October 7, 2008 - No. 136 - Supplement

For Your Information

Notes on the Deepening Economic Crisis

This information is provided to assist people to face the situation calmly by assessing what people in their workplaces, educational institutions and communities can do. At this time the Marxist-Leninist Party is proposing the building of committees for democratic renewal that will fight to empower the people politically. With organizational strength and growing numbers comes the capacity to be an effective opposition that can force into being programs that serve the people and lead to their empowerment.

Canadian Mutual Funds Suffer Record Redemptions
- Globe and Mail, October 3, 2008 -

Canadian investors, rattled by plunging stock markets and worried about the safety of their money market funds, yanked a record $4.6-billion from mutual funds in September.

It was the largest month for net outflows since the Investment Funds Institute of Canada (IFIC) began collecting data in 1990. The second highest month was April, 2003 when investors pulled $1.7-billion.

"Given what has happened in the markets, people are terrified," said independent fund analyst Peter Loach. "People who are approaching retirement have seen a significant amount of their retirement savings disappear." Stock markets have tanked in the wake of a severe U.S. financial crisis that has led to venerable institutions like Lehman Brothers failing, while a credit squeeze has led to fears of slowing global growth.

The S&P/TSX composite index plummeted 15 per cent in September, for a year-to-date loss of 17 per cent to the end of the month. (It fell a further 7 per cent yesterday.) In the United States, the S&P 500 index has a year-to-Sept. 30 loss of 21 per cent. The index dropped 4 per cent October 2.

September was the first time the mutual fund industry has seen net outflows since August, 2007 when investors withdrew $1.5-billion on fears about money market funds holding troubled asset-back commercial paper (ABCP). The outflows stopped after fund companies bought back the tainted paper but that situation is far from resolved.

Some Canadian investors have become spooked about holding money market funds after seeing a wave of U.S. investors withdrawing cash from these investments south of the border last month.

Some U.S. money market funds were hit with losses and redemptions because they held commercial paper of troubled financial firms like Lehman Brothers.

Canadian securities regulators may be fuelling some anxiety by launching a review of domestic money market funds to see whether they are exposed to bad debt.

RBC Asset Management, Canada's largest fund company, which also owns Phillips Hager & North Investment Management, suffered from nearly $1.3-billion in net outflows last month, including $1-billion in money market funds.

Among the other banks, TD Asset Management had net outflows of nearly $1.2-billion, while CIBC Asset Management posted net redemptions of $536-million.

Among independent fund companies, Invesco Trimark Ltd., formerly AIM Funds Management Inc., suffered from $510-million in net redemptions; Franklin Templeton Investments Corp., $346-million; IGM Financial Inc., which owns Investors Group and Mackenzie Financial, $182-million and AGF Management Inc., $167-million.

Banks Seize Deripaska's 20 Million Magna Shares
- Globe and Mail and Associated Press, October 4, 2008 -

Russian billionaire Oleg Deripaska has been forced to hand over his stake in Magna International Inc. to his banks, after taking a margin call on his $1.54-billion (U.S.) investment in the Canadian auto parts maker.

In a stunning turn of events, Paris-based bank BNP Paribas SA seized the Russian oligarch's 20 million shares in Magna, unwinding a deal that closed 13 months ago and making one of the world's richest men the latest casualty of the global credit crisis.

The move hands full control of the auto parts giant back to its founder, Frank Stronach.

According to people familiar with the transaction, BNP Paribas led a syndicate that financed an estimated $1-billion.

That amounts to about two-thirds of the total purchase price.

It is understood that the lending agreement gave the banks the power to reclaim the Magna shares in the event they fell more than 40 per cent below the $76.83 a share Mr. Deripaska paid for the stock. That threshold appears to have been triggered on Thursday, when the shares slumped to a closing price of $45.59 on the New York Stock Exchange.

The aggressive move to force one of Russia's richest men to hand over assets casts a stark spotlight on the harsh new lending environment for businesses seeking to raise capital or hang on to acquisitions that were snapped up in headier times.

Sources said banks lined up to lend money to Mr. Deripaska in the spring of 2007, when he first announced he had struck the agreement with Mr. Stronach. Eighteen months later, a deal that was code-named Project Pearl is in tatters because of a crisis that could spiral into an "economic Pearl Harbour," according to a warning issued this week by Omaha billionaire Warren Buffett.

"It is a whole new world. When a deal falls apart 18 months after the fact, anything is possible. Nothing can be taken for granted," said one person close to Magna.

Like many financial upsets in the past few weeks, the unravelling of the Magna investment happened with breath-taking speed.

Sources said Magna executives were stunned late Thursday [October 2] when they were informed that Mr. Deripaska was ceding his stake to banks.

At Thursday's closing price of $45.59 in New York, his 20 million Magna shares were worth $911.8-million, suggesting that the loss on the sale will cost him almost $630-million.

"He had to make a decision based on market conditions," said one high-ranking European auto source familiar with Magna and Mr. Deripaska's investment. "He had to choose his priorities." The news sent Magna's stock plunging initially in Toronto and New York, although it rallied in trading later in the day to close at $43.45, down $2.14 on the NYSE.

Investment sources and analysts said Morgan Stanley Inc. began selling off the shares October 3 to large investors.

Several sources said Magna is in a blackout period and could not use its $2.5-billion (U.S.) in cash to buy back the shares.

But the surrender contributed to a wild day on the RTS exchange in Russia, which halted all trading three times yesterday and finally shut early amid growing worries that some Russian companies will default on their debts.

Magna shares have been falling steadily for weeks in the midst of massive production cuts at the Detroit Three auto makers -- three of its five largest customers -- and growing worries about the European auto market, which generated more revenue than North America for Magna during the second quarter.

When Magna was urging shareholders to support the deal more than a year ago, it said the financial investment by Mr. Deripaska and Russian Machines in the Canadian auto parts giant was crucial to its plans to grow in Russia.

"In targeting the Russian market, Magna believes that the best way to minimize risk and maximize returns is by working with an established industrial partner with an aligned economic interest," the company said in the management circular for the deal. "Magna believes that having Russian Machines, its controlling shareholder, Basic Element, and its ultimate controller, Mr. Oleg Deripaska, as a strategic alliance partner for Russia will assist Magna in carrying out its expansion strategy in Russia and other emerging markets." (This "crucial" plan has now fallen apart.)

More than 60 Corporate Loan Defaults So Far in 2008, vs. 16 in All of 2007
- New York Times, October 2, 2008 -

Numbers could get a lot worse, says Standard and Poors

As the economic environment deteriorated in September, corporate loan defaults increased, according to a report issued October 2 by Standard & Poor's.

Nine companies defaulted last month, including bankrupt Lehman Brothers Holdings and failed Washington Mutual, bringing the year-to-date total to 61. That rate is much higher than in 2007, when 16 companies defaulted, and 2006, when 22 could not meet their obligations.

Given the increase, S&P analysts expect the situation will only get worse. "We expect the speculative-grade default rate to escalate to a mean forecast of 4.9% by August 2009, but it could reach as high as 8.5% if economic conditions are worse than expected," wrote S&P analysts Diane Vazza, Jacinto Torres and Nicholas Kraemer.

Other companies that defaulted last month included automotive company Motor Coach Industries International, and two companies in the leisure and media sector: UTGR and HRP Myrtle Beach Holdings.

The analysts noted that U.S. corporate bond spreads are also higher than they were last year, with the investment-grade spread at 305 basis points as of Sept. 30, compared with 169 basis points a year ago.

The speculative-grade spread is at 919 basis points, compared with 415 basis points a year ago.

Given these increases, the S&P distress ratio was 33.9% as of Sept. 30. "This is well above the 3.2% in September 2007, and is the highest level seen since November 2002, when it hit 37.2%," the analysts noted.

U.S. Employment Drops
- CBC News, October 3, 2008 (excerpts) -

The U.S. economy shed 159,000 jobs in September, the U.S. Labour Department reported October 3, a much higher figure than economists had expected and the biggest drop in five years.

The cut represented the ninth straight month that U.S. firms have reduced payrolls and the largest one-month decline since March 2003, when payrolls were down 212,000.

"Over the month, employment continued to decline in manufacturing, construction and retail trade," the department said in a release.

The U.S. economy, once the job-creating envy of the industrialized world, has lost 760,000 jobs since the beginning of the year.

Economists had expected payrolls to be reduced in September, with a low estimate in the range of 80,000 and an average estimate of 105,000.

September's actual job cuts were more than 40 per cent higher than that average.

Even more troubling is the fact the household survey of employment was conducted for the week of Sept. 9. Thus, the financial meltdown that Wall Street experienced in the month was only beginning.

On Monday, Sept. 9, the bankruptcy of Lehman Brothers began an unprecedented period of upheaval in the global financial community as American International Group Inc. and Merrill Lynch also were taken over.

Thus, any job cuts related to the financial crisis are unlikely to be reflected in the September report.

Within the various sectors, U.S. manufacturers shed 35,000 positions in the month. Service companies cut a further 80,000 jobs in September, with retail trade accounting for 50 per cent of the reduction, or 40,000 jobs.

Construction companies chopped another 35,000 jobs in the month.

Sell-Off Sends TSX to 2-Year Low
- Canwest News Service, October 3, 2008 -

Growing concerns over a global economic slowdown and the fate of the ailing U.S. financial sector knocked the air out of Canada's commodity stocks on October 2, sending the resource-heavy Toronto Stock Exchange to its lowest level in two years -- 10,900.54 -- after the day's 813.97-point drop.

Those sharp declines were accompanied by economic forecasts that ranged from bad to worse, with the Canadian economy said to be flirting with recession for several quarters to come, and the U.S. destined for a deep and protracted downturn.

"We're likely headed into global recession, and it's just not a very conducive period for commodity prices in general," said TD Bank senior economist and commodities specialist Derek Burleton. "The concerns aren't just focused on the U.S. anymore. There are increased worries about Europe, about Japan and even China."

Ninety-Year Old Woman Facing Eviction Shoots Herself

AKRON, Ohio - Addie Polk, 90 years old, shot herself multiple times, as she was being evicted from her home of 38 years. Countrywide Home Loans filed for foreclosure last year, and Polk's 101-year-old home was sold to Fannie Mae at a sheriff's auction in June. Deputies were to escort Polk from her home Wednesday when gunshots were heard inside.

Polk's long-time neighbor, Robert Dillon, climbed through her window and found her lying in bed bleeding with a gun next to her. He visited Polk in the hospital on October 3. The 90-year-old woman who shot herself in the chest as sheriff's deputies attempted to evict her is expected to survive.

"She said it was a crazy thing to do, now that she's had time to think about it," Dillon said.

After the shooting became widely known, mortgage finance company Fannie Mae said October 3 it is forgiving the mortgage debt and will allow her to return to the Akron home where she's lived since 1970.

Polk became the home's sole owner in 1995 when her husband died. She took out a mortgage loan in 2004 at the age of 86 to pay unspecified expenses and debt, court and property records show. Her mortgage debt became one of the millions bundled together in the now infamous mortgage-backed commercial paper, which was sold and resold around the world.

(Source: Associated Press)

Europeans Scramble to Save Failing Banks
- Associated Press, October 5, 2008

STOCKHOLM, Sweden - Germany joined Ireland and Greece on October 5 in guaranteeing all private savings accounts, putting Europe's biggest economy at odds with calls for a unified European response to the global financial meltdown.

The decision came as governments across Europe scrambled to save failing banks, working largely on their own a day after leaders of the continent's four biggest economies called for tighter regulation and a coordinated response.

Chancellor Angela Merkel said that no citizen should fear for the safety of their investments, speaking to reporters as her government held crisis talks on the collapse of a ballyhooed euro 35 billion (U.S.$48.4 billion) bailout of Hypo Real Estate AG, the country's second-biggest property lender.

In Iceland -- particularly hard-hit by the credit crunch -- government officials and banking chiefs were discussing a possible rescue plan for the country's overstretched commercial banks.

Belgian Prime Minister Yves Leterme said he aims to find a new owner for troubled bank Fortis NV to restore confidence in the company before the opening of markets on Monday.

Leterme told two media outlets that government officials were going over a takeover bid for Fortis' Belgian operations. The bank's Dutch operations were nationalized amid fears they could go insolvent.

In the past year the British government has acted to nationalize struggling mortgage lenders Northern Rock and Bradford & Bingley.

"The European banking industry is feeling the wind of default blowing from the other side of the Atlantic," said Axel Pierron, senior vice president at Celent, a Boston, Massachusetts-based financial research and consulting firm.

The erosion has also been seen in overall confidence and concern among investors, politicians and the European public, too.

The leaders of Germany, France, Britain and Italy met Saturday to discuss the growing meltdown, which has leapfrogged across the Atlantic from the U.S. to Europe.

Their failure to agree to an EU-wide plan showcased the divisions in Europe on how to deal with the crisis.

Hypo Real Estate said October 4 that the rescue plan had fallen apart after private lenders withdrew support, a key element to the proposal that had already been approved by the EU earlier this week.

Icelandic banks expanded rapidly after deregulation of the domestic financial market in the 1990s and now have combined foreign liabilities in excess of euro100 billion (U.S.$138.34 billion) -- dwarfing the tiny country's gross domestic product of euro14 billion (U.S.$19.37 billion.

The government last week took over Iceland's third-largest bank, Glitnir, a decision that prompted major credit ratings agencies to downgrade both Iceland's four major banks and its government credit rating.

Looming large was a growing sense that the Federal Reserve and Europe's major central banks -- which have been flooding euros and dollars to banks that have become increasingly stingy about lending money even to themselves -- were ready to institute emergency cuts to their benchmark interest rates this week.

Robert Brusca, chief economist at the New York-based Fact and Opinion Economics, said that if the ECB does issue such a cut it would be a sign "that they're really, really scared."

Financial and Corporate System Is in Cardiac Arrest:
The Risk of the Mother of All Bank Runs
- Nouriel Roubini, October 3, 2008 (excerpts)

The following excerpts from Nouriel Roubini's website are an indication of how serious the crisis has become in the view of one of the leading U.S. economists.

***

We are indeed at the cardiac arrest stage and at risk of the mother of all bank and non-bank runs as: - The run on the shadow banking system is accelerating as: even the surviving major broker dealers (Morgan Stanley and Goldman Sachs) are under severe pressure (Morgan losing over a third of its hedge funds clients); the run on hedge funds is accelerating via massive redemptions and roll-off of their overnight repo lines; the money market funds are experiencing further withdrawals in spite of government blanket guarantee.

- A silent run on the commercial banks is underway. In Q2 of 2008 the FDIC reported $4462bn insured domestic deposits out of $7036bn total domestic deposits; thus, only 63% of domestic deposits are insured. Thus $ 2574bn of deposits were not insured. Given the risk that many banks -- small, regional and national -- may go bust (as even large ones such as WaMu and Wachovia went recently bust) there is now a silent run on parts of the banking system. Deposit insurance formally covers only deposits up to $100000. Thus any individual, small or large business and/or foreign investor or financial institution with more than $100000 in a FDIC insured bank is now legitimately concerned about the safety of its deposits. Even if as likely the deposit insurance limit will be temporarily raised to $250000 by Congress there will be about $1.5 trillion of uninsured deposits; a mass of uninsured deposits will remain at risk as even small businesses have usually more than $250K of cash while medium sized and large firms as well as any domestic and foreign financial institution or investor with exposure to U.S. banks has average exposure in the millions of dollars. Particularly at risk are the cross border interbank lines of U.S. banks with their foreign counterparties that are estimated to be close to $800 billion.

- A run on the short term liabilities of the corporate sector is also underway as the commercial paper market has effectively shut down with little trading and no issuance or rollover of such debt while corporations have no access to long or short term credit markets and they are therefore facing massive rollover problems (over $500 billion of rollover of maturing debts in the next 12 months). Indeed, the market for commercial paper plummeted $94.9 billion to $1.6 trillion for the week ended Oct. 1. Especially banks and insurers were unable to find buyers for the short-term debt: financial paper accounted for most of the decline, plunging $64.9 billion, or 8.7 percent. Discount rates for investment-grade non-financial commercial paper spike to 599bp for 60 day maturities. More companies are borrowing against or tapping their revolving credit lines. This is largely due to the dislocation caused in the money markets by the failure of Lehman and the subsequent withdrawals from money market funds, which are some of the biggest providers of liquidity in the short term funding/commercial paper. Even the largest corporations are at severe stress: AT&T last week was forced to rely on overnight funding for its treasury operations, as lenders were unwilling to provide more long term financing due to fears in money market funds over investor redemption. The CEO said "It's loosened up a bit, but it's day-to-day right now. I mean literally it's day-to-day in terms of what our access to the capital markets looks like.'' Things are much worse for non-investment grade corporations and for small and medium sized businesses.

- The money markets and interbank markets have shut down as -- despite the Senate passing the bail-out bill -- yesterday [October 2] USD Overnight Libor was still at 268bp after reaching an all-time high of 6.88%; the USD 3m Libor-OIS spread widened to record 270 basis points; EUR 3m LIBOR-OIS spread is at record 130bp; the TED spread is at record 360bps (TED was 11bps one month ago); Money and credit markets are dysfunctional also in emerging markets ; and agency bond spreads are also at highs again.

So we are now facing:

- a silent run on the huge mass of uninsured deposits of the banking system and even a run on some insured deposits are small depositors are scared;

- a run on most of the shadow banking system (300 non bank mortgage lenders now bust; SIVs and conduits now all bust; major brokers dealers bust (Bear and Lehman) or under severe stress even while converted into banks (Merrill, Morgan, Goldman); a run on money market funds; a serious run on hedge funds; a looming refinancing crisis for private equity firms and LBOs);

- a run on the short term liabilities of the corporate sector as the commercial paper markets has frozen while access to medium terms and long term financings for corporations is frozen at a time when hundreds of billions of dollars of maturing debts need to be rolled over;

- a total seizure of the interbank and money markets.

This is indeed a cardiac arrest for the shadow and non-shadow banking system and for the system of financing of the corporate sector. The shutdown of financing for the corporate system is particularly scary: solvent but illiquid corporations that cannot roll over their maturing debt may now face massive defaults due to this illiquidity. And if the financing of the corporate sectors shuts down and remains shut down the risk of an economic collapse similar to the Great Depression becomes highly likely.

So what needs to be done? Even several hundred of billion dollars in emergency liquidity support to the financial system by the Fed and other central banks in the last week alone have not been enough to stop the seizure of liquidity in interbank markets and the shut down of financing for the corporate sector as counterparty risk is now extreme (no one trusts any more in this crisis of confidence even the most reputable and trustworthy financial and corporate counterparties).

Thus, emergency times where we are at risk of a systemic meltdown require emergency measures. These include:

- a temporary six-month blanket guarantee on all US deposits (not just those below $250k) combined with a rapid triage between insolvent banks that should be quickly closed and distressed but solvent

- conditional on liquidity and capital injections

- banks that should be rescued. To stop the silent run on the banking system you do need now such blanket guarantee on all (insured and uninsured) deposit regardless of their size .

- Extension of the emergency liquidity support of the Fed (both TSLF-Term Securities Lending Facility and PDCF- Primary Dealer Credit Facility) to a broader range of institutions in the shadow banking system, especially those directly providing credit to the corporate sector.

A similar requirement may need to be imposed on all other financial institutions (banks and non bank primary dealers) that are now shutting down or rolling off their exposure to the corporate sector. Of course a crucial triage of the corporate sector is also necessary: those firms that would have ended up into Chapter 11 or 7 even under less extreme financial conditions should not be rescued and thus allowed to go into bankruptcy court.

- If larger and systemically important hedge funds were at risk of failing the Fed will have to engineer a massive private sector bail-in of such hedge funds (a larger scale rescue a la LTCM) where the prime brokers of such funds are forced to maintain repo exposure to such funds rather than be allowed to shut off such exposure .

- Direct lending to the business sector from the Fed via extension of the PDCF and TSLF to the non financial corporate sector. This could include Fed purchases of commercial paper from corporations and other forms of financing of the short term liabilities of the corporate sector. This could also include emergency loans from the Small Business Administration to small businesses secured in appropriate ways. Given the collapse of the corporate Commercial Paper market and the banking system reluctance to provide loans to the corporate sector (credits lines are being shut down) the only alternative to the Fed becoming directly the biggest emergency bank for the corporate sector would be to force the banking system to maintain its exposure to the corporate sector, possibly in exchange for further Fed provision of liquidity to the banking system. The former option may be better than the latter to deal with the looming illiquidity of the corporate sector.

- Have a coordinated 100bps reduction in policy rates by all major advanced economies central bank and, possibly, even some emerging market economies central banks.

- Redesign the Treasury TARP rescue plan to make it effective, efficient and fair [Troubled Asset Relief Program-the official name for the $700 billion Paulson bailout -- TML Ed. note]: this implies that in addition to the government purchase of toxic assets, a triage between insolvent and illiquid and undercapitalized but solvent banks should be made; the debt burden of household sector should be reduced across the board; and a recapitalization of solvent bank should be done via public injection of preferred shares and matching contributions by current shareholders of the banks.

The suggested policy actions are extreme and radical but the times and conditions in financial markets and the corporate sector are also extreme. Thus, to avoid another Great Depression radical and unorthodox policy action needs to be taken now. This credit crisis is both a crisis of confidence and illiquidity and a crisis of credit and solvency. But while the insolvent institutions should go bust we have now reached a point where many financial institutions and now non financial firms may become insolvent because of pure illiquidity; and this would lead to an extremely severe economic contraction similar to an economic depression rather than a mild recession. At this point we will experience an ugly recession and an ugly financial and banking crisis regardless of what we do. What radical policy action can do is to prevent what will now be an ugly and nasty two year recession and financial crisis from turning into a systemic meltdown and a decade long economic depression.

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