The news that the US Mint had to suspend sales of gold coins because of the surge in demand was a perfect headline for last week and for the time we are living in. The Federal Government (roughly translated into “we the taxpayers”) will in all likelihood provide the funding for the largest bailout in history. The actual cost or profit will take many years to calculate, but the bailout should provide sufficient encouragement to the system to allow credit to start flowing and life to return to normal, which would include up and down markets. The blame game will also increase in intensity, but we should all try to remember that everyone benefitted from cheap and easy credit for many years, people who would never have been able to afford houses, luxury cars or vacations, now enjoyed those benefits; local authorities enjoyed higher property tax revenues as prices soared, benefitting the community at large. Clearly there were also excess greed with massive bonuses and salaries, independent of whether companies were doing well and on occasion highly expensive shower curtains, but just about everyone enjoyed the abundance of cheap money and now it is time for all to pay the price as the pendulum swings back from deregulation to over regulation.

SAVING the world is a thankless task. The only thing beyond dispute in the $700 billion plan of Hank Paulson, the treasury secretary, and Ben Bernanke, chairman of the Federal Reserve, to stem the financial crisis is that everyone can find something in it to dislike. The left accuses it of ripping off taxpayers to save Wall Street, the right damns it as socialism; economists disparage its technicalities, political scientists its sweeping powers.

Spending a sum of money that could buy you a war in Iraq should not come easily; and the notion of any bail-out is deeply troubling to any self-respecting capitalist. Against that stand two overriding arguments. First this is a plan that could work. And, second, the potential costs of producing nothing, or too little too slowly, include a financial collapse and a deep recession spilling across the world: those far outweigh any plausible estimate of the bail-out’s cost.

America’s financial system has two ailments: it owns a huge amount of toxic securities linked to falling house prices. And it is burdened by losses that leave it short of capital (although the world has capital, not enough has been available to the banks). For over a year, since August 2007, central bankers, principally Mr Bernanke, have been trying to make this toxic debt liquid. But by September 17th, following the bankruptcy of Lehman Brothers and the nationalisation of American International Group earlier that week, the problem started to become one of the system’s solvency too. The market lost faith in a strategy that saved finance one institution at a time. The economy is not healing itself. If credit markets stay blocked, consumers and firms will enter a vicious spiral.

Mr Paulson’s plan relies on buying vast amounts of toxic securities. The theory is that in any auction a huge buyer like the federal government would end up paying more than today’s prices, temporarily depressed by the scarcity of buyers, and still buy the loans cheaply enough to reflect the high chance of a default. That would help recapitalise some banks—which could also set less capital aside against a cleaner balance sheet. And by creating credible, transparent prices, it would at last encourage investors to come in and repair the financial system: this week Warren Buffett and Japan’s Mitsubishi-UFJ agreed to buy stakes in Goldman Sachs and Morgan Stanley.

The economics behind this is sound. Government support to the banking system can break the cycle of panic and pessimism that threatens to suck the economy into deep recession. Intervention may help taxpayers, because they are also employees and consumers. Although $700 billion is a lot—about 6% of GDP—some of it will be earned back and it is small compared with the 16% of GDP that banking crises typically swallow and trivial compared with the Depression, when unemployment surged above 20% (compared with 6% now). Messrs Bernanke and Paulson also have done well by acting quickly: it took seven years for Japan’s regulators to set up a mechanism to take over large broke banks in the 1990s.

Mr Paulson’s plan also has its shortcomings. He will find it hard to stop sellers from rigging auctions, if only because no two lots of dodgy securities are exactly the same. Taxpayers may thus pay over the odds and banks may be rewarded for their stupidity. Yet these costs seem small against the benefit of putting a floor under the markets. And fine calculations about moral hazard are less pressing when investors are fleeing risk.

For the entire article from THE ECONOMIST click here:

The Federal Reserve could be prompted to make an emergency interest rate cut in the next few days in an attempt to boost confidence in the battered banking sector.

The central bank could even move as soon as Tuesday to cut its fed funds rate, a key overnight lending rate, by at least a quarter percentage point, according to interest rate futures for September listed on the Chicago Board of Trade.

The Fed's next scheduled meeting to discuss interest rates is a two-day session that ends on October 29.

Even though some think an emergency rate cut may have only a limited impact on the economy, it may be necessary to boost investor and consumer confidence.

For the entire article from CNNMoney click here:

On Wednesday, Barack Obama, the US Democratic presidential candidate, urged a solution to the finance crisis “that protects American taxpayers and our economy without rewarding those whose greed led us to this point”. That evening, President George W. Bush warned that economic ruination loomed if Americans chose to “stand back and allow the irresponsible actions of some to undermine the financial security of all”.

The problem is, responsibility is more widely spread. Few Americans are innocent of the cardinal sins of this crisis: extravagance, leverage and complexity. The high-rollers who ran the banks have made a terrible mess. But the common man, had he been given a bank of his own, would have responded in the same way. We know this because, in effect, Americans were given banks of their own: their houses. Thanks in large part to tax laws that allow homeowners to deduct the interest on their mortgages, homes became investment engines – rickety ones.

The deduction is almost designed to overheat the housing market and push people towards “more house than they can afford”. That is because you cannot get this deduction for borrowing against an existing mortgage, aside from the $100,000 mentioned above. You can only get it on your “acquisition loan” or “first lien”. If you bought a house for $300,000 that appreciated by $700,000, you need to sell your house and move into a new one to unlock the full deductibility.

Why do that? For access to inexpensive capital to reinvest. Speculating with one’s house was considered a sensible strategy not just by day traders and stock touts but by respectable investment counsellors. Forbes magazine, in a 2004 article called “Hock Your House”, urged homeowners to “leverage up and invest”. In New York, the combined federal and state income-tax rate for the richest is about 40 per cent, Forbes noted. So when a New Yorker took out a $1m, five-year adjustable-rate mortgage at 4.9 per cent, his effective after-tax rate was 2.9 per cent. You need not be especially cocky to believe you can turn a profit if you are given $1m at below market rates. And the principle is the same even if you are on step one of the leverage ladder, in a $109,000 trailer home with a $100,000 mortgage.

Treating one’s house as an investment bank was logical under the circumstances. The incentive was to keep equity as low as possible. “Interest-only” mortgages proliferated. People did not even feign wanting to pay off their mortgages one day. But at heart it contradicted the rhetoric – about “fulfilling the American dream” and the civic benefits of widespread homeownership – that is used to justify the mortgage deduction. Americans often brag about their 69 per cent rate of home ownership. Mr Bush hailed the millions of first-time home- buyers in his speech on Wednesday. But at these levels of debt, is “ownership” the right word for people’s relationship to their houses? It might be better to describe them as renters with an option to buy, even if they call their rent a “mortgage”.

An important underlying question is whether incentives created a hollowing-out of home ownership that nobody would have wished for in an undistorted market, or whether people simply care less about having equity in a house nowadays. Mr Bush’s frequent invocation of an “ownership society” implies that many socially desirable things result when people own their own homes – stability, virtue and wider citizen participation. In Thomas Jefferson’s time, having as many property-owning yeomen as possible was a democratic aspiration and we claim to cherish it still. There are unquestionably cases in which encouraging home ownership – as in the case of the widespread privatisation of council homes under Margaret Thatcher – can bring people out of the social shadows.

But to most of us, the belief that full membership of society hinges on property ownership sounds like an 18th-century prejudice. It is against the spirit of our age. We have no sentimental attachment to anything. Everything gets steadily more disposable and short-lived – razors, news stories, jobs, marriages. Education, too: recent reports that Sarah Palin attended five colleges in six years showed her to be flighty, but not atypical. Why should property be immune to this trend? What sense do 30-year mortgages make in an age of migration and retraining? Being not so good a fit with the institutions of our time, the privately owned house has been fitted to a less sentimental use. People have been allowed to collateralise huge loans with an asset that, when push comes to shove, they care less about than popular mythology assumed. The system worked well for a while. While it did, a lot of people were able to move into their dream houses. Now they are moving into their reality houses.

For the entire article from THE FINANCIAL TIMES click here:

U.S. stocks retreated, driving the Standard & Poor's 500 Index to its steepest weekly slump since May, as Congress failed to approve a $700 billion bank bailout the president said is needed to avert a recession.

``The market is holding its breath to wait and see what comes out of Washington,'' said Malcolm Polley, who manages about $1.2 billion as chief investment officer of Stewart Capital Advisors in Indiana, Pennsylvania. ``Wall Street has been very good in the last week at telling Congress, `You've got to get something done or bad things are going to happen.' This is one time where they can't afford to not do anything.''

The S&P 500's retreat erased almost half of the 8.5 percent rally on Sept. 18-19 that was the biggest two-day surge since the aftermath of the 1987 crash. Members of Congress failed to reach a deal after a group of House Republicans said they wouldn't support Treasury Secretary Henry Paulson's proposal. President George W. Bush said Sept. 25 that a rescue is needed to avert a ``long and painful'' recession.

For the entire article from BLOOMBERG NEWS click here:

The U.S. Mint is temporarily halting sales of its popular American Buffalo 24-karat gold coins because it can't keep up with soaring demand as investors seek the safety of gold amid economic turbulence.

Mint spokesman Michael White said Friday that the sales were being suspended because demand for the coins, which were first introduced in 2006, has exceeded supply and the Mint's inventory of the coins has been depleted.

With the financial crisis gripping markets in recent weeks, investors have rushed to safe havens such as gold and Treasury securities. Demand for three-month Treasury bills last week pushed their yields down sharply to levels not seen in decades.

Investment advisers, however, caution that the volatility often seen in gold prices could make investments in this area more of a risky decision if gold prices suddenly begin to fall sharply.

For the entire article from CNBC click here:

THOSE who hoped Europe might escape Wall Street’s woes were sorely disappointed this week. Not only did markets slide across the continent, with bank shares especially hard-hit, but also a purchasing managers’ index for the euro area fell to its lowest since 2001, and three business-confidence indicators were unexpectedly weak. The figures suggest that a recession may even have begun already. The questions are how deep it will be, and how long it will last. And the answers will depend heavily on the two biggest economies: Germany and France.

Germans feel aggrieved. While others were living on easy credit and blowing bubbles, they practised virtue. The economy clawed back lost competitiveness via low wage rises. The public sector was in surplus last year. Exports and investment have done well, giving Germany its best spell of growth since the early 1990s. Yet one does not have to indulge in a vice to contract a disease. The entire euro area was boosted by house-price increases, notes Jörg Krämer, chief economist of Commerzbank. “Germany can’t decouple.”

So was all that economic virtue pointless? Not quite. Labour-market reforms will dampen the rise in unemployment. Households and businesses are less indebted than elsewhere. Consumer debt stands at 101% of disposable income in Germany, compared with 140% in America and 172% in Britain. German firms finance investment out of profits more than debt, and so are less exposed to the credit crunch. Some German banks, especially in the public sector, binged on subprime American assets, and further losses may come to light. But bank lending to enterprises rose by 9% in the year to mid-2008.

Unlike Germany, France has little room for expansionary fiscal policy. The government made big tax cuts in 2007. The budget deficit next year could easily exceed the euro-area limit of 3% of GDP. “Even in Spain there is huge scope for counter-cyclical fiscal measures,” says Carlos Caceres, an economist at Morgan Stanley. “But the French really have their hands tied, and it will be almost impossible for them not to break the 3% ceiling.” France does not share Germany’s keenness on fiscal austerity.

There are three broader reasons for worry about the euro area’s prospects. One is the currency. In recent months, the euro has fallen against the dollar, offering hard-pressed exporters welcome relief. But the dramatic events of the past two weeks could easily spill over into renewed dollar weakness. Second, though European banks look healthier than American ones, they remain dangerously exposed, both to Lehman and to the American housing market. Among the most vulnerable are some big banks that cross borders in Europe. The American authorities were able to assemble their bail-out plans fast. In Europe, it could be harder and take longer, as supervision is largely national and the role of the ECB in dealing with a troubled cross-border bank remains fuzzy.

Third are the well-known structural weaknesses of the biggest euro-area economies. America’s economy is famously flexible, quick to lay off workers but also to hire them again. It may go into recession more suddenly, but it tends also to revive more speedily. In Europe, rigid product and labour markets inhibit such flexibility. So the risk is that the euro area will remain in the doldrums a lot longer.

For the entire article from THE ECONOMIST click here:

From Glen McCoy

 

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