It began as a subprime surprise, became a credit crunch and then a global financial crisis. At last week’s World Economic Forum in Davos, Switzerland, Russia and China blamed America, everyone blamed the bankers, and the bankers blamed you and me. From where I sat, the majority of the attendees were stuck in the Great Repression: deeply anxious but fundamentally in denial about the nature and magnitude of the problem….

[Leaders] need to grow up and face the harsh reality: The Western world is suffering a crisis of excessive indebtedness. Governments, corporations and households are groaning under unprecedented debt burdens. Average household debt has reached 141% of disposable income in the United States and 177% in Britain. Worst of all are the banks. Some of the best-known names in American and European finance have liabilities 40, 60 or even 100 times the amount of their capital.

The delusion that a crisis of excess debt can be solved by creating more debt is at the heart of the Great Repression. Yet that is precisely what most governments propose to do.

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The federal government overpaid for stocks and other assets in attempting to help financial institutions last year, a government watchdog said Thursday, taking further issue with the beleaguered $700 billion rescue program.

Elizabeth Warren, chairwoman of the Congressional Oversight Panel for the bailout funds, told the Senate Banking Committee on Thursday that Treasury in 2008 paid $254 billion and received assets worth about $176 billion.

The figures were reached by extrapolating the results of a study of 10 government transactions, comparing the price paid by Treasury and the value of the asset at the time of purchase. Warren did not present details of the transactions the panel analyzed. A full report will be released Friday.

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The Obama administration is expected to impose a cap of $500,000 for top executives at companies that receive large amounts of bailout money, according to people familiar with the plan.

Executives would also be prohibited from receiving any bonuses above their base pay, except for normal stock dividends.

President Obama and Treasury Secretary Timothy F. Geithner plan to announce the executive compensation plan on Wednesday morning at the White House.

The new rules would be far tougher than any restrictions imposed during the Bush administration, and they could force executives to accept deep reductions in their current pay. They come amid rising public fury about huge pay packages for executives at financial companies being propped up by federal tax dollars.

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Call it the Great Repression. The reality being repressed is that the western world is suffering a crisis of excessive indebtedness. Many governments are too highly leveraged, as are many corporations. More importantly, households are groaning under unprecedented debt burdens. Worst of all are the banks. The best evidence that we are in denial about this is the widespread belief that the crisis can be overcome by creating yet more debt.

The US could end up running a deficit of more than 10 per cent of gross domestic product this year (adding the cost of the stimulus package to the Congressional Budget Office’s optimistic 8.3 per cent forecast). Today’s born-again Keynesians seem to have forgotten that their prescription of a deficit-financed fiscal stimulus stood the best chance of working in a more or less closed economy. But this is a globalised world, where unco-ordinated profligacy by national governments is more likely to generate bond market and currency market volatility than a return to growth.

There is a better way to go but it is in the opposite direction. The aim must be not to increase debt but to reduce it. Two things must happen. First, banks that are de facto insolvent need to be restructured ”“ a word that is preferable to the old-fashioned “nationalisation”….

The second step we need to take is a generalised conversion of American mortgages to lower interest rates and longer maturities.

Read it all from the Financial Times.

The central question facing policy makers: How does the government help banks exorcise their bad bets? For many of these assets, there is no current market price. If the government buys the assets for more than they are ultimately worth, taxpayers will take the hit. If the government pays too little, banks will have to record losses on other similar assets, exacerbating the problem.

Read it all from the front page of today’s Wall Street Journal.

Some of Mr. Obama’s advisers have asked who the government would get to run the banks. Many of the most experienced executives are tainted by the decisions they made during the age of excess. And how would the government attract the best talent if it demanded that they take minimal pay ”” a political reality in the current environment?

Another option is for the government to buy the banks’ most toxic assets either through a giant fund, or, more likely, a federally supported bad bank designed to buy up troubled investments. But in that case, taxpayers might well be the losers: They would have all of the banks’ worst assets and none of their performing loans. And unless a deal is worked out to take a larger share of the banks whose bad loans are shuffled off to the government, the taxpayers would not have the chance to benefit by selling the shares back to private investors.

Moreover, cleaning up the banks’ bad assets, without extracting a heavy price for the bank managers, shareholders and their lenders, is exactly what Mr. Summers and Mr. Geithner warned against during the Asian financial crisis.

“We told the Asians that they had to be willing to let banks and companies fail,” said Jeffrey Garten, a professor at the Yale School of Management and a top official in the Clinton administration. “We warned that there was great moral hazard if governments just bailed them out.”

“And now,” he said, “we are doing the polar opposite of our advice.”

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President Bush is leaving office amid the worst recession in 25 years, and naturally his economic policies are getting the blame. But before we move on to the era of Obamanomics, it’s important to understand what really happened during the Bush years — not least so we don’t repeat the same mistakes….

By pushing all of this excess credit into the economy, the Fed created a housing and mortgage mania that Wall Street was only too happy to be part of. Yes, many on the Street abandoned their normal risk standards. But they were goaded by an enormous subsidy for debt. Wall Street did get “drunk” but Washington had set up the open bar.

For that matter, most everyone else was also drinking the free booze: from homebuyers who put nothing down for a loan, to a White House that bragged about record home ownership, to the Democrats who promoted and protected Fannie Mae and Freddie Mac. (Those two companies helped turbocharge the mania by using a taxpayer subsidy to attract trillions of dollars of foreign capital into U.S. housing.) No one wanted the party to end, though sooner or later it had to….

This history is crucial to understand, both for the Democrats who now assume the levers of power and for Republicans who will want to return to power some day. Mr. Bush and his team did many things right after inheriting one bubble. They were ruined by monetary excess that created a second, more dangerous credit mania. They forgot one of the main lessons of Reaganomics, which is the importance of stable money.

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Why save banks if they will not lend?

That has become a significant political issue on both sides of the Atlantic as governments confront the reality that preventing the financial system from collapsing is not the same as repairing it.

In Britain, that led the government of Prime Minister Gordon Brown to announce a new round of bailouts, with a twist. “In return to access to any government support, there will have to be an increase in lending, and that will be legally binding,” Mr. Brown told a news conference today.

In the United States, aides to President-elect Barack Obama sounded a similar theme. “The focus isn’t going to be on the needs of banks,” Mr. Obama’s chief economic adviser, Lawrence H. Summers, said. “It’s going to be on the needs of the economy for credit.”

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Many commentators have suggestions for Barack Obama on what should be his first meeting at the White House. Here is mine: Mr. Obama and his economic team should convene the 300 leading bank presidents in the East Room and the president should say to each one of them something like this:

“Ladies and gentlemen, this crisis started with you, the bankers, engaging in reckless practices, and it will only end when we clean up your mess and start afresh. The banking system is the heart of our economy. It pumps blood to our industrial muscles, and right now it’s not pumping. We all know that in the past six months you’ve gone from one extreme to another. You’ve gone from lending money to anyone who could fog up a knife to now treating all potential borrowers, no matter how healthy, as bankrupt until proven innocent. And, therefore, you’re either not lending to them or lending under such onerous terms that the economy can’t get any liftoff. No amount of stimulus will work without a healthy banking system.

“So here’s what we’re going to do: we’re going to unclog the arteries. My banking experts have analyzed each of your balance sheets. You will tell us if we’re right. Those of you who are insolvent, we will nationalize and shut down. We will auction off your viable assets and will hold the toxic ones in a government reconstruction fund and sell them later when the market rebounds. Those of you who are weak will be merged. And those of you who are strong will receive added capital for your balance sheets, after you write down all your remaining toxic waste. I am not going to continue rewarding the losers and dimwits amongst you with handouts.”

Without this sort of come-to-Jesus strategy, we’re going to continue to just limp along. We’ll never quite confront the real problem because we don’t want to take the upfront pain. Therefore, the market will never clear ”” meaning start-ups in need of capital will be choked in their cribs and profit-making firms won’t be able to grow as they should.

Read it all. As far as I am concerned, Mr. Friedman hits this one out of the park. This crisis is about massive overleveraging at every level of the economy, especially in the banking system. It has to be fixed, and those who want to fix it need to get ahead of the problem (they are still behind)–KSH.

At the Palm Beach Ritz-Carlton last November, John C. Hope III, the chairman of Whitney National Bank in New Orleans, stood before a ballroom full of Wall Street analysts and explained how his bank intended to use its $300 million in federal bailout money.

“Make more loans?” Mr. Hope said. “We’re not going to change our business model or our credit policies to accommodate the needs of the public sector as they see it to have us make more loans.”

As the incoming Obama administration decides how to fix the economy, the troubles of the banking system have become particularly vexing.

Congress approved the $700 billion rescue plan with the idea that banks would help struggling borrowers and increase lending to stimulate the economy, and many lawmakers want to know how the first half of that money has been spent before approving the second half. But many banks that have received bailout money so far are reluctant to lend, worrying that if new loans go bad, they will be in worse shape if the economy deteriorates.

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This week, banks ran into yet deeper crisis: the sector is in more trouble than was feared. As Ben Bernanke, chairman of the US Federal Reserve, noted in a speech in London this week, however, economic recovery will not begin until the financial sector recovers its health. Governments must act.

In October, following a British lead, governments around the world recapitalised their banks. This drastic measure saved the sector from collapse. But, as the events of this week have demonstrated, the banks are still on the ropes….

Governments must now act swiftly to move ahead of the crisis. Ad hoc nationalisation of insolvent banks and recapitalisation of impaired ones is simply not enough. Governments must act to draw out the poisonous uncertainty caused by the toxic assets held by solvent banks.

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The government moved early Friday morning to shore up Bank of America with an additional $20 billion from the bailout fund. The government is still spending the first half of the bailout money. The Senate released the other half of the $750 bailout package Thursday. David Wessel of The Wall Street Journal talks with Renee Montagne about how well the plan is working.

Listen to it all from NPR

The U.S. government is close to committing billions in additional aid to Bank of America Corp. as the nation’s largest bank by assets tries to digest its Jan. 1 acquisition of Merrill Lynch & Co., according to people familiar with the situation.

The discussion began in mid-December when Bank of America, already the recipient of $25 billion in federal rescue funds, told the U.S. Treasury Department it was unlikely to complete its purchase of the ailing Wall Street securities firm because of Merrill’s larger-than-expected losses in the fourth quarter, according to a person familiar with the talks.

Treasury, concerned the deal’s failure could affect the stability of U.S. financial markets, agreed to work with the Charlotte, N.C. lender on the “formulation of a plan” that includes new government capital. The terms are still being finalized, this person said, and details are expected to be announced with Bank of America’s fourth-quarter earnings, due out Jan. 20.

Simply unbelievable. Read it all.

In Olmstead Falls, Ohio, Superintendent Todd Hoadley sent in the paperwork two days before Thanksgiving to request $100 million from the federal government, half of it for school construction. He has yet to see a check and concedes he dabbling in a bit of hyperbole by latching onto the program, but he says the problems are real.

“We were trying to make the statement: ‘Don’t forget public education,’ ” Hoadley says.

In Olmstead Falls, 1,200 students cram into a 40-year-old high school built for 800. The school board wants to cut $1 million from the district’s $34 million budget, and Gov. Ted Strickland has asked advisers to see what a 25% statewide school funding cut would look like.

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Republican and Democratic Senate leaders signaled on Monday that they would support the release of the second half of the Treasury’s $700 billion financial system bailout fund, despite anger among many rank-and-file lawmakers over the Bush administration’s management of the program.

As Congress prepared to act, regulators directed thousands of banks to provide more information about how they have used the money received through the bailout program, responding to concern that financial institutions were hoarding the cash rather than lending it to businesses and consumers.

President-elect Barack Obama said on Monday that like Democrats and Republicans on Capitol Hill, his administration would demand substantially greater oversight of the program.

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In a move being coordinated with the Obama transition team, senior Bush administration officials are preparing to ask lawmakers for the second half of the $700 billion financial rescue package, despite intense opposition in Congress, sources familiar with the matter said.

The initiative, if it goes ahead, could create an unusual political straddle between the Bush and Obama administrations. If Congress were to vote down the measure, either President Bush or Obama might have to exercise a veto in order to get the money. While Obama officials prefer that current administration issue a veto, the White House is declining to address that question.

Democratic Senate aides were notified in a meeting this afternoon that the request could come as soon as this weekend and that a vote could be held as soon as next week, congressional sources said.

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“See the USA in your Chevrolet!” trilled Dinah Shore week after week on TV.

Can you still see the USA in your Chevrolet? Through a windscreen darkly.

General Motors now has a market valuation about a third of Bed, Bath & Beyond, and no one says your Swash 700 Elongated Biscuit Toilet Seat Bidet is too big to fail. GM has a market capitalization of about $2.4 billion. For purposes of comparison, Toyota’s market cap is $100 billion and change (the change being bigger than the whole of GM). General Motors, like the other two geezers of the Old Three, is a vast retirement home with a small money-losing auto subsidiary. The UAW is AARP in an Edsel: It has three times as many retirees and widows as “workers” (I use the term loosely). GM has 96,000 employees but provides health benefits to a million people.

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With a record amount of commercial real-estate debt coming due, some of the country’s biggest property developers have become the latest to go hat-in-hand to the government for assistance.

They’re warning policymakers that thousands of office complexes, hotels, shopping centers and other commercial buildings are headed into defaults, foreclosures and bankruptcies. The reason: according to research firm Foresight Analytics LCC, $530 billion of commercial mortgages will be coming due for refinancing in the next three years — with about $160 billion maturing in the next year. Credit, meanwhile, is practically nonexistent and cash flows from commercial property are siphoning off.

Unlike home loans, which borrowers repay after a set period of time, commercial mortgages usually are underwritten for five, seven or 10 years with big payments due at the end. At that point, they typically need to be refinanced. A borrower’s inability to refinance could force it to give up the property to the lender.

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UNFORTUNATELY, Treasury Secretary Henry M. Paulson Jr. has turned this old song into the unofficial theme of the Troubled Assets Relief Program, the $700 billion bailout. His frequent changes of direction are not only embarrassing, they also upset the very markets this program was designed to calm.

It pains me to say this, because I was among the first to call upon Congress to create two institutions to deal with the financial crisis: one to buy and refinance home mortgages, the other to buy what came to be called “troubled assets.” The legislation signed in October empowered the TARP to do both. Sadly and amazingly, it has done neither.

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President Bush has grudgingly allowed General Motors and Chrysler to drive away with the last few billion bucks in Treasury’s TARP till, which boasted $350 billion a mere 77 days ago.

How did it all slip away so fast?

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“We need a Czar Czar, to crack the whip on all the czars. ”¦ P.S.: Also a federal czar policy. Right now, czar decisions are made on an ad hoc, case-by-case basis, with no attempt at czar harmonization.”

Mickey Kaus

MS. CARLY FIORINA: …I think all of those statistics are an important reminder. While we have been focused in Washington on big companies…

…the Detroit automakers, and big unions, the truth is we’re not as concerned, and we should be, about the hundreds and thousands of small businesses who actually create two-thirds of the jobs in this country. Which brings me all the way back to the original problem. We have a recession, a deepening recession right now because credit is unavailable. Credit is unavailable to small businesses so they can’t hire. When hundreds of small businesses can’t hire 10 and 15 people, over time that creates big unemployment numbers. They may not have big unions to represent their interests in Washington. They’re the little guy, but the little guy matters. When credit isn’t available, consumers don’t have the money they need to spend. So I think we have to go back to the root of this problem, ultimately, which is credit is still unavailable. And that is despite massive bailouts of big financial institutions who are still not lending (my emphasis).

Read it all from today’s edition of Meet the Press (and comments from two others besides these three also).

“Without giving specific names, most of the significant American banks, the larger banks, are bankrupt, totally bankrupt,” said [Jim] Rogers, who is now a private investor.

“What is outrageous economically and is outrageous morally is that normally in times like this, people who are competent and who saw it coming and who kept their powder dry go and take over the assets from the incompetent,” he said. “What’s happening this time is that the government is taking the assets from the competent people and giving them to the incompetent people and saying, now you can compete with the competent people. It is horrible economics.”

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BTW, while…[the] folks in the Big Media churned out hundreds of thousands of words…waxing euphoric about the prospect for enhanced back office clearing of CDS contracts, the real issue is the festering credit situation in the front office. Truth is that the DTCC and the other dealers, working at the behest of Mr. Geithner, Gerry Corrigan and many others, have largely fixed the operational issues dogging the CDS markets. The danger of CDS is not a systemic blowup – though that will come soon enough. It is the normal operation of the now electronically enabled CDS market wherein lies the threat to the entire global financial system, this via the huge drain in liquidity illustrated above as CDS contracts are triggered by default events.

The only way to deal with this ridiculous Ponzi scheme is bankruptcy. The way to start that healing process, in our view, is by the Fed emulating the FDIC’s treatment of DSL, withdrawing financial support for AIG and pushing the company into the arms of the bankruptcy court. The eager buyers for the AIG insurance units, cleansed of liability via a receivership, will stretch around the block.

By embracing Geithner, President-elect Barack Obama is endorsing the ill-advised scheme to support AIG directed by Hank Paulson et al at Goldman Sachs and executed by Tim Geithner and Ben Bernanke. News reports have already documented the ties between GS and AIG, and the backroom machinations by Paulson to get the deal done. This scheme to stay AIG’s resolution cannot possibly work and when it does collapse, Barak Obama and his administration will wear the blame due through their endorsement of Tim Geithner.

Read it carefully and read it all.

American International Group Inc. owes Wall Street’s biggest firms about $10 billion for speculative trades that have soured, according to people familiar with the matter, underscoring the challenges the insurer faces as it seeks to recover under a U.S. government rescue plan.

The details of the trades go beyond what AIG has explained to investors about the nature of its risk-taking operations, which led to the firm’s near-collapse in September. In the past, AIG has said that its trades involved helping financial institutions and counterparties insure their securities holdings. The speculative trades, engineered by the insurer’s financial-products unit, represent the first sign that AIG may have been gambling with its own capital.

Read it all.

i found this helpful.

To understand how the short-term response might serve the country’s long-term economic interest, I called up Michael Porter, the competitiveness guru at Harvard Business School. Porter wrote an outstanding overview of America’s long-term economic challenges in the Oct. 30 issue of BusinessWeek.

Porter wrote that the U.S. economy has historically benefited from several great assets: an unparalleled environment for entrepreneurialism, a tremendous infrastructure for scientific research, the world’s best universities, a strong commitment to competition and free markets, decentralized regional economies, and efficient capital markets.

But, Porter continued, these advantages are starting to erode. The U.S. has an inadequate rate of reinvestment in science and technology. America’s confidence in free markets is waning. Lack of regulatory oversight has undermined capital markets. Universities have not sufficiently increased graduation rates. American workers do not have a credible safety net. Regulations and litigation have inflated the cost of business. Most important, there is no long-term economic strategy to organize responses to these problems.

I asked Porter how this short-term crisis might serve as an opportunity to address those long-term problems. First, he said, the Obama team will have to avoid a few temptations: Don’t just try to throw out money as fast as possible to stimulate demand. Don’t spread the spending around too thinly. Don’t try to save jobs that are going to disappear anyway.

Then he threw out a bunch of ideas that could be part of a stimulus package….

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In the old days — from the Venetian Republic to, oh, the Bear Stearns rescue — if you wanted to get rich, you did it the Warren Buffett way: You learned to read balance sheets. Today you learn to read political tea leaves. If you want to make money on Wall Street (or keep from losing your shirt), you do it not by anticipating Intel’s third-quarter earnings but by guessing instead what side of the bed Henry Paulson will wake up on tomorrow.

Today’s extreme stock market volatility is not just a symptom of fear — fear cannot account for days of wild market swings upward — but a reaction to meta-economic events: political decisions that have vast economic effects.

As economist Irwin Stelzer argues, we have gone from a market-driven economy to a politically driven economy….

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Pub-owner Sean Hughes, who’s his 20s, has seen a big change in people’s spending habits even in his young life.

SEAN HUGHES, Pub Owner: When I was very young, I mean, it was different then, because credit wasn’t a real kind of thing in people’s lives. It was obviously — you know, if you had the money to buy something, then you could buy it.

Whereas now, people just seem to look at something like a television, and be like, “I want that,” and they can get it, because they can get on no percent interest or they can get it on whatever.

SELLER: We got things for 5 pounds, 10 pounds, 20 pounds.

MARGARET WARNER: That attitude led many British consumers, especially younger ones, to run up huge levels of personal debt, more than even in the United States. Total household indebtedness here, credit card and mortgage debt combined, stands at 160 percent of GDP, the highest in the developed world….

MARGARET WARNER: But now British banks are squeezing these consumers through their credit cards. Credit counselor Jahanara Hussain works for a nonprofit in London’s East End.

Read or watch the whole thing.