As long as the U.S. national debt is entirely denominated in dollars, there is no risk that we will run into the sort of financial crisis that small countries often run into. What gets them into trouble isn’t the debt per se, but an inability to acquire sufficient foreign exchange with their own currency to service it. While the U.S. Treasury has never issued bonds denominated in foreign currencies, it is conceivable that it could be forced to do so if the dollar falls sharply and foreign demand for U.S. bonds wanes. That will be the point at which our debt problem becomes more than theoretical and we are really on the road to national bankruptcy.

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As long as the U.S. national debt is entirely denominated in dollars, there is no risk that we will run into the sort of financial crisis that small countries often run into. What gets them into trouble isn’t the debt per se, but an inability to acquire sufficient foreign exchange with their own currency to service it. While the U.S. Treasury has never issued bonds denominated in foreign currencies, it is conceivable that it could be forced to do so if the dollar falls sharply and foreign demand for U.S. bonds wanes. That will be the point at which our debt problem becomes more than theoretical and we are really on the road to national bankruptcy.

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The euro is under attack like never before, as the promises on which it was based turn out to be lies. Hedge funds are speculating against Greek debt, while euro-zone politicians work behind the scenes to cobble together rescue packages. But fundamental flaws in the monetary union need to be fixed if Europe’s common currency is to survive.

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A new congressional report released Friday says the United States’ long-term fiscal woes are even worse than predicted by President Barack Obama’s grim budget submission last month.

The nonpartisan Congressional Budget Office predicts that Obama’s budget plans would generate deficits over the upcoming decade that would total $9.8 trillion. That’s $1.2 trillion more than predicted by the administration.

The agency says its future-year predictions of tax revenues are more pessimistic than the administration’s. That’s because CBO projects slightly slower economic growth than the White House.

The deficit picture has turned alarmingly worse since the recession that started at the end of 2007, never dipping below 4 percent of the size of the economy over the next decade. Economists say that deficits of that size are unsustainable and could put upward pressure on interest rates, crowd out private investment in the economy and ultimately erode the nation’s standard of living.

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The Table is of the worst deficits as a percentage of GDP in the world, according to OECD figures.

Guess where the United States is before you look.

The Fed stressed on Thursday that the ”modifications are not expected to lead to tighter financial conditions for households and businesses and do not signal any change in the outlook for the economy or for monetary policy”.

“The increase in the spread and reduction in maximum maturity will encourage depository institutions to rely on private funding markets for short-term credit and to use the Federal Reserve’s primary credit facility only as a back-up source of funds,” the Fed said.

But economists and strategists differed on how to read the move, which had been anticipated after comments from Fed board members and this week’s minutes from the monetary policy meeting which indicated it was close.

Aaron Kohli, strategist at RBS Securities, said: ”This is more a case of normalisation, rather than a precursor to a change in monetary policy.”

Others considered the discount rate hike as part of the broader “exit strategy” from exceptional measures, which are likely to precede an eventual tightening in monetary policy after months of near-zero interest rates.

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Wall Street tactics akin to the ones that fostered subprime mortgages in America have worsened the financial crisis shaking Greece and undermining the euro by enabling European governments to hide their mounting debts.

As worries over Greece rattle world markets, records and interviews show that with Wall Street’s help, the nation engaged in a decade-long effort to skirt European debt limits. One deal created by Goldman Sachs helped obscure billions in debt from the budget overseers in Brussels.

Even as the crisis was nearing the flashpoint, banks were searching for ways to help Greece forestall the day of reckoning. In early November ”” three months before Athens became the epicenter of global financial anxiety ”” a team from Goldman Sachs arrived in the ancient city with a very modern proposition for a government struggling to pay its bills, according to two people who were briefed on the meeting.

The bankers, led by Goldman’s president, Gary D. Cohn, held out a financing instrument that would have pushed debt from Greece’s health care system far into the future, much as when strapped homeowners take out second mortgages to pay off their credit cards.

Read it all from the front page of today’s New York Times.

EU leaders say they are ready to act to shore up Greece’s finances and ensure stability in the eurozone – but they have made no specific promise of aid.

Greece must take further measures to tackle its huge debts and cut its budget deficit by 4% this year, the EU leaders said after a Brussels summit.

The statement did not spell out what was meant by “determined and co-ordinated action, if needed”.

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As the eurozone’s dominant economy, Germany would be expected to take the lead in marshalling financial support for a Greek bail-out. There are fears the crisis could spread to other eurozone states with big deficits such as Spain and Portugal.

“We’ve had to face up to the fact that what is now a Greek problem could turn into a European one,” the official said.

”We’re thinking about what we should do if the crisis spills from Greece into other euro countries. So it’s more about finding firewalls, containing the problem, than principally about helping the Greeks.” He added there were ”no concrete plans” as yet.

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Senior Chinese military officers have proposed that their country boost defense spending, adjust PLA deployments, and possibly sell some U.S. bonds to punish Washington for its latest round of arms sales to Taiwan.

The calls for broad retaliation over the planned U.S. weapons sales to the disputed island came from officers at China’s National Defence University and Academy of Military Sciences, interviewed by Outlook Weekly, a Chinese-language magazine published by the official Xinhua news agency.

The interviews with Major Generals Zhu Chenghu and Luo Yuan and Senior Colonel Ke Chunqiao appeared in the issue published on Monday.

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European nations are discussing various ways to help troubled Greece cope with its mountain of government debt, officials indicated Tuesday, as conflicting reports sent markets on a roller coaster ride, bolstering the faltering euro and contributing to a stock market rally that later pulled back from its heights.

The specifics of any bailout remained unclear and officials played down reports that Germany and France had already agreed on a rescue plan for Greece.

“This will be further discussed in the coming days,” Olli Rehn, who is about to take over as European economic affairs commissioner, said in an interview in Strasbourg. “We are talking about support in the broad sense of the word. I cannot specify it now. Solidarity goes both ways.”

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Don’t get confused by the size of the numbers at stake. Pay attention to the ratio of cumulative debt to the size of the national economy. That will tell you how easily we can manage the debt.

The debt-to-GDP ratio right now is close to 53%””still in the manageable zone. But after the boomers hit retirement, it will soar. One of the most telling figures in the president’s budget document is the Congressional Budget Office’s projection that by 2020 the debt-to-GDP ratio will be 77%, assuming no entitlement reforms. That’s bad news. The ratio is moving in the wrong direction. At some point, the dollar could tank and interest rates explode.

—Robert Reich in today’s Wall Street Journal

Growing fears over the health of Europe’s weakest economies rocked global markets on Thursday, sparking sharp falls in shares on the continent and a worldwide flight to the safety of the US dollar and Treasuries.

The impact of declining sentiment in Europe was compounded in the US by poor employment data, with the number of American workers claiming jobless benefits rising unexpectedly last week.

In the space of weeks, investor fears that had initially been confined to Greece have spread to Portugal and Spain, and spilled over into equity markets in the US and the UK.

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As the CBO notes, Fannie and Freddie “purchase mortgages at above-market prices,” driving down interest rates and passing some of the savings to home buyers. That subsidy is felt right away, but the risks in providing it are stored up over time, and their real costs may not be felt for years or even decades””as was the case in the years leading up to their spectacular collapse in 2008.

Yet this is precisely the fiction that the Obama Administration seeks to preserve by keeping the cost of Fan and Fred off the government’s books. The Administration’s budget accounting assumes Fannie and Freddie are private companies. So under its preferred treatment, the only recognized cost to taxpayers is the money that is being pumped in to keep them afloat””$110 billion so far.

That’s plenty as it is, but in the wake of their government takeover, there is no justification for pretending that their risks aren’t taxpayer risks. This is all the more true with the likes of New York Senator Chuck Schumer giving the companies marching orders to rescue tenants in the Stuyvesant Town development in Manhattan.

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Mr Zhu noted that investors are increasingly borrowing the cheap US dollar, and investing the borrowed funds in emerging markets, where interest rates are higher, and therefore generating a better return than saving in the dollars.

This phenomenon called carry trade in the US dollar is a “massive issue today,” said Mr Zhu.

“It’s bigger than the Japanese yen carry trade 12 years ago,” he said.

However, if the United States were to tighten its lax monetary policy, making borrowing more costly, funds could then flow out just as suddenly from emerging markets, back into the US market.

This could cause a collapse in emerging markets’ currencies, and spark a repeat of the 1997-1998 Asian financial crisis.

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1) Immediately vest the FDIC (or other regulator that has a strict consumer-protection mandate) with the authority to take receivership / conservatorship of distressed bank and non-bank financial institutions, including bank holding companies, in the event of insolvency….

2) Require a significant portion of the capital of bank and non-bank financial institutions to be in the form of convertible debt (contingent capital).

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Obama’s economic team could have raised the limits on how much mortgage securities Fannie and Freddie can buy, allowing those firms to replace the Fed’s purchasing program. But Barr said the administration thinks the mortgage business will stand on its own without such special assistance, similar to the way the nation’s biggest banks weaned themselves off federal bailout funds by raising private capital.

“The basic goal is to implement a gradual process where the government’s role in the economy goes down,” Barr said. “It has to be consistent with the basic goal of stability, but it is appropriate.”

Administration and Fed officials expressed confidence that rates will rise only modestly — perhaps a quarter of a percentage point. They attribute their optimism to the lengthy notice they have given the market. The markets already should have anticipated the government’s exit by adjusting interest rates higher. Yet mortgage rates have been falling slightly the past few weeks.

The optimism at the White House and the Fed, however, is not shared across the government. A few senior policymakers at the central bank view the economic recovery as still too fragile, suggesting that purchases perhaps should expand further. These dissenters also warn that mortgage rates could shoot up, perhaps to 6 percent or higher, because private investors buying securities would demand a greater rate of return than the Fed. To reach it, lenders may have to raise rates for consumers.

“Presumably, there is pent-up demand from the private sector, but the question is: At what rate are they going to be interested?” said Eric S. Rosengren, the president of the Federal Reserve Bank of Boston, who has indicated that he supports expanding the Fed’s mortgage securities purchase program.

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Manufacturing expanded in the United States in December, the fifth straight month of gains, amplifying hopes that a job market hobbled by double-digit unemployment might finally be adding paychecks. New jobless claims slipped markedly last week. Some economists think data to be released on Friday will show the economy gained jobs in December, the first monthly net increase in two years.

“We’re really coming back,” said Allen Sinai, chief global economist at the research firm Decision Economics. “The expansion is picking up the pace….”

But many economists remain worried that momentum could soon weaken, with the economy sliding back into glum times.

Indeed, the only area in which economists can reliably declare expansion is in the supply of competing narratives about the economy ”” perhaps to be expected in any transition between downturn and the inevitable turn for better.

“That is always the nature of the boomlet after recession,” Mr. Sinai said. “People think it’s going to fade away.”

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Geithner said some of the signs that confidence is returning in the fourth quarter include consumers spending more, businesses investing again, stronger exports and a more stable housing market.

“These things all help ”” they all make a big difference,” Geithner said. “But we were in a very deep hole, and it’s going to take a long time to repair the damage done to confidence.”

Geithner said it’s important that the administration continue to work with Congress to pass financial reform legislation that can “prevent the next crisis” and build a “more stable financial system.”

“But right now, the real risk we face is that banks are not lending enough and not going to provide the capital businesses need to grow for the economy to strengthen going forward,” he said.

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Take a careful look .As Shedlock writes:

Because allowances for loan losses are a direct hit to earnings, and because allowances are at ridiculously low levels, bank earnings (and capitalization ratios) are wildly over-stated….

There are many more reasons banks are not lending including: rising unemployment, rising taxes, uncertainty over health care costs, proposed cap-and-trade costs, increasing consumer frugality, rampant overcapacity, and boomer demographics.

The latest calculation of the National Debt as posted by the Treasury Department has – at least numerically – exceeded the statutory Debt Limit approved by Congress last February as part of the Recovery Act stimulus bill.

The ceiling was set at $12.104 trillion dollars. The latest posting by Treasury shows the National Debt at nearly $12.135 trillion.

A senior Treasury official told CBS News that the department has some “extraordinary accounting tools” it can use to give the government breathing room in the range of $150-billion when the Debt exceeds the Debt Ceiling.

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The last two quarters were even more extreme: Productivity in the nonfarm business sector grew at a shocking 8.1% annual rate. There are two possible explanations. One: The last two quarters were among the most technologically innovative and entrepreneurial in the history of the United States. Two: Fearful businesses pared payrolls to the bone. If the second is closer to the truth, payrolls are extraordinarily lean right now. Which means that firms will need to hire more workers as their sales and production grow. Which means that employment may start growing sooner than the pessimists think.

I have been pointing this out for months, but until the last employment report, it was a hypothesis supported by no evidence. Not anymore. While payrolls continued to decline in November, it was by only a scant 11,000 jobs; and the job counts for September and October were revised upward. The data now show a clear trend that suggests that net job creation may be only a month or two away. We’ll see.

There is more to the case for optimism. For one thing, less than 30% of February’s $787 billion fiscal stimulus has been spent to date; over 70% is still in the pipeline. Pessimists dote on the fact that the rate of increase of stimulus spending has probably peaked and will be lower in 2010. True. But the level of GDP will continue to get support from fiscal policy, and a second job-creation package (“Please don’t call it a stimulus!”) looks to be in the works.

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There is a brewing crisis, which, if it develops as seems inevitable, has the potential of reducing all of the drama of the early Obama administration to child’s play beginning next year. Only this time, it will be the government’s crisis, not the nation’s.

The New York Times recently noted that the government has gone on what the Concord Coalition’s Robert Bixby calls a “teaser rate” borrowing binge, at an interest rate approaching … zero. Rates will rise, substantially, and soon. (The Treasury Department already is attempting to lock in rates on longer-term borrowing– already driving its short-term costs up.)

How bad could this be? So glad you asked.

The federal government currently pays, according the article, $202 billion a year in interest. White House estimates that interest payments will rise to $700 billion a year in 2019.

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In the field of investment the man who is reliably wrong is a twisted genius. A good return is possible if the investor can do the precise opposite of everything that he recommends. The Church Commissioners, the asset managers for the Church of England, have a claim on the title of anti-investors supreme. Stung by sinking the lottery plate into property at the top of the market, they switched heavily into equities just as the long boom came to an end.

The result is a severe depletion of the Church’s pension fund at a time when retired clergy are living longer than ever. The clergy live in tied accommodation and earn only a small stipend, which makes reforming their fixed-benefit scheme difficult. As the task force established by the Archbishops of Canterbury and York concluded: “A guaranteed pension and access to affordable retirement housing have come to be seen as important ingredients of the compact.”

The fund is therefore in a parlous state.

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In The Warning, veteran FRONTLINE producer Michael Kirk unearths the hidden history of the nation’s worst financial crisis since the Great Depression. At the center of it all he finds Brooksley Born, who speaks for the first time on television about her failed campaign to regulate the secretive, multitrillion-dollar derivatives market whose crash helped trigger the financial collapse in the fall of 2008.

“I didn’t know Brooksley Born,” says former SEC Chairman Arthur Levitt, a member of President Clinton’s powerful Working Group on Financial Markets. “I was told that she was irascible, difficult, stubborn, unreasonable.” Levitt explains how the other principals of the Working Group — former Fed Chairman Alan Greenspan and former Treasury Secretary Robert Rubin — convinced him that Born’s attempt to regulate the risky derivatives market could lead to financial turmoil, a conclusion he now believes was “clearly a mistake.”

Take the time to watch it all and take special note of who the key characters are.

Many small and midsize American businesses are still struggling to secure bank loans, impeding their expansion plans and constraining overall economic growth, even as the country tentatively rises from its recessionary depths.

Most banks expect their lending standards to remain tighter than the levels of the last decade until at least the middle of 2010, according to a survey of senior loan officers conducted by the Federal Reserve Board. The enduring credit squeeze appears to reflect an aversion to risk among lenders confronting great uncertainty about the economy rather than any lingering effects of the panic that gripped financial markets last fall, after the collapse of the investment banking giant Lehman Brothers.

Bankers worry about the extent of losses on credit card businesses as high unemployment sends cardholders into trouble. They are also reckoning with anticipated failures in commercial real estate. Until the scope of these losses is known, many lenders are inclined to hang on to their dollars rather than risk them on loans to businesses in a weak economy, say economists and financial industry executives.

“The banks are just deathly afraid,” said Sam Thacker, a partner at Business Finance Solutions in Austin, Tex., which helps small businesses line up financing. “I don’t see commercial banks coming back to the market anytime soon.” In the long view, tighter loan standards seem healthy after a terrible crisis attributed in part to years of recklessly lenient lending.

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Anyone counting on a meaningful economic recovery will be greatly disappointed. How do I know? I follow credit, and credit is contracting. Access to credit is being denied at an accelerating pace. Large, well-capitalized companies have no problem finding credit. Small businesses, on the other hand, have never had a harder time getting a loan.

Since the onset of the credit crisis over two years ago, available credit to small businesses and consumers has contracted by trillions of dollars, and that phenomenon is reflected in dismal consumer spending trends. Equally worrisome are the trends in small-business credit, which has contracted at one of the fastest paces of any lending category. Small business loans are hard to find, and credit-card lines (a critical funding source to small businesses) have been cut by 25% since last year.

Unfortunately for small businesses, credit-line cuts are only about half way through. Home equity loans, also historically a key funding source for start-up small businesses, are not a source of liquidity anymore because more than 32% of U.S. homes are worth less than their mortgages.

Why do small businesses matter so much? In the U.S., small businesses employ 50% of the country’s workforce and contribute 38% of GDP. Without access to credit, small businesses can’t grow, can’t hire, and too often end up going out of business.

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Homeowners and businesses were not alone in taking on piles of debt over the last decade. Nonprofits of all sizes did the same, and now they, too, are paying the price.

Far from being conservative stewards of their assets, many nonprofits engaged in what some experts call risky financial behavior. “They did auction-rate securities, interest-rate arbitrage, complex swaps ”” which backfired on them the same way it would backfire on any hedge fund or asset manager,” said Clara Miller, chief executive of the Nonprofit Finance Fund, which has experienced a huge increase in organizations turning to it for assistance with soured bonds. “Organizations got to be all fancy-pants with their financial management.”

Those struggling now include the full range of nonprofits, including museums, colleges, orchestras and small local social service providers.

For example, Brandeis University, with $208 million in tax-exempt bonds outstanding, plans to close its art museum and sell off the collection to raise money. The Orange County Performing Arts Center, with $265 million in bonds, has laid off staff members. Copia, a culinary center in Napa, Calif., went bankrupt in December with $78 million in bond-related debt that its lawyer blames for its failure.

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The U.S. government will have issued $7 trillion in bonds by the time the current fiscal year ends next week, but it expects the debt deluge to stabilize by mid 2010, a Treasury official said on Wednesday.

Though markets and the economy are improving, efforts to provide a firm foundation for recovery will require increases to the U.S. Treasury’s conventional bonds going forward, as well as debt securities that are indexed to inflation.

However, this expansion may take place in an environment where investors consider leaving the safe-haven Treasury market for riskier assets, and debt issuance is likely to level off mid next year, said Treasury Acting Assistant Secretary for Financial Markets Karthik Ramanathan.

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