If you don’t read anything else today, read these two columns:

• Op-Ed, Floyd Norris: A year of financial contradictions and chaos - New York Times
• Op-Ed, Paul Krugman: The Madoff Economy – The New York Times

Krugman’s column shows the Bernard Madoff Affair as a microcosm – if you can use “micro” to describe a $50 billion bilking – of the entire state of the financial services system.  An excerpt:

So, how different is what Wall Street in general did from the Madoff affair? Well, Mr. Madoff allegedly skipped a few steps, simply stealing his clients’ money rather than collecting big fees while exposing investors to risks they didn’t understand. And while Mr. Madoff was apparently a self-conscious fraud, many people on Wall Street believed their own hype. Still, the end result was the same (except for the house arrest): the money managers got rich; the investors saw their money disappear.

We’re talking about a lot of money here. In recent years the finance sector accounted for 8 percent of America’s G.D.P., up from less than 5 percent a generation earlier. If that extra 3 percent was money for nothing — and it probably was — we’re talking about $400 billion a year in waste, fraud and abuse.

Norris does an overview of just how profoundly out of balance the credit system was in 2008.  Things we thought were sure bets got turned on their heads.

In 2007, the people who ran Wall Street, and the ones who regulated it, did not understand how serious the financial crisis was becoming. They saw the primary problem as one of a housing slowdown caused by a subprime mortgage crisis, and assumed the securitization machine — which had come to finance everything from corporate loans to credit cards to student loans — would keep on ticking even if its mortgage factory could keep operating only with the government guaranteeing almost everything.

In 2008, the government effectively nationalized Fannie Mae, Freddie Mac and the American International Group, and it bailed out those who had lent to Bear Stearns. It let Lehman Brothers fail, briefly reassuring market ideologues but terrifying many market participants, and the rout was on.

The securitization machine ground to a halt, and the banking industry was in no position to assume its historical role as a lender that patiently waited for loans to be repaid. To the contrary, banks trusted neither their own balance sheets nor those of other banks. For a significant part of the economy, the government became the lender of first and only resort.

For most of 2008, the Federal Reserve and the Treasury failed to realize that the banking system faced a solvency crisis rather than a liquidity crisis. Liquidity-providing moves proved ineffectual because no one had confidence in the values of enormous amounts of derivatives and securitizations that the banks owned.

“No financial market can function normally when basic information about the solvency of market participants is lacking,” wrote Michael D. Bordo, a Rutgers economist.

Trust and transparency – these are primary factors in any long-term, healthy relationship among people.  They also help people who aren’t so inter-personally involved exist in healthy business relationships.  Norris and Krugman nail the importance of these two principles to our financial system.  Barack Obama has a big job ahead of him to restore trust and transparency to finance and politics.  I can hardly wait for 2009.

In a nutshell, here’s what the Fed did today:

1. Announced it will buy $100 billion in debt now owned by Fannie Mae, Freddie Mac and the Federal Home Loan Banks.
2. Said it will buy up to $500 billion in mortgage securites from Fannie, Freddie and Ginnie Mae.
3. Began a $200 billion program to support consumer finance including things like auto and education loans.

This sounds like another $700 billion bailout, only it’s $800 billion.  I also didn’t read that anyone voted on this or that there is any oversight.  I obviously need to have a better understanding of just how much the Fed can do, but this is sort of scary.  Isn’t the Fed the public’s bank – the bank for banks?  Aren’t respectable banks supposed to have standards?

We’ve got many problems in this country and one of them is that we’ve become a debtor society.  We’re addicted to credit.  Many people spend beyond their means and now the Fed is going to own a big chunk of this debt.  What are the potential unintended consequences of this much money on the line?

Better yet, when do the financial wizards who dreamed up collateralized debt obligations and mortgage backed securities – which led to the credit default swaps – start to pay?

At the time we had been through Fannie and Freddie, Lehman was failing, more banks were failing and the federal government and media began explaining things like credit default swaps to America.  Things looked bad, but some were still touting the “fundamentals” of the U.S. economy and the publicly traded companies on our major stock exchanges shouldn’t pay too high a price (with dropping share values) for the excesses of the financial services industry.  Also at that time, I was reading Kevin Phillps’ book, Bad Money.  If you want a better understanding than the average bear – or bull – of the current U.S. financial system Bad Money is a must read.  At any rate, under the influence of that book, it was just obvious that as stocks dropped sharply that day there were probably many more shoes to drop, hence the market wasn’t at the bottom yet.

Now I’ll revise my estimate.  On top of the crisis in the financial system and all that it entails, from failing banks to a still too tight credit market there are many more economic indicators pointing to the final quarter of 2008 just being the beginning of a difficult economic downturn.  Here are a few things that immediately come to mind:

1. Jobs – Job losses mount and job creation lags.  Citi Corp. announced the largest single cutback in people ever in the last week with plans to cut 52,000 employees.  Here in Ohio, 2008 has brought the double whammy of DHL and GM closures with job losses of around 12,000 combined.  Even the once vaunted ‘service industry’ which was supposed to employ all of the Americans who used to work in manufacturing took a huge hit with the closure of 600 Starbucks – the same Starbucks which was one of the few service industry employers with even half a soul.
2. Deflation – Stocks fell today partly on news that the Consumer Price Index fell by 1% in October.  This was the largest drop in the history of this measure of what consumers pay for food, clothes, and other goods and services.  The spectre of deflation is upon us and it doesn’t just mean paying less for milk.  For some, it will mean more job losses as businesses make cuts to deal with less revenue.  When prices drop, already in-place salaries and wages don’t. 
3. Housing and Real Estate – Building things means jobs and there’s not a great deal being built relative to recent history.  We all know housing construction has been down.  Part of this is a glut of foreclosed homes in some markets.  What else is at work is tight credit markets.  A little anecdotal evidence: A friend of mine took a trip to Las Vegas two weeks ago.  He said he saw no fewer than four major construction projects on or near The Strip simply shut down midstream.  He asked a native what was up and the reply was “funding dried up.”
4. The Big Three – The major U.S. automakers – GM, Ford and Chrysler – have spent more time and energy recently begging for a taxpayer bailout than they have re-thinking their current strategic position in the world’s automobile market.  The statistic that 1 in 10 U.S. jobs is related to the auto industry has been thrown around quite a bit lately.  I have no idea if it’s true.  What does seem to be true is that between the largesse of the corporate car titans and the United Auto Workers, these venerable brands may be dying.  Great timing guys!  Today’s closing share prices: GM, $2.79; Ford, $1.26.  In another round of hearings on a proposed Big Three Bailout, all three CEOs of GM, Ford and Chrysler flew to Washington, D.C. in their private jets.  That’s three separate corporate jets to ask for our money.
5. Globalization – In the early days as the U.S. financial crisis began to take hold, our European friends smugly rolled their eyes and wagged their fingers.  Oh, the arrogant piggish Americans.  Within weeks they were in as much trouble as we were.  Everything is bought and sold everywhere these days.  That includes unregulated, speculative investment vehicles like credit default swaps(CDS).  It’s estimated that the size of the CDS turd in the world’s punchbowl is $50 trillion.  Looks like there are capitalist pigs everywhere.
6. Recession – Is it here or isn’t it?  Technically not yet but it seems like a foregone conclusion.  It has arrived in Europe.
7. Bank Failures – There’s been 19 this year. 
8. Layaway – It’s back.  You can go down to JC Penney or KMart and actually put something on layaway just like in the olden days before teeny boppers had their own credit cards.  I’m just old enough to remember an America that when you wanted something that wasn’t a car or a house you saved for it or you put it on layaway – paying for it over time and not getting it until it was paid for.  Layaway coming back may be the best sign of the times.

Back on October 6 when I was reading Bad Money, the financial crisis was taking off and the Dow was dropping, 8,000 points or thereabouts seemed a likely bottom – it just felt like there were more shoes to drop.  They have and it still feels like there’s a ways to go for the bottom.  I’m revising to 7,000.

This afternoon, McCain announced he would suspend his campaign tomorrow morning due to the “financial crisis.”

My first question is, “John, could you just leave it in suspension until about forever?”

McCain claims the crisis is just too serious for life as he knows it to go any longer until Congress passes the $700 billion corporate give-away late this week or early next. Most laughable was what he said he’s going to do while he’s in a state of suspended campaignation. He’s going to get to work on the crisis.

Huh?

What the hell is John S. McCain going to do? The last time he got really involved in an issue that involved troubled lenders he and the four other Keating Five clan nearly lost their political careers. His campaign manager ran the lobbying operation for Fannie Mae, one of the biggest pigs at the public’s trough. Just two days ago the McCain campaign said he wasn’t even going to show up in Washington for the bailout vote unless it was so close they needed his ‘yea.’ In a fit of impetuousness last week, at the beginning of the current wrangling over the Paulson plan, McCain tried to look like a player and looked like Barney Fife trying to pull the revolver from the holster. Oh, and he wants Sen. Barack Obama to “postpone” their debate on Friday night.

Did I ask yet, “What the hell is McCain going to add to the scrum in Washington?” He’s already admitted that the economy is not his strong suit. There are not many other members of Congress in the House or Senate who are cozier with the K Street elite – that’s not what the other pols need for their PR campaign. There are about a dozen Bush Administration officials and Congressional leaders who will decide the legislative fate of the bailout bill – John McCain’s not one of them. What’s he going to do?

So, what changed today. Number one, the Bush Economy, for which McCain has been chief apologist for, (fundamentally strong economy) has hit home with voters hard in the last ten days. Obama is pulling away in the polls again. Florida is in play. The flash in the pan that is Sarah Palin is starting to fizzle. Number two: the panic button. Irascible John rolled out of bed today and punched it. When he hit that button, this bonehead move came out of the campaign machinery.

In the end, McCain’s attempt at high drama just looks like more of the erratic behavior for which his campaign has become known.

McCain would have us believe this is about a “national crisis.” What this is really about is taking America’s mind off of a flagging campaign.

I’ve canceled my travel today to stay in Washington, where I will continue to closely monitor the situation in our financial markets and consult with my economic advisors. I spoke to Secretary Paulson this morning, and I will meet with him later on today.

In recent weeks, the federal government has taken extraordinary measures to address the challenges confronting our financial markets. We’ve taken control of Fannie Mae and Freddie Mac — the home finance agencies — to help promote market stability and to ensure they can continue to play a role in helping our housing market recover. This week, the Federal Reserve acted to prevent the disorderly failure of the insurance company AIG — a development that could have caused a severe disruption in our financial markets and threatened other sectors of the economy. Yesterday, the Security and Exchange Commission took action to strengthen investor protections and step up its enforcement actions against illegal market manipulation. Last night, the Federal Reserve, in coordination with central banks around the world, took a substantial step to provide additional liquidity to the U.S. financial system.

These actions are necessary, and they’re important. And the markets are adjusting to them. Our financial markets continue to deal with serious challenges. As our recent actions demonstrate, my administration is focused on meeting these challenges. The American people can be sure we will continue to act to strengthen and stabilize our financial markets and improve investor confidence.

Thank you.

END 10:17 A.M. EDT

(Source: White House Press Office)

• Doubt, Distrust, Delay – Washington Post
• Spying on Iraqi Leader – Worth the Risk? – Washington Post

Watch CBS Videos Online

National & World News

• Palin’s politics and family mix - Washington Post
• U.S. unveils takeover of two mortgage giants – New York Times
• A tangled web with many masters – New York Times
• What the takeover means for your mortgage – Washington Post
• Bhutto’s widower elected Pakistani president – Washington Post
• Talibanistan – New York Times Magazine
• The vanishing Republican voter – New York Times Magazine
• Rival tickets are redrawing battlegrounds – New York Times
• Coming to grips with Russia’s new nerve – New York Times
• Hurricane Ike kills 59 on Hispaniola, headed for Cuba – Chicago Tribune

Noon Sunday

• Paulson lays out plan for Fan-Fred – Wall Street Journal
• Treasury engineers takeover – Bloomberg
• GSE takeover – Reuters
• Bernanke endorses move – Reuters
• U.S. unveils takeover of Fannie, Freddie – New York Times

Taxpayers Will Now Own the Billions of Dollars of Mistakes of Others

For an explanation of what are Fannie Mae and Freddie Mac see this post.

• Rescue Cost: The Big Unknown – CNN

Google Finance FNMA, FRE Comparison Chart Year

News

• 8 p.m. Saturday: Government plan to hit shareholders – Reuters
• 6 p.m. Saturday: Bloomberg story updates with Barney Frank – Bloomberg

“This is no bailout, particularly for the shareholders,” Frank said. The federal government “will be senior to all shareholders, preferred and common.”

Holders of the companies’ corporate debt and preferred shares are “very unlikely to come out of this at all happy,” and the chief executive officers will be forced out, Frank said. Paulson met with Fannie Mae CEO Daniel Mudd and Freddie Mac CEO Richard Syron yesterday to tell them of the decision to put the companies into conservatorship, and remove the executives from their jobs, according to two people briefed on the discussions. – Bloomberg, Quotes from U.S. Rep. Barney Frank

• 6 p.m. Saturday: Loan Giant Overstated Size of Its Capital Base – New York Times
• Paulson readies the bazooka - CNN/Fortune
• U.S. to take control of Fannie, Freddie: Reports – Reuters
• U.S. rescue seen at hand for two mortgage giants – New York Times
• Questions, and hope, on plans for mortgage giants – New York Times
• Paulson Plans to take control of Fannie, Freddie – Bloomberg
• U.S. nears rescue plan for Fannie, Freddie – Washington Post
• U.S. nears deal on Fan-Fred – Wall Street Journal
• Obama says Fannie, Freddie too large to let fail – Bloomberg

• Oil rises on tropical storm, other news – Bloomberg

Look here.

• Obama arrives in Basra - New York Times
• Obama lands in Iraq amid troop pullout talk - The Times
• Minor parties a November wild card – Columbus Dispatch
• Some help on way for foreclosure crisis – Columbus Dispatch
• Editorial: To the Rescue – Columbus Dispatch
• Editorial: Taxpayer financed cars for members of Congress – Columbus Dispatch

If they were to make the switch to more economical cars, they could do what Ohio’s state government did and declare the Ford Focus the default car choice.

• Ohio’s unemployment fund on edge of crisis - Cleveland Plain Dealer
• After 2000 McCain learned to work the levers of power – New York Times
• Mideast faces choice between crops, water - New York Times
• Black, female, accomplished, attacked – Washington Post

When I look at the graphic, part of the caption nags me – particularly the part about how OPEC produced less oil last year and is “cutting back” at a time of growing demand. The problem here is that as far as I know, there is very little transparency among OPEC member nations concerning their actual proven reserves. When one describes the situation as OPEC “cutting back” that implies a conscious decision by producers to take fewer barrels to market. What I wonder, is if it isn’t a cutting back situation, but a reality built on truly more scarce supply.