We insisted that the bank would be closed in two separate articles here and here, both of them in September 2008. Needless to say, there are many more such banks in this great crisis of the industry, but we have neither the interest nor the time to screen all of them here.

The government and the Federal Reserve are trying to make the American people spend like they were doing in the past, but unlike the past, there’s no credit, no secure jobs, no appreciating asset markets to back their exhortations. In response, Americans are saving like they have not done for quite a while. The dream is that ghe government can make people spend by simply giving them money; a foolish proposition disproven by the decades-long slump of the Japanese economy, and the various stagflationary periods of different nations.

There are two types of economic boom. One is created by expanding money supply and government action. The other is caused by fundamental factors such as technological innovation, or the global spread of productivity-enhancing techniques and tools. The former only creates illusory periods of speculative inflation, and its consequences are destructive, not creative. The latter can also fuel speculative activity, but it’s impact is usually long-term, and positive for the society at large. Our pessimism for the next 5-10 years is due to the fact that there will be a lot more monetary expansion than productivity-driven growth during the period. And the consequences of that will be turmoil, conflict, poverty, and despair.

As the sole remedy, we would be much more optimistic if China could be made to unleash its potential in a healthy manner. But given the attitude of the government, and also the traditions of the China people, we have grave doubts about the credibility of the “China-saves-the-world” scenario.

Yes, the stock market is rallying right now. Commodity markets are also rallying, and even shipping rates have been rising for a while. But we ask the reader to keep our word in mind, and to come back here a while later to check if we have been right or not: these episodes in all these markets are but bouts of volatility, created by the disappearance of the many liquidity-generators. The up-up-up markets of the past were an aberrance, and now we’re back to a normal situation where volatility complicates trading decisions, and economic analyis.That the economy will be in a slump for many years to come is a certainty. How much money the governments will print in their futile endeavour to resurrect a dead banking system in a deflationary environment is uncertain. Consequently, it is not possible to know if the price of a barrel of oil will be 1 USD, 10 USD, 100 USD, or 1000 USD, but until real liquidation and consolidation reshape the global financial system, volatility will remain high, real GDP growth will be low, and ROI in general miserable. We’d willing to bet one million dollars on this conjecture.

Technical analysis (and its more sophisticated cousin, quantitative analysis), both are predicated on the notion that markets discount all available information to market participants. Markets indeed discount most, if not all of the information available, but the problem arises out of the weightings attached to each piece of data can alter the outcome of these studies massively. The market discounts rumours, unrevised data, high and low frequency information with equal avidity, and weighs them depending on the mood and attitude of the day. Thus, the picture painted by the markets is similar to a cubist painting, rather than a clear descriptive one depicting the situation as it is. It is clear that the discounting mechanism of the markets is a deeply flawed one, but that dfoesn’t mean that there’s a better method, medium for pricing assets.

Technical analysis assumes that historical prices offer guidance on future price movements. Instead, most scientists believe that stock prices possess the Markov Property. In other words, all one needs to know to guess the future price is the price of today, with everything before that completely irrelevant to future price action. Indeed, experience tells us the same too: how many times has the trader seen breakouts occur without absolutely no hint on the previous price action?

Technical and quantitative analysis both discount fat tails of the probability distribution as improbable. On the other hand, experience clearly shows that spikes and collapses are the most common feature of the markets, with periods of calm being the exception. These periods usually emerge as a result of non-market influences,  such as government action, or central bank expansion of the money supply. 

The predictive power of technical analysis is as limited as that of astrology. It’s effectiveness is as limited as that of gambling strategies in the long term. Confidence and success are the greatest rewards of trading. But confidence and success are the enemies of technical analyst, since he believes that success and failure come in strings.

There appears to be a belief now that the dollar is going to collapse rather soon, driving the US Treasury bond interest rates to higher levels. There’s also a lot of speculation that there’s a bubble in Treasuries.

It’s true that there’s a bubble in Treasuries. Negative interest rates, or zero interest rates are simply too low to be justified by the fundamentals of the US economy, and it is true that the dollar must eventually lose much of its value in order to allow the US economy to find a balance.

On the other hand, bubbles can run for longer periods than people expect them to. Irrational valuations can deteriorate even further if the conditions that sustain the bubble persist.

In that sense, we must ask ourselves: What is there in the world, today, other than Treasuries that can suck out the uncommitted dollars in the system, and allow the global economy to breathe?  That the stock markets are incapable of doing so is obvious, as there’s too much uncertainty, at this stage, to allow this. Commodities are unlikely to appreciate much, unless emerging markets return to their growth path, but they can’t do so without US demand coming pack, which will not happen for many years. Gold is a speculative instrument tied to commodities, and it’s hard to hold it in very large quantities. The money flows that sustained its rise over the past few years, such as Asian exporter money, and Middle-Eastern, or Russian petrodollars, are blocked. The Euro cannot gain much value, because the ECB, despite its hawkishness, is likely to be forced to follow the rest of the world as financial conditions deteriorate: Eurozone banks are no less leveraged than their US counterparts.  

On the other hand, dollar demand is no less urgent than before. While libor values may have eased somewhat, the fundamental factors that force financial actors to hoard dollars are still powerful: Deleveraging is continuing in the West, Asian firms are facing bankruptcy, and many firms are facing great difficulty in the finding the dollars to meet their obligations. Of course, as we see at the moment, there’re periods of relaxation, but the underlying theme is as alive as ever, and it is premature, therefore, to speak of the demise of the dollar until the real impact of the global stimulus is seen. At the moment, it’s still unclear if it will be of much help, because of the global nature and scale of this crisis.

The rally in Treasuries that pushed yields on bills below zero percent this week is adding to concerns that the $5.3 trillion market for government debt is a bubble waiting to burst.

Investors seeking safety from losses in equity and credit markets charged the Treasury zero percent interest when the government sold $30 billion of four-week bills on Dec. 9, the same day three-month bill rates turned negative for the first time since the U.S. began selling the debt in 1929. Yields on two-, 10- and 30-year securities touched record lows this month.

“Treasuries have some bubble characteristics, certainly the Treasury bill does,” said Bill Gross, co-chief investment officer of Newport Beach, California-based Pacific Investment Management Co., which oversees the world’s largest bond fund. “A Treasury bill at zero percent is overvalued. Who could argue with that in terms of the return relative to the risk?” he said in a Bloomberg Television interview yesterday.

The 30-year bond returned 23.6 percent since September, including reinvested interest, more than it earned in any one year since gaining 34.1 percent in 1995, according to Merrill Lynch & Co. index data. Treasuries of all maturities gained an average of 11.9 percent this year, compared with a 41 percent drop in the Standard & Poor’s 500 Index and a loss of 15.3 percent in Merrill Lynch’s broadest corporate bond index.

Rising Supply

Rising supply of government debt to pay for the bailout of the economy and financial system has done little to damp demand. Treasury Assistant Secretary Karthik Ramanathan said in a speech yesterday in New York that the U.S. may introduce new financing methods to meet borrowing needs of $1.5 trillion to $2 trillion in the financial year that ends in September.

While supply has increased, rates on three-month bills fell 2.89 percentage points in the last year to 0.01 percent today, after trading as low as negative 0.05 percent on Dec. 9. The rate on four-week bills plummeted from a peak of 5.175 percent on Jan. 29, 2007. The three-month bill yield was unchanged today.

An investor who bought $1 million in three-month bills at the closing rate of negative 0.01 percent on Dec. 9 would realize a loss of $25.56 when the securities mature. Bills are sold at a discount and appreciate to par at maturity.

Even at the low yields, the government received bids for four times the amount of four-week bills it auctioned this week, according to the Treasury.

‘Insatiable Demand’

“There is basically insatiable demand for Treasury bills,” Ira Jersey, a New York-based interest-rate strategist at Credit Suisse Group AG, said in a Bloomberg Television interview. “There is a number of reasons for this, not only angst over deflation and what’s going on with risky assets, but there is also just a lot of cash that does not want to take any credit risk.”

Hunger for Treasuries increased as financial companies reported $984 billion of losses and writedowns related to the collapse of subprime mortgages since the start of 2007. The losses froze credit markets and helped send the U.S., Europe and Japan into the first simultaneous recessions since World War II.

Gross said he regrets not buying Treasuries in the past year. “If we went back 12 months and we had known then what we know now, it would have been all invested in Treasuries,” he said in the interview.

David Rosenberg, the chief North American economist at New York-based Merrill Lynch, said last week that demand for Treasuries had reached the “bubble” phase like in technology stocks in 2000 and real estate six years later.

Waive Fees

Record-low yields on government debt have led money-market funds to waive fees to keep returns positive. If the Federal Reserve cuts its 1 percent target rate for overnight loans between banks, as is expected next week by all but two of 56 economists surveyed by Bloomberg, some Treasury fund returns may turn negative, said Peter Crane, president of Crane Data LLC, a research firm in Westborough, Massachusetts.

Sentiment among investors in Treasuries turned negative for the first time in four months, according to a JPMorgan Securities Inc. survey of clients. The firm’s weekly index fell to minus 6 on Dec. 8, from this year’s high of 27 a month ago. The figure is the difference between the percentage of investors betting prices will rise and those expecting a decline.

Deflation Speculation

Speculation that the recession will result in deflation, or a prolonged slide in prices, is also driving demand for Treasuries. Consumer prices fell 1 percent in October, the most since records began in 1947, and may drop 1.2 percent in November, according to a Bloomberg survey of economists.

Deflation may worsen the economic downturn by making debts harder to pay and countering the impact of Fed rate cuts. Deflation also makes bonds more valuable, even with yields at record lows.

Treasuries may actually be “fairly valued,” Tony Crescenzi, chief bond strategist at Miller Tabak & Co. in New York, said in a report yesterday. Even so, yields will likely rise in mid-January as investors’ focus turns to prospects for an economic recovery, he wrote.

The U.S. pledged $8.5 trillion, more than half of the country’s gross domestic product, to spur lending and limit the damage of the recession.

Economists forecast higher bond yields as those efforts take effect over the next year. The yield on the 10-year note will rise to 3.66 percent by the end of 2009 from 2.67 percent today, according to 50 estimates in a Bloomberg survey. That would result in a loss of 3.88 percent as bond prices decline.

“At some point we are going to get some signal, some indication that this massive policy response is getting some traction,” said Mitchell Stapley, who oversees $22 billion as chief fixed-income officer for Grand Rapids, Michigan-based Fifth Third Asset Management. “The flight out of Treasuries is something that will be breathtaking.”

The median of Bloomberg’s analyst estimates is that US consumption will shrink by about 1 percent during 2009. To put this in context, this is the first time such a contraction is happening since Pearl Harbour. In other words, no one knows what kind of impact this will have on the global economy, let alone the domestic one.

By now it’s clear to most people that next year will be a nightmare for the US consumer. The Obama administration is planning total spending to the size of 3-4 billion over two years, but that amount is likely to be dwarfed by what the US economy will eventually need to stay afloat. And I doubt that the government will be willing or able to create anything else in this scale over the next few years.

The Federal government’s chosen path is indeed scary, but the danger that state governments and local authorities face is even greater. Unlike the Federal Government, which is still seen as a kind of safe heaven by fearful investors, the local governments are regarded as risky, unstable, partisan entities that can offer little guarantee for asset value during an economic crisis. They are unable to tap the international markets, and in most cases they will not be able to raise taxes to reorder the balance sheets. This will probably add anyother item to the list of federal government bailouts.

But the real danger is that the negative loop will be perpetuated by the continued deterioration of the Us economy. At this stage, all should be done to support the US consumer, but I’m afraid that the exponential deterioration in the status of the US consumer is only following a bubble, and it may therefore be irreversible in the medium term, and unstoppable.

An argument Bloomberg makes today is that many companies hold so much cash or cash equivalents that buying stocks now allows a speculator free and immedite profit. Prudent invdividuals will not be overtaken by that suggestion by countering that there’s a reason for the existence of these firms’ cash hoards: they have no confidence in the future, they have no investment plans, and they are very worried about their own survivability. The fact is that this mentality can indeed create magnificent bargains under the right circumstances, but most of the time it will create large holes in the investors pockets.

What can be said with some confidence, in my opinion, is that we’re very far from being in a healthy investing environment. Valuations are suffering revisions quite often, and the life span of any firm is much shorter than it was only 13-15 months ago. It’s certain that the economy will suffer muchmwore before it will be able to grow again in  meaningful manner, and we also know that risks are still extremely high, with rewards only modest, when averaged for a portfolio. More importantly, there’s no need to hurry at the moment. Liquidity is gone for a very long time, and the market simply has no potential to create any bubbles.  Patient people will prosper.

Just to sober us all, here’s a report from Bloomberg today:

Most U.S. mortgages modified in a voluntary effort to keep struggling borrowers in their homes and stem foreclosures fell back into delinquency within six months, the chief regulator of national banks said.

Almost 53 percent of borrowers whose loans were modified in the first quarter were more than 30 days overdue by the third quarter, John Dugan, head of the Treasury Department’s Office of the Comptroller of the Currency, said today at a housing conference in Washington.

“The results, I confess, were somewhat surprising, and I say that not in a good way,” Dugan said, citing a third-quarter survey his agency plans to release next week.

Lenders and loan-servicing companies have been modifying mortgages by lowering interest rates or creating repayment plans through the voluntary Hope Now Alliance. The group, which includes Citigroup Inc., JPMorgan Chase & Co. and Bank of America Corp., said last month it helped 225,000 borrowers keep their homes in October.

Foreclosures rose to a record in the third quarter as one in 10 U.S. homeowners fell behind on payments or were in foreclosure, the Mortgage Bankers Association said last week.

“Our third-quarter report will show many of the same disturbing trends as other recent mortgage reports,” Dugan said. “Credit quality continued to decline across the board, with delinquencies increasing for subprime, Alt-A and prime mortgages.”

The OCC’s survey represents institutions that service more than 60 percent of all first mortgages, or 35 million loans worth $6 trillion, Dugan said.

‘More Questions’

The data “raises more questions than answers because it fails to define, in any meaningful way, the modifications that have re-defaulted,” Federal Deposit Insurance Corp. Chairman Sheila Bair said in a statement.

The lack of detail makes it tough to distinguish “re- default rates of sustainable modifications versus cosmetic modifications that by their nature are more likely to re- default,” said Bair, who has proposed using $24 billion from the U.S. Treasury’s $700 billion financial-rescue package to modify 1.5 million mortgages through the end of 2009.

Dugan’s figures reflect a failed focus on interest rates in loan modifications, House Financial Services Committee Chairman Barney Frank said today in a Bloomberg Television interview. If companies were to cut the amount owed on mortgages, borrowers would be less likely to default again, Frank said.

“The people who made the bad loans or bought the bad loans from others need to realize” that they would be better off with principal reductions than with foreclosure, the Massachusetts Democrat said.

Foreclosure ‘Timeout’

New Jersey Governor Jon Corzine, speaking at the conference earlier today, urged a three- to six-month “timeout” on foreclosures, saying keeping people in their homes is necessary to correct a “deeply troubled” market.

“Housing markets and mortgage-finance markets are the fuel for this problem,” said Corzine, a Democrat and former chairman of Goldman Sachs Group Inc. “We need a systematic protocol and process.”

John Reich, director of the Office of Thrift Supervision, questioned whether the federal government should be more involved in foreclosure prevention.

“I do have a concern of allocating government resources with such a high rate of re-default,” said Reich, whose agency sponsored today’s National Housing conference

THE EMPLOYMENT SITUATION:  NOVEMBER 2008

   Nonfarm payroll employment fell sharply (-533,000) in November, and
the unemployment rate rose from 6.5 to 6.7 percent, the Bureau of Labor
Statistics of the U.S. Department of Labor reported today.  November’s
drop in payroll employment followed declines of 403,000 in September and
320,000 in October, as revised.  Job losses were large and widespread
across the major industry sectors in November.

Unemployment (Household Survey Data)

   Both the number of unemployed persons (10.3 million) and the unemploy-
ment rate (6.7 percent) continued to increase in November.  Since the start
of the recession in December 2007, as recently announced by the National
Bureau of Economic Research, the number of unemployed persons increased by
2.7 million, and the unemployment rate rose by 1.7 percentage points.  
   The unemployment rates for adult men (6.5 percent) and adult women (5.5
percent) continued to trend up in November.  The unemployment rates for
teenagers (20.4 percent), whites (6.1 percent), blacks (11.2 percent), and
Hispanics (8.6 percent) showed little change over the month.  The jobless
rate for Asians was 4.8 percent in November, not seasonally adjusted. 
   Among the unemployed, the number of persons who lost their job and did not
expect to be recalled to work increased by 298,000 to 4.7 million in November. 
Over the past 12 months, the size of this group has increased by 2.0 million.  
   
   The number of long-term unemployed (those jobless for 27 weeks or more) was
little changed at 2.2 million in November, but was up by 822,000 over the past
12 months. 

Total Employment and the Labor Force (Household Survey Data)

   In November, the labor force participation rate declined by 0.3 percentage
point to 65.8 percent.  Total employment continued to decline, and the employ-
ment-population ratio fell to 61.4 percent.  

   
   Over the month, the number of persons who worked part time for economic
reasons (sometimes referred to as involuntary part-time workers) continued
to increase, reaching 7.3 million.  The number of such workers rose by 2.8
million over the past 12 months.  This category includes persons who would
like to work full time but were working part time because their hours had
been cut back or because they were unable to find full-time jobs. 

Persons Not in the Labor Force (Household Survey Data)

   About 1.9 million persons (not seasonally adjusted) were marginally
attached to the labor force in November, 584,000 more than 12 months
earlier.  These individuals wanted and were available for work and had
looked for a job sometime in the prior 12 months.  They were not counted
as unemployed because they had not searched for work in the 4 weeks pre-
ceding the survey.  Among the marginally attached, there were 608,000 dis-
couraged workers in November, up by 259,000 from a year earlier.  Discour-
aged workers are persons not currently looking for work specifically be-
cause they believe no jobs are available for them.  The other 1.3 million
persons marginally attached to the labor force in November had not searched
for work in the 4 weeks preceding the survey for reasons such as school
attendance or family responsibilities. 

Industry Payroll Employment (Establishment Survey Data)
  
   Total nonfarm payroll employment fell by 533,000 in November, bringing
losses to 1. 9 million since the start of the recession in December 2007.
Two-thirds of these losses occurred in the last 3 months.  In November,
employment declined in nearly all major industries, although health care
continued to add jobs. 

   In November, employment continued to decline in manufacturing (-85,000),
with widespread job losses occurring among the component industries.  Manufacturing employment has declined by 604,000 since December.  Within durable goods manufacturing, job losses occurred in November in fabricated
metal products (-15,000), machinery (-11,000), wood products (-9,000),
furniture and related products (-7,000), primary metals (-7,000), and com-
puter and electronic products (-7,000).  Employment in transportation
equipment edged up, as a return of 27,000 aerospace workers from strike
more than offset a job loss in motor vehicle and parts (-13,000).  In the
nondurable goods component, job losses occurred in plastics and rubber
products (-12,000), printing and related support activities (-5,000), and
textile mills (-5,000).
  
   Employment in construction fell by 82,000 in November, with losses oc-
curring throughout the industry.  Since peaking in September 2006, con-
struction employment has decreased by 780,000.  Specialty trade contrac-
tors lost 50,000 jobs in November, with both residential and nonresiden-
tial components contributing to the decline.
  
   Within professional and business services, the employment services
industry lost 101,000 jobs over the month, bringing total job losses
since December to 495,000.  In November, employment fell by 10,000 in
architectural and engineering services.
  
   Employment in retail trade fell by 91,000 in November.  Job losses
continued in automobile dealerships (-24,000).  Employment in the indus-
try has fallen by 115,000 since December, with much of the decrease oc-
curring over the last 2 months.  In several other retail industries, sea-
sonal hiring for the holidays fell short of normal in November.  After
seasonal adjustment, employment declined in clothing and accessories
stores (-18,000); sporting goods, hobby, book, and music stores (-11,000);
and furniture and home furnishing stores (-10,000).  Wholesale trade em-
ployment was down by 25,000 over the month, with most of the decrease
among durable goods wholesalers.
  
   Employment in leisure and hospitality declined by 76,000 in November,
with most of the decline occurring in accommodation and food services
(-54,000).  Since peaking in April 2008, accommodation and food services
has lost 150,000 jobs.

                                 – 4 -

   In November, employment in financial activities continued to decline
(-32,000).  Within the industry, job losses occurred in credit intermedi-
ation and related activities (-16,000) and in rental and leasing services
(-9,000).  Job losses in financial activities have accelerated over the
last 3 months, bringing the total decline since December to 142,000.
  
   Elsewhere in the service-providing sector, employment in transporta-
tion and warehousing declined by 32,000 in November, with most of the
losses in truck transportation (-12,000) and couriers and messengers
(-8,000).  The information industry lost 19,000 jobs over the month.
  
   Health care employment grew by 34,000 in November.  Over the past 12
months, health care has added 369,000 jobs.
  
   The change in total nonfarm employment for September was revised from
-284,000 to -403,000, and the change for October was revised from -240,000
to -320,000.  In both months, there were large revisions in most of the
major industry sectors.  These revisions resulted primarily because of the
normal monthly recalculation of seasonal factors rather than the incorpora-
tion of additional sample reports.
  
Weekly Hours (Establishment Survey Data)
  
   In November, the average workweek for production and nonsupervisory
workers on private nonfarm payrolls fell by 0.1 hour to 33.5 hours, sea-
sonally adjusted–the lowest in the history of the series, which began
in 1964.  Both the manufacturing workweek and factory overtime fell by
0.2 hour over the month, to 40.3 and 3.3 hours, respectively.  

   
   The index of aggregate weekly hours of production and nonsupervisory
workers on nonfarm payrolls fell by 0.9 percent in November.  The manu-
facturing index declined by 1.4 percent.
  
Hourly and Weekly Earnings (Establishment Survey Data)
  
   In November, average hourly earnings of production and nonsupervisory
workers on private nonfarm payrolls rose by 7 cents, or 0.4 percent.  This
followed gains of 6 cents in October and 3 cents in September.  Over the
past 12 months, average hourly earnings increased by 3.7 percent, and
average weekly earnings rose by 2.8 percent.

 New York approved Intercontinental Exchange Inc.’s application to form a state-regulated trust to guarantee trades in the $31 trillion credit-default swap market, boosting the company’s bid to beat rival CME Group Inc. in running a clearinghouse for the trades.

The state Banking Department approved the application after a meeting today, Chairman Richard Neiman said in a statement. The approval paves the way for Intercontinental, the second-largest U.S. futures exchange also known as ICE, to raise capital to fund the clearinghouse, according to the statement. ICE U.S. Trust LLC, as the subsidiary is known, still needs regulatory approval from the Federal Reserve.

“We have worked closely with our counterparts at the Federal Reserve Bank of New York in overseeing this industry initiative,” Neiman said in the statement. A clearinghouse for CDS contracts will “reduce systemic risk” within the banking industry, he said.

The Fed has been pushing for a clearinghouse after Lehman Brothers Inc., one of the largest dealers in the CDS market, went bankrupt in September, threatening the stability of its trading partners. A clearinghouse, capitalized by its members, all but eliminates counterparty default risk by becoming the buyer for every seller and the seller for every buyer.

CME Group

Chicago-based CME Group, the world’s largest futures market, is seeking to use its existing clearinghouse to back CDS trades. It still requires regulatory approval from the Commodity Futures Trading Commission, as well as license agreements from Markit Group Ltd., which owns the most used CDS indexes and pricing systems.

A clearinghouse owner could earn between $100 million and $400 million a year in revenue from clearing CDS trades, according to estimates by Wachovia Capital Markets and Keefe Bruyette & Woods Inc.

NYSE Euronext and Eurex AG are also seeking to clear CDS trades. ICE earlier this year said it will buy the Clearing Corp., the clearinghouse owned by banks including Goldman Sachs Group Inc. and JPMorgan Chase & Co., to secure commitments from nine dealers in the CDS market to participate in its plan.

European Central Bank President Jean- Claude Trichet signaled he’s reluctant to cut interest rates so low that policy makers are “trapped” with few options to respond to a deepening recession.

“We have to beware of being trapped at nominal levels that would be much too low,” Trichet said at a press conference in Brussels today. The ECB earlier lowered its benchmark by three quarters of a percentage point to 2.5 percent, the biggest cut in its ten-year history.

Some of the ECB’s 21 policy makers have advocated a steady- hand approach to tackling the recession.

Council Split?

Luxembourg’s Yves Mersch told Luxembourg’s Tageblatt newspaper today that the bank is “entering calmer waters” with future rate changes more likely to be in the order of 25 basis points. Executive Board member Lorenzo Bini Smaghi said on Oct. 31 that “the present crisis is partially due to interest rates that remained at low levels for too long.”

“The council is split between those wanting to cut rates by only 50 basis points and those who wanted a more aggressive 100 basis-point cut,” said Juergen Michels, chief European economist at Citigroup Inc. in London. “So 75 basis points was a compromise and policy makers can keep their powder dry until February.”

Trichet said today’s decision was reached by “consensus,” and declined to divulge if there were calls for smaller or bigger cuts. ECB has reduced rates by 1.75 percentage points since October after the financial-market crisis intensified.

ECB forecasts published today show the euro-region economy will shrink about 0.5 percent next year, which would be its first full-year contraction since 1993. Inflation will average about 1.4 percent in 2009 and 1.8 percent in 2010, the new projections show, meeting the ECB’s price-stability goal of keeping the rate just below 2 percent.

“European policy makers, as we’ve seen in past global crises, continue to underestimate both the degree of the problem and their own part in its creation and solution,” Jim O’Neill, chief economist at Goldman Sachs Group Inc., said in a Bloomberg Television interview. “I prayed that the ECB would do 100. At least they didn’t do 50.”

Manufacturing and service industries contracted at the fastest pace on record in November and economic confidence plunged to a 15-year low. With oil prices collapsing, the inflation rate fell the most in almost 20 years last month, to 2.1 percent from 3.2 percent in October.

Recovery

While “global and euro-area demand are likely to be dampened for a protracted period of time,” lower commodity prices may support a gradual recovery from the second half of next year, Trichet said.

As well as cutting rates, the bank has flooded money markets with cash and widened its collateral rules to unfreeze credit markets. Trichet said today it may be possible for the ECB to purchase assets and securities outright, while declining to say if it would.

With those who don’t receive unemployment payouts included, the total joblessnumber is close to 6 million now:

The number of people on unemployment benefit rolls rose to 4.09 million in the week ended Nov. 22, the most since December 1982. A separate report showed orders at U.S. factories tumbled in October by the most in eight years as demand collapsed at home and abroad.

AT&T Inc., DuPont Co. and Viacom Inc. today announced plans to eliminate more than 15,000 jobs as consumer spending falters and the recession deepens.

Figures from the Commerce Department showed factory orders dropped 5.1 percent, the biggest decline since July 2000. Excluding transportation gear, bookings decreased for a third consecutive month.

Fed Perspective

Dennis Lockhart, president of the Fed Bank of Atlanta, told a conference in New Orleans the economy was “in the midst of a long and very painful adjustment process.” Chicago Fed President Charles Evans, speaking in Dearborn, Michigan, said the U.S. faced a “very substantial downturn.”

Trending Up

The four-week moving average of initial claims, a less volatile measure, climbed to 524,500, the highest since 1982, from 518,250, today’s report showed.

The unemployment rate among people eligible for benefits, which tends to track the jobless rate, increased to 3.1 percent, the highest since 1992, from 3 percent. These data are reported with a one-week lag.

Forty-nine states and territories reported an increase in new claims, while 4 reported a decrease. The biggest increases were reported by California, Ohio and Michigan.

Longer Slump

What started as a housing slump has spread to manufacturing and services. The Institute for Supply Management’s factory index dropped last month to the lowest level since 1982, and its services gauge, which accounts for almost 90 percent of the economy, fell to the lowest level since records began in 1997.

Financial firms are among those making the biggest job cuts. JPMorgan Chase & Co., the largest U.S. bank by assets, said this week it will cut 9,200 jobs nationwide at Washington Mutual Inc. as it acquires the Seattle-based lender.

“We have seen a fairly significant dropoff in demand, starting in October,” Delta Airlines Inc. President Ed Bastian said on a Webcast of a Credit Suisse Group AG airline conference in New York this week. “The revenue environment is as cloudy as it’s ever been. We’ve never seen the level of demand destruction that some are forecasting for our business.”

Delta, the world’s largest carrier, said it will cut seating capacity by as much as 8 percent in 2009 and eliminate an unspecified number of jobs.

The SIV story is not entirely over yet, and Bloomberg today reports that the creditors of the failed SIV “Sigma” may not paid “in full or in part”. In other words, they may get zero cent(s) on the dollar…

Sigma, which held securities with a face value of $2 billion, according to Moody’s Investors Service, raised a total $306 million from a Dec. 2 auction as part of its liquidation, the SIV’s receivers Ernst & Young LLP said in a statement today. Sigma has $6.2 billion of secured debt outstanding, the receivers said.

“Short-term liabilities which fell due for payment after Oct. 23, 2008 will not be met either in full or in part out of these assets,” the statement said. The liquidation follows a judgment by the U.K. Court of Appeal and the receivers said their estimate may change should the case go before the House of Lords.

Sigma, created by London-based Gordian Knot Ltd., survived longer than other SIVs that defaulted after money markets shut down by borrowing from banks through collateralized loans known as repurchase agreements. Sigma stopped paying creditors at the end of September after failing margin calls, according to court documents.

Sigma pledged $25 billion of its assets to banks to cover $17.4 billion of borrowings, according to Moody’s, leaving just $2 billion of unencumbered assets to repay about $6 billion of outstanding bonds.

Senior creditors in Cheyne Finance Plc, the first SIV to collapse, recovered about 61 percent after the company was reorganized, according to an Aug. 12 statement.

Not only hedge funds suffer redemptios. Mutual funds are also facing something of a run by worried investors nowadays. One positive development is the return of investors to money market funds, which is for now preventing some investment grade companies from falling apart:

Investors fled from stock and bond mutual funds for the third straight month in November, removing $86.4 billion as signs of a worsening economy drove them out from all but the safest investments.

Shareholders removed $52 billion from stock funds and $34.4 billion from bond funds last month, said Conrad Gann, chief operating officer of TrimTabs Investment Research, citing preliminary data compiled by the Sausalito, California-based firm. While outflows were less than a record $111 billion in October, investors are still scared, he said.

“There’s still plenty of fear out there,” Gann said. “It’s more of a continuing drumbeat.”

Stock and bond mutual funds have lost $270 billion to investor withdrawals since September. Every bond-fund category has lost ground in 2008 except those that invest in U.S. Treasuries.

Cash has poured into money-market funds, considered the safest investments outside of bank deposits and government-backed bonds. Taxable money-market mutual fund assets surged to a record of $3.657 trillion in the week ended Dec. 2, according to IMoneyNet of Westborough, Massachusetts.

Drop Since May

Mutual funds had $9.6 trillion in assets as of Oct. 31, a 22 percent drop since May, according to data compiled by Washington, D.C.-based Investment Company Institute.

Merril Lynch says that oil may fall to $25 per barrel if China falls into a recession:

Crude oil fell below $44 a barrel to the lowest since January 2005 and gasoline dropped below $1 a gallon as the deepening recession in the U.S., Europe and Japan cuts fuel consumption.

Prices may dip below $25 a barrel next year if the recession spreads to China, Merrill Lynch & Co. said in a report today. “We’ve got the U.S, U.K., Europe and Japan all in recession for the first time since World War II, and the oil market is reacting,” said Chip Hodge, a managing director at MFC Global Investment Management in Boston, who oversees a $5 billion energy-company bond portfolio.

Oil prices have tumbled 70 percent since reaching a record $147.27 on July 11.

 “There is no sign where it will stop,” said Tom Bentz, senior energy analyst at BNP Paribas in New York. “We are now looking at $41.15, which was the pre-Gulf-War high and after that at the $40 and $37 level.”

Oil reached a then-record $41.15 in October 10, 1990, when Iraqi troops were occupying Kuwait. The milestone held until May 2004. Prices were last below $40 a barrel in July 2004.

“A temporary drop below $25 a barrel is possible if the global recession extends to China and significant non-OPEC cuts are required,” Merrill commodity strategist Francisco Blanch said in today’s report. “In the short run, global oil-demand growth will likely take a further beating as banks continue to cut credit to consumers and corporations.”

OPEC oil ministers agreed on Oct. 24 in Vienna that the 11 members with quotas would cut supply by 1.5 million barrels a day starting in November.

“Prices won’t rebound until either the financial crisis is fixed or oil-market fundamentals tighten,” said Michael Lynch, president of Strategic Energy & Economic Research, in Winchester, Massachusetts. “We will have to see substantial inventory reductions and OPEC cuts.”

Most people are by now very well aware that the dollar is not rallying because of any illusions about the US economy, but rather because it was the most important funding currency for the global excesses of the past ten years, along with the yen. Unlike the yen, however, the dollar was not only the tool of domestic US-based speculators, but it also served as the currency of trade for the Middle Eastern and Asian investor-speculators who channelled dollar-assets accumulated through goods or commodity exports into emerging markets, the Euroland, Russia, India among others, into derivatives and  many other kinds of assets. The size of these movements far outweighs whatever drawbacks the US deficits create for the US currency, and their unwinding is naturally causing the dollar to rally rather strongly in the short and possibly medium term.

Put in another way though, this also implies that the ability of the US government to finance its deficits without monetising it depends on the persistence of panic in the financial markets. If panic and fear were to dissipate the dollar would quickly disappear as a usable currency,  in my opinion. However, as long as dollarholders are too afraid to buy anything other than government paper, there’s no circulation of dollars, and as past obligations come due for corporations and banks and governments, especially those with deficits or heavy burdens of debts, the dollar squeeze intensifies, and continues.

Thus betting that the dollar will fall is equal to betting that the global economy will heal. I’d like to wish those brave souls who would like to make that bet good luck, but for now, I can’t join them in this trade. While it makes sense to expect people to buy gold when there’s so much concern about the sustainability of US external position, the fact is that most people and institutions are busy trying to find the dollars with which they will meet their oligations, rather than worrying about where to save or invest the dollars that they have ready at hand. If one has no dollars, he can’t buy gold. And we must remember that most of the money the Fed prints and pumps never make it to the market – if it had made there, libor, corporate bond spreads, should have been much much lower than where they are today

Commercial mortgage delinquencies rose in November and will climb as the economy slows and unemployment grows, according to Barclays Plc.

Payments more than 60 days late on commercial real estate loans that were bundled together and sold as bonds increased to 0.69 percent last month, compared with 0.57 percent in October and 0.51 percent in September, Barclays data show.

The “relative spike” in delinquent loans marks the “beginning of a sustained, upward trend,” Barclays analysts led by Aaron Bryson in New York said in a report yesterday. “We have repeatedly stressed that CMBS delinquencies are a lagging indicator of performance and tend to lag changes in employment by close to a year.”

Waning demand for the bonds, which are backed by pools of commercial mortgages, caused sales to slump to $12.2 billion this year, compared with a record $237 billion in 2007, according to JPMorgan Chase & Co. estimates.

Delinquent Retailers

Retailers are leading the rise in commercial mortgage delinquencies, according to Barclays. Late payments on retail space rose to 0.58 percent in November, compared with 0.43 percent in October, the data show.

 “The depth and length of this economic downturn looks to be materially worse than many investors initially expected and worse than that experienced during the last recession,” the analysts wrote in a Nov. 26 report.

Looser Underwriting

Underwriting standards on commercial real estate mortgages taken out between 2005 and 2007 were looser than those on loans in prior years, which will contribute to more delinquencies, the JPMorgan analysts said.

The impending default of two commercial mortgages sent spreads soaring to record highs last month. A $209 million loan to finance the Westin La Paloma Resort & Spa in Tucson, Arizona, and the Westin Hilton Head Island Resort & Spa in South Carolina, is near default after cancellations sapped revenue. In southern California, the owner of the Promenade Shops at Dos Lagos missed two payments on a $125 million loan.

The loans were among the largest in a $1.16 billion commercial mortgage debt offering sold by JPMorgan on April 30, Bloomberg data show.

Another hedge fund has frozen redemptions:

Fortress Investment Group LLC fell 25 percent to a record low after the private-equity and hedge-fund manager halted redemptions from its Drawbridge Global Macro fund, which had lost value this year.

Investors asked to withdraw $3.51 billion by year-end, including the $1.5 billion in redemption notices disclosed last month, the New York-based company said today in a filing with the U.S. Securities and Exchange Commission. Fortress spokeswoman Lilly Donohue declined to comment.

“The market essentially lost faith in Fortress as a franchise so that anything Fortress does is tainted by problems that it had in its private-equity portfolio,” said Jackson Turner, an analyst with Argus Research Co. in New York, who has a “sell” rating on the company.

More than 80 firms have liquidated funds, restricted redemptions or segregated assets following a stock-market decline and a credit freeze that started with a housing slump and rising defaults on U.S. subprime mortgages. Hedge funds have posted losses averaging 23 percent this year through Dec. 1, according to Chicago-based Hedge Fund Research Inc.’s HFRX Global Hedge Fund Index.

Fortress said in November its hedge-fund clients asked to pull more than $4.5 billion, or 25 percent of their money, as the company reported its first quarterly loss since going public. The Drawbridge fund had $8 billion as of Sept. 30, and the requested withdrawals amount to about 44 percent of the money pool, said Roger Smith, an analyst with Fox-Pitt Kelton Cochran Caronia Waller USA LLC in New York. Drawbridge lost 12 percent this year, he said.

The hedge-fund industry may shrink as much as 45 percent by the end of this month to $1.1 trillion from its peak of $1.9 trillion in June because of investor redemptions and market losses, Morgan Stanley analyst Huw van Steenis said in a Nov. 24 report.

Yields on speculative-grade bonds imply a default rate of 21 percent, which is higher than the record of the Great Depression. Moody’s forecasts the U.S. default rate to rise to 3.3 percent in October, to 4.9 percent in December 2008 and to 11.2 percent by November 2009. In other words, the US economy will face a period of consolidation and reorganisation, and the US economy of tomorrow will probably depend on exports and manufacturing to a far greater degree than the economy today does. In essence, we’re witnessing that much feared, and discussed, seldom understood unwinding of global imbalances: China is forced to shrink its export sector, as the US is forced to restrain its domestic spending habits. While in sum this is a healing process, the surgery is rather painful because the patient was a bit too late in seeking help for its illnesses:

The extra yield investors demand to own U.S. high-yield bonds was 19.19 percentage points on Dec. 1, according to Moody’s. Assuming a 20 percent recovery rate, the spread implies a default rate of 20.9 percent, John Lonski, chief economist at Moody’s Investors Service, said yesterday in a market commentary. That compares with a rate of 11 percent in January 2001, 12.1 percent in June 1991 and 15.4 percent in 1933.

Defaults and bankruptcies are accelerating as financing options for high-yield companies dwindle amid the longest U.S. economic recession in at least 26 years. The U.S. default rate rose to 3.3 percent in October, according to Moody’s, which forecasts the rate to increase to 4.9 percent in December and 11.2 percent by November 2009.

“The default rate is going to start rising quickly, soon enough it’s going to be breaking above 10 percent,” Lonski said in an interview. “Lack of access to financial capital is a very big problem for high-yield bonds.”

Hawaiian Telcom Communications Inc., a provider of local and long-distance telephone service, and Pilgrim’s Pride Corp., the largest U.S. chicken producer, sought bankruptcy protection on Dec. 1, as they struggled with too much debt taken on before the credit crisis.

Trump Entertainment

Trump Entertainment Resorts Inc., the casino company founded by Donald Trump, had its ratings cut by Moody’s on Dec. 1 after announcing last week it would forgo a $53 million interest payment to conserve cash. Moody’s lowered its probability of default rating to Ca from Caa2 and its rating on the company’s senior secured notes due 2015 to Ca from Caa2, with a negative outlook, suggesting the company is more likely to default.

Three companies have sold $2.7 billion of high-yield bonds this quarter, compared with $30 billion in the same period a year ago, according to data compiled by Bloomberg. Leveraged loans arranged this year total $301 billion, down more than a third from last year, Bloomberg data show.

“There’s a lot of forced selling of high-yield bonds by hedge funds owing to the need to de-lever as well as by mutual funds in response to redemptions,” Lonski said. “You’re looking at a market where the sellers well outnumber the buyers and the reluctance on the part of buyers makes sense if only because a bottom for economic activity is not yet in sight.”

High-yield, high-risk bonds are rated below Baa3 by Moody’s and BBB- by Standard & Poor’s.

May contracts on the Chicago Board Options Exchange Volatility Index, or VIX, closed yesterday at 43.80, while futures expiring before then trade at higher levels, showing investors expect the Standard & Poor’s 500 Index to rise or fall at least 2.8 percent a day through June 17, according to data compiled by Bloomberg. The last time the benchmark index for U.S. stocks moved that much during the same amount of time was 1932.

“It’s astonishing,” said Jeremy Wien, a volatility trader at Societe Generale SA in New York. “It’s beyond even what were considered worst-case scenarios just last year.”

The S&P 500 rose or fell 4 percent or more on 26 days since Sept. 15, as bank writedowns and losses from the U.S. mortgage market’s collapse approached $1 trillion worldwide. The last time the S&P 500 had as many 4 percent moves was 1933, when it happened 38 times, according to data compiled by Bloomberg. The index has increased or decreased 0.8 percent each day on average in its 80 years of history, Bloomberg data show.

Record High

The 18-year-old VIX, which never exceeded 50 before October, closed at a record 80.86 on Nov. 20 when the S&P 500 tumbled to the lowest level since 1997. The VIX fell four straight years through 2006 and slid to a 13-year low of 9.89 in January 2007, a month before surging a record 64 percent to 18.31 on Feb. 27, 2007, as U.S. equities suffered the worst rout in four years. It lost 8.1 percent to 62.98 today.

The VIX averaged 30.98 this year and 56.14 since Sept. 15, compared with 15.60 in 2003 through the jump in February 2007. January VIX futures closed at 56.24 yesterday, while March contracts were at 47.88.

GM wants 4 billion to survive this month:

GM won’t have enough money to finish this year, asked Congress for $4 billion immediately and access to $18 billion total as a worsening economy forces the automaker to use more cash.

GM is seeking $12 billion in loans and an additional credit line of $6 billion, as it tries to shrink U.S. employment by 34 percent, close plants and emphasize only four of eight current U.S. brands, according to a statement today on its Web site. The Detroit-based company also is seeking to cut debt in half and win new concessions from the United Auto Workers union.

Ford Motor Co. earlier today asked Congress for a credit line of as much as $9 billion, saying it expects to break even or be profitable before taxes in 2011.

The two companies’ requests exceed the $25 billion in aid lawmakers have been considering for all three U.S. automakers. Ford, GM and Chrysler LLC must convince a divided Congress their plans to shrink are severe enough to ensure repayment of the loans.

1. Companies thrive in an environment of deregulation. Regulation is not only costly, but it also prevents “innovative” CFO’s from getting the best performance from extraordinary accounting methods. Regulation is best when it can prevent bubbles from forming, but where there’s no overconfidence, no euphoria, and no stupidity, people are less willing to take risks, and less risk means less growth, less profit and more volatility.
2. A lot of people have been very badly burnt in the recent economic collapse. History shows that in the aftermath of an event as severe as this, people save more, spend less and take greater care of how they allocate their savings. All this results in less leverage, and consequently slower growth.
3. Economical events of this scale are usually followed by periods of political instability, and international turmoil. Political instability is never a friend of the stock market.
4. It’s highly likely that the severe damage that many economies suffer and will suffer from will result in increased protectionism in many countries. I already read reports of governments with high current account deficits encouraging citizens to use domestically produced goods. Protectionism is the bane of globalization, and it’s almost certainly bad for everyone. Trade has been a major stimulant of progress and growth throughout the ages. Yet after so much rampant internationalization, politicians are certain to be drawn to protectionist policies and nationalism to alleviate the people’s concerns and anger, which will lead to slower growth, and lesser profits.
5. The banking system at the heart of the global economy, has almost been nationalized in many countries. The resurrection of the financial system will take a lot of time, and in the mean time, the lack of credit will cause stagnant stock prices, even in the best of circumstances.  
6. Many nations have chosen to prolong the crisis by allowing bankrupt and unsustainable firms to continue their existence through government grants. This is obviously a mistake, and there’s a significant chance that these inefficient actors will reduce the global growth potential until they’re able to work through their accumulated losses which should take a long time.
7. The bailouts across the globe will eventually have to be financed by the taxpayer. That means higher taxes, higher taxes means less consumption, and that means slower growth.

Why were the Treasuries sold? Because the government wanted to assume the role of the financial intermediary, as banks were unable to undertake their usual duties in that capacity. Since liquidity didn’t flow through private financial channels, the government sucked it out, and splashed it on bankrupt firms, by virtue of its AAA credit rating, and sovereign status. So what makes the Federal Reserve expect that throwing that same liquidity back into the market through Treasury buybacks will cause any changes? In fact, it’s a declaration of bankruptcy. The more he tries to reduce the rates on treasury bonds, the more liquidity will be sucked from markets, since more attractive government paper will necessarily cause other asset classes to present  even less value to investors. We’re back to square one:

“Although further reductions from the current federal funds rate target of 1 percent are certainly feasible, at this point the scope for using conventional interest-rate policies to support the economy is obviously limited,” Bernanke said in remarks to the Austin Chamber of Commerce.

One option for reviving the economy is for the Fed to buy “longer-term Treasury or agency securities on the open market in substantial quantities,” Bernanke said. “This approach might influence the yields on these securities, thus helping to spur aggregate demand.”

While Bernanke was “pretty aggressive on the possibility of the Fed using its balance sheet aggressively through Treasury purchases,” he wasn’t specific about the policy path because he probably didn’t want to preempt the discussion at the FOMC meeting in two weeks, said Sack, a former Fed economist.

The Fed will “continue to explore ways” to keep the market federal funds rate closer to policy makers’ target, after paying 1 percent interest on banks’ reserves failed to stabilize the rate, Bernanke said. The average daily rate has been below the central bank’s target every day since Oct. 10.

That’s because Fannie Mae and Freddie Mac, which are “large suppliers of funds,” aren’t eligible to get interest from the Fed and thus lend below the Fed’s target, Bernanke said.

Last week, the Fed announced two new programs aimed at unfreezing credit for homebuyers, consumers and small businesses. Those include a commitment to buy as much as $600 billion of debt issued or backed by government-chartered housing-finance companies and a $200 billion initiative to support consumer and small-business loans.

 ‘Sustainable Level’

The Fed’s balance sheet “will eventually have to be brought back to a more sustainable level,” Bernanke said. “However, that is an issue for the future; for now, the goal of policy must be to support financial markets and the economy.”

US manufacturing contracted in November at the steepest rate in 26 years. Chinese manufacturing PMI aso contracted.

The Institute for Supply Management’s factory index dropped to 36.2, below economists’ forecasts, and its gauge of raw- material costs plunged to the least in six decades, intensifying concern over deflation. The Tempe, Arizona-based group’s report came as factory indexes in China, the U.K., euro area, and Russia all fell to record lows.

 “This downturn in the global economy is probably more synchronized than we have ever seen,” said Jonathan Basile, an economist at Credit Suisse Holdings in New York. Policy makers should “open the flood gates” for more action, he said.

Construction Spending

A report from the Commerce Department also showed construction spending fell 1.2 percent in October, a bigger drop than forecast, as a slump in homebuilding spread to non- residential projects such as power plants, churches and highways.

China’s purchasing managers’ index fell to a seasonally adjusted 38.8 from 44.6 in October, the China Federation of Logistics and Purchasing reported today. An index covering the 15 nations sharing the euro dropped to 35.6, the lowest since Markit Economics began the poll in 1998.

VTB Bank Europe’s index covering Russia fell to 39.8, and the U.K.’s Chartered Institute of Purchasing and Supply’s factory index was at 34.4, the least since the survey began in January 1992.

New Orders, Production

The U.S. ISM’s purchasing managers’ gauge of new orders for factories decreased to 27.9, the lowest since 1980, from 32.2 the prior month. The production measure fell to 31.5 from 34.1.

The index of prices paid dropped to 25.5, the lowest level in six decades, from 37. That adds to concern that the U.S. economy may be at risk of deflation, a sustained decline in prices and wages caused by scarce credit. Deflation can worsen a recession by making debts harder to pay and countering the effect of interest-rate cuts.

Orders from overseas continue to weaken as economies abroad contract. ISM’s export gauge was unchanged at 41, the lowest reading since records began in 1988.

 ‘Difficult Years’

“We are all expecting the year 2009 to be a very low year in terms of demand, not only in the United States, but globally,” Carlos Ghosn, chief executive officer of Nissan Motor Co., said in a Nov. 19 interview on Bloomberg Television. “We may be facing a couple of difficult years, with very low demand.”

In anti-climactic moment, NBER has declared a recession in the US:

The U.S. economy entered a recession a year ago this month, the panel that dates American business cycles said today, making this contraction already the longest since 1982.

The declaration was made by a committee of the National Bureau of Economic Research, a private, nonprofit group of economists based in Cambridge, Massachusetts. The last time the U.S. was in a recession was from March through November 2001, according to NBER.

 “It is clearly not going to end in a few months,” Jeffrey Frankel, a member of the NBER committee and a professor at Harvard University, said in an interview. “We would be lucky to get done with it in the middle of next year.”

The loss of 1.2 million jobs so far this year was the biggest factor in determining the starting point of the U.S. recession, the NBER said. By that measure, the contraction probably deepened last month.

At 12 months, the current contraction is already the longest since the 16-month slump that ended in November 1982, and exceeds the postwar average of 10 months.

The contraction is the second under President George W. Bush’s watch, making him the first U.S. leader since Richard Nixon to preside over two recessions.

Summers, More Action

Lawrence Summers, President-elect Barack Obama’s pick for White House economic adviser, said the economy is getting worse and requires more legislative action.

“Recent economic evidence suggests that the pace of this downturn is accelerating,” Summers said in a statement. He said Obama wants to enact a recovery package “soon after taking office.”

The likely length of this downturn may cast doubt on economists’ view that the business cycle was moderating in recent decades.

“Everyone had thought long, deep recessions were a thing of the past,” Frankel said. “There was a lot of talk of the new economy.”

More than 80 hedge funds have liquidated, restricted redemptions or segregated assets during the credit crisis so far. The reader should remember that market-size contraction is the hallmark of this crisis. Another one did so today:

Tudor Investment Corp., the firm run by Paul Tudor Jones, temporarily suspended client redemptions from the $10 billion BVI Global Fund Ltd. as it plans to split the hedge fund into two.

Tudor is proposing to put hard-to-sell investments, mostly corporate bonds and loans from emerging markets, into a new fund called Legacy, Jones said in a Nov. 28 letter to investors. BVI Global, the flagship fund Tudor started in 1986, would focus on easier-to-trade stocks, bonds, commodities and currencies.

Investors asked to pull 14 percent of their money from BVI Global as it lost 5 percent this year through November, according to the letter. That compared with an 18 percent loss through October of the Multi-Strategy Index compiled by Hedge Fund Research Inc.

Tudor, which oversees $17 billion, is asking BVI Global investors to approve the plan to split the fund in the next two months. Clients would have their money allocated between BVI Global and Legacy based on the division of assets.

Legacy will account for about 29 percent of BVI’s assets as of March 31, 2009, according to the letter. It will include emerging-market corporate credit debt, which has “ceased to be tradable,” as well as investments in private equity and hedge funds.

Emerging-markets securities have fallen as commodity prices plunged and investors shunned riskier assets on concern the global economy is entering a recession. The MSCI Emerging Markets Index has dropped 58 percent this year.

Jones, 54, told clients in August that Jim Pallotta, head of equities, is leaving to start his own firm. Pallotta will keep the Raptor Global Fund that he runs out of Boston from January. The fund lost 16.5 percent this year through Nov. 19, according to investors.

Industry Contracts

The hedge-fund industry may shrink as much as 45 percent by the end of this month to $1.1 trillion from its peak of $1.9 trillion in June because of investor redemptions and market losses, Morgan Stanley analyst Huw van Steenis said in a Nov. 24 report.

Hedge funds have posted losses averaging 22 percent this year through Nov. 24, according to Chicago-based Hedge Fund Research’s HFRX Global Hedge Fund Index.

And another one:

Highbridge Capital Management LLC, the $20 billion investment firm run by Glenn Dubin and Henry Swieca, is limiting client withdrawal requests to avoid selling assets at distressed prices, according to a person familiar with the matter.

Investors who submit withdrawal requests to the $1.9 billion Asia Opportunities Fund this quarter will get half their money by the end of January. The fund, which lost 32 percent this year through October, will return the rest within 12 to 18 months.

Highbridge, based in New York, will segregate hard-to-sell assets and sell them off over time in the hope that prices recover and clients get more money back. Firms including Tudor Investment Corp. and GLG Partners Inc. have taken similar steps in the past month.

The fund gained 18.7 percent last year, 15.4 percent in 2006 and 6.88 percent in the previous year when it was started. JPMorgan Chase & Co., the largest U.S. bank by assets, bought a majority stake in New York-based Highbridge four years ago and increased its ownership to 78 percent in January.

The Economist stated, on Nov20th 2008:

“An important reason why the American economy has been so resilient and recessions so mild since 1982 is the energy of consumers. Their spending has been remarkably stable, not only because drops in employment and income have been less severe than of old, but also because they have been willing and able to borrow. The long rise in asset prices—first of stocks, then of houses—raised consumers’ net worth and made saving seem less necessary. And borrowing became easier, thanks to financial innovation and lenders’ relaxed underwriting, which was itself based on the supposedly reliable collateral of ever-more-valuable houses. On average, consumers from 1950 to 1985 saved 9% of their disposable income. That saving rate then steadily declined, to around zero earlier this year (see chart). At the same time, consumer and mortgage debts rose to 127% of disposable income, from 77% in 1990.

Bruce Kasman and Joseph Lupton of JPMorgan predict that the saving rate will jump to around 4.5% by the end of next year, the sharpest jump in so short a time in the post-war period. This compulsory return to thrift will be deeply painful; consumer spending and housing are almost three-quarters of GDP. Of the 1.2 million, or 0.9%, decline in jobs since December, about 700,000 are directly related to consumers: retail trade, transportation manufacturing and home-building. The rise in unemployment, from 4.4% in 2006 to 6.5% in October, is nearing that of 2001-03 and is not over. Consumer prices plunged a record 1% in October from September, and by 0.1% excluding fuel and food, the first such decline since 1982. The Fed’s vice-chairman, Donald Kohn, said outright deflation “is a risk out there but it’s still small.

Until 1982 recessions were often induced by the Fed to weaken demand and reduce inflation. Declines in GDP were dominated by business inventories and interest-sensitive spending such as cars and houses. Once the Fed eased money, spending sprang back.

Since then inventories have become less important to the business cycle and deregulation and financial innovation mean higher interest rates take longer to affect spending. Expansions are marked by sizeable growth in assets and debt. When the cycle turns, falling asset values and debt reduction weaken the kick of lower rates, producing anaemic recoveries with rising unemployment. The Fed has already lowered its interest-rate target to 1%, but it is fighting gale-force headwinds as lenders reduce their loan portfolios. Citigroup recently told many of its credit-card holders that it was raising their interest rates by up to three percentage points.

Lenders once routinely pooled credit-card, student and car loans into securities and sold them to capital-markets investors. Joseph Astorina of Barclays Capital says no one wants to buy such securities now for fear that some overextended investor will dump its own holdings a week later, driving their values down sharply. The issuance of credit-card-backed securities, which averaged $8 billion a month in 2007, was zero in October, he says.

Alan Greenspan, the former Fed Chairman, told The Economist this week that banks were satisfied with capital equal to 10% of their assets in the past. Now, to soothe depositors and investors, they will need a much higher ratio—perhaps around 15%. Until they get there, through a combination of raising new capital, reducing dividends and share buybacks, and shedding assets, lending will be constrained.”

Comment: Most of the surge in the household debt ratio has occurred after 2000, roughly coinciding with the skyrocketing of US external deficit. Though well-known, it is still an important harbinger of the massive correction that US consumption will go through, because the rise had mostly been funded by Asian export money and petrodollars. With the collapse of global trade, this source of funding will dry out, leaving the US consumer’s excesses dependent on government handouts.

Nonetheless, the correction should be allowed to happen, as the opposite is impractical. US consumers have to learn to live like responsible individuals, and others in the world must learn to generate domestic demand to replace American profligacy.

We’re now having a Thanksgiving holiday for the markets. Indeed, there’s a slight chance that we’ll see a bear market rally in the coming weeks, the realization of which will depend on the success of central banks in easing year-end funding issues. A lot has been done, and at least for me, it’s hard to predict the outcome. Nevertheless, today’s developments in the interbank market do not emit positive signals:

The cost of borrowing in dollars for one month in London jumped the most since 1999 as banks sought to bolster balance sheets through year-end amid a squeeze on credit that’s being exacerbated by the global economic slump.

The London interbank offered rate, or Libor, that banks say they charge one another for such loans climbed 47 basis points to 1.90 percent today, British Bankers’ Association data showed. The Libor for three-month loans rose two basis points to 2.20 percent. The Libor-OIS spread, a measure of the willingness of banks to lend, also increased.

“There is some concern about the turn of the year,” said Patrick Jacq, a senior fixed-income strategist in Paris at BNP Paribas SA. “I wouldn’t be surprised to see this tension easing over the next few days as central banks address the situation with more liquidity.”

With little more than a month to go until the end of 2008, banks are vying for loans that mature after Dec. 31 to strengthen their balance sheets as they prepare to report to investors. Financial institutions mark the value of loans and cash positions at the end of each quarter. The euro interbank offered rate, or Euribor, for one-month loans rose 22 basis points to 3.61 percent today, the first increase in 24 days, according to the European Banking Federation.

Cash Hoarding

Banks and companies are hoarding cash amid concern interest-rate cuts and injections of liquidity along with government-spending programs won’t be enough to avert the worst global recession since World War II. Rates on U.S. commercial paper, or short-term company loans, climbed yesterday by the most in more than a month.

The Federal Reserve this week committed as much as $800 billion to thaw a freeze in credit for consumers and small businesses. The U.S. also provided a $306 billion rescue to Citigroup Inc. Financial institutions are cutting jobs amid $970 billion of writedowns and credit losses since the start of 2007.

Asian Rates

Money markets began seizing up in August 2007 as banks became wary of lending to each other on concern their counterparties were holding assets linked to U.S. subprime mortgages. They froze up after the Sept. 15 collapse of Lehman Brothers Holdings Inc. sparked concern more banks would follow. The one-month dollar rate jumped 40 basis points on Nov. 29 last year as banks sought cash for the year-end.

Asian financing costs were calmer today. Hong Kong’s three-month interbank lending rate, Hibor, rose about five basis points to 2 percent. Tokyo’s rate increased one basis point to about 0.87 percent. Singapore’s three-month U.S. dollar rate, known as Sibor, slipped to 2.20 percent, from about 2.21 percent.

China’s central bank yesterday lowered its one-year lending rate by the most since the 1997 Asian financial crisis, less than three weeks after Premier Wen Jiabao unveiled a 4 trillion yuan ($586 billion) stimulus plan.

‘Toxic Debt’                                                       

In a further indication of the squeeze in lending, the European Central Bank registered almost 217 billion euros ($280 billion) of cash deposited by banks yesterday in its overnight facility. It was the sixth straight day the figure surpassed 200 billion euros. The daily average in the first eight months of the year was 427 million euros.

The Libor-OIS spread, a gauge of cash scarcity among banks favored by former Fed Chairman Alan Greenspan, was little changed at 178 basis points. The difference between what banks and the Treasury pay to borrow money for three months, known as the TED spread, widened two basis points to 217 basis points. The spread, which reached a low this year of 76 basis points in May, was at 464 basis points on Oct. 10, the most since Bloomberg began compiling the data in 1984.

Hedge fund liquidations and redemptions, of course, continue unabated:

Bluebay Asset Management Plc dropped the most since its initial public offering two years ago after the manager of fixed-income investments said it will shut down its Emerging Market Total Return Fund.

The $1.2 billion hedge fund, which accounts for 6 percent of assets under management, had dropped 53 percent this year, Bluebay said today in a statement. Fund manager Simon Treacher resigned “following a breach of internal valuation policy,” it said. He couldn’t immediately be reached for comment.

“Marketing other funds may now become very difficult,” said Gurjit Kambo, a London-based analyst at Numis Securities Ltd. who tracks the industry. “People become more nervous about putting money into Bluebay.”

Bluebay won’t retreat from credit-market investments despite “extremely challenging” conditions, Chief Executive Officer Hugh Willis said in the statement. Satellite Asset Management LP and Artemis Asset Management joined the list this week of more than 75 hedge funds that have liquidated or restricted investor redemptions since the beginning of the year.

Bluebay declined 30 percent to 70 pence, valuing the London-based company at 135 million pounds ($208 million). The shares, which peaked at 568.25 pence in June 2007, have fallen 80 percent this year.

The Emerging Market Total Return Fund was hurt by “liquidity conditions” and is no longer viable on its own, Bluebay said. The closure means that revenue from funds that bet on both rising and falling share prices will probably be below analysts’ estimates, Bluebay said.

The fund was hurt by “a perfect storm” after two wrong bets on cash bonds and credit default swaps, Kambo said. The value of cash bonds failed to rise as Bluebay expected, and credit default swaps narrowed, meaning the perceived risk of default decreased, he said.

Satellite Asset Management LP, founded by former employees of billionaire George Soros, stopped client withdrawals from its three largest hedge funds and eliminated more than 30 jobs after losses reduced the firm’s assets to about $4 billion this year.

Satellite Overseas Fund Ltd., Satellite Fund II LP and Satellite Credit Opportunities Ltd. have declined as much as 35 percent in 2008, said a person with knowledge of the funds’ performance. Simon Rayler, Satellite’s general counsel, declined to comment and wouldn’t disclose how many people remain at the firm’s New York headquarters or London offices. Satellite oversaw about $7 billion for clients at the end of last year.

More than 75 hedge funds have liquidated or restricted investor redemptions since the start of the year as they cope with fallout from the global financial crisis. Investors pulled $40 billion from hedge funds last month, while market losses cut industry assets by $115 billion to $1.56 trillion, according to data compiled by Hedge Fund Research Inc. in Chicago.

“Barring volatility in the markets, I expect that by the end of the year, we would’ve seen the bulk of these redemption suspensions done,” said Ron Geffner, who represents hedge funds at the New York-based law firm Sadis & Goldberg LLP.

Satellite was started in 1999 by Lief Rosenblatt, Gabe Nechamkin and Mark Sonnino, who worked together for 11 years at Soros Fund Management LP in New York. The firm is retaining teams that trade bonds and loans and invest in companies going through events such as takeovers, said the person, who asked not to be identified because the information is private.

21% Redemption Rate

The company has received withdrawal notices, which are effective through June, for 21 percent of the $2 billion Satellite Overseas Fund Ltd., its largest fund, the person said.

Satellite has cash to meet current redemptions and will continue to run the funds and sell securities over a period of years to avoid unloading them quickly in slumping markets, the person said.

Commodities keep falling too. Of course with the investments of the past two years

Lead fell to a two-year low in London as reductions in automobile production erode demand for the metal used mostly in car batteries. Copper declined.

U.S. vehicle sales at the lowest since 1991 prompted cuts at General Motors Corp. and Ford Motor Co. China’s output of lead concentrate, used to make refined metal, climbed 14 percent in the first 10 months, according to Mainland Marketing Research Co.

“Investors and consumers have given up,” said David Thurtell, an analyst at Citigroup Global Markets in London. There is “a sharp rise in Chinese production and a sharp fall in auto demand.”

Lead for delivery in three months declined $81, or 6.8 percent, to $1,105 a metric ton on the London Metal Exchange, the lowest since July 2006. Prices have dropped 57 percent this year. Inventories in warehouses monitored by the LME rose 250 tons, or 0.6 percent, to 41,200 tons, according to the exchange’s daily report.

Copper fell on concern a slumping U.S. economy will crimp consumption of Chinese imports and demand for industrial metals in the Asian economy. Some economic indicators in China showed a “faster decline” this month, National Development and Reform Commission Chairman Zhang Ping said in Beijing today.

Copper usage in the U.S., the largest buyer after China, fell 9 percent in the first eight months and demand in China rose 13 percent, according to the International Copper Study Group.

“Over the last month or so, the perception is that China was slowing down faster than people thought it would,” said William Adams, an analyst at London-based Basemetals.com. “The Western world is putting on the brakes rapidly and therefore China can see their export demand will suffer.”

And yesterday China cut rates by the largest amount in 11 years.

China’s biggest interest-rate cut in 11 years highlights government concerns that the country risks spiraling unemployment, social unrest and the deepest economic slowdown in almost two decades.

The central bank yesterday lowered its benchmark one-year lending rate by the most since the 1997 Asian financial crisis, less than three weeks after Premier Wen Jiabao unveiled a 4 trillion yuan ($586 billion) stimulus plan.

“China’s trying to draw a line under unemployment and civil unrest,” said Glenn Maguire, chief Asia-Pacific economist at Societe Generale SA in Hong Kong. “It’s the most challenging set of circumstances Beijing has had to face since late 1989 that culminated in the protests in Tiananmen Square.”

About 1,000 police and security guards this week attempted to break up a demonstration of fired workers that overturned a police car, smashed motorbikes and broke company equipment in southern Guangdong province, the state-run Xinhua News Agency reported yesterday. The nation’s “top policy priority” is maintaining growth to create jobs, Zhang Ping, chairman of the National Development and Reform Commission, told a briefing in Beijing today.

The central bank cut the key one-year lending rate 108 basis points to 5.58 percent. The deposit rate fell by the same amount to 2.52 percent.

‘Forceful, Fast’ Measures

China vaulted past the U.K. in 2005 to become the world’s fourth-largest economy, with growth averaging 9.9 percent for the past 30 years. The economy has expanded 68 times in size since free-market reforms began in 1978.

Gross domestic product may grow 5.5 percent next year, the slowest since a 3.8 percent expansion in 1990, CLSA Asia Pacific Markets forecasts. That compares with an 11.9 percent gain in 2007.

Some economic indicators declined more quickly this month, showing the urgency of “forceful and fast” measures to stimulate growth, the NDRC’s Zhang said.

China, the world’s most populous nation, is aiming for at least 8 percent growth to provide jobs for workers moving to the cities from the countryside. A decline to even that level would be tantamount to a recession, according to Tao Dong, chief Asia economist with Credit Suisse AG in Hong Kong.

Exports are suffering as recessions in the U.S., Europe and Japan cut demand for China’s toys, sneakers and computers. Net exports — the difference between exports and imports — accounted for a fifth of GDP growth last year.

Toy Exporters

Two-thirds of small toy exporters closed in the first nine months of this year, the customs bureau said this week.

“Employment is being impacted by factory closures and many migrant workers are returning to their home towns,” Zhang said.

China is trying to keep the official urban unemployment rate below 4.5 percent this year, which would be the highest in at least a decade. The Labor Ministry says the figures don’t account for millions of migrants who work in urban areas but aren’t registered there.

“Twenty percent of migrant workers may lose their jobs and in some provinces it is already at that level,” said Andy Xie, an independent economist in Shanghai who was formerly Morgan Stanley’s chief Asia economist. “When they return to their villages we don’t know how these things might work out.”

Deflation Risk

The size of the rate reduction also signals the central bank’s concern that the economy faces a bout of deflation as oil and commodity prices drop. That’s a switch from the first half of this year, when Governor Zhou Xiaochuan was focused on fighting inflation that rose to a 12-year high in February.

“The aggressive rate cut is a response to the central bank’s concern about the short-term deflation risk,” said Xing Ziqiang, an economist at China International Capital Corp. in Beijing, who predicts another 108 basis points of rate reductions in the coming year.

“There is still ample room to cut rates in the future,” said Peng Wensheng, head of China research at Barclays Capital in Hong Kong, who sees a 54 basis point reduction in December.

The fourth rate reduction since mid-September adds to the government’s package of measures to stimulate growth through 2010.

The State Council has pledged “fast and heavy-handed investment” and a “moderately loose” monetary policy. The plan spans housing, rural development, railroads, power grids and rebuilding after May’s earthquake in Sichuan province.

China’s cabinet said yesterday that it was studying extra measures to help struggling companies in the steel, auto, petrochemical and textile industries; to increase key commodity reserves; and to expand insurance for the jobless.

“In previous crises China could always get out of trouble by boosting its exports,” said Xie. “This time that’s not an option.”

“Tight credit conditions, the ongoing housing contraction, and some slowing in export growth are likely to weigh on economic growth over the next few quarters. Over time, the substantial easing of monetary policy, combined with ongoing measures to foster market liquidity, should help to promote moderate economic growth.

Inflation has been high, spurred by the earlier increases in the prices of energy and some other commodities. The Committee expects inflation to moderate later this year and next year, but the inflation outlook remains highly uncertain.

The downside risks to growth and the upside risks to inflation are both of significant concern to the Committee. The Committee will monitor economic and financial developments carefully and will act as needed to promote sustainable economic growth and price stability.”

Showing how reckless, inept, and ad-hoc the government has been in this crisis requires no lengthy elaboration. But whether the same people who saw moderate economic growth in September, and thought that downside risks to growth and upside risks to inflation were balanced, should still be running the economy is an open question.

Citigroup Inc. received a U.S. government rescue package that shields the bank from losses on toxic assets of $306 billion and injects $20 billion of capital, bolstering the stock after its 60 percent plunge last week.  In return for the cash and guarantees, the government gets $27 billion of preferred shares paying an 8 percent dividend and warrants equivalent to a 4.5 percent stake in the company. The warrants accompanying the preferred shares give the government the right to buy 254 million Citigroup shares at $10.61 each, allowing taxpayers to profit if the stock rallies following the government’s investment. The $20 billion of new cash adds to a $25 billion infusion the bank collected last month under TARP.

Under the asset guarantees, Citigroup will cover the first $29 billion of pretax losses on the $306 billion asset pool, in addition to any reserves it already has set aside. After that, the government covers 90 percent of the losses, with Citigroup covering the rest.

Dividend Cut

The cost of the new preferred shares will reduce earnings left over for common shareholders. Under the terms of the deal with the government, Citigroup also has to slash its quarterly shareholder dividend to 1 cent from 16 cents.

The asset guarantees and capital infusion will boost Citigroup’s Tier 1 ratio — a gauge of the bank’s ability to withstand loan losses — to 14.8 percent, from 8.19 percent at the end of September. A bank needs a 6 percent Tier 1 ratio to meet the regulatory requirements for “well-capitalized” status, and Citigroup has at least $100 billion more capital than it needs to reach that threshold, Citigroup CFO Gary Crittenden said.

Vanishing Value

Citigroup’s market value, which at $274 billion at the end of 2006 was bigger than any of its U.S. rivals, has since slumped to $31 billion, ranking No. 6 behind JPMorgan Chase & Co., Wells Fargo & Co., Bank of America Corp., U.S. Bancorp and Bank of New York Mellon Corp.

Citigroup remains vulnerable to losses on loans and securities outside the U.S., said Peter Kovalski, a portfolio manager at Alpine Woods Capital Investors LLC in Purchase, New York, which oversees $8 billion and holds Citigroup shares. The bank also is keeping its credit-card and consumer-finance loans, where delinquencies also have surged.

The government plan “gives them a little bit of breathing room, but longer term, things may deteriorate and losses increase,” said Kovalski. “The Achilles heel with Citi is their exposure to emerging markets and what’s going to happen when emerging markets turn down, as they’re doing now.”

Hedge fund redemptions are continuing:

Millennium Partners LP, the $13.5 billion hedge-fund firm run by Israel Englander, plans to return $1 billion to investors who asked for their cash back by year-end, according to two people familiar with the matter.

The redemptions, equal to 7.4 percent of client assets, would have been higher except they triggered limits set by the New York-based firm, said the people, who asked not to be identified because the information is private. A spokeswoman for Millennium declined to comment.

 “We’re seeing the result of hedge funds’ being subject to the whims of those in asset allocation,” said Adam Sussman, director of research at Tabb Group LLC, a New York-based adviser to financial-services companies. “No fund is immune.”

Investors pulled $40 billion from the loosely regulated, private pools of capital last month and market losses cut the assets by $115 billion to $1.5 trillion, according to Chicago- based Hedge Fund Research.

Different Restrictions

Some Millennium investors might rescind redemptions before year-end, which would prevent the limits, known as gates, from taking effect, said one of the people. Each share class of the fund has different rules that restrict the amount clients can withdraw.

And U.S. stocks are posting the biggest two-day rally since 1987 on Citigroup, according to Bloomberg:

U.S. stocks posted the biggest two- day rally since 1987 after the government guaranteed $306 billion of troubled Citigroup Inc. assets and lawmakers pledged to pass another economic stimulus package.

The S&P 500 surged 6.5 percent to 851.81, capping a two-day gain of more than 13 percent. The Dow Jones Industrial Average climbed 396.97 points, or 4.9 percent, to 8,443.39. The Nasdaq Composite rose 6.3 percent to 1,472.02. Europe’s Dow Jones Stoxx 600 climbed 8.4 percent, while the MSCI Asia Pacific Index slipped 0.7 percent.

Obama today announced Lawrence Summers, a former Treasury Secretary who stepped down as president of Harvard University in June 2006, as White House economic director. He said policy makers had to “act swiftly and act boldly” to avert the loss of millions of jobs next year.

Concern that Citigroup may need a government rescue sent bank stocks down 24 percent last week, the worst slide in at least 19 years.

Energy companies in the S&P 500 climbed 6.1 percent collectively as oil rallied 9.2 percent to $54.50 a barrel in New York as the rescue of Citigroup boosted confidence and a weaker dollar enhanced the appeal of commodities.

Daily swings of 3 percent or more in the S&P 500 have became the norm as the benchmark gauge of U.S. equities extended losses in its worst year since 1931. During the first nine months of 2008, the index moved at least 3 percent on 14, or 7.4 percent, of the 189 trading days, and there were only two days when it gained or lost more than 5 percent.

Only November 1929 overshadowed October 2008 as the most volatile month for the index, according to S&P analyst Howard Silverblatt, citing moves of at least 1 percent on 86 percent of last month’s trading days.

One can speak of a money saturation event as the mirror image of hyperinflation which is nowadays more often seen in emerging markets and developing nations, where the ability of the financial system to mask inflation through speculative activity and sustained asset price rises is far more limited. In an advanced economy such as the US, where the political mechanisms are so formed that the wage-setting power of the employee is much less limited, the increasing money supply is directed to channels that cause inflation in a more subtle and less obvious way: instead of the employee causing prices to rise through increased demand, the  employer causes asset values to rise through speculative activity, the windfall from which is shared with employee through the transmission channels of an advanced economy, such as mutual funds, REITs, and others.

In other words, inflation caused by higher wages is the fruit of a more socialistically-inclined system. Inflation caused by higher asset prices, leading to money saturation, is the creation of a more capitalistic system, where political power is willing to check the irrational desires of labour, but is far more complacent with the nonsensical activities of the rich and powerful. The terms “rich” and “labour” are only used in a general sense here, without implying that the agents that cause asset price inflation are always the “rich” in the direct sense of the word.

Once a more unified understanding of inflation is thus achieved, it is also easier to see why gold is not gaining against the dollar nowadays, and why, for instance, despite the extreme profligacy of the government, the dollar is not collapsing. The simple fact is that the collapse in the value of the dollar that many in the market have been anticipating in the past years has already occurred: gold has already appreciated from around 220 dollar per ounce to more than 1000 per ounce in the course of around eight years. In that sense, the US was already going through a period of hyperinflation, however, the event was masked by asset price appreciation, as CPI remained relatively tame. Thus, whereas in a developing nation, or an emerging market, extreme rises in money supply will result in hyperinflation, and will essentially lead to money being to worthless to be used as a transaction mechanism, a money saturation event will lead to money being too valuable to be used as a tranaction mechanism, with the result, however being the same. Both hyperinflation, and money saturation lead to recessions. The hallmark of hyperinflation is extremely high nominal rates, while that of money saturation is negative rates.  

The implication of all this, of course, is that an economy without the structures (such as securitisation, investment banking, pension insurance) that can channel money supply in effective ways to create asset bubbles, will be faced with hyperinflation in the classical sense, provided that there is enough growth in money supply to create it. However, the characteristic of a money saturation event is the rapid shrinkage of money supply which essentially precludes any wage inflation until the underlying pessimism is overcome.

The cost of protecting corporate bonds from default surged to records around the world as the prospect of U.S. automakers filing for bankruptcy protection fueled concern of more bank losses and a deeper recession.

“Markets are back in crisis mode,” said Agnes Kitzmueller, a Munich-based credit strategist at UniCredit SpA, Italy’s biggest bank. “There is fear in the market.”

General Motors Corp., Ford Motor Co. and Chrysler LLC executives left Washington empty handed yesterday after two days of pleading with lawmakers for a $25 billion bailout. Credit markets have “significant” liabilities to the automakers, raising the prospect of “continued writedowns,” BNP Paribas SA analysts told investors today.

Credit-default swaps on the Markit CDX North America Investment-Grade index jumped 23 basis points to an all-time high 270, according to broker Phoenix Partners Group at 11:15 a.m. in New York. The Markit iTraxx Crossover Index of 50 European companies with mostly high-yield credit ratings rose 37 basis points to 927, having earlier traded at 933.

Stocks slumped worldwide as a Conference Board report of leading economic indicators fell for the third time in four months, signaling a deepening recession. U.K. retail sales dropped for a second month in October as rising unemployment and the financial crisis dissuaded shoppers from spending.

Treasury yields declined to record lows, with two-year notes dropping below 1 percent for the first time, as investors shunned all but the safest assets.

Credit-default swaps on New York-based Citigroup Inc. rose 40 basis points to 405, Phoenix prices show. Contracts on Goldman Sachs Group Inc increased 65 basis points to 400 and Morgan Stanley rose 60 to 515.

“Anything’s possible in this market,” said Mark Bayley, a director of credit at ABN Amro Holding NV in Sydney. “You’re seeing sellers of risk and very few buyers. The sellers are becoming more stressed and willing to accept very wide spread levels for corporate bonds.”

Investors also shunned high-risk, high-yield loans, driving the Markit iTraxx LevX index of CDS on leveraged buyouts down to a record low of 78.5, BNP Paribas prices show. The current series of the index began trading at 99 on Sept. 29. The benchmark falls as credit risk rises.

The US Treasuries keep outperforming everything else. But this may not remain so forever, if the Fed decides to activate its most outlandish contingency plans, so to speak. I believe that the Federal Reserve is soon going to engage in the most unprecedent reflationary effort of any government at any time, and we’ll together see the results of the experiment. Three month treasuries are yielding 2 basis points, that is 2 hundredths of one percent, at the moment.

Treasury yields declined to record lows, with two-year notes dropping below 1 percent for the first time, as global stocks slumped and a deepening recession drove investors to the safest assets.

Yields on two- and five-year notes and 30-year bonds dropped to the least since the Treasury began regular issuance of the securities. Ten-year note yields touched the lowest since 2003 after yesterday’s release of the minutes of last month’s Federal Reserve meeting showed policy makers expect the economy to contract through the middle of 2009 and more interest-rate cuts may be needed to counter deflation.

Investors turned to government debt as recessions in the U.S., Europe and Japan hurt corporate earnings and drove prices of shares, commodities and real estate lower. Stocks declined worldwide, with the MSCI World Index losing 2.4 percent.

Longer Maturities

The 30-year yield fell as much as 21 basis points to 3.70 percent, the lowest level since regular sales started in 1977. Yields on five-year notes declined to 1.93 percent, not seen since 1954, according to data compiled by Bloomberg and the Fed.

Treasury Bill Rates

Two-year notes returned 6.5 percent in 2008, compared with 7.5 percent last year, according to indexes compiled by Merrill Lynch & Co. The yield declined from 3.11 percent on June 13, the highest level this year.

Rates on three-month bills dropped to 0.02 percent. That equals the level reached after the collapse of Lehman Brothers Holdings Inc. on Sept. 17, the lowest since the start of World War II.

Fed officials lowered their economic-growth estimates to zero to 0.3 percent for 2008, from 1 percent to 1.6 percent previously, the median forecast of Fed governors and district- bank presidents showed. The predictions for GDP next year ranged from a contraction of 0.2 percent to growth of 1.1 percent. The jobless rate is projected to be 7.1 percent to 7.6 percent.

Derivatives contracts tied to the value of the yen have helped drive down 10- and 30-year interest-rate swap spreads as the Japanese currency rallies against the dollar, Ahrens said. The yen has gained 12 percent since September as investors purchase the currency to repay loans made in Japan in order to unwind investments in higher-yielding assets.

Paulson’s Decision

The price to exchange, or swap, floating for fixed-rate payments for 30 years fell below the yield on similar maturity Treasuries by the most ever as dealers hedged against risk related to derivatives, Ahrens said. The yield on the 30-year bond was as much as 51 basis points higher than the 30-year swap rate. The swap rate has remained below the long bond’s yield since Nov. 5.

The gap between 10-year swaps and the 10-year note yield reached as low as 6 basis points, the narrowest since at least 1988, when Bloomberg data began tracking the instruments.

Yields have hit record lows since Treasury Secretary Henry Paulson said on Nov. 12 he would abandon plans to use the Troubled Asset Relief Program to buy mortgage assets from banks. The London interbank offered rate has spiked 11 basis points in the three days after Paulson’s shift. Before Paulson’s announcement Libor, which banks charge each other for three- month loans in dollars had fallen for 23 straight days.

“Changing the terms of the TARP as suddenly as he did undermined investor confidence,” said Richard Schlanger.

Investors erased more than $33 trillion from global stock markets this year as the U.S., Europe and Japan slipped into recession.

Breakeven rates, which show the difference in yields between inflation-linked and nominal bonds, suggest traders are betting the U.S. economy may face deflation over the next two years. The two-year U.S. breakeven rate was minus 4.09 percentage points.

“You have the cloak of a declining inflationary environment,” said Tom Tucci, head of U.S. government bond trading in New York at RBC Capital Markets, the investment- banking arm of Canada’s biggest lender. “People are denying it, but we are mirroring the whole Japanese situation and if that’s the case interest rates are going to go a lot lower.”

Credit rating downgrades are going on, adding fuel to fire. Though of course, it’s the natural outcome of past’s complacency, and the rating agencies should not be blamed for downgrading these firms now, but for not having downgraded them before.

Macy’s Inc., the second-biggest U.S. department-store company, is headed into the holidays facing the possibility of losing its 11-year-old investment-grade rating.

Macy’s debt has started trading like a junk bond, a signal that ratings companies may demote the owner of Bloomingdale’s department stores to non-investment grade. That would increase the company’s cost of raising funds at a time when capital is increasingly difficult to come by and the retailer is preparing for about $1 billion in 2009 debt repayments.

“The last thing Macy’s needs at this point is a downgrade,” Pete Hastings, a fixed-income analyst with Morgan Keegan & Co. in Memphis, said today. “They’ve got enough trouble the way the economy is going, and this would just make things tougher for them.”

Junk Territory

The extra yield, or spread, that investors demand to own Macy’s 5.35 percent notes due 2012 instead of similar-maturity Treasuries was more than 15 percentage points yesterday, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

That was greater than the 13.2 percentage-point spread on non-investment-grade BB rated bonds, according to Merrill Lynch & Co. index data. The spread on J.C. Penney Co.’s similarly rated debt due 2023 was 765 basis points. A basis point is 0.01 percentage point.

Moody’s Investors Service said Oct. 15 that it had a “negative” outlook on Macy’s Baa3 rating — the lowest investment grade — meaning it was more inclined to downgrade the retailer. Standard & Poor’s Corp. did the same on Oct. 10. They may next put Macy’s on review for a downgrade, or simply cut ratings without the interim step.

`Not Ordinary Times’

“Ordinarily they wait until the holiday season is over to make changes to retailing ratings, but these are not ordinary times,” Carol Levenson, an analyst with Gimme Credit LLC in Chicago, said Oct. 15. “Given the agencies’ waning credibility in other areas, they may be quicker to pull the trigger on marginal names such as Macy’s than they would have been before the credit crisis.”

The company plans to pay off debt due next year with cash and may use its $2 billion credit facility, he said. It has borrowed $150 million, he said.

That plan may impair the retailer, Hastings said in a telephone interview.

“If they use cash on the balance sheet to reduce debt to keep the investment grade, they would have less flexibility to weather the downturn,” he said.

Sales at stores open at least a year may fall as much as 6 percent in the fourth quarter, after dropping in 10 of the last 11 quarters, Macy’s said.

A rating downgrade can depresses demand for bonds because some funds prohibit investing in junk. The rating increases borrowing costs by forcing the company to offer investors a higher interest rate to assume more risk.

Macy’s would be joining General Motors Corp. and a growing number of so-called fallen angels — former investment-grade companies. There were 40 as of Nov. 11, compared with 29 a year earlier, according to an S&P report. Fifty-seven more, including Macy’s, are at risk of being downgraded to speculative grade, S&P said.

Macy’s, which runs more than 850 stores, has $350 million of bonds coming due in April and about $600 million in July, according to data compiled by Bloomberg.

The retailer’s ratio of debt to earnings before interest, taxes, depreciation and amortization — a measure of earnings that the credit rating companies track — rose to 3.17 times in the third quarter, from 3.04 times a year earlier. Junk-rated Sears has a ratio of 1.82.

Will Citigroup survive this crisis? It depends entirely on the government. If the government shows hesitancy, they are doomed.

Citigroup Inc. fell as much as 25 percent in New York trading, after losing almost a quarter of its value yesterday, as concern intensified that the U.S. recession will generate losses and weaken demand for financial services.

Citi, down for eight of the past nine trading days, declined 81 cents to a 13-year low of $5.59 on the New York Stock Exchange at 1:09 p.m. The stock, which fell as low as $4.76, slumped even after Saudi billionaire Prince Alwaleed bin Talal said he would boost his stake in the New York-based bank.

Chief Executive Officer Vikram Pandit said this week Citigroup will cut 52,000 jobs in the next year, double the target announced in October, as loan losses surge and the economy shrinks. JPMorgan Chase & Co., the largest U.S. bank, plans to fire about 10 percent of its investment-banking staff, or about 3,000 people, a person familiar with the bank said today. Its shares dropped $3.35, or 12 percent, to $25.12.

Citigroup has lost about $20 billion in the past four quarters as bad loans increased and demand for banking services declined. Analysts surveyed by Bloomberg expect a $673 million deficit for the fourth-quarter.

U.S. Aid

The world’s biggest finance companies have taken almost $1 trillion in writedowns and losses since the credit markets seized up last year. The U.S. has injected more than $200 billion into the top U.S. banks and insurance companies to shore up their finances, and analyst Paul Miller at FBR Capital Markets in Arlington, Virginia, said as much as $1 trillion may be needed.

Jobs, Cars

The U.S. unemployment rate rose to 6.5 percent in October, the highest since 1994, as companies slashed payrolls, the Labor Department said this month. Auto sales plunged 32 percent, manufacturing contracted at its fastest pace in 26 years and consumer confidence fell by the most on record during the month.

The irrational and disastrous expansion of the TARP is continuing. The latest is GMAC. It is obvious that if he could, Mr. Bernanke would save the entire wreck of the financial system of today, and perpetuate it to the next decade. Sadly for him, but fortunately for the US, I suspect that even he can’t save the reckless lenders of these years.

-GMAC LLC, the largest lender to General Motors Corp. car dealers, has applied for status as a bank holding company so it can get access to the Treasury’s $700 billion rescue fund for the financial industry.

The lender also began an exchange offer for $38 billion of notes issued by the company and its Residential Capital LLC home lending unit to reduce outstanding debt levels, Detroit-based GMAC said today in a statement.

GMAC joins money-losing commercial lender CIT Group Inc. in trying to shore up its finances to gain bank status. That may help GMAC quell doubts about its survival after home foreclosures pressured the mortgage unit and GM’s auto sales plummeted to the worst level since 1945. GMAC may also be able to obtain U.S. government guarantees on new debt as a bank.

“If you let this many people participate, the benefit gets so diluted you haven’t done a lot of good,” said Peter Sorrentino, a senior portfolio manager at Cincinnati-based Huntington Asset Advisors. “You can’t save everybody. That’s the hard call.”

Meanwhile the future of GM looks more ominous by the day. The issue is whether it can survive until the next handout under the Obama administration. It’s unclear to me, whether they can do so.

General Motors Corp., the largest U.S. automaker, probably has weeks rather than months left before it runs out of cash without federal aid, said Jerome York, an adviser to billionaire Kirk Kerkorian and former GM board member.

Chief Executive Officer Rick Wagoner “all but said” at congressional hearings in the past two days that GM can’t continue to operate until a new U.S. administration takes over in January, York said in a Bloomberg Television interview today.

GM, Ford Motor Co. and Chrysler LLC should develop a detailed plan for sustained operations and present it to Congress as a condition of receiving support, with “chains” rather than “strings” attached, York said.

U.S. lawmakers after hearing from Wagoner, Ford chief Alan Mulally and Chrysler CEO Robert Nardelli remain deadlocked on an auto-industry bailout. Democratic congressional leaders disagreed with Republicans and President George W. Bush’s administration over how to provide $25 billion in aid to the three companies, with just two days left in Congress’ lame-duck session.