Re: Boycott Foreign Products, Buy American

Curly Surmudgeon wrote:
Economic Stimulus Payment Q & A


This is a very exciting new program that I will explain using the Q
and A format:

Q. What is an Economic Stimulus Payment?
A. It is money that the federal government will send to taxpayers.

Q. Where will the government get this money?
A. From taxpayers.

Q. So the government is giving me back my own money?
A. Only a smidgen.

Q. What is the purpose of this payment?
A. The plan is that you will use the money to purchase a
high-definition TV set, thus stimulating the economy.

Q. But isn't that stimulating the economy of China ?
A. Shut up.


Below is some helpful advice on how to best help the US economy by
spending your stimulus check wisely:

If you spend that money at Wal-Mart, the money will go to China.

If you spend it on gasoline it will go to the Arabs.

If you purchase a computer it will go to India.

If you purchase fruit and vegetables it will go to Mexico, Honduras,
and Guatemala ..

If you buy a car, it will go to Japan.

If you purchase useless crap, it will go to Taiwan.
.
If you pay your credit cards off or buy stock, it will go to
management bonuses and they will hide it offshore.

Instead, you can keep the money in America by spending it at yard
sales, going to ball games, or spending it on prostitutes, beer or
tattoos, since those are the only American businesses still operating
in the US .
"Character is doing the right thing when nobody's looking. There are too
many people who think that the only thing that's right is to get by, and the
only thing that's wrong is to get caught."
~J.C. Watts


There isn't a single reason America ought to go on the hook to create jobs
in China, Mexico or anywhere else. That GM must export Chinese production to
repatriate their profits is a problem for GM, not the American taxpayer and
it should not be allowed to become one at our expense. Not in the numbers
GM's latest restructuring plan indicates. That plan says only one thing to
me. GM just doesn't get it and that means they don't deserve to survive. The
amount of debtor in possession financing needed, fifty billion dollars,
will also insure that GM ends up following a Chapter 11 proceeding with a
Chapter 22 and maybe even a 33. The conditions under which $50 Bn dollars
can reasonably be repaid don't now exist and never will. A number that large
can't be made to work in any business plan that is viable in the long term.

Let's review history for a minute here. When gasoline hit $4.00 plus per
gallon, You couldn't get a Prius Hybrid without paying a 25 percent premium
and even then the wait was long.
Honda, Toyota, Hyundai, Smart, Lexus, Aptera, Tesla and a host of others had
either all electric or Hybrids vehicles for sale during this period. The
Roewe 750 Hybrid made it's debut in China at this time.

General Motors, the company that had Hybrid (Stirling/Electric) vehicles
under test as long ago as 1969

http://www.treehugger.com/files/2009/05/gm-hybrid-car-ad-1969-stirling-engine.php
http://www.treehugger.com/files/2008/09/1969-gm-hybrid.php

and leased units (EV1) in the field in 1999 which they destroyed at the end
of the lease cycle

http://www.greencar.com/articles/20-truths-gm-ev1-electric-car.phpwas

losing more than one billion dollars per month on operations, didn't have a
Hybrid car for sale at all and was losing $2,500.00 per vehicle on the
gasoline powered models they did build that got great gas mileage andfor
which there was demand. GM did, however, make their 2008 Tahoe,
Yukon,Sierra, and Silverado, models available as a V8 Hybrids and Saturn had
their AURA "sort of hybrid" model.

For 2009, GM's Hybrid capacity doesn't exist at all because they
aren'tbuilding vehicles of any sort. Not really anyway.
Ford, Honda, Lexus, Saturn, Mercury, Aptera, Fisker, Bright and Phoenix
MotorCars all have Hybrids in production, many are plug in Hybrids, while GM
has staked its future on the Chevrolet Volt, the automotive equivalent of
vaporware, and will have to compete with things like the 2009 Nissan Cube
for market share with the vehicles they can actually produce.

Finally, GM makes, or at least made, money in every market but North
America. Their Chinese sales are both growing and profitable. Holden and
Opel are solid companies.

Given all of that, GM ought to be able to save themselves by simply pulling
out of North America after having dumped their baggage in Federal Bankruptcy
Court. Vehicle sales are down so there would be a tough year ortwo but so
what. American taxpayer's need not to go on the hook to the tune of $50 Bn
to save GM and if we do we will merely delay GM's second and possibly third
trip through the courts.

"Old" GM is now gone and for good if common sense prevails, and it's time to
release the productive capital of the 19 banks just stress tested back to
the market. This is a step that absolutely must happen and if it doesn't we
will be continuing a pattern of privatizing gains and socializing losses. We
have a mechanism to do what's required and that mechanism, for better or
worse, has been prevented from working.
Bankruptcy is the way Americans release talent and resources back to the
market for productive use, and it works. We have currently turned capitalism
upside down, and have been doing so for thelast 30 plus years. This is
especially true during Republican administrations but isn't exclusive to one
party or the other. Larry Summersa nd Bob Rubin are both Democrats, for
instance. Bill Clinton signed the act of Congress repealing Glass-Steagal.

Congress, the Obama administration and the American public need to stop the
hand wringing and get on with it.

A non-bank, AIG, would be a very good place to move to next. Congress should
pass the necessary legislation, authorize funding with additional new
legislation and then just bankrupt AIG the way we seize a bank and
reorganize it. By failing to do so, we are encouraging the notion that the
America's laws and regulations really don't work. It's a direct attack on
the integrity of our system of government, our country, and doesn't inspire
confidence".

American's are not the ones that need a confidence transplant, it's
thebanking and financial services giants. The confidence that Citi and the
rest need to have is that when they make mistakes that threaten the system,
the American taxpayer is going to come in, seize and sell their assets, kill
the men, rape the women and then burn what's left to the ground without
batting an eye and then move on. Were the 19 "Stress Tested" banks to
believe that this might be their fate, they would probably alter their
conduct in the direction of prudent behavior. The banking business might
then go back to being the completely dull and pedestrian enterprise it was
in the 40's and 50's.

The financial services industry has been removing more than six
hundredbillion dollars per year from the real economy since the turn of
thecentury, more or less, and you can't remove that much capital
withoutconsequences. It is worth considering how financial services became
so"exciting" in the first place. "Exciting", by the way, is the term used
inthe banking and financial services industries for clerical help that
receives a $90,000.00 bonus or a junior account executive getting a million
bucks at the end of the year.What's not to be excited about?

We started down this road not in August of 2008, but in March of 1982, and
what seemed clever at the time is now ingrained habit. The consequences of
failure have become systemic.

In 1980/81, Savings and Loans were collapsing.

The initial S&L crisis was dealt with using tax policy and revisions to
regulatory legislation. The advantage of formulating or modifying tax laws
over having the Federal government just write a check is that nobody
understands tax law. The benefits can be substantial but they are indirect.
It's easy to pass a tax cut and very hard to put money directly into
someone's hands without voters noticing. Long term debt, mortgages returning
six percent, was being supported by short term borrowings a rates well above
six percent. Mortgages didn't have to default in order to be toxic assets,
they were toxic by definition. Usury laws prevented interest rates on short
term debt from exceeding certain levels -about 18 percent - but these were
State, not Federal, laws. The Federal Reserve raised interest rates
dramatically under Paul Volker, a Reagan appointee, to get inflation under
control and the cost of money skyrocketed. Prime plus one meant 21 percent
interest in 1982. You couldn't get a mortgage at all really, and the economy
suffered with high unemployment as a result.

Inflation, however, was tamed.

Garn-St. Germaine, meant to help S&L's compete, was a key legislative
alteration in the financial landscape. S&L's entered all sorts of areas with
products they hadn't been able to offer and interest rate caps were
removed.The complete "cure" under the Reagan administration was to allow
S&L's to sell off mortgages with low returns, sustain the losses, and then
apply those losses directly against taxes paid to the Federal government
over the preceding ten years. Initially, there was neither a mechanism to
accomplish such sales or a meansto dispose of the offloaded mortgages. This
defect was corrected by the creation of mortgage backed securities in the
form of bonds. The sale of these instruments to Federally chartered banks
was illegal initially and had been for 50 years but that was rectified in
short order. Fannie and Freddie promptly blessed or "Franked" the things and
we had the first example of the moral hazards involved with the GSE model.

The S&L industry didn't just get well, they made a lot of profit on these
tax abetted transactions.S&L's were chock full of money in an environment
where demand for their product, mortgages, was low. Before anyone could say
"Boo", entire mortgage portfolios had been sold and the IRS/Treasury
Department had filled the coffers with yesterdays tax payments.. This is
where the money came to fund the explosive growth of the next bubble
andbust - High Yield Bonds.That "boom" busted out and the taxpayers bailed
out the S&L's with actual cash at that point through the FSLIC and REITC.
The cost of failure hadn't been either avoided or even shifted. It had grown
significantly, however,and the American taxpayer shouldered a burden of $200
Bn that was originallyl ess than twenty five.

This cycle has repeated several times since. The financial services sector
sucks one vein dry only to move on the next, and with a larger bore needle
for each subsequent vein, always with the support of bought and paid for
politicians ( on both sides of the aisle ) and with the full knowledge that
the Republican Party had adopted the pattern as one of its formal,
underlying policies. If only the markets were truly free, so went the
mantra, and beginning in 1999, the markets were so freed, or at least the
major impediments removed. The repeal of Glass-Steagal, a seminal event,
went almost unnoticed. By the end of the first Bush term, banking rules and
regulations had been rewritten to allow pensions to invest directly in hedge
funds, hedge funds to own banks, investment banks to own chartered
banks,hedge funds and so forth. This was something that had been completely
illegal - for the obvious reason.

Congress, in it's infinite wisdom, had passed the Graham amendment to the
Commodity Futures Trading Act with language that specifically precluded any
government regulatory agency from either regulating, in anyway, or even
asking about derivatives. It was literally against the law, as an example,
for the SEC to ask AIG what was going on inside their financial products
subsidiary. Furthermore, to add a little gasoline to the fire, Henry Paulson
restated the regulatory cap on leverage as one of his first acts as
Secretary of the Treasury. What had previously been capped at $1 dollar in
cash for $10 in borrowed money was officially raised to $1 dollar in cash or
assets to $35 dollars in borrowed money and these ratios were just guidance.
Some people went as high as 60:1, intra quarter, without having a regulator
complain. The rationale, once again, was that markets would self correct if
things got out of hand or, stated another way, *** out - we know what we
are doing.

This is the very definition of a license to steal. The question being asked
in the industry was "is this actually legal?" not "is this a good idea
andsurvivable?".
The result has been predictable. America's business schools,
Harvard,Wharton, and the like, admit selectively, and they specifically
select in favor of sociopaths. It shouldn't come as a surprise to anyone
when the graduates, upon rising tothe pinnacle of their respective
professions, create havoc in their wake, but that indeed seems to be the
case.
I'm shocked that anyone would be shocked. Repeating a process and expecting
alternative results on a regular basisisn't a sign of a higher power or
greater intellect. It also doesn't mean anyone knows what they are doing at
all. It means they are literally insane, even if they do happen to know what
they are doing.

The single remaining bastion in 2004 was The Social Security Trust fund.That
money would have provided a fresh vein - the additional fuel to keep what is
really a giant Ponzi scheme, rolling.
Unfortunately for the Bush administration and Wall Street, Americans were
beginning to understand that they had been repeatedly played for fools.
Thank the deity of your choice that the administration of George W. Bush had
incompetence and deceit as it's hallmarks. The Bush administration's plan to
privatize SS was met with what can only be called a resounding THUD, largely
because the President of theUnited States wasn't trusted to tell anything
resembling the truth or believed capable of exercising good judgment. A
fortunate happenstance, on the one hand, and a terrible condemnation on the
other.

As a practical matter, this isn't even a political judgment, it's just the
obvious truth. In the event, America dodged a bullet.

At this point, American's needn't worry that the guys running the show
areWall Street insiders colluding with their peers. They are not. They are,
however, the product of the culture of bail outs that has grown upover 30
years or so. Given that the only tool they know and can use is a hammer,
every problem looks like a nail. Bernanke, Paulson, Geithner and Kashkari
run around forcefully making the case that there was nothing else to do when
the real truth is that there wasn't anything else that THEY knew how to do.
Their response has been entirely Pavlovian.

The peasant class has also responded in kind, repeating and voting a mantra
that they don't understand and is actually contrary to their own best
interests.

The failure of the domestic automobile industry was said to be due to the
costs of union labor and pension benefit overhead. What this analysis
overlooks is the $2,500.00 per vehicle disadvantage GM had which would only
have dropped to $1,000.00 or so if the labor and cost differential were
removed completely. In other words, they still wouldn't have made money on
sales of the vehicles people wanted to buy in the face of $4.50 per gallon
gasoline.I n fact, the losses would have continued at a grand per vehicle
and the costs that they had divested would just have been shifted to the
State and Federal governments. The other consequence is that the American
standard ofliving would have taken another hit. Taken to it's logical
conclusion, the last thing GM or anyone else ought to be cheering is labor
cost reductions to the point of profitability. You end up looking just like
Chinese then, and everyone knows Chinese, in China, can't afford cars at
all. This is where Ronald Reagan's firing of the striking Air Traffic
Controller's hasl ead us as an unintended consequence.

In order to understand what's happened in the current context, you have to
look at guys like Dave Li, whom I have referred to a couple of times
aspatient zero. Dave is a smart guy but hardly an intellectual. Educated at
MIT, he's a mathematician and it's a shame he went to work on Wall Street
instead of Mound Road but you know, when you offer a guy a choice between
Wall Street "Shooting Star" and working for the auto industry and having
your friends ask you "What went wrong?" at class reunions, you go with the
money and prestige. Dave did, and you can hardly fault his choice.

Mathematically modeling the financial universe is as old as mankind. So is
fortune telling. Both are undertaken by amateurs with an interest or reason
and professional mathematicians, like David Li, or economists like Paul
Krugman. The goal, at least in his case, is to precisely estimate risk.Doing
so is especially important if what you want to do is sell unregulated risk
that isn't backed up with a reserve. You absolutely must properly value
default products correctly because you only really get one bite at the apple
if the risk market fails.

The model Dave created went further even, than that. It supported
theproposition that you could not only resolve risk down to a single value,
butthat you could use the model to test pools of risk and formulate
securitiesfor which risk had been driven to zero. It's the greatest thing if
you cando this because you get to charge by the individual risk product but
neverhave to PAY anything. It's not "like" free money, it IS free money. I
saw the Li model while it was being written because I was working on
something similar but using different topology . I only had a couple of
comments and I pointed out that thinking that you could express something
complex as asingle value seemed unlikely and that any risk analysis that
excluded a behavioral component was just wrong. This was the reason I was
using a fractal based model for what I was doing. I even showed my work, the
underlying studies and data and, as I later learned, that was the actual
reasona nyone was interested in what I was doing - Fractal geometric
economic modeling. Some guys tinker with old cars.

In the end, they finished their work and I gave up on mine. I thought at the
time that my model didn't work and I didn't know how to get it fixed.
What I know now is that it was working, it just didn't produce the result I
was interested in seeing. My model kept crashing my virtual economy.As it
turns out, the real world behaved in a similar manner and I, being an
amateur, just didn't draw the appropriate conclusion.

The David Li model, on the other hand, did seem to work and was rolled out
as the "Gaussian Cupola". That model, its clones and derivatives, was what
gave the government, as well as the financial "Masters of the Universe", the
confidence to remove the barriers previously in place that barred certain
asset pools and cash flows from being invested inappropriately. Some of the
worlds best economists looked the Gaussian Cupola and laughed. The
mathematics, however, were sound and could be demonstrated. That was the
road show, or sales pitch, and it was persuasive enough to steam roll the
economists misgivings. Mathatematics is a science, economics is guessing.
The math Geeks ruled theday, largely because they had produced equations
supporting something that was highly desired, revenue streams which produced
income but not value.

Credit Default Swaps are an excellent tool and a way needs to be found to
continue their use.
In their simplest form, CDS's are insurance against loss. When a home owner
takes out a mortgage, they and obtain privatemortgage insurance. Should the
owner expire, the mortgage is paid off. Lenders take that mortgage and,
along with others, put a "wrapper" on them and sell these securities as
bonds to private and institutional investors. Those investors protect
themselves from loss by purchasing a CDS which pays off in the event the
bond defaults. One difference between your private mortgage insurance policy
and a CDS is that when you contract for private mortgage insurance, the
insurer has to place actual money in reserve to cover a possible loss. A CDS
has no such requirement and is just a promise to pay. That is a poor idea
and we know from history that the result is failure - we've been through
this more than once. That is why we regulate insurance companies.

This is a real good place to remember again that a Republican House,
Senate,and President passed/signed a law specifically forbidding regulation
or oversight of products like Credit Default Swaps. They aren't called
insurance, even though they really are, and it's against the law to regulate
them, by an Act of Congress no less.

Even these transgressions would have been pretty straightforward to address.
What came next isn't and won't be.

A CDS that is on the other side of a mortgage is tolerable. You have
amortgage of $X and a CDS with a face value of $X as insurance. The amounts
are at least known. Using the Gaussian Cupola, however, people started
creating and selling unlimited credit default swaps on the same debt
instruments. In some cases, $X in face value for a mortgage backed bond
generated $1,000X dollars in CDS notional value and groups of CDS's were
bundled together with other things to close the loop on the Gaussian
Cupola.The resultant products are called CDO's and SIV's, or Collateralized
Debt Obligations and Securitized Investment Vehicles. Catchy names, both.

This only had value because issuers created a market and began to actively
trade these thingswithout either regulation or even suprevision. The system
was completely opaque.
Because you run out of counter trade when there is more CDS involved that
bond value, these things (CDO's andCDS's), became purely speculative. They
were just gambling in the simplestf orm. A billion dollar GM bond might end
up supporting 100 billion dollars in "insurance" and none of that
"insurance" was backed up with even a little bit of real money the way
actual insurance would have been.

That doesn't mean the owners won't expect to be paid if GM defaults. They
will, and a one billion dollar default could trigger one hundred billion
dollars in payment obligations if there is enough money around, and that is
the rub.There isn't any requirement for money to, in fact, be anywhere and
it just isn't. What you end up with instead is a lot of unpaid "insurance"
claims.

The economy of the United States generates $13 trillion dollars per year in
value. We call this our Gross Domestic Product. Reasonable estimates put the
notional value of existing CDS's, CDO's, and SIV's at $62 Trillion dollarso
n the low side, and $255 trillion dollars on the high. Remember, there isn't
a single thin dime backing them up. This is the real reason that the judge
in the Chrysler bankruptcy forced the minority bond holders to take the
settlement they were offered. Their billion dollars in Chrysler bonds could
very well be supporting a trillion dollars in insurance that has no reserve
to cover payment. Those "insurance policies" didn't have to pay because the
bond holders cut a deal and the bonds, therefore, didn't actually default.
That's pretty slick and was only necessary because David Li's model said
risk could be driven to zero if you were smart enough. People bought
hugeamounts of CDS's on Chrysler bonds - HOPING that Chrysler would default.

Increasing reserves and stress testing by Daddy Warbucks is really just
tinkering around the edges. Financial institutions can't bring themselves
toface their situation head on and so far, they haven't had to. The American
economy can't work without the secondary credit markets. Two thirds,
approximately, of lending is supported there. That market, and the banks
that hold linked derivative products won't work again until all of the
flaky, zero risk products are isolated and the wealth destruction they
represent monetized.

Period.

Everything undertaken so far has been an effort to keep the patient alive
long enough to figure out how to do the surgery. Everyone knows what to cut
off but since this limb can't be seen, it isn't certain how big a piece we'd
be amputating and it could be ten times the size of the remaining body.
Everyone is wondering how to dispose of a huge piece of biohazardous
wastethat might be the size of New York.

Seizing the banks would make the entire reality impossible to avoid. You
couldn't just show part of your hand and ask for help with a specific
problem and in the end, Americans are going to be on the hook for the losses
anyway, it's unavoidable, so we ought just to get on with it. It's a bill
our kids will have to pay, like it or not. That will be easier for them todo
if we leave them a vibrant and growing economy to do it with and the sooner
America sets foot on that path, the better.

You will know something is going to happen when Bernanke, Geithner and our
President start to use the phrase "Hold to Maturity", a length of time as
long as forty years in some cases. That is what we are going to have to do
because Li was wrong, the risk coefficient can be preordained but peoples
perceptions ad how they act on them can't and that, in the end, is what
counts.

The Treasury Department is beginning to put forth a program to oversee and
regulate derivative products and the derivatives market. That is necessary.

What I'll be interested in learning, and what is important, is how they
address the tremendous quantity of these things already in existence through
the current, unregulated system. Even a modest reserve requirement might
break the financial system. Nobody knows, which is exactly the point and
brings the discussion full circle.

The Untied States is mired in the deepest cyclical contraction since atleast
World War II, and arguably the depression. Falling home prices led usinto
this crisis, and are still falling. The financial crisis in 2008 hasbecome
the economic crisis in 2009, as more than 2 million jobs were lost injust
the first quarter, with another 3 to 5 million likely before year end.With
the unemployment rate headed over 10%, and maybe up to 12% next year, the
default rate on every type of consumer credit - prime mortgages,
Alt-Amortgages, Option Arm mortgages, sub-prime mortgages, homeequity lines,
credit cards, auto loans, student loans - is headed muchhigher. Commercial
real estate values are plunging, and corporate default rates are set to
soar. Although every bank has 'passed' the government'sstress test, some
banks will fail the real world stress test, and need billions more in
capital. Treasury has now agreed to put billions of TARP dollars into the
insurance industry.

Sooner or later, the Treasury Department will likely have to go hat in hand
asking for more money from Congress.

For the first time since World War II, the global economy will contract in
2009. In addition to the daunting cyclical problems challenging the
economy, there are a number of issues that will make it even more
difficult for a self sustaining recovery to develop in 2010.

Between 1982 and 2007, the amount of Total debt grew from $1.60 to $3.53 for
each $1.00 of GDP. This was made possible as the cost of money fell from 15%
to 20% in 1982 to the lows of the last few years. As interest rates fell,
consumers were able to take on more debt without their monthly payments
increasing. Household debt has increased from $.44 in 1982 to $.98 for each
dollar of GDP in 2007. However, there is no more relief coming from lower
rates, so consumers are going to have to pay for their debt from income.

From the mid1990's until 2007, most consumers had the luxury of believing
that their homes and 401Ks would provide most of what they would need for
their retirement. The saving rate fell from over 8% 15 years ago to near 0%
in2007. The last 18 months has convinced them they need to increase their
savings. The saving rate has rebounded to near 4% in the last six
months,which is one reason why the economy has been so weak. As debt levels
increased over the last 25 years, GDP was boosted as consumer's bought cars,
bigger homes, second homes, took vacations, and basically lived the good
life.
However, since 1966, each dollar of additional debt has given the economy
less of a boost.

In 1966, $1 dollar of debt boosted GDP by $.93. But by 2007, $1 dollar of
debt lifted GDP by less than $.20.The message from these facts is clear.
Debt levels are high, and any increase in interest rates will impose a
bigger burden on the economy and quickly stunt growth. Consumer debt is
already so high and interest ratesa re so low that it will be difficult for
consumers to add debt. This means economic growth will be far weaker than
the debt induced growth of the last 25 years.

As consumers increase their savings, GDP will be lowered by .70%for each 1%
consumers increase their saving, since consumer spending represents almost
70% of GDP. In addition, the banking system remains crippled. Lending
standards are high and are not coming down with the economy remaining weak.
The need for additional capital will lower future lending by several
trillion dollars, as banks work to repair their balance sheets and lower
their leverage ratios from 30 to the low teens.

The securitization markets provide more credit than the banking system but
they remain on life support. Credit availability will remain constrained
well into 2010, which will counterbalance the lift from any fiscal stimulus.
The diminishing boost given to GDP from each additional $1.00 of debt since
1966 indicates that adding more debt will not return the economy to
prosperity.

Over the last 60 years, the United States has used a combination of fiscal
stimulus and monetary policy to soften each recession and spur the
subsequent recovery, with apparent success.
From 1982 until 2007, the U.S. only experienced two shallow recessions that
each lasted just 8 months. This stretch of 25 years may be the best 25 years
in our economic history. But much of this prosperity was bought with debt,
as the ratio of debt to GDP rose from $1.60 to $3.50 for each $1.00 of GDP.

Sometime in the last 25 years, we passed the point of no return.

What this means as a practical matter is that consumers are going to spend
the next few years deleveraging in the same way that financial institutions
are.
Every cloud has a silver lining, but of course, the reverse is also true.
Financial institutions tend to be able to suffer pain better because they
spread that pain over large numbers.
Only Russians, East Europeans, Asians and Africans "downsize" at the family
level to do this. Americans are less likely to layoff or sell a kid to match
a reduced budget with overhead. That is the equivalent.

New research by the Federal Reserve and Boston University of credit spreads
of 900 non-financial companies from 1990-2008 predicted changes in the
economy 'phenomenally' well. Based on their initial research on low to
medium risk corporate bonds with more than 15 years to maturity, the
researchers went back to 1973 and found the analysis still worked well. With
the massive widening of corporate bond spreads last fall, the
researcher'smodel predicts the economy will lose another 7.8 million jobs by
the end of 2009, and industrial production will fall another 17%. In the
spirit of optimism, let's assume this 'phenomenal' model is off by 35%, due
to the extreme nature of this credit crisis. That still results in
another5.1 million lost jobs, and an 11% drop in industrial production.

In that scenario, the unemployment rate climbs to near 12.5%, the
underemploymentrate breaches 20%, and another 500,000-750,000 foreclosures
result.The International Monetary Fund (IMF) now estimates the U.S.,
European, and Japanese financial sectors face losses of $4.1 trillion. Banks
are confronting losses of $2.5 trillion, insurers $300 billion, and other
financial institutions $1.3 trillion. To date, the banking sector has
written down $1 trillion of expected losses. The IMF estimates that U.S. and
European banks need to raise $875 billion in equity by next year to return
to pre-crisis levels.

Recently, a number of banks have reported first quarter earnings, which wasa
pleasant surprise. Citigroup said it made $1.6 billion. One of the waysC
itigroup achieved this gain was booking a profit of $2.7 billion on the
decline in Citi's own debt. Say what? Under accounting rules, Citi was
allowed to book a one-time gain equivalent to the decline in its bonds
because, in theory, it could buy back its debt cheaply and save $2.7 billion
over time. Of course, Citi didn't actually do that.
Even though more consumer loans went bad in the first quarter, Citi reduced
its loan loss reserve from $3.4 billion in the fourth quarter to $2.1
billion in the first quarter, thereby picking up another $1.3 billion of
'earnings'. And the recent change in mark to market accounting enabled Citi
to book anadditional $413 million in 'profit' on impaired assets. Without
these one-time adjustments, Citi's $1.6 billion in first quarter profit
becomes a $2.8 billion loss. According to a Wall Street Journal analysis of
Treasury Department data, the 19 banks that received tax payer funds made or
refinanced 23% less in new loans in February versus last October. Why lend
money when all you've got to do is make a few adjustments and make even more
money.

Between 2000 and 2008, the major credit card companies increased the number
of credit cards issued to small businesses from 5 million to 29 million.
During that period, many small business owners increasingly relied on their
cards to provide short term financing for their business. Spending on small
business credit cards increased from $70.4 billion in 2000, to
$296.3billion, according to the Nilson Report. Over the last 15 months,
business bankruptcy filings have risen faster than consumer bankruptcies,
with the average charge-off rising to $11,000 from $7,000, according to
Equifax, Inc.

In response, the card issuers have been aggressively scaling back, and have
reduced available credit lines by almost $500 billion. Just another
exampleof how the availability of credit to the economy is evaporating,
despite all the Fed's efforts.
Industrial production fell 1.5% in March, and is down 12.8% from a year
ago.Capacity utilization fell to 69.3%, the lowest since records began in
1967.
Excess capacity is a powerful dynamic. Companies are forced to reduce or
eliminate budgeted investments in new equipment, which compete for every
dollar of revenue, even if it means accepting thinner profit margins, and
reduce costs through job cuts. The amount of excess capacity that has been
created by the depth of this economic contraction is unprecedented. What
most inflation bugs and investors fail to understand is how long it will
take to work off the current overhang of excess capacity. If the output gap
grows from the current 7% to10% next year, Goldman Sachs estimates it could
be 2015 before all the excess capacity is used up, and that's if GDP grows
4.75% per year,something that is very unlikely.

Ironically, one of the reasons the economy is not likely to grow that fast
is that business investment will be weaker than in prior business
cycles.With so much excess capacity, businesses won't need to materially
increase business investment for the next 2 or 3 years.The economy needs to
create 125,000 jobs each month, just to absorb the number of new entrants
into the labor market. If job growth were to average 325,000 per month in
coming years, it would still take more than four years to replacea ll the
jobs lost in this recession. With so much excess labor capacity,wage growth
will be weak for the next few years, which will make it harderf or consumers
to increase savings and spending. The combination of less credit
availability, weaker business investment and consumer spending will be
headwinds whenever the economy emerges from this recession.


--
John R. Carroll


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