Texas Firm Accused of $8 Billion Fraud

HOUSTON — In Texas, Robert Allen Stanford was just another wealthy financier.

Joe Skipper/Reuters

Robert Allen Stanford, the chief of the Stanford Financial Group.

But in the breezy money haven of Antigua, he was lord of an influential financial fief, decorated with a knighthood, courted by government officials and basking in the spotlight of sports and charity events on which he generously showered his fortune.

On Tuesday, his reign was thrown into turmoil as a caravan of cars and trucks carrying federal authorities pulled up to the headquarters of his company, the Stanford Group, to shut down what the regulators described as a “massive ongoing fraud” stretching from the Caribbean to Texas, and around the world.

Unknown is the status of investments in as much as $8 billion in high-yielding certificates of deposit held in the firm’s bank in Antigua, which the Securities and Exchange Commission, in a civil suit, said Mr. Stanford and two colleagues fraudulently peddled to scores of investors.

Also unknown Tuesday were the whereabouts of Mr. Stanford — or Sir Allen, as he became known after the Antiguan prime minister knighted him — whose financial activities on the tiny island had raised eyebrows among American authorities as far back as a decade ago.

Like Bernard L. Madoff, who is accused of operating a $50 billion Ponzi scheme, Mr. Stanford offered investment opportunities that sounded almost too good to be true: promises of lucrative returns on relatively safe certificates of deposit that were often more than twice the going rate offered by mainstream banks.

In fact, a substantial portion of the bank’s portfolio was in very illiquid real estate and private equity investments. The portfolio was monitored by only two individuals — Mr. Stanford and James M. Davis, a director and chief financial officer of Stanford Group and the Antigua-based bank affiliate. The Antiguan auditor does not audit the bank’s portfolio or verify its assets.

While regulators are not accusing Mr. Stanford of operating a Ponzi scheme, they claim Stanford Group lulled investors into believing the C.D. purchases were safe by advertising investments in “liquid” securities that could be bought and sold easily.

Stanford Group said it could pay higher rates on the C.D.’s because of the consistently high returns it made on investor assets. And it claimed to be safe, thanks to monitoring by a team of more than 20 analysts and yearly audits of the investments by regulators in Antigua.

None of that was true, according to the S.E.C.’s complaint.

In its filing, the S.E.C. said the bank’s consistent returns — it reported identical returns of 15.71 percent in 1995 and 1996 — were “improbable, if not impossible.”

And while the size of the alleged fraud spun by Mr. Stanford and his colleagues pales in comparison to Mr. Madoff’s scheme, the revelation that Stanford Group’s returns may, in fact, have been ephemeral is likely to further erode confidence among investors who place money with investment advisers.

“I am extremely concerned. On a scale from one to 10 — infinity,” said Brett Zagone, a Houston technology saleswoman who walked up to Stanford Group’s Houston offices Tuesday to find out what had happened to the money she had invested there.

At the St. John’s branch of Stanford’s Bank of Antigua, a long line of customers waited to withdraw money as the news spread, Reuters reported.

Regulators, too, are likely to face tough questions as more is learned about Mr. Stanford’s activities. Already under fire for missing several red flags over the years in the Madoff case, regulators could face similar questions as Mr. Stanford’s offshore banking activities caught the attention of law enforcement agencies dating as far back as 1998. In its complaint, filed in Federal District Court in Dallas, the S.E.C. accused Mr. Stanford, Mr. Davis and Laura Pendergest-Holt, the chief investment officer of both organizations, with misrepresenting the safety and liquidity of the C.D.’s. The Antiguan bank and its registered broker-dealer in Houston, which sold the C.D.’s, were also named. The bank claims $8.5 billion in assets and 30,000 clients in 131 countries, and the brokerage unit operates about 30 domestic offices.

Most witnesses, including Mr. Stanford, Mr. Davis and the Antigua-based bank’s president, failed to appear to testify and did not provide any documents shedding light on the assets. Stanford Group declined to comment.

Over the years, Mr. Stanford cultivated the profile of a successful American businessman, partly by burnishing his connections with athletes. For example, the pro golfer Vijay Singh signed a deal to make the firm’s logo, the Golden Eagle, the dominant brand on his apparel and golf bag. A spokesman for Mr. Singh’s agent declined to comment.

On the tiny island of Antigua, Mr. Stanford’s presence was both large and controversial. He was viewed by many as cozying up with key politicians to win their favor. His activities there drew the eye of American law enforcement agencies in the late 1990s, when regulators were closely scrutinizing the growth of the offshore banking sector, after a couple of money-laundering scandals had hit the industry.

Around that time, Mr. Stanford had also become an adviser to Lester Bird, then Antigua’s prime minister, who formed a banking advisory board to clean up the country’s image. Mr. Stanford’s bank was the largest bank regulated by the board. The project was paid for by the Antiguan government from money lent or granted by Mr. Stanford.

“They wanted to convince us that Antigua was clean and to highlight reform efforts,” recalled Jonathan Winer, who was at the time a deputy assistant secretary of state.

In 2001, Antigua was removed from the financial watch list.

Mr. Stanford and his firm have emerged as recent contributors to various American lawmakers, focusing particularly on legislators considering bills that could change offshore banking rules. In 2008, he made $3,300 in political contributions to Representative Charles B. Rangel, a New York Democrat who has presided over legislation easing tax policies for the Virgin Islands as head of the House Ways and Means Committee.

The current S.E.C. charges stem from an inquiry opened in October 2006 after a routine exam of Stanford Group, according to Stephen J. Korotash, an associate regional director of enforcement with the agency’s Fort Worth office.

He said the S.E.C. “stood down” on its investigation at the time at the request of another federal agency, which he declined to name, but resumed the inquiry in December 2008.

Wealthy cities discovering they're not recession-proof

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Brian Vander Brug / Los Angeles Times

A driver in a convertible Rolls Royce passes a Santa Monica Boulevard clothing store offering 30% to 70% off. The recession has landed in Beverly Hills as many stores around the ritzy Rodeo Drive retail neighborhood have hung out signs offering savings of up to 80% and there are many vacant spaces for lease.

Beverly Hills, Santa Monica and Newport Beach, which are usually shielded from economic downturns, are seeing decreases in sales tax revenues, along with two-thirds of cities in Southern California.

There are million-dollar mansions in foreclosure, layoffs on Rodeo Drive. And reservations are no longer a must at all but the most exclusive restaurants.

As recently as the summer, many wealthy Southern California enclaves appeared beyond the reach of the worst recession in decades. But rich cities, it turns out, aren't always so different from the rest.

City officials in Beverly Hills -- a place insulated from most economic downturns -- now project a $24-million drop in tax revenues over the next 16 months. The loss represents about 15% of the general fund budget, said Beverly Hills City Manager Roderick Wood.

"This will be the largest percentage budget reduction, as far as we can tell, during the city's history," Wood said. "Even for a community as well-funded as Beverly Hills, you absolutely feel a 15% reduction in the budget."

A formal hiring freeze is expected as soon as March, though police officers and firefighters would continue to be replaced, he said. Among other options on the table: reducing police overtime and charging clubs to use city sporting facilities, which would be a first.

Santa Monica officials blame falling hotel occupancy rates, tanking car sales and a sluggish housing market for across-the-board reductions needed to close a budget gap that could swell to $10 million next year. Although the city still has excess revenue from last fiscal year to subsidize this year's budget, City Manager P. Lamont Ewell said he is asking departments for proposals to reduce spending by at least 3% now and 5% next year.

In Newport Beach, a precipitous drop in luxury car sales has left the city with an anticipated $3.5-million budget gap. City Manager Homer Bludau plans to reduce spending on capital improvement projects, including the beautification of street medians, by about $1.4 million. He is also asking departments to trim their budgets by about $1.4 million. Most city job vacancies will be filled internally or not at all.

Sales tax proceeds have declined in more than two-thirds of Southern California cities, according to a Times analysis of municipal revenues collected in the last half of 2008 compared with the same period the year before. Among those affected were some of the wealthiest, including Bradbury, Indian Wells and San Marino.

Even in cities such as Malibu, where sales tax revenues appear to be holding up, officials are bracing for lean days ahead. Administrative services director Reva Feldman said Malibu relies more heavily on property taxes, which she said won't show the effect of the downturn until the next budget cycle. There has also been a decline in building-permit and planning fees as homeowners put off costly remodeling jobs, she said.

The fact that famous revenue generators such as Beverly Hills, Santa Monica and Newport Beach are trimming their expenditures and considering service cutbacks underscores the extent of the meltdown in California municipal finances.

Such places are usually shielded from downturns because they cater to the very rich, have diversified their economies and draw high-spending foreign visitors, even when Americans start watching their wallets.

But with property values, incomes and spending plunging across the country -- and the global economy in serious trouble as well -- few places remain unscathed, said Christopher Hoene, director of policy and research at the National League of Cities in Washington, D.C. A survey of city finance officers conducted by the league in December and January found that 83% were cutting services and expenditures, and 80% expected to make further cutbacks in the 12 months beginning in July.

The effect of the recession is clear in Beverly Hills' destination shopping district where, for the first time anyone can remember, shops are advertising discounts of up to 80%. The number of vacant storefronts on Rodeo and Beverly drives has multiplied, with big names such as Lisa Kline and Rock & Republic looking for retailers to take over expensive leases. And jittery sales assistants confide that at least two luxury brand boutiques have handed out pink slips in recent months.

More and more of those accustomed to paying for luxury services are tightening their belts, in some cases because they have lost their high-paying jobs.

Katie Ittner, a hairstylist at Awilda Salon on Robertson Boulevard, said she had a client who called in tears because she could no longer afford to spend $95 to $250 to get her hair colored and had no idea how to do the job herself.

Those who still can spend thousands on a handbag are increasingly reluctant to do so.

After receiving a selection of accessories by mail to choose from, one regular client told a designer boutique on Rodeo Drive that she felt it was wrong to spend that kind of money when so many were losing their homes and jobs. When the store's assistant manager sent her an e-mail saying: "We need you to spend. . . . Stimulate the economy!" the client selected a $3,000 bag and returned the $6,000 one she preferred, he said.

The assistant manager repeated the exchange on condition that the store not be identified. On streets where image is essential, few would talk openly about the new reality. At other high-end stores, clerks refused to speak at all, referring questions to corporate headquarters. Requests for comment from retailers such as Gucci and Escada were declined or the calls not returned.

Beverly Hills' luxury retailers, five-star hotels and restaurants could previously count on well-heeled foreign visitors to see them through any serious downturns. This time, however, even the tourists are staying away, and shoppers in general are sparse.

On a recent weekday at Gallery Michael, where the Picasso prints run from about $2,000 to $700,000, fine art consultant Robert Avellano said he opened at 10 a.m. and did not see a customer until 2 p.m.

With less spending comes less tax revenue. Beverly Hills officials say that business activity accounts for 78% of city revenues, leaving them no choice but to trim the fat. At more than $173 million, Wood concedes the city's operating budget may appear exorbitant for a place with fewer than 36,000 residents.

He noted, however, that the daytime population can swell to nearly 300,000. High-profile visitors and events such as the Golden Globes award ceremony also require levels of policing unusual for a city this size, he said.

Beverly Hills has staked its economic future on its identity as a center of luxury, which brings an expectation of a higher level of service. So city officials said they are looking at other ways to cut costs.

They plan to curtail travel and entertainment expenses and delay filling vacancies and replacing equipment. But such steps won't close the budget gap, Wood said.

Beverly Hills has about $54 million in reserve that it could tap to meet its commitments -- funds the city would need to respond to a major disaster such as an earthquake.

Wood said that in an ordinary market downturn, he would advise the City Council to use those reserves more aggressively.

"This one, I think you have to be a little more cautious on that," he said, "because it's a structural recession, where the core economy itself is crumbling."

The city admittedly remains far from the poorhouse, and analysts predict that Beverly Hills and others like it will be among the first to recover. As Wood notes, the city's name itself remains a strong draw for those who still have money to invest.

"If you want to have a high-end address," he said, "Beverly Hills is where you want to put it."

Bankers told they are too risky for a loan

Financial sector and property workers suddenly find themselves under scrutiny from lenders. Patrick Collinson reports

Do you want a mortgage from a bank? Whatever you do, don't work there. It emerged this week that a job in a bank, once seen as a sign of financial probity, is regarded by banks themselves as a risk factor when it comes to assessing suitability for a mortgage.

Lenders are also refusing loans to people who work in the property industry - from estate agents to removal workers - amid fears of further job losses in the housing market slump.

According to mortgage brokers, Royal Bank of Scotland is rejecting applications for loans from anyone who derives more than 30% of their income from property. When an application for a mortgage from the manager of a lettings agency was turned down, Ray Boulger of John Charcol says he quizzed RBS, and was told the criteria would apply to anyone connected to the property industry, such as conveyancing solicitors, removal workers - and even mortgage brokers.

Meanwhile, Woolwich, part of the Barclays group, is understood to be turning down applications from workers across the financial services sector who rely on bonuses for a significant part of their income.

Melanie Bien of broker Savills Private Finance says: "It's basic salary only. We had a client who works for one of the big investment banks, who earns £140,000 per year in basic salary plus a bonus of £1.3m a year for the past three years. But Woolwich would only take the basic into account." Lenders are also checking every detail of an applicant's financial history - and if there are any blemishes, no matter how small, individuals are rejected.

Bien says: "We had one case where the client had exceeded his overdraft limit by £30 (it was only £500) and this was registered as an arrear on his credit file, which meant his mortgage application was rejected.

"He has had to get his bank to change his file before the application could be resubmitted. The problem has been exacerbated by the fact that in the past, the broker could have reasoned with the lender and explained the situation. Now it is all automated. Even though he hasn't missed any payments as such, as far as the lender was concerned he was a bad payer."

Big law firms hit hard by layoffs

Pity the poor lawyer.

Seriously?

Last week, big firms around the country laid off nearly 1,000 lawyers. In the last two months, nearly 70 of the nation’s biggest law firms have cut staff.

“It’s quite dramatic,” said Esther Lardent, president of the Pro Bono Institute, a nonprofit group that works with all the big firms to increase charitable legal work. “This is probably the most intense economic downturn that I’ve ever seen.”

How bad is it? Last week, The Examiner called the D.C. office of Holland & Knight to get their view of the economic crisis. A couple of hours later, the firm released a statement saying it was firing 70 lawyers.

The Web site “Above the Law” referred to the carnage wrought on employees at law firms in the past week as, “The Valentine’s Day Massacre.”

When the site asked for suggestions on a shorthand title for the week that was, lawyers responded by abandoning all sense of professional decorum.

“I am pretty [expletive] sad for my friends who were fired today and pretty [expletive] scared that I might be next,” one wrote.

Another wrote, “Shoulda taken the MCAT.”

The MCAT is the entrance exam for medical school.

“I can’t remember a single day or week when we’ve had so many lawyers let go,” said David Brown, editor in chief and publisher of Legal Times, a D.C. newspaper that covers the legal profession.

Tough times for lawyers can rattle D.C. like few other cities.

The District is the nation’s third-largest legal market, behind New York and Chicago. An estimated 80,000 people are licensed by the D.C. bar alone, with thousands of additional lawyers licensed in Maryland and Virginia living in area suburbs.

According the National Association for Law Placement, a D.C. nonprofit group that tracks hiring trends in the legal profession, there are nearly 13,000 lawyers working in Washington law firms. That’s about 10 percent of the nation’s total.

The legal community in Washington is hoping the political and economic dynamism of the early days of a new administration will provide some job security for lawyers.

President Obama is promising to hand out $1.5 trillion in relief and companies will be counting on K Street lawyers to get them a cut.

“One of the things that's happening is that we're in the area of regulation,” Lardent said. “And the D.C. firms have always had a strong regulatory practice.”

The problem is that the stimulus may be only a short-term fix, said Northwestern University sociologist Brian Uzzi, one of the nation’s leading scholars on trends in the legal profession.

“I think this will create a systemic shift in law firm pricing. And it’ll be a permanent shift,” Uzzi said.

Sandy Ain, a Washington divorce lawyer who also counsels leaders at some of D.C.’s biggest firms, said, “I think what’s happened is that the economic pressure on corporations to cut back in every way they can. ... In some cases, it’s going to mean flat fees.”

That means that law firms are going to have to rethink their entire business model.

“There are no efficiencies of scale in the service sector,” said Leander Gray, partner at GrayHaile LLC. “You open a new office, you've got new rent, new secretaries, new staff, new heating bills.”

Brown, Legal Times publisher, said he thinks that we’ll continue to see law firms bleeding. “It has a different quality than the last recession. And they're feeling that they have to cut back expenses in a dramatic way, in a way that I think they've never done before,” he said.

California state workers layoff process begins

SACRAMENTO — With budget negotiations stalled, Gov. Arnold Schwarzenegger will begin the process of laying off thousands of state workers.

Schwarzenegger spokesman Aaron McLear said Monday the administration will issue 20,000 notices to employees with the least seniority.

The notices will start going out today to workers in corrections, health and human services and other agencies that receive money from the general fund.

Administration officials are seeking to eliminate up to 10,000 jobs as part of the governor's order to cut 10 percent from the government payroll.

The governor had delayed releasing the notices Friday when it appeared lawmakers would pass a compromise plan to fill the state's $42 billion shortfall. But a marathon weekend session has so far failed to produce the necessary votes.

The layoffs are projected to save $750 million in the 2009-10 fiscal year.

Kansas may delay tax refunds, paychecks

TOPEKA - Income tax refunds and state employee paychecks could be late after Republican leaders and the Democratic governor clashed Monday over how to solve a cash-flow problem.

Payments to Medicaid providers and schools also could be delayed.

"We are out of cash, in essence," state budget director Duane Goossen said.

The move places state taxpayers, workers and schoolchildren in the middle of a political battle over budget cuts.

Republicans, who hold majorities in both chambers, blocked Gov. Kathleen Sebelius’ proposal to borrow $225 million from healthy state funds to cover shortages in accounts used to meet the state’s payroll and issue tax refunds.

GOP leaders said they won’t approve the IOUs until Sebelius either cuts the current budget herself or signs the bill they passed last week slashing $326 million — including $32 million for education — to balance the budget.

Republican leaders said they had no choice, that by law the state can’t borrow any more money from itself.

Sebelius and Democrats disagree and accuse the GOP of playing politics with people’s paychecks.

"Through their refusal to act today, the Republican legislative leadership is jeopardizing our citizens' pocketbooks for no other reason than to play political games — games in which the only ones set to lose are Kansas families, workers and schools," Sebelius said in a written statement.

Replied House Speaker Mike O’Neal: "While we all can agree that these are trying times for Kansas families, seniors and business owners, the Kansas House of Representatives respectfully disagrees with breaking the law in order to gain political capital."

The Senate approved the budget-cutting bill Thursday, but the governor has yet to receive it. It is being proofread and could reach Sebelius as early as Tuesday.

Her spokeswoman has said she will carefully consider it. She could sign it, veto it or veto portions of it.

Lower tax revenues

Kansas’ cash-flow problem stems in part from the worsening recession and lower-than-expected tax revenue.

As a result, the state had only $10æmillion in its checking account Monday morning.

Most immediately, that means the state does not have $24 million to cover payroll for the state's 42,000 employees and about $20 million for payments to Medicaid providers such as doctors, hospitals and nursing homes, Goossen said. Usually the state processes the payments on Wednesday and sends the checks out Friday.

"State employees simply have no more to give. Paychecks shouldn’t be held hostage for political maneuvering," said Lisa Ochs, president of the Kansas Organization of State Employees.

Kansas taxpayers also are due about $12 million in income tax returns. The state stopped payments on the refunds Friday.

Washburn University political science professor Bob Beatty likened the impasse to the 1995 budget battle between President Clinton and U.S. House Speaker Newt Gingrich. That dispute prompted a shutdown of the federal government. He said Kansas legislative leaders are making a dangerous gamble.

"Gingrich went too far," Beatty said. "If you go too far, you lose."

Options for borrowing

The state will pay its bills — "in a lawful manner," said O’Neal, R-Hutchinson.

At issue is whether the state can borrow now from other state funds. Such loans — called certificates of indebtedness — have routinely been used in the past when the state runs short on cash.

The move is similar to a family shifting unused money from one banking account to another to temporarily cover an expense, then putting the money back into the original account later.

The state would borrow unused money from one state agency's fund to pay immediate expenses for another agency, then replenish the borrowed amount later. The money has to be paid back by June 30, when the budget year ends.

State leaders already have authorized $550æmillion in certificates this fiscal year — $300 million last summer and $250 million in December.

In December, Republican leaders worried the state wouldn’t have the money to pay itself back. That’s the concern now, they say.

They say that although the state has borrowed from itself before, it has never borrowed this much in one year.

The Kansas Finance Council — which includes Sebelius and six Republican leaders — must approve any certificates of indebtedness.

"We cannot issue more certificates if the funds will not materialize by the end of the year," O’Neal said in a statement. “Without the revised 2009 budget bill, there is no way that we can legally issue a certificate knowing full well that the money will not be available to retire the debt."

Legislative leaders contend that if Sebelius had made cuts to state programs in late 2008, then the state wouldn’t be facing this problem. She could still make cuts to programs, guaranteeing the money would be available at the end of the year, O’Neal said.

Goossen said even if the governor ordered the cuts, called allotments, it wouldn’t fix the current predicament.

“The problem today is we don’t have cash to pay our bills in a timely fashion," he said. "Allotments only allow the governor to hold spending back."

State Treasurer Dennis McKinney, a Democrat, said the legislative leaders' move put the state's reputation as a reliable bill payer, and its credit rating, at risk.

"This is taking a budget fight one step too far," McKinney said.

Other ripples

In addition to payroll spending, the tax refunds and Medicaid payments, payments to schools and cities could be affected eventually if the impasse continues.

The state is scheduled March 2 to pay $185 million to public schools and $25 million to cities and counties to offset money lost when the state abolished the machinery and equipment tax, Goossen said.

Diane Gjerstad, lobbyist for Wichita schools, said she didn’t expect the district to be harmed. She added that the situation pointed to why districts need to have their own contingency fund. "If the state is short, we want to be able to make our payroll," she said.

Andover schools would be able to pay employees for the near future, said district spokeswoman Keturah Austin.

"If the state didn’t make it on time in February, we have enough cash reserves for one month," she said.

Government pension agency braces for recession

WASHINGTON (AP) — The deepening recession spells trouble for a little-known government corporation that insures the pensions of 44 million workers and retirees.

The Pension Benefit Guaranty Corp. already has an $11 billion deficit that seems sure to grow larger as Corporate America suffers through the worst economic crisis since the Great Depression.

With companies reporting shortfalls in their pension funds, it's all but certain that the PBGC will be forced to take over the pension plans of a rising number of bankrupt businesses.

That means more red ink at the corporation before things possibly can improve.

The future financial health of the agency is hard to forecast. It is hinged on interest rates, the length of the recession and the PBGC's own luck in playing the market, where it has billions invested.

The agency has $63 billion in assets. But it is obligated to spend $74 billion on pension benefits in the coming years. The PBGC might have time to rebound, but over the long term it might become insolvent and require a bailout.

"Someday — probably more than 20 years from now — there's a significant chance that somebody is going to have to pay the piper," said former PBGC Director Charles E.F. Millard, a Bush administration appointee who stepped down on Jan. 20 when Barack Obama became president. "In the near- to medium-term, there will be no need for a bailout of PBGC."

The PBGC quietly operates in a brick office building a few blocks from the White House. Its fate is important to the workers covered by the more than 29,000 employer-sponsored benefit pension plans it insures, and to all taxpayers who could be asked to foot the bill if its financial picture worsens down the road.

Congress created the PBGC in 1974 to guarantee the retirement security of workers covered by defined benefit pension plans. These traditional plans, which pay a specified monthly benefit at retirement, are being phased out as companies turn to 401(k)-style programs that require workers to make contributions and shoulder investment risks. The PBGC, which receives no tax dollars, gets its money from premiums paid by companies that sponsor the pension plans, along with revenue from its investments.

The corporation's balance sheet has taken heavy hits in recent years. Nine of the 10 largest pension plan terminations in PBGC's history, including United Airlines, Bethlehem Steel and Kaiser Aluminum, have occurred since 2001.

When a plan is terminated, the PGBC takes over and pays benefits to the retired workers. But they might not get the full amount that their employer promised. The maximum guaranteed amount currently is $54,000 a year for a person retiring at age 65.

Some pension experts shrug their shoulders at the PBGC's $11 billion deficit, noting that the 35-year-old corporation has been operating at a deficit for most of its existence. They say the PBGC has many years to recoup its losses and fulfill its obligations to pensioners.

"Every time the economy bounces around, everybody acts like everything is going to collapse and that they should worry about the PBGC, and then things come back," says Dallas Salisbury, president of the Employee Benefit Research Institute in Washington.

Others who pore over the PBGC annual reports predict a bailout is inevitable.

"Barring some absolutely phenomenal gains in the market or what PBGC's new or future investment strategy comes up with, the PBGC will need taxpayer money at some point in time," said David John, a pensions expert at the conservative Heritage Foundation.

For now, the PBGC, which is awaiting a new boss, will remain on the Government Accountability Office's "high risk" watch list for the seventh consecutive year because of worries that the economic crisis could mean more pension plan terminations and swell the PBGC's deficit.

Taking over the pension plan of General Motors Corp., which just announced it will cut 10,000 salaried jobs, would more than double the PBGC's current $11 billion deficit. But the PBGC also would inherit substantial assets from the automaker's pension fund.

Companies that have underfunded pension plans, but are otherwise on solid financial footing, pose little risk for the PBGC. It's the companies in danger of going under that present the biggest threat. But declines in the market have left corporate pension plans severely underfunded — to the tune of $409 billion, according to Mercer, a global consulting firm.

The underfunding trend is likely to continue. Even though Congress passed a law in 2006 requiring companies to meet target dates to eventually fund 100 percent of their pension obligations, those restrictions were relaxed in December to help them weather the bad economic times.

The business community is lobbying to further waive the rules during the current economic slump. Because of plummeting asset values, companies this year are faced with having to contribute to their pension funds two to three times what they had expected, said Aliya Wong, director of pension policy at the U.S. Chamber of Commerce.

"Because this is coming out of the bottom line, companies are making decisions not just about freezing their pension plans but whether they can even continue in business," Wong said.

The PBGC successfully shaved nearly $3 billion off its deficit in the 2008 budget year, which ended Sept. 30, primarily because 13 auto parts makers reorganized and didn't dump their pension liabilities on the institution.

Those gains were recorded before the market tanked. Still, Millard insists that a new investment strategy, which allows the PBGC in invest more aggressively in stocks and alternative investments, makes it less likely that it will need a multibillion-dollar congressional bailout.

General Motors' High-Wire Bankruptcy Act

It's Wall Street against Big Labor as GM and Chrysler hint at Chapter 11 filings to frighten creditors and workers into discounting debt

On the eve of a deadline to submit their viability plans to the U.S. Treasury, General Motors (GM) and Chrysler executives continued scrambling on Feb. 16 to cut a deal that would restructure both labor costs and debt. If the companies don't show that they are viable in the long run, the government could refuse to give either one additional money. Without help from the government, Chapter 11 bankruptcy is a real option.

But getting all sides to agree is tough. GM said in December that it wants its bondholders to take 30¢ on the dollar for their GM debt and receive stock to make up for the rest. GM also wants to give a United Auto Workers-led trust fund half the value of $21 billion in obligations in cash and the rest in stock. Both the union and a committee of GM bondholders want the other creditor to make big concessions. "It will be a face off between the union and bondholders with GM in the middle," says David E. Cole, chairman of the Center for Automotive Research in Ann Arbor, Mich.

Bondholders are unhappy that they are being offered 30% on their bonds while the union is being offered 50% on its debt. The UAW is wary of taking too steep a cut on the cash portion of the so-called VEBA, or Voluntary Employee Benefits Association Trust. The trust fund is supposed to be set up next year with $36 billion in GM cash and bonds to pay for retiree healthcare for some 80 years. But with GM short of cash, the company can't afford to fund the trust. So the company wants the UAW to take $10 billion in cash and the rest in equity for the remaining $20 billion the company owes.

Federal task force needs time, too

To satisfy Treasury Secretary Timothy Geithner and Lawrence Summers, one of President Barack Obama's chief economic advisors, GM will have to placate both the UAW and the bondholders. Officially, GM has said only that it is talking to all parties.

Privately, GM executives say that they will probably not have everything done by the Tuesday deadline. That may be just fine. The new task force—which is headed by Geithner and Summers but includes members from such other departments as Commerce, Energy, Transportation, Labor, and the Environmental Protection Agency—will probably not make a final decision on funding this week.

If they don't think the automakers' plans go far enough, the task force could ask all parties to get back to negotiating a deal that restructures GM and Chrysler. Thus the Feb. 17 deadline is more likely to start the process of restructuring the two companies. "I highly doubt that the President set up a task force to vote up or down this week," says Rep. Thaddeus McCotter (R-Mich). "This is a first important step in what will be the start of the process between all stakeholders."

Do Bondholders Lack Leverage?

Meanwhile, sources say that GM has looked at the possibility of a bankruptcy filing. But executives say that the company still views that as a last-ditch move. The prospect could also be used as leverage with bondholders, some of whom want to hold out for a better deal than GM has offered. Ultimately, Cole says, "the bondholders are going to have to play."

It's easy to see why. GM had somewhere around $12 billion in cash before borrowing $9.4 billion from the government. Even if the company still had the $21.4 billion in cash, unsecured creditors stand behind $11.8 billion in secured debt and the government loans. Plus a bankruptcy judge would order the company to pay suppliers first. That could leave bondholders begging in bankruptcy.

But do they believe that GM will go bankrupt? The government will want to avoid that, says IHS Global Insight analyst Aaron Bragman. It would cost more than $100 billion to put workers on unemployment benefits and draw on other social programs should GM fail, says Bragman. The bondholders know this and may use it as bargaining power to ask for more than 30 cents on the dollar. "It may simply be a tactic to try to get the UAW and the company's bondholders back to the negotiating table, Bragman says.

To get a deal done, GM and Treasury officials will have to convince the bondholders that the threat of Chapter 11 is real.

World trade hit by collapsing demand

The global downturn is tightening its grip. Over the past few months there has been a "dramatic" slump in trade, said Ambrose Evans-Pritchard in The Daily Telegraph. All major economies are affected, with US trade activity (imports and exports) down 7% year-on-year in November, and 18% since July.

Japanese exports posted a record decline in November and its overall trade was down by an annual 20%. Chinese trade slipped 9% – it looks set for a hard landing, the World Economic Forum warned this week – and Germany's was down 7%; the four biggest EU economies' exports tumbled by 10% in November alone. Asia is also suffering, with Korean exports down an annual 30% in January.

Trade between Asia and Europe is "an unmitigated disaster", said Charles de Trenck, with some shipping brokers now effectively waiving fees to transport containers. Asian trade to Europe and the US will fall by up to 12% and 7% this year, said de Trenck. Outbound traffic from America's top two ports, Los Angeles and Long Beach, is down 18% year-on-year. "This is no regular cycle slowdown but a complete collapse in foreign demand," said ING's Lindsay Coburn. A dearth of credit to back up trade deals has also hampered global exports. The World Bank now thinks trade could fall by 2.1% this year, the first fall since 1982.

Heading for the 1930s?

We should keep a close eye on trade figures over the next few months, said Martin Hutchinson on Breakingviews. The 66% decline in trade amid mounting protectionism is "what made the Great Depression Great". Averting a "1930s-style death spiral" in trade may soon become "the world's top priority".

Economy Strains Under Weight of Unsold Items

Richie Franklin of the United Auto Workers Local 2999 in Strasburg, Va. The local's plant lost 200 workers as demand for auto parts sags. (By Kevin Clark -- The Washington Post)

The unsold cars and trucks piling up at dealerships and assembly lines as consumers cut back and auto companies scramble for federal aid are just one sign of a major problem hurting the economy and only likely to get worse.

The world is suddenly awash in almost everything: flat-panel televisions, bulldozers, Barbie dolls, strip malls, Burberry stores. Japan yesterday said its economy shrank at an 12.7 percent annual pace in the last three months of 2008 as global demand evaporated for Japanese cars and electronics. Business everywhere are scrambling to bring supply in line with demand.

Downsizing can be tricky, though. No one knows how much worse the economy will get, and while everyone waits for the recession to peter out, businesses are grappling with how to cut costs and survive without sabotaging their ability to grow when the economy picks up.

And there is a lot to cut.

"There is over-capacity in everything," from "retail to manufacturing to housing," said Richard Yamarone, chief economist at Argus Research. "If capacity is too large, you don't need that many people employed, which is another reason we're seeing such high job losses."

As long as capacity far outstrips demand, businesses have little reason to expand, buy new equipment or hire workers. Even if the government funds bridge repairs and banks step up lending, many industries still have to go through massive restructuring before growth can resume. But executives say they have to tread carefully. If they put off critical investments in technology or research for too long, they could hobble their recovery and even the economy's.

Few industries have been as stung as severely by excess capacity as the U.S. auto industry, which produces millions more vehicles than it can sell. In 2008, there were enough automotive assembly plants in North America to churn out 18.3 million vehicles a year, according to the Center for Automotive Research. Analysts estimate that consumers this year will buy about 11 million. At current sales levels, it would take 116 days to sell all the cars and trucks clogging lots.

Automakers are scheduled to submit plans today outlining how they hope to restructure their operations to deal with a smaller marketplace, while still developing the new fuel-efficient cars that may be key to their future.

Auto suppliers are also trying to figure out how to survive in the face of massive excess capacity globally.

At its plant in Strasburg, Va., International Automotive Components, a Michigan-based supplier, secured wage and benefit concessions from workers in 2007 in hopes of staying competitive. But when Ford closed a factory in Norfolk, IAC had to lay off more than 200 workers, a third of the workforce in Strasburg. Since then, IAC has been able to line up more work for the plant.

"The unfortunate thing is we know . . . it comes at the cost of other workers whose plants were unable to survive," said Karen Foster, president of United Auto Workers Local 2999, which represents the IAC employees at the affected plant.

There are echoes of the automakers' plight throughout the economy. Sandra Berg, chief executive of Ellis Paint in Los Angeles, an industrial paint and coating manufacturer, recently found herself confronting over-capacity head on. Her company had been growing steadily since 2000 and was able to hand out bonuses for 2008. The downturn started to affect business toward the end of last year. Then came January, and "we just slammed into a brick wall," Berg said.

Since the new year, as sales have plummeted, Ellis Paint has announced two rounds of layoffs, imposed a hiring freeze and cut pay for management by 5 percent. The company has cut everywhere but sales, marketing, and research and development. "Our goal is to keep our expenses at the level of sales. I don't need to make a lot of money. I just need to break even . . . and look for the opportunities," Berg said.

Non-manufacturing sectors are trying to get rid of excess capacity as well. Retail chains such as Ann Taylor and Gap are closing stores after years of expansion, and others, such as Mervyns, are closing for good. "We've tremendously expanded the square feet of stores but not the number of yuppies occupying them," said Standard & Poor's economist David Wyss.

Some analysts say over-capacity is so rampant that it will stymie government efforts to unfreeze credit markets. Banks have little reason to lend not only because they still have bad debt on their books but also because businesses don't have a pressing need to expand, said Mike Shedlock, an investment analyst with Seattle-based Sitka Pacific who writes the popular blog Mish's Global Economic Trend Analysis.

"What is it that we need more of?" Shedlock said. "Do we need more Wal-Marts, more Pizza Huts, more nail salons?"

Strip malls and stores proliferated alongside housing developments, but many of those houses are empty; there were never enough people to fill them in the first place, and there won't be anytime soon.

Harvard economist Edward Glaeser estimates that from 2002 to 2007, the country's housing stock increased by 8.65 million units, outpacing the number of new households, which increased only by 6.7 million over the same period. Taking into account a rise in the number of vacation homes, Glaeser estimates an overhang of about 1.3 million vacant units. Absorbing that excess, he said, could take an additional two years.

Over-capacity in the housing industry has spilled over into countless other peripheral industries -- forcing cuts at chemical companies, home improvement stores and furniture manufacturers. The slump has prompted layoffs at PPG Industries, a leading paint company; Owens Corning, which makes roof shingles; and Therma-Tru, a door-manufacturing company. Therma-Tru recently moved up plans to close its plant in Fredericksburg later this year, citing "weaker-than-expected business forecasts."

Some businesses that were careful to manage inventories during the boom are facing a hard adjustment.

Ben Anderson-Ray, who runs Hubbardton Forge, a small maker of high-end lighting fixtures in Vermont, said he's had to lay off 26 employees after initially cutting hours, even though he expanded the business steadily and his customers aren't stuck with massive quantities of unsold goods.

For now, Anderson-Ray said, he has not scaled back work on new products; he simply cannot afford to do so. As one of the last lighting companies that manufactures its goods in the United States, Hubbardton Forge has survived in part because of its original designs and constant innovation. It cannot compete with overseas producers on price.

"If our order rates improve, we have the capacity in place to come back," Anderson-Ray said. But if order levels fall further over the next few months, he may have to consider further cuts. "We are watching our orders every day," he said.

Some analysts see ending the credit crunch as soon as possible as critical to preventing lasting damage. Harvard economist Diego A. Comin, in his research on Japan's decade-long bout of economic stagnation in the 1990s, found that demand stayed low long enough that businesses didn't make necessary investments. Computer adoption rates, for example, slowed, as did productivity growth. Businesses lost ground to competitors in countries such as South Korea, which made it harder for Japan to emerge from its slump.

Investing in new products and processes matters even more in highly competitive global industries plagued by over-capacity.

"In China, during the boom, there was huge over-capacity in various lines of activity ranging from shoes and clothing, light manufacturing -- all of that stuff. So that is why from the perspective of U.S. companies, we have found it so important to be on the innovative edge," said Harvard business professor Joseph L. Bower. "The only way to create value is to be on the innovative, high-tech, fashion-forward side."

If the credit crunch in the United States persists, "companies will find it difficult to invest in technology for a while, and then once the financial markets are back on track and demand recovers, companies will find themselves in a difficult position," Comin said. "Productivity growth will be declining for a while. They will have a hard time catching up."

McEwen, Goldcorp Founder, Bets Crisis Will Drive Gold to $5,000

By Stewart Bailey

Feb. 11 (Bloomberg) -- Goldcorp Inc. founder Rob McEwen, who has more than $100 million in gold investments, said he expects the metal to top $5,000 an ounce as governments increase the money supply to combat recession.

Bullion will more than double to $2,000 an ounce by the end of next year before rising to McEwen’s target by the end of the cycle, which could take an additional four years, the investor said.

“Politicians around the world are listening to cries from their electorates and they’re giving money to all callers,” McEwen said yesterday in a telephone interview from Toronto.

McEwen, who founded what is now the world’s second-largest gold producer by market value, owns stakes in three Canadian precious-metal explorers worth more than $100 million. He said he also has a “big, big” holding in bullion. Gold gained for the eighth straight year in 2008 amid investor concern the economy would collapse and government efforts to prevent that would increase inflation.

Gold futures for April delivery rose $29.10, or 3.2 percent, to $943.30 an ounce at 11:51 a.m. on the Comex division of the New York Mercantile Exchange, the highest for a most-active contract since July 23. The metal climbed to a record $1,033.90 on March 17.

McEwen said he started buying bullion in August 2007, at the beginning of the subprime mortgage crisis. Gold has jumped 40 percent since Aug. 1 of that year, touching a high of $948.20 today, while the Standard & Poor’s 500 Index has dropped 43 percent.

“I realized we had reached an inflection point regarding money,” McEwen said. “It was all about protecting money, and gold served that purpose.”

McEwen is the largest shareholder in Lakewood, Colorado- based U.S. Gold Corp., Vancouver-based Rubicon Minerals Corp. and Spokane, Washington-based Minera Andes Inc. Vancouver-based Goldcorp is the world largest gold producer by market value after Toronto-based Barrick Gold Corp.

Barter Fits the Bill for Strapped Firms

Small businesses, squeezed for cash and unable to get loans, are turning to an ancient payment system: barter.

Daniel Blank, creative director at Bureau Blank Inc., a New York graphic-design and brand-identity company, first used bartering when he started the company in 2004, because it was hard to get capital for a start-up. But he hadn't had to barter since then, until now.

For the past couple of months, Mr. Blank has been getting advice on running his business from Joe Hunt, a former ad-agency owner who has started Workforce Enterprises LLC, a document-solutions company in New York. For about two hours each week, Mr. Hunt helps Bureau Blank with its accounting and finance operations, among other things.

Specialty Moving & Delivery

Eddie Bolch, foreground, sometimes barters his company's moving services.

In return, Bureau Blank is helping Mr. Hunt shape his company's communications strategy, as well as designing the company's logo and Web site.

"It's a result of the economy being a lot tougher now," says Mr. Blank, who estimates the traded work amounts to about $10,000 worth of services.

He adds: "I wouldn't have done the project if I had to pay the cash."

As small businesses find it impossible to borrow money and customers are slower to pay bills, the barter economy is becoming a crucial way for many companies to find the cash they need to keep operating.

"It's really of value to small businesses because it helps them to survive through the recession," says Carmen Bianchi, director of the Entrepreneurial Management Center Business Forum and adjunct professor of family business management at San Diego State University.

Atlanta Refrigeration Service Co. worked out a deal with a local sandwich shop that was 90 days overdue on a $1,500 bill: The sandwich shop paid $500 and agreed to cater lunch to Atlanta Refrigeration's office five times over the next six months.

Bartering is "critical to us in this recession," says Dave Brautigan, chief operating officer of the Atlanta-based refrigeration company. "As more and more of our clients find themselves in positions where they cannot pay the bill in full, it becomes our responsibility to figure out how to get that money in."

Although companies do bartering one on one, many deals are conducted via membership networks in barter companies, where technology and tracking software have modernized the centuries-old system.

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Typically, a small business sets up an account at a barter company, similar to a checking account at a bank, for a one-time fee. "Trade dollars" earned for services rendered are deposited into the account and can be spent on any product or service in the network. Companies regularly find others willing to barter via the barter site's online directory of services, email newsletters, referrals or by contacting a firm's account manager.

On top of the setup fee, both parties pay the barter company a transaction fee of about 5% to 6% on each deal.

In 2008, about 250,000 North American companies conducted barter transactions worth more than $16 billion, according to the International Reciprocal Trade Association, a nonprofit based in Portsmouth, Va., that regulates and provides standards for modern trade and barter-service companies. The amount for small businesses climbed to an estimated $11 billion last year from $10 billion in 2007. David Wallach, the association's president, says if the trend continues he expects a 15% gain this year to about $12.7 billion.

NuBarter.com, a barter company in Savannah, Ga., has seen its sales grow -- from $285,000 in transactions in the first quarter of last year to $464,000 in the fourth quarter. In addition, the number of transactions has doubled in the past six months, to 650 per month from 310 a month. NuBarter has 800 members, up from 400 a year ago.

"Companies that had turned us down a few years ago are joining now," says Gary Field, NuBarter's president.

Similarly, Seattle-based BizXChange Inc. saw a 40% increase in new members to 1,300 last year. Its transactions were up 55% to $5.5 million.

FloridaBarter.com of Orlando, Fla., saw membership rise 25%, or 400, to 1,600 clients in 2008 and finished the year with $16 million in transactions, up 8% from 2007. Scott Whitmer, FloridaBarter's president, says members in the construction and real-estate industries were new to the network.

Bartering has been helpful to new start-ups. Viscape Ltd., an Arlington, Va., company whose online listings site for vacation properties went live in July, would be hard-pressed to find the cash to send its executives to places to promote the company. So it has given clients free ads on its site -- in return for discounted or free hotel rooms.

"It's all good for everybody," says Dan Engfer, Viscape's founder and chief executive. "They get an ad for more business. We get cheaper accommodations to do onsite PR stints."

Mr. Engfer, who says he has saved about $10,000 by bartering, would obviously prefer to sell the ads. But he didn't feel like he had much choice.

In addition, Mr. Engfer has used the bartering strategy to hire staff, who were all willing to take a pay cut to be able to potentially stay at the vacation properties that they sell. The 10 employees just have to pay their own way to get there, he says.

Other small-business owners who have done bartering in the past have seen their bartering activity increase, as their businesses take a hit. Eddie Bolch, owner of Specialty Moving & Delivery in Savannah, Ga., says he conducted about $10,000 worth of bartering last year, about 30% more than in 2007. Among other things, he was able to trade moving services for business cards, as well as to rent monthly storage units.

Saving the cash was important, since the housing market's woes cut his revenue to $140,000 in 2008, from $200,000 in 2007.

Companies whose services aren't widely used must be prepared to spend a lot of effort finding another business that wants its services in a barter deal.

"It takes work," says Matthew Weiss, president of Weiss & Associates PC, which fights traffic tickets on behalf of clients. "Sometimes, you call three painters...and they're not interested." Recently he wanted to hire a caterer for an event in downtown New York, but couldn't find one wanting to barter for his services, so he had to hire someone out of pocket.

"It doesn't always work," says Mr. Weiss, who is a member of two barter companies and saved his company $10,000 worth of barter transactions in 2008, including flower purchases and theater tickets. "And even if it does work, you must be willing to invest the time."

Willem Buiter warns of massive dollar collapse

Americans must prepare themselves for a massive collapse in the dollar as investors around the world dump their US assets, a former Bank of England policymaker has warned.

By Edmund Conway, Economics Editor
Last Updated: 3:05PM GMT 06 Jan 2009

MPC founder member Willem Buiter. Photo: CHRISTOPHER COX

The long-held assumption that US assets - particularly government bonds - are a safe haven will soon be overturned as investors lose their patience with the world's biggest economy, according to Willem Buiter.

Professor Buiter, a former Monetary Policy Committee member who is now at the London School of Economics, said this increasing disenchantment would result in an exodus of foreign cash from the US.

The warning comes despite the dollar having strengthened significantly against other major currencies, including sterling and the euro, after hitting historic lows last year. It will reignite fears about the currency's prospects, as well as sparking fears about the sustainability of President-Elect Barack Obama's mooted plans for a Keynesian-style increase in public spending to pull the US out of recession.

Writing on his blog , Prof Buiter said: "There will, before long (my best guess is between two and five years from now) be a global dumping of US dollar assets, including US government assets. Old habits die hard. The US dollar and US Treasury bills and bonds are still viewed as a safe haven by many. But learning takes place."

He said that the dollar had been kept elevated in recent years by what some called "dark matter" or "American alpha" - an assumption that the US could earn more on its overseas investments than foreign investors could make on their American assets. However, this notion had been gradually dismantled in recent years, before being dealt a fatal blow by the current financial crisis, he said.

"The past eight years of imperial overstretch, hubris and domestic and international abuse of power on the part of the Bush administration has left the US materially weakened financially, economically, politically and morally," he said. "Even the most hard-nosed, Guantanamo Bay-indifferent potential foreign investor in the US must recognise that its financial system has collapsed."

He said investors would, rightly, suspect that the US would have to generate major inflation to whittle away its debt and this dollar collapse means that the US has less leeway for major spending plans than politicians realise.

How Gold Is Being Driven by a $4 Trillion Hallucination

Wednesday morning, the United States Treasury Department issued a press release that constituted the Treasury Borrowing Advisory Committee’s (TBAC) report to the Secretary of the Treasury. TBAC membership is derived from senior members of the Securities Industry and Financial Markets Association. These would be the proverbial foxes advising the chickens - a favorite Midas Letter theme.

This group forms the consulting connection between the U.S. Treasury and the investment industry who is tasked with finding investors for U.S. debt so that the behemoth debt machine can continue its primary function of maintaining the United States standard of living at the expense of foreign treasuries.

Remarkably, the foreign treasury managers have either not yet caught on, or are duplicitous in maintaining the illusion of a sustainable deficit government that would swallow the global GDP of several generations should it ever be called for repayment.

This group meets in closed conference in a hotel in downtown Washington, and the Treasury lays out what it needs, and the TBAC tells them how they think it can be done. What is interesting in the published minutes of the meetings is that it now is apparent that both sides are concerned solely with rolling out new and modified debt instruments in increasing quantity to service the debt requirements of the nations future spending requirements. Servicing current debt is barely mentioned, though one might deduce that those requirements are incorporated by default into future borrowing figure requirements. (The following quotes are taken from the press release):

The deterioration in the budget outlook, combined with expenditures associated with the TARP, potential FDIC guarantees, and expected additional stimulus spending have increased private forecasts for total funding needs of the U.S. government for fiscal year 2009 to approximately $2 trillion. This is likely to stress the existing auction schedule and consequently warrants tangible adjustments to that schedule.

Faced with an unprecedented increase in net borrowing needs, the Treasury in its first charge to the Committee sought our advice and recommendation on changes to the auction calendar for debt issuance.

The strategy for financing the new debt required for the TARP (Toxic Asset Relief Program) purchases and the stimulus packages calls for the expansion of debt instrument auctions across the entire maturity spectrum:

Faced with such extraordinary financing needs, the Committee focused on the optimal potential size of each coupon issue, while not jeopardizing a successful auction process.

It was the Committee's recommendation that existing monthly 2-year and 3-year notes could be increased by $5 billion in size, to $45 billion and $35 billion, respectively.

Furthermore, the Committee recommends that monthly 5-year notes have the greatest room for expansion given their liquidity and focus and should be increased by as much as $10 billion per issue. This would bring the monthly issuance size to as much as $40 billion.

And lastly, the committee recommends that the Treasury increase the size of the newly issued quarterly 10-year notes by $5 billion and by $4 billion when re-opened the two months following the new issue. In other words, the sizes of the 10-year issuances would increase from $20 billion, $16 billion and $16 billion each quarter to $25 billion, $20 billion and $20 billion, respectively.”

What a brilliant solution! In the absence of demand, and abundant supply, issue more supply!

Significantly, the estimated spending requirement for 2009 has, in the estimation of this committee, now ballooned to $2 trillion, and the stipulation is made that a similarly grotesque figure will be required for 2010.

The net supply of Treasurys in 2009 and 2010 combined seems likely to total more than $3 trillion and could climb as high as $4 trillion. The Congressional Budget Office (CBO) estimates the 2009 Federal budget deficit to be $1.2 trillion. The consensus of private sector analysts is similar to that figure. Yet, neither the CBO estimate nor the private consensus reflect fully the funding needs associated with the Obama Administration's fiscal stimulus plans, the implementation of TARP (or another TARP-like program), or the rumored creation of a bad/aggregator bank to help deal with the underperforming assets weighing down financial institutions. Some of the funding of these government programs will spill over into 2010, a year in which the "core" budget position also will be weak according to mainstream expectations for economic performance.

Importantly, the committee acknowledges for the first time that China will likely be a less reliable sucker for the continued sale of the expanding sea of U.S. debt instruments:

China, on the other hand, could slow its accumulation of dollar-denominated debt. Such a trend already has begun to develop with respect to its accumulation of overall dollar assets as the flow of private capital into China has cooled alongside the global downturn, alleviating the need to offset capital inflows.

And, in apparent support of the argument for diminishing demand for U.S.Dollar-denominated junk debt, the committee suggests that having a bigger “primary dealer community” would bolster the odds against future auction failures. The solution appears to be to hire more salesmen.

And finally, a larger primary dealer community would help to reduce on the margin the possibility of an undersubscribed auction(s). There currently are just 17 primary dealers, down from 30 a decade ago. Government bond trading desks at the dealers also are not immune from sector-wide capital/balance sheet issues and desks at many dealers are being encouraged to minimize risk.

What an operation! How can this charade be allowed to continue? The only explanation, and it's glaringly obvious, is that nobody, from the executive administration level down to Joe the Plumber, is willing to step up and be first to pull the plug on the artificial standard of living we’ve created for ourselves at the current expense of foreign treasuries and at the future expense of our progeny.

What a sad statement on the integrity of the human race.

But, whatever. We can't afford to sit around and pity ourselves just because we allowed the thieves of Wall Street and Washington administer this unlubricated broomstick to our collective backsides.

The only intelligent thing to do, and yes I do believe there is a "stuck record" frequency developing here, is to buy gold and silver. This $4 trillion hallucination on the part of the United States financial mismanagers is directly dilutive to the the value of any currency issued by that bankrupt nation, and is therefore a natural exponential driver for the gold price.

Gold bullion, gold mining shares, and for maximum upside (with correlated risk) gold juniors. If you choose NOT to participate in gold, you will have no one but yourself to blame for the splinters you'll be plucking out from your derriere that have "In God We Trust" printed on them.

Ticker Forum: "There is a forced-liquidation event underway that is massive, it is against all asset classes and it is spreading"

I do not know what is going on here, and I don't think I want to. Someone,

apparently someone in Asia, wants dollars. A LOT of dollars. There is a

forced-liquidation event underway that is massive, it is against all asset

classes and it is spreading. It originated at approximately 7:15 CT this

evening and originated out of Asia somewhere. All of the primary currency

crosses got hit at once - Euro, Pound, Yen - all weakened dramatically

against the dollar and it is still going on. The Asian stock markets got

walloped at the same time in coordinated waves of forced selling. At the

same time the US futures markets got nailed as well, down some six

handles on the /ES in a near-vertical drop. While this sounds "not that big"

to move these markets in a coordinated fashion like this is a trillion-dollar

enterprise - this is not some small company that went bankrupt, or even a

large company. There is no news coverage at the present time identifying

the source of this but it is not small and contrary to some reports it is not

"automatic selling"; this is forced liquidation. Folks, if this translates into

Eastern Europe where there are severe instabilities already brewing literally

everything in the financial world could come apart "all at once." The worse

news is that if this happens Bernanke will have killed us by extending those

swap lines all over the planet during the last six months. These will become

uncollectable and they are massive, many hundreds of billions of dollars.

Chris Hedges: U.S. Military Preparing for "Violent, Strategic Dislocation Inside the United States"; Possibly from "Economic Collapse"

By Chris Hedges

We have a remarkable ability to create our own monsters. A few decades of meddling in the Middle East with our Israeli doppelgänger and we get Hezbollah, Hamas, al-Qaida, the Iraqi resistance movement and a resurgent Taliban. Now we trash the world economy and destroy the ecosystem and sit back to watch our handiwork. Hints of our brave new world seeped out Thursday when Washington’s new director of national intelligence, retired Adm. Dennis Blair, testified before the Senate Intelligence Committee. He warned that the deepening economic crisis posed perhaps our gravest threat to stability and national security. It could trigger, he said, a return to the “violent extremism” of the 1920s and 1930s.

It turns out that Wall Street, rather than Islamic jihad, has produced our most dangerous terrorists. You wouldn’t know this from the Obama administration, which seems hellbent on draining the blood out of the body politic and transfusing it into the corpse of our financial system. But by the time Barack Obama is done all we will be left with is a corpse—a corpse and no blood. And then what? We will see accelerated plant and retail closures, inflation, an epidemic of bankruptcies, new rounds of foreclosures, bread lines, unemployment surpassing the levels of the Great Depression and, as Blair fears, social upheaval.

The United Nations’ International Labor Organization estimates that some 50 million workers will lose their jobs worldwide this year. The collapse has already seen 3.6 million lost jobs in the United States. The International Monetary Fund’s prediction for global economic growth in 2009 is 0.5 percent—the worst since World War II. There are 2.3 million properties in the United States that received a default notice or were repossessed last year. And this number is set to rise in 2009, especially as vacant commercial real estate begins to be foreclosed. About 20,000 major global banks collapsed, were sold or were nationalized in 2008. There are an estimated 62,000 U.S. companies expected to shut down this year. Unemployment, when you add people no longer looking for jobs and part-time workers who cannot find full-time employment, is close to 14 percent.

And we have few tools left to dig our way out. The manufacturing sector in the United States has been destroyed by globalization. Consumers, thanks to credit card companies and easy lines of credit, are $14 trillion in debt. The government has pledged trillions toward the crisis, most of it borrowed or printed in the form of new money. It is borrowing trillions more to fund our wars in Afghanistan and Iraq. And no one states the obvious: We will never be able to pay these loans back. We are supposed to somehow spend our way out of the crisis and maintain our imperial project on credit. Let our kids worry about it. There is no coherent and realistic plan, one built around our severe limitations, to stanch the bleeding or ameliorate the mounting deprivations we will suffer as citizens. Contrast this with the national security state’s strategies to crush potential civil unrest and you get a glimpse of the future. It doesn’t look good.

“The primary near-term security concern of the United States is the global economic crisis and its geopolitical implications,” Blair told the Senate. “The crisis has been ongoing for over a year, and economists are divided over whether and when we could hit bottom. Some even fear that the recession could further deepen and reach the level of the Great Depression. Of course, all of us recall the dramatic political consequences wrought by the economic turmoil of the 1920s and 1930s in Europe, the instability, and high levels of violent extremism.”

The specter of social unrest was raised at the U.S. Army War College in November in a monograph [click on Policypointers’ pdf link to see the report] titled “Known Unknowns: Unconventional ‘Strategic Shocks’ in Defense Strategy Development.” The military must be prepared, the document warned, for a “violent, strategic dislocation inside the United States,” which could be provoked by “unforeseen economic collapse,” “purposeful domestic resistance,” “pervasive public health emergencies” or “loss of functioning political and legal order.” The “widespread civil violence,” the document said, “would force the defense establishment to reorient priorities in extremis to defend basic domestic order and human security.”

“An American government and defense establishment lulled into complacency by a long-secure domestic order would be forced to rapidly divest some or most external security commitments in order to address rapidly expanding human insecurity at home,” it went on.

“Under the most extreme circumstances, this might include use of military force against hostile groups inside the United States. Further, DoD [the Department of Defense] would be, by necessity, an essential enabling hub for the continuity of political authority in a multi-state or nationwide civil conflict or disturbance,” the document read.

In plain English, something bureaucrats and the military seem incapable of employing, this translates into the imposition of martial law and a de facto government being run out of the Department of Defense. They are considering it. So should you.

Adm. Blair warned the Senate that “roughly a quarter of the countries in the world have already experienced low-level instability such as government changes because of the current slowdown.” He noted that the “bulk of anti-state demonstrations” internationally have been seen in Europe and the former Soviet Union, but this did not mean they could not spread to the United States. He told the senators that the collapse of the global financial system is “likely to produce a wave of economic crises in emerging market nations over the next year.” He added that “much of Latin America, former Soviet Union states and sub-Saharan Africa lack sufficient cash reserves, access to international aid or credit, or other coping mechanism.”

“When those growth rates go down, my gut tells me that there are going to be problems coming out of that, and we’re looking for that,” he said. He referred to “statistical modeling” showing that “economic crises increase the risk of regime-threatening instability if they persist over a one to two year period.”

Blair articulated the newest narrative of fear. As the economic unraveling accelerates we will be told it is not the bearded Islamic extremists, although those in power will drag them out of the Halloween closet when they need to give us an exotic shock, but instead the domestic riffraff, environmentalists, anarchists, unions and enraged members of our dispossessed working class who threaten us. Crime, as it always does in times of turmoil, will grow. Those who oppose the iron fist of the state security apparatus will be lumped together in slick, corporate news reports with the growing criminal underclass.

The committee’s Republican vice chairman, Sen. Christopher Bond of Missouri, not quite knowing what to make of Blair’s testimony, said he was concerned that Blair was making the “conditions in the country” and the global economic crisis “the primary focus of the intelligence community.”

The economic collapse has exposed the stupidity of our collective faith in a free market and the absurdity of an economy based on the goals of endless growth, consumption, borrowing and expansion. The ideology of unlimited growth failed to take into account the massive depletion of the world’s resources, from fossil fuels to clean water to fish stocks to erosion, as well as overpopulation, global warming and climate change. The huge international flows of unregulated capital have wrecked the global financial system. An overvalued dollar (which will soon deflate), wild tech, stock and housing financial bubbles, unchecked greed, the decimation of our manufacturing sector, the empowerment of an oligarchic class, the corruption of our political elite, the impoverishment of workers, a bloated military and defense budget and unrestrained credit binges have conspired to bring us down. The financial crisis will soon become a currency crisis. This second shock will threaten our financial viability. We let the market rule. Now we are paying for it.

The corporate thieves, those who insisted they be paid tens of millions of dollars because they were the best and the brightest, have been exposed as con artists. Our elected officials, along with the press, have been exposed as corrupt and spineless corporate lackeys. Our business schools and intellectual elite have been exposed as frauds. The age of the West has ended. Look to China. Laissez-faire capitalism has destroyed itself. It is time to dust off your copies of Marx.

Can The Euro Survive?

Milton Friedman famously predicted that the euro would not last past their first economic crisis. This week we look at commentary by Niels Jensen that explores the news from Euroland. Can the euro survive? He explores a number of options which are most definitely not on the radar screen for most investors. It is good to get a perspective from those outside of our own back yard. Note that when he says "our country" he is referring to Great Britain.

Niels is the Managing Partner of Absolute Return Partners based in London (which is my European partner). I work closely with Niels for years and have found him to be one of the more savvy observers of the markets I know. You can see more of his work at www.arpllp.com and contact them at info@arpllp.com. The numbered footnotes are at the end of the letter.

John Mauldin, Editor
Outside the Box

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Do BRICs (and Germans) Eat PIGS?

When the euro was introduced about ten years ago, the pessimists didn't give it much chance of reaching its tenth anniversary. The euro, or so the argument went, was doomed from the outset because of the wide spread in economic performance and discipline amongst the member countries. At one end you had, and still have, the highly disciplined, but also slow growing, economies of Germany and the Netherlands. At the other end you find the faster growing but poorly disciplined countries such as Spain and Greece. As icing on the cake, you also had, and still have, countries that lack in both departments, such as Italy, making it difficult for the union to 'gel' - well, according to sceptics.

There is admittedly an embedded weakness in the way the European currency union is structured. In the United States, arguably that largest currency union in the world, fiscal transfers between member states allow for the federal government to adjust for variances in economic performances. There is no such mechanism within the euro zone, which explains why the member states are subjected to a number of rules1. These rules require for everyone to exercise a high level of economic discipline. The problem is that there is little or no such discipline.

The best example is the huge spread in the rise of unit labour costs over the past few years. Unit labour costs measure labour (wage) costs adjusted for changes in productivity. It is probably the best measure that exists in terms of tracking the changes in competitiveness between nations. When the Stability and Growth Pact behind the euro was established, there was no reference made to unit labour costs which, with the benefit of hindsight, was a major mistake. Even Jean-Claude Trichet, the Head of the European Central Bank, who rarely admits mistakes, has publicly stated that if he could design the currency union all over again, he would push for a unit labour cost stability pact.

Back to the sceptics. What they failed to realise was that Europe, together with the rest of the world, was about to enter a period of unprecedented prosperity. The good times would not only gloss over the deeper problems, but the euro would actually go from strength to strength to a point where it now threatens to unseat the US dollar as the premier reserve currency of the world. It is therefore perhaps a mystery to some of you, why one should question the longer term viability of the euro. That is nevertheless what I intend to do.

The problem, as I have already alluded to, is poor discipline amongst several of the member states. Ever heard of the four PIGS? This less than flattering acronym stands for Portugal, Italy, Greece and Spain, four members of the euro zone which are all in much deeper trouble than they are prepared to admit. They are often considered the 'antidote' to the BRIC countries, the fast growing emerging market economies of Brazil, Russia, India and China. Let's take a closer look at the unit labour cost index for various countries (see table 1).

Table 1: 2007 Unit Labour Cost Index (2000=100)

Notes: *2006. PIGS countries in bold. Source: http://stats.oecd.org/

Since the introduction of the euro, the PIGS have failed miserably to keep up with Germany on this measure of competitiveness. So has Ireland by the way, hence its current predicament. On the other hand, Brazil (the only BRIC country which the OECD reports unit labour costs on) scores very well on this account, a fact which is not going to make life any easier for the PIGS.

EU countries outside the euro zone, such as the UK, have also lost out to Germany in recent years, but the UK has been able to play a card which is not at the disposal of the euro zone members. That card is called devaluation. Whether by design or otherwise, the UK has received a massive boost to its competitiveness in recent months as a result of the sharp fall in the value of the pound. Italy used to play this card repeatedly back in the days of the Lira. So did countries like Denmark in the dark days of the 1970s.

Back in those days there was less economic integration and recessions were rarely global. Devaluations could therefore be used to stimulate exports. The situation today is fundamentally different. The global nature of the current crisis makes it far more difficult for any country to grow its way out through higher exports. The UK will offer a great case study to test whether devaluations are still a powerful tool.

Another issue, which is potentially even more destabilising for the euro longer term, is the massive liabilities facing Europe as its population ages. We have borrowed table 2 below from Goldman Sachs which makes no secret of the challenges facing a number of European countries. Greece is clearly facing the biggest challenge. Public debt, which currently stands at about 95% of GDP, will grow to a whopping 555% of GDP by 2050 if the current pension and social security programme is left unchanged. The Greek government is painfully aware of this and have been working on several new initiatives. It was the passing of one of those new laws which caused the riots in Athens before Christmas.

Table 2: Actual Debt & Age Related Contingent Liabilities

Source: Goldman Sachs, European Weekly, 22/01/2009

Considering the poor record of fiscal discipline, many euro zone members will probably allow their debt to grow much larger before decisive action is taken. The problems are so massive - and the solutions so painful - that most politicians chicken out and pass the problem to the next generation of politicians.

A third problem facing Europe is the sheer scale of the banking crisis. Although this is not just a European problem, European countries are probably worse off than the US because a larger part of European debt has to be financed externally. As you can see from chart 1, more than $2 trillion of European and U.S. bank debt needs to be re-financed before the end of next year. Unless there is a material improvement in market conditions, re-financing at such a massive scale is simply not doable.

Chart 1: Maturing Bank Securities in 2009/10 (USD)

Source: UBS

The European approach, at least until now, has been to save the banking system at any cost. It is therefore possible that a significant share of the re-financing cost will find its way to the sovereign balance sheets and hence ultimately to the tax payer. This could further destabilise the currency union.

All these challenges are surfacing as the global economy faces the worst year since World War II. I have noted that most economic forecasters are still quite sanguine about the prospects for 2010. Be careful. The models upon which these forecasts are built are based on experience from prior recessions; however, this is no ordinary recession and historical data is therefore largely irrelevant. I am becoming increasingly convinced that most of us are underestimating how long it will take to get the global economy firmly back on its feet again.

Kenneth Rogoff and Carmen Reinhart published a research paper about a month ago which should be mandatory reading for all investors2. They have studied every single banking crisis of the past 100 years and reach some rather unsettling conclusions. As they point out: "Broadly speaking, financial crises are protracted affairs".

Following a banking crisis, asset prices fall more and for longer than most investors realise (see charts 2a and 2b). So do output and unemployment. Most importantly, though, the real value of government debt explodes (see chart 2c) but not for the reasons you might think. Yes, the bailout costs are significant, but the main driver of rising government debt is actually the subsequent collapse of tax income.

Chart 2a: Decline in Real House Prices during Banking Crises

Peak to Trough Decline & Duration

Source: See footnote 2.

Chart 2b: Decline in Real Equity Prices during Banking Crises

Peak to Trough Decline & Duration

Source: See footnote 2.

Chart 2c: Cumulative Increase in Real Public Debt

First 3 Years following the Banking Crisis

Source: See footnote 2.

So when we are told that the bailout cost, although large, is still manageable, it is only half the story. The loss of tax revenue is another nail in the coffin and could lead to a dramatic - and unpredicted - rise in public debt. Have you heard any mention of that from your government?

At this point I need to introduce something as alien as the "flow-of-funds accounting identity"3:

Δ(G-T) = Δ(S - I) + ΔNFCI⁴

I rarely throw formulas at you for the simple reason that it scares many readers away. I urge you to stay with me for a bit longer, though, because this formula is critical in order to understand how the government response to the current crisis is likely to impact interest rates longer term. The equation states that any change in fiscal stimulus (Δ(G-T)) must equal the change in private sector net savings (Δ(S-I)) plus the change in net foreign capital inflows.

Translation: If our government stimulates the economy through public spending, as it is currently doing in spades, we must either save more or we have to rely on foreigners being prepared to invest in our country. There are no exceptions to this rule.

The key question, as our economic adviser Woody Brock points out, is what will cause this equation to hold true? It is quite simple. We will save more if we get paid more to do so (through higher interest rates) or if we are so scared of the future that we stop spending and start investing instead.

Foreign investors are no different. Now, with the trillions of dollars being spent around the world to shore up our financial system, the fear factor alone is not going to be enough. Higher - possibly much higher - interest rates will be required to ensure sufficient savings.

Obviously, there is another option at the government's disposal. The central bank can monetize some or all of the deficit by buying the bonds issued by the government. This line of action will keep Δ(G-T) down; hence the need for increased private savings (and/or capital inflows) drops accordingly. The problem with this approach, as an old Danish saying states, is that it is like wetting your pants to stay warm. Monetization executed on a big scale is highly inflationary in the long run, inevitably driving bond yields higher.

The good news is that we are very unlikely to loose control of inflation in the short run. The economy is simply too weak for that to happen. In Frankfurt, the 'eurocrats' are currently congratulating themselves that they, through strict monetary discipline, killed inflation in the aftermath of last year's explosion in commodity prices. The reality, however, is that the credit crunch killed inflation - they didn't - and Europe is now at a junction where even the smallest policy mistake could be very expensive indeed. In my opinion, the ECB has been way too slow in responding to the current crisis and they must act swiftly and reduce the policy rate to near zero levels in order to avoid a deep recession throughout the euro zone.

So, could all this lead to the destruction of the euro? Could the currency union actually break up? It is not that the risk to the PIGS has not been recognised by bond investors. As you can see from chart 3 below, investors in long dated Greek government bonds now earn about 2.5% more than they do by investing in correspondent German bunds.

Chart 3: PIGS Sovereign Debt Spreads over Germany

Source: Goldman Sachs, European Weekly, 22/01/2009

On the other hand, I may disappoint one or two readers (I will certainly disappoint Ambrose Evans-Pritchard of the Daily Telegraph who appears to have declared war on the euro), but I firmly believe that the euro will almost certainly survive the current crisis. I am much more worried about some of the member countries.

There is nothing in the Maastricht treaty which prevents a member country from leaving the euro, yet the decision to join is effectively irreversible. There are a number of reasons for this, the most important being economic costs. Take Italy which has a history of compensating for lost competitiveness through regular devaluations. If Berlusconi did the unthinkable tomorrow (sorry - nothing is unthinkable in Berlusconi's world), Italy's borrowing costs would explode. My guess is that bond investors would demand double digit returns on a Lira denominated bond to compensate for the dramatically increased devaluation risk. Already in a precarious fiscal position, Italy could quite simply not afford that.

So, if any country were to leave the euro, it would more likely be from a position of strength, and only one country possesses enough strength to pull that off in the current environment. That country is Germany. And, although the euro is not particularly popular in Germany, I believe it is extremely unlikely for Germany to make such a move unilaterally. There are several reasons for that - Germany's history in Europe being the most important.

At the same time, the fact that the euro has saved the bacon of more than one country in recent months - Ireland being the most obvious example - should not be ignored. For this very reason, the euro membership is actually far more likely to grow than to shrink as a result of the financial and economic crisis engulfing the world. The issue the EU has to deal with is whether the new applicants should actually be welcomed. Most of those who would want to join will bring plenty of baggage.

Another possible outcome, which you hear almost no mention of, is the possibility of a new Transatlantic currency. When I mention this possibility, everyone laughs, but think about it for a second. The economic crisis on both sides of the Atlantic is enormous. Both are resorting to the same formulas - large fiscal stimulus and quantitative easing (a word invented by central bankers because 'printing money' smacks too much of Zimbabwe). There is a real risk that the entire financial and monetary system on either side of the pond needs to be re-designed. If that were to happen, I am pretty confident that the Fed and the ECB would at least sit down and discuss the possibility of a joint currency. That would also allow the UK to join a currency union without too much egg on its battered face.

In the short to medium term, though, there is no such bailout on the horizon. In recent years, the weaker members of the euro, such as Italy, have managed to 'muddle through' (to borrow one of John Mauldin's favourite terms), mostly because the global economy has been strong enough to gloss over any weaknesses. D-day is now firmly on the horizon. As I see things, it is not inconceivable that a member country could be forced to default on its sovereign debt. Interestingly, any euro member country defaulting on its debt could (and probably would) carry on as a full member of the currency union. And I will bet almost anything that the EU would rather have one of its members defaulting on its debt than having to break up the currency union.

Another, and more likely, outcome is the possibility of one or more member countries coming under EU administration. This would almost certainly include the most painful of all cures - mandatory wage reductions in order to get unit labour costs back in line. It would be a lot easier for the government of, say, Greece to get the EU to do the dirty job than to do it itself. Civil unrest will no longer be the privilege of countries such as Indonesia or Thailand. The recent crowd trouble in Greece could very well turn out to be the dry run for much bigger and more organised labour market unrest across Europe as reality begins to bite.

For the time being, though, European governments continue to be in denial. When the IMF recently recommended that Spain implement various structural reforms, the idea was flatly rejected by Prime Minister Zapatero. In the meantime, you can sit back and prepare for the drama to unfold. Very simplistically, it is a choice between Zimbabwe and Japan. Our central bankers can choose to monetize their way out of the current slump and run the risk of much higher interest rates and a rapidly deteriorating currency like Zimbabwe or they can show fiscal discipline and accept perhaps ten years of below par growth a la Japan. Or they can find the delicate balance in between the two and everyone will live happily thereafter. But that requires both skill and luck.