The trillion dollar question: China or America?

Who is going to come out of the economic crisis stronger and with the whip hand - China or America, asks Niall Ferguson.

 

By Niall Ferguson
Published: 7:27PM BST 01 Jun 2009

Comments 53 | Comment on this article

A delegation led by US Treasury Secretary Timothy Geithner, second from right, meets a Chinese led by vice-premier Wang Qishan in Beijing Photo: Bloomberg News

Two years ago, economist Moritz Schularick and I coined the word "Chimerica" to describe what we saw as the key relationship in the then-booming global economy: China plus America. Cheap Chinese labour was making US corporations highly profitable. Spendthrift American consumers, in turn, were keeping Chinese corporations busy with export orders. And the Chinese monetary authorities were converting export surpluses into dollar denominated reserves with the aim of preventing their own currency from appreciating. The unintended consequence was a multi-billion dollar credit line to the United States, financing America's deficit at rock-bottom rates.

It was those low long-term rates – combined with monetary policy errors by the Fed, excessive bank leverage and reckless financial engineering – that inflated the American property bubble, the bursting of which triggered this crisis.

 

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To simplify the story, think of an unhappy marriage in which one partner does all the saving, while the other does all the spending. (We all know at least one couple like that.) But then the partner with the retail therapy habit maxes out on his/her credit cards. At the same time, the parsimonious partner finds her/his job under threat. What previously was a stable relationship is suddenly on the rocks.

In February, the People's Daily acknowledged the "global importance and influence" of Chimerica, but warned of an impending "period of chillness". Could this be one of those great turning points in history, when the balance of power tilts decisively away from an established power and towards a rising challenger? It is possible. Financial crises often accelerate the gradual shifting of the geopolitical tectonic plates; they are to history what earthquakes are to geology.

It was inflation that undermined the foundations of Habsburg power and opened the way for the Dutch Republic. It was the disastrous Mississippi Bubble of 1718-19 that fatally weakened ancien régime France, while Britain survived the contemporaneous South Sea Bubble with its fiscal system intact. For most of the nineteenth century, financial crises in the United States had only marginal effects on the City of London. By 1907, however, a Wall Street crash could send a shockwave across the entire British Empire, a harbinger of a new era of American power.

Something similar may be happening as a consequence of the American financial crisis that began nearly two years ago. The flapping of a butterfly's wings may trigger a hurricane in the Home Counties; in much the same way, a crisis in the market for subprime mortgages could signal the waning of US hegemony and the advent of a Chinese century. Just visit the nearest bookshop if you don't believe me. There, alongside Fareed Zakaria's prophetic The Post-American World, you'll soon find Martin Jacques's darkly visionary When China Rules the World.

Just consider the impact of this crisis on the United States and China. According to the International Monetary Fund, the US economy will contract by 2.8 per cent this year – while China's is forecast to grow by more than 6 per cent.

The US stimulus package – worth $787 billion – has had rather a muted impact. The economy will do better in the current quarter than in the last one. But house prices are still falling at close to 20 per cent year on year. The rate of foreclosures per month is still rising. And a crisis in commercial real estate could blow a new hole in the balance sheets of US banks.

Moreover, no amount of stimulus can swiftly reduce the debt burden weighing down America's over-leveraged consumers. According to Bank Credit Analyst research, for household debt to return to a more sustainable level, real consumer spending would need to grow at no more than 1.3 per cent a year between now and 2013. If that calculation is correct, the Obama administration will have to junk its predictions of 3 per cent growth next year and 4 per cent the year after that.

China's stimulus is worth less in dollar terms – $585 billion – but Beijing is clearly getting more bangs for its bucks. In April, fixed investment surged by nearly
34 per cent. Net imports of iron ore leapt by a third, and imports of oil by just under 14 per cent. It's a measure of China's new economic influence that commodity traders attribute much of the recent upward pressure on oil, copper and other raw material prices to Chinese purchases. Indeed, China's growing presence in commodity markets in sub-Saharan Africa and South America – not just as a buyer, but also as an investor – has an almost imperial character to it.

Of course, China has not been wholly unscathed by the astonishing collapse of exports that struck Asian economies in late 2008 and early 2009. Many more Chinese than American workers have lost their jobs since this crisis began. Yet I do not believe (as some Sino-pessimists do) that the regime in Beijing faces a serious threat of social unrest. Like other rising powers in past centuries, China is imbued with a remarkable sense of patriotism that is not just a product of Communist Party propaganda. People are proud of their country's economic miracle over the past 30 years. After two wretched centuries, they believe China is on the way back. People whose grandparents survived the Great Leap Forward and whose parents endured the Cultural Revolution can surely cope with a decline in the growth rate from 11 to 6 per cent.

In short, it may be time to start believing the projections made by Jim O'Neill and his colleagues at Goldman Sachs, who predicted just a few years ago that China's gross domestic product could equal that of the United States by 2027. Three years ago, China did not have a single bank among the world's top 20, measured by market capitalisation. Today the top three are all Chinese. In 2006, the United States had seven of the top 20 banks, including the top two; today it has three, and the biggest, JP Morgan Chase, is rated fifth.

Even before its economy becomes the world's biggest, China can play a much more assertive role in its relations with the United States. The spouse with the money generally wins the argument, after all. Especially when the argument is about the other spouse's debts.

And what debts! The US federal government's deficit this year will be $1.84 trillion – roughly half of total expenditure and nearly 13 per cent of GDP. Not since the Second World War has the gap between income and spending been so huge. Moreover, the Congressional Budget Office anticipates that total debt will nearly double in the decade ahead. With the lion's share (around 70 per cent) of their $2 trillion of international reserves held in the form of US bonds, the Chinese are understandably alarmed by this tsunami of red ink. Last week's financial market action – which saw both bonds and the dollar drop sharply – will have caused palpitations in Beijing.

To be sure, China is still piling up those dollar-denominated bonds. In March alone, China's holdings of US Treasuries rose $23.7 billion. But Deutsche Bank recently predicted that Chinese reserves will rise by only $100 billion this year, compared with $418 billion last year. You don't need a Nobel prize in economics to know that $100 billion won't finance much of a $1.84 trillion deficit.

We know pretty much what Treasury Secretary Timothy Geithner is hearing in Beijing this week because the Chinese have been grumbling about American profligacy for months. "We have lent a huge amount of money to the United States," Wen declared in March. "Of course we are concerned about the safety of our assets. To be honest, I am a little bit worried." Soon after that, on the eve of the G20 Summit in London, the Chinese central bank governor Zhou Xiaochun proposed that the US dollar might eventually be replaced as the world's main reserve currency.

"The United States is making policy decisions purely according to domestic considerations and is giving little thought to the outside world," complained Zhang Ming, an economist at the Chinese Academy of Social Sciences, in April. "This being so, the Chinese government should prepare its defences. We can keep buying US debt but we have to attach some conditions."

The big question is: what conditions? For Mr Geithner knows the truth of the old adage: when you owe the bank a small amount, the bank has the power. But when you owe the bank a huge amount, it's the other way round. Luo Ping, a director-general at the China Banking Regulatory Commission, put it nicely in an interview back in February: "Except for US Treasuries, what can you hold? US Treasuries are the safe haven. For everyone, including China, it is the only option. We hate you guys. Once you start issuing $1 trillion to $2 trillion [of bonds] we know the dollar is going to depreciate, so we hate you guys, but there is nothing much we can do."

"We hate you guys?" Now that really does have the ring of marital breakdown. Let's hope Mr Geithner is good at ducking crockery. Like divorces, major shifts in the balance of power are seldom amicable.

Niall Ferguson's 'The Ascent of Money: A Financial History of the World' is published in paperback by Penguin this week

Financial Bankruptcy, the US Dollar and the Real Economy

Friday, August 24, 2007
par Rodrigue Tremblay

"The U.S. government is on a 'burning platform' of unsustainable policies and practices."
David Walker, U.S. Comptroller General

"Modern society, based as it is on the division of labor, can be preserved only under conditions of lasting peace."
Ludwig von Mises, Austrian economist

"People know that inflation erodes the real value of the government's debt and, therefore, that it is in the interest of the government to create some inflation."
Ben S. Bernanke, Fed Chairman

"Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again."
Ben S. Bernanke, Nov. 8, 2002 (Fed Chairman, talking to economist Milton Friedman)

Ordinary investors and people in general will have to get accustomed to hearing a lot about financial terms they never heard before, such as the subprime mortgage market, aggressive underwriting, asset securitization, repackaged loans, subprime loans, "no-doc" loans,
adjustable rate mortgage interest rate adjustment (ARM) loans, collateralized debt obligations (CDOs), asset backed securities, mortgage-backed securities, closed-end second-lien loans, subprime second-lien loans, alternative-A (Alt-A) mortgage loans, piggyback
loans, asset-backed commercial paper (ABCP),...etc.

—As a general definition, "subprime" or "high-risk" loans" are those made to people with poor credit and at lax conditions. Second-lien loans are loans that are placed in second place for any potential recovery after the primary lender on a property. —Residential mortgage-backed security (RMBS) are created when mortgage lenders sell their loans (and the risks associated with such loans) to banks, which package them together and slice them into different classes before selling them to (gullible) investors. This process, called "asset securitization" is the method whereby interests in mortgage loans and other receivables are packaged, underwritten, and sold in the form of "asset-backed securities". This is financial alchemy, through which subprime mortgage loans are transformed into AAA-rated paper for unsuspecting investors.

Some of these artificial or derivative securities are low-grade quality, and when their prices fall because borrowers cannot meet their interest or capital payments, such financial instruments become quickly "illiquid" or unsalable, since nobody wants to touch them. They become fictitious capital.

Those who hold them, investors, banks or other types of lenders, are stuck with them: they cannot sell them and they cannot borrow while placing such shaky assets as collateral. These are the imprudent lenders and investors that central banks now are trying to bail out.

During the French Revolution (1789-1799) the Jacobins (the Neocons of the day) had the brilliant idea of issuing securities, called "assignats", based on the properties (buildings and lands) the government had taken away from the Church and its religious orders.  The new securities were quickly "monetized" into fiatmoney  and transformed into readily available cash. This caused a massive hyperinflation and a subsequent deflation.

Mind you, this was not the first time that 18th-century France lived an experience of inflationary finance, since a similar incident took place three quarters of a century before, between 1716 and 1720, when Scottish banker and businessman John Law (1671-1729) led France into a fiat money fiasco and engineered a land-backed securities scheme known as the Mississippi Bubble.

John Law's earlier experiment and the French Revolution assignats debacle [http://www.mises.org/story/1504"
http://www.mises.org/story/1504] should be clear reminders of the danger and folly of "monetizing" illiquid assets-based securities.

Like all "Ponzi schemes",  such pyramidings of debts with no liquid assets behind them are bound to implode sooner or later. And that is what we are witnessing today, i.e. the implosion of unfunded credit derivatives-based "Ponzi schemes". In 1998-2000, we got an idea of what could happen when portfolios are highly leveraged and laden with derivative financial products with the collapse of one large hedge fund, the Long-Term Capital Management.

This should have been a warning sign to  regulators of financial markets. But hedge funds  and other financial operators' greed—and political
corruption—were too strong, and no one stopped the march to disaster. Now, things are getting worse, because central banks, led by the Fed, are following the assignats route and have been aggressively
"monetizing" the unfunded derivative debts, lending new cash not for a day or two, and not against T-bills, but for months on end against illiquid and partly unsolvable and artificial derivative debts. Who
knows where this could lead?

One possibility is the complete collapse of the U.S. dollar and an uncontrollable burst of inflation in the years ahead if the salvaging operation were to increase money supply  on a permanent basis. Indeed, if central banks continue to shore up the artificial financial houses of cards to prevent them from going bankrupt, they may end up
monetizing mountains of unsolvable debts with the potential of creating a monstrous inflation. A dollar panic may be just around the corner —Thus, the cure for fighting a credit crisis could be a tremendous
push of inflation in a few years, if the Fed cannot withdraw the new cash fast enough from the system.

This surely can be the case, since it has announced that it is discounting non-government home mortgages and mortgage-backed securities, jumbo mortgages, and asset-backed commercial paper, and a broad range of collateral for discount-window loans, besides the typical Treasury and government agency paper. The problem is that some of these so-called "securities" may be worthless in a few months, thus making it difficult for the Fed to sell them back and retrieve its cash.

Over the past few weeks, central banks worldwide have supplied hundreds of billions of fresh loans to banks and other financial dealers, to make cash available for lending and they have lowered interest rates amid signs that credit was drying up. The partly privately-owned Fed,
 for example, has accepted billions in "repos", by which it bought billions in illiquid securities from dealers, who then deposited the money into commercial banks, thus "liquifying" the entire financial system. This is
a short-term measure designed to alleviate the "liquidity crisis", even if it is pursued for a few months.

It alleviates the "liquidity crisis", for sure, but this does nothing to cure the underlying "solvency crisis" of institutions holding large chunks of non-performing mortgage-based assets. Sooner or later, such low
valued derivatives will have to be written off, and this will necessarily lead to an erosion of these institutions' capital base. Bankruptcies of the most leveraged and imprudent institutions are to be expected. For a few weeks, the Fed's interventions and buying by the Treasury's special division, the "Working Group on Financial Markets", also commonly
known as the "Plunge Protection Team" (PPT) http://www.financialsense.com/fsu/editorials/dorsch/2007/0809.html] will sustain the financial markets. But come mid-September and early October, the law of gravity is likely to regain its importance.

As I explained in my blog of last October 16 (2006), (Headwinds for the US Economy), macroeconomic conditions made it a "matter of months,
not years", before the U.S. economy and the U.S. dollar begin to experience some downward pressures.  And, as I repeated on May 5 (2007), (A Slowdown or a Recession in the U.S. in 2008?), we are "approaching [the] point of reckoning."

As I said in May, we could expect "the collapse of one and possibly several major financial institutions under the pressures of bad loans and record foreclosures. Particularly at risk is the some $2.5 trillion mountain of debt concentrated in subprimes and Alt-A loans. Already, one major sub-prime lender (New Century Financial) has filed for Chapter 11 bankruptcy protection.  Others are likely to follow, because 2007 is the year when a large number of sub prime real estate loans
have to be renegotiated at higher interest rates. The rate of foreclosure is bound to spike in the coming months, possibly culminating in the next two years into a financial hurricane."

The practice of sub-prime loans and the creation of even more creative and artificial "derivative financial products" is much more widespread in the USA than in other countries. For example, such risky loans
represent as much as 20 percent of mortgage loans in the U.S., while the incidence is only 5 percent in neighbouring Canada. [Indeed, out of the U.S. $10 trillion mortgage market, about $2 trillion constitute the sub-prime mortgage market.] —But where were the American central bank, the Fed under Alan Greenspan and B. S. Bernanke, the Security and Exchange Commission (SEC) under former congressman and venture
capitalist Christopher Cox, and the Bush-Cheney Treasury Department when this mountain of shaky real estate debt was being built by unscrupulous and ruthless financial operators?

Why did they not intervene -first, to protect mortgage borrowers by putting a stop to mortgage loans that require no or not much documentation about a borrower's income (so-called "no doc" or "low doc" loans), -second, to prevent a solvency dilution of the capital base of American financial institutions and, -third, to prevent an unsustainable real estate bubble that sooner or later was going to burst and drag down
the rest of the economy? —It is indeed the duty of a lifeguard to prevent people from jumping into a swimming pool that is without water. —But when you have a Treasury Secretary who is a former president of
deal-making and hedge-funds-famous Goldman Sacks, a SEC chairman who is a former venture capitalist and a chairman of the Fed who is on record as saying he favours inflationary policies, you may have part of the answer. When the fox is put in charge of the chicken coop, you cannot expect the chickens to be safe. One has to remember that President Herbert Hoover’s Secretary of the Treasury, in 1929, was financier Andrew W. Mellon,  with his far right economic policies of lowering taxes for the rich. We have the uneasy feeling that history repeats itself.

Since the Bush-Cheney White House wanted the economy to keep bubbling before the 2004 and 2006 elections, there was nobody to whistle the end of the recreation. As the French King Louis XIV
said, "Après moi, le déluge!" ("When I am gone, I don't care what happens!). In fact, U.S. regulators not only did not intervene to stop the madness of no-interest, no questions asked, no down payment loans, but they encourage unbridled speculation by abolishing the Roosevelt era crash-preventing "uptick rule" designed to force short sellers to wait for an uptick in the price of a stock before they could complete
their short trade. Indeed, it will be an historic irony that on July 6 (2007), the Security and Exchange Commission (SEC) removed the protection in order to allow hedge fund operatorsto short stocks on down ticks, thus making sure that market volatility would increase tremendously.

_________

Rodrigue Tremblay is a Canadian economist who lives in Montreal; he can be reached at This e-mail address is being protected from spambots. You need JavaScript enabled to view it
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Author's Website: Check Dr. Tremblay's coming book "The Code for GlobalEthics" at: Posted, Friday August 24, 2007, at 5:30 am

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Obama is attempting to navigate between placating public anger over AIG and similar outrages by Wall Street firms that have received hundreds of billions of dollars in taxpayer funds and satisfying the demands of the financial elite, which will brook no government interference in its drive for self-enrichment.

Responding to an outpouring of public anger over the revelation that AIG, the recipient of $173 billion in government loans and cash, last week granted large bonuses, some in the millions of dollars, to executives and traders in its financial products division, the House voted 328 to 93 to impose a 90 percent surtax on bonuses given to employees with a family income of $250,000. The bill covers only firms that have received $5 billion or more in government handouts under the $700 billion Troubled Asset Relief Program (TARP) and other financial rescue programs.

The financial products division was the unit of the insurance company that sold trillions of dollars worth of credit default swaps to banks, hedge funds and other financial companies to insure their investments in collateralized debt obligations and other exotic financial instruments backed by subprime mortgages. It played a major role in erecting the financial house of cards that has come crashing down, effectively bankrupting AIG and much of the US and international financial system and plunging the world economy into the deepest recession since the 1930s.

All but six House Democrats voted for the bill and nearly half of House Republicans joined in support, defying House Minority Leader John Boehner, who opposed the measure. The bill is retroactive, covering all bonuses at affected companies granted after January 1, 2009. It thus includes the AIG bonuses that have become a focal point for public anger over the entire government bailout of Wall Street.

The House bill, in fact, covers only 13 of the more than 500 companies that have received some $250 billion in cash infusions from the US Treasury. In addition to AIG, the list includes Citigroup, JPMorgan Chase, Wells Fargo, Bank of America, Goldman Sachs, Morgan Stanley, PNC Financial Services Group, US Bancorp, General Motors, General Motors Acceptance Corporation and the mortgage finance giants Fannie Mae and Freddie Mac.

The Senate version, which could be voted on as early as next week, covers a wider range of firms—those receiving $100 million or more in government cash. It would impose a 70 percent surtax on most bonuses at these companies, half to be paid by the individual recipients and half by the firms.

The aim of the House and Senate measures, far from fundamentally reforming the financial system or requisitioning the vast fortunes of Wall Street speculators, is to mitigate public anger in order to pave the way for passage of a new round of bank bailouts being prepared by the Obama administration. This was signaled by Democratic Congressman Artur Davis of Alabama, who said, "We're eroding confidence in the way taxpayer dollars are managed and spent. And the cost of that? It's going to make it harder than ever for us to do the things that must be done to get this economy going moving forward."

Similarly, in the Senate, Democrat Max Baucus, the chairman of the Senate Finance Committee, indicated at a hearing Wednesday that the bill he coauthored was aimed at pressuring AIG to voluntarily revoke the bonuses. He told the CEO of AIG, "We're going to introduce the bill. I think it's sufficient leverage to get these paid back."

As the Wall Street Journal reported Friday, "Still, the feeling at one major bank Thursday was that the legislation would get significantly watered down, making it applicable only to AIG, or, perhaps, firms that have received more government assistance than just the initial handouts made under the TARP program..."

Nevertheless, the measures have ignited a storm of indignant protest from Wall Street and threats to refuse to participate in government financial rescue programs. Amid charges of "McCarthyism" and denunciations of the proposals as "vengeance," leading banking figures are threatening, in effect, to allow the financial system to collapse rather than accept even the most modest limits on executive pay.

Already, more than 200 banks have withdrawn their applications to receive government cash in order to avoid government limits on executive pay and restrictions on their financial operations.

The vast fortunes piled up by Wall Street executives have played a major role in the destabilization of the US and world economy. Over the past three decades, trillions have been drained from society's resources and the wealth created by the working class to sustain the lavish lifestyles of the modern robber barons. Just last year, as they were recording record losses, Wall Street firms paid more than $18.4 billion in bonuses in New York City.

The Washington Post summed up the attitude of the financial elite to the House bill in its lead editorial Friday, headlined "Washington Gone Wild." The newspaper wrote, "Yesterday, the House had the feel of a mob scene..." It went on to warn that "The effective confiscation of legally earned and contractually promised payments may well be unconstitutional..."

Needless to say, the leading newspaper of the nation's capital has expressed no similar qualms about government diktats requiring the ripping up of union contracts at auto companies and the slashing of workers' wages and benefits.

The editorial echoed the assertions of bankers that such limits on corporate compensation would "drive away the best talent" at AIG and other firms. Precisely the nature of the "talent" of executives who masterminded the collapse of the company and much of the financial system, the newspaper did not explain.

It then got to its central point: "The Obama administration reportedly intends in the next week or two to announce the details of a "private-public partnership" to buy troubled assets from ailing banks. The participation of private hedge funds, investment banks and other firms will be key to the plan's success..."

This refers to the administration's plan to entice speculators into buying bad loans from the banks by using taxpayer money to give them low-cost loans and guarantee the vast bulk of any potential losses. This is a scheme to guarantee returns of 20 percent or more to big investment firms and provide a new source of fees and profits to the banks, while offloading the banks' worthless assets onto the public.

Following the House vote, Obama issued a statement designed to appeal to popular anger while making no commitment to support the measure. He said the vote "rightly reflects the outrage that so many feel over the lavish bonuses that AIG provided its employees at the expense of the taxpayers who have kept this failed company afloat." He continued, "I look forward to receiving a final product that will serve as a strong signal to the executives who run these firms that such compensation will not be tolerated."

Appearing that evening on the "Tonight Show with Jay Leno," Obama responded to a question from the comedian on the House bill by further distancing himself from it. "I understand Congress' frustrations," he said. "They're responding to, I think, everybody's anger. But I think the best way to handle this is to make sure that you close the door before the horse gets out of the barn."

This statement sums up the hypocrisy of the administration as well as Congress. Obama, both before and after assuming office, intervened to prevent the door from being closed to AIG and other financial firms—including Merrill Lynch, Fannie Mae and Freddie Mac—that used taxpayer money to award lavish bonuses.

During the presidential campaign, candidate Obama joined with the Bush administration in opposing any serious executive pay restrictions in the original TARP bailout legislation. As president elect, he lobbied to block attempts to attach meaningful compensation limits in the congressional authorization for the second $350 billion installment of TARP funds. And his administration intervened in the final stages of congressional action on his economic stimulus bill to sanction bonuses at AIG and other firms receiving government cash by exempting bonuses agreed to before the February 11 enactment of the stimulus legislation from limits on executive compensation.

Subsequently in the Leno interview, Obama responded to a question as to whether some people should go to jail for the economic debacle by offering a virtual blanket amnesty to Wall Street. "Most of what got us into trouble was perfectly legal," he said. He sought to discredit public anger as "finger-pointing," declaring that he was seeking to "break a pattern in Washington where everybody's always looking for someone to blame."

The real attitude of the Obama administration was spelled out by the Wall Street Journal, which reported Friday that "privately, there's concern within the Obama administration that the angry political atmosphere now surrounding the federal bailout program will scare away private participants the government needs to help bolster the financial system."

The newspaper added that administration officials "are looking for ways to blunt the bill's impact if it becomes law..."

On the same day that Obama vouched for the lawfulness of the American financial aristocracy, the House Ways and Means Committee's oversight subcommittee revealed that thirteen of the largest recipients of government bailout funds failed to pay more than $220 million in federal taxes, including two firms—which the committee refused to name—that owe $113 million and $102 million.

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This crisis is far more serious than the Great Depression. All major sectors of the global economy are affected. Recent reports suggest that the system of Letters of Credit as well as international shipping, which constitute the lifeline of the international trading system, are potentially in jeopardy.  

The proposed bank "bailout" under the so-called Troubled Asset Relief Program (TARP) is not a "solution" to the crisis but the "cause" of further collapse.  

The "bailout" contributes to a further process of destabilization of the financial architecture. It transfers large amounts of public money, at taxpayers expense,  into the hands of private financiers. It leads to a spiraling public debt and an unprecedented centralization of banking power. Moreover, the bailout money is used by the financial giants to secure corporate acquisitions both in the financial sector and the real economy. 

In turn, this unprecedented concentration of financial power spearheads entire sectors of industry and the services economy into bankruptcy, leading to the layoff of tens of thousands of workers. 

The upper spheres of Wall Street overshadow the real economy. The accumulation of large amounts of money wealth by a handful of Wall Street conglomerates and their associated hedge funds is reinvested in the acquisition of real assets. 

Paper wealth is transformed into the ownership and control of real productive assets, including industry, services, natural resources, infrastructure, etc. 

Collapse of Consumer Demand

The real economy is in crisis. The resulting increase in unemployment is conducive to a dramatic decline in consumer spending which in turn backlashes on the levels of production of goods and services. 

Exacerbated by neoliberal macro-economic policy, this downward spiral is cumulative, ultimately leading to an oversupply of commodities. 

Business enterprises cannot sell their products, because workers have been laid off. Consumers, namely working people, have been deprived of the purchasing power required to fuel economic growth. With their meager earnings, they cannot afford to acquire the goods produced. 

Overproduction Triggers a String of Bankruptcies

Inventories of unsold goods pile up. Eventually, production collapses; the supply of commodities declines through the closing down of production facilities, including manufacturing assembly plants. 

In the process of plant closure, more workers become unemployed. Thousands of bankrupt firms are driven off the economic landscape, leading to a slump in production. 

Mass poverty and a Worldwide decline in living standards is the result of low wages and mass unemployment. It is the outcome of a preexisting global cheap labor economy, largely characterized by low wage assembly plants in Third World countries.   

The current crisis extends the geographic contours of the cheap labor economy, leading to the impoverishment of large sectors of the population in the so-called developed countries (including the  middle classes). 

In the US, Canada and Western Europe, the entire industrial sector is potentially in jeopardy. 

We are dealing with a long-term process of economic and financial restructuring. In its earlier phase, starting in the 1980s during the Reagan Thatcher era, local and regional level enterprises, family farms and small businesses were displaced and destroyed. In turn, the merger and acquisition boom of the 1990s led to the concurrent consolidation of large corporate entities both in the real economy as well as in banking and financial services.  

In recent developments, however, the concentration of bank power has been at the expense of big business. 

What is distinct in this particular phase of the crisis, is the ability of the financial giants (through their overriding control over credit) not only to create havoc in the production of goods and services, but also to undermine and destroy large corporate entities of the real economy. 

Bankruptcies are occurring in all major sectors of activity: Manufacturing, telecoms, consumer retail outlets, shopping malls, airlines, hotels and tourism, not to mention real estate and the construction industry, victims of the subprime mortgage meltdown.  

General Motors has confirmed that "it could run out of cash within a few months, which could prompt one of the biggest bankruptcy filings in U.S. history". (USNews.com, November 11, 2008))  In turn this would backlash on a string of related industries. Estimates of job losses in the US auto industry range from 30,000 to as much as 100,000.(Ibid). 

Collapse of General Motors Share Price

In the US, consumer retail companies are in difficulty: the share prices of JC Penney and Nordstrom department store chains have collapsed. Circuit City Stores Inc. filed for Chapter 11 protection. The shares of Best Buy, the electronics retail chain, have plunged. 

The Vodafone Group PLC, the world's biggest mobile phone company not to mention InterContinental Hotels PLC are in difficulty, following the collapse of stock values. (AP, Nov 12, 2008). Worldwide, over two dozen airlines have gone under in 2008, adding to a string of airline bankruptcies in the course of the last five years. (Aviation and Aerospace News, 30 October 2008). Denmark's Second commercial airline Stirling has declared bankruptcy. In the US, a growing list of real estate companies have already filed for bankruptcy protection.

Vodophone. Collapse of Share Price



InterContinental Hotels PLC

In the last two months, there have been numerous plant closures across America leading to the permanent layoff of tens of thousands of workers. These closures have affected several key areas of economic activity including the pharmaceutical and chemical industries, the automobile industry and related sectors, the services economy, etc. 

US factory orders have declined dramatically. Research firm Autodata reported in October that "sales of cars and light trucks in September had declined 27 percent compared with a year earlier."(Washington Post, October 3, 2008)

Unemployment

According to the US Bureau of Labor Statistics, an additional 240,000 jobs were lost during the month of October alone:

"Nonfarm payroll employment fell by 240,000 in October, and the unemployment rate rose from 6.1 to 6.5 percent, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. October's drop in payroll employment followed declines of 127,000 in August and 284,000 in September, as revised. Employment has fallen by 1.2 million in the first 10 months of 2008; over half of the decrease has occurred in the past 3 months. In October, job losses continued in manufacturing, construction, and several service-providing industries...

Among the unemployed, the number of persons who lost their job and did not expect to be recalled to work rose by 615,000 to 4.4 million in October. Over the past 12 months, the size of this group has increased by 1.7 million." (Bureau of Labor Statistics, November, 2008)

The official figures do not describe the seriousness of the crisis and its devastating impact on the labor market, since many of the job losses are not reported. 

The situation in the European Union is equally disturbing. A recent British report points to the potential plight of mass unemployment in North Eastern England. In Germany, a report published in October, suggests that 10-15% of all automotive jobs in Germany could be lost.

Job cuts have also been announced at General Motors and Nissan-Renault plants in Spain. Sales of new cars in Spain plummeted by 40 percent in October in relation to sales in the same month last year. 

 

Workers of Nissan automaker protest in front of the Japanese company's building in Barcelona (AFP)

Bankruptcies and Foreclosures: A Money-spinning Operation for the Financial Giants 

Among the companies on the verge of bankruptcy are some highly lucrative and profitable operations. The important question: who takes over the ownership of bankrupt giant industrial corporations? 

Bankruptcies and foreclosures are a money-spinning operation. With the collapse in stock market values, listed companies experience a major collapse of the price of their stock, which immediately affects their creditworthiness and their ability to borrow and/ or to renegotiate debts ( which are based on the quoted value of their assets).  

The institutional speculators, the hedge funds, et al have cashed in on their windfall loot. 

They trigger the collapse of listed companies through short selling and other speculative operations. They then cash in on their large scale speculative gains. 

According to a report in the Financial Times, there is evidence that the plunge of the US automobile industry was in part the result of manipulation:  "General Motors and Ford lost 31 per cent to $3.01 and 10.9 per cent to $1.80 despite hopes that Washington may save the industry from the brink of collapse. The fall came after Deutsche Bank set a price target of zero on GM." (FT, November 14, 2008, emphasis added)

The financiers are on a shopping-spree. America's Forbes 400 billionaires are waiting in limbo. 

Once they have consolidated their position in the banking industry, the financial giants including JP Morgan Chase, Bank of America, et al  will use their windfall money gains and bailout money provided under TARP, to further extend their control over the real economy. 

The next step consists in transforming liquid assets, namely money paper wealth, into the acquisition of real economy assets. 

In this regard, Warren Buffett's Berkshire Hathaway Inc. is a major shareholder of General Motors. More recently, following the collapse in stock values in October and November, Buffett boosted his stake in oil producer ConocoPhillips, not to mention Eaton Corp, whose price on the NYSE tumbled by 62% in relation to its December 2007 high (Bloomberg).  

The target of these acquisitions are the numerous highly productive industrial and services sector companies, which are on the verge of bankruptcy and/or whose stock values have collapsed.  

The money managers are picking up the pieces.    

Ownership of the Real Economy

As a result of these developments, which are directly related to the financial meltdown, the entire ownership structure of real economy assets is in turmoil.    

Paper wealth accumulated through insider trading and  stock market manipulation is used to acquire control over real economic assets, displacing the preexisting ownership structures. 

What we are dealing with is an unsavory relationship between the real economy and the financial sector. The financial conglomerates do not produce commodities. They essentially make money through the conduct of financial transactions. They use the proceeds of these transactions to take over bona fide real economy corporations which produce goods and services for household consumption.   

In a bitter twist, the new owners of industry are the institutional speculators and financial manipulators. They are becoming the new captains of industry, displacing not only the preexisting structures of ownership but also instating their cronies in the seats of corporate management. 

No Reform Possible under the Washington-Wall Street Consensus

The November 15 G-20 Financial Summit in Washington upholds the Washington-Wall Street consensus. 

While formally presenting a project to restore financial stability, in practice, the hegemony of Wall Street remains unscathed. The tendency is towards a unipolar monetary system dominated by the United States and upheld by US military superiority. 

The architects of financial disaster under the 1999 Gramm-Leach-Bliley Financial Services Modernization Act (FSMA) have been entrusted with the task of mitigating the crisis, which they themselves created. They are the cause of financial collapse.  

The G20 Financial Summit doesn't question the legitimacy of the hedge funds and the various instruments of derivative trade. The final Communiqué includes an imprecise and blurred commitment "to better regulate hedge funds and create more transparency in mortgage-related securities in a bid to halt a global economic slide." 

A solution to this crisis can only be brought about through a process of  "financial disarmament", which forcefully challenges the hegemony of the Wall Street financial institutions including their control over monetary policy. "Financial disarmament" would also require freezing the instruments of speculative trade,  dismantling the hedge funds and democratizing monetary policy. The term "financial disarmament" was initially coined by John Maynard Keynes in the 1940s.

Obama Endorses Financial Deregulation 

Barack Obama has embraced the Washington-Wall Street consensus. In a bitter twist, former Congressman Jim Leach, a Republican who sponsored the 1999 FSMA in the House of Representatives is now advising Obama on formulating a timely solution to the crisis. 

Jim Leach

Jim Leach, Madeleine Albright and former Treasury Secretary Larry Summers, who also played a key role in pushing through the FSMA legislation, were in attendance at the November 15 G-20 Financial Summit, as part of President-elect Barack Obama's advisory team: 

"President-elect Barack Obama and Vice President-elect Joe Biden announced that former Secretary of State Madeleine Albright and former Republican Congressman Jim Leach would be available to meet with delegations at the G-20 summit on their behalf. Leach and Albright are holding these unofficial meetings to seek input from visiting delegations on behalf of the president-elect and vice president-elect. (mlive.com, November 15, 2008)

by Jeremy Frombach

www.opednews.com

This financial bubble is so, so easy to understand. Don't be steered by economists, brokers, and politicians using lofty terms and numbers far beyond the understanding of the average American aimed at confusing you. It all comes down to two words: Bretton Woods.

During Nixon's presidency, our country was ready for it's own foreclosure. The many years of fighting in Vietnam had left us completely broke, with citizens taxed through the roof and not an extra dime left to give. A tax hike was unthinkable. However at this time, the dollar was tied to gold. The Bretton Woods agreement in 1971 moved to permanently break the  bond between the US dollar and it's gold backing. Why would they do this? Well, it essentially removed the very last obstacle in the way of the federal government from literally having an unlimited budget. They could now spend whatever they pleased. Print and print and print, even with no gold left to back it. This inflationary system was genius. It gave the government the ability to now pillage the people's wages and savings without needing a single congressman to even donate a signature. Want another 300 million in the budget for defense spending? Don't use tax money, just call the Federal Reserve and have them print it. Give them a briefcase full of official looking paper (U.S. Treasury Bills) and they'll hand back bags full of freshly printed currency. Take that paper and deposit it in the bank and write checks against it. That's it. Did you need to pass a tax hike? Do the people even know or care about what you just did? No and no.

Ask yourself this question- why is no one in this country allowed to print their own money? The obvious answer being it would make money worthless. Everyone would be printing as much as they wanted, so it would really mean nothing. However, this is exactly what banks in our country are legally priviliged to do. Let's say you are a bank. I deposit $10,000 into your bank. You are legally allowed to lend out 90% of it, or $9,000. So that's what you do that same day, you loan it out.
What if I come back the next day and say I need to withdraw $9,000? Do you say "Oh, sorry sir, that money's been lended"? No, you say "Fine, Mr. Frombach. Here is your $9,000." Okay, so wait a second, you just loaned my $9,000 to someone else yesterday, so where did this $9,000 you just handed me come from? Here is the eureeka moment- they created it. When they loan your money, they aren't actually loaning your money. They use your $10,000 as a sort of momentary collateral. They digitally create $9,000 new dollars on a computer screen, send it to another computer at another bank as a loan, and leave your $10,000 sitting in the vault. Or in the computer, however you want to picture it. This results in the creation of billions and billions of dollars over time. How many billions, or trillions, you ask? Great question- no one knows. Congress has no authority to audit the Federal Reserve, we don't even know how much money they print anymore. They're not legally required to disclose it. They are allowed to run the printing press 24/7, loaning that new money away to banks on a daily basis, which the banks then use to create their own money and loan it to another bank, who then takes it and creates their own money out of it, and so on and so on.

This practice is what caused the financial bubble. Don't buy into 'oh the mortgage rates adjusted and blah blah blah and subprime lending and less regulations'. Complete nonsense. What caused this bubble is simple- We have a central bank going around literally counterfeiting money. They are printing it and printing it, and niether you, me, Congress or even the President of the United States has the authority to say "Hey, Mr. Bernanke- stop." The Federal Reserve Act of 1913 gives the central bank full monetary authority, and the federal government zero. Don't be confused- the Federal Reserve is not a government run or owned bank. It is owned by private citizens, just like the mom & pop dry cleaner down the street. Who exactly, we don't know, because again we have no authority to even investigate or audit. Back to my point! You have all these banks running around digitally creating money left and right, and then giving that digital money to other banks, so they can turn around and create digital money off of it, so forth. THAT, my friends, is why the financial system has imploded. It's because money is becoming a trivial term. It is no different than the anarchy that would ensue if all of us were giving the authority to print our own money. "You want a million for this house?" :scribble scribble: "Here you go! How about that car? $90,000?" :scribble scribble: "Great doing business with you!"

Want to know how we got to this point? For the last 40 years the government has been doing exactly that. We have been buying countless foreign goods. Damn near everything is manufactured overseas. Stereos, computers, TV's, cars, cel phones, clothing, furniture; all bought with our currency, which is nothing but a piece of paper with scribbles on it. And now all those countries have FINALLY caught on and they're saying whoa whoa, I get it now! The US isn't that wealthy, they don't have a bunch of money, they're just printing it!

It's like suddenly realizing your supplier has been selling you nothing but knock-offs. And now comes our day of reckoning. That free ride we've had for the last 40 years is now over, and this financial dream world we've been living in in this country has finally been brought back to reality.

Here is what HR 2755 proposes-

NO MORE COUNTERFEITING OF U.S. MONEY. PERIOD.

It moves to abolish the Federal Reserve from having the authority to print money. Why does this matter to you? Because the supply of an asset is directly tied to it's value. If you owned the only handwritten letter still in existence of say, Abraham Lincoln, what would that be worth? And what if some joker went around counterfeiting a bunch of handwritten letters claiming it was also the writing of Lincoln, and no one could tell the difference? Now there are 50,100, 500, or even a thousand of them? What is your letter worth now? This is what is happening to your money on a daily basis. In 2006, if you rounded up every paper dollar in the country, it totalled $10.3 Trillion. As of Feb. 2008 that total was at 14.6?? There is 40% more paper money now being passed around, and you wonder why the financial system is imploding? Keep in mind this is longggg before all the bailouts, which are all funded by freshly printed paper money. Or digitally created money. It's so clever- it gives our government an endless budget through printing money when there is not enough tax money to pay the bills. It raises our living expenses due to the debasement caused by printing, forces us to lower our standards of living and make sacrifices in the same manner a tax increase would have done, yet they don't even have to get it passed through Congress, report it to the news, or even ask for our permission. Genius.

By abolishing the Federal Reserve, closing all of their banks, and repealing their authority to create money, you are essentially throwing the counterfeiter in jail. Your money will now retain it's value. When banks want to loan money, they have to actually have it, they can no longer just go to the Fed and be given an injection of artificial money, and then use it to create new money.

Call your local congressman (find your congressman athttp://directory.usayfoundation.org/) and tell them to SUPPORT HR 2755. Then call or email every friend and family member and tell them to do the same.

No more financial crashes, no more manipulation of our currency, and no more private individuals wielding complete control over the world's confidence in our dollar!

If Mr. Obama truly wants change, he too will publicly support this legislation. And it is up to all of you that voted for him to be sure that he does.

Iceland’s neophyte bankers no doubt wish they’d paid more attention to this warning. In the past two months, many countries have seen their banks brought low by excess leverage, but none has been punished so thoroughly as Iceland, where the currency and the government’s credit rating have joined the banking system on the ash heap of history. “Too big to fail” turned into “too big to save”—the banks’ holdings were so large relative to Iceland’s economy that the government had no credibility as a lender of last resort. The economy looks likely to shrink by 10 percent this year, and future growth may not be enough to cover the interest on the massive foreign loans that Iceland needs simply to keep functioning.

Notably, Iceland’s financial industry had little exposure to American subprime mortgages. In this, Iceland serves as an important reminder: ultimately, leverage, more than houses, is to blame for the severity of the international financial crisis. And leverage is what regulators worldwide will need to tackle as we seek to clean up the mess.

Click the image above to view a larger version of this map.

Dec. 12 (Bloomberg) -- For General Motors Corp., the question is no longer whether it will get a government loan or if Chief Executive Officer Rick Wagoner will be replaced. It’s whether anything can prevent the largest U.S. automaker from sliding into bankruptcy.

Even an offer by the Treasury Department today to provide temporary relief, after the Senate rejected a bailout plan approved by the House, isn’t likely to offset the Dec. 10 announcement that GM’s 49 percent-owned affiliate, GMAC LLC, lacked the capital to become a bank holding company. That means the financing unit won’t be able to access Treasury’s Troubled Asset Relief Program to help make auto loans.

GMAC may now have to file for Chapter 11 protection, with or without a loan, joining GM’s biggest parts supplier, Delphi Corp., which is already in bankruptcy. The Detroit-based automaker, leaking $67 million a day -- enough to buy a fleet of 1,800 Cadillac CTS coupes -- may soon be sucked into the vortex.

“GM already is bankrupt and should file for bankruptcy,” said David Littman, senior economist for the Mackinac Center for Public Policy, a policy research organization in Midland, Michigan. “They have too much overhead and too little time left to reduce size to be a survivor in this industry.”

The company eschewed the Chapter 11 option for months, believing it would make consumers unwilling to buy their cars. Lead director George Fisher said last week that bankruptcy is “way down the list of options.” GM has been working with New York lawyer Martin Bienenstock of Dewey & LeBoeuf to devise an option for using the bankruptcy process to restructure, according to a person familiar with the contingency plan.

Cash Concerns

A bankruptcy filing in the U.S. wouldn’t necessarily include overseas subsidiaries such as GM Europe, which builds Opel and Vauxhall automobiles. It would, said Alan Baum, manager of forecasting for Planning Edge, a consulting firm in Birmingham, Michigan, make a foreign supplier or partner “fear that a GM bankruptcy might eat up its cash.”

The Senate thwarted the government bailout in a procedural vote after talks failed in a dispute with Republicans over how quickly auto-union wages should be cut. Only 10 Republicans voted to move forward on the rescue plan.

GM shares fell about 4 percent to $3.94 in New York Stock Exchange composite trading as of 5:30 p.m.

To GM’s critics, worries about cash are three years too late. The financial crisis wasn’t the culprit that brought the company to the brink of insolvency, as Wagoner told Congress last month. It was just the final straw in a succession of unresolved or unaddressed issues.

Shrinking Sales, Value

Since 2005, GM has lost a cumulative $72.4 billion, had its debt downgraded to junk, watched its share of U.S. auto sales shrink by almost 1 million vehicles and shed 90 percent of its market value. It introduced gas-guzzling vehicles as fuel prices rose, failed to slim down its product offerings and dealer networks quickly enough and wasn’t able to cap its labor costs in time to stem the bleeding. In September 2007, the company won the right to hire new workers at lower wages starting in 2010 -- too far down the road to avoid the consequences of a recession and a credit crunch that engulf it now.

“We made mistakes,” Wagoner conceded at a Senate hearing last week. Among the errors, he said, were “failing to build sufficient flexibility into our operations and not moving fast enough to invest in smaller, more fuel-efficient vehicles.”

100th Birthday

Wagoner, 55, who has been CEO since 2000 and declined to be interviewed for this article, was also slow to see the impact of the credit crisis. On Sept. 16, the day after Lehman Brothers Holdings Inc. filed the biggest bankruptcy in U.S. history, he told reporters at a party at Detroit’s Renaissance Center marking the company’s 100th birthday that he saw “no big impact” on consumers. The next month GM’s auto sales in the U.S. plunged 45 percent.

After 77 years as the world’s largest automaker, GM and its executives were unable to embrace change. The company continued to plow resources into sport-utility vehicles and make bad alternative-fuel bets, even after consumer buying habits shifted. It rejected an offer from Carlos Ghosn, CEO of Renault SA and Nissan Motor Co., to form a global alliance. And it dismissed calls for radical restructuring from former board member Jerome York and other critics.

Ignoring Advice

York, 70, a former Chrysler Corp. finance chief, was advising Tracinda Corp. CEO Kirk Kerkorian, who had amassed a 9.9 percent stake in GM. He told analysts in January 2006 that the time had come for the automaker “to go into a crisis mode and act accordingly.” York calculated that GM was burning through cash at a rate of $24 million a day, which meant it had about 1,000 days before it ran out -- in October 2008.

GM ignored York’s advice to reduce its number of models, including getting rid of the Hummer and Saab brands, and to cut both management and labor costs in what he called an “equality of sacrifice.” He resigned nine months later, in October 2006, frustrated by the board’s unwillingness to take action. Only after York left did GM decide to sell Hummer. Now it’s talking about getting rid of Saab and Saturn, as well as Pontiac.

“Three years ago I thought GM had the time and financial resources to save itself,” York, now CEO of Harwinton Capital LLC, said in an interview. “Now I’m not so sure. Who’s responsible? Top management and the board of directors.”

Auto Bubble

Although York’s prediction was prescient -- GM has told Congress it will run out of cash by the end of the year if it doesn’t get relief -- what no one could foresee then were two developments that sealed GM’s fate: a run-up in gasoline prices and a credit-market freeze that followed Lehman’s collapse.

The frozen credit markets signaled the end of an era of easy money that delayed GM’s day of reckoning. In a parallel to the housing bubble, GM and its Big Three brethren enjoyed a decade of artificially inflated sales. Finance companies did a booming business in subprime auto loans, a rarity in 2000, which accounted for 18 percent of new-car financing by 2005, according to CNW Market Research in Bandon, Oregon. And the automakers’ own subsidiaries offered low-interest financing that helped move cars off dealers’ lots.

That did nothing to stem GM’s steady loss of market share in the U.S., from 30 percent in 2000 to 22 percent today. It did help keep the industry’s annual U.S. sales at or near record levels, topping 17 million vehicles.

Managed for Cash

“They were trying to delay the draconian measures they needed to take,” said Ashvin Chotai, managing director of Intelligence Automotive Asia Ltd., a consulting firm in London.

GM gave the bubble a boost with a zero percent “Keep America Rolling” financing campaign started eight days after the Sept. 11 terrorist attacks. Sales jumped 42 percent in October. The program got the company even more hooked on incentives than it had been in the 1980s. “Keep America Rolling” was followed by “Employee Pricing,” “Red Tag Specials” and other low-interest and rebate deals that made discounting the norm.

“It was a great initiative to prop up the market, but it’s a trap they fell into,” said Chotai, who estimates that annual U.S. auto sales would have fallen to 13 million to 14 million without incentives. “Nobody believes list price anymore, so you’ve destroyed your pricing power and you’ve diluted your brand.”

That’s only one way GM executives were short-sighted. It’s not that Wagoner, who received an MBA from Harvard University in 1977, doesn’t know management. It’s that between dwindling liquidity and its sky-high fixed costs, the company was increasingly managed for cash, even at the expense of profit.

‘Alternate Universe’

GM continued to build unprofitable models because it needed the cash to meet financial obligations, such as a roughly $5 billion annual health-care bill for workers and retirees. In 2007, even though GM posted a $38.7 billion net loss, it managed to generate $189 million in free-cash flow. That’s equivalent to burning the furniture in order to stay warm.

“These are not stupid people, but they had created an alternate universe,” said James Womack, co-author of “The Machine That Changed the World,” a book about the Toyota Motor Corp. production system that bested Detroit’s. “They lived in a cocoon. GM was weak for reasons that were under the surface, and the financial crisis brought it all out.”

To John Shook, a former Toyota manager who worked at a joint-venture plant run by the Japanese company and GM in Fremont, California, that explains why the two automakers are in such different shape today. When it comes to engineering and manufacturing, Shook says, Toyota and GM are about equal. Where they differ is in their corporate cultures.

“Toyota is built on trial and error, on admitting you don’t know the future and that you have to experiment,” Shook said. “At GM, they say, ‘I’m senior management. There’s a right answer, and I’m supposed to know it.’ This makes it harder to try things.”

‘Increasing Certitude’

So while Toyota assumed it must continuously adapt if it wanted to succeed in the U.S., Shook says, GM believed it would forever be the market leader. Its managers brought Toyota’s manufacturing methods from Fremont to Detroit. They couldn’t duplicate Toyota’s zen: question everything.

Wagoner, a 31-year GM veteran, was the embodiment of its culture, an apostle of incremental change. Exciting as a Saturn, quotable as an owner’s manual, the one-time Duke University basketball player exuded quiet confidence about GM’s future.

“I know that things will turn around,” he told Fortune magazine in February 2006, after problems erupted at the automaker. The magazine concluded in a cover story that “the evidence points, with increasing certitude, to bankruptcy.”

“GM people tend to internalize, to think that they can figure things out on their own,” said Don Runkle, chairman of Inkster, Michigan-based battery maker EaglePicher Inc. and a former GM chief engineer.

Perot Appalled

Over the years, the occasional outsider who entered the company with notions of shaking it up has been rejected as a foreign organism. GM acquired Electronic Data Systems Corp. for $2.55 billion in 1984 and gave its chairman, H. Ross Perot, a seat on the board. The brash Texan, appalled at GM’s ways, shocked directors by challenging then-CEO Roger Smith in meetings and publicly ridiculing the company.

“The first EDS-er to see a snake kills it,” Perot told Business Week in 1986. “At GM, first thing you do is organize a committee on snakes. Then you bring in a consultant who knows a lot about snakes. Third thing you do is talk about it for a year.”

In 1986, GM paid Perot $700 million for his stock and his resignation from the board.

Even when GM did make changes, they weren’t revolutionary. In 1992, a year when the automaker posted a $23.5 billion loss, Chairman and CEO Robert Stempel resigned under pressure after 27 months on the job. It named director John Smale, the retired CEO of Procter & Gamble Co., as non-executive chairman and appointed Jack Smith, a GM lifer, as CEO.

‘Run Common, Run Lean’

Smith invested in SUVs and pickup trucks, starving cars, especially smaller models where Japanese automakers dominated. He rode a wave of prosperity, cheap gasoline and a strong North American housing market to eight straight years of profitability and a record share price of $93.62 in April 2000 before turning over the wheel to his protégé, Wagoner.

While Smith’s mantra was “run common, run lean,” he never achieved the goal of creating shared platforms and standards that might have slashed operating costs. GM has long been penalized, compared with its Japanese rivals, by its capital costs. It develops scores of chassis to meet different consumer preferences around the world. Yet it wasn’t until this year, after more than a decade of reorganization, that the company introduced its first common chassis for use worldwide. It will serve a mid-size Opel Insignia in Europe and a new Buick LaCrosse to be built in the U.S. next year.

Pontiac Aztek

Smith was also unable to drive sales with novel products. The Pontiac Aztek, a mid-size crossover introduced in 1999 as “the most versatile vehicle on the planet,” was so unsightly, so badly received, it was voted the ugliest car of all time in an August 2008 poll by the London Telegraph. The model was discontinued in 2004.

Challenged by 2001’s twin shocks of recession and 9/11, the new CEO, who had spent most of his career in finance, fell back on what he knew best. Through its GMAC LLC unit, GM attracted ever more buyers with creative financing gambits. One was the “incentivized lease,” requiring no money down and low monthly payments. While that lured customers and stoked production, when the leases expired, GM had to write off the difference between a vehicle’s assumed value, for lease purposes, and its true market value. Since resale prices had been reduced by the surfeit of GM product on the market, so was the company’s profit.

Shattered Illusion

The illusion of prosperity would vanish when the era of easy money passed. In the first quarter of 2005, after 12 straight years of profit, GM lost $1.3 billion. The company’s guidance on March 15 that a loss was coming startled Wall Street. Investors beat down the company’s shares by 24 percent over the next four weeks.

On May 4, Kerkorian, 91, who had reaped $3 billion on a 10 percent stake in Chrysler that he sold in 1998, disclosed that he had amassed 3.9 percent of GM’s shares and was launching a tender offer for more. The next day Standard & Poor’s knocked the company’s bonds down to one grade below investment quality. GM, once the bluest of blue-chips, now had junkers for bonds.

Turnaround Plan

Wagoner unveiled a “turnaround plan” in November 2005. It called for closing nine plants, eliminating 30,000 jobs, boosting employee contributions to GM’s health-care plan, increasing investment in its best-selling models such as the Hummer and revamping marketing efforts.

To Kerkorian and York, who joined GM’s board in February 2006, that wasn’t bold enough. The plant closings and health- care changes saved only $2 billion a year, they said, and the company’s idea of innovation was more versions of the same thing: the SUVs and trucks whose sales had been carrying GM.

Others had come to a similar conclusion. A month after Wagoner’s plan was announced, S&P again downgraded GM’s debt and called bankruptcy “not far-fetched.”

Wagoner found the crisis talk overblown. He dismissed a flurry of Chapter 11 questions by saying there was “no plan, strategy or intention for GM to file for bankruptcy.”

In April 2006, Wagoner took charge of GM’s North America division. That same month, he announced the sale of 51 percent of GMAC to New York-based private-equity firm Cerberus Capital Management LP for $7.4 billion. The move was intended to improve GM’s liquidity and protect GMAC’s access to credit markets, which had been threatened by the parent company’s ratings.

Confidence Vote

Wagoner sought a vote of confidence from the board that month and got it -- though not from GM’s newest director. York said he thought more sweeping changes were needed and that they weren’t going to come from within.

He and Kerkorian began to pursue Ghosn, 54, who had pulled Nissan back from the brink of bankruptcy. In May, Kerkorian met with Ghosn in Nashville, Tennessee, and asked him to consider an alliance. Renault and Nissan would each take a 10 percent stake in GM, share resources and collaborate as a way of cutting costs and spurring change. Ghosn was interested, according to York, and said he’d want a seat on the GM board. That would give him influence over the company’s strategy and perhaps position him to succeed Wagoner.

Kerkorian then sent a letter to Wagoner. In GM fashion, the proposal was studied for months and brought to the board. For directors, it was another opportunity to show their confidence in the incumbent CEO. On Oct. 4, they put an end to any alliance talks. Two days later, York quit the board.

“I haven’t found an environment in the boardroom that is very receptive to probing much beyond the materials provided by management,” York wrote in his letter of resignation.

Twin Pillars

GM shares dropped 6.3 percent on the news, and over the next two months Kerkorian unwound his position in GM. He netted $106 million on his $1.7 billion investment, according to regulatory filings.

In 2007, the two pillars holding up the company began to crumble, and not even the deal to reduce labor costs with the United Auto Workers could save it.

First, the subprime-loan market imploded, hurting GMAC’s Residential Capital LLC unit. On Nov. 1, 2007, GMAC reported a third-quarter loss of $1.6 billion as a result of subprime- mortgage writedowns. Over the next three weeks, GM lost one- third of its market value.

$4.11 a Gallon

Then gasoline prices began climbing, topping out at an average price of $4.11 a gallon in July 2008, ending America’s love affair with SUVs and pickup trucks -- the very categories that Wagoner had staked the company’s future on in his 2005 turnaround plan.

It’s not as if other automakers hadn’t also favored trucks in recent years. Gas-guzzlers were more profitable than light vehicles and, as long as fuel was cheap, far more popular.

The problem was that GM so skewed its model lineup away from sedans that it was out of position when the market turned. To make matters worse, at the moment many Americans became concerned with getting better gas mileage and going “green,” GM was years behind on developing alternative-energy cars.

Toyota and Honda Motor Co. each introduced gas-electric hybrid cars in 1997 -- the Prius and Insight, respectively. GM engineers scoffed at both. These were small, odd-looking and costly to produce. Why would people buy a car whose price outweighed the gas savings? GM executives told reporters the hybrids were public-relations gimmicks.

EV1’s Demise

GM discontinued its one alternative-energy vehicle -- the battery-powered EV1 -- in 2003, after spending more than $1 billion on a car with limited range that flopped with consumers. Company engineers believed that cars powered by hydrogen fuel cells were the real future in this field.

“They knew the home run was 20 years away, and they weren’t willing to settle for singles and doubles in the meantime,” said Shook, the former Toyota manager. “At Toyota, they said, ‘We don’t know the future; let’s try something we can do right now.’”

Today, with Prius a hit with consumers, GM is scrambling to catch up. It has several hybrid models of its own and, with Congress badgering him to produce more alternative-energy cars, Wagoner has made their development a major part of the restructuring program for which he’s seeking $10 billion.

GM Apologizes

He conceded the error of his ways in June, when GM’s board gave the go-ahead to market the electric-powered Chevrolet Volt in 2010. “Axing the EV1 electric-car program and not putting the right resources into hybrids,” Wagoner told Motor Trend magazine, when asked to name his greatest mistake as CEO. “It didn’t affect profitability, but it did affect image.”

The confession may have come too late. As did an ad GM placed on Dec. 8 in the Automotive News, an industry publication, acknowledging it had “disappointed” Americans in recent years with its quality, design and reliance on trucks.

Without a reduction in debt and lower labor costs, GM may not weather the current slowdown in U.S. vehicle sales. Congressional critics have argued that the rescue plan passed by the House on Dec. 10 doesn’t give the government leverage to force substantive changes on management and labor. Even a bridge loan, said Edward Altman, a finance professor at New York University’s Stern School of Business, “is destined to fail.”

“They’ve actually done some terrific stuff,” said Womack, the author, who is chairman of management-training firm Lean Enterprise Institute in Cambridge, Massachusetts. “It’s just that the scale is so large and the changes came so late in the game. The band was all tuned up, the brass was polished, but the ship had already hit the iceberg.”

Thanksgiving Menu 2008

appetizers
Mélange Of Frozen Markets
Tossed Assets With Government Guarantees
Frisée Of Foreclosures And Defaults

main dishes
Évaporation de Credit à la Cold Turkey
House Signature Dish
Seared Investors In Bottomless Pit With Caramelized Investments
Overheated Markets Without Oversight à la SEC
Braised Bankers Rump With Bailout Coulis

desserts
Sorbet Trio Of Shock, Disbelief And Insolvency
Off Balance Sheet flambé

Featured wine
Great Depression Grand Siècle 1933 méthode creditoise

THE LAST HAPPY CHRISTMAS

Last fall when the crisis caused by the August 2007 credit contraction began to gain momentum, its effects were initially confined to the financial sector. The lives of most individuals were still not affected by the spreading contagion of defaults emanating from investment banks in New York , London , Tokyo , Europe and elsewhere.

In America , Thanksgiving Day occurs in November and begins the autumn holiday season which ends with Christmas and the New Years festivities. At this time last year, the financial crisis had not yet affected America 's holiday celebrations although I knew it would soon do so.

Last fall, I predicted that Christmas 2007 would be remembered as “the last happy Christmas”. Today, the financial crisis has now reached the lives of those far removed from global financial centers and this holiday season will be unlike those previous. Next year, it will be worse.

THE FAST BOYS BURN THE SLOW BOYS

In today's credit/debt based economies, the flow of capital, sic debt and credit, between the fast boys, i.e. investment bankers—the packagers of credit, sic merchants of debt, and the slow boys, i.e. pension funds, insurance companies, investment funds, etc. needs to constantly grow.

As the quantity of debt-based money increases so too does the total amount of debt. This dynamic is heightened by the fact that debt is constantly compounding and the amount of debt is increased thereby almost exponentially.

As part of this process, the fast boys sell the slow boys debt-based “investments” on which the return is hoped to be in excess of inflation. Because the constant printing of debt-based money debases the value of previously issued “money”, savers are forced to constantly re-bet their savings in a world where the fast boys, the investment bankers, have a systemic advantage.

Because of their proximity to the spigots of credit, the fast boys, the investment banks, are able to bet the money of others (the slow boys) in such a way that they (the fast boys) profit immensely. When their bets are good, the fast boys profit far more than the slow boys whose money they leveraged. However, when the bets go bad, the results are shared more equally.

In credit/debt based economies, the sale of “investment” debt is critical in the confidence game that fiat money has forced on society. If such investment debt is not retired, sold, or rolled forward, the confidence game comes to a halt; and, when the merry-go-round of debt slows sufficiently, the game is over.

CREDIT INTERRUPTUS AND LIBOR PAINS

This is where we are today. Between 2002 and 2006 when the fast boys sold billions of dollars of subprime AAA rated soon-to default CDOs to the slow boys, the slow boys realized the fast boys had burned them, leaving them, the slow boys, with enormous amounts of bad debt totaling hundreds of billions of dollars.

When this happened, not only did the trust between the slow boys and fast boys disappear, so too did the trust between the fast boys themselves. LIBOR, the London Interbank Offered Rate, moved quickly higher after August 2007 signifying that bankers no longer even trusted each other to repay their debts.

A BANKER'S TRUST AND A WOMAN'S HEART

Trust is critically important in financial markets because debt/credit based economies founded on fiat currencies are little more than floating crap games where it is only a matter of time (perhaps a long time) until a crisis occurs that alerts the participants that the value of their paper assets including money can suddenly and without warning disappear.

Bankers by nature are often distrustful and women generally are not; but, in this area, bankers and women have something in common. As many know, when a woman's trust is violated the loss of that trust is often irreparable and the same is true, ironically enough, with bankers.

This is now the main concern of central bankers, the ringmasters of the financial circus masquerading as capital markets. Since August 2007, because the slow boys increasingly have shunned the debt-based offering of the fast boys, capital markets have remained frozen—and capital markets, like bicycles, do not do well at slow speeds.

THE RINGMASTERS RESPONSE

Bloomberg News noted on November 24, 2008 that the US government has now pledged $7.76 billion of taxpayer money to the banks and capital markets in the hopes of once again moving the sale of debt in now frozen markets.

The central bankers are doing this hoping that the slow boys will again return and begin buying the debt-based investments of the fast boys. This hope may well be in vain because now the underlying economies themselves are in serious danger of collapse.

Buying debt when economies are collapsing is not a good bet and the slow boys know this better than anyone else. More taxpayer money will not move the slow boys to purchase debt in today's market. It will take their belief that debt is once again safe and profitable—and in collapsing markets that belief is highly unlikely.

THANKSGIVING IN AMERICA

This year, Thanksgiving in America will be different. The mood will be more serious and the thanks offered for what has been given and received will be more heartfelt; and those who previously warned about an economic collapse may be viewed more seriously by those gathered around the Thanksgiving table.

In early November in Canberra , Australia , participants heard Professor Antal E. Fekete and others discuss, among other topics, how much time remained before markets began their final descent into catastrophic collapse.

The professor said his view has now changed because of the speed and severity of recent events, that such a collapse will now occur sooner than he had previously expected, perhaps in two years.

Those who do not believe in such a collapse are also those who did not foresee the recent collapse of banks, hedge funds, money market funds and insurance companies or the collapse of global equity markets on a scale unseen since the Great Depression.

THE PENDULUM IS A WRECKING BALL

The world is rebalancing itself and financial markets are not the only institution that will be affected in the coming years. Change is a constant occurrence in the universe and is now in the process of speeding up considerably.

A fundamental rebalancing of universal polarities is now in progress. It will affect economies, nations, religions, societies and all institutions that reflect the current paradigm. A new paradigm is on the way. It will be better than the present one—and that is something to be thankful for.

By Darryl Robert Schoon
www.survivethecrisis.com
www.drschoon.com
blog www.posdev.net

About Darryl Robert Schoon
In college, I majored in political science with a focus on East Asia (B.A. University of California at Davis, 1966). My in-depth study of economics did not occur until much later.

In the 1990s, I became curious about the Great Depression and in the course of my study, I realized that most of my preconceptions about money and the economy were just that - preconceptions. I, like most others, did not really understand the nature of money and the economy. Now, I have some insights and answers about these critical matters.

In October 2005, Marshall Thurber, a close friend from law school convened The Positive Deviant Network (the PDN), a group of individuals whom Marshall believed to be "out-of-the-box" thinkers and I was asked to join. The PDN became a major catalyst in my writings on economic issues.

When I discovered others in the PDN shared my concerns about the US economy, I began writing down my thoughts. In March 2007 I presented my findings to the Positive Deviant Network in the form of an in-depth 148- page analysis, " How to Survive the Crisis and Prosper In The Process. "

The reception to my presentation, though controversial, generated a significant amount of interest; and in May 2007, "How To Survive The Crisis And Prosper In The Process" was made available at www.survivethecrisis.com and I began writing articles on economic issues.

The interest in the book and my writings has been gratifying. During its first two months, www.survivethecrisis.com was accessed by over 10,000 viewers from 93 countries. Clearly, we had struck a chord and www.drschoon.com , has been created to address this interest.

The Treasury Department and the Federal Reserve have been in discussions over the weekend to devise a strategy to stabilize the company, according to people familiar with the talks. They spoke on condition of anonymity because the discussions were ongoing.

ADVERTISEMENT

One option being considered is taking some of the risky assets held by Citigroup off its balance sheet, a move that would give the company more breathing room and put it in a better position to raise capital. It was unclear, however, exactly how that option might be structured, the people said. Another option would be for the government to make another cash injection into the company.

A spokesman for New York-based Citigroup declined comment.

The company has seen its shares lose 60 percent of their value in the past week, reflecting a crisis of confidence among skittish investors. They are worried all the risky debt on Citigroup's balance sheet will turn into losses as the economy worsens and the markets stay turbulent -- losses that could be nearly impossible to reverse.

Citigroup is such a large, interconnected player in the financial system that if it were to collapse it would wreak havoc on already fragile financial and economic conditions. The company has operations stretching around the globe in more than 100 countries.

Analysts consider Citigroup the most vulnerable among the major U.S. banks -- especially after it failed to nab Wachovia Corp., which was bought instead by Wells Fargo & Co. That was a missed opportunity for Citi to gets its hands on much-needed U.S. deposits that would bolster its cash position.

Citigroup was especially hard hit by the meltdown in risky, subprime mortgages made to people with tarnished credit or low incomes. Foreclosures on those mortgages spiked, leaving Citi and other financial companies racking up huge losses on the soured investments. The company has failed to turn a profit during the past four quarters.

The company has already received $25 billion from the Treasury Department's $700 billion financial bailout program. In return for the cash infusion, the government gets a partial ownership stake.

Sen. Charles Schumer, D-N.Y., said Sunday he is confident the government and Citigroup "can come up with a plan that ensures Citigroup's viability, which is really important for the whole economy. ... If you let it go down, millions of innocent people are hurt, and the economy suffers at a time when it's terribly, terribly fragile," he said on ABC's "This Week."

Sen. Richard Shelby, R-Ala., a free-market advocate who opposes government intervention, said he thought any effort to aid Citigroup was a mistake.

"Citi has got to save itself," Shelby said. "And, can they do it by a merger with somebody else or going to somebody else? I don't know," he said on ABC.

AP Business Writer Madlen Read in New York contributed to this article.

We offer little new here, but a precious history of how the tentacles of the Credit Crisis are reaching more and more segments of the financial markets. No amount of interbank lending will recover meaningfully most segments from the firm grip of those tentacles.    

The Causes of the Financial Crisis
We do not attempt to explain the fundamental causes of the current Credit Crisis. No doubt that in coming decades tomes will be written on the subject. Nevertheless, the basics are simple – America borrowed and spent for decades driving its savings rate to nil, while printing trillions of dollars in attempt to sustain the (unsustainable) global imbalances caused by its own profligacy and saddling the rest of the world with trillions of bad debt. 

The Trigger of the Financial Crisis
The trigger of the crisis can be attributed to the decreased confidence in the markets for mortgage-backed securities following the August 2007 collapse of two Bear Stearns' hedge funds that were heavily exposed to subprime mortgages. Resetting of teaser rates and adjustable-rate mortgages triggered an avalanche of defaults. Once default rates started rising, many institutional investors, both U.S. and global, began to realize that the MBS's and CDO's in their portfolios might not be worth what they initially thought. Investment banks, insurance companies, mutual funds, and hedge funds alike began recognizing losses related to their holdings of mortgage-backed securities. Confidence was shaken. Margin calls forced further liquidations of those mortgage-backed securities, but as few were standing ready to buy, prices dropped even further, invoking even more margin calls. It was a death-spiral. The resulting losses just went snowballing. As a result, the markets for those structured financial products froze up and liquidity suddenly dried up. The Credit Crisis reared its ugly head.

1. Subprime Mortgages

The first indicator signaling the Subprime Meltdown surfaced in February 2007 “when scores of mortgage originators went bust amid rising defaults and tightening lending standards” . In mid-June, a second significant sign of financial collapse became evident as two CDO-focused Bear Stearns hedge funds blew up. Those hedge funds were too big and distracted investors' attention from another smaller in proportions, but still significant bankruptcy - California based brokerage firm Brookstreet Securities.  This was the early beginning of the crisis.

In the second week of July 2007, Moody's and Standard & Poor's announced downgrades on billions of bonds backed by subprime mortgages. Though the downgrades did not reveal the unsoundness of the bonds, it signaled the demise of the Ponzi mortgage investment market backed by inflated real estate.

In early August the looming Credit Crunch could already be felt. Several of Wall Street's biggest foreign customers announced enormous losses on their holdings of mortgage backed securities. Once the “teaser rates” began to reset, mortgage defaults spiked. Foreign investors realized that the bond collateral fell short of the bond principal, in banker-speak, the LTV exceeded 100%. Home equity vanished and mortgage payments shot up. Dwindling foreign lending was a sure sign of the impending crisis.

At the end of August many financial institutions began to sense the looming disaster. Calls for various government bailout schemes for homeowners were only meant to bail the lenders out. Amidst the unraveling of the subprime crisis, the Fed responded by aggressively cutting interest rates. However, tightening lending standards, widening credit spreads, and rising down payments exacerbated default rates and mounted further losses for the Leveraged Speculator Community, aka, hedge funds. A common sense of mistrust gripped the markets. Confidence evaporated, and so did liquidity. The subprime market was terminally ill – no amount of Fed cutting and liquidity injections could ever possibly revive it again! This market has been dead for more than year.

2. Jumbo Mortgages

With the meltdown of subprime mortgages, the tentacles of the Credit Crunch began to take firm hold of other sectors of the financial system.  The next victim was the market for jumbo mortgages – mortgages of high denominations, technically above $417,000 at the time. Further tightening of lending standards and more realistic perceptions of the underlying risk of those mortgages basically froze the market for Jumbo MBS. The major force behind the inflating California and Florida real estate bubbles was inanimate. Now these markets were set for a spectacular bust; the government's attempt to resurrect the Jumbo market (by raising the limit to $730,000) miserably failed. This market has been comatose for well over a year and jumbo rates remain stubbornly high. No amount of liquidity or interbank lending will revive the Jumbo market any time soon!

3. Home Equity loans

With dying subprime and jumbo markets and tightening mortgage credit, something that for decades was believed impossible, suddenly became inevitable -- real estate prices began to fall. As a result, the tentacles of the credit crisis snatched another victim -- Home Equity Loans and Home Equity Lines of Credit (HELOCs). These loans, commonly referred to as “second mortgages”, allow homeowners to borrow against the value of their home equity to finance a range of expenditures, such as medical bills, home improvements, college tuitions, and well-deserved vacations. The market quickly degenerated with rapidly deteriorating LTV ratios and skyrocketing number of “underwater” mortgages. Consumers fell behind on those loans at the highest level in 15 years. No more refis for consumers who already extracted the last drop of equity. With real estate prices falling, there was equity no more, With equity gone, so were the home equity loans. We can safely say that home equity loans are now a thing of the past and no amount of government stimulus and interbank lending will revive this market for many years!

4. SIVs and Conduits

Structured investment vehicles (SIVs) played a crucial role in the historic expansion of credit. A brainchild of ingenious financial engineers, large investment banks created and sponsored these entities. They invested largely in ABSs and MBSs that were manufactured primarily by the same large investment banks. To finance these investments, they issued investment-grade commercial paper and structured notes to investors around the world. This scheme allowed large financial institutions to remove a major portion of their risk exposure off their balance sheets, while at the same time “consolidating” any profits that resulted from the SIV operations. To put it in simple terms, they kept the profits on the balance sheet, but kept the risk off the balance sheet. This was the ultimate game in finance – return without risk, converting junk into AAA, turning led into gold – this was the Magic of Wall Street, the Alchemy of Finance.

However, with SIVs and Conduits loaded up with subprime, it was only a matter of time before this alchemic dream would turn into an ugly nightmare. Rising defaults and falling real estate prices shook investors' confidence. A series of downgrades inflicted grave damages. Some very risk-averse investors reaped distressing losses. Many risk-averse pension funds and university endowments relied on the AAA ratings and treated the securities as higher-yielding alternatives to safe money-market instruments. Repricing of ABS and MBS resulted in major writedowns for those SIVs and magnified the losses of their leveraged investors. Yet another victim fell into the tentacles of the Credit Crisis. As Doug Noland has pointed out so well, “the collapse of structured investment vehicles has proven to be the ultimate failure of Wall Street Finance in its attempt on risk intermediation between highly risky mortgage-backed securities and perceived safe and liquid money market instruments”. Today, it is accepted that Alchemy doesn't work, and that SIVs were hoped to do just that -- convert led into gold. The reality is that no amount of interbank lending and liquidity injections will do that.

5. CDOs

Some of the most pervasive exposures of leveraged financial institutions have been related to CDOs backed by subprime debt. This was another creature of mad financial engineers that was destined to fall in the tentacles of the Credit Crisis. It was meant to pool dodgy debt that with proper slicing and dicing would magically turn into a AAA-asset; it turned led into gold.

The bulk of the colossal losses of large investment banks, brokerage firms, hedge funds, and other financial institutions have been related to write-downs of CDOs. Their demand stalled as some top-rated classes of mortgage-linked CDOs lost their entire value amid surging foreclosures. Series of CDO downgrades by credit rating agencies led to enormous losses for investors around the world. Top-rated CDO tranches were devalued in late October 2007 due to expectations of excessive future losses from jumbo mortgages, Alt-As and option ARMs. Following the collapse of the two Bear Stearns hedge funds that were heavily invested in subprime CDOs, the CDO market has suffered severe illiquidity and lack of confidence. In late January Merrill Lynch CEO John Thain asserted that “[The company is] not going to be in the CDO and structured-credit types of businesses”. Since then the market has been for all practical purposes dead. It is dead because the underlying assets (jumbo, Alt-A, option ARMs) were never creditworthy in first place. No amount of liquidity injections and interbank lending will make the underlying instruments more creditworthy than before, and therefore cannot resurrect this financial instrument.

6. Commercial Paper

The familiar notion of borrowing short and lending long has come into question since the Credit Crisis began. Thousands of financial institutions have previously met their demise as a result of a maturity gap. Most of the companies engaged in this business were issuing commercial paper backed by MBSs or CDOs. With the unfolding of the crisis, questions about the value of the underlying collateral became ever more pervasive and eroded confidence. As a result, the market for commercial paper (CP) has fallen into the tentacles of the Credit Crisis. The first to experience the difficulties were the investment banks, then the commercial banks, and later other financial institutions. The difficulties spread even to the best investment-grade industrial corporations. As of April 11, 2008 total outstanding commercial paper has contracted by 11.4%. This market is not dead, but on life support, as the Fed has directly intervened to monetize commercial paper. Indeed, this market desperately needs the life support by the Fed in order to stay alive. By monetizing CP, the Fed has become the Lender of Last Resort for major corporations.

7. Private-Label MBS

The market for private-label MBS, which has been central to the creation of easily-available cheap credit, has suffered from a severe liquidity seizure, falling into the tentacles of the Financial Crisis. By securitizing mortgage loans, Wall Street was able to provide endless amounts of credit to homebuyers and homeowners, which led to the inflation of a real estate bubble of extreme proportions. Escalating home prices, in turn, made it possible for mortgage lenders to extend even more credit to borrowers with questionable credit history, without having to worry about being repaid, On the way up, it was a well-oiled Ponzi scheme; on the way down – an unmitigated disaster. The scheme depended crucially on rising real estate prices; once the prices stagnated or began to fall, no amount of liquidity injections or interbank lending could potentially revive this market. 

8. Leveraged Loans

The loan market for Private Equity and Leveraged Buyouts (LBOs) is not functioning. Those loans that finance Private Equity deals or LBOs are known as “leveraged loans”. The tentacle of the credit crisis has gripped this market too. As the real economy has suffered a serious slowdown and plunges into a recession, the rate of corporate bankruptcies has been soaring. As a result, in October 2007 some of the major banks, such as Bank of America, Citigroup and JP Morgan, had to write down $2.5 Billion in loans for LBOs. These losses prompted most of the big players to slash their LBO loans. Some estimates indicate that only the very best deal can possibly get any financing; the volume has fallen almost 10 times. With an economy in recession, no amount of liquidity injections and interbank lending can revive this market.

9. Alt-A Mortgages

The Alt-A mortgage sector has not escaped the tentacles of the credit crisis. In a manner quite similar to Subprime and Jumbo mortgages, this market has slowed to a trickle. However, with the nationalization of the GSEs, the government is attempting to revive this market by forcing the GSEs to purchase more of these mortgages. As the GSEs themselves are now “owned” and guaranteed by the Treasury, this is tantamount to the Treasury buying up Alt-A mortgages. Given that the Treasury itself is financed mostly through monetization of the Fed, the ultimate effect is that this market is supported, just like the commercial paper market, with the printing press. The economic interpretation is that of a classic government subsidy financed by an inflation tax – redistributive, inefficient, and replete with moral hazards that sets up the system for a spectacular blowup down the road.    

10. Prime Mortgages

The next victim in the tentacles of the Credit Crisis became the prime mortgages. Already in deep trouble, the financial system damaged even its healthiest credit market instrument. Reacting to the defaults in subprime and Alt-A mortgages, investors were compelled to manage risk more carefully. Practically, all sorts of loans became inaccessible for any borrower. This dried the liquidity, further causing huge bankruptcies of the borrowers who cannot refinance their loans. The prime residential mortgage market has been revived with the spectacular “bankruptcy” and subsequent nationalization of the GSEs, backed directly by the Treasury and indirectly by the Fed.

11. Commercial Mortgages

The commercial mortgage market has been practically frozen for many months. As the debacle in subprime, jumbo, Alt-A, and prime mortgages has unfolded, investors turned their attention to commercial mortgages. Over time, it became clear that investing in commercial mortgages is fraught with risk. The first obvious risk was overvaluation. The second obvious risk was a decelerating economy. The evolution of the Credit Crisis introduced a well-forgotten type of risk – liquidity risk. Investors saddled with heavy losses from other mortgage instruments decided to withdraw and stay on the sidelines. This, coupled with shaken confidence was enough to choke this market. Risk premiums have skyrocketed as the perceived risks of commercial mortgages have realigned with reality. Recession has exposed the fundamental weaknesses of many projects. The private sector wants none of this market. The Credit Crisis has extended its tentacles to commercial mortgages. No amount of liquidity injections and interbank lending can revive this market; only a direct intervention by the Treasury can do the trick.

12. Auction-Rate Securities

An auction-rate security is technically a debt instrument, typically a municipal bond, with a long nominal maturity, for which the interest rate is regularly reset through an auction, usually on a weekly basis. One economic interpretation of this concept is that of a fund borrowing with low short-term interest rates and lending to long-term municipal bonds, passing on the low interest rate to the municipal borrower. The other economic interpretation is that illiquid municipal bonds are securitized and transformed into liquid securities that are regularly traded at auctions.
As deleveraging tightened its vice grip on the credit market in February 2008, liquidity evaporated from the credit system and the auction-rate securities suddenly crashed out of the blue. It was another nail in the coffin of Wall Street Structured Finance and another victim in the tentacles of the Credit Crisis. This market has been dead for half a year and nothing short of extraordinary amount of liquidity coupled with government guarantees has the potential of reviving it.

13. Corporate Debt

The Credit Crisis has extended its tentacles to the corporate bond market. Credit spreads of investment-grade corporate bonds have been steadily rising and are much higher than even two months ago. Credit spreads for junk bonds have surged from 650 basis points at the end of September 2008 to 950 basis points at the beginning of November. Yes, credit is available to corporations, but the cost is becoming prohibitive. The tentacles have reached the corporate market and are beginning to strangulate it. Just like the market for auction-rate securities, this market desperately needs a torrent of liquidity to overcome the strangling tentacles. A Bloomberg story from October 31 tells the sorry tale of this market:
  “Corporate debt markets in the U.S. and Europe endured their worst month as the credit crisis spread beyond financial firms to industrial companies amid the prospect of a global recession.  Corporate industrial bonds in October are set to post their steepest monthly loss on record, while the gaps between yields on those bonds and government debt soar by the most ever.”

14. Credit Default Swaps

The US monolines are on the verge of bankruptcy as more and more of the credit that they insure defaults. They initially encountered difficulties in the beginning of January 2008. Indices of corporate credit risk widened, showing that the tentacles of Credit Crisis have reached the corporate bond market. The price of credit protection soared.

The monolines staggered because some major insurers were downgraded as investors questioned their ability to perform. Investors' minds were suddenly preoccupied with another well-forgotten risk – counterparty risk. A vicious spiral gripped the monolines -- CDSs lost their attractiveness, resulting in less cash inflows for monolines, which in turn decreased their ability to provide adequate credit risk insurance, lowering in turn their ability to sell CDSs… And another victim fell prey into the tentacles of the Credit Crisis.

The CDS market has not collapsed completely. However, its imminent collapse will indirectly affect international finance. Inability to hedge with CDS will eventually destabilize the US financial system. Many corporate borrowers will be unable to borrow, which in turn will result in higher corporate defaults, and another vicious cycles will inevitably take hold of the financial system.

15. Letters of Credit

The tentacles of the Credit Crisis have recently taken another victim: Letters of Credit. A Bloomberg story from October 29 explains this ugly turn for the worse: the Credit Crisis spreads beyond the financial sector and into the real economy. Do you remember the good old days when Bernanke and Paulson assured us that the Credit Crisis is contained? Here is the Bloomberg story:

“Richard Burnett's lumber company had started loading wood onto ships heading for China. More was en route to the docks. It was all part of an order that would fill 100 40-foot cargo containers.  Then Burnett got a call from his buyer at Shanghai VIVA Wood Products Co. The deal was dead. He told Burnett… he couldn't get a letter of credit to guarantee payment for at least six months.  ‘It was like a spigot got cut off,' Burnett said… The inability of buyers in China and Vietnam to get letters of credit has cost his company as much as $4 million this year, a third of projected revenue, forcing him to lay off 15 of 35 employees, he said.  Suppliers of oil, coal, grains and consumer products from Chicago to Mumbai are losing sales as the credit crisis spreads beyond financial institutions, and banks refuse financing or increase the fees for buyers.”

16. Credit Card Loans

In October 2008 another market has fallen into the tentacles of the Credit Crisis: the market for credit card loans. Credit card companies usually do not retain most of their credit card debt on their balance sheet; instead, they securitize it and sell it. The latest data from Dealogic indicates that the consumer-based securitization market has shrunk in October to $500 million from $50 billion previously. This means that the ability to securitize and sell consumer-based loans has fallen almost 100 times in one year. The implication is clear – credit card companies will be forced to cut consumers from credit card debt. This will bring the American consumer to his knees and means the end of the Consumer Economy. No wonder that in the last three months the media frequency of the word “Depression” has increased hundred-fold. 

Going Forward

No amount of interbank lending and liquidity injections will revive most of the markets for various financial instruments. No amount of monetary and fiscal policy can resurrect genuine productive lending in the economy. The tentacles of the Credit Crisis have spread to every sector of the financial markets. The “Real Estate Economy” is dead; the “Financial Economy” is dead; the “Consumer Economy” is dying; and the “Service Economy” is dying. Enter the Depression Economy! Or shall we say, “Enter the Zimbabwe Economy”!?

Thursday's "seminar for the policy community" is entitled "Islamic Finance 101." It will be held in Treasury's headquarters building next to the White House and - judging by the slated speakers - it will amount to little more than a vehicle for promoting Shariah-Compliant Finance. Apparently, there will be no discussion of the seditious nature of Shariah, which explicitly seeks to destroy the government and Constitution of the United States in favor of a global theocracy.

Speakers will include Robert Spencer, renowned author and expert on Shariah law, Jihadwatch.org project of the David Horowitz Freedom Center; Frank Gaffney, Center for Security Policy; Dan Pollak for Mort Klein, Zionist Organization of America; Andrea Lafferty, Traditional Values Coalition, and others. Speaker updates will be listed at www.usastopshariah.org

Members of the Coalition include Concerned Women for America, ACT for America, Institute for the Study of Islam and Christianity, the Zionist Organization of America, Traditional Values Coalition, Center for Security Policy, Endowment for Middle East Truth, Unity Coalition for Israel, Let Freedom Ring, Christian Solidarity International, Tradition Family & Property Inc., Women United, Jewish Action Alliance, Florida Security Council, Society of Americans for National Existence and the Center for Security Policy.

The Coalition to Stop Shariah speaks for peoples of all faiths and political affiliations who do not want to submit to the jihadist doctrine of Shariah. Its members have joined forces to oppose those seeking to impose Shariah's intolerant, barbaric code in America through the stealthy penetration of, among other things, our culture, legal system and capital markets. The Coalition is particularly concerned about the possibility that the Treasury Department will use the vast powers it has been given to cope with the subprime financial crisis as a means of promoting Shariah-Compliant Finance - a fear only heightened by the fact that the host of Thursday's seminar is the same Treasury official responsible for the $700 billion Troubled Asset Relief Program (TARP), Assistant Secretary Neel Kashkari.

The Coalition to Stop Shariah calls on the Treasury Department to cancel this indoctrination session, to cease its efforts to promote Shariah-Compliant Finance and to recognize Shariah for what it is - sedition - and treat it accordingly by, among other things, banning its application to U.S. financial institutions and products.

Coalition founder Frank Gaffney said, "The first campaign of the Coalition to Stop Shariah will be to challenge the Obama Treasury Department Transition Team to repudiate the U.S. Treasury Department's embrace of Shariah Compliant finance. Coalition members are preparing a more credible "Shariah Compliant Finance 101" course for the Obama Treasury Department Transition Team, and for members of the 111th Congress. The Coalition is alerting the Obama transition team and the U.S. Treasury Department that they are endangering America's taxpayers, financial institutions and legal system by this introduction of Shariah law to the United States."

Some three-quarters of a million people have lost their homes across the US so far this year and foreclosure filings are up 82.6 percent from a year ago, according to the web site ForeclosureS.com. The same report notes that 107,500 homes were lost in September alone.

The city of Detroit has the highest repossession rate for a major city in the US, with real-estate owned (REO) homes—that is, homes repossessed by banks or mortgage holders—at 3.7 percent in 2007. Cleveland, Ohio came in a close second with a 3 percent REO rate.

The social reality behind these figures is illustrated by a recent sale of a foreclosed home in Detroit. In September, a modest two-story single-family home on Detroit’s east side near the Detroit City Airport sold for one dollar. Less than two years ago, in November 2006, the same home sold for $65,000.

While abandoned homes are hardly a new phenomenon in Detroit, the story of this one house is a testament to the speed, scope, and depth of the foreclosure crisis. The one-dollar sale of the Detroit house even made the Sunday Times of London, which recently ran a piece titled “America’s Darkest Fear: to end up like Detroit.”

The WSWS interviewed Constance and her stepdaughter Toshiana, who live near Detroit City Airport. As Toshiana explained: “I actually am surprised that you came and talked to us at all. When the news came they all were taking pictures of the place up the street that sold for a dollar.

“We finally came out to see what it was about, why the news trucks were here. It took three days before they finally came to us and asked the people on the block what they thought. I don’t think they really care about people like us and what we think.”

Prior to the collapse of auto manufacturing in Detroit, the neighborhood had been relatively prosperous and home to thousands of autoworkers. Now, foreclosed properties are lowering home values and causing urban blight throughout the area. Constance rents a house on the same street as the foreclosed home and grew up nearby.

“I heard about the house up the street selling for one dollar,” Constance told the WSWS. “They had just fixed it up real nice a year and half ago, new siding, things like that. It looked beautiful. Now it’s a mess.”

Last summer the bank foreclosed on the home after the owners fell behind on their mortgage. “They had some renters come in and then it was empty. It didn’t take long for them to come and strip the place clean,” Toshiana said.

“When I was a baby my father was at an auto plant,” Toshiana added. “He had a brother working at the plant also. I had another uncle who worked at Dodge Main in Hamtramck. They all came up from the South in the early 1970s. There are not many people around here at the plants anymore. My mother says she is leaving Michigan and moving back to Louisiana as soon as she retires.”

The term “toxic mortgage” only begins to describe the effect of the housing crisis on working class communities across the US. The family that falls behind on mortgage payments or rent is out on the street. Neighborhoods become distressed. Abandoned houses catch fire and burn—a common phenomenon in Detroit—producing a noxious odor that permeates whole neighborhoods for months.

Toshiana noted the absence of the most basic services in the city of Detroit. “We don’t even have a grocery store anymore.”

She continued, “You actually have to go back to the early ’90s to see when all this started to happen. I could tell you a couple blocks I lived on in Detroit that I watched gradually torn down. They were really nice when I was there, but what happened? One place, I came back five years after I had moved, just to visit. I could not believe what had happened. The place was a mess; the houses were in terrible shape.

“Look around here. All you see are empty lots. Realtors may call these an investment opportunity, but who wants to live next to an empty lot? Scrappers make money off tearing the houses up. I really don’t understand why they even give out junking licenses, when they know this is going on in the neighborhoods. The decline is very ugly.”

According to a report in the August 13 Detroit News, there are now several properties listed for one dollar in Detroit, including a single family home and a duplex. In some cases subprime lenders, “find themselves the owners of whole neighborhoods of vacant, deteriorating homes.”

“My 14-year-old son could buy a block of Detroit property,” said a representative of the realty management firm that sold the one-dollar house.

Foreclosures are rising in several metropolitan areas across the state of Michigan. According to figures released by RealtyTrac, the state as a whole ranked fourth nationwide in the total number of foreclosure filings in August, with 13,605. Foreclosure filings rose 17 percent over July levels. Michigan ranked fifth nationwide in foreclosure filings, with one for every 332 households. That compares with a national rate of one filing for every 416 households.

A 2006 Association of Community Organizations for Reform Now (ACORN) report, “The Impending Rate Shock,” singled out Detroit as one of the cities likely to experience a housing disaster. In 2005 more than half the home purchase loans made in Detroit were high-cost loans, “making the city particularly vulnerable to rate shock,” the report noted. There were 23 metropolitan areas in the US where high-cost loans represent at least one of every three loans made to homebuyers.

See Also:
Bank Seizures of US homes reach a record high
[16 August 2008]
Detroit: Highest foreclosure rate in the US
[20 February 2008]