As I have mentioned here before, the Tarp is not enough to resolve anything, and Paulson himself seems to have acknowledged this fact today. In a move that is prudent and proper, the Treasury has decided to use half of the authorized funds for bank rescues in buying securitized consumer loans, such as credit cards, auto loans, and others. Of course the causes that necessitated the use of those funds for the previous purposes have not evaporated, and  I believe that the Tarp will have to multiplied a number of times, before it is in any way able to alleviate any of the problems in the economy.

What we now see is really nothing other that the actualization of a process which I outlined in a series of articles right after the collapse of Lehman. The cascade effect of the collapse of the US economy will hit every nation in the world. Note that the implosion of the US consumer’s spending is only now beginning. It’s therefore a certainty that we’re going to see a lot more national and international bankruptcies in the coming year and beyond.

And finally, the dream of getting private buyers back to the  securitized credit markets, or having them assume some of the risks of the troubled mortgage paper is a dream, nothing more. It’s simply unthinkable than any investor will dip his feet into that inferno, and the speculators who had have already evaporated .

U.S. Treasury Secretary Henry Paulson plans to use the second half of the $700 billion financial rescue program to help relieve pressures on consumer credit, scrapping an effort to buy devalued mortgage assets.

“Illiquidity in this sector is raising the cost and reducing the availability of car loans, student loans and credit cards,” Paulson said today in a speech at the Treasury in Washington. “This is creating a heavy burden on the American people and reducing the number of jobs in our economy.”

Paulson’s remarks are an acknowledgement that the pitch he made to Congress for the bailout hasn’t delivered what was promised.

Treasury and Federal Reserve officials are exploring a new “facility” to bolster the market for securities backed by assets, Paulson said, adding that the program would be “significant in size.” Officials are considering using a portion of the bailout money to “encourage private investors to come back to this troubled market,” he said.

Private Capital

The Treasury chief said the department is also considering having companies that accept new taxpayer funding get matching private capital. Buying “illiquid” mortgage-related assets — the reason the program was established a month ago — is no longer being considered, he said.

Paulson has committed all but $60 billion of the initial $350 billion allocated by Congress to take equity stakes in banks and in insurer American International Group Inc. Lawmakers, who could reject Treasury requests for the remaining $350 billion, are pushing for aid to automakers including General Motors Corp. Paulson is resisting.

Paulson said he has no timeline for notifying Congress of his intent to use the remaining TARP funds, and reiterated that he’s “comfortable” that $700 billion is “what we need” to stabilize the financial system.

Paulson’s change in plans sent U.S. home-loan bonds without government backing down to new lows, credit default swap indexes suggest.

The ABX-HE-PENAAA 07-2 index of swaps tied to subprime-loan bonds rated AAA when created in the first half of 2007 dropped about 8 percent to a mid-price of 42, according to a note to clients today from Goldman Sachs Group Inc. The level suggests the bonds might fetch about 42 cents for each dollar of unpaid balances.

More on the credit card and auto-loan markets:

Currently, there is $356.3 billion in credit card asset- backed debt outstanding, with $256.3 billion in student-loan securities and $199 billion in auto loan borrowing,

`Broad Impact’

In the CPFF, which began last month and purchased $244.6 billion of the short-term debt through Nov. 5, the Fed set up a limited-liability company to buy the assets. The Fed is funding the facility at the target federal funds rate, currently 1 percent, and Treasury provided a $50 billion deposit. It is thought that the new facility will have a similar structure.

Seize Assets

Paulson said lending through the new consumer credit bailout  program would be on a non-recourse basis, meaning the government wouldn’t have rights to seize other assets should a borrower default.

The Fed’s program that lends to banks to buy asset-based commercial paper from money-market mutual funds had $85.1 billion in non-recourse loans outstanding as of Nov. 5.

Credit-card companies were shut out of the market for bonds backed by customer payments in October for the first time in more than 15 years, Wachovia Corp. data showed. Issuers sold $17.1 billion of the debt in October 2007. Top-rated credit card-backed securities maturing in three years traded at a premium of 500 basis points over Libor, last week, up 25 basis points over the previous week,. The debt was trading at 50 basis points more than Libor in January.

`Dramatic Fall’

I doubt that this is going to have a big offset to the really dramatic fall in consumer spending that we’re going to see over the coming year,” in part because of a $10 trillion slump in home values, Feldstein said of the new lending program.

Ford Motor Co., GMAC LLC and Chrysler LLC were shut out of the market for bonds backed by auto loans for the fifth straight month in October. Sales of auto bonds slumped to $500 million, compared with $9 billion in October 2007, according to Merrill Lynch & Co. data.

More Aid

House Financial Services Committee Chairman Barney Frank proposed giving $25 billion in additional aid to GM, Ford and Chrysler. He told reporters today that legislation is needed to authorize the Treasury to put money into the automakers.

Distressed sales of commerical real estate are going to increase dramatically, this article from Bloomberg says. Of course, 2006 and to a lesser extent 2007 were some of the laxest years of commercial real estate loan standards. What this means is that there will be a lot more writedowns for what remains of the US banking system:

Distressed sales of commercial real estate may rise in 2009 as about $36 billion in securitized loans written in 2006 and 2007 come due, an executive of Grubb & Ellis Co. said today.

That figure will grow to $55 billion of commercial mortgage- backed security debt due in 2012, triggering delinquencies, defaults and forced sales, said Glen Esnard, president of capital markets for the Santa Ana, California-based real estate services firm., citing research by JPMorgan Chase & Co.

“A lot of that debt is not refinanceable at its current level or current rate,” Esnard said at a briefing for reporters today in New York.

Sales of commercial properties in the U.S. have fallen 72 percent this year through October, Real Capital Analytics Inc., a property research firm, said last week, as the global credit crisis made financing for acquisitions scarce.

Loans made to be sold into the CMBS market were the predominant form of financing for commercial real estate buyers between 2004 and 2007, when U.S. commercial property prices rose almost 60 percent, according to the Moody’s/REAL Commercial Property Price Index. That index has fallen 13 percent since peaking in November 2007.

Qualcomm says it won’t hire anyone else:

Qualcomm Inc. Chief Executive Officer Paul Jacobs said he’s stopped hiring and is eliminating some research projects after a “dramatic” contraction in chip orders from mobile-phone makers.

“We have basically shut off our new hiring growth,” Jacobs said in an interview in New York today. “Before it was, `Let’s let a thousand flowers bloom,’ now we’re going to do a bit of pruning. We’ve shut down some projects.”

Jacobs, who heads the biggest maker of mobile-phone chips, said orders dropped off in October because handset manufacturers cut back on their stockpiles of unused parts, a reduction that will last for about two quarters. Consumer demand for mobile phones with Qualcomm chips is holding up, he said.

“The end-user market, while it’s slowing a little bit, isn’t that dramatic,” said Jacobs, 46. Still, there is “some uncertainty” in the company’s earnings projections.

Revenue this quarter may fall as much as 6 percent from a year earlier, the first decline in seven years, Qualcomm said last week. Annual sales increased 22 percent on average in the past six years as Qualcomm benefited from increasing use of its chips in mobile phones that provide high-speed Internet access.

Qualcomm, based in San Diego, fell $2.50, or 7.1 percent, to $32.57 at 4 p.m. New York time on the Nasdaq Stock Market. The stock has declined 17 percent this year.

While Jamie Dimon, head of JPMorgan says that the recession may be worse than the credit crisis:

JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon said the U.S. recession “could be worse” than the credit-market crisis that brought lending to a standstill.

Rising unemployment and the process of de-leveraging by financial companies may bring on a “deep” recession in the U.S., Dimon, 52, said today. “We are prepared for a difficult environment.”

JPMorgan, the largest U.S. bank by market value, will add about $2.4 billion in reserves to cover bad loans in the fourth quarter as losses on credit cards and home loans continue, Dimon said. The U.S. unemployment rate rose to 6.5 percent in October, the highest level since 1994, 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.

Still, Dimon said there is reason for optimism about prospects for the economy. “We’re not running this company like we have a Great Depression,” he said. JPMorgan continues to invest in businesses that benefit clients, including advisory work and raising money for corporations, he said.

Shares Decline

Goldman Sachs Group Inc., where Paulson was CEO before joining the Bush administration, predicted the deepest economic contraction since 1982 for the fourth quarter. The New York- based firm said the jobless rate may jump to 8.5 percent by the end of next year.

Banks and securities firms worldwide have taken $929 billion in losses, writedowns and credit provisions since the beginning of 2007, according to Bloomberg data. Firms have raised $819 billion in capital to offset the losses.

“We think the economy could be worse than the capital- markets crisis,” Dimon said. “You really need to separate them because they have completely different effects on our businesses and on most businesses.”

Consumer Loans

Dimon said JPMorgan continues to lend money to consumers. Loans to some types of corporate clients and in the investment bank have increased by $8 billion since the end of the third quarter, he said. Loan balances across the business lines have climbed $24 billion.

The bank also expects to post a $500 million loss on private-equity investments during the quarter, Dimon said.

JPMorgan announced a plan last month to assist 400,000 families with $70 billion in troubled mortgages in the next two years. An additional 250,000 families with $40 billion in mortgages have already been helped under existing loan- modification programs.

JPMorgan is the third-largest mortgage originator in the country with 13.6 percent of the market as of Oct. 31, according to Inside Mortgage Finance data. The lender has reduced volume 17 percent compared with an industrywide contraction of 56 percent since the beginning of 2007.

Not even the so-called super-rich are immune anymore:

Exclusive ski and golf community Yellowstone Club, in Montana, has filed for bankruptcy protection, a sign that the financial crisis roiling the real estate and leisure industries is not limited to the low end of the market.

The club, in the pristine mountain area around Big Sky, Montana, not far from Yellowstone National Park, is part resort and part residential community for the super-rich.

It advertises housing lots on the sides of its ski slopes and golf course at prices ranging from $2 million to more than $6 million.

In a filing made in federal bankruptcy court in Montana on Monday, Yellowstone Mountain Club LLC filed for Chapter 11 bankruptcy protection, listing assets and liabilities in the range of $100 million to $500 million.


The news clips are from Bloomberg and Reuters




The Tarp is a mistake, and it is very likely to fail. Why? Because it is like trying to extinguish a fire without first shutting down the gas supply. The Fed is throwing money at institutions which are burning it at an alarming rate, and is it hoping that it can thusprevent the financial system from collapsing. But is the financial system itself the cause of the turmoil? Is it really a lack of liquidity, the irrational unwillingness of the banking system to lend which lies at the root of the problem? If indeed this was the case, flooding the system with liquidity, a few rescues and some emergency lending by the Fed should have already contained the problem. The crisis of 1998, which was not born of the long-term weaknesses of the system, was more or less dealt with by means of the aforementioned measures. So why don’t these measures work now, will they? 


For reasons that I have stated in previous posts, and for others that I will also expound on today, I am confident that the Fed and the Treasury’s extreme and heavy-handed measures  will have no effect at all in solving this crisis. At best we can hope that they will reduce the severity, and lengthen the course of some of the worst aspects of the crisis.


If we carefully examine all the steps that have been taken so far, we notice that they are mostly aimed at alleviating the pains of financial institutions. The Fed’s facilities, the Tarp, the bailouts, all these have one purpose in mind, and that is to allow the firms that dominate the financial system today to survive the calamitous phase of this crisis, and, one would assume, thereby to prevent a severe and general evaporation of confidence in the US financial structure.


The counter-intuititive, and anti-capitalistic nature of these measures aside, there’s one crucial aspect that appears to be ignored by many of the commentators in visual and print media. It is that all the solutions that have been offered by the govenment are ad-hoc and anti-symptomatic in that not even one of the purported panaceae to  the ills of the financial system aims at curing the causes and the uprooting the base of the crisis: overleveraged consumer defaulting on his obligations, unpaid mortgages causing home values to plummet, and the consequent collapse in economic activity which causes unemployment to rise, and leads the other factors to intensify in effect, and perpetuates them.


What is the wisdom of bailing out banks, when the rising lists of foreclosed homes adds non-stop to the burden of write-downs? Wouldn’t it be far more prudent to spend all these sums in rescuing, or bailing out the subprime borrower, and the reckless overleveraged consumer? In other words, isn’t it wiser to first cut off the gas supply, before trying to extinguish the fire with buckets of water?   


I’d like to ask the reader the wisdom of lending free and unlimited cash to all banks when the failure of the bankrupt consumer and corporate sector to pay their debts is essentially creating a depthless black hole in the balance sheets of these financial institutions. Is it not clear, at this stage, to every prudent individual in the world, that we’re only at the beginning of the reversal of the debt cycle, and that the consumer especially is on an irreversible journey to the bankruptcy court? Is it not obvious, by now, after two decades of toying with monetary policy, that loose money is completely useless in solving any problem as long as the fundamental, underlying issues are not addressed and resolved first? Do we need another collapse in the US, probably in the credibility and credit of the US government, before we understand that financial folly, borrowing without worrying about repayment, and spending without looking at the bill, are a sure recipe to doom and mayhem? The US consumer borrowed without worrying how he’d pay back, now he’s in the process of going bankrupt. The US government is now doing the same, should we really expect that the outcome will be any different in the end?


Is the American public so delirious that it will entrust the future of this country to a group of people at the Federal Reserve whose credibility has been torn to shreds by their own record, and whose only promise, only solution to any problem is just creating more money?


Whether it is me and the likes of myself, or the Fed, and their learned supporters who are deranged and deluded about what they propose, will be seen in all clarity in a few years. And this, at least, is a source of consolation.




Here’s an article from the New York Times, November 10th.



Almost 90 percent of homeowners in Mountain House, Calif., owe more on their mortgages than their houses are worth.

Because of plunging home values, almost 90 percent of homeowners here owe more on their mortgages than their houses are worth, according to figures released Monday. That is the highest percentage in the country. The average homeowner in Mountain House is “underwater,” as it is known, by $122,000.


A visit to the area over the last couple of days shows how the nationwide housing crisis is contributing to a broad slowdown of the American economy, as families who feel burdened by high mortgages are pulling back on their spending.


Jerry Martinez, a general contractor, and his wife, Marcie, an accounts clerk, are among the struggling owners in Mountain House. Burdened with credit card debt and a house losing value by the day, they are learning the necessity of self-denial for themselves and their three children.


No more family bowling night. No more dinners at Chili’s or Applebee’s. No more going to the movies.

“We make decent money, but it takes a tremendous amount to pay the mortgage,” Mr. Martinez, 33, said.

First American CoreLogic, a real estate data company, has calculated that 7.6 million properties in the country were underwater as of Sept. 30, while another 2.1 million were in striking distance. That is nearly a quarter of all homes with mortgages. The 20 hardest-hit ZIP codes are all in four states: California, Florida, Nevada and Arizona.


“Most people pay very little attention to what their equity stake is if they can make the mortgage,” said First American’s chief economist, Mark Fleming. “They think it’s a bummer if the value has gone down, but they are rooted in their house.”

And yet the magnitude of the current declines has little precedent. “When my house is valued at 50 percent less than it was, does this begin to challenge the way I’m going to behave?” he said.


Mountain House, a planned community set among the fields and pastures of the Central Valley about 60 miles east of San Francisco, provides a discomfiting answer.


The cutbacks by the Martinezes and their neighbors are reflected in a modest strip of about a dozen stores in nearby Tracy. Three are empty while a fourth has only a temporary tenant. Some of those that remain say they are just hanging on.


“Before summer, things were O.K. Not now,” said My Phan of Hailey Nails and Spa. “Customers say they cannot afford to do their nails.” She estimated her business had fallen by half.


At Cribs, Kids and Teens, Jason Heinemann says his business is also down 50 percent. He opened the store in early 2006; last month was his worst ever. “Grandparents are big buyers of kids’ furniture, but when their 401(k)’s are dropping $10,000 and $20,000 a week, they don’t come in,” he said.


Mr. Heinemann laid off his one employee, a contribution to an unemployment rate in San Joaquin County that has surpassed 10 percent. He dropped his advertising in the local newspaper and luxury magazines.


As Mr. Heinemann’s sales sink, he is tightening his own belt. “I used to be a big spender,” he said. “We’re setting a budget for Christmas.”


In the window of another tenant, Wells Fargo Home Mortgage, a placard shows two happy homeowners holding a sign saying, “Someday we’ll owe a lot less than we thought.”


Someday, maybe, but not now. First American has been refining its figures on underwater mortgages, formally known as negative equity. The data company evaluated 42 million residential properties with mortgages. (Though Maine, Mississippi, North Dakota, South Dakota, Vermont, West Virginia and Wyoming were excluded because of insufficient data, none of those states have been central to the mortgage crisis.) A computer model was used to calculate current values, using comparable sales. More than 10 million homes do not have mortgages.


The figures rank the 20 ZIP codes that are furthest underwater. The 95391 ZIP code, which includes all of Mountain House and some properties outside it, has the unwelcome distinction of being first in the country.


Out of 1,856 mortgages in the ZIP code, First American calculates that nearly 90 percent are underwater. Only 209 owners owe less on their mortgages than the homes are worth.



The government may well have to bail out the state of California in the next step.

This website declared a few days ago the Fed offers unlimited funding to institutions which it knows are bankrupt, but demands punitive interest in return, which it probably knows cannot be repaid.” Here are the latest developments on this matter:

American International Group Inc. got a $150 billion government rescue package, almost doubling the initial bailout of less than two months ago as the insurer burns through cash at a record rate. The Fed will reduce the $85 billion loan to $60 billion, buy $40 billion of preferred shares, and purchase $52.5 billion of mortgage securities owned or backed by the company. The interest rate on the $60 billion credit line will be reduced to the three-month London interbank offered rate plus 3 percentage points, from a previous spread of 8.5 percentage points in the original rescue plan.  The original $85 billion loan was disclosed on Sept. 16, a day after the collapse of  Lehman Brothers. AIG later received an additional $37.8 billion credit line on Oct. 8 to shore up its securities-lending program and then another $20.9 billion on Oct. 30 under the Fed commercial paper program designed to unlock short-term debt markets. AIG has about $5.6 billion left unused in the CPFF. The company renewed doubt about its prospects today by saying in a federal filing that it might not survive.

AIG has posted a $24.5 billion third- quarter loss today. The insurer has posted about $43 billion in quarterly losses tied to home mortgages. Edward Liddy’s plan to repay the original $85 billion loan by selling units stalled as plunging financial markets cut into their value and hobbled potential buyers.

“It was obvious to me from Day One that the terms of that arrangement were really quite punitive in terms of the interest rate and the commitment fee and the shortness of it,” Liddy said today in a Bloomberg Television interview. “I started really about a week after I got here trying to renegotiate.”.

AIG’s third-quarter loss equaled $9.05 a share and compared with profit of $3.09 billion, or $1.19, a year earlier, AIG said in a statement. Losses in the past year erased profit from 14 previous quarters dating back to 2004.

The revised rescue may fix two AIG operations that are draining cash because of the collapse of subprime mortgage markets. In the first, the U.S. will provide as much as $30 billion to help buy the underlying assets of credit-default swaps that AIG sold to investors, including banks. AIG will contribute $5 billion and bear the risk of the first $5 billion in losses, the Fed said.

Credit-Default Swaps

The insurer guaranteed about $372 billion of fixed-income investments in CDS as of Sept. 30, compared with $441 billion three months earlier. AIG booked more than $7 billion in writedowns during the quarter on the value of the swaps.

The New York Fed also will lend as much as $22.5 billion to a new limited-liability company to fund the purchase of residential mortgage-backed securities from AIG’s U.S. securities-lending collateral portfolio. AIG will make a $1 billion subordinated loan to the new entity and bear the risk for the first $1 billion of any losses, the Fed said. The securities lending operation and the previous $37.8 billion credit line from the Fed will be shut down, AIG said.

Securities lending accounted for $11.7 billion, or about two-thirds, of the $18.3 billion in impaired investments in the third quarter, AIG said.

The biggest insurers in North America posted more than $120 billion in writedowns and unrealized losses linked to the collapse of the mortgage market from the start of 2007, with AIG representing about half that total. The company has units that insure, originate and invest in home loans.

What’s the new one-year price target for GM? It’s zero, according to Deutsche Bank. GM is one of the best suited companies in the US for bankruptcy, as it hasn’t posted an annual profit since 2004 and its sales in the U.S. have declined every year since 1999. On what kind of capitalistic basis can the US government justify the saving of such a company? If it offers any great danger to the system, than it should be dismantled gradually. But to save it, and to allow it to exist as a living corpse is entirely against all the principles of a free market economy.

General Motors Corp. plummeted as much as 31 percent and moved toward its lowest level in 62 years after a Deutsche Bank AG analyst downgraded the shares, saying they may be worthless in a year.

“Even if GM succeeds in averting a bankruptcy, we believe that the company’s future path is likely to be bankruptcy-like,” Deutsche Bank’s Rod Lache wrote today in a note which recommended selling the shares and cut his 12-month price target to zero. He previously advised holding the stock.

Barclays Capital and Buckingham Research Group cut their price targets for GM to $1.

Government Support

This weekend, U.S. House Speaker Nancy Pelosi of California and Senate Majority Leader Harry Reid of Nevada wrote to Treasury Secretary Henry Paulson in order to urge that bank-bailout funds be opened up for loans to automakers. As Rahm Emanuel, chief of staff to President-elect Barack Obama, said the U.S. auto industry is “essential” to the economy, the White House signaled its opposition, saying aid to the industry wasn’t discussed during the debate on the banking bailout. Congress may take up automaker assistance when it returns next week.

GM, in a regulatory filing today said “Based on our estimated cash requirements through December 31, 2009, we do not expect our operations to generate sufficient cash flow to fund our obligations as they come due, and we do not currently have other traditional sources of liquidity available to fund these obligation.”

Implied volatility for GM options exceeded 300, a level Lehman Brothers Holdings Inc. topped before its bankruptcy filing and American International Group Inc. reached prior to the U.S. government’s bailout.

The particular case of GLG is related to Lehman, and thus its troubles are not that unexpected. However, we keep getting reports of more hedge funds freezing client withdrawals, as their debt-financed business model appears to have lost its credibility in the eyes of many investors:

GLG Partners Inc. limited client withdrawals from the $2.9 billion GLG European Long-Short Fund so it isn’t forced to sell selected investments that have tumbled in price, people familiar with the matter said. The fund, the London-based firm’s largest, segregated the securities in an account called a side-pocket, where it plans to hold them until values recover. Investors’ redemption requests will be reduced because the fund has fewer assets available for sale to raise cash.

GLG, which oversees $17 billion, took a similar step last month with its Emerging Markets Fund. GLG said last week it suspended redemptions from its Market Neutral Fund and GLG Credit Fund, also to prevent forced sales of investments.

“Hedge funds have seen and will likely see continued outflows given the market conditions,” Noam Gottesman, GLG’s chairman and co-chief executive officer, said in a call with analysts and investors today.

GLG, founded as a unit of Lehman Brothers Holdings Inc., said today that third-quarter profit excluding acquisition costs fell 25 percent to $21.8 million. Assets dropped 27 percent to $17.3 billion at the end of September from $23.7 billion on June 30.

Pre-IPO Securities

The European Long-Short fund saw the percentage of assets invested in companies preparing an IPO rise as the value of its publicly traded shares dropped. Those securities couldn’t be sold at the prices the fund paid for them.

Lagrange’s fund fell 14.6 percent this year through Sept. 30, according to data compiled by Bloomberg. That compares with the average 23 percent loss by long-short funds, according to data compiled by Hedge Fund Research Inc. in Chicago.

Meanwhile despite fears of waning demand, Treasuries gained after the government’s first sale of three-year notes in 18 months attracted stronger-than-forecast demand today. So far there is no evidence of any inflation panic among investors, and the continued massive borrowings of the government may hinder some inflation being realized, as the liquidity sucked out of the markets through government auctions is lost in the clogged channels of the US banking system, where the government throws it. But it’s especially important that, from Bloomberg “indirect bidders, a class of investors that includes foreign central banks, bought 36.1 percent of the notes sold today, the most since May 2005, when they purchased 40.3 percent. Investors bid for 3.07 times the amount offered, the most since May 1998.” This data in itself is enough to ensure continued strengthening of the dollar. Indeed, that is what I expect to occur throughout next year, and possibly beyong, based on the assumption that the economic slump will be long-lasting.

Yields on two-year notes fell to an almost eight-month low. The $25 billion auction drew a yield of 1.8 percent. Today’s sale was the first of three this week totaling $55 billion, the biggest quarterly refunding in more than four years.

“It was pretty obviously a very strong auction,” said, an interest-rate strategist in New York at Barclays Capital Inc., one of the 17 primary government securities dealers required to bid at Treasury sales. “It indicates that strong demand remains for short-end Treasuries and the Treasury’s not yet being penalized for increasing supply significantly.

Yields on the benchmark 10-year note fell 4 basis points to 3.75 percent, below their 200-day moving average of 3.79 percent.

AIG Rescue

The U.S. revived the three-year note to help pay for the Treasury’s $700 billion bank-rescue plan and fund a budget deficit projected to widen from last fiscal year’s $455 billion as the economy shrinks and tax receipts slow. The Federal Reserve and the Treasury today enhanced a rescue package for American International Group Inc., almost doubling to $150 billion an initial bailout in September, as the insurer burns through cash.

The government plans to sell $20 billion in 10-year notes Nov. 12 and $10 billion in 30-year bonds Nov. 13 as part of its quarterly refunding, the biggest since February 2004. The Securities Industry and Financial Markets Association recommended trading close at 2 p.m. in New York and stay shut worldwide tomorrow for the U.S. Veterans Day holiday.

`Find a Home’

“The fear was that this particular auction was going to fare poorly because the three-year was on a short day, the holiday was coming and we have more supply coming” this week, said Tom di Galoma, head of U.S. Treasury trading at Jefferies & Co., a brokerage for institutional investors in New York. “Money has got to find a home somewhere, and there are a lot of products that don’t exist anymore or institutions that just won’t buy those products anymore.”

Goldman Sachs Group Inc. forecast the deepest recession since 1982, with the economy contracting 3.5 percent in the fourth quarter and 2 percent in the first three months of 2009.

18-Month Turnaround

It will take at least 18 months to turn around the U.S., even if President-elect Barack Obama “does everything perfectly,” Columbia University Professor Joseph Stiglitz, a Nobel Prize-winning economist, wrote in the Washington Post yesterday.

The difference between two- and 10-year yields increased to 2.50 percentage points as the shorter-maturity notes outperformed. That’s the highest since October 2003, based on closing prices.

The yield gap reached a record of 2.74 percentage points in August 2003 after the Fed finished a series of 13 rate reductions. Typically, the spread is steepest as the central bank stops lowering borrowing costs and investors anticipate an economic recovery, according to Tony Crescenzi, chief bond strategist at Miller Tabak & Co. LLC in New York.

`Remain Depressed’

“I think yields will remain depressed and continue to decline here, particularly on the front end” of the Treasury market, said Martin Mitchell, head government bond trader at the Baltimore unit of Stifel Nicolaus & Co. “The Treasury needs to fund all these bailout programs they are announcing, and that could keep pressure on the curve and keep it relatively steep, and that could present a struggle for the long end.”

The Treasury today also auctioned $27 billion in three- month bills at a rate of 0.355 percent and $27 billion of six- month bills at a rate of 0.99 percent.

After Australia, China, Japan, India, the U.S., the euro region and the U.K. all reducing interest rates within the past three weeks, there’s some improvement in the unsecured lending market. However, with the Libor-OIS spread still at an enormous 170 points, compared with a normal of just  11 basis points in the five years before the crisis started, we’re very far from a recovery in lending, and we’ll probably see even worse numbers in the coming weeks.

The London interbank offered rate, or Libor, that banks say they charge each other for such loans declined 5 basis points to 2.24 percent today, the lowest level since November 2004, the British Bankers’ Association said. The overnight rate rose 2 basis points to 0.35 percent, still 65 basis points below the Federal Reserve’s target rate. The Libor-OIS spread, a measure of banks’ willingness to lend, narrowed.

In a sign that central bank attempts to loosen credit are starting to work, interest rates on U.S. commercial paper, or CP, fell to the lowest in at least 12 years today. Rates on the highest-ranked 30-year CP dropped 16 basis points to 0.88 percent, or 12 basis points less than the Fed’s target’s rate. Average rates soared to a record 278 basis points more than the target rate on Oct. 9, according to yields offered by companies and compiled by Bloomberg since January 1996.

On the other hand, financial institutions lodged 225.5 billion euros ($288 billion) in the European Central Bank’s overnight deposit facility Nov. 7, down from 297.4 billion euros the previous day, the ECB said, indicating many banks are still reluctant to lend to each other. The daily average in the first eight months of the year was 427 million euros.

In Asia, three-month Hibor, the benchmark for Hong Kong interbank loans, dropped 10 basis points to 2.14 percent as the city’s monetary authority added funds to the system. Australian banks lowered the rate they charge each other for three-month loans by 3.7 basis points to 4.95 percent as the Reserve Bank of Australia signaled more rate cuts. A basis point is 0.01 percentage point.


There’s now speculation of widespread devaluations in emerging market currencies, and I believe that defaults in the emerging market sphere will be inevitable during the next two years. Bloomberg is reporting on Russia, but I’m much more concerned about Turkey, with its very large and worrying external deficit position, and its seemingly complacent economic leadership.  


Goldman is added to list of those who are dissatisfied with their analysts:

Goldman Sachs Group Inc., the Wall Street bank that cut 3,200 jobs, about 10 percent of its work force, last week, identified six equity analysts who were fired by the firm, including William Tanona, who covered companies such as JPMorgan Chase & Co., and Deane Dray, who followed General Electric Co.

“Goldman has always been the best, and when the best of the breed starts to weaken, it’s not a good sign for any of them,” said Joseph Saluzzi, the co-head of equity trading at Themis Trading LLC in Chatham, New Jersey. “Research was kind of a loss leader. If you’re not making money on the trading side, you can’t support the research.”

Bank and brokerages worldwide have eliminated about 150,000 jobs since the subprime mortgage market collapsed last year.

But the analysts themselves keep fluttering in Cloudcuckooland: (kudos to Aristophanes for this term)

Even after cutting estimates at the fastest rate ever, Wall Street strategists still need the biggest year-end rally in the Standard & Poor’s 500 Index for their forecasts to come true.

David Kostin of Goldman Sachs Group Inc. predicts an advance because U.S. companies are cheap relative to earnings. Strategas Research Partners’ Jason Trennert is counting on a resumption in bank lending to lift equities. Thomas Lee at JPMorgan Chase & Co. says stocks are swinging so much that a 25 percent jump by Dec. 31 isn’t out of the question. Kostin, Trennert and Lee are among the most pessimistic of Wall Street strategists with year-end estimates tracked by Bloomberg.  The average Wall Street forecast calls for the S&P 500 to break out of a bear market and surge 20 percent to 1,118 by Dec. 31 — more than twice as much as the biggest-ever advance to close out a year. Strategists were even more bullish at the beginning of the year, predicting that the S&P 500 would end 2008 at a record 1,632.

Strategists were also calling for a record gain at this time last year, after the first quarterly decline in corporate profits dragged the S&P 500 down from its high of 1,565.15 on Oct. 9. It never materialized and stocks have dropped 41 percent since.

The S&P 500 is poised for its worst year since the 1930s after almost $700 billion in bank losses froze credit markets and spurred concern the economy will shrink. U.S. equities posted the steepest monthly loss in 21 years in October and $6 trillion was erased from U.S. markets in 2008.

The strategist who cut his projection the most since September was Deutsche Bank AG’s Binky Chadha. Chadha abandoned his year-end call for the S&P 500 to reach 1,350, decreasing it on Nov. 7 to as low as 800 and becoming the first strategist to acknowledge the possibility that stocks may fall for the rest of the year. Chadha, previously one of Wall Street’s biggest bulls, declined to comment through spokeswoman Renee Calabro.

Fair Value                                          

Merrill Lynch & Co.’s Richard Bernstein also reduced his forecast last week. “Severe overvaluation at the end of August is correcting,” wrote Bernstein, who doesn’t provide a year-end estimate, on Nov. 4. “Our models are still working their way back to fair value.”

The rate at which strategists are reducing their estimates is a sign equities are close to a nadir, some investors say.

“The U.S. is going to be the first market out of the bottom,” Barton Biggs, a former Morgan Stanley strategist who now runs Traxis Partners LLC, a New York-based hedge fund, said on Bloomberg Television. “We’re at a major buying opportunity.”

And this is also where my 500 target for the S&P 500 in 2009 comes from: The S&P 500 trades at 10.39 times next year’s estimated earnings from continuing operations, compared with the weekly average of 21.1 times historical operating profit over the past decade, says Bloomberg. The key phrase here, is, of course, “estimated”. With the “analysts” performing with the accuracy of a coin toss, or a dice roll, it’s only a matter of time before the estimates are reduced to much lower levels, and that is when even todays P/E ratios will appear expensive. There’s some time for all this, but at least I’m quite confident in what I expect from next year.

And finally:

The state agency that runs New York City’s buses and subways may raise fares next year by more than the 8 percent it had previously proposed and implement deeper service cuts amid a swelling deficit.

The Metropolitan Transportation Authority needs to find ways to fill a budget gap that may widen by a third from a July projection to as much as $1.2 billion in 2009. The agency is facing lower projected tax revenue, higher debt costs and less money from fares as ridership is forecast to drop because of the climbing unemployment rate in the New York metropolitan area.

All news clips are from Bloomberg.

Bankruptcies of shipping companies are highly likely to rise in the coming months, as their profit margins collapse with the collapsing price of commodities. Today crude settled around 60 dollars.

 DryShips Inc., a transporter of commodities including iron ore and coal, dropped $4 to $15.30 in Nasdaq Stock Market composite trading. The shares have fallen 80 percent this year, reducing its market value to $666 million, after saying that it may not be able to raise enough money to pay off loan commitments if low charter rates continue, The company said it may sell as much as 25 million shares from time to time to help raise capital.

The company had $2.9 billion in debt at the end of the third quarter, according to a Nov. 3 earnings release.

The Baltic Dry Index, a measure of shipping costs for commodities, has fallen 91 percent this year due to a global economic slowdown and slowing international trade amid tight credit markets.

“We are especially concerned about the company’s compliance under its debt covenants, specifically its value maintenance covenants, given the potential for a fall in secondhand asset values in this weak market environment,” Natasha Boyden, an analyst at Cantor Fitzgerald LLC in New York, said today in a note to investors. She cut her rating on the company to “hold” from “buy.”

The stock market keeps on with its collapse, as central banks keep slashing rates to calm the speculators. They will probably keep falling until the end of December. There may be a brief rally then, but there may be not. What is certain is that the stock markets will keep losing value next year, along with most other asset classes:

U.S. stocks slid, sending the market to its biggest two-day slump since 1987, after jobless claims jumped and the shrinking economy crushed earnings.

 “We’re a long way from the end of the economic challenges,” said Mike Morcos, who helps manage $1 billion at Old Second Wealth Management in Aurora, Illinois. “Earnings next year are going to be significantly lower and estimates are going to continue to come down.”

The Standard & Poor’s 500 Index fell 5 percent to 904.88, extending its two-day loss to 10 percent. Switzerland’s central bank and the European Central Bank reduced their main lending rates by 50 basis points.

The S&P 500 is down 38 percent this year, poised for the steepest annual retreat since 1937. The VIX, as the Chicago Board Options Exchange Volatility Index is known, climbed 17 percent to 63.68.

Worries about General Motors viability keep intensifying:

GM’s Survival

General Motors Corp. had the steepest decline in almost a month, tumbling 14 percent to $4.80. The largest U.S. automaker is focused on winning government aid to survive through 2009, not to help a merger with Chrysler LLC, as it uses cash faster than it forecast, people familiar with the plans said. GM plans to give an update on liquidity when it reports third-quarter results tomorrow.

Blackstone tumbled $1.05 to $7.55 after the financial crisis eroded the value of the businesses and real estate it has acquired, triggering a quarterly loss excluding items of $502.5 million. Blackstone had been expected to break even, based on the average estimate of seven analysts in a Bloomberg survey.

As analysts continue to expect profit growth from 2009:

Companies in the S&P 500 may see fourth-quarter earnings advance 15 percent, down from 42 percent projected at the end of August, according to a Bloomberg survey of analysts. Profits in 2009 may grow 13 percent, analysts say, compared with the 24 percent predicted two months ago.

Meanwhile hedge fund clients continue to withdraw their funds, forcing more firms to liquidate. Clients worldwide may pull as much 25 percent of their money from hedge funds by the end of the year, according to a Morgan Stanley report of Oct. 24.

Platinum Grove Asset Management LP, the hedge-fund firm co-founded by Nobel laureate Myron Scholes, temporarily stopped investor withdrawals from its biggest fund after it lost 29 percent in the first half of October. The decline left Platinum Grove Contingent Master fund with a 38 percent loss this year through Oct. 15, according to investors. It joins Blue Mountain Capital Management LLC and Deephaven Capital Management LLC which have also frozen freeze funds to stem the tide of withdrawals.

Scholes, 67, winner of the 1997 Nobel Prize in economics, was a founding partner in Long-Term Capital Management LP, the hedge fund that lost $4 billion a decade ago after a debt default by Russia.

Investors worldwide may pull as much 25 percent of their money from hedge funds by the end of the year, Morgan Stanley said in an Oct. 24 report. Combined with investment losses, industry assets may shrink to $1.3 trillion, a 32 percent drop from the peak in June, the New York-based bank said.

Brazilian hedge funds saw a record 14.3 billion reais ($6.7 billion) in withdrawals last month after returns trailed a fixed-income benchmark even while defying a 25 percent plunge in the Bovespa stock index.

Which all leave Fed as the most active financial player at the moment:

The Federal Reserve expanded its holdings of commercial paper issued by U.S. corporations by $98.9 billion, boosting its share of the $1.6 trillion market in short-term debt to 15 percent. It has incrased its holdings by 68 percent to $244.6 billion in the week ended yesterday.

Direct loans to commercial banks fell to $108.6 billion as of yesterday down from a previous record of $110.7 billion a week earlier, while cash borrowing by securities firms totaled $71.6 billion, down from $79.5 billion the previous Wednesday.

Interest rates on the highest-ranked 90-day commercial paper have dropped more than 1 percentage point since then to 2.24 percent, according to yields offered by companies and compiled by Bloomberg.

Central bankers are flooding financial institutions with temporary loans in an effort to overcome cash hoarding by banks. The loans have enlarged the Fed’s balance sheet to $2 trillion in total assets, $1.2 trillion from a year earlier.

In addition to the CPFF, the Fed started a separate program in September to lend to banks for purchases of asset-backed commercial paper from money-market mutual funds. Loans under that program totaled $85.1 billion as of yesterday, down from $96 billion a week earlier.

A third Fed program involving commercial-paper purchases, the Money Market Investor Funding Facility, will begin soon. Under that program, the Fed will lend up to $540 billion to five special funds to buy certificates of deposit, bank notes and commercial paper with a remaining maturity of 90 days or fewer.

But if you really want to see what will happen in the end, look no further than the California of today:

California Governor Arnold Schwarzenegger said his state’s finances have deteriorated so rapidly that a budget he signed just six weeks ago has already fallen into a $11.2 billion deficit and taxes must be raised.

Schwarzenegger ordered lawmakers into a special session to consider ways to close the gap. He proposed increasing the sales tax by 1.5 percentage points for three years as well as raising oil severance and alcoholic beverage taxes and motor vehicle fees. In all, taxes and fees would increase $4.7 billion while spending is cut $4.5 billion.

“We have a dramatic situation here and it will take dramatic solutions to solve it,” Schwarzenegger, a 61-year-old Republican, told reporters in Sacramento. “We must stop the bleeding.”

Let me first say that I am an economical pragmatist, and that I subscribe to no ideology. I believe that government intervention, and even state corporatism can have a role to play in certain circumstances, but I also believe that a nation should always aspire to be as free as possible, culturally, politically, and economically, simply because an efficient dictatorship is always harder to create. In general, people know and do their own business better, and survival and prosperity are the business of all human beings, wherever they live, whatever tongue they speak.


In this context, I’d like to emphasise that I have no grudge against the government, and even sympathise with their difficult situation. There’s no question, in my mind at least, that Mr. Paulson is a respectable and decent individual, that Mr. Bernanke is a brilliant economist, and that both of them have the best intentions in this very severe crisis.


But truth must be spoken. There’s a lot to be criticized about their actions, but time is limited, so I’ll only deal with the CPFF, and what it is doing for the economy, in this post, briefly, but hopefully also succinctly.


Now, we have recently seen the Fed intervening in the commercial paper market, and buying practically unlimited amounts of all sorts of CP (commercial paper), in accordance with the belief that panic in markets is causing an illogical and unjustifiable contraction in issuance. Numbers released by them show the commercial paper outstandings expanding in the last week, as the impact of the heavy hand of the government hits the market.


Let us consider this graphic, which shows data as of November 5th.






It  shows outstandings, that is, the total amount of commercial paper, in different categories. What do we see here? First of all, the yellow line, which shows asset-backed commercial paper including suprime and alt-A mortgage backed paper, has been collapsing since August 2007, and its precipitous contraction was the starting bell of this crisis. The red line shows financial commercial paper, which includes paper issued by investment banks, and others, and which rang the bells for the second, panic phase of this crisis in September, with the collapse of Lehman. The third, blue line shows the issuance of non-financial corporations, like automotive firms or computer manufacturers, in other words, it shows the real economy.


What do we notice here? And what do we discern with respect to Federal policy?


In a sense, this is a typical graphic which demonstrates increased correlation  across asset classes and convergence of risk perception for different classes financial assets. We see clearly how the panic of last year has been spreading across sectors of the economy, causing financial actors to treat all counterparties in a single category of risk, and eventually inhibiting activity, and preventing ever larger parts of the economy from functioning. We also see that the changes in attitude do not occur gradually, but with leaps and bounds. In other words, people often refuse to adjust their positions to account for changes in economical data and risk perception, but rather choose to be crushed by the data, following the stampeding crowd once panic forces everyone to adjust, regardless of whether they believe or understand the changes or not.


So much for the efficient market hypothesis…


And what does it tell us further about Fed policy, how efficient, prudent, or meaningful it is?


First of all, a careful analysis of the data shows that the recent rapid correction in outstandings of commercial paper should not be unwelcome. The graphic clearly shows that there was an enormous bubble in financial CP outstandings in the period of 2003- 2008, and ABCP issuance in the period 2004-2007. The burst of this bubble, and the subsequent contraction in issuance is not only natural, but it is also entirely natural, and should be welcomed by every prudent regulator. There was never any financial discovery, any economical development in the US in these periods to justify the massive expansion in commercial paper issuance. The financial sector had overexpanded by speculative activity in an easy money environment, and as it, so does it’s issuance of commericial paper.


If this is the case, what is the Federal Reserve gaining by inflating a market which, due to the most basic tenets of free market principles, should contract? What is the Federal Reserve achieving by irrationally sustaining a market which has been exceedingly overextended in the past years, and only has to contract so that it readjust and reform itself?


Of course the Fed is gaining nothing, and by trying to inflate a market, which should and undoubtedly will contract in the future,  is only throwing public money away into the gutter. What the experience of the Stock market bubble, and the housing bubble of the last ten years has thought us is that it is not possible to contain or prevent the bursting of a bubble. Attempts directed to toward sustaining a bubble are usually counterproductive, and eventually increase the severity of the crisis, rather than easing it.


The Fed justifies its actions by citing the blue line in the graphic, and the massive rise in spreads in the period that led to its interventions. While it is true that some intervention was necessary, the swooping scoop method that the Fed has used is so indiscriminate about what it saves that it will, in the end, almost undoubtedly cause much harm to the economy, and will probably prolong the healing process, if it at all works, and I don’t think it will. We will see more collapses and more panic in the coming weeks. It will last until some firms are allowed to go bankrupt.    

In the present scheme of events the most valuable, and reliable data that we posses is the Fed’s senior loan officer survey. Not only does it present a very accurate and recent snapshot of the health of the economy’s circulatory system (the banks, I mean) but also it provides almost infallible guidance to the next three to six months of economic activity, because the core and center of this crisis is the banking system, and without that sector healing, any kind of speculation of an economic recovery can never go beyond being a dream. 


We finally had the October update on this report, and here are the graphics: 






In the first graphic we see the rate at which domestic US banks are increasing the risk premium which they add to their cost of funding before lending to others. As can be seen clearly here, this spread is now at  a third consecutive all time high, and has basically nowhere to increase further, because all the banks in the Fed’s latest survey have been increasing their risk premiums on the loans they offer, in other words, they are lending the funds which they obtain at a  very dear cost already at an even dearer rate to the end user, that is, corporations or consumers, which causes economic activity to contract. In the second graphic we see how this continuing tightening of credit by banks, and higher borrowing costs is leading C&I (commercial and industrial) loan demand to plummet. To be sure, this second phenomenon has other causes, but  the unusual characteristics of the situation are obvious. More importantly, in the second graphic we can see that demand for C&I loans still has a long way to fall, which implies that we’re only about half way through with job cuts and downsizing in the wider economy. Loan demand appears to lag the other indicators here by a few quarters. 





It’s interesting to note here that the government’s assumption of Fanny and Freddie’s obligations appears to have had almost no impact on mortgage availability. There was a slight improvement in the percentage of banks tightening credit standards  on prime residential mortgages, which could well be due to the government actions, but even then, demand in all sectors of the mortgage market contracted in the recent quarter. What does this show us? The consumer cannot be fooled into spending like five year old children, because everyone is nowadays aware of the difficulties of the economy. Even if banks do reduce lending standards a bit, which is highly unlikely, it will be hard to induce the debt-laden and bankrupt US consumer to borrow, and this is the other side of the problem. There’s not only a reluctance to lend, but also a reluctance to borrow. 




We see the same picture here. In the first graphic we can see a slight improvement in the ratio of those banks that tighten credit standards, but in the third graphic we can observe demand for such loans collapsing. These numbers should be sobering for the government.


In general the nature of this crisis can be summarized in


  1. A general contraction in all markets from derivatives, to lean hog, both in the number of actors, and the volume of transactions
  2. Collapse in both supply and demand for credit
  3. and consequently a feedback loop which thrives on panic and pessimism.


A long time ago I wrote hear that the feedback loop was the greatest danger to the global economy. Unfortunately,  the loop is active now, and we’re likely to see massive damage done before the crisis solves itself through mass unemployment and bankruptcies.

Today the GDP numbers for third quarter have been published, and they came at minus 0.3, defying expectations of a worse number. My own choice is generally to ignore most of these numbers, because they are subject to dramatic revisions, and basing one’s analysis on preliminary data is usually gambling. The contraction in the third quarter of 2000, for instance, was first. reported as a 2.7 percent gain.

A more significant development is the 3.1 percent contraction in private consumption, and although it’s worse than expected, there’s no surprise in the result, as it would contradict logic if the US consumer, whose profligacy always depended on borrowing, could continue his habits during this unprecedented period of credit tightening. What must be realised is that this is only the beginning of a phase that will last for at least another year in the mildest scenario, and the chain reaction will have consequences for not only the US economy, but the rest of the world too, in particular for exporters such as Japan and China, Singapore and others, who made the most of the irrational excesses of the American consumer.

At this stage there is very little merit in preaching the obvious to the pious. The bankruptcy of Lehman was an event similar to those of August 2007, when the collapse of several hedge funds, and the reesulting inability to price mortage related assets caused a general paradigm shift in how the market valued certain asset classes. The demise of Lehman should only be seen as a further escalation of this trend, in which impossibles become possible, causing panic among speculators. It is meaningless to speak of investors at this stage, as volatility compels us to redefine “long term” within the span of a few months. Until a number of bankruptcies brings clarity to the situation, very few serious actors will be willing to assume long term exposure to the markets, and this will only make life harder for the governments.

Much is made of the recent easing in overnight rates, and the slight softening of the tensions in unsecured interbank lending. But while the governments’ massive injections of liquidity, and cash grants in the form of share and asset purchases appear to have made some banks and others more willing to accept higher levels of risk in overnight lending, with the Libor-OIS spread at 253 bp, one can only speak of lessening tensions in relative terms, comparing the situation to the period before the Lehman event. Otherwise it is clear that there’s very little lending going on between banks, and financial actors continue to be fearful in their dealings with each other. This is confirmed by the continued contraction in lending to consumers and the real sector, with both consumer credit, and corporate borrowing becoming more anemic by the day.

Others tie their hopes to the TARP and the Fed’s mergency lending and swap facilities, but while the latter may be of some use in alleviating the severity of the crisis, the former, in my opinion, will only make the problems worse, as there appears to be an irrational assumption in many quarters that throwing money at insolvent institutions can jump-start lending, and thereby the economy.

But this is deeply flawed reasoning. As I have stated here many times before, what the financial sector needs, and in fact, in an indirect way, demands, is bankruptcies. It’s very easy to gain a general idea on the status of many banks in the US by examining the FDIC’s statistics, or easier still, by visiting the FED’s website. What we see in the former is that banks have no money to cover their bad loans, and that this is a general phenomenon. The cover ratio of non current loans on banks’ balance sheets is only 70 percent at this stage, which is by far the lowest on record, and the situation is almost certain to deteriorate further from here. And on the Federal Reserve’s website one can see that they have been lending more than 100 billion dollars to commercial banks for the last two weeks, and although a bit crude as a measure, this serves well to demonstrate the difficulty in obtaining funding from other channels.

And so, why is the TARP counter-productive? Because it is funding institutions that have only one use for the funds they receive: patching up their books, covering their losses, and sustaining themselves. But what is the purpose of a bank, from the point of view of the public? It is to expand credit to the real economy and consumers. If the numerous banks that the TARP and the Fed are funding cannot expand credit, and are using the funds which they receive only for continuing their existence, isn’t the TARP prolonging and perpetuating the crisis, by helping those institutions that cannot, will not, and should not survive in the first place? If the program succeeds, and the complete mess of a system that we have now survives, will the financial system be in a better form where it is led and directed by players who exist as parasites on government subsidies, and whose only purpose is continued existence through government help? With the balance sheets that they have, and the managements that have brought them to where they are, can the American financial system have any hope of recovery if it expects the recovery to be financed by credit from institutions which are, for all intents and purposes, bankrupt, and which only exist at the mercy of the FDIC, and the federal government?

The TARP is a mistake, but given the way that the government has been reacting to each crisis, it’s not a surprising mistake.

Naturally, the reader will expect me to propose my own solution after this negative assessment of the government’s plan. In my opinion, what the economy needs is a dismantling of today’s system: the failed and bankrupt actors of yesterday should be nationalised when this is unvoidable, but for the greatest part, the government should manage a controlled liquidation of all firms that are clearly inoperable, and insolvent. Under normal circulmstances, this would have been managed by the free market, but there’s too much risk, excessive political costs, and too much uncertainty that make this choice undesirable and impractical. We should never try to forgo the cathartic period of the free market system, but the process should be managed and gradual. If this is the case, we need an organisation similar to the TARP, but its explicit purpose should be the liquidation of the firms that it helps for a brief period. The government could seek authority from the Congress for this purpose, and given the loathing that many of these financial firms arouse everywhere nowadays, such powers would be much easier to obtain than legislation that would sustain them. If, however, the government continues to throw money at these firms, it will only have the impact of feedings cancerous cells, it will surely bring no benefit, and is likely to cause much harm in the longer run.

Tomorrow I hope to write about emerging markets. Fed has recently been lending them billions over swap channels, and this is a phenomenon that is likely to go for quite a while. I believe the next phase of this crisis will be experienced in its severest form by developing nations.

Alpha Bank was on the list I placed here on September 11th, and I wrote that I believed their collapse was imminent. This bank was closed on October 24th.

I also wrote on September 11th that “I believe that they(FED) will cut a few times before 2008 is over.” And of course, they’re going to zero. But the dollar rally will continue longer than the one year I expected back then.

I’m glad that I wasn’t mistaken in any of these.

I have been ill these weeks, and had to stay in bed, but I will return to updating this website as soon as possible, hopefully from tomorrow.

Finally, with respect to today’s massive rally, let me record here that I expect S&P 500 to go as low as 500 over the next year. The TARP will probably perpetuate the crisis, rather then solving it, as I also hope to explain here tomorrow. And the hopes of the market in a socialistic solution to the financial crisis is likely to be broken in short order by developments to come in the next months.

On September 11th I wrote here:

“If conditions remain as they are now, if unemployment continues to rise, and financial markets remain in their present panicky situation, I’m convinced that we’ll get further rate cuts from the Federal Reserve.

How soon will this be? The timing will not be decided by data or by the central bank itself, but by markets. If the terrible state of the financial markets continues in its present shape, the Federal Reserve will have to act rather soon.

I believe that they will cut a few times before 2008 is over.”

Today central banks have reduced rates by fifty basis points in a joint action, which was joined by the People’s Bank of China in an independent move. VIX, on the other hand, rose to another all-time intraday record of 58.36, breaking the previous record for the second time this week.
From the Fed:

“For release at 7:00 a.m. EDT
Joint Statement by Central Banks

Throughout the current financial crisis, central banks have engaged in continuous close consultation and have cooperated in unprecedented joint actions such as the provision of liquidity to reduce strains in financial markets.

Inflationary pressures have started to moderate in a number of countries, partly reflecting a marked decline in energy and other commodity prices. Inflation expectations are diminishing and remain anchored to price stability. The recent intensification of the financial crisis has augmented the downside risks to growth and thus has diminished further the upside risks to price stability.

Some easing of global monetary conditions is therefore warranted. Accordingly, the Bank of Canada, the Bank of England, the European Central Bank, the Federal Reserve, Sveriges Riksbank, and the Swiss National Bank are today announcing reductions in policy interest rates. The Bank of Japan expresses its strong support of these policy actions.

Federal Reserve Actions
The Federal Open Market Committee has decided to lower its target for the federal funds rate 50 basis points to 1-1/2 percent. The Committee took this action in light of evidence pointing to a weakening of economic activity and a reduction in inflationary pressures.

Incoming economic data suggest that the pace of economic activity has slowed markedly in recent months. Moreover, the intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit. Inflation has been high, but the Committee believes that the decline in energy and other commodity prices and the weaker prospects for economic activity have reduced the upside risks to inflation.

The Committee will monitor economic and financial developments carefully and will act as needed to promote sustainable economic growth and price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Elizabeth A. Duke; Richard W. Fisher; Donald L. Kohn; Randall S. Kroszner; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh.

In a related action, the Board of Governors unanimously approved a 50-basis-point decrease in the discount rate to 1-3/4 percent. In taking this action, the Board approved the request submitted by the Board of Directors of the Federal Reserve Bank of Boston.

Information on Actions Taken by Other Central Banks
Information on the actions that will be taken by other central banks is available at the following websites:

Bank of Canada
Bank of England
European Central Bank
Sveriges Riksbank (Bank of Sweden)
Swiss National Bank”

Of course, all this is aimed at reducing panic in financial markets, and it will have an effect on the severity of the crisis in some of thiese nations. But it will neither ease the credit crisis, nor prevent bankruptcies, because it’s too late by now. I called for international intervention many times, but central bank action alone is not enough, because the difficulties in interbank markets, and credit markets in general are not born of any clear problems about borrowers, but from the problems of lenders themselves. What does that mean?

As I have stated before, the banking system has no desire to function until it has gone through a period of natural selection, which eliminates the weakest players, and leaves those that remain to deal among themselves without worrying about counterparty risk. The central banks are fighting this trend, but they cannot win because they’re dealing with sophisticated actors who know only too well how bad the balance sheets of hundreds of medium and large institutions around the world are. No level of interest will induce them to lend as long as they’re unsure about recovering the principal. The one and only solution to this problem is a string of bankruptcies, and until we have seen hundreds of banks in the US, and tens of banks in Europe and elsewhere fail, the crisis will continue. Short of buying all the bad mortgage, consumer, corporate debt in the system, nothing that the governments do will solve this crisis.

And why does it have to be that way?

Because it’s too late by now. The problem has spread to every single part of the global economy, and has reached monstrous proportions. Central banks, as financial actors, have only a very indirect impact on the countless credit channels that have now been blocked. For instance, while the libor serves as a benchmark for many purposes, the rate itself is only useful for uncollaterised interbank lending on a period of between 0-30 days. It has an ignorable effect on risk premiums in capital markets, and, in the present circumstances, no effect at all on banks’lending plans. To put it in another way, overnight libor was at 2.97 on Monday, today it is at 4,52. The difference is similar to the rate cut of today by central banks. In other words, in an environment of extreme volatility even in overnight rates, central bank target rates lose most of their significance.

Indeed, the Fed, and to a lesser extent many other central banks, have a lot of difficulty maintaining their overnight target rate through their market operations.

Of course, while it’s not very useful, reducing rates is what central banks can do, and their attempts should be supported, even applauded. But expecting that these actions can end this crisis is not a logical and realistic assumption.

So when will the crisis end? It will end when Asians finance the bailout of the US financial system, or, if that doesn’t happen, it will end when unemployment reaches double digits, S&P reaches 500, and thousands of firms become bankrupt. My own expectation for S&P 500 is 500 for 2009.

The Fed has decided to buy commercial paper from firms, in another attempt to deal with the complete shutdown in financial markets. This essentially means that it is financing the day-to-day running of the US economy, and it is a positive step, as long as it is conducive to eliminating a bit of the panic and fear in the markets, but it will not address the basic insolvency and leverage issues, and will not prevent bankruptcies. From the Fed:

“For release at 9:00 a.m. EDT

The Federal Reserve Board on Tuesday announced the creation of the Commercial Paper Funding Facility (CPFF), a facility that will complement the Federal Reserve’s existing credit facilities to help provide liquidity to term funding markets. The CPFF will provide a liquidity backstop to U.S. issuers of commercial paper through a special purpose vehicle (SPV) that will purchase three-month unsecured and asset-backed commercial paper directly from eligible issuers. The Federal Reserve will provide financing to the SPV under the CPFF and will be secured by all of the assets of the SPV and, in the case of commercial paper that is not asset-backed commercial paper, by the retention of up-front fees paid by the issuers or by other forms of security acceptable to the Federal Reserve in consultation with market participants. The Treasury believes this facility is necessary to prevent substantial disruptions to the financial markets and the economy and will make a special deposit at the Federal Reserve Bank of New York in support of this facility.

The commercial paper market has been under considerable strain in recent weeks as money market mutual funds and other investors, themselves often facing liquidity pressures, have become increasingly reluctant to purchase commercial paper, especially at longer-dated maturities. As a result, the volume of outstanding commercial paper has shrunk, interest rates on longer-term commercial paper have increased significantly, and an increasingly high percentage of outstanding paper must now be refinanced each day. A large share of outstanding commercial paper is issued or sponsored by financial intermediaries, and their difficulties placing commercial paper have made it more difficult for those intermediaries to play their vital role in meeting the credit needs of businesses and households.

By eliminating much of the risk that eligible issuers will not be able to repay investors by rolling over their maturing commercial paper obligations, this facility should encourage investors to once again engage in term lending in the commercial paper market. Added investor demand should lower commercial paper rates from their current elevated levels and foster issuance of longer-term commercial paper. An improved commercial paper market will enhance the ability of financial intermediaries to accommodate the credit needs of businesses and households.”