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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.