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.

Recovery

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

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

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

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

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

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

Fed Perspective

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

Trending Up

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

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

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

Longer Slump

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Drop Since May

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

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

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

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

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

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

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

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

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

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

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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.