Firms are feeling the pinch as earnings slow along with the economy. Third-quarter profits of the Standard & Poor's 500 companies may sink the most in seven years, according to analyst estimates compiled by Bloomberg News. Foreign sales -- until now a major source of strength for U.S. companies -- are also hurt by the fallout from the credit crisis as the U.S. slowdown seeps abroad. Japan's government said last week that its economy, the world's second-largest, is weakening. Dell Inc., the world's second-biggest personal-computer maker, said Aug. 28 that ``continued conservatism'' from some U.S. customers was spreading to Western Europe and Asia. Companies are also getting hit by dearer credit. The average yield on the most actively traded investment-grade bonds fell Sept. 19 on Washington's moves to fight the crisis, yet still stood nearly 0.9 percentage point higher than a week earlier.

Commodities Bottom as Speculators Disappear, Paulson's Plan Spurs Demand The worst may be over for commodities after the steepest rout since at least 1956 drove out speculators and the U.S. government unveiled a plan to end the worst credit-market seizure since the Great Depression. The Standard & Poor's GSCI Index of commodities had the biggest three-day gain in 18 years, surging 8.4 percent through Sept. 19, the day U.S. Treasury Secretary Henry Paulson said the government will spend ``hundreds of billions'' to cleanse banks of mortgage-related assets. Crude oil rose 6.8 percent that day, while wheat and copper gained 3.6 percent. ``What the government just did is the end game, and it's going to mean a good rally for commodities,'' said Michael Pento, a senior market strategist who helps oversee $1.5 billion at Delta Global Advisors in Holmdel, New Jersey. ``Six weeks ago, I thought it was prudent to exit most commodities. Now you want to own these things. I'm jumping in twice with both feet.'' Commodities, which had the best first half in 35 years, tumbled so far this quarter as the combination of slowing economic growth and the strengthening U.S. dollar popped the speculative bubble that drove prices to record highs. The Reuters/Jefferies CRB Index of 19 raw materials is down 22 percent since June 30, heading for the biggest quarterly loss since at least 1956, data compiled by Bloomberg show.

Wall Street’s woes are hurting emerging markets  SO MUCH for decoupling. In the wake of Lehman Brothers’ failure, emerging markets have suffered one of their biggest sell-offs in years. On September 18th Russia’s main bourses suspended trading in shares and bonds for a third day in a row after the largest one-day stockmarket fall for a decade; the central bank poured billions into big banks and the money market in a forlorn bid to calm fears. JPMorgan’s emerging-markets bond index fell by more than 5% in the week to September 16th, giving up in a few days all the gains it had made this year. Prices of Argentina’s credit-default swaps, a gauge of credit risk, rose to their highest-ever level. Unexpectedly, the People’s Bank of China cut its benchmark lending rate by 27 basis points on September 15th, to 7.2%, the first cut for six years. These actions reflected a variety of concerns, such as a darkening economic mood in China and political worries in Russia. But they all have something in common: investors may be changing their minds about emerging markets. For the past few years, China, Brazil and others, with their high growth rates and large current-account surpluses, began to seem like desirable alternatives to developed markets. For part of last year, the MSCI emerging-markets index was even trading at a higher multiple of earnings than the index of rich-world shares. That is changing as investors lose their appetite for risk. Merrill Lynch’s most recent survey of fund managers found that they are now holding more bonds than normal for the first time in a decade (indicating a flight to safety). They also have smaller positions in emerging-market equities than at any time since 2001. In the past three months, says Michael Hartnett of Merrill Lynch, emerging-market funds have seen an outflow of $26 billion, compared with an inflow of $100 billion in the previous five years. Falling oil and commodity prices are partly to blame. When these were rising, money poured into Brazil and Russia, which became targets of the “carry trade” (investors borrow in low-yielding currencies and buy high-yielding ones). Now oil prices are falling (dipping almost to $90 a barrel this week), they are undermining the carry trade and forcing Russia to prop up the rouble. Indebted investors are also being forced by their banks to sell as falling prices reduce the value of their collateral.

Fannie, Freddie Subprime Buying Spree May Add $100 Billion to Bailout Tab Freddie Mac Chief Executive Officer Richard Syron stood before investors at New York's Palace Hotel in May last year lauding his company's ``cautious'' avoidance of the subprime-mortgage crisis. What Syron, who was ousted last week, didn't say was that Freddie Mac had been gorging on subprime and Alt-A debt. While it and the larger Fannie Mae bought the safest classes of the mortgage-loan pools, Freddie's purchases totaled $158 billion, or 13 percent, of all the securities created in 2006 and 2007, according to data from its regulator and Inside MBS & ABS, a Bethesda, Maryland-based newsletter used by Federal Reserve researchers. Fannie, which was also seized by the U.S. on Sept. 7, bought an additional 5 percent. The purchases by Freddie and Fannie helped fuel the boom in lending that led to frozen credit markets, more than $514 billion in bank losses and the collapse of two of the country's biggest securities firms. The subprime overhang may determine whether the $200 billion U.S. Treasury Secretary Henry Paulson earmarked for the companies will all be used to rev up mortgage lending. He may have to spend about $300 billion…

AIG Holders Plan Meeting to Trump U.S. Rescue; Willumstad Spurns Severance American International Group Inc. shareholders, opposed to an $85 billion Federal Reserve takeover that dilutes their stakes, plan to meet today in New York City to discuss alternatives. Maurice ``Hank'' Greenberg, the former chief executive officer of the New York-based insurer and one of the biggest stakeholders, will probably be represented at the afternoon meeting, said his lawyer, David Boies, in an interview late yesterday. Attorneys for other investors contacted Boies in the past week about the gathering, he said, without naming them or saying how many will attend. Greenberg, who saw the value of the AIG stake he controls plunge by more than $5 billion this month, has said the takeover might have been avoided if AIG got a bridge loan, tapped private investors and sold assets. Greenberg sent a letter to Willumstad before the latter resigned offering to help and complaining that his earlier offers had been rebuffed.

Goldman Sachs, Morgan Stanley Become Banks, Ending an Era for Wall Street The Wall Street that shaped the financial world for two decades ended last night, when Goldman Sachs Group Inc. and Morgan Stanley concluded there is no future in remaining investment banks now that investors have determined the model is broken. The Federal Reserve's approval of their bid to become banks ends the ascendancy of the securities firms, 75 years after Congress separated them from deposit-taking lenders, and caps weeks of chaos that sent Lehman Brothers Holdings Inc. into bankruptcy and led to the rushed sale of Merrill Lynch & Co. to Bank of America Corp. Goldman, whose alumni include Henry Paulson, the Treasury Secretary presiding over a $700 billion bank bailout, and Morgan Stanley, a product of the 1933 Glass-Steagall Act that cleaved investment and commercial banks, insisted they didn't need to change course, even as their shares plunged and their borrowing costs soared last week. By then, it was too late. As financial markets gyrated --the Dow Jones Industrial Average whipsawed 1,000 points in the week's last two days -- and clients defected, executives at the two firms concluded they had no choice. The Federal Reserve Board met at 9 p.m. yesterday and considered applications delivered that day, said Michelle Smith, a spokeswoman for the central bank. The decision was unanimous, she said. The announcement paves the way for the two New York-based firms, both of which will now be regulated by the Fed, to build their deposit base, potentially through acquisitions. That will allow them to rely more heavily on deposits from retail customers instead of using borrowed money -- the leverage that led to the undoing of Bear Stearns and Lehman.

Ford, Dow execs to announce national summit in '09 Amid the turmoil on Wall Street, leaders from two global companies hard hit by economic and industrial upheavals are expected to unveil plans Monday for a national convention being held next year to discuss the future of manufacturing, technology, energy and the environment. Ford Motor Co. Executive Chairman Bill Ford and Dow Chemical Co. Chairman and Chief Executive Andrew Liveris were scheduled to announce The National Summit after the Detroit Economic Club meeting Monday. The nonpartisan, nonprofit group is convening the summit, which is set for June 15-17 at Ford Field, the home of the Detroit Lions.Beth Chappell, the economic club's CEO, said the idea grew out of listening to leaders who have addressed the venerable speakers' forum during the past couple years. "So many speakers from the platform have this call to action ... and the themes -- technology, energy, environment and manufacturing -- kept coming up over and over again," she said. "This is not about Detroit, this is not about Michigan and this is not about automotive. It's cross-country and cross-industry." Ford and Liveris will serve as the summit's co-chairmen. Ford is the economic club's outgoing chairman, and General Motors Corp. Chairman and CEO Rick Wagoner succeeds him on Monday. Organizers hope the first-of-its kind U.S. gathering, which they say has received sponsorship pledges of more than $2 million from more than 50 organizations, will draw as many as 5,000 leaders and others from business, govern