Today the ECB has reduced its main refinancing rate (which is quivalent to the Fed funds rate)  by 75 percent points, the biggest amount in its short history. The Bank of England also cut its key rate by one percentage point to 2 percent and Sweden’s Riksbank lowered the same by the most since 1992. My attitude toward the ECB has been the same throughout this crisis. They’re more disciplined, because the financial state of the governments and citizens who they regulate is much better than that of their counterparts in the US. M. Trichet today showed some willingness to purchase some troubled paper directly, but whatever, and whenever this happens, its size and scope is likely to be far smaller than the Fed’s operations.

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.


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.”


Commercial mortgage delinquencies continued to rise in November, as would be expected. The highest-rated CMBS are right now paying about a massive 12 percentage points more than Treasuries, compared with with just 0.82 in January:

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.

Today Mr. Bernanke enlightened us further on his solution to the credit crisis. What they will be doing, in essence, is selling Treasuries to the market in order to accumulate the funds with which the bailouts are financed, and after that, as yields fall to very low levels, buying the same Treasury bonds, and thereby injecting liquidity to the markets. Thus it sound circular? It does, and it is another of the Federal Reserve’s much publicized but eventually useless financial trickery.  

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.

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 “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.”








On Thursday this website had stated that Citigroup wouldn’t survive without a government bailout. And they have been bailed out during the weekend. We also noted here that the 700 billion of Tarp was far from being enough. And recently the President-Elect has been speaking about another trillion for the US economy, as the Fed is adding another 300 billion to its toxic assets. So the Tarp has almost been tripled already. And there will be more.

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.

Russia is now likely to enter a prolonged period of hardship as the financial structure of the nation collapses under the impulse of falling commodity prices, and the heavy-handed ineptitude of the Medvedev-Putin administration.  These two appear to have believed that initiating a geopolitical gamble in the middle of a global economic crisis was a wise move, or rather, that they would be able to bully the economics of the country into submission, as they did with its people. Their scheming has failed. But I believe that the economic problems will make the government even more despotic, as they will attempt to prevent social disorder by instituting stricter controls on the country’s political and economic system, and its media. They certainly have the power to do so, and there doesn’t appear to be any alternative other than chaos, given the turbulent situation of this nation in almost every aspect.

In any case, the troubles of Russia are only a prelude to the next phase of this crisis which will severely test the resilience of emerging markets worldwide. Many of these nations owed their prospertity to the low risk-aversion of developed world investors, and as this source of funding evaporates, with global trade, and global economic activity slowing down significantly, and possibly contracting, the underlying inefficiencies and weaknesses of these nations will place them under very difficult conditions.

How much has changed in seven years! Many nations, such as Brazil, Argentina, and Turkey are ruled by individuals whose culture of governance has very little difference to that of their corrupt and bankrupt predecessors. I know for a fact that neither in Turkey, nor in Brazil the fundamental problems of the past years which used to cause periodical crashes and high inflation have been resolved. And the main characteristic of the leaders of all three nations is populism, not any particular management skill, nor understanding of the workings of the global economy. But the dreamy state of mind of investors in the developed world, their low home bias, and speculative herding, have allowed all these nations to live in false prosperity, often financed through borrowing, and supplemented through the boon of high commodity prices.

Now those bubbles are collapsing, and the return to reality will be very painful, I’m afraid.

Russia’s erratic stock market closures and the central bank’s policy of seeking to manage the ruble’s value are deepening the effects of the global crisis as the price of oil, the country’s biggest export earner, tumbles.

Slumping commodities prices, state-backed corporate probes and the war with Georgia have combined with frozen global capital markets to spook investors. The Micex Index is down more than 60 percent since Aug. 1 and holders of Russian assets have withdrawn about $158 billion, BNP Paribas SA estimates.

Goldman Sachs Group Inc. predicts the ruble may weaken 18 percent versus the central bank’s dollar-euro basket in the next 12 months as Bank Rossii continues to sell foreign-currency reserves to stave off the flight of capital.

“Russia has moved at least a decade away from becoming a real financial center,” says James Fenkner, managing partner at Red Star Asset Management in Moscow, which holds about $100 million in Russian stocks. “The government’s incompetence is making this crisis worse for anyone stuck on the Micex and RTS,” bourses.

The Micex closed and reopened for the 29th time since Sept. 16 today, having announced it would remain shut until after the weekend.

No Advert

Stocks have been further hurt after the government reopened an investigation into a 2006 mine flood at OAO Uralkali, Russia’s second biggest potash producer. The announcement on Nov. 7 knocked its shares down 10 percent and brought back memories of recent probes against steelmaker OAO Mechel and oil companies TNK-BP and Yukos, which made investors nervous about state interference in the country’s natural-resources industry.

Those cases contributed to “an environment that is not an advertisement for a country you want to place your money in. It’s the opposite,” said Andrew Bosomworth, who helps manage more than $50 billion of emerging market debt in Munich at PIMCO.

Compounding the economic woes, Bank Rossii let the ruble weaken 1 percent versus the basket on Nov. 11, a move that may spur capital flight. The central bank manages the currency against the basket to minimize the effect of currency swings on Russian exporters.

The devaluation was “clumsy,” and has “triggered a new speculative attack on the ruble,” analysts at Renaissance Capital including Kayta Malofeeva and Nikolay Podguzov said in report e-mailed today.

Oil Price

Oil’s fall is undermining the currency of the world’s biggest energy producer and it sends the $91.2 billion current- account surplus toward a deficit. Urals crude oil fell for a third day today, losing 1.8 percent to $48.80 per barrel, the lowest since January 2007 and more than $20 per barrel lower than the level needed to balance next year’s budget.

The $50 level, which Urals broke yesterday, is “psychologically important” and will increase pressure on the ruble, Chris Weafer, UralSib Financial Corp.’s chief strategist, said on Nov. 11.

“By opening the door 1 percent when nobody believes that’s the full magnitude of the fall, that just attracts speculators to short it,” said Bosomworth. “Anybody doubting before that it was going to weaken, they now know that it is going to weaken.”

The central bank should devalue the ruble in several, larger steps of as much as 7 percent, interspersed with occasional movements strengthening the currency to increase volatility and shake out speculators, the Renaissance Capital analysts wrote.

That could leave it as much as 20 percent lower against the dollar at 32 by the end of the year and would make speculative bets on the ruble dropping further “minimal,” they said.


To be sure, an overly aggressive devaluation could panic a population still smarting from the ruble’s 71 percent devaluation against the dollar in 1998.

Russians have purchased more than $3.4 billion of foreign cash in September, or almost twice as much as they bought per month throughout the year, Alfa Bank said today, citing the central bank’s figures.

Any sharp devaluation may exacerbate that trend, Anna Zadornova, an economist in London at Goldman Sachs, wrote in a note today.

“The central bank of Russia is wary to allow a large step devaluation, fearing that it could encourage capital flight and increase uncertainty about the economic stability in the population,” she said.

RBC Capital has a new target for the century-old Nortel Networks; it’s zero, predicting that Nortel will go bankrupt. It is by now a story with which we’re becoming more familiar by the day:

Nortel Networks Corp., North America’s largest maker of telephone equipment, may go bankrupt by 2011 without a cash injection from the government or financial backers, RBC Capital Markets said.

The company is “overwhelmed with debt and burning cash,” Mark Sue, an RBC analyst in New York, said today in a note. He cut his price target on the stock to $0 from $1.50.

Nortel, founded more than a century ago, has lost about 95 percent of its market value this year as customers reined in spending and switched to newer technology from Cisco Systems Inc. Nortel may be forced to sell its Metro Ethernet unit, used to deliver Internet, TV and telephone service, at a fraction of the intended price, RBC said.

“Assets sales couldn’t have come at a worse time,” Sue said. “The world moved on while Nortel was stuck in restructuring mode.”

The company may finish 2009 with $1.6 billion in cash, about the amount it needs to run its business for 12 months, Sue said. Nortel has $1 billion of debt due in 2011.

Nortel’s U.S. stock reached a split-adjusted high of almost $900 in 2000.

Bonds Fall

This week, Nortel announced plans to cut 1,300 jobs. Chief Executive Officer Mike Zafirovski has eliminated 18 percent of the workforce since taking over three years ago. Nortel has lost $3.66 billion so far this year.

The problems of hedge funds keep growing. I think that it’s a simple fact of economic cycles that there are times when one shouldn’t borrow, and isn’t this one of those times? Is a leveraged model feasible in this environment? Does the risk-reward paradigm suit the expectations of a prudent investor? The answer to these questions, obviously, is no. But hedge funds don’t seem so worried about all these for now, and it seems, despite being burned many times already, they are still willing to gamble. Greed is good, but only when tempered by fear. These people have little fear, because the money they gamble with is not their own. (Update: Hedge funds are now much more cautious about what they do)

Fortress Investment Group LLC’s hedge-fund clients have asked to pull more than $4.5 billion, or 25 percent of their money, over the next few months as the company reported its first quarterly loss since going public.

The redemption requests poured in as Fortress’s Drawbridge Global Macro funds lost 13.5 percent this year through Sept. 30 and its Special Opportunities funds declined as much as 7.2 percent, the New York-based company said in a statement today. Hedge funds fell an average of 11.6 percent in the same period, according to the HFRX Global Hedge Fund Index.

The worst financial crisis since the 1930s is battering Fortress’s primary businesses of taking companies private and running hedge funds. The company was forced to write down $50 million of private-equity holdings. Investors withdrew an estimated $60 billion from the $1.7 trillion hedge-fund industry in October, Singapore-based Eurekahedge Pte said today.

“The problems at Fortress have shifted from private equity to hedge funds,” said Jackson Turner, an analyst at Argus Research in New York. Turner, who anticipated hedge-fund redemptions of less than 10 percent, recommends investors sell Fortress shares. “Investors have lost faith in the franchise.” .


Fortress said it received $2.6 billion in withdrawal requests payable through the end of January for its liquid hedge funds, which manage $9.1 billion in assets between the Drawbridge Global Funds and the Fortress Commodities Fund.

Investors asked to pull $1.9 billion, effective Dec. 31, from its hybrid hedge funds. The Drawbridge Special Opportunities Funds and Fortress Partners Funds managed $8.2 billion as of Sept. 30. Those redemptions will be paid out over time as investments are liquidated, the company said.

Revenue Falls

Revenue dropped by 25 percent to $185.1 million. The company reported a net loss of $57.4 million, or 66 cents a share, wider than a loss of $37.6 million, or 52 cents a share a year ago. That included $298 million in compensation to the firm’s founders tied to the IPO. Fortress expects net losses for the next three and a half years because of the payments.

Earlier this week, Sparx, Asia’s biggest hedge-fund manager, with $8.5 billion in assets, posted a first-half loss on redemptions and falling stock prices. Its assets under management on a preliminary basis were 839.1 billion yen ($8.8 billion) as of Oct. 31, compared with a peak of 2 trillion yen in August 2006.

Fortress joins rivals Blackstone Group LP and KKR & Co. LP in cutting the value of assets to match a global decline in prices. Blackstone, the world’s largest private-equity firm, posted the biggest quarterly loss in 18 months as a public company on Nov. 6 as the financial crisis eroded the value of the businesses and real estate it has acquired.

Fortress said in September it wouldn’t pay a third-quarter dividend to shareholders, saying the money can be better spent by investing in financial companies.

And there’s ever more trouble with commercial real estate. Naturally the vicious cycle of tightening standards, more defaults, and more tightening will continue, until life is sucked out of the economic system, and the remaining core offers a very positive risk profile to lenders, or rather what will remain of them. Bankruptcies are the only solution to the gigantic crisis that we are going through.  

CIT Group Inc., the largest independent U.S. commercial lender, applied to become a bank holding company and requested an investment from the U.S. Treasury after six straight quarterly losses drained capital.

CIT joins American Express Co. Goldman Sachs, and Morgan Stanley in seeking to reorganize as a bank.

CIT may need cash after $2.9 billion in net losses since the second quarter of last year. Chief Executive Officer Jeffrey Peek is making fewer loans, tightening lending standards and raising borrowing costs for customers amid the worldwide credit crisis.

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.”